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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended July 31, 2000 Commission File No.: 0-24338
VARIFLEX, INC.
(Exact name of Registrant as specified in its charter)
Delaware 95-3164466
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)
5152 North Commerce Avenue
Moorpark, California 93021
(Address of principal executive offices)
Registrant's telephone number, including area code:
(805) 523-0322
______________________
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value per share
______________________
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 preceding 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___
---
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [_]
The aggregate market value of the Common Stock held by non affiliates of
the Registrant as of October 2, 2000 was approximately $5,427,000 based upon the
closing sale price of the Registrant's Common Stock on such date, as reported on
the Nasdaq National Market. Shares of Common Stock held by each executive
officer and director and each person owning more than 5% of the outstanding
Common Stock of the Registrant have been excluded in that such persons may be
deemed to be affiliates of the Registrant. This determination of affiliate
status is not necessarily a conclusive determination for other purposes.
Shares of $.001 par value Common Stock outstanding at October 2, 2000:
4,584,432 shares.
______________________
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive Proxy Statement for its 2000 Annual
Meeting of Stockholders scheduled to be held on December 1, 2000 are
incorporated by reference into Part III of this Form 10-K.
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PART I
Item 1. Business.
Statements in this Annual Report on Form 10-K as well as oral statements
that may be made by Variflex, Inc. (the "Company") or by officers, directors or
employees of the Company acting on the Company's behalf, that are not historical
fact constitute "forward-looking statements" within the meaning of Section 27A
of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. All statements, trend analysis and other
information contained in this Form 10-K relative to markets for the Company's
products and trends in net sales, gross margins and anticipated expense levels,
as well as other statements including words such as "anticipate," "plan,"
"estimate," "expect," "intend" and other similar expressions, constitute
forward-looking statements. These forward-looking statements involve risks and
uncertainties, including, but not limited to: the risk of reduction in consumer
demand for the product categories in which the Company does business or for the
Company's products in particular; the risk that the Company may not continue to
expand and diversify its business and product lines; the risk of loss of one or
more of the Company's major customers; the risk that the Company may not be able
to continue to provide its products at prices which are competitive or that it
can continue to design and market products that appeal to consumers even if its
products are price competitive; the risk that the Company may not be able to
obtain its products and supplies on substantially similar terms, including cost;
uncertainty regarding the consumer response to the recall of certain of the
Company's X Games helmets which did not comply with all applicable Consumer
Products Safety Commission standards; and uncertainty regarding the reactions of
the retailers to the recall. In addition, the Company's business, operations and
financial condition are subject to risks which are described in the Company's
reports and statements filed from time to time with the Securities and Exchange
Commission, including this Report. Actual results of operations may differ
materially from those contained in the forward-looking statements. For a
discussion of factors that might cause such a difference, see "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Additional Factors That Could Affect Operating Results. "
(a) General Development of Business.
The Company is a leading distributor and wholesaler in the United States
of in-line skates, skateboards, scooters, recreational protective equipment
(such as wrist guards, elbow pads and knee pads used by skaters and
skateboarders) and helmets, portable instant canopies, and springless
trampolines. The Company designs and develops these products which are then
manufactured to the Company's detailed specifications by independent
contractors. The Company distributes its products throughout the United States
and in foreign countries.
The Company was originally incorporated in California in 1977, and
reincorporated in Delaware in March 1994. Unless the context otherwise
requires, references in this Form 10-K to the "Company" refer to Variflex, Inc.
and its subsidiaries.
(b) Financial Information about Industry Segments.
Financial information concerning the Company's business is included in
Items 6, 7, 8 and 14.
(c) Narrative Description of Business.
(1) Products.
The Company's principal products are in-line roller skates, which feature
wheels mounted in a straight line on a composite plastic chassis, functioning
much like the blade on an ice skate. The Company currently sells various models
of in-line skates to the mass market under the Variflex(R) brand.
The Company's in-line roller skates generally consist of a molded polymer
boot with a wheel chassis attached to the bottom of the boot, and high density
polyurethane wheels mounted on bearings and bolted through the wheel chassis.
The boot contains a removable breathable nylon liner which increases comfort.
The wheel chassis is, depending on the model, made of either fiberglass-filled
nylon, aluminum, or various plastics. Each chassis holds three or four wheels
mounted in line, and each pair of skates has either one or two brakes mounted on
the rear of the chassis.
The Company also markets skateboards, scooters, and skoot skates. The
Company presently offers different models of skateboards under the Variflex(R)
and Static(R) brands, different models of scooters under the Variflex(R) brand,
and various models of the Variflex Skoot Skate, which is a skateboard with a
removable handle for young children and beginners. Additionally, the Company
offers a line of skating and skateboarding protective equipment, such as knee
pads, elbow pads and wrist guards.
The Company has developed and markets its Quik Shade(R) instant canopy,
designed to offer portable shade and shelter for a variety of uses with the
convenience of easy set-up and take-down. The Company presently offers multiple
models of the Quik Shade(R) and a line of Quik Shade(R) accessories.
2
The Company also markets a line of recreational protective helmets.
Different helmets are marketed to cyclists, skateboarders and in-line skaters.
The Company presently has adult helmet models, young adult models, youth models,
child models and toddler models. Each model features ventilated aerodynamic
designs with adjustable straps, and each comes in a variety of colors and
graphics. The Company's helmets are manufactured by independent contractors
using either a process of injecting a polyurethane foam or expanded polystyrene
(EPS) to form a strong, lightweight protective inner shell bonded to a hard PVC
outer shell. These helmets currently meet or exceed the applicable standards of
the American Society for Testing and Materials (ASTM) or the Consumer Product
Safety Commission (CPSC). In October 2000, the Company announced that it was
voluntarily recalling certain of its X Games helmets which did not comply with
all applicable CPSC standards.
During 1999, the Company entered into an exclusive license agreement with
Product Resource and Development, Inc. to manufacture and market a springless
trampoline that uses an elastic material to provide the bounce and lift. The
agreement gives the Company worldwide rights to the patented technology. The
trampolines are being sold under the Airzone(TM) and Ultraflex brands.
Additionally, the Company markets trampoline enclosures and trampoline covers.
The Company, during 1999, entered into a license agreement to produce a
line of in-line skates, accessories, snowboards, helmets, yo-yo's, and
skateboards under the "X Games" brand.
During 1999, the Company terminated its exclusive right to manufacture,
market and distribute all snowboards bearing the Barfoot(TM) brand name.
During 1998, the Company sold the assets of the manufacturing operation of
its wholly-owned subsidiary, Static Snowboards, Inc., and closed the
manufacturing factory, and is sourcing snowboards from independent contractors.
For the fiscal years ended July 31, 2000, 1999, and 1998, these products
comprised the following percentages of the Company's total gross sales:
2000 1999 1998
---- ---- ----
In-line skates 36% 51% 56%
Canopies 18% 18% 9%
Trampolines 16% - -
Skateboards and scooters 15% 15% 18%
Recreational protective equipment and helmets 13% 7% 12%
Snowboards 1% 2% 5%
Yo-yo's 1% 6% -
Other (*) 1% (*)
---- ---- ----
Total 100% 100% 100%
==== ==== ====
___________________________________
(*) Less than one-half of one percent.
The Company's products are marketed in North America primarily through a
network of independent sales representatives and marketing organizations,
through attendance by representatives of the Company at industry trade shows and
through customer visits by Company employees. The Company's current customers
consist primarily of national mass merchandisers, regional mass merchandisers,
catalog houses, major sporting goods chains, major home improvement chains, and
international exporters. The Company's wholly owned subsidiary, Oketa Ltd., is
used to facilitate sales and the shipment of products to international customers
and to customers in the United States who desire to purchase product through
international letter of credit transactions.
3
(2) Status of products in development.
The Company frequently changes the cosmetic features of its products, such
as graphics and colors, and attempts to develop new products or new designs for
existing products in response to customer requests or changes in consumer
preferences.
During 2000, the Company introduced a line of mini-scooters, with initial
shipments made in the fourth quarter of 2000.
Also during 2000, the Company introduced additional models of its
Airzone(TM) springless trampoline and its Ultraflex brand springless trampoline,
as well as trampoline enclosures and accessories.
During 2000, the Company introduced additional models of its Quik Shade(R)
portable instant canopy. A U.S. Patent was issued for the Quik Shade(R) during
1998.
Despite these and other efforts by the Company to update the designs,
features and componentry of existing products and to develop potential new
products or new designs, there can be no assurance that such efforts will be
successful or that such changes or new products will be readily acceptable to
customers and consumers.
(3) Source of materials.
The Company's products are sourced from independent contractors located
primarily in Asia. These suppliers manufacture, assemble and package the
Company's products under the detailed specifications of the Company's management
representatives who visit frequently to oversee quality control and work on cost
containment. The raw materials and subcomponents for these products are
manufactured by independent contractors, most of which are also located
primarily in Asia, that have been procured by the Company's suppliers or, often,
by the management of the Company.
The Company submits purchase orders to its manufacturers for the production
of specific amounts of its products and has not entered into any long-term
contractual agreements. The Company negotiates the cost of its products
directly with its foreign suppliers in U.S. Dollars.
A significant portion of the Company's products, including various models
of its in-line skates, are manufactured in mainland China, which trades with the
United States under a Normal Trade Relations ("NTR") trade status. While the
Company believes that alternative manufacturing sources could be found,
maintaining existing costs will depend upon these products continuing to be
treated under NTR tariff rates. From time to time, the U.S. has threatened to
rescind NTR tariff rates and impose trade sanctions on certain goods
manufactured in China. To date, no such sanctions have been imposed that have
affected the Company or its products; however there can be no assurance with
regard to the possible imposition of sanctions in the future.
(4) Patents, trademarks, licenses, franchises and concessions.
The Company holds or has pending certain design patents and utility
patents. In the course of its business the Company employs various trademarks
and trade names, including its own logos, in the packaging and advertising of
its products. The Company has registered the Variflex(R), Static(R), Quik
Shade(R) and Airzone(TM) trademarks in the United States, and has secured a
worldwide watch to alert the Company to any unauthorized use in any other parts
of the world. Registration of various other trademarks for the Company's
products are pending. In fiscal 1999, the Company entered into (1) an exclusive
license agreement to manufacture and market a springless trampoline and (2) a
license agreement to produce "X Games"-identified merchandise.
(5) Major customers.
The Company had three customers which have each individually accounted for
more than 10% of the Company's sales in one or more of the past three fiscal
years: the Kmart Corporation, based in Detroit, Michigan; Target Stores, based
in Minneapolis, Minnesota; and Toys "R" Us, Inc., based in Paramus, New Jersey.
Collectively, sales to Kmart, Target, and Toys "R" Us represented approximately
64%, 59%, and 57% of the Company's total gross sales for the fiscal years ended
July 31, 2000, 1999, and 1998, respectively.
4
(6) Backlog.
The Company had approximately $15,526,000 in unfilled purchase orders as of
September 30, 2000, compared to approximately $2,438,000 as of September 30,
1999. The Company believes that substantially all of these unfilled orders are
firm and will be filled in the 2001 fiscal year. Of the backlog as of September
30, 2000, approximately $10,247,000 represented orders for products which had
not yet been received from suppliers as of that date. Substantially all of the
remaining $5,279,000 of the backlog at September 30, 2000 represents fall
booking orders of products on hand to be shipped at future dates.
(7) Government contracts.
The Company has no United States or foreign government contracts.
(8) Competition.
The principal competitive factors in each of the Company's product
categories are price and performance. With respect to in-line skates in
particular, the main areas of difference in product performance are in the
weight and strength of the boot and frame, the hardness of the wheels, and the
quality of the wheel bearings. The Company offers a 60-day warranty on its
products with the exception of the recreational helmets, and the Quik Shade(R)
instant canopy where a one year warranty is offered and the Airzone(TM)
trampoline where a tiered warranty averaging two years is offered. Beyond such
warranty, the Company does not offer service on its products, and does not
believe that is an important competitive factor.
Independent research indicates that the Company has a significant market
share in the in-line skate category, particularly in the mass market segment,
where Variflex enjoys name recognition and is considered a market leader. The
Company's primary competitors in the mass market include First Team Sports, Inc.
(Skate Attack), Roller Derby (CAS), Seneca and certain models from Rollerblade,
Inc. (Blade Runner). In the case of recreational protective equipment, Franklin
Sports is the Company's primary competitor in the mass market. Bell Sports
Corp. (Bell and BSI) and Protective Technologies, Inc. (PTI) are the primary
competitors in the recreational helmet mass market. For instant canopies, the
Company's primary competitors are International E-Z Up, Inc. and Enviroworks,
Inc. For trampolines, the Company's primary competitors are Jumpking, Inc. and
Hedstrom. In addition, the Company may compete with its primary customers when
such customers directly source products that the Company sells.
While management believes that the quality of its products and the service
it provides to its customers are important factors in retaining accounts, the
Company clearly operates in a highly competitive environment and there are no
significant technological or manufacturing barriers to entry for most product
categories other than the Quik Shade(R) instant canopy and the Airzone(TM)
trampoline. Management believes that price is a major competitive factor,
particularly in the mass market. At present, the Company believes that its
products in each category, when compared to competitors' products of comparable
quality, are currently offered at comparable prices to most of its competitors.
However there can be no assurance that other companies, whether new enterprises
or established members of the retail or sporting goods industries, will not be
able to develop products of comparable or higher quality at lower prices, or
that the Company's price structure will not be affected by future circumstances.
(9) Research and development.
Estimated research and development expenses for Company-sponsored research
activities relating to the development of new products, services or techniques
or the improvement of existing products, services or techniques were not
material in fiscal 2000, fiscal 1999, and fiscal 1998.
(10) Effect of environmental regulation.
To the extent that the Company's management can determine, there are no
federal, state or local provisions regulating the discharge of materials into
the environment or otherwise relating to the protection of the environment, with
which compliance by the Company has had or is expected to have a material effect
upon the capital expenditures, earnings or competitive position of the Company.
(11) Employees.
As of July 31, 2000, the Company employed approximately 88 full-time
employees. None of the Company's employees are represented by unions.
5
Item 2. Properties.
The Company's principal facility is a leased 104,000 square foot concrete
tilt-up building comprising the Company's corporate headquarters and executive
offices, as well as serving as the United States distribution center for the
Company's products, located at 5152 North Commerce Avenue, Moorpark, California,
approximately forty miles northwest of Los Angeles, California. The Company
also subleases in an immediately adjacent building approximately 27,000 square
feet consisting primarily of additional warehouse space. The leases for these
facilities expire December 31, 2005 and June 30, 2001, respectively, after which
management believes new leases can be negotiated, at those locations or for
other equivalent space, on commercially satisfactory terms. The Company also
stores inventory in temporary facilities from time to time as required due to
the timing of shipments.
The Company's subsidiary, Static Snowboards, Inc., leased a facility of
approximately 30,000 square feet, located in Huntington Beach, California which
expired September 30, 2000. With the closure of the Static manufacturing
operation, the Company had sublet this facility.
Management believes that the Company's present facilities will be adequate
for the near future.
Item 3. Legal Proceedings.
In March 1998, the Company was served with two lawsuits entitled: (i) Mark
C. Carter and International E-Z Up, Inc. v. Variflex, Inc. and Service
Merchandise Co., Inc. (Case No. 98-0167 WJR (RNBx)) in the United States
District Court for the Central District of California in Los Angeles (the
"Carter action") and (ii) James P. Lynch and KD Kanopy, Inc. v. Variflex, Inc.
(Civil Action No. 98-D-477) in the United States District Court of Colorado (the
"Lynch action"). In the Carter action, Service Merchandise Company, Inc., a
customer of the Company, was also named as a defendant. The Complaint in the
Carter action alleged, among other things, that the Company's Quik Shade(R)
product infringed a patent owned by the plaintiff which plaintiff used in a
competing instant set-up, collapsible canopy product, and infringes plaintiff's
trade dress, and (b) prayed for unspecified monetary damages, treble damages,
punitive damages, costs and attorney's fees, an injunction and the destruction
of all allegedly infringing products. The Complaint in the Lynch action (a)
alleged that the Company's Quik Shade(R) product infringed two patents owned by
that plaintiff and (b) prayed for an accounting, general damages, treble
damages, an injunction and costs and attorney's fees. The Company filed an
answer in both lawsuits denying the allegations of the Complaints and filed
counterclaims in both lawsuits seeking declarations of patent invalidity and
non-infringement as to the plaintiffs' patents, as well as damages against the
plaintiffs for alleged antitrust violations and restitution for unfair
competition violations.
In September 1998, the Company received a demand for defense and
indemnification of Service Merchandise Company, Inc. The Company agreed to
indemnify and defend Service Merchandise Company, Inc.
On May 12, 2000 the Company entered into a Settlement Agreement with
plaintiffs in the Carter action, pursuant to which that action was dismissed
with prejudice by the Court on May 22, 2000 with respect to the Company and
Service Merchandise Company, Inc. Accordingly, the defense and indemnification
action brought against Service Merchandise Company, Inc. has also been dismissed
with prejudice.
On April 26, 2000 the Company entered into a Settlement Agreement with
plaintiffs in the Lynch action, which included the purchase by the Company from
Lynch and KD Kanopy of U.S. Patent No. 4,779,635 for an initial cash payment of
$1,450,000 and a promissory note payable in installments of $200,000 each to be
paid annually over an eight-year period commencing on August 1, 2000. The Lynch
action was dismissed with prejudice by the Court on June 5, 2000. Under this
settlement, plaintiff claims of infringement of U.S. Patent No. 5,224,001 were
dismissed with prejudice, with no finding of infringement or non-infringement as
to the Company's Qui-Shade I Product and a finding of non-infringement as to the
Company's Quik-Shade II Product, and all of plaintiffs' remaining claims and the
Company's counterclaims were dismissed with prejudice.
In the Carter action, SAFECO Insurance Company of America ("SAFECO") agreed
to provide the Company with a defense, subject to a reservation of rights to
deny certain coverage. On September 28, 1999, SAFECO filed, and on October 11,
1999 caused to be served on the Company, a Complaint for Declaratory Relief
entitled SAFECO Insurance Company of America vs. Variflex, Inc., et al., (Case
No. BC217286) in the Superior Court of the State of California for the County of
Los Angeles (the "Coverage Action"). The complaint in the Coverage Action
asserted a single cause of action for declaratory relief by which SAFECO sought
a declaration concerning seven different theories of defense to certain coverage
liability in the Carter action. The Company answered the complaint in the
Coverage Action, denying its material allegations and asserted several
affirmative defenses.
On January 13, 2000, the Company tendered to SAFECO the defense of the
Lynch action referenced above. On March 7, 2000, SAFECO issued a letter that
denied any coverage for the Lynch action but which also agreed to provide a
defense of the action, subject to a reservation of rights to deny coverage and
to terminate the defense at any time.
6
On June 27, 2000, the Company instituted an arbitration proceeding against
SAFECO pursuant to California Civil Code Section 2860 concerning the disputed
matter of reimbursement of attorneys' fees, costs, expert witness fees and other
defense expenses in connection with both the Lynch and Carter actions ("the Fee
Arbitration").
Following the settlement and dismissal of the Carter and Lynch actions, the
Company on September 18, 2000, filed a Cross-Complaint against SAFECO for claims
arising out of the Carter and Lynch actions. The Cross-Complaint (i) alleges
breach of contract, tortious breach of the Covenant of Good Faith and Fair
Dealing (as to the Carter action), and Unfair Business Practices under Section
(S) 17200 of the California Business and Professions Code (as to the Carter
action) and (ii) seeks declaratory relief. On September 19, 2000, SAFECO filed
a First Amended Complaint for (1) declaratory relief, (2) reimbursement of
attorneys' fees and costs, and (3) reimbursement of indemnification as to both
the Carter and Lynch actions.
On October 24, 2000, the Company and SAFECO entered into A Settlement
Agreement with respect to all claims and cross-claims in the Coverage Action and
the Fee Arbitration, whereby each party released the other party from any
further liability with respect to these actions. Pursuant to the terms of this
confidential Settlement Agreement, SAFECO made a cash payment to the Company in
consideration for the Company releasing all claims that it had against SAFECO
with respect to both the Carter and Lynch actions.
On March 17, 2000, plaintiff Rocco Attolico, a former employee of the
Company, filed a complaint in the Superior Court of the State of California for
the County of Ventura (Case No. SC026211) (the "Attolico action"), against the
Company, the President of the Company, a Vice President of the Company, and Does
1 through 50, inclusive. The complaint was subsequently amended on June 29,
2000. This lawsuit arises out of the termination of the plaintiff's employment
by the Company. The first amended complaint in the Attolico action (a) alleges
against the Company, among other things, racial discrimination, harassment, and
retaliation in employment, retaliation for whistle blowing, wrongful
termination, intentional infliction of emotional distress, negligent
investigation, defamation, and unfair competition and (b) alleges against the
Company's President and Vice President, among other things, intentional and
negligent infliction of emotional distress, defamation, and unfair competition.
The first amended complaint notes that, and alleges that, (i) on November
5, 1999, the Moorpark, California Police Department arrested and booked
plaintiff on the charge of embezzlement and (ii) the Ventura County District
Attorney's office has failed to file a complaint against plaintiff.
The first amended complaint also alleges in substance that plaintiff was
terminated because he allegedly complained that (a) the Company improperly
filled customer orders and (b) a member of senior management of the Company
engaged in conduct which benefited him personally at the expense of the Company.
Plaintiff also alleges that the Company's President and Vice President, among
others, told the Moorpark, California Police Department false information
alleging embezzlement by plaintiff.
In his Statement of Damages, plaintiff claims damages in the amount of $1.7
million and punitive damages in the amount of $1 million. Plaintiff also seeks
treble damages, attorney's fees and costs.
The first amended complaint was served upon the defendants on July 28,
2000. On August 9, 2000, the Company tendered the defense and coverage of the
Attolico action to its primary insurance carrier who subsequently accepted the
tender. The Company's insurance policy with its primary insurance carrier
affords limits of liability for covered losses in the amount of $2 million and a
$25,000 retention. On September 11, 2000, the defendants filed an answer to the
plaintiff's first amended complaint denying the allegations of the first amended
complaint. The defendants believe that the plaintiff's claims are without merit
and plan to vigorously defend the lawsuit. The Company does not believe that
either the outcome of the Attolico action, or the costs to be incurred in
defending the Attolico action, or the efforts of management in connection with
this matter, will have a material adverse effect on the Company's business,
financial condition or results of operations.
From time to time, the Company is involved in other claims and lawsuits
arising in the ordinary course of its business. In the opinion of management,
all of these claims and lawsuits are covered by insurance or these matters will
not have a material and adverse effect on the Company's business, financial
condition, results of operations or cash flows.
Item 4. Submission of Matters to a Vote of Security Holders.
No matters were submitted to a vote of the Company's stockholders during
the quarter ended July 31, 2000.
7
Executive Officers and Directors of the Company
The following sets forth the names and ages of executive officers and
directors of the Company as of October 30, 2000, in addition to information
regarding their positions with the Company, their periods of service in such
positions, and their business experience for the past five years.
Name and Age of Current Positions with Company and Principal
Executive Officer Occupations for the Past Five Years
- --------------------------------------------------------------------------------
Mark S. Siegel Chairman of the Board and Director since November
Age 49 1997; Secretary of the Company since July 2000;
President of REMY Investors & Consultants, Inc.,
a private investment and financial management
company, and its affiliates (collectively,
"Remy") since its founding in 1993.
Raymond H. Losi, II Chief Executive Officer since November 1997;
Age 48 Chief Operating Officer of the Company since
January 1992; Director of the Company since 1985;
President of the Company from 1992 to August
1998; Vice President of Procurement for the
Company from 1984 to January 1992; Director of
Product Development for the Company since its
inception in August 1977. Mr. Losi is the son of
Raymond H. Losi, who is a director of the
Company.
Steven L. Muellner President of the Company since August 1998;
Age 50 President and Co-Chief Executive Officer of
Applause Enterprises, a gift and toy company,
from July 1996 to May 1998; Executive Vice
President, Sales and Marketing for Caradon Doors
& Windows, Ltd., a door and window manufacturing
company, from January 1995 to June 1996.
Roger M. Wasserman Chief Financial Officer of the Company since May
Age 59 1998 and Treasurer of the Company since June
1998; Controller of several divisions of Kellwood
Company, a major apparel wholesaler and
distributor, from July 1995 to May 1998.
Paula Coffman Vice President of Operations since April 1999;
Age 36 Vice President of Administrative Services for the
Company from January 1993 to April 1999; Product
and Sales Planning Manager for the Company from
December 1991 to January 1993.
Warren F. Marr Vice President of Sales for the Company since
Age 59 January 1990.
Kenneth N. Berns Director of the Company since October 1998;
Age 40 Secretary of the Company from October 1998 to
July 2000; Employed by Remy since December 1994.
Michael T. Carr Director of the Company since March 1998; Vice
Age 47 President Business Development of forestfactory,
inc., an internet solutions for commercial paper
company, since May 2000; President and Chief
Executive Officer of Weider Publications, Inc., a
publisher of several consumer magazines and
specialty publications, from April 1990 to April
1999.
Loren Hildebrand Director of the Company since February 1994;
Age 61 President of Creative Consultants, which provides
consulting services to the toy industry, since
1992; Executive Vice President of Lewis Galoob
Toys, Inc., toy manufacturer, from May 1994 to
September 1997.
Raymond H. Losi Director of the Company since its inception in
Age 77 August 1977; Chairman of the Board from 1977
until November 1997; Chief Executive Officer of
the Company from August 1989 until November 1997;
President of the Company from 1977 until August
1989. Mr. Losi is the father of Raymond H. Losi
II, who is an officer and director of the
Company.
8
PART II
Item 5. Market for Company's Common Equity and Related Stockholder Matters.
(a) Market Information.
The high and low last sale prices for the Company's Common Stock, as
reported on the Nasdaq National Market, during each of the quarters of the
fiscal years ended July 31, 1999 and 2000 were as follows (per share):
High Low
---- ---
Quarter ended:
October 31, 1998 5/1/8/ 4/1/8/
January 31, 1999 6 4/3/4/
April 30, 1999 6 4/1/2/
July 31, 1999 6/1/2/ 4/1/2/
October 31, 1999 6/7/16/ 5/1/8/
January 31, 2000 6/3/8/ 5/3/8/
April 30, 2000 6/1/4/ 4/1/2/
July 31, 2000 6 4/5/8/
The Company's Common Stock is traded on the Nasdaq National Market under
the symbol "VFLX." As of October 2, 2000, the closing sale price of the
Company's Common Stock on the Nasdaq National Market was $5.5625.
(b) Holders.
There were 97 holders of record of the Company's Common Stock on October 2,
2000.
(c) Dividends.
The Company has never paid cash dividends and has no present intention to
pay cash dividends in the foreseeable future. The Delaware General Corporation
Law also restricts the Company's ability to pay dividends. The Delaware General
Corporation Law provides that a Delaware corporation may pay dividends either
(1) out of the corporation's surplus (as defined by Delaware law), or (2) if
there is no surplus, out of the corporation's net profit for the fiscal year in
which the dividend is declared or the preceding fiscal year. Any determination
in the future to pay dividends will depend on the Company's financial condition,
capital requirements, results of operations, contractual limitations, legal
restrictions and any other factors the Board of Directors deem relevant.
Item 6. Selected Financial Data.
The following selected consolidated financial data with respect to the
Company's consolidated financial position as of July 31, 2000 and 1999 and
results of operations for the years ended July 31, 2000, 1999, and 1998 has been
derived from the Company's audited consolidated financial statements appearing
elsewhere in this Annual Report. This information should be read in conjunction
with such consolidated financial statements and the notes thereto. The selected
financial data with respect to the Company's consolidated financial position as
of July 31, 1998, 1997, and 1996 and results of operations for the years ended
July 31, 1997 and 1996 has been derived from the Company's audited consolidated
financial statements, which are not presented in this Annual Report.
(In thousands, except per share data)
------------------------------------------------
2000 1999 1998 1997 1996
------- ------- ------- ------- -------
Operations Data:
Net sales $55,201 $37,370 $43,148 $51,661 $72,379
Pre-tax income (loss) (1,983) 983 (2,704) (3,083) 680
Net income (loss) (1,983) 803 (3,488) (1,805) 564
Net income (loss) per share:
Basic ($0.39) $ 0.14 ($0.58) ($0.30) $ 0.09
Diluted ($0.39) $ 0.14 ($0.58) ($0.30) $ 0.09
Weighted average shares outstanding:
Basic 5,092 5,817 6,025 6,025 6,025
Diluted 5,092 5,860 6,025 6,025 6,039
Balance Sheet Data:
Total assets $43,217 $40,617 $44,755 $47,893 $49,405
9
Working capital 27,192 34,072 39,283 40,210 28,346
Long-term obligations 942 - - - -
Stockholders' equity 30,369 35,561 39,872 43,100 44,812
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
The following discussion should be read in conjunction with the
information under "Selected Financial Data" and the Company's Consolidated
Financial Statements and Notes thereto and other financial data, included
elsewhere in this Annual Report. Certain statements under this caption
constitute "forward-looking statements" under Section 27A of the Securities Act
of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as
amended, which involve risks and uncertainties. The Company's actual results of
operations may differ materially from the results discussed in these forward-
looking statements. For additional information concerning factors that might
cause such a difference, see "Additional Factors That Could Affect Operating
Results."
Results of Operations
Year Ended July 31, 2000 Compared to Year Ended July 31, 1999
Net Sales. Net sales for the fiscal year ended July 31, 2000 totaled
$55,201,000, an increase of $17,831,000, or 48% from fiscal 1999 net sales of
$37,370,000. Significant increases in volume with respect to the Company's
skateboard and scooter, recreational protective equipment and helmet, instant
canopy, and trampoline categories, were the primary factors leading to the
increase in total sales.
With respect to in-line skates, gross sales for fiscal 2000 totaled
$20,625,000, an increase of approximately $749,000, or 4%, compared to fiscal
1999, as unit volume in fiscal 2000 totaled 1,517,000 units, an increase of
approximately 177,000 units, or 13%. The average price per unit (gross revenues
divided by units sold) of the Company's in-line skates was approximately $13.60
during fiscal 2000, compared to $14.83 for fiscal 1999. This sales price
decline was primarily due to competitive pressures in this product category.
The increase in sales was primarily due to additional sales volume of lower
price in-line skates.
Gross sales of skateboards and scooters during fiscal 2000 totaled
$8,923,000, an increase of approximately $3,156,000, or 55%, compared to fiscal
1999, on total volume of 675,000 units, an increase of approximately 183,000
units, or 37%. The increase was primarily due to an industry-wide increase in
consumer demand for skateboards and mini-scooters.
10
Gross sales for recreational protective equipment and helmets during
fiscal 2000 totaled $7,489,000, an increase of approximately $4,805,000 or 179%,
compared to fiscal 1999 (in which period the Company separately reported
athletic protective equipment and recreational safety helmets), as unit volume
in fiscal 2000 was 891,000 units, an increase of approximately 533,000 units or
149%. The Company's increase in sales of these products was primarily related to
the increase in sales of in-line skates and skateboards and scooters, as well as
to additional sales volume of combination packages of aggressive skater helmets
with protective equipment.
Gross sales of portable instant canopies during fiscal 2000 totaled
$10,540,000, an increase of approximately $3,456,000, or 49%, compared to fiscal
1999, on total volume of 130,000 units, an increase of approximately 46,000
units, or 55%. The increase in Quik Shadeo(R) instant canopy sales was primarily
due to increased distribution in major home improvement chains, regional mass
merchandisers and major sporting goods chains, as well as an industry-wide
increase in consumer demand for portable instant canopy products.
Gross sales of snowboards and snowboarding accessories, such as bindings,
leashes, and miscellaneous apparel items, during fiscal 2000 totaled $411,000, a
decrease of approximately $532,000, or 56%, compared to fiscal 1999, while unit
volume of snowboards decreased approximately 11,200 units, or 48%, to a total of
12,200 units during fiscal 2000. The decrease in snowboard and snowboarding
accessories sales was primarily due to the Company's decision to reduce emphasis
in this product category and to terminate its exclusive right to manufacture,
market and distribute all snowboards bearing the Barfoot(TM) brand name during
1999.
Gross sales of yo-yo's during fiscal 2000 totaled $432,000, a decrease of
approximately $1,719,000, or 80%, compared to fiscal 1999. The decrease was
primarily due to an industry-wide decline in consumer demand compared to the
prior year.
Gross sales of trampolines totaled $9,065,000 during fiscal 2000, which
was the Company's first full year in this product category. This unique
springless product was introduced in the fourth quarter of fiscal 1999 with
sales of only $55,000. Approximately $6,200,000 of the fiscal 2000 sales
increase was due to orders received from one customer from which repeat orders
are not expected to be received in fiscal 2001.
Sales to the Company's four largest accounts during fiscal 2000
represented 69% of the Company's gross sales in fiscal 2000, compared to 69% for
the four largest accounts during fiscal 1999.
By product category, in-line skates and recreational protective equipment
and helmets accounted for 36% and 13%, respectively, of the Company's total
gross sales during fiscal 2000, compared to 51% and 7%, respectively, during
fiscal 1999. Skateboards and scooters accounted for 15% of the Company's total
gross sales during fiscal 2000 and 1999. Portable instant canopies represented
18% of total gross sales during 2000 and 1999. Snowboards and snowboarding
accessories represented 1% of total gross sales during fiscal 2000, compared to
2% in fiscal 1999. Yo-yo's represented 1% of total gross sales during 2000,
compared to 6% in the prior year. Trampolines represented 16% of total gross
sales during 2000, the first full year of sales.
Gross Profit. Gross profit for the fiscal year ended July 31, 2000
increased by $4,812,000 compared to the fiscal year ended July 31, 1999,
representing a 64% increase. The Company's gross profit margin as a percentage
of net sales was 22.3% in fiscal 2000, compared with 20.1% in fiscal 1999. The
increase in gross margin percentage was due to several factors, including the
impact of increased sales of the higher margin Quik Shade(R) canopies,
recreational protective equipment and helmets, and trampolines, offset to a
lesser degree by increases in ocean freight costs and decreases in sales prices
of in-line skates as discussed above. There can be no assurance that the Company
can continue to increase or maintain sales of higher margin products and to
obtain its products from suppliers at sufficiently low costs to fully offset the
downward pressure on sales prices for in-line skates in order to sustain or
improve present gross profit margins.
Operating Expenses. The Company's operating expenses (consisting of
selling and marketing expenses and general and administrative expenses) for
fiscal 2000 totaled $12,163,000, or 22.0% of net sales. Operating expenses for
fiscal 1999 were $8,613,000, or 23.0% of net sales.
Selling and marketing expenses increased by $1,117,000, or 27%, to
$5,235,000 for fiscal 2000 compared to fiscal 1999. Selling and marketing
expenses for fiscal 2000 amounted to 9.5% of net sales, compared to 11.0% in the
prior year. The increase in dollar amount was primarily due to increases in
various expenses, such as co-op advertising and sales commissions, that are
directly related to sales and increased correspondingly with the higher sales
level described in the Net Sales section, partially offset by a decrease in
promotional advertising expense. The decrease as a percentage of net sales was
primarily due to decreases in promotional advertising expense and the result of
certain other expenses that are basically fixed in amount and are not directly
related to the higher sales level.
11
General and administrative expenses increased by $683,000, or 15%, to
$5,178,000 for fiscal 2000 compared to fiscal 1999. General and administrative
expenses for fiscal 2000 amounted to 9.4% of net sales, compared to 12.0% in
fiscal 1999. The increase in dollar amount was primarily due to an increase in
expenses, net of insurance recoveries, related to the legal proceedings
described in "Item 3. Legal Proceedings," and to a lesser extent to an increase
in product development expenses, consulting fees and bonus expense.
In fiscal 2000, the Company recorded an estimated product recall charge of
$1,750,000 relating to the voluntary recall of certain of its X Games helmets
which did not comply with all applicable Consumer Product Safety Commission
standards.
Other Income (Expense). Other income (expense) for the fiscal year ended
July 31, 2000 was $(2,130,000), a decrease of $4,228,000, or 202%, compared to
fiscal 1999. This decrease was primarily due to realized losses from the sale
of marketable securities and to a lesser extent to decreased interest income due
to the reduced amount of the marketable securities.
Provision for Income Taxes. There is no provision for income taxes for
fiscal 2000 due to reductions in the valuation allowance. The Company's
effective tax rate for fiscal 1999 is less than the federal statutory rate due
to changes in the valuation allowance.
Recent Results. Net sales for the three months ended July 31, 2000, which
represents the fourth quarter of the Company's fiscal year, were $17,648,000, an
increase of 136%, compared to $7,473,000 for the corresponding period of the
prior year. For the quarter, sales of in-line skates, skateboards and scooters,
recreational protective equipment and helmets, and instant canopies were up
approximately $553,000 or 16%, $3,550,000 or 568%, $2,667,000 or 505%, and
$1,507,000 or 55%, respectively, in comparison to the fourth quarter for the
prior year, while sales of snowboards and yo-yo's were not significant. Sales
of trampolines for the fourth quarter of fiscal 2000 totaled approximately
$2,950,000 compared to approximately $50,000 during the corresponding period of
the prior year. These fourth quarter fluctuations were due to similar factors
as discussed above in the year-over-year comparisons for each of these product
categories.
The Company's net loss for the quarter ended July 31, 2000 was
$(2,177,000) or $(0.47) per share, compared with net income of $246,000, or
$0.04 per share for the corresponding period of the prior year. The decrease in
income was primarily due to the product recall charge recorded in the quarter,
realized losses from the sale of marketable securities, decreased interest
income due to the reduced amount of marketable securities, and increased sales
commission and co-op advertising expenses, offset to a lesser extent by the
insurance recoveries described in "Item 3. Legal Proceedings," increased gross
profit as a result of the increased net sales discussed above, and the higher
margin sales product mix for the quarter ended July 31, 2000 versus the quarter
ended July 31, 1999.
Year Ended July 31, 1999 Compared to Year Ended July 31, 1998
Net Sales. Net sales for the fiscal year ended July 31, 1999 totaled
$37,370,000, a decrease of $5,778,000, or 13% from fiscal 1998 net sales of
$43,148,000. Decreases in volume with respect to the Company's in-line skate,
athletic protective equipment, skateboard and scooter, helmet and snowboard
categories, offset to a lesser degree by increases in volume in the yo-yo and
instant canopy categories, were the primary factors leading to the decline in
total sales. Net sales were also adversely affected slightly during fiscal 1999
by a sales price decline in some of the Company's product categories.
With respect to in-line skates, gross sales for fiscal 1999 totaled
$19,876,000, a decrease of approximately $5,050,000, or 20%, compared to fiscal
1998, as unit volume in fiscal 1999 totaled 1,340,000 units, a decrease of
approximately 167,000, or 11%. The average price per unit (gross revenues
divided by units sold) of the Company's in-line skates was approximately $14.83
during fiscal 1999, compared to $16.54 for fiscal 1998. The decrease in in-line
skate sales was primarily due to the fact that Kmart Corporation, which
accounted for approximately $1,900,000 of the Company's gross sales for fiscal
1998 accounted for no sales for fiscal 1999, and was no longer a major customer
for the Company's in-line skates and skateboards, and a reduction in in-line
skate sales to Sears, Roebuck and Co. of approximately $2,300,000 between fiscal
1999 and fiscal 1998, since Sears exited the in-line skate business during
fiscal 1999.
Gross sales for athletic protective equipment during fiscal 1999 totaled
$758,000, a decrease of approximately $1,415,000, or 65%, compared to fiscal
1998, as unit volume in fiscal 1999 was 108,000 units, a decrease of
approximately 333,000, or 76%. The Company's decline in sales of these products
was directly related to the direct sourcing of athletic protective equipment by
the Company's larger customers.
Gross sales of skateboards and scooters during fiscal 1999 totaled
$5,767,000, a decrease of approximately $1,990,000, or 26%, compared to fiscal
1998, on total volume of 492,000 units, a decrease of approximately 86,000, or
15%. The decrease was primarily due to an industry-wide decline in consumer
demand compared to the prior year, as well as a reduction in skateboard sales to
Kmart Corporation of approximately $450,000 between fiscal 1999 and fiscal 1998.
12
Gross sales of recreational safety helmets during fiscal 1999 totaled
$1,926,000, a decrease of approximately $1,186,000, or 38%, compared to fiscal
1998, while unit volume decreased approximately 152,000, or 38%, to a total of
250,000 units during fiscal 1999. The decrease in helmet sales was primarily
due to a significant increase in margin protection programs being offered by the
Company's competitors.
Gross sales of snowboards and snowboarding accessories, such as bindings,
leashes and miscellaneous apparel items, during fiscal 1999 totaled $943,000, a
decrease of approximately $1,142,000, or 55%, compared to fiscal 1998, while
unit volume of snowboards decreased approximately 5,800, or 20%, to a total of
23,400 units during fiscal 1999. The decrease in snowboard and snowboarding
accessories sales was primarily due to the Company's decision to reduce emphasis
in this product category and to terminate its exclusive right to manufacture,
market and distribute all snowboards bearing the Barfoot(TM) brand name during
1999.
Gross sales of yo-yo's totaled $2,151,000 during fiscal 1999, which was
the Company's first year in this product category.
Gross sales of portable instant canopies during fiscal 1999 totaled
$7,084,000, an increase of approximately $3,013,000, or 74%, compared to fiscal
1998, on total volume of 84,000 units, an increase of approximately 43,000, or
105%. The increase in Quik Shade(R) instant canopy sales was primarily due to
increased distribution in major home improvement chains, regional mass
merchandisers and major sporting goods chains.
Sales to the Company's four largest accounts during fiscal 1999
represented 69% of the Company's gross sales in fiscal 1999, compared to 67% for
the four largest accounts during fiscal 1998. The increase was the result of
several factors including the addition of The Home Depot as one of the Company's
four largest accounts as a significant customer for the Quik Shade(R) Canopy,
partially offset by the deletion of Kmart during 1998 as a major customer for
the Company's in-line skates and skateboards.
By product category, in-line skates, athletic protective equipment and
helmets accounted for 51%, 2% and 5%, respectively, of the Company's total gross
sales during fiscal 1999, compared to 56%, 5% and 7%, respectively, during
fiscal 1998. Skateboards and scooters accounted for 15% of the Company's total
gross sales during fiscal 1999, compared to 18% during fiscal 1998. Portable
instant canopies represented 18% of total gross sales during 1999, compared to
9% in the prior year. Snowboards and snowboarding accessories represented 2% of
total gross sales during fiscal 1999, compared to 5% in fiscal 1998. Yo-yo's
represented 6% of total gross sales during 1999, the first year of sales.
Gross Profit. Gross profit for the fiscal year ended July 31, 1999
increased by $881,000 compared to the fiscal year ended July 31, 1998,
representing a 13% increase. The Company's gross profit margin as a percentage
of net sales was 20.1% in fiscal 1999, compared with 15.3% in fiscal 1998. The
increase in gross margin percentage was due to several factors, including the
impact of increased sales of the higher margin Quik Shade(R) canopies and yo-
yo's, as well as lower product costs as a result of beneficial sourcing during
fiscal 1999, and the decrease in sales to Kmart Corporation during fiscal 1999
which had a positive impact on the Company's gross margin. There can be no
assurance that the Company can continue to obtain its products from suppliers at
sufficiently low costs to fully offset the downward pressure on sales prices in
order to sustain or improve present gross profit margins.
Operating Expenses. The Company's operating expenses (consisting of
selling and marketing expenses and general and administrative expenses) for
fiscal 1999 totaled $8,613,000, or 23.0% of net sales. Operating expenses for
fiscal 1998 were $10,780,000, or 25.0% of net sales.
Selling and marketing expenses decreased by $762,000, or 16%, to
$4,118,000 for fiscal 1999 compared to fiscal 1998. Selling and marketing
expenses for fiscal 1999 amounted to 11.0% of net sales, compared to 11.3% in
the prior year. The decrease in dollar amount was primarily due to decreases in
various expenses, such as co-op advertising and sales commissions, that are
directly related to sales and decreased correspondingly with the lower sales
level described in the Net Sales section, partially offset by an increase in
promotional advertising expense.
General and administrative expenses decreased by $410,000, or 8%, to
$4,495,000 for fiscal 1999 compared to fiscal 1998. General and administrative
expenses for fiscal 1999 amounted to 12.0% of net sales, compared to 11.4% in
fiscal 1998. During fiscal 1998, non-cash consulting expenses of $702,000 were
recognized in connection with the Company entering into consultation agreements,
and issuing stock warrants as compensation under the agreements, with REMY
Capital Partners IV, LP, a private investment partnership ("Remy") and Raymond
H. Losi, the Company's co-founder and former Chairman of the Board. As
compensation under these agreements, Remy and Mr. Losi received warrants to
purchase 400,000 and 200,000 shares, respectively, of the Company's common
stock. Excluding such consulting expenses, the Company's general and
administrative expense for fiscal 1999 increased $292,000, or 7% compared to
fiscal 1998, due primarily to an increase in legal expenses related to the legal
proceedings described in "Item 3. Legal Proceedings," partially offset by a
decrease in computer consulting expense. The Company anticipates that it will
continue to incur significant legal expenses related to this matter.
During fiscal 1998 the Company recognized an impairment loss of $995,000
for write-downs of fixed assets and a write-off of the remaining unamortized
balance of goodwill relating to the snowboard operations of its wholly-owned
subsidiary, Static
13
Snowboards, Inc. Static's operating losses and the continuing challenges facing
the snowboard industry in general led to the conclusion that impairment of the
subsidiary's assets had occurred. In fiscal 1998, the Company sold certain
assets of Static, resulting in no significant gain or loss, and closed its
manufacturing facility with the intention of sourcing snowboards from
independent contractors located in Asia.
Other Income (Expense). Other income for the fiscal year ended July 31,
1999 was $2,098,000, an increase of $639,000, or 44%, compared to fiscal 1998.
This increase was due to an increase in interest income as a result of a change
during the third quarter of fiscal 1998 in the investment of marketable
securities from lower yielding tax-exempt securities to higher yielding taxable
securities, of which 60% was invested in high-yield bond funds.
Provision for Income Taxes. The Company's effective tax rate for fiscal
1999 is less than the federal statutory rate due to changes in the valuation
allowance. The provision for income taxes for fiscal 1998 consists of the
valuation allowance established against the prior year net deferred tax asset.
No tax benefit was recorded for the fiscal 1998 net operating losses due to
either the non-deductibility of certain charges included in the net operating
loss or the uncertainty of realizing the tax benefits of such losses under
Statement of Financial Accounting Standard No. 109 "Accounting for Income
Taxes."
Liquidity and Capital Resources
Since its initial public offering, the Company has funded its activities
principally from cash flow generated from operations and credit facilities with
institutional lenders. In June 1994, the Company completed an initial public
stock offering, issuing a total of 1,500,000 new common shares which raised
approximately $20,723,000 in proceeds to the Company, net of fees and expenses.
A portion of these proceeds was used by the Company to pay off borrowings on its
line of credit and for other working capital purposes. The remainder was
invested in marketable securities.
The Company has a credit agreement with a major bank providing a $10.0
million revolving line of credit, for the issuance of commercial letters of
credit. The agreement, which expires December 31, 2001, is secured by inventory
and receivables. The agreement requires that the Company satisfy certain
financial covenants.
Cash and marketable securities available for sale totaled $14,066,000 as
of July 31, 2000, compared to $25,235,000 as of July 31, 1999. Net working
capital as of July 31, 2000 was $27,192,000 compared to $34,072,000 as of July
31, 1999, and the Company's current ratio was 3.3:1 as of July 31, 2000,
compared to 7.7:1 as of July 31, 1999. The decreases in working capital and
current ratio are primarily due to decreases in cash of approximately $5,600,000
used for the purchase of treasury stock and $1,450,000 used as partial payment
for the purchase of a canopy patent during fiscal 2000, as well as due to cash
used in and generated from operations and increases and decreases in inventory
and increases and collections of accounts receivable, that result in daily
fluctuations in short-term investments.
The Company had long-term debt of $942,000 as of July 31, 2000, compared
to no long-term debt as of July 31, 1999, with the increase relating to the
acquisition of a canopy patent during fiscal 2000. The Company had net
stockholders' equity of $30,369,000 as of July 31, 2000, compared to $35,561,000
as of July 31, 1999, with such decrease due primarily to the purchase of
treasury stock and the operating results for the fiscal year ended July 31,
2000, offset by a decrease in accumulated other comprehensive loss due to
unrealized losses on investments in marketable securities. Management believes
that inflation has not had a significant impact upon the Company's costs and
prices during the past three fiscal years.
Capital expenditures for fiscal 2000 totaled $157,000 compared to $110,000
during fiscal 1999. The increase is primarily due to the acquisition of a new
show booth for approximately $67,000. Of the fiscal 2000 total, approximately
$51,000 represented machinery and equipment expenditures for computer equipment
and $10,000 represented production molds compared to $25,000 and $68,000,
respectively, for such expenditures during the prior year.
Future Liquidity and Financial Position
The Company intends to continue to focus upon building and maintaining its
existing product lines. The Company also plans to continue to devote resources
toward the pursuit and development of new products. In addition, management
continues to explore the possibility of making selected acquisitions of other
companies or products which would offer a strategic fit with the Company's
existing products and its sourcing and distribution channels in the mass market.
The Company also is considering expanding international distribution and
developing additional distribution arrangements in order to take further
advantage of growth opportunities which management believes exist for its
products outside the United States.
Management believes that its current cash position, funds available under
existing banking arrangements, and cash generated from operations will be
sufficient to meet the Company's presently projected cash and working capital
requirements for the next fiscal year assuming continued financial performance
at present levels.
Foreign Exchange
Management does not believe that the fluctuation in the value of the
dollar in relation to the currency of its suppliers has in the last three fiscal
years had any significant material and adverse impact on the Company's ability
to purchase products at
14
agreed upon prices. Typically, the Company and its suppliers negotiate prices in
U.S. Dollars and payments to suppliers are also made in U.S. Dollars.
Nonetheless, there can be no assurance that the value of the dollar will not
have an impact upon the Company in the future.
Additional Factors That Could Affect Operating Results
The following factors, together with other information contained elsewhere
herein, should be considered carefully in evaluating the Company and its
business.
Reliance on Major Customers. In the past three fiscal years, the Company
has had several customers which accounted for a majority of the Company's sales.
As is customary in the industry, the Company does not have long-term contracts
with any of its customers. The loss of, or a reduction in business from, any of
its major customers could have a material and adverse effect on the Company's
business results of operations and financial condition. In addition, because a
large percentage of the Company's accounts receivables are due from the major
customers, the failure of any of them to make timely payments with respect to
its account could have a material and adverse effect on the Company's results of
operations and financial condition.
Competition from Other Manufacturers/Developers of Products; Price
Sensitivity of Customers. The Company operates in a highly competitive
environment and there are no significant technological or manufacturing barriers
to entry for most product categories other than the Quik Shade(R) instant canopy
and the Airzone(TM) trampoline. While the Company believes that the principal
competitive factors in its market are price, quality of product, brand
recognition, accessibility and customer service, the Company's primary
customers, mass merchandisers, are extremely price sensitive. As a result, the
Company must continually monitor and control its costs while refining its
products to maintain its market position. There can be no assurance that the
Company can continue to provide its products at prices which are competitive or
that it can continue to design and market products that appeal to consumers even
if price competitive. Many of the Company's current and potential competitors
have longer operating histories, larger customer bases, greater brand
recognition and significantly greater financial, marketing and other resources
than the Company. In addition, smaller retailers may be acquired by, receive
investments from or enter into other commercial relationships with larger, well-
established and well-financed companies. The Company also competes to a lesser
degree with manufacturers of specialty or premium priced products.
The Company's primary competitors in the mass market for in-line skates
include First Team Sports, Inc. (Skate Attack), Roller Derby (CAS), Seneca and
certain models from Rollerblade, Inc. (Blade Runner). In the case of
recreational protective equipment, Franklin Sports is the Company's primary
competitor in the mass market. Bell Sports Corp. (Bell and BSI) and Protective
Technologies, Inc. (PTI) are the primary competitors in the recreational helmet
mass market. For instant canopies, the Company's primary competitors are
International E-Z Up, Inc. and Enviroworks, Inc. For trampolines, the Company's
primary competitors are Jumpking, Inc. and Hedstrom. In addition, the Company
may compete with its primary customers when such customers directly source
products that the Company sells.
At present, the Company believes that its products in each category, when
compared to competitors' products of comparable quality, are currently offered
at comparable or lower prices than most or all of its competitors. However
there can be no assurance that other companies, whether new enterprises or
established members of the retail or sporting goods industries, will not be able
to develop products of comparable or higher quality at lower prices, or that the
Company's price structure will not be affected by future circumstances.
Shifting and Uncertain Consumer Demand. The Company must continually
anticipate the emergence of, and adapt its products to, the popular demands of
consumers. No assurance can be given, however, that consumer demand for the
Company's product categories in general or the Company's products in particular
will continue into the future. A reduction in the demand for these products
could have a material and adverse effect on the Company's results of operations.
Government Regulations Could Hurt the Company's Business. The consumer
retail industry is regulated by many agencies including but not limited to, the
Consumer Product Safety Commission and the California Department of Food and
Agriculture Division of Measurement Standards. Existing legislation or
regulation and any new laws or regulations could hurt the Company's business.
The nature of any new laws and regulations and the manner in which existing and
new laws and regulations may be interpreted and enforced cannot be fully
determined. The enforcement of existing laws and regulations and the adoption
of any future laws or regulations might decrease the demand for the Company's
products, impose taxes or other costly technical requirements or otherwise
increase the cost of doing business which could hurt the Company's business.
The Company cannot predict the impact, if any, that future regulation or
regulatory changes may have on the Company's business.
15
Fluctuations in the Company's Quarterly Operating Results May Negatively
Affect the Company's Stock Price. The Company's quarterly results may fluctuate
from quarter to quarter in the future due to a variety of factors, not all of
which are under the Company's control. Some of the factors that could cause the
Company's revenues and operating results to fluctuate include the following:
. inventory returns;
. the timing and magnitude of capital expenditures;
. increasing operating expenses;
. changes in the prices for the Company's products;
. the compensation of the Company's sales personnel based on achievement
of periodic sales quotas;
. fluctuations in the duration of the sales cycle for the Company's
products;
. the announcement or introduction of new or enhanced products by the
Company's competitors or by the Company; and
. conditions specific to the consumer retail industries and general
economic factors.
It is possible that in some future periods the Company's results of
operations may fall below the expectations of public market analysts and
investors. This could result in a decline in the value of the Company's common
stock.
Reliance on Foreign Suppliers to Source the Company's Products. The
Company's products are primarily sourced from suppliers located in Asia with
whom the Company does not have long-term contractual agreements. If the Company
were unable to develop and maintain relationships with suppliers that would
allow it to obtain sufficient quantities of merchandise on acceptable commercial
terms, its business, prospects, financial condition and results of operations
would be materially and adversely affected. Moreover, the Company may not be
able to obtain its products and supplies on substantially similar terms,
including cost, in order to sustain its operating margins. Although management
presently believes that other suppliers could be obtained in such instances,
there can be no assurance that the Company would be able to obtain products and
supplies on substantially similar terms, including cost, in the future. In
addition, purchasing products from foreign suppliers subjects the Company to the
general risks of doing business abroad. These risks include potential delays in
shipment, work stoppages, adverse fluctuations in currency exchange rates,
changes in import duties and tariffs, changes in foreign regulations and
political instability.
A significant portion of the Company's products, including various models
of its in-line skates, are manufactured in mainland China, which trades with the
United States under a Normal Trade Relations ("NTR") trade status. While the
Company believes that alternative manufacturing sources could be found,
maintaining existing costs will depend upon these products continuing to be
treated under NTR tariff rates. From time to time, the U.S. has threatened to
rescind NTR tariff rates and impose trade sanctions on certain goods
manufactured in China. To date, no such sanctions have been imposed that have
affected the Company or its products, however there can be no assurance with
regard to the possible imposition of sanctions in the future.
In addition, economic conditions in Asia could have a material and adverse
impact upon the Company's ability to procure products from suppliers. The
economic and financial difficulties experienced in Asia in 1998 could, if such
crisis reoccurred, cause a delay or inability to procure products from the
Company's suppliers which could have a material adverse effect on its business,
operating results and financial condition. However, the Company may be able to
move production quickly to alternate sources in response to economic or
political circumstances that might arise in any particular country.
Product Liability Claims, Insurance. Due to the nature of its products,
the Company is subject to product liability claims, including claims for serious
personal injury or death. Coverage is on a claims-made basis, and is subject to
certain deductibles. Although the Company believes that it has adequate
liability insurance for risks arising in the normal course of business,
including product liability insurance with respect to all of its products, there
can be no assurance that insurance coverage will be sufficient to cover one or
more large claims or that the applicable insurer will be solvent at the time of
any covered loss. Further, there can be no assurance that the Company will be
able to obtain insurance coverage at acceptable levels and cost in the future.
Successful assertion against the Company of one or a series of large claims, or
of one or a series of claims exceeding any insurance coverage, could have a
material and adverse effect on the Company's results of operations and financial
condition.
16
Trademarks and Proprietary Rights. There are risks inherent in the design
and development of new products and product enhancements, including those
associated with patent issues and marketability. Potential liability from
patent and other intellectual property infringements can have a material and
adverse effect on the Company's business, financial condition, results of
operations or cash flows.
In March 1998, the Company was named as a defendant in two lawsuits. The
plaintiffs in both lawsuits alleged that certain of the Company's products
infringed upon patents owned by the plaintiffs. The Company settled these
lawsuits in April and May 2000 and pursuant to one of the settlement agreements,
purchased a patent. For further details concerning these lawsuits, please see
Item 3 under Part 1 of this Report.
With respect to the Company's own patents, service marks, trademarks, trade
secrets and similar intellectual property, the Company considers such
proprietary rights as critical to its success, and relies on patent and
trademark law, trade secret protection and confidentiality and/or license
agreements with its employees, customers, partners and others to protect its
proprietary rights. The Company holds or has pending certain design patents and
utility patents and employs various trademarks, trade names, including its own
logos, in the packaging and advertising of its products. The Company has
registered the Variflex(R), Static(R), Quik Shade(R) and Airzone(TM) trademarks
in the United States, and has secured a worldwide watch to alert the Company to
any unauthorized use in any other parts of the world. Registration of various
other trademarks of the Company's products are pending.
Effective patent, trademark, service mark and trade secret protection may
not be available in every country in which the Company's products and services
are made available. There can be no assurance that the steps taken by the
Company to protect its proprietary rights will be adequate or that third parties
will not infringe or misappropriate the Company's patents, trademarks and
similar proprietary rights. In addition, there can be no assurance that other
parties will not assert infringement claims against the Company. The Company
has been subject to claims and expects to be subject to legal proceedings and
claims from time to time in the ordinary course of its business, including
claims of alleged infringement of the trademarks and other intellectual property
rights of third parties by the Company. Such claims, even if not meritorious,
could result in the expenditure of significant financial and managerial
resources.
Risks Associated With Entry Into New Business Areas. The Company may
choose to expand its operations by developing and promoting new or complementary
products, expanding the breadth and depth of products and services offered or
expanding the acquisition of new or complementary businesses, products or
technologies, although it has no present understandings, commitments or
agreements with respect to any material acquisitions or investments. There can
be no assurance that the Company would be able to expand its efforts and
operations in a cost-effective or timely manner or that any such efforts would
increase overall market acceptance. Furthermore, any new business or product
line launched by the Company that is not favorably received by consumers could
damage the Company's reputation or its various brand names. Expansion of the
Company's operations in this manner would also require significant additional
development and operations expenses and would strain the Company's management,
financial and operational resources. The lack of market acceptance of such
efforts or the Company's inability to generate satisfactory revenues from such
expanded businesses or products to offset their cost could have a material and
adverse effect on the Company's business, prospects, financial condition and
results of operations.
Dependence on Key Personnel. The Company's performance is substantially
dependent on the continued services and on the performance of its senior
management and other key personnel, particularly Raymond (Jay) H. Losi II, who
has entered into an employment agreement with the Company. The loss of Mr. Losi
II could have a material and adverse effect on the Company. Although the
Company carries a $5,000,000 life insurance policy on Mr. Losi II, no assurance
can be given that the proceeds will be sufficient to protect against such a
loss. The Company's performance also depends on the Company's ability to retain
and motivate its other officers and key employees. The loss of the services of
any of its executive officers or other key employees could have a material and
adverse effect on the Company's business, prospects, financial condition, and
results of operations. Other than the aforementioned exceptions, the Company
has long-term employment agreements with only a few of its key personnel. The
Company's future success also depends on its ability to identify, attract, hire,
train, retain and motivate other highly skilled technical, managerial,
merchandising, marketing and customer service personnel. Competition for such
personnel is intense, and there can be no assurance that the Company will be
able to successfully attract, assimilate or retain sufficiently qualified
personnel. The failure to retain and attract the necessary technical,
managerial, merchandising, marketing and customer service personnel could have a
material and adverse effect on the Company's business, prospects, financial
condition and results of operations.
17
Consumer Regulation of Company Products. Certain of the Company's products
are subject to regulation by the Federal Consumer Products Safety Commission
(the "CPSC"), and may therefore be subject to recall request by the CPSC. In
October 2000, the Company announced that it was voluntarily recalling certain of
its X Games helmets which did not comply with all applicable CPSC standards. In
fiscal 2000, the Company recorded an estimated product recall charge relating to
these helmets. Although the Company is not aware of any current proceeding by
the CPSC which would result in the recall of the Company's products, any such
proceeding could have a material and adverse effect on the Company's business,
prospects, financial condition and results of operations.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
The Company is exposed to changes in interest rates primarily from its
investments in short-term instruments and money market funds and in available-
for-sale securities. These investments are subject to risks associated with the
level of volatility within the various financial markets, changes in interest
rates, the condition of the United States and world economies and many other
factors. Available-for-sale securities are reported by the Company at fair
value. The Company currently has no derivative financial instruments.
Item 8. Financial Statements and Supplementary Data.
The financial statements and schedules included herein are listed in Item
14.
18
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
Variflex, Inc.
We have audited the accompanying consolidated balance sheets of Variflex, Inc.
(the Company) as of July 31, 2000 and 1999, and the related consolidated
statements of operations, stockholders' equity and cash flows for each of the
three years in the period ended July 31, 2000. Our audits also included the
financial statement schedule listed in the Index at Item 14. These financial
statements and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Variflex, Inc. at
July 31, 2000 and 1999, and the consolidated results of its operations and its
cash flows for each of the three years in the period ended July 31, 2000, in
conformity with accounting principles generally accepted in the United States.
Also, in our opinion, the related financial statement schedule, when considered
in relation to the basic financial statements taken as a whole, presents fairly
in all material respects the information set forth therein.
/s/ Ernst & Young LLP
Woodland Hills, California
September 22, 2000, except for Note 16 and the third paragraph of
Note 6, as to which the date is October 24, 2000
19
VARIFLEX, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
July 31
----------------------------------------------
2000 1999
----------------- --------------------
Assets
Current assets:
Cash and cash equivalents $ 14,066 $ 5,343
Marketable securities available for sale - 19,892
Trade accounts receivable, less allowances of $421 and
$430 as of July 31, 2000 and 1999, respectively 13,412 6,900
Inventory 8,926 5,748
Deferred income taxes 1,192 604
Prepaid expenses and other current assets 1,502 641
----------------- --------------------
Total current assets 39,098 39,128
Property and equipment, net 261 283
Intangible assets 3,326 458
Other assets 532 748
----------------- --------------------
Total assets $ 43,217 $ 40,617
================= ====================
Liabilities and stockholders' equity
Current liabilities:
Trade acceptances payable $ 957 $ 133
Accounts payable 1,869 466
Accrued warranty 1,101 844
Accrued salaries and related liabilities 1,204 410
Accrued co-op advertising 2,064 1,612
Accrued returns and allowances 1,367 429
Accrued product liability claims 414 267
Accrued product recall expenses 1,750 -
Income taxes payable 221 272
Other accrued expenses 759 623
Current maturities of note payable 200 -
----------------- --------------------
Total current liabilities 11,906 5,056
Note payable, less current maturities 942 -
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.001 par value; authorized 5,000,000 shares
Issued and outstanding shares - none - -
Common stock, $.001 par value; authorized 40,000,000 shares
Issued shares - 6,025,397 as of July 31, 2000 and 1999 9 9
Common stock warrants 702 702
Additional paid-in capital 21,023 21,023
Retained earnings 17,350 19,333
Accumulated other comprehensive loss - (2,432)
Treasury stock, at cost, 1,440,965 shares and 512,979 shares
as of July 31, 2000 and 1999, respectively (8,715) (3,074)
----------------- --------------------
Total stockholders' equity 30,369 35,561
----------------- --------------------
Total liabilities and stockholders' equity $ 43,217 $ 40,617
================= ====================
See accompanying notes.
20
VARIFLEX, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
Year Ended July 31
-----------------------------------------------------------
2000 1999 1998
--------------- --------------- ----------------
Net sales $ 55,201 $ 37,370 $ 43,148
Cost of goods sold 42,891 29,872 36,531
--------------- --------------- ----------------
Gross profit 12,310 7,498 6,617
--------------- --------------- ----------------
Operating expenses:
Selling and marketing 5,235 4,118 4,880
General and administrative 5,178 4,495 4,905
Impairment write-off - - 995
Product recall charge 1,750 - -
--------------- --------------- ----------------
Total operating expenses 12,163 8,613 10,780
--------------- --------------- ----------------
Income (loss) from operations 147 (1,115) (4,163)
--------------- --------------- ----------------
Other income (expense):
Loss on sale of marketable securities (3,712) - -
Interest expense (32) - -
Interest income and other 1,614 2,098 1,459
--------------- --------------- ----------------
Total other income (expense) (2,130) 2,098 1,459
--------------- --------------- ----------------
Income (loss) before income taxes (1,983) 983 (2,704)
Provision for income taxes - 180 784
--------------- --------------- ----------------
Net income (loss) $ (1,983) $ 803 $ (3,488)
=============== =============== ================
Net income (loss) per share of common stock:
Basic $ (0.39)
$ 0.14 $ (0.58)
=============== =============== ================
Diluted $ (0.39) $ 0.14 $ (0.58)
=============== =============== ================
Weighted average shares outstanding:
Basic 5,092 5,817 6,025
=============== =============== ================
Diluted 5,092 5,860 6,025
=============== =============== ================
See accompanying notes.
21
VARIFLEX, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands, except share data)
Accumulated
Common Additional Other
Common Stock Stock Paid-In Retained Comprehensive
------------
Shares Amount Warrants Capital Earnings Income (Loss)
------ ------ -------- ------- -------- -------------
Balance at July 31, 1997 6,025,397 $ 9 $ - $21,023 $22,018 $ 50
Comprehensive loss:
Net unrealized holding losses on
debt securities available for sale - - - - - (442)
Net loss - - - - (3,488) -
Total comprehensive loss
Issuance of common stock
warrants - - 702 - - -
--------- ------ -------- ------- ------- ------------
Balance at July 31, 1998 6,025,397 9 702 21,023 18,530 (392)
Comprehensive loss:
Net unrealized holding losses on
debt securities available for sale - - - - - (2,040)
Net income - - - - 803 -
Total comprehensive loss
Purchase of treasury shares - - - - - -
--------- ------ -------- ------- ------- ------------
Balance at July 31, 1999 6,025,397 9 702 21,023 19,333 (2,432)
Comprehensive income (loss):
Net realized losses on debt
securities sold - - - - - 2,432
Net Loss - - - - (1,983) -
Total comprehensive income
Purchase of treasury shares - - - - - -
--------- ------ -------- ------- ------- ------------
Balance at July 31, 2000 6,025,397 $ 9 $ 702 $21,023 $17,350 $ -
========= ====== ======== ======= ======= ============
Treasury Stock
--------------
Shares Amount Total
------ ------- -----
Balance at July 31, 1997 - $ - $43,100
Comprehensive loss:
Net unrealized holding losses on
debt securities available for sale - - (442)
Net loss - - (3,488)
-------
Total comprehensive loss (3,930)
Issuance of common stock
warrants - - 702
--------- ------- -------
Balance at July 31, 1998 - - 39,872
Comprehensive loss:
Net unrealized holding losses on
debt securities available for sale - - (2,040)
Net income - - 803
-------
Total comprehensive loss (1,237)
Purchase of treasury shares 512,979 (3,074) (3,074)
--------- ------- -------
Balance at July 31, 1999 512,979 (3,074) 35,561
Comprehensive income (loss):
Net realized losses on debt
securities sold - 2,432
Net Loss - - (1,983)
-------
Total comprehensive income - 449
Purchase of treasury shares 927,986 (5,641) (5,641)
--------- ------- -------
Balance at July 31, 2000 1,440,965 $(8,715) $30,369
========= ======= =======
See accompanying notes.
22
VARIFLEX, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Year Ended July 31
----------------------------------------------
2000 1999 1998
------------ ------------ ----------
Operating activities
Net income (loss) $ (1,983) $ 803 $ (3,488)
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating activities:
Depreciation and amortization 173 326 713
Amortization of intangibles 192 42 92
Non-cash interest charge 32 - -
Deferred income taxes (588) (604) 784
(Gain) loss on sale of marketable securities 3,712 1 (27)
(Gain) loss on disposal of fixed assets 2 2 (38)
Impairment write-off - - 995
Common stock warrants issued - - 702
Changes in operating assets and liabilities:
Trade accounts receivable (6,512) 1,305 1,395
Inventory (3,178) 735 3,223
Prepaid expenses and other current assets (861) 1,168 783
Trade acceptances payable 824 (251) (186)
Accounts payable 1,403 95 (306)
Accrued product recall expenses 1,750 - -
Other current liabilities 2,673 329 582
------------ ------------ ----------
Net cash provided by (used in) operating activities (2,361) 3,951 5,224
------------ ------------ ----------
Investing activities
Purchases of property and equipment (157) (110) (308)
Proceeds from sale of assets 4 - 325
Gross purchases of available-for-sale securities (1,361) (1,788) (26,026)
Gross sales of available-for-sale securities 19,973 2 20,348
Purchase of intangible assets (1,950) (500) -
Other assets 216 (660) 136
------------ ------------ ----------
Net cash provided by (used in) investing activities 16,725 (3,056) (5,525)
------------ ------------ ----------
Financing activities
Purchase of treasury shares (5,641) (3,074) -
------------ ------------ ----------
Net cash used in financing activities (5,641) (3,074) -
------------ ------------ ----------
Net increase (decrease) in cash 8,723 (2,179) (301)
Cash and cash equivalents beginning of period 5,343 7,522 7,823
------------ ------------ ----------
Cash and cash equivalents at end of period $ 14,066 $ 5,343 $ 7,522
============ ============ ==========
Cash paid during the period for:
Interest $ - $ - $ -
Income taxes $ 638 $ 512 $ -
Supplemental disclosure of non-cash financing and investing activities:
In April 2000, the Company recorded the non-cash portion of the acquisition
of a patent of $1,110,000 and the resultant note payable. See Note 11.
See accompanying notes.
23
VARIFLEX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
July 31, 2000
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation and Basis of Presentation
The consolidated financial statements include the accounts of Variflex, Inc., a
Delaware corporation, and its two wholly owned subsidiaries, Oketa Limited
(Oketa), a Hong Kong corporation, and Static Snowboards, Inc., a Delaware
corporation (collectively, the Company). The Company markets and distributes in-
line skates, skateboards, recreational protective equipment (such as knee pads,
elbow pads and wrist guards) and helmets, portable instant canopies,
trampolines, snowboards and other products. The Company designs and develops
these products which are then manufactured to the Company's specifications by
independent contractors. The Company's products are sold, primarily in the
United States, to retailers, with some sales to wholesalers and distributors.
All significant intercompany accounts and transactions have been eliminated in
consolidation.
Use of Estimates
Financial statements prepared in accordance with generally accepted accounting
principles require management to make estimates and judgments that affect
amounts and disclosures reported in the financial statements. Actual results
could differ from those estimates. Significant estimates made in preparing the
consolidated financial statements include allowances made against accounts
receivable, reserves taken against inventory, accruals for sales returns and
allowances, warranty, product liability claims, and other litigation related
matters, and the accrual for the product recall charge discussed in Note 16.
Revenue Recognition and Warranty
The Company recognizes revenue from product sales upon shipment net of estimated
returns and allowances. The Company has established programs with its customers
which enable them to receive credit for defective merchandise covered under its
warranty policy. The Company's products are under warranty against defects in
material and workmanship for varying periods from date of purchase. The amount
of potential credits is estimated and provided for in the period of sale.
Concentration of Risk
The Company performs periodic evaluation of the credit worthiness of its
customers and generally does not require collateral. Credit losses relating to
the Company's customers, mainly mass merchant retailers, have consistently been
within management's expectations and are provided for in the financial
statements.
The Company operates within one industry segment where certain customers
represent a significant portion of the Company's business. Sales to the
Company's largest customers which have each individually accounted for more than
10% of the Company's sales as a percentage of consolidated gross sales, were
36%, 17%, and 11% for fiscal 2000; 40% and 19% for fiscal 1999; 31% and 21% for
fiscal 1998. Receivables from these customers as a percentage of the Company's
total trade accounts receivable were 57%, 7%, and 2% at July 31, 2000.
With the exception of snowboards, which were manufactured domestically at the
Company's factory during 1998 (see Note 14), and yo-yo's, which were
manufactured by independent contractors located domestically and in Asia, all of
the Company's products are manufactured by independent contractors located in
Asia. The Company presently knows of no circumstances that would materially
affect its supply or costs of goods; however, there can be no assurances with
respect to events which may arise in the future.
Cash Equivalents
Short-term investments and money market funds with original maturities of three
months or less are classified as cash equivalents. The carrying value of cash
equivalents approximates market value.
Marketable Securities
The Company accounts for investments in marketable securities in accordance with
Statement of Financial Accounting Standard No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." Management has determined all
investments should be classified as available-for-sale.
Available-for-sale securities are carried at fair value, with the unrealized
gains and losses, net of tax, reported as accumulated other comprehensive income
(loss). The amortized cost of debt securities in this category is adjusted for
amortization of premiums and accretion of discounts to maturity. Such
amortization is included in investment income. Realized gains, losses and
declines in value judged to be other-than-temporary on available-for-sale
securities are included in other income (expense). The cost of securities is
based on the specific identification method. Interest and dividends on
securities classified as available-for-sale are included in interest income.
Inventory
Inventory is stated at the lower of cost (first-in, first-out method) or market
and consists of the following:
July 31
-----------------------------
2000 1999
------- --------
(In thousands)
Raw material and work-in-process $ 1,027 $ 554
Finished goods 7,899 5,194
------- -------
$ 8,926 $ 5,748
======= =======
Long Lived Assets
In accordance with FASB Statement No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, the Company
records impairment losses on long-lived assets (including goodwill) used in
operations when events and circumstances indicate that the assets might be
impaired and the undiscounted cash flows estimated to be generated by those
assets are less than the carrying amounts of those assets. The impairment loss
is measured by comparing the fair value of the asset to its carrying amount.
See Note 14.
Property and Equipment
Property and equipment are stated at cost. Depreciation is provided using the
straight-line method over the estimated useful lives of the related assets or,
for leasehold improvements, over the terms of the related leases, if shorter.
See Note 14 for discussion of write-down of property and equipment.
Intangible Assets
Goodwill arising from acquisitions is amortized on a straight-line basis over a
period of 15 years. As discussed in Note 14, unamortized goodwill of $495,000
was written down during fiscal 1998.
License agreement assets described in Note 10 are amortized on a straight-line
basis over a period of 8 years and are included net of amortization as a
component of intangible assets in 2000 and 1999. Accumulated amortization of
license agreements as of July 31, 2000 and 1999 amounted to $146,000 and
$42,000, respectively.
The patent described in Note 11 is amortized on a straight-line basis over a
period of 7-1/4 years and is included net of amortization as a component of
intangible assets in 2000. Accumulated amortization of patents as of July 31,
2000 and 1999 amounted to $88,000 and $0, respectively.
Earnings (Loss) Per Share
Basic earnings (loss) per share is computed based on the weighted average number
of shares of common stock outstanding during the period. Dilutive earnings
(loss) per share is based on the weighted average number of shares of common
stock outstanding, and common stock equivalents, when dilutive. Common stock
equivalents represent the dilutive effect of the assumed exercise of certain
outstanding options and warrants. For the year ended July 31, 1999 the number of
shares used in the calculation of diluted earnings per share included 42,778
shares issuable under stock options and warrants using the treasury stock
method. Common stock equivalents are excluded from the computation for the
years ended July 31, 2000 and 1998 because their effect is antidilutive.
Advertising Costs
Advertising costs are expensed as incurred. Advertising costs for the years
ended July 31, 2000, 1999, and 1998 amounted to $2,034,000, $1,988,000 and
$2,490,000, respectively.
Stock-Based Compensation
Statement of Financial Accounting Standard No. 123, "Accounting for Stock-Based
Compensation," encourages but does not require companies to record compensation
expenses for stock options at fair value. The Company has chosen to continue to
account for stock options using the intrinsic value method prescribed in
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," and related interpretations. Accordingly, the Company has computed
the pro forma disclosures of the earnings per share as determined under the
provision of SFAS No. 123.
Comprehensive Income
In accordance with Statement 130, "Reporting Comprehensive Income," unrealized
gains or losses on the Company's available-for-sale securities are included in
other comprehensive income (loss) for the years ended July 31, 2000, 1999 and
1998 as follows:
2000 1999 1998
------- ------- -----
(In thousands)
Unrealized holding gains (losses) arising during period,
net of taxes of zero in each period $(1,280) $(2,041) $(415)
Reclassification adjustments for (gains) losses realized in net income 3,712 1 (27)
------- ------- -----
Net change in unrealized loss $ 2,432 $(2,040) $(442)
======= ======= =====
The deferred tax benefit arising from the unrealized holding losses is offset by
the valuation allowance.
Segment Reporting
Pursuant to Statement of Financial Accounting Standards No. 131 ("SFAS No.
131"), "Disclosure about Segments of an Enterprise and Related Information," the
Company has determined, based on its internal system of management reporting and
since it assesses performance as a single operating unit, that in the years
ended July 31, 2000, 1999 and 1998, it operated in only one segment.
Gross sales of similar products for that segment are as follows:
2000 1999 1998
------- ------- -------
(In thousands)
In-line Skates $20,625 $19,876 $24,924
Canopies 10,540 7,084 4,071
Trampolines 9,065 - -
Skateboards and Scooters 8,923 5,767 7,757
Other 8,706 6,151 7,532
------- ------- -------
Total gross sales 57,859 38,878 44,284
Returns and allowances (2,658) (1,508) (1,136)
------- ------- -------
Total net sales $55,201 $37,370 $43,148
======= ======= =======
Reclassifications
Certain reclassifications have been made to the 1999 and 1998 financial
statements to conform with the 2000 presentation.
2. INVESTMENTS
Available-for-sale securities consist of the following:
Available-for-Sale Securities
-------------------------------------------------------------
Gross Gross Estimated
Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
(In thousands)
July 31, 2000
Corporate and high-yield bond mutual funds $ - $ - $ - $ -
======= ======== ======= =======
July 31, 1999:
Corporate and high-yield bond mutual funds $22,324 $ - $ 2,432 $19,892
======= ======== ======= =======
The Company experienced a net realized loss of $3,712,000, a net realized gain
of $1,000, and a net realized gain of $27,000 on sales of available-for-sale
securities during the fiscal years ended July 31, 2000, 1999, and 1998
respectively. The net adjustments to unrealized holding losses on available-
for-sale securities as of July 31, 2000 and 1999 are reflected in accumulated
other comprehensive loss. In fiscal 2000, the Company sold all of its
investment in bond mutual funds.
3. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
July 31
-------------------------
2000 1999
------- -------
(In thousands)
Computer equipment $ 469 $ 419
Trade show assets 226 159
Machinery and equipment 261 255
Furniture and fixtures 202 197
Leasehold improvements 173 166
Molds, dies and tooling equipment 3,743 3,734
------- -------
5,074 4,930
Less accumulated depreciation and amortization (4,813) (4,647)
------- -------
$ 261 $ 283
======= =======
4. REVOLVING LINE OF CREDIT
As of July 31, 2000, the Company had a $8,000,000 revolving line of credit with
a major bank for the issuance of commercial letters of credit. The credit line
matures on December 31, 2001. The agreement is secured by inventory and
receivables and requires the Company to comply with certain financial ratios and
covenants.
As of July 31, 2000, letters of credit in the amount of $3,824,000 were open for
the receipt of future merchandise. Of this amount, $957,000 is recorded as trade
acceptances in the accompanying consolidated balance sheet at July 31, 2000 and
$2,867,000 has not been reflected on these financial statements since title to
the merchandise has not yet passed to the Company.
5. NOTE PAYABLE
The Company has an outstanding promissory note payable, as described in Note 11,
which consists of the following:
July 31
------------------
2000 1999
---- ----
(In thousands)
Note Payable (approximates fair value) $1,142 $ -
Less current maturities 200 -
------ ------
$ 942 $ -
====== ======
Aggregate future maturities of the note payable are as follows:
Maturities
--------------
In thousands)
Years ending July 31:
2001 $ 200
2002 200
2003 200
2004 200
2005 200
Thereafter 600
------
1,600
Less imputed interest (458)
------
$1,142
======
6. COMMITMENTS AND CONTINGENCIES
Litigation
The Company is involved in various claims arising primarily from sales of
products in the normal course of business. Management has recorded a $414,000
allowance for product liability losses at July 31, 2000 ($267,000 at July 31,
1999). In addition, the Company carries product liability insurance on its
products. In the opinion of management, any additional liability to the Company
arising under any pending product liability litigation would not materially
affect its financial position, cash flow or results of operations.
In March 1998, the Company was served with two lawsuits alleging that the
Company's Quik Shade(R) product infringed on patents owned by the plaintiffs.
The Company filed counterclaims in both lawsuits. In September 1998, the
Company received a demand for defense and indemnification which was virtually
identical to one of the March 1998 lawsuits. In April and May 2000, the Company
entered into settlement agreements with the plaintiffs in the two lawsuits and
all claims and counterclaims were dismissed.
In October 1999, the Company was served with a Complaint for Declaratory Relief
filed by SAFECO Insurance Company of America ("SAFECO"), which previously had
agreed to provide the Company with a defense in one of the lawsuits, subject to
a reservation of rights to deny certain coverage. The Company filed a cross-
complaint against SAFECO for claims arising out of the patent infringement
lawsuits. In October 2000, the Company and SAFECO entered into an agreement to
settle all claims and cross-claims, with SAFECO agreeing to make a final cash
payment to the Company. All legal and related charges are recorded net of
insurance recoveries in the accompanying financial statements.
In July, 2000, the Company was served with a lawsuit filed by a previous
employee alleging wrongful termination and other unlawful employment practices.
The Company believes it has meritorious defenses for this action and intends to
conduct a vigorous defense. The Company currently believes the outcome of this
matter will not have a materially adverse effect on its financial position, cash
flow, or results of operations.
However, there can be no assurance that an adverse outcome of these matters will
not have a material adverse effect on the Company's financial condition.
Lease Commitments
The Company leases warehouse and office facilities under an operating lease that
requires minimum monthly payments of $35,000, and also provides for the lessee
to pay property taxes, insurance, repairs and maintenance and utilities. The
lease expires on December 31, 2005 and is subject to escalation every eighteen
months based on changes in the consumer price index. The Company has an option
to extend this lease for sixty months based on the escalation amount determined
above and the Company has a right of first offer to purchase this facility. The
Company also subleases additional warehouse and office space in an adjacent
building under a separate operating lease requiring minimum monthly payments of
$8,000, which amount includes property taxes and utilities, but which provides
for the Company to pay insurance and repairs and maintenance costs. This
agreement expires June 30, 2001. The Company's subsidiary, Static Snowboards,
Inc., leased office and manufacturing facilities under an operating lease that
required monthly payments of $13,000 and expired in September 2000. The Company
had entered into a sublease agreement with a third party for this facility. The
agreement provided monthly receipts of $13,000 and expired in September 2000.
The Company has no capital leases as of July 31, 2000. Annual future minimum
lease payments under existing operating leases are as follows:
Operating
Leases
----------
(In thousands)
Years ending July 31:
2001 $ 629
2002 562
2003 524
2004 522
2005 and thereafter 213
----------
Total minimum lease payments $ 2,450
==========
Total rent expense was $594,000, $508,000, and $775,000 for the fiscal years
ended July 31, 2000, 1999 and 1998, respectively.
Employment Agreements
The Company has employment and consulting agreements in effect with certain of
its employees. The agreements provide for varying terms of employment
aggregating $349,000 in base compensation during the fiscal year ended July 31,
2001.
29
7. PENSION PLAN
Effective August 1, 1997, the Company established a defined contribution pension
plan covering substantially all of its employees. Company contributions were
determined at the discretion of the Company. Contributions for fiscal 1999 and
fiscal 1998 were zero and $40,000, respectively. Effective August 1, 1999, the
Company amended and restated this plan as a 401(k) profit sharing plan, with the
Company matching contributions determined at the discretion of the Company.
Contributions for fiscal 2000 were approximately $73,000.
8. INCOME TAXES
The (benefit from) provision for income taxes for the fiscal years ended July
31, 2000, 1999 and 1998 is as follows:
2000 1999 1998
------- ------ -------
(In thousands)
Current (benefit) provision:
Federal $ 439 $ 731 $ -
State 149 53 -
------- ------ -------
Total current (benefit) provision 588 784 -
Deferred provision (benefit):
Federal (1,116) (352) (750)
State (205) (56) (3)
------- ------ -------
Total deferred provision (benefit) (1,321) (408) (753)
------- ------ -------
Valuation allowance 733 (196) 1,537
------- ------ -------
$ - $ 180 $ 784
======= ====== =======
Deferred income taxes consist of the tax effect of timing differences related to
the following components:
2000 1999
------- -------
(In thousands)
Deferred tax assets:
Unrealized loss on marketable securities $ - $ 962
Realized loss deductible against capital gains 1,470 -
Inventory valuation allowances 345 464
Inventory 206 369
Warranty allowances 319 334
Allowances for losses on receivables 167 274
Sales return allowances 349 170
Product liability 164 106
Product recall 693 -
Other 395 612
------- -------
Total deferred tax assets 4,108 3,291
Deferred tax liabilities:
Depreciation (168) (168)
Unremitted earnings of Oketa (197) (115)
Prepaid Insurance (81) (80)
Insurance receivable (396) -
Other - (21)
------- -------
Total deferred tax liabilities (842) (384)
------- -------
Net deferred tax assets 3,266 2,907
Valuation allowance (2,074) (2,303)
------- -------
$ 1,192 $ 604
======= =======
30
During fiscal 1998, due to the net operating losses for the fiscal years ended
July 31, 1998 and 1997, the Company established a valuation allowance against
the fiscal 1997 deferred tax asset of $784,000 and the fiscal 1998 net deferred
tax benefit of $753,000 in accordance with Statement of Financial Accounting
Standard No. 109 "Accounting for Income Taxes." The deferred tax benefit and
related valuation allowance on the unrealized loss on marketable securities is
reflected in equity.
A reconciliation of the statutory federal income tax rate to the effective tax
rate, as a percentage of income before taxes based on income, follows:
2000 1999 1998
---- ---- ----
Statutory federal income tax rate (34%) 34% (35%)
Valuation allowance 32 (18) 56
Tax exempt interest income - - (6)
Non-deductible stock warrants - - 9
Other non-deductible expenses 2 2 5
--- --- ---
-% 18% 29%
=== === ===
Pretax income (loss) earned by Oketa amounted to $328,000, $(32,000), and
$431,000 in fiscal 2000, 1999 and 1998, respectively, and is not subject to Hong
Kong tax as provided under that country's taxation requirements. The Company
provides deferred taxes on Oketa's income until such income is repatriated to
the United States.
9. Stock Option Plans
In April 1993, the Company established a non-qualified stock option plan (the
Plan) to grant stock options to one of its officers. Under the Plan, stock
options were granted each April through April 1997. Each of these grants shall
vest cumulatively at 20% per year over five years. The options are exercisable
over ten years at an exercise price of $0.0004 per share. The number of shares
granted at each grant date will have an aggregate fair market value of $20,000
as of such grant date. The Company has granted options to purchase a total of
20,129 shares of the Company's common stock under the Plan. The Company has
recorded compensation expense related to these options.
On April 1, 1994, the stockholders of the Company approved the 1994 Variflex
Stock Plan (the 1994 Stock Plan) which became effective at the initial public
offering date of June 17, 1994. Under the 1994 Stock Plan, options, stock
appreciation rights (SARS) and bonus stock may be granted for the purpose of
attracting and motivating deserving employees and directors of the Company. The
exercise price of the options is to be not less than the market price of the
common stock at the time of grant with respect to incentive stock options, and
not less than 85% of the market price of the common stock at the time of grant
with respect to non-qualified options. The maximum number of shares reserved for
issuance under the 1994 Stock Plan is 600,000. At July 31, 2000, 312,500 shares
are available for grant under the 1994 Stock Plan.
In June 1997, the Company terminated certain incentive stock option plans and
stock options granted in April 1994 for the purchase of 280,000 shares of common
stock at $15.50 per share. In connection with the termination of these stock
options and stock option plans the Company granted to certain officers and
employees of the Company incentive stock options, under the 1994 Stock Plan, for
the purchase of an aggregated amount of 145,000 shares of the Company's common
stock. The options vest over the next two to five years, with exercise prices
ranging from $5.00 to $5.50 per share and are exercisable over 10 years from the
date of grant.
On March 16, 1998, the Company established the 1998 Stock Option Plan for Non-
Employee Directors (the 1998 Stock Plan) for the purpose of attracting and
retaining experienced and knowledgeable non-employee directors of the Company.
Under the 1998 Stock Plan, each non-employee director receives an option to
purchase 4,000 shares of common stock of the Company upon being appointed or
elected as a director, and an option to purchase 2,000 shares as an annual
retainer upon being re-appointed or re-elected as a director. The exercise
price of the options is to be not less than the market price of the common stock
at the time of grant. The options vest on the first business day prior to the
first anniversary of the date of grant and are exercisable over 10 years from
the date of grant. The maximum number of shares reserved for issuance under the
1998 Stock Plan is 250,000. At July 31, 2000, 234,000 shares are available for
grant under the 1998 Stock Plan.
There were no options exercised in the years ended July 31, 2000, 1999 and 1998.
31
A summary of stock option activity and data is as follows:
Options Outstanding
-------------------------------------------
Number Weighted
of Shares Average Price
---------------- -------------------
Balance at July 31, 1997 165,129 $4.6631
Granted 33,000 5.3788
Canceled (12,500) 5.0000
----------------
Balance at July 31, 1998 185,629 4.7676
Granted 134,000 4.6567
Canceled (6,250) 5.0000
----------------
Balance at July 31, 1999 313,379 4.7156
Granted 10,250 5.8034
Canceled - -
----------------
Balance at July 31, 2000 323,629 4.7500
================
Information regarding stock options outstanding as of July 31, 2000 is as
follows:
Options Outstanding Options Exercisable
- -------------------------------------------------------------------------------------- ---------------------------------------
Weighted
Average
Remaining Weighted Weighted
Number Contractual Average Number Average Exercise
Price Range of Shares Life Exercise Price of Shares Price
-------------------------------------------------------------------------------------- ---------------------------------------
$0.0004 20,129 4 years $0.0004 18,015 $0.0004
$4.625 to $6.375 303,500 8 years $5.0650 138,250 $5.1591
The weighted average exercise prices and fair market value of stock options and
warrants (see Note 13) using the Black-Scholes option valuation model were as
follows:
2000 1999
-------------------------------- ---------------------------
Fair Exercise Fair Exercise
Value Price Value Price
------------- ------------- -------------- --------
Exercise price equals market value of stock at date of grant $2.43 $5.80 $1.75 $4.66
The weighted average fair values of 2000 and 1999 stock option grants were
estimated at the date of grant using the Black-Scholes option valuation model
and the following average actuarial assumptions:
2000 1999
---- ----
Risk-free interest rate 5.5 5.5
Expected life 5.0 5.0
Expected volatility .377 .301
Expected dividend yield None None
32
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options. The Company's employee stock options have
characteristics significantly different from those of traded options such as
vesting restrictions and extremely limited transferability. In addition, the
assumptions used in option valuation models (see above) are highly subjective,
particularly the expected stock price volatility of the underlying stock.
Because changes in these subjective input assumptions can materially affect the
fair value estimate, in management's opinion, the existing models do not provide
a reliable single measure of the fair value of its employee stock options.
For purposes of the pro forma disclosure of net income (loss), the estimated
fair value of the stock options and warrants granted in 1998, 1999 and 2000 is
amortized as compensation expense over the options' vesting period. Pro forma
net income (loss) and pro forma diluted income (loss) per share for fiscal 2000,
1999 and 1998 would have been $(2,084,000), $693,000, and $(3,243,000) and
$(.26), $0.12, and $(0.54), respectively. However, the pro forma effect on net
income for 2000 and 1999 is not representative of the pro forma effect on net
income in future years because it does not take into consideration pro forma
compensation expense for future years. Pro forma information in future years
may reflect the amortization of a larger number of stock options granted in
several succeeding years.
10. LICENSE AGREEMENTS
In December 1998, the Company entered into an exclusive license agreement with
another company to manufacture and market a "springless" trampoline. The
Company paid $1,000,000 in cash upon execution of the agreement, $500,000 of
which will be applied towards royalties otherwise payable by the Company. In
December 1999, an additional $500,000 was paid by the Company when a U.S. patent
on this technology was issued. Total royalties and amortization of the license
agreement were $164,000 and $42,000, respectively, during the years ended July
31, 2000 and 1999.
11. PATENTS
In April 2000, the Company purchased a patent which involves a collapsible
canopy with a telescoping roof support structure. The Company purchased the
patent for an initial cash payment of $1,450,000 and a promissory note payable
in installments of $200,000 each to be paid annually over an eight-year period
commencing on August 1, 2000. The note was recorded at its present value of
$1,110,000, based on the Company's estimated incremental borrowing rate of
interest. The total cost recorded for the patent was $2,560,000. Total
amortization of the patent was $88,000 during the year ended July 31, 2000.
12. TREASURY STOCK
In January 1999, the Company purchased 371,279 shares of its common stock, which
were tendered as a result of a self-tender offer, pursuant to a modified Dutch
auction. The shares were purchased at a price of $6.00 per share. In June
1999, the Company, in a private sale transaction, purchased an aggregate of
141,700 shares of its common stock at a price of $5.50 per share pursuant to an
unsolicited offer to sell received by the Company. In December 1999, the
Company purchased 512,075 shares of its common stock, which were tendered as a
result of a self-tender offer, at a price of $6.50 per share. In May 2000, the
Company, in a private sale transaction, purchased an aggregate of 415,911 shares
of its common stock at a price of $5.41 per share pursuant to an unsolicited
offer to sell received by the Company. Treasury stock is recorded at cost,
including all applicable fees and expenses.
13. STOCK WARRANTS
In November 1997, in connection with the acquisition of approximately 28% of the
Company's outstanding common stock from existing shareholders by REMY Capital
Partners IV, L.P., a private investment partnership ("Remy"), the Company
entered into consultation agreements with Remy and Raymond H. Losi, the
Company's co-founder and former Chairman of the Board. As compensation under
those agreements, Remy and Mr. Losi received warrants to purchase 400,000 and
200,000 shares respectively, of the Company's common stock for $5.10 per share,
all of which are currently exercisable until November 2004. The Company
recognized in general and administrative expenses non-cash consulting expenses
of $702,000 in connection with the issuance of those stock warrants. The amount
of consulting expense was determined in accordance with FASB Statement No. 123,
"Accounting for Stock-Based Compensation," and the Company recognized the entire
amount of the expense immediately.
33
Also in connection with the Remy common stock acquisition, Raymond H. Losi, II,
the Company's Chief Executive Officer, received warrants to purchase 100,000
shares of the Company's common stock for $5.10 per share, all of which are
currently exercisable until November 2004.
14. IMPAIRMENT AND SALE OF CERTAIN ASSETS
During fiscal 1998, as required by FASB Statement No. 121, "Accounting for the
Impairment of Long-Lived Assets," the Company considered the operating losses of
its wholly-owned subsidiary, Static Snowboards, Inc., and the continuing
challenges facing the snowboard industry in general and concluded that
impairment of the subsidiary's assets had occurred. Accordingly, an impairment
loss totaling $995,000, representing the excess of the carrying value over the
estimated fair market value of assets, was recognized for write-downs of fixed
assets and write-off of the remaining unamortized balance of goodwill relating
to such subsidiary.
In May 1998, the Company entered into a Purchase and Sale Agreement to sell
certain assets of Static Snowboards, Inc. resulting in no significant gain or
loss. The Company closed its manufacturing factory in California, with the
intention of sourcing snowboards from independent contractors located in Asia.
15. RELATED PARTY TRANSACTIONS
The Company has purchased certain inventories from an entity affiliated with an
officer and stockholder of the Company. Total inventory purchases made from the
related party were approximately $70,000, $1,530,000 and $0 during the years
ended July 31, 2000, 1999 and 1998, respectively. Amounts due to the related
party are recorded in accounts payable and paid under normal terms. Amounts
recorded in accounts payable at July 31, 2000 and 1999 were $0 and $6,000,
respectively.
16. PRODUCT RECALL
In October 2000, the Company announced that it was voluntarily recalling certain
of its X Games helmets which did not comply with all applicable Consumer Product
Safety Commission standards. Approximately 200,000 of these helmets were
shipped by the Company between October 1999 and September 2000, with
approximately 150,000 sold by retailers during that time period. The Company
recorded an estimated product recall charge of $1,750,000 in the fourth quarter
of fiscal 2000. Management believes this represents a reasonable estimate of
the cost of the recall; however, due to the various factors involved in the
estimation, including return rates, replacement periods, and other items, actual
results could substantially differ from this estimate.
34
17. QUARTERLY OPERATING DATA (UNAUDITED)
The following is a summary of unaudited quarterly results of operations:
First Second Third Fourth
---------- -------------- ------------- -----------------
(In thousands, except per share data)
Year ended July 31, 2000:
Net sales $9,503 $10,941 $17,109 $17,648
Gross profit 1,916 2,350 4,077 3,967
Net income (loss) 105 (317) 406 (2,177)*
Net income (loss) per share:
Basic .02 (.06) .08 (.47)*
Diluted .02 (.06) .08 (.47)*
Year ended July 31, 1999:
Net sales $8,876 $10,626 $10,395 $ 7,473
Gross profit 1,654 2,739 2,398 707
Net income 108 131 318 246
Net income per share:
Basic .02 .02 .06 .04
Diluted .02 .02 .06 .04
* Net loss and net loss per share include $3,399,000 realized loss on sales of
marketable securities and $1,750,000 product recall charge, and are reduced by
the insurance recovery discussed in Note 6.
35
VARIFLEX, INC.
VALUATION AND QUALIFYING ACCOUNTS
Three years ended July 31, 1999
Additions
Balance at Charged Write-offs Balance
Beginning to Charged to At End
of Period Expense Allowance of Period
--------------- ----------------- ---------------- ----------
Year ended July 31, 2000:
Reserves and allowances deducted from asset accounts:
Allowance for uncollectable accounts $430,000 $ 10,000 $ 19,000 $421,000
Year ended July 31, 1999:
Reserves and allowances deducted from asset accounts:
Allowance for uncollectable accounts $413,000 $ 95,000 $ 78,000 $430,000
Year ended July 31, 1998:
Reserves and allowances deducted from asset accounts:
Allowance for uncollectable accounts $549,000 $(24,000) $112,000 $413,000
36
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
Not applicable.
PART III
Item 10. Directors and Executive Officers of the Registrant.
Item 11. Executive Compensation.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
Item 13. Certain Relationships and Related Transactions.
Except as noted in the following paragraph, the information required by
Items 10, 11, 12 and 13 is included in the Company's definitive Proxy Statement
to be filed pursuant to Regulation 14(A) not later than 120 days after the close
of fiscal 2000 in connection with the Company's 2000 Annual Meeting of
Stockholders, and is therefore incorporated herein by reference.
Additionally, with respect to information called for by Item 10 regarding
executive officers and directors of the Registrant, reference is made to the
information following Item 4 under Part I of this Report.
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
Financial Statements
The following financial statements are included in Part II, Item 8 of this
Annual Report on Form 10-K:
Independent Auditors' Report on Consolidated Financial Statements and
Schedule
Consolidated Balance Sheets as of July 31, 2000 and 1999
Consolidated Statements of Operations for the years ended July 31, 2000,
1999 and 1998
Consolidated Statements of Stockholders' Equity for the years ended July
31, 2000, 1999 and 1998
Consolidated Statements of Cash Flows for the years ended July 31, 2000,
1999 and 1998
Notes to Consolidated Financial Statements
Financial Statement Schedules
The following schedules are included in Part II, Item 8 of this Annual
Report on Form 10-K:
Schedule II. Valuation and Qualifying Accounts
Schedules I and III through V are omitted for the reason that they are
not applicable, not required or the information is presented in the
consolidated financial statements or related notes.
Reports on Form 8-K
None
37
EXHIBIT INDEX
Exhibit No. Description Note No.
- ------------------------------------------------------------------------------------------------------------------------------------
3.1 Certificate of Incorporation of the Company (1)
3.2 By-laws of the Company (1)
9.1 Voting Agreement dated November 18, 1997, by and among Raymond H. Losi, Raymond H. Losi, II, (3)
Raymond H. Losi, as Trustee of the 1989 Raymond H. Losi Revocable Trust under Declaration of Trust
dated January 23, 1989, Losi Enterprises Limited Partnership, Raymond H. Losi, II and Kathy Losi,
as Co-Trustees of the Jay and Kathy Losi Revocable Trust dated January 1, 1989, EML Enterprises,
L.P., Eileen Losi, as Trustee of the Eileen Losi Revocable Trust under Declaration of Trust dated
October 13, 1993, Barbara Losi, as Trustee of the 1989 Barbara Losi Revocable Trust under
Declaration of Trust dated January 31, 1989, The BL 1995 Limited Partnership, Raymond H. Losi, as
Trustee of the Diane K. Losi Trust and Remy Capital Partners IV, L.P.
10.1 Lease for property located at 5152 North Commerce Avenue, Moorpark, California, (6)
dated December 1, 1999
10.2 Reserved.
10.3 Reserved.
*10.4 Employment agreement dated April 1, 1994 with Raymond H. Losi II (1)
*10.5 Employment agreement dated April 1, 1994 with Warren Marr (1)
*10.6 Employment agreement dated April 1, 1994 with Paula Coffman (formerly Paula Montez) (1)
*10.7 Employment agreement dated May 11, 1998 with Roger M. Wasserman (4)
*10.8 Employment agreement dated August 24, 1998 with Steven Muellner (4)
*10.9 Consulting Agreement dated November 18, 1997, by and between Variflex, Inc. and Remy Capital (3)
Partners IV, L.P.
*10.9.1 First Amendment dated November 18, 1999, to the November 18, 1997 Consulting Agreement by and (6)
between Variflex, Inc. and Remy Capital Partners IV, L.P.
*10.10 Consulting Agreement dated November 18, 1997, by and between Variflex, Inc. and Raymond H. Losi (3)
*10.10.1 First Amendment dated December 21, 1999, to the November 18, 1999 Consulting Agreement by and (6)
between Variflex, Inc. and Raymond H. Losi
*10.11 Indemnification agreement dated April 1, 1994 with Raymond H. Losi (1)
*10.12 Indemnification agreement dated April 1, 1994 with Raymond H. Losi II (1)
*10.13 Indemnification agreement dated April 1, 1994 with Loren Hildebrand (1)
*10.14 Indemnification agreement dated September 17, 1998 with Mark S. Siegel (4)
*10.15 Indemnification agreement dated September 17, 1998 with Michael T. Carr (4)
10.16 Indemnification agreement dated September 17, 1998 with Steven Muellner (4)
10.17 Indemnification agreement dated September 17, 1998 with Roger M. Wasserman (4)
10.18 License Agreement with Rollerblade, Inc. dated September 1, 1993 (1)
10.19 1994 Variflex Stock Plan dated April 1, 1994 (1)
10.20 Business Loan Agreement dated March 31, 2000, between Bank of America, N. A. and Variflex, Inc. (6)
10.21 Security Agreement dated March 31, 2000, between Bank of America, N.A. and Variflex, Inc. (6)
10.22 Reserved.
10.23 Reserved.
10.24 Stock Purchase Agreement dated November 18, 1997, by and between Remy Capital Partners IV, L.P., (3)
The RHL Limited Partnership, EML Enterprises, L.P. and The BL 1995 Limited Partnership
10.25 Registration Rights Agreement dated November 18, 1997, by and among Variflex, Inc., Remy Capital (3)
Partners IV, L.P. and Raymond H. Losi, II
10.26 Warrant to purchase Variflex, Inc. Common Stock issued to Remy Capital Partners IV, L.P. (3)
38
Exhibit No. Description Note No.
- ---------------------------------------------------------------------------------------------------------------------------------
*10.27 Warrant to purchase Variflex, Inc. Common Stock issued to Raymond H. Losi (3)
*10.28 Warrant to purchase Variflex, Inc. Common Stock issued to Raymond H. Losi, II (3)
*10.29 1994 Stock Option Plan, as amended (4)
*10.30 Non-Employee Directors Compensation Plan (4)
*10.31 Exclusive License Agreement dated December 1, 1998, by and between Variflex, Inc., on the one hand (6)
and Product Resource & Development Inc. and Rolland Wayne Rich, on the other hand
21.1 Subsidiaries of the registrant (2)
27.1 Financial Data Schedule (6)
- ---------------------------------------------------------------------------------------------------------------------------------
(1) Previously filed together with the Company's Registration Statement on Form
S-1, Reg. No. 33-77362.
(2) Previously filed together with the Company's annual report on Form 10-K
(file no.: 0-24338) on October 24, 1995.
(3) Previously filed together with the Company's report on Form 8-K (file no.:
0-24338) on November 26, 1997.
(4) Previously filed together with the Company's annual report on Form 10-K
(file no.: 0-24338) on October 29, 1998.
(5) Previously filed together with the Company's annual report on Form 10-K
(file no.: 0-24338) on October 20, 1999.
(6) Filed herewith.
* Management contract, compensatory plan or arrangement.
39
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
VARIFLEX, INC.
By /s/ RAYMOND H. LOSI, II
--------------------------------
October 30, 2000 Raymond H. Losi II
Chief Executive Officer (Principal
Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
October 30, 2000 /s/ MARK S. SIEGEL
--------------------------------
Mark S. Siegel
Chairman of the Board
October 30, 2000 /s/ RAYMOND H. LOSI II
--------------------------------
Raymond H. Losi II
Chief Executive Officer (Principal
Executive Officer) and Director
October 30, 2000 /s/ STEVEN L. MUELLNER
-------------------------------
Steven L. Muellner
President
October 30, 2000 /s/ ROGER M. WASSERMAN
-------------------------------
Roger M. Wasserman
Chief Financial Officer (Principal
Financial and Accounting Officer)
October 30, 2000 /s/ KENNETH N. BERNS
-------------------------------
Kenneth N. Berns
Director
October 30, 2000 /s/ MICHAEL T. CARR
-------------------------------
Michael T. Carr
Director
October 30, 2000 /s/ LOREN HILDEBRAND
-------------------------------
Loren Hildebrand
Director
October 30, 2000 /s/ RAYMOND H. LOSI
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Raymond H. Losi
Director
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