ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the financial
statements of the Company and the related notes thereto, and the other financial
information included elsewhere in this Report.
Set forth below is a discussion of the financial condition and results of
operations of the Company for the three fiscal years ended December 31, 1999.
Because of the significant effect of the Reorganization on the Company's results
of operations, the Company's historical results of operations and
period-to-period comparisons will not be indicative of future results.
Overview
Net Sales
The Company's net sales are generated from (i) licensing the Marvel
characters for use in merchandise, promotions, feature films, television
programs, theme parks and various other areas; (ii) publishing comic books,
including related advertising revenues; and (iii) marketing and distributing
toys, including toys based on the Marvel characters, proprietary toy products
and toys based on properties licensed to the Company from third parties.
Licensing, publishing and toys have accounted for 10%, 13% and 77%,
respectively, of the Company's net sales for the year ended December 31, 1999.
The Company's strategy is to increase the media exposure of the Marvel
characters through its media and promotional licensing activities, which it
believes will create revenue opportunities for the Company through sales of toys
and other licensed merchandise. In particular, the Company plans to focus its
future toy business on marketing and distributing toys based on the Marvel
characters, which provide the Company with higher margins because no license
fees are required to be paid to third parties and, because of media exposure,
require less promotion and advertising support than the Company's other toy
categories. The Company intends to use comic book publishing to support consumer
awareness of the Marvel characters and to develop new characters and storylines.
The Company records as revenue the present value of licensing fees from its
licensing activities at the time the Company's characters are available to the
licensee and the collection of licensing fees is reasonably assured. Licensing
fees booked as revenue but not yet received are recorded as receivables.
Licensing receivables due more than one year beyond the balance sheet date are
discounted to their net present value.
Operating Expenses: Cost of Sales
There generally is no material cost of sales associated with the licensing
of the Company's characters.
Cost of sales for comic book publishing consists of art and editorial,
printing and distribution costs. Art and editorial costs account for the most
significant portion of publishing cost of sales. Art and editorial costs consist
of compensation to editors, writers and artists. The Company generally hires
writers and artists on a freelance basis but has exclusive employment contracts
with certain key writers and artists.
The Company out-sources the printing of its comic books to an unaffiliated
company. The Company's cost of printing is subject to fluctuations in
commodity-based products such as paper.
Cost of sales for the toy business consists of product and package
manufacturing, shipping and agents' commissions. The most significant portion of
cost of sales is product and package manufacturing. The Company, which utilizes
multiple manufacturers, solicits multiple bids for each project in order to
control its manufacturing costs. A substantial portion of the Company's toy
manufacturing takes place in China. A substantial portion of the Company's toy
manufacturing contracts are denominated in Hong Kong dollars.
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Operating Expenses: Selling, General and Administrative
Selling, general and administrative costs consist primarily of advertising,
royalties, general and administrative, warehousing and store merchandising. The
most significant portion of selling, general and administrative costs is
advertising and royalties.
Advertising expense varies with the Company's product mix.
Royalties are payable on toys based on characters licensed from third
parties, such as World Championship Wrestling, Universal Studios and Sony
Pictures, as well as toys developed by outside inventors. There are no royalty
payments for Marvel-character-based toy products.
General and administrative costs consist of salaries and corporate
overhead.
The Company expects warehousing and store merchandising costs to change
over time in line with the Company's toy sales.
Operating Expenses: Depreciation and Amortization
Depreciation and amortization expense consists of amortization of goodwill
and other intangibles, tooling, product design and development, packaging design
and depreciation expense. Amortization expense increased significantly as a
result of the goodwill created pursuant to the combination of Toy Biz, Inc. and
MEG, which is amortized over an assumed 20-year life.
Tooling and product design and development and packaging design expense,
which are attributable to the toy business, are amortized over the life of the
respective product.
Results of Operations of the Company
Year ended December 31, 1999 compared with year ended December 31, 1998
The Company's net sales increased to $319.6 million for the year ended
December 31, 1999 from $232.1 million in the 1998 period. The increase in net
sales was partially due to the inclusion of twelve months of licensing and
publishing revenues in 1999, while only three months of activity was included in
1998, accounting for an increase of approximately $25.9 million and
approximately $28.3 million in licensing and publishing revenues , respectively.
Toy Biz sales increased by approximately $33.3 million from 1998 to 1999
primarily due to sales of WCW action figures, a product line that was introduced
in 1999 and increased sales of large and small dolls, partially offset by a
decline in the sales of Marvel-related product.
Gross profit increased $64.7 million to $168.8 million for 1999 from $104.1
million in 1998. The inclusion of the licensing and publishing divisions for
twelve months in 1999, while included for only three months in 1998, accounted
for approximately $25.7 million and approximately $11.9 million, respectively,
of the increase while gross profit from the Toy Biz division increased
approximately $27.1 million. Gross Profit as a percentage of net sales increased
to approximately 53% in 1999 from approximately 45% in 1998. The licensing and
publishing divisions produced gross margins of 98% and 44%, respectively. The
gross profit margin for the Toy Biz division increased to 49% in 1999 from 44%
in 1998 due primarily to a higher percentage of promotional products, that
generally have higher gross profit margins, sold during 1999 and various
one-time sales adjustments relating to the Company's acquisition of MEG recorded
in 1998.
Selling, general and administrative expense increased $27.5 million to
$124.6 million in 1999 from $97.1 million in 1998. Selling, general and
administrative expense as a percentage of net sales decreased to approximately
39% in 1999 from approximately 42% in 1998. The selling, general and
administrative expenses for the licensing , publishing and corporate divisions
increased approximately $29.5 million from $5.6 million in 1998 to approximately
$35.1 million in 1999 due to the inclusion of the full-year's activity in 1999.
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The Toy Biz division produced a net decrease of approximately $2.0 million from
$91.5 million in 1998 to $89.5 million in 1999; however, the 1998 period
included $11.7 million of expenses relating to the termination of license
agreements resulting from the Company's integration of MEG's operations which
did not recur in 1999. Discounting the one-time charges from 1998, the Toy Biz
division accounted for an increase of approximately $9.7 million primarily due
to increased advertising and royalty expenses related to increase sales of
promotional items in 1999.
Depreciation and amortization expense decreased $1.2 million to $18.1
million in 1999 from $19.3 million in 1998 primarily due to additional
amortization expense recorded in 1998 related to early write-offs of
discontinued toy products based on Marvel characters as a result of the
Bankruptcy Case.
Amortization of goodwill and other intangibles increased $18.8 million to
$25.9 million in 1999 from $7.1 million in 1998. The increase was due to the
amortization of goodwill created pursuant to the MEG acquisition completed on
October 1, 1998.
Interest expense increased $22.7 million to $32.1 million in 1999 from $9.4
million in 1998, primarily due to $25.4 million in interest on the Senior Notes
in 1999, offset by a reduction in interest expense related to the Bridge Loan
from 1998 to 1999.
As a result of the above, the Company reported a net loss of $33.8 million
in 1999 compared to a net loss of $32.6 million in 1998. The Company reported a
loss per share after preferred dividends of $1.43 in 1999 compared to a loss per
share after preferred dividends of $1.23 in 1998.
Year ended December 31, 1998 compared with year ended December 31, 1997
The Company's net sales increased to $232.1 million for the year ended
December 31, 1998 from $150.8 million in the 1997 period. The increase in net
sales was partially due to the inclusion of $19.6 million in publishing and
licensing revenues in the fourth quarter of 1998 as a result of the acquisition
of MEG on October 1, 1998. Net sales in the toy division increased $61.6 million
to $212.4 million in 1998. Net sales in the domestic boys' toys category
increased $20.1 million to $63.2 million in 1998 due primarily to the
introduction of the WCW/NWO Bashin' Brawlers in the second half of 1998, which
accounted for $17.2 million in net sales. Net sales in the domestic girls' toys
category increased $3.3 million in 1998 to $42.0 million due primarily to the
increased product line of new promotional dolls in 1998. Net sales of domestic
activity toys and other products increased $3.7 million to $31.7 million in 1998
due primarily to shipments of products related to the Godzilla feature film
released in 1998. The Company believes that its net sales in each of its
domestic toy categories was adversely affected by Toys 'R' Us' decision to
eliminate excess inventory through a one-time reduction in inventory that
resulted in significant declines in its purchases from toy manufacturers. Net
sales of toy products sold through the import division increased $16.7 million
to $47.2 million in 1998, due primarily to shipments of Godzilla products in
1998. International net toy sales increased $.7 million to $28.1 million in
1998. The Company recorded sales allowances of $2.9 million in 1998 which were
attributable to the impact of the Merger on the Company's relationship with
certain of its international distributors, compared to $18.0 million of sales
allowances in 1997 that the Company believes were related to the impact of the
Bankruptcy Case on Toy Biz, Inc.'s relationships with its international
distributors.
Gross profit increased $60.2 million to $104.1 million for 1998 from $43.9
million in 1997 in part as a result of lower sales allowances in 1998 described
above. Gross profit as a percentage of net sales increased to approximately 45%
in 1998 from approximately 29% in 1997. The inclusion of MEG's publishing and
licensing operations in the fourth quarter of 1998 resulted in $11.4 million of
additional gross profit. The gross profit of the publishing and licensing
operations as a percentage of publishing and licensing net sales was
approximately 58% in the fourth quarter of 1998.
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Selling, general and administrative expense increased $25.0 million to
$97.1 million in 1998 from $72.1 million in 1997. Selling, general and
administrative expense as a percentage of net sales decreased to approximately
42% in 1998 from approximately 48% in 1997. The increase in selling, general and
administrative expense was partially due to the inclusion of $5.7 million of
publishing and licensing selling, general and administrative expense for the
fourth quarter of 1998. The increase during 1998 was also due to $11.7 million
of expenses relating to the termination of license agreements resulting from the
Company's integration of MEG's operations, as well as a $9.8 million increase in
royalty and advertising expense in 1998 primarily related to the success of the
WCW/NWO Bashin' Brawlers.
Depreciation and amortization expense decreased $1.2 million to $19.3
million in 1998 from $20.5 million in 1997 primarily due to additional
amortization expense recorded in 1997 related to early write-offs of
discontinued toy products based on Marvel characters as a result of the
Bankruptcy Case.
Amortization of goodwill and other intangibles increased $6.6 million to
$7.1 million in 1998 from $0.5 million in 1997. The increase was due to the
amortization of goodwill created pursuant to the MEG acquisition completed on
October 1, 1998.
Interest expense increased $8.6 million to $9.4 million in 1998 from $0.8
million in 1997, primarily due to $8.6 million in interest expense on the Bridge
Loan for the fourth quarter of 1998.
As a result of the above, the Company reported a net loss of $32.6 million
in 1998 compared to a net loss of $29.5 million in 1997. The Company reported a
loss per share after preferred dividends of $1.23 in 1998 compared to a loss per
share after preferred dividends of $1.06 in 1997.
Liquidity and Capital Resources
The Company's primary sources of liquidity are cash on hand, cash flow from
operations and cash available from the $60.0 million Citibank working capital
facility. The Company anticipates that its primary needs for liquidity will be
to: (i) conduct its business; (ii) meet debt service requirements; (iii) make
capital expenditures; and (iv) pay Administration Expense Claims.
Net cash provided by the Company's operations during fiscal 1997, 1998 and
1999 was $12.8 million, $42.0 million and $0.8 million, respectively.
At December 31, 1999, the Company had working capital of $91.9 million.
On October 1, 1998, the Company obtained the Bridge Loan from UBS. The
Company used a portion of the proceeds from the Notes Offering to repay the
Bridge Loan on February 25, 1999.
On October 1, 1998, the Company and UBS entered into a $50 million credit
facility. There were no borrowings under that credit facility, and it was
terminated on February 25, 1999.
On February 25, 1999, the Company completed a $250.0 million offering of
senior notes (the "Senior Notes") in a private placement exempt from
registration under the Securities Act of 1933 ("the Act") pursuant to Rule 144A
under the Act. Net proceeds of approximately $239.8 million were used to pay all
outstanding balances under the Bridge Facility and for working capital. The
Senior Notes are due June 15, 2009 and bear interest at 12% per annum. The
Senior Notes may be redeemed beginning June 15, 2004 for a redemption price of
106% of the principal amount, plus accrued interest. The redemption price
decreases 2% each year after 2004 and will be 100% of the principal amount, plus
accrued interest, beginning on June 15, 2007. In addition, 35% of the Senior
Notes may, under certain circumstances, be redeemed before June 15, 2002 at 112%
of the principal amount, plus accrued interest. Principal and interest on the
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Senior Notes are guaranteed on a senior basis jointly and severally by each of
the Company's domestic subsidiaries. On August 20, 1999, the Company completed
an exchange offer under which it exchanged virtually all of the Senior Notes,
which contained restrictions on transfer, for an equal principal amount of
registered, transferable notes whose terms are identical in all other material
respects to the terms of the Senior Notes.
In February 1999, in connection with the repayment of the Bridge
Facility and the termination of the UBS Credit Facility, the Company recorded an
extraordinary charge of approximately $1.5 million, net of tax benefit for the
write-off of deferred financing costs associated with these two facilities.
On April 1, 1999, the Company and Citibank, N.A. ("Citibank") entered an
agreement for a $60.0 million Revolving Credit Facility ("Citibank Credit
Facility"). The Citibank Credit Facility bears interest at either the bank's
base rate (defined as the higher of the prime rate or the sum of 1/2 of 1% plus
the Federal Funds Rate) plus a margin ranging from 0.75% to 1.25% depending on
the Company's financial performance or at the Eurodollar rate plus a margin
ranging from 2.25% to 2.75% depending on the Company's financial performance.
The Citibank Credit Facility requires the Company to pay a commitment fee of
0.625% per annum on the average daily unused portion of the facility unless
there is at least $20.0 million outstanding borrowings in which case the rate is
0.50% per annum for the amount outstanding above $20.0 million. The Company has
not borrowed under the Citibank Credit Facility. The amount available under this
facility is reduced by the amount of letters of credit outstanding, which is
approximately $385,000 as of March 15, 2000. The Citibank Credit Facility is
secured by a lien on all of the Company's inventory and receivables.
On October 1, 1998, the Company sold 9.0 million shares of 8% Preferred
Stock at $10 per share for an aggregate of $90.0 million. The 8% Preferred Stock
pays quarterly dividends on a cumulative basis on the first business day of
January, April, July and October in each year, commencing January 4, 1999.
Dividends are payable, at the option of the Board, in cash, in additional shares
of 8% Preferred Stock or in any combination thereof. The Company is restricted
under the Indenture and under the Citibank Credit Facility from making dividend
payments on the 8% Preferred Stock except in additional shares of 8% Preferred
Stock. Each share of 8% Preferred Stock may be converted, at the option of its
holder, into 1.039 shares of Common Stock. The Company must redeem all
outstanding shares of 8% Preferred Stock on October 1, 2011.
On the consummation date of the Plan, the Company made the Initial
Administration Expense Claims Payment of $20.2 million. In December 1998, the
Company paid approximately $4.2 million of additional Administration Expense
Claims and during 1999 the Company paid an additional $10.4 million of
Administration Expense Claims. The Company estimates that it may be required to
pay between $8.5 million and $10.5 million of additional Administration Expense
Claims, although there can be no assurance as to the amount the Company will be
required to pay.
The Company will be required to make the Unsecured Creditors Cash Payment
at such time as the amount thereof is determined. The Company deposited $8
million into a trust account to satisfy the maximum amount of such payment. The
balance in the trust account as of December 31, 1999 is approximately $8.5
million.
Capital expenditures (excluding acquisitions) by the Company during fiscal
1997, 1998 and 1999 were approximately $17.7 million, $17.3 million and $21.0
million, respectively.
The Company believes that cash on hand, cash flow from operations,
borrowings available under the Citibank working capital facility and other
sources of liquidity, will be sufficient for the Company to conduct its
business, meet debt service requirements, make capital expenditures and pay
Administration Expense Claims.
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Seasonality
The Company's annual operating performance depends, in large part, on its
sales of toys during the relatively brief Christmas selling season. During 1997,
1998 and 1999, 67%, 60% and 62%, respectively, of the Company's domestic net toy
sales were realized during the second half of the year. Management expects that
the Company's toy business will continue to experience a significant seasonal
pattern for the foreseeable future. This seasonal pattern requires significant
use of working capital mainly to build inventory during the year, prior to the
Christmas selling season, and requires accurate forecasting of demand for the
Company's products during the Christmas selling season.