10-Q 1 doc1.txt SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 ------ FORM 10-Q (Mark One) [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the quarterly period ended June 30, 2002 ----------------- OR [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the transition period from _______________ to _______________ Commission file number 0-27415 The Topaz Group, Inc. -------------------------------------------------------------------------------- (Exact Name of Registrant as Specified in Its Charter) Nevada 91-1762285 ---------------------------------------- ------------------------------------ (State or Other Jurisdiction (I.R.S. Employer Identification No.) of Incorporation or Organization) . 126/1 Krungthonburi Road Banglampoo Lang, Klongsarn Bangkok 10600 Thailand -------------------------------------------------------------------------------- (Address of Principal Executive Offices) (Zip Code) Registrant's Telephone Number, including area code (425) 392-3144 -------------- - N/A - -------------------------------------------------------------------------------- Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report 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 ---- ----

The Topaz Group, Inc. and Subsidiaries CONSOLIDATED BALANCE SHEETS ASSETS

The accompanying notes are an integral part of these statements. 2 The Topaz Group, Inc. and Subsidiaries CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)

The accompanying notes are an integral part of these statements. 3 The Topaz Group, Inc. and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

The accompanying notes are an integral part of these statements. 4 The Topaz Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) NOTE A - FINANCIAL STATEMENTS The unaudited consolidated financial statements of the Company and its subsidiaries have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles of the United States of America (GAAP) have been condensed or omitted pursuant to such rules and regulations. The results of operations for interim periods are not necessarily indicative of the results to be expected for the entire fiscal year ending December 31, 2002. This Form 10-Q should be read in conjunction with the Form 10-K that includes audited consolidated financial statements for the years ended December 31, 2000 and 2001, and the related consolidated statements of earnings, stockholders' equity and cash flows for the three years in the period ended December 31, 2001. NOTE B - BASIS OF PRESENTATION The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned Thailand subsidiaries, Creative Gems & Jewelry Limited (Creative), Advance Gems & Jewelry Limited (Advance) and Advance Gems Manufacturing Co., Ltd (Advance Manufacturing) (collectively, the Subsidiaries). All significant intercompany accounts and transactions have been eliminated. Except as otherwise disclosed all amounts are in U.S. dollars. NOTE C - INVENTORIES Inventories consist of the following: December 31, June 30, 2001 2002 ------------ ------------- Raw materials $ 981,139 $ 3,091,016 Finished stones 17,200,314 19,684,384 Finished jewelry 823,347 1,579,670 ------------ ------------- $ 19,004,800 $ 24,355,070 ============ ============ 5 The Topaz Group, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) NOTE D - EARNINGS (LOSS) PER COMMON SHARE The components of basic and diluted earnings (loss) per share were as follows:

(1) The dilutive effect of warrants outstanding during each of the presented periods was immaterial to these computations. (2) Excluded from computation due to their anti-dilutive effect. NOTE E - SUBSEQUENT EVENT Subsequent to June 30, 2002, the Company borrowed approximately $220,000 from a company controlled by one of the directors. The borrowing is secured by a 60-day note payable that bears 15% interest and could be extended at the option of the Company for an additional 60-day period. 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion of the financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes thereto. The following discussion contains certain forward-looking statements that involve risk and uncertainties. Our actual results could differ materially from those discussed herein. Factors that could cause or contribute to such differences include, but are not limited to, risks and uncertainties related to the need for additional funds, the rapid growth of the operations and our ability to operate profitably after the initial growth period is completed. We undertake no obligation to publicly release the results of any revisions to those forward-looking statements that may be made to reflect any future events or circumstances. Six and Three Months Ended June 30, 2002 and June 30, 2001 Sales. Total sales for six months ended June 30, 2002 were $10,531,495 compared to $9,486,245 for the six months ended June 30, 2001, an increase of 11%. The increase in sales is primarily attributed to increased revenues during the three months ended March 31, 2002. Revenues for the three months ended June 30, 2002 were $4,906,225, which represents a slight increase from $4,899,963 during the comparable year ago quarter. Sales were relatively flat for the second quarter ended June 30, 2002 compared to the same period of the previous year as a result of continued softness in the U.S. economy. The retail market in the U.S. represented approximately 70% of our annual sales for fiscal 2001. Cost of Goods Sold. Cost of goods sold for the six months ended June 30, 2002 was $8,878,853 representing 84.3% of sales, compared to $6,666,915 for the six months ended June 30, 2001, which represented 70.3% of sales. Cost of goods sold for the three months ended June 30, 2002 was $4,722,456 or 96.3% of sales as compared to $3,386,618 or 69.1% of sales during the three months ended June 30, 2001. The increase in cost of goods sold was due to a combination of the following factors: the recovery of the Thai Baht currency, an increase in the price of gold, an increase in the cost per unit of jewelry, an increase in the consumption of gold in our products, and a shift in product mix. - Recovery of the Thai Baht Currency. We bill 70% of our sales in U.S. dollars. U.S. sales are not affected by fluctuations in the Thai currency. However, we maintain direct and indirect overhead and administrative costs in the Thai currency. As a result, conversions from Thai Baht transactions into U.S. dollars are performed at a higher current rate, as compared to the previous period, because of the increased value of the Baht. - Increase in the Price of Gold. At the time we quote our customer's orders, we typically estimate gold price fluctuations for the period of time in which our customer's orders are in a material procurement, production, and quality inspection stage prior to shipping. However, gold prices unexpectedly increased for orders placed during the six months ending June 30, 2002. Specifically, from the period commencing approximately March 15, 2002 and ending June 30, 2002, gold prices increased approximately $50.00 per ounce. As a result, certain orders were exposed to higher gold prices and resulted in lower margins. 7 - An Increase in the Cost Per Unit of Jewelry. We maintain two specific revenue streams: stone production and jewelry manufacturing. Stones typically represent approximately 40% of total sales and jewelry typically represent approximately 60% of total sales. The overhead costs of stone production is primarily comprised of piecework (labor) and, therefore, direct labor per piece remains the constant per unit production cost. We use salaried skilled labor for jewelry manufacturing. Our sales are highly seasonal so that the fourth quarter of each year can represent as much as 40% of total sales. A reduction in the number of skilled workers during the slower months would significantly adversely impact our production output during our busy months. Jewelry sales for the quarter ended June 30, 2002 decreased by 13% as compared to sales during the quarter ended March 31, 2002, while overhead costs remained constant. As a result, cost per unit of jewelry production rose during the quarter ended June 30, 2002 causing a erosion in our gross margin. - Increase in the Consumption of Gold. We allocate overhead costs to jewelry sales based upon grams of gold consumed in the quarter. Profit margins for gold jewelry products are significantly lower than profit margins for stone or diamond products. Gold consumption in the first and second quarter of the year ending December 31, 2002 was approximately $700,000 and $1,100,000, respectively. Jewelry sales during the three months ended June 30, 2002 as compared to the three months ended March 31, 2002, were relatively flat. However, applied overhead increased by 67% due to an increase in consumption of gold. Over an extended period of time gold consumption should average normal production levels for costing purposes. To address this issue, we are planning to change the method of overhead allocation to allocation on the basis of direct labor hours starting with January 1, 2003. - Shift in Product Mix. We allocate production costs of goods sold based upon the average cost of certain types of stones. Significant shifts in demand to smaller stones cause actual gross margins to fluctuate. We apply an average costing method due to the significant number of product codes we employ which, over an extended period of time, should represent the actual results of the overall flow of costs. Effective July 1, 2002, we implemented the use of codes for sub-groups within stone categories. The sub-groups should improve our overall accuracy in precious gems and semi-precious gems costing when product mix varies significantly. We implemented sub-grouping for diamonds prior to the end of the second quarter. The net effect increased diamond ending inventory values for the quarter ended June 30, 2002 by $356,146 and correspondingly increased net income by the same amount. Selling, General and Administrative Expenses. Selling, general and administrative expenses were $1,106,611, or 22.6% of sales, and $2,027,688, or 19.3% of sales, respectively, for the three and six months ended June 30, 2002, as compared to $1,038,315, or 21.2% of sales, and $1,877,097 or 19.8% of sales, respectively, for the three and six months ended June 30, 2001. The increase is primarily attributed to an increase in administrative salaries. Earnings (Loss) from Operations. Net loss from operations for the three and six months ended June 30, 2002 was ($922,842) and ($375,046), respectively, compared to net earnings from operations of $475,030 and $942,233, respectively, for the three and six months ended June 30, 2002. The losses are primarily due to an increase in the cost of sales. 8 Other Income (Expenses). Other income (expense) was ($262,570) and ($282,319), respectively, for the three and six months ended June 30, 2002, as compared to $500,239 and $1,275,328, respectively, for the three and six months ended June 30, 2001, or a decrease of 152.5% and 122.1%, respectively. The change is primarily due to gains (losses) resulting from currency fluctuations. The remeasurement gain (loss) was ($226,439) and ($295,235), respectively, for the three and six months ended June 30, 2002, compared to $608,779 and $1,290,444, respectively, for the three and six months ended June 30, 2001. The reduced effect of currency fluctuations was principally due to our using U.S. Dollars for a majority of our sales transactions. We implemented a new software package in June 2001 to record the Baht transactions in U.S. dollars as they occur. Recording the transactions as they occur in U.S. dollars is intended to reduce our exposure to currency remeasurement gains and losses. Remeasurement of the ordinary shares for the six months ended June 30, 2002 represents a currency loss on remeasurement of ($295,235). Net Earnings (Loss). Net loss for the three and six months ended June 30, 2002 was ($1,185,412) and ($657,365), respectively, compared to earnings of $975,269 and $2,217,561, respectively, for the three and six months ended June 30, 2001. The difference is largely attributed to an increase in cost of sales and effects of foreign currency fluctuations. Liquidity and Capital Resources Our principal source of working capital is income from operations, borrowings under our revolving credit facilities and short-term loans from a company affiliate. As of June 30, 2002, we had a cash and cash equivalent balance of $720,901 and working capital of $18,795,915. Our operating activities provided cash of $124,713 for the six months ended June 30, 2002 as compared to $85,412 for the six months ended June 30, 2001. The increase in cash provided by operating activities resulted primarily from increases in accounts payable. Our accounts payable balance increased as a result of delayed vendor payments caused by negative operating profits and increases in inventory balances. The net cash provided by financing activities for the six months June 30, 2002 was $449,703 compared to $400,989 for the six months ended June 30, 2001. This net increase is due to new borrowings on our lines of credit. We have line-of-credit arrangements with two Thai financial institutions and a line of credit arrangement with a U.S. financial institution entered into in October 1999, April 2000 and October 2001, respectively. The Thai lines are renewable automatically on a yearly basis and the U.S. line expires in September 2002; the lines are also subject to the banks' periodic reviews resulting in adjustment of our credit limit. The Thai lines bear interest at a rate equal to Thai LIBOR plus two percent (9.25%-10% as of June 30, 2002); the U.S. line bears interest at prime plus 1.25% (6% as of June 30, 2002). The 1999 line is personally guaranteed by two of our directors and collateralized by various real estate properties belonging to us and one of our directors. The 2000 line is also guaranteed by two of our directors and secured by a deed on a real estate property owned by a related party. The U.S. line is secured personally by one of our directors, our U.S. receivables and inventory and by a lien on various Thai real estate properties and fixed assets of a related party. As of June 30, 9 2002, approximately $2,192,910 was available for commercial draft borrowing under both the 1999 and 2000 lines. As of June 30, 2002, the outstanding balance under the Thai lines of credit and the US line of credit were $559,012 and $1,939,517, respectively. The effects on liquidity of carrying large values of inventory can be referenced by days of sales in inventory. On average, for the twelve months ended June 30, 2002 and 2001, inventory would remain on the books for 419 days and 378 days, respectively, until sold. The inventory is classified as a current asset on the balance sheet but restricts the use of working capital until the inventory is sold. The increase in inventory days was caused by the build up of inventories to support the replenishment of inventories with wholesalers and retailers. Inventory is valued by applying a moving average method for valuation. Under this method of valuation, generally, the finished stone inventory does not progressively devalue with age and the prices per carat remain relatively stable. The average cost includes the raw cost of the product plus any additional costs to bring it to its current condition including processing, transportation, insurance and holding costs. Variances in valuation under the moving average cost method occur when stone prices, overhead cost and other related costs, which make up the value of the inventory, vary significantly up or down within the fiscal period. As such, material variances in the inventory costs are identified and valued separately to reflect true value. Our business can be classified into two major groups including sale of finished jewelry and finished stones, to a lesser degree. Most of our finished jewelry is made to order and is shipped when completed. Inventory valuations include the lesser of manufactured cost or market valuation per unit times the quantities on hand. Lower of cost or market is referenced by recent sale prices of the finished stones compared to the cost to produce or acquire such stones. If recent sales of an existing stone are not available, current market price samples in the selling market will dictate the lower of cost or market for valuation purposes. Management believes we have the ability to meet our current and anticipated financing needs for the next twelve months with the facilities in place and funds from operations, however, given our growth prospects, we may need to seek increases in our credit facilities during the upcoming year to sustain further revenue growth. Item 3. Quantitative and Qualitative Disclosures about Market Risk Currency Fluctuations 1. Forward-Looking Statements From time to time, we may make certain statements that contain "forward-looking" information. Words such as "anticipate", "estimate", "project", "believe" and similar expressions are intended to identify such forward-looking statements. Forward-looking statements may be made by management orally or in writing, including, but not limited to, in press releases, as part of the Financial Information or Management's Discussion and Analysis or Plan of Operations and as part of other sections of this registration statement. Such forward-looking statements are subject to certain risks, uncertainties and assumptions, including without limiting those identified below. Should one or more of these risks or uncertainties materialize, or should any of the underlying assumptions prove incorrect, actual results of current and future operations may vary materially from those anticipated, estimated or projected. 10 Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their respective dates. 2. Exchange Rate Information Our Consolidated Financial Statements are prepared in U.S. dollars. The financial statements of our foreign subsidiaries are remeasured into U.S. dollars in accordance with Statement of Financial Accounting Standards No. 52. Fluctuations in the value of foreign currencies cause U.S. dollar amounts to change in comparison with previous periods and, accordingly, we cannot quantify in any meaningful way, the effect of such fluctuations upon future income. This is due to the constantly changing exposure in the Thai Baht for our Thai subsidiaries. As of June 30, 2002, the average daily interbank exchange rate for the Baht was trading at 41.58 Baht to one US dollar. The exchange rate in Thailand has shown signs of recovery in early 2002 and we anticipate this to stabilize through the latter part of 2002. Weakening in the Baht may come from the gap between the U.S. and Thai interest rates giving a further boost to exports. Regions of Thailand continue to promote exports to strengthen their economies. We are unable to predict whether the trends noted above would have a material effect on our future financial condition or the results of operations and, if so, whether such an effect will be positive or negative. 3. Exchange Rate Fluctuation Thai Baht ----------------------------------------------------------- First Qtr Second Qtr Third Qtr Fourth Qtr 2002 High 44.57 43.82 Average 43.80 42.85 Low 43.00 41.26 2001 High 45.00 45.85 45.87 45.07 Average 43.29 45.45 44.98 44.40 Low 42.19 44.68 43.92 43.37 2000 High 38.30 39.45 42.77 44.49 Average 37.96 38.67 40.97 43.44 Low 36.71 37.72 39.10 41.88 Future volatility in the Baht may come from the continued strength in the Thai exports. Other Asian countries are showing overall weakness in exports and large technology industries, with the exception of Japan. Japan's problems are primarily domestic. Asian countries overall will weaken with some support domestically by China and India. We do not anticipate Thailand to be effected by Japan's economic downturn and that of surrounding Asian region's, however; there can be no assurance of this. 11 We anticipate the cost of raw materials, which includes precious and non-precious metals, to show moderate cost decreases in the short-term. 4. Foreign Currency Risk As of June 30, 2001, we had no open forward-contracts. Our Thai subsidiaries keep their books in the Thai Baht currency. As a result, the Thai balances are exposed to currency gains and losses depending upon the currency rate fluctuations when compared to the US dollar for the respective periods. The currency and remeasurement gains and (losses) for the three and six months ended June 30, 2002 and 2001, were ($226,439), ($295,235), $1,290,444, and $608,779, respectively. 5. Interest Rate Fluctuations Our interest expenses and income are sensitive to changes in interest rates. As of June 30, 2002, we had $5,269,931 in interest bearing obligations at various rates, and any fluctuation in the interest rate will have a direct impact on our interest expenses, cash flow and results of operations. PART II OTHER INFORMATION Item 1. Legal Proceedings. None. Item 2. Changes in Securities and Use of Proceeds. None. Item 3. Defaults Upon Senior Securities. None. Item 4. Submission of Matters to a Vote of Security Holders. None. Item 5. Other Information. None. Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits: 99: Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 11 (b) Reports on Form 8-K: There were no reports on Form 8-K filed during the quarter ended June 30, 2002 12 SIGNATURES Pursuant to the requirements 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. Date: August 19, 2002 THE TOPAZ GROUP, INC. By: /s/ Terrance C. Cuff ---------------------------------- Name: Terrance C. Cuff Title: Chief Financial Officer 13

TOPAZ GROUP INC 10-Q