10-Q 1 b311547_10q.txt QUARTERLY REPORT UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarter ended March 31, 2001 or TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ___________ to _______________ Commission file number 001-14600 D.G. JEWELRY INC. (Exact name of registrant as specified in its charter) Province of Ontario N/A ------------------------------- ----------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1001 Petrolia Road Toronto, Ontario Canada M3J 2X7 ----------------------- ---------------------- (Address of principal executive offices) (Zip Code) (416) 665-8844 (Registrant's telephone number, including area code) -------------- Check 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, and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No |_| The number of shares outstanding of the registrant's Common Stock, No Par Value, on May 11, 2001 was 6,649,655 shares. D.G. JEWELRY INC. MARCH 31, 2000 QUARTERLY REPORT ON FORM 10-Q TABLE OF CONTENTS PART I - FINANCIAL INFORMATION

2 SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS This Quarterly Report on Form 10-Q contains forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Forward-looking statements include statements concerning plans, objectives, goals, strategies, future events or performance and underlying assumptions and other statements, which are other statements of historical facts. These statements are subject to uncertainties and risks including, but not limited to, product and service demand and acceptance, changes in technology, economic conditions, the impact of competition and pricing, government regulation, and other risks defined in this document and in statements filed from time to time with the Securities and Exchange Commission. All such forward-looking statements are expressly qualified by these cautionary statements and any other cautionary statements that may accompany the forward-looking statements. In addition, D.G. Jewelry Inc. (the "Company") disclaims any obligations to update any forward-looking statements to reflect events or circumstances after the date hereof. 3 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS D.G.Jewelry Inc. Interim Consolidated Balance Sheets As of March 31, 2001 and December 31, 2000 (Amounts expressed in US dollars) (Unaudited)

4 D.G.Jewelry Inc. Interim Consolidated Statements of Income For the three months ended March 31, 2001 and 2000 (Amounts expressed in US dollars) (Unaudited)

5 D.G.Jewelry Inc. Interim Consolidated Statements of Cash Flows for the three months ended March 31, 2001 and March 31, 2000 (Amounts expressed in US dollars) (Unaudited)

6 D.G.Jewelry Inc. Interim Consolidated Statements of Stockholders' Equity For the Years Ended December 31, 2000 and 1999 (Amounts expressed in US dollars) (Unaudited)

7 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES a) Basis of Consolidated Financial Statements Presentation These Interim Consolidated Financial Statements have been prepared in accordance with Form 10-QSB specifications and, therefore, do not include all information and footnotes normally shown in full annual Financial Statements. These financial statements consolidate, using the purchase method, the accounts of the company and its two wholly-owned subsidiaries, Diamonair, Inc. and Aviv, Inc. All material intercompany accounts have been eliminated. The investment in NETJEWELS.COM is accounted for based on the equity method. b) Principal Activities The company was incorporated in Canada on October 18, 1979. The company is principally engaged in the production and trading of jewelry in Canada and the United States of America. c) Cash and Bank Indebtedness Cash and bank indebtedness includes cash in bank, amounts due to banks, and any other highly liquid investments purchased with a maturity of three months or less. The carrying amount approximates fair value because of the short maturity of those instruments. d) Other Financial Instruments The carrying amount of the company's accounts receivable approximates fair value because of the short maturity of these instruments. e) Long-term Financial Instruments The fair value of each of the company's long-term financial assets and debt instruments is based on the amount of future cash flows associated with each instrument discounted using an estimate of what the company's current borrowing rate for similar instruments of comparable maturity would be. f) Inventory Raw materials and work-in-process are valued at the lower of cost (first-in, first-out basis) or market. Finished goods are valued at the lower of cost or market. Cost is calculated using selling price less normal gross margin. g) Property, Plant and Equipment Property, plant and equipment are recorded at cost and are mainly depreciated on the declining balance basis over their estimated useful lives. Leasehold improvements are amortized on the straight-line basis over the terms of the lease. h) Goodwill Goodwill is the excess of cost over the value of tangible assets acquired on the acquisition of subsidiary companies. It is being amortized on the straight-line basis over 40 years. 8 The valuation and amortization of goodwill is evaluated on an ongoing basis and, if considered permanently impaired, goodwill is written down. The determination as to whether there has been an impairment in value is made by comparing the carrying value of the goodwill to the projected undiscounted net revenue stream to be generated by the related activity. i) Sales Sales represent the invoiced value of goods supplied to customers. Sales are recognized upon delivery of goods and passage of title to customers. j) Foreign Currency Translation The translation of the Interim Financial Statements from Canadian dollars ("CDN$") INTO United States dollars is performed for the convenience of the reader. Balance Sheet accounts are translated using closing exchange rates in effect at the Balance Sheet date and income and expense accounts are translated using an average exchange rate prevailing during each reporting period. No representation is made that the Canadian dollar amounts could have been, or could be, converted into United States dollars at the rates on the respective dates and or at any other certain rates. Adjustments resulting from the translation are included in the cumulative translation adjustments in stockholders' equity. k) Use of Estimates The preparation of Interim Financial Statements requires management to make estimates and assumptions that affect certain reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the Interim Financial Statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. l) Long-Lived Assets On January 1, 1996, the company adopted the provosions of SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of SFAS No. 21 requires that long-lived assets to be held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Management used its best estimate of the undiscounted cash flows to evaluate the carrying amount and have determined that no impairment has occurred. m) Stock Based Compensation In December 1995, FAS No. 123, Accounting for Stock-based Compensation, was issued. It introduced the use of a fair value-based method of accounting for stock-based compensation. It encourages, but does not require, companies to recognize compensation to employees based on the new fair value accounting rules. The company chose to continue to account for stock-based compensation using the using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees", and related interpretations. Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of the company's stock at the measurement date over the amount an employee must pay to acquire the stock. n) Concentrations of Credit Risks The company's receivables are unsecured and are generally due in 90 days. Currently, the company's customers are primarly local, national and international users of jewelry products. The company's receivables do not represent significant concentrations of credit risk as at March 31, 2001, due to the wide variety of customers, markets and geographic areas to which the company's products are sold. 9 o) Net Income and Fully Diluted Net Income Per Weighted Average Common Stock Net income per common stock is computed by dividing net income for the period by the weighted average number of common stock outstanding during the period. Fully diluted net income per common stock is computed by dividing net income for the period by the weighted average number of common stock outstanding during the period, assuming that all stock options were exercised. Stock warrants have not been included in the fully diluted net income per common stock calculations as their inclusion would have been anti-dilutive. 2. CASH SURRENDER VALUE OF LIFE INSURANCE The cash surrender value of life insurance represents the value of life insurance policies of former directors of Aviv, Inc. 3. BANK INDEBTEDNESS The bank indebtedness bears interest at the bank's prime lending rate plus 3/4% per annum. As security, the company has provided a general assignment of accounts receivable, a general security agreement constituting a first charge over all present and future personal property of the company and an assignment of key man life insurance of a director payable to the bank. The facility contains covenants specifying minimum and maximum financial ratios. The agreement contains restrictions on changes in ownership and line of business, on further encumbrances of assets and on the guarantees and other contingent liabilities. 10 4. CAPITAL STOCK a) Authorized March 31, December 31, 2001 2000 $ $ ----------- ------------ An unlimited number of common stock Issued 6,649,655 Common Stock (6,407,780 for December 31, 1999) 12,363,737 12,363,737 1,265,000 Warrants 113,225 113,225 ----------- ----------- $12,476,962 $12,476,962 Proceeds received from issuance of 241,875 (1999-554,250) common shares on exercise of stock options -- 559,922 ----------- ----------- $ -- $ 559,922 b) Stock Option Plan 1996 Plan - 500,000 authorized (all issued) 1998 Plan - 500,000 authorized (all issued) 1999 Plan - 500,000 authorized (433,500 issued) 5. COMPREHENSIVE INCOME The company has adopted Statement of Financial Accounting Standards No. 130 "reporting Comprehensive Income" as of January 1, 1998 which requires new standards for reporting and display of comprehensive income and its components in the financial statements. However, it does not affect net income or total stockholders' equity. The components of comprehensive income are as follows:

11 6. NET INCOME PER COMMON SHARE Net income per common share is computed by dividing net income by the weighted average number of common shares outstanding. Fully diluted income per share is computed by dividing net income by the weighted average number of shares calculated using the "treasury stock" method. 7. CHANGE OF NAME The Company changed the name from "D.G. Jewellery of Canada Ltd." to "D.G. Jewelry Inc." effective July 29, 1999. 12 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the Company's consolidated financial statements and related notes included elsewhere in this Form 10-Q. The Company's future success as a manufacturer and distributor of value-priced, stone-set jewelry will be influenced by several factors including technological developments in the mass production of jewelry, the Company's ability to efficiently meet the design and production requirements of its customers, and the market acceptance of its jewelry. Further factors impacting the Company's operations are increases in expenses associated with continued sales growth, the Company's ability to control costs, management's ability to evaluate the public's tastes and orders to target satisfactory profit margins, the ability to develop and manage the introduction of new designed products, and competition. Quality control is also essential to the Company's success, since customers demand compliance with design and product specifications and consistency of production. The Company's utilization of our high-volume manufacturing techniques sometimes results in excess inventories. In the past, the Company either sold these excess inventories in lots at prices which usually resulted in losses of the Company's investment in labor and overhead and without recovering the Company's full cost of stones, or the Company internally recycled the metal and most stones by disassembling the product, re-melting the gold or silver and removing the stones. This recycling resulted in additional incurred labor and overhead costs. Once Diamante established its factory outlet stores, it provided the Company with an opportunity to sell its excess inventories on more favorable terms. By selling to Diamante, the Company avoids the costs and losses that it had incurred in the past and the Company is afforded a more advantageous method of dealing with its excess inventories. The Company is the primary supplier of products to Diamante and the Company accounts receivable from Diamante is fully secured by all the assets of Diamante, which security interest has been pledged by the Company to The Bank of Nova Scotia for the Company's financing facilities. In addition, the Company performs certain administrative functions for Diamante. Generally, the Company does not provide products pursuant to long-term contracts. The Company has an exclusive jewelry supply contract with Zellers, Inc. of Canada that, pursuant to its terms, is to terminate in December 2004. On November 21, 1997, the Company acquired substantially all of the assets of the wholesale jewelry division of Litton Systems, Inc., which division had operated under the trade name Diamonair, for approximately $5.8 million. The acquisition was accounted for using the purchase accounting method. In accordance with the purchase accounting method, Diamonair's results have been included in the Company's consolidated financial statements since the acquisition date. 13 On February 10, 1998, the Company completed its acquisition of substantially all of the assets of Aviv, Inc., by assuming approximately $4.3 million in debt. The effective date of the acquisition was June 1, 1997. The Company continuously reviews its administrative costs to determine if there are areas where expenses could be reduced through further integration and consolidation of the acquisitions. Although the Company expects to achieve some level of consolidation, these potential cost reductions are limited in many areas because (i) operating in the United States and Canada limits the advantages of consolidating certain accounting and human resources functions and (ii) management believes that maintaining the existing Aviv and Diamonair sales offices and manufacturing facilities will be beneficial for maintenance of those divisions' existing customer relationships and will increase the Company's opportunities in the United States. Fluctuations in the Canadian dollar against other currencies, especially the U.S. dollar, may have a material effect on the Company's results of operations. A substantial portion of the Company's sales and purchases are set in U.S. dollars or are influenced by local currency against the U.S. dollar. To date, the Company has not sought to hedge the risks associated with fluctuations in exchange rates and currently does not have a policy relating to hedging. Results of Operations Three Months Ended March 31, 2001 Compared to Three Months Ended March 31, 2000 Revenues. Revenues for the three months ended March 31, 2001 were approximately $8.8 million, or an approximate 2% increase over the three months ended March 31, 2000 revenues of approximately $8.7 million. The increase was mainly a result of increased sales to the Internet and television customer base. Gross Profit. Gross profit for the three months ended March 31, 2001 increased by approximately $61,000, or approximately 2.2%, to approximately $2.9 million, as compared to approximately $2.8 million for the three months ended March 31, 2000. This was attributed to the increase in gross profit as a percentage of sales and increased sales. Gross profit as a percentage of sales increased from 32.45% for the three months ended March 31, 2000 to 32.50% for the three months ended March 31, 2001. Selling Expenses. Selling expenses for the three months ended March 31, 2001 increased by $40,000, or approximately 7.7%, to $608,697, as compared to $564,775 for the three months ended March 31, 2000. The increase was mainly a result of additions to the Company's sales team. Administrative Expenses. Administrative expenses for the three months ended March 31, 2001 increased by $46,436, or approximately 11.5%, to $446,436, as compared to approximately $400,000 for the three months ended March 31, 2000. The increase was mainly a result of an increase in the number of administrative employees. 14 Interest Expense. Interest expense for the three months ended March 31, 2001, as compared to the three months ended March 31, 2000, increased by approximately $65,000, or approximately 17.5%, to $439,117. This increase was mainly the result of interest rate fluctuations and an increased loan level. As a result of the above factors, net income for the three months ended March 31, 2001 as compared to the three months ended March 31, 2000 increased to $828,615 from $766,465. Liquidity and Capital Resources In April 1997, the Company completed an initial public offering in which it sold 1,265,000 shares of common stock and 1,265,000 warrants to purchase common stock. The Company realized net proceeds of $6.7 million from this offering. The Company may realize additional proceeds from the exercise of the warrants, although there can be no assurance that such warrants will be exercised. The Company currently has an operating line of credit with The Bank of Nova Scotia in the amount of $21.3 million subject to certain margin requirements. The amount available to the Company is equal to 75% to 80% of "eligible accounts receivable", as defined in the Line of Credit Agreement, plus 50% of the inventory values up to a maximum advance against inventory of approximately $10.3 million. The Company utilized the credit line to borrow the $5.8 million and $4.3 million necessary for the acquisitions of Diamonair and Aviv, respectively. The Company's borrowings under the line of credit bear interest at Canadian prime plus 3/4% which at March 31, 2001 amounted to 7.50%. Interest on any borrowings is payable monthly. The Company is in full compliance with all of the banking covenants (including the financial covenants and ratios) and is required to report to its bankers on a monthly basis. The Company's obligations under the revolving credit are secured by a security interest on all of our assets, guaranteed by Diamante and Pegasus, jewelry retail chains owned by Mr. Berkovits' daughter and are further secured by a mortgage on the property owned by a limited partnership controlled by Jack Berkovits and leased to the Company, which mortgage the Company has guaranteed. At March 31, 2001, the Company had loans outstanding from its principal shareholder, Jack Berkovits, of approximately $1,900,000 million, which bear interest at 15% per annum. In May 1999, the Company issued 615,385 shares of common stock and an aggregate of 172,308 warrants exercisable at $8.13 per share in connection with a private placement offering. The exercise price of the warrants is subject to adjustment in certain circumstances. These warrants are exercisable from May 1999 until May 2004. The Company issued 615,385 shares of common stock to Haymarket, LLC, 110,769 warrants to purchase common stock to Haymarket, LLC, and 61,539 warrants to purchase common stock to Oscar Gruss & Son. The Company was required to issue additional shares of our common stock to cover any potential adjustment in the amount of shares of common stock purchased in the May private placement offering. Pursuant to the Common Stock Purchase Agreement between Haymarket, LLC and the Company, the number of shares purchased by Haymarket, LLC was to be adjusted to reflect a reset in the purchase price of the shares acquired according to the following terms: (i) the reset price of the shares was to be 15 the average of the lowest twelve bid prices of the Company's common stock during the applicable reset period (as defined below); (ii) the number of shares of common stock to be issued upon the expiration of each of the two reset periods was to be calculated by the following formula: (307,692.5 (1/2 the number of shares purchased)) x (1,500,000 x 115% - the average of the lowest twelve bid prices of the Company's common stock during the applicable reset period) / (the average of the lowest twelve bid prices of the Company's common stock during the applicable reset period); and (iii) there was to be two reset periods, each reset period consisting of thirty trading days. The Company has not issued any additional shares required to be issued pursuant to the agreement. See "Part II - Item 1 - Legal Proceedings." Pursuant to the terms of the Common Stock Purchase Agreement, the Company had the option to sell, and Haymarket, LLC had agreed to buy, up to a maximum of $2,000,0000 worth of the Company's common stock. The number of shares acquired by Haymarket, LLC was to be calculated according to the following formula: (the dollar amount of the shares the Company has an option to issue (up to a maximum of $2,000,000 worth)) / ($3,000,000 / 100% of the bid price of the shares of the Company's common stock on the trading day immediately preceding the date of the purchase of the additional shares). The issuance of the additional shares was to occur on the earlier of (a) November 13, 1999 or (b) 20 days after the expiration of the second reset period. The Company was required to exercise its option to sell the additional shares within 20 days after the earlier of (a) or (b). The Company did not exercise the option. The net cash used in operating activities decreased by approximately $0.7 million for the three months ended March 31, 2001 over March 31, 2000. The principal use of cash was traced mainly to an increase in accounts receivable and a decrease in accounts payable. This was partially offset by a decrease in inventory levels. The cash flow from bank financing increased by approximately $0.4 million as at March 31, 2001 compared to the previous period in 2000. The Company repaid approximately $0.1 million more in loans. During the period, the Company did not issue any capital stock nor were any options currently outstanding exercised. The Company did not receive any proceeds from the issuance of capital stock during the three months ended March 31, 2001 and March 31, 2000. The Company anticipates that cash flow from operations, as well as borrowings available under the Company's existing credit line will be sufficient to satisfy the Company's credit needs for the next twelve months. In addition, the Company may sell equity securities to raise additional capital as needed. 16 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not Applicable 17 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS In January 2000, Haymarket LLC commenced an action in the Supreme Court of the State of New York, County of New York, and seeking undetermined damages. The complaint alleged that D.G. breached the terms of a Purchase Agreement entered into by the parties. In its defense, D.G. asserted that Haymarket was barred from enforcing the agreement because it had wrongfully and in bad faith manipulated the price of D.G. Jewelry stock downwards. The case was split into separate determinations on the issues of liability and damages, and the issue of liability was tried before a jury in November, 2000. On November 16, 2000, the jury returned a verdict in D.G.'s favor, and the judge thereafter set aside the jury verdict and directed a verdict for Haymarket. On December 13, 2000, the court entered judgment for Haymarket, ordering the delivery of 316,933 shares of D.G.'s stock to Haymarket. D.G. filed a Notice of Appeal on January 4, 2001 and obtained a stay of enforcement on the order requiring delivery of the shares while the appeal is pending. No trial on damages will be scheduled unless D.G. fails to prevail on its appeal. As a result of the contingent liability for damages and costs associated with this litigation should the company's appeal fail, provision has been made at December 31, 2000 for these damages and costs approximating $2,400,000. It is the opinion of management that the amount provided for will be sufficient to cover the ultimate liability, if any. On May 4, 2001, Southridge Capital Management LLC, Cootes Drive LLC and York, LLC commenced an action in the Supreme Court for the State of New York against D.G. Jewelry Inc., Samuel Jacob Berkovits and another, alleging breach of contract, tortious interference with contract, defamation and libel, and seeking compensatory damages, punitive damages and costs. Both will be defending the claim, and will be filing counterclaims. Management believes that the plaintiffs' claims against the company and Mr. Berkovits are entirely without merit. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS None. ITEM 3. DEFAULTS IN SENIOR SECURITIES None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. ITEM 5. OTHER INFORMATION None. 18 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Reports on Form 8-K. The Company did not file any reports on Form 8-K during the three month period ended March 31, 2001. 19 SIGNATURES In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. D.G. JEWELRY INC. Dated: May 15, 2001 By: /s/ Samuel Jacob Berkovits ------------------------------------ Samuel Jacob Berkovits Chairman of the Board, Chief Executive Officer, Chief Financial Officer and President 20

D G JEWELRY INC 10-Q