-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, SsuAiQSSqH8rhwtTPT8+hS10b/LfRcyGwvUFGySeHxPTgLHKHXE4vblXHcbXKHsr pJq1jpBhRTG41+WieHvwYQ== 0000912057-02-012934.txt : 20020415 0000912057-02-012934.hdr.sgml : 20020415 ACCESSION NUMBER: 0000912057-02-012934 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 10 CONFORMED PERIOD OF REPORT: 20011231 FILED AS OF DATE: 20020401 FILER: COMPANY DATA: COMPANY CONFORMED NAME: DSI TOYS INC CENTRAL INDEX KEY: 0001034257 STANDARD INDUSTRIAL CLASSIFICATION: WHOLESALE-MISC DURABLE GOODS [5090] IRS NUMBER: 741673513 STATE OF INCORPORATION: TX FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-22545 FILM NUMBER: 02596773 BUSINESS ADDRESS: STREET 1: 1100 W SAM HOUSTON PKWY N STREET 2: STE A CITY: HOUSTON STATE: TX ZIP: 77043 BUSINESS PHONE: 7133659900 10-K 1 a2074077z10-k.txt FORM 10-K 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: COMMISSION FILE NUMBER: DECEMBER 31, 2001 0-22545 DSI TOYS, INC. (Exact name of Registrant as specified in its charter) TEXAS 74-1673513 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 1100 WEST SAM HOUSTON PARKWAY, NORTH HOUSTON, TEXAS 77043 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (713) 365-9900 SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: Title of each class Name of each exchange on which registered ------------------- ----------------------------------------- Common Stock, $.01 par value Nasdaq SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: None 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 voting common stock held by non-affiliates of the Registrant as of March 15, 2002 was $1,934,209. As of March 15, 2002 there were 9,066,365 shares of common stock, $.01 par value, outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the definitive Proxy Statement for the registrant's 2002 Annual Meeting of Shareholders to be held on June 18, 2002, are incorporated by reference in Part III of this Form 10-K. TABLE OF CONTENTS
Page Part I Item 1. Business.............................................................................Page 1 Item 2. Properties..........................................................................Page 13 Item 3. Legal Proceedings...................................................................Page 14 Item 4. Submission of Matters to a Vote of Security Holders.................................Page 14 Part II Item 5. Market for Registrant's Common Equity and Related Shareholder Matters...............Page 15 Item 6. Selected Consolidated Financial Data................................................Page 17 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations............................................................Page 18 Item 7A. Quantitative and Qualitative Disclosures about Market Risk..........................Page 26 Item 8. Financial Statements and Supplementary Data.........................................Page 26 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.............................................................Page 26 Part III General .......................................................................................Page 27 Part IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K....................Page 27 Signatures ....................................................................................Page 28 Index to Consolidated Financial Statements and Schedule............................................F-1 Index to Exhibits..................................................................................E-1
i PART I ITEM 1. BUSINESS GENERAL DEVELOPMENT OF THE BUSINESS Except as otherwise indicated, references to the "Company" refer to DSI Toys, Inc. and its four wholly owned Hong Kong subsidiaries, DSI(HK) Limited ("DSI(HK)"), Meritus Industries Limited, RSP Products Limited and Elite Dolls Limited. The terms "fiscal year" and "fiscal" refer to the Company's fiscal year which is the year ending December 31 of the calendar year mentioned (e.g., a reference to fiscal 2001 is a reference to the fiscal year ended December 31, 2001). Effective December 31, 1999, the Company changed its fiscal year end from January 31 to a calendar year end. The Company designs, develops, markets and distributes high quality, innovative dolls, toys and consumer electronics products. Core products include TECH-LINK -Registered Trademark- communications products, KAWASAKI - -Registered Trademark- electronic musical instruments, GEARHEAD -TM- remote control vehicles, the LAZERDOODLE -TM- electronic drawing toy and a full range of special feature doll brands including SASSY SECRETS -TM-, SOMERSAULT SARA -TM-, TOO CUTE TWINS -TM-, CHILDHOOD VERSES -TM-, PRIDE & JOY -Registered Trademark-, LITTLE DARLINGS -Registered Trademark-, along with interactive plush products including KITTY KITTY KITTENS -Registered Trademark-, FRISKY KITTENS - -TM-, PUPPY PUPPY PUPPIES -Registered Trademark-, and girls' activity products, AIR NAILS SALON -TM-, and TWIST AND TWIRL BRAIDER -TM-. The Company was incorporated in Texas in 1970. Its executive offices are located at 1100 West Sam Houston Parkway North, Houston, Texas, telephone (713) 365-9900. The Company maintains its primary worldwide website at www.dsitoys.com. MERITUS ACQUISITION Effective January 7, 2000, the Company acquired by way of merger Meritus Industries, Inc. ("Meritus"), a privately held toy manufacturer, engaged in the manufacturing and marketing of dolls, doll houses, doll accessories, and girls' toys. As a result of the merger, the Company added the FOREVER GIRL FRIENDS - -Registered Trademark- brand accessories for 11-1/2" fashion dolls, and LITTLE DARLINGS -Registered Trademark- brand value-priced action feature dolls to its product offerings, as well as the ELITE DOLLS -TM- brand, which was created by Meritus specifically to manufacture and market LIFETIME PLAY DOLLS -TM-, a line of exquisite 18" dolls and accessories suitable for playing or collecting. The Company also acquired with the merger with Meritus, three wholly-owned Hong Kong subsidiaries: Meritus Industries Limited, RSP Products Limited, and Elite Dolls Limited, which were engaged in doll manufacturing operations. The Company has transferred the operations of these entities to DSI (HK) and is in the process of liquidating the three acquired subsidiaries. DESCRIPTION OF BUSINESS SEGMENTS AND PRODUCTS The Company has three major product categories which represent the Company's operating segments: Juvenile Audio Products, Girls' Toys and Boys' Toys. Notwithstanding the foregoing, because these operating segments all have similar economic characteristics, the Company has one reportable business segment. For additional information with respect to the Company's business segment reporting, see Note 12 to the Consolidated Financial Statements. JUVENILE AUDIO PRODUCTS The Juvenile Audio Product category consists of Youth Communications products and Musical Instruments. Products in the Youth Communications line include walkie-talkies, wrist watch walkie-talkies, audio products and novelty electronic products. The category brands include TECH-LINK -Registered Trademark- and MICRO LINK -TM- communications products, Harley-Davidson - -Registered Trademark- walkie-talkies and bike alarms, and the Company's new BIOSCAN -TM- 1 ROOM GUARDIAN -TM-, and the LAZERDOODLE -TM- electronic drawing toy. The Musical Instrument line includes the branded line of KAWASAKI -Registered Trademark- guitars, drum pads, saxophones and keyboards. GIRLS' TOYS The Girls' Toys product category includes dolls, interactive plush toys, play sets, accessories, and girls' activity toys. The Girls' Toys portfolio of brands includes SASSY SECRETS -TM-, SOMERSAULT SARA -TM-, TOO CUTE TWINS -TM-, CHILDHOOD VERSES -TM-, PRIDE & JOY -Registered Trademark-, LITTLE DARLINGS - -Registered Trademark-, along with interactive plush products including KITTY KITTY KITTENS -Registered Trademark-, FRISKY KITTENS -TM-, PUPPY PUPPY PUPPIES - -Registered Trademark-, and girls' activity products, AIR NAILS SALON -TM-, and TWIST AND TWIRL BRAIDER -TM-. BOYS' TOYS The Boys' Toys product category includes radio control and infra-red control vehicles. The brands in this product category are GEARHEAD -TM- radio control vehicles, including the INSECTOR -Registered Trademark-, and the unique ultra-articulated STREET SAVAGE -TM-. The GEARHEAD -TM- brand also includes GEARHEAD -TM- JR. infra-red control vehicles. PRODUCT INTRODUCTIONS New product introductions during 2001 included Kawasaki Mega Chords Guitar, Kawasaki Mega Deluxe Drum Pad, TOO CUTE TWINS -TM-, and SUSIE SO SMART -TM- interactive electronic dolls; KITTY KITTY KITTENS -Registered Trademark- plush toys and the unique STREET SAVAGE -TM- radio control vehicle. The following table depicts the Company's net sales, as a percentage of total net sales, by product category for the fiscal years indicated.
Product Category 2001 2000 1999 ---------- ---------- ---------- Juvenile Audio Products 38.8% 39.5% 61.0% Girls' Toys 46.4 39.8 14.5 Boys' Toys 12.6 18.0 19.0 Other 2.2 2.7 5.5 ----- ----- ----- Total 100.0% 100.0% 100.0% ===== ===== =====
The significant increase in Girls' Toys as a percentage of net sales reflects the acquisition of Meritus and its product lines in January 2000. Meritus was engaged in the development, manufacture and marketing of Girls' Toys only. Between 30% and 40% of the Company's products (by dollar volume of net sales) are replaced each year through the introduction of new products. As a result of this turnover, product development is critical to the Company's business. The Company develops both proprietary and non-proprietary products. The Company's proprietary product lines consist of products that (i) are licensed from outside inventors and designers, (ii) incorporate trademarks licensed to the Company, (iii) are designed in-house, or (iv) are manufactured using Company owned tooling, dies and molds based on a proprietary design or idea owned by the Company or the inventor. Proprietary toys accounted for approximately 80%, 78%, and 72% of the Company's net sales for fiscal 2001, 2000, and 1999, respectively. The Company's proprietary products generally yield higher gross margins to the Company than non-proprietary products. Non-proprietary products are defined by the Company as toys designed and manufactured by independent toy manufacturers and marketed by the Company, usually on an exclusive basis in the Company's primary markets. The Company selects its non-proprietary products after an evaluation of several factors, including the quality and pricing of the product, as well as whether the product presents an opportunity for the Company to utilize packaging and marketing to differentiate the product from other toys. The Company often markets these toys under in-house brands, such as TECH-LINK -Registered Trademark- and MY MUSIC MAKER -Registered Trademark-. Non-proprietary products accounted for approximately 20%, 22%, and 28% of the Company's net sales for fiscal 2001, 2000 and 1999, respectively. 2 CUSTOMERS The Company made sales to over 850 different customers in approximately 50 countries during fiscal 2001. The table below sets forth the Company's net sales by geographic area as a percentage of total net sales for the specified fiscal years.
Geographic Area 2001 2000 1999 ---------- ---------- ---------- United States 82.8% 81.1% 77.4% All Foreign Countries 17.2 18.9 22.6
The Company's principal customers are retailers, including mass merchandising discounters such as WalMart, Kmart and Target, specialty toy retailers such as Toys "R" Us, Kay Bee Toy & Hobby and QVC, and deep discount stores such as Family Dollar Stores, Inc., Consolidated Stores Corporation and Value City Department Stores, Inc. The Company's top five customers accounted for approximately 53.2% of the Company's net sales in fiscal 2001. During fiscal 2001, Wal-Mart and Kmart accounted for 21.1% and 10.4%, respectively, of the Company's net sales. In fiscal 2000, Wal-Mart and Toys "R" Us accounted for 18.1% and 11.5% respectively, of the Company's annual net sales. The only customer that accounted for more than 10% of the Company's annual net sales in fiscal 1999 was Wal-Mart (20.8%). During fiscal 2001, the Company's sales to Toys "R" Us, Wal-Mart, Kmart, Target and Kay-Bee Toy & Hobby, the five largest toy retailers in the United States, increased as a percentage of the Company's net sales to 49.2% compared to 46.1% of net sales during fiscal 2000 and 42.5% of net sales during fiscal 1999. The Company does not have long-term contractual arrangements with its customers. The increase in sales in the United States in fiscal 2000 over fiscal 1999, as a percentage of the total net sales, reflects the effects of the addition of Meritus, which historically had minimal international sales. Notwithstanding the foregoing, within the United States the Company and Meritus had very similar customer bases; as a result there was no change in the Company's top five customers due to the Meritus acquisition. MARKETING AND SALES The Company's selling strategy consists of in-house sales personnel and a network of independent, commission-based sales representatives. Significant product presentations are made by either executive management, in the case of new product presentations, or in-house sales personnel. The independent sales representatives manage the day-to-day account administration. New toys are marketed primarily by members of the Company's executive management and sales department at the Company's showrooms in Hong Kong, New York and Dallas during major, international toy shows in those cities (Hong Kong in January, July and September/October, Dallas in January, and New York in February and October). The Company also maintains a showroom at its headquarters in Houston. In international markets, the Company generally sells its products to independent distributors. These distributors retain their own sales representatives and product showrooms where products are marketed and sold. The Company also sells directly to international retailers, principally as a result of contacts made at the Company's showrooms. ADVERTISING In recent years, the Company has allocated the majority of its advertising budget to television promotion, retailer-based programs and print advertising. During 2001, the Company devoted the bulk of its television advertising to the fall and Christmas season, principally to promote TOO CUTE TWINS -TM- and FASHION BUZZ -TM- AIR NAILS SALON -TM-. In addition, during 2001 and 2000 the Company utilized a portion of its advertising budget on print advertising for the PRIDE & JOY -Registered Trademark- product line as well as participating in retailer based programs. The Company expects to continue using promotional programs involving television and consumer magazine advertising of certain, unique proprietary products, as well as year-round public relations programs, participation in national consumer-based toy test awards programs, internet linkages where appropriate, trade advertising and traditional retailer-based ad programs including cooperative promotional ads, special offers and retail catalogues. 3 MANUFACTURING The Company annually contracts with 30 or more independent manufacturers located within a 300-mile radius of Hong Kong, principally in the Peoples' Republic of China (the "PRC"), for the manufacture of its products. The Company may use more than one manufacturer to produce a single product. The manufacturers that accounted for more than 10% of the Company's purchases of products during fiscal 2001 were Wah Lung (16.7%), which manufactured dolls and girls playsets; Potex Toys Manufacturer, Ltd. (11.8%), which manufactured musical instruments and infrared control vehicles; and Loyal Technology Co. Ltd. (10.1%), which manufactured walkie-talkies and audio products. Manufacturing commitments are made on a purchase order basis. The Company does not have long-term contractual arrangements with its manufacturers. Decisions related to the choice of manufacturer for non-proprietary products generally are based on reliability, merchandise quality, price and the manufacturer's ability to meet the Company's or its customers' delivery requirements. Proprietary products designed by the Company are placed with a specific manufacturer whose expertise is in that type of toy. The Company currently has its tooling placed in several different manufacturing facilities and generally receives delivery 60 to 90 days after issuing its purchase orders to the manufacturer. The Company subsidiary, DSI(HK), monitors manufacturing operations, including quality control, production scheduling and order fulfillment from the manufacturers. DSI(HK) utilizes a quality control and assurance staff of degreed engineers and inspectors. The principal materials used in the production of the Company's products are plastics, integrated circuits, batteries, corrugated paper (used in packaging and packing material) and textiles. The Company believes that an adequate supply of materials used in the manufacture and packaging of its products is readily available from existing and alternative sources at reasonable prices. DISTRIBUTION The Company distributes its products either FOB Asia or through direct sales made from inventory maintained at its U.S. distribution facilities. For FOB Asia sales, the customer places its order and provides shipping instructions; the toys are then manufactured and shipped directly from the factory to the customer or its freight consolidator. The Company's primary distribution facility has been located in Houston, Texas. Basic, continuous stock toys that are offered by retailers on a year-round basis have historically been shipped to customers by the Company from its inventory in Houston. During 2001, the Company contracted with a public warehouse fulfillment center in Fife, Washington for a portion of its domestic distribution to increase the speed of distribution to customers of faster-selling television promoted items and to evaluate potential distribution cost savings. In addition, certain faster-selling toys are often shipped directly to major customers for seasonal selling and stocked by the Company in Houston and now Fife for peak season back-up and continuous supply. The Company also maintains inventory which is intended for specific customers for peak holiday season support, as well as some inventory which is available for smaller retailers and for opportunistic selling strategies. The Company decided in March 2002 to consolidate its inventory and transfer all its domestic distribution to the Fife facility during 2002. The decision was based on successful distribution performance and cost savings achieved from using the Fife facility in 2001, along with the expiration of the Company's primary Houston facility lease in August 2002. Most of the Company's larger customers have instituted electronic data interchange ("EDI") programs to reduce the retailers' inventory carrying requirements and place more inventory risk on the supplier. When selling toys out of its domestic inventory, the Company participates in the EDI programs of most of its customers who have established EDI programs, including Wal-Mart, Kmart, Toys "R" Us, Target and Kay-Bee Toy & Hobby. Although these programs require the Company to bear some inventory risk, the Company believes the programs can be utilized to monitor store inventory levels, schedule production to meet anticipated reorders and maintain sufficient inventory levels to serve its customers. 4 LICENSE AGREEMENTS Various license agreements with third parties, including Kawasaki Motors Corp., U.S.A., ("Kawasaki") and inventors, permit the Company to utilize the trademark, character or product of the licensor in its product line. In return, the Company agrees to pay to the licensor a percentage of net sales ("royalty rate") of the licensed product. Typically, these royalty rates range from 4% to 7% of net sales. Sales of licensed products such as the INSECTOR -Registered Trademark- R/C vehicle, the PRIDE & JOY -Registered Trademark- brand dolls, and the KAWASAKI -Registered Trademark- musical instruments accounted for approximately 68%, 59%, and 54% of the Company's net sales during fiscal 2001, 2000, and 1999, respectively. The acquisition of licenses also typically requires the payment of non-refundable advances and/or guaranteed minimum royalties. The Company initially entered into a license agreement with Kawasaki in January of 1994, and that agreement, together with subsequent amendments, and renewals thereof, has authorized the Company to use the KAWASAKI -Registered Trademark- brand name in connection with several different products, including R/C motorcycles, bicycle accessories, walkie-talkies and a complete line of electronic musical instruments, including keyboards, guitars and percussion instruments. The current agreement with Kawasaki expires on December 31, 2002. The Company has commenced negotiations to renew the license for a multi-year period and anticipates entering into such renewal prior to the 2002 year end. The Company has also entered into licensing agreements with Harley-Davidson Motor Company, Inc. for the Harley-Davidson -Registered Trademark- trademarks and service marks for the marketing and sale of communication products, and GM Design Center, General Motors Corporation for the Chevrolet Super Sport Roadster (SSR) trademark and related names, emblems and body designs for the marketing and sale of R/C vehicles. As of December 31, 2001, the aggregate guaranteed royalties payable by the Company under all of its licenses total approximately $150,000 in fiscal 2002 and $225,000 thereafter through fiscal 2003. During fiscal 2001 and 2000, the Company's license strategy has changed to reduce its long-term commitments to licensors in favor of larger advance royalty payments. The Company believes that this strategy will better match royalty liabilities with the product life cycles and minimize potential negative impact on future earnings. The Company believes that by developing licensed products based principally on popular properties and trademarks, it can establish a licensed product portfolio that is characterized by products with a longer life cycle than is typical in the toy industry. The Company intends to continue to develop its licensed product lines by targeting licensing opportunities to take advantage of advertising, publicity and media exposure. COMPETITION The toy industry is highly competitive. Dun & Bradstreet categorizes over 1,000 companies as toy manufacturers. Competitive factors include product appeal, new product introductions, space allocation by the major retailers, price and order fulfillment capability. The Company competes with many companies that have greater financial resources and advertising budgets than the Company, including Mattel, Inc. and Hasbro, Inc., the largest U.S. toy companies. The Company also considers Trendmaster, Inc., The Lego Company, Inc., Playmates Toys, Inc., ToyMax International, Inc., Toy Biz, Inc., KIDdesigns, Inc., and MGA Entertainment to be among its other competitors. In addition, due to the low barriers to entry into the toy business, the Company competes with many smaller toy companies, some of which market single products. SEASONALITY Retail sales of toy products are seasonal, with a majority of retail sales occurring during the Christmas holiday period: September through December. As a result, shipments of toy products to retailers are typically greater in each of the third and fourth quarters than in the first and second quarters combined. This seasonality is increasing as the large toy retailers are becoming more efficient in their inventory control systems. See "Risk Factors." In anticipation of this seasonal increase in retail sales, the Company significantly increases its production during the second quarter in advance of the peak selling period, with a corresponding build-up of inventory levels. This results in significant peaks in the second and third quarters in the respective levels of inventories 5 and accounts receivable, which result in seasonal working capital financing requirements. See "Seasonal Financing." SEASONAL FINANCING The Company's financing of seasonal working capital typically peaks in the third quarter of the year, when accounts receivable are at their highest due to increased sales volume and sales programs, and when inventories are at their highest in anticipation of expected second half sales volume. See "Seasonality." The Company financed its seasonal working capital requirements in 2001 primarily by using internally generated cash and borrowings under its line of credit with State Street Bank and Trust Company (the "Hong Kong Credit Facility") and its revolving line of credit (the "Revolver") with Sunrock Capital Corp. ("Sunrock"). The Hong Kong Credit Facility terminated on November 30, 2001. The Company replaced the Hong Kong Credit Facility with a line of credit with Dao Heng Bank Limited ("Dao Heng Facility") effective December 4, 2001, under terms which are not materially different from the previous facility. Additionally, the Company borrows, as needed, against customers' letters of credit with several Hong Kong banks. The bank is selected based on the most advantageous terms to the Company and as directed by customers. The Company believes that cash flows from operations and amounts available under its lines of credit will be adequate to meet its seasonal requirements. GOVERNMENT AND INDUSTRY REGULATION The Company is subject to the provisions of the Federal Hazardous Substances Act and the Federal Consumer Product Safety Act. Such Acts empower the United States Consumer Products Safety Commission (the "CPSC") to protect the public from hazardous goods. The CPSC has the authority to exclude from the market goods that are found to be hazardous and require a manufacturer to repurchase such goods under certain circumstances. The Company sends samples of all of its marketed products to independent laboratories to test for compliance with the CPSC's rules and regulations, as well as with the product standards of the Toy Manufacturers of America, Inc. ("TMA"). The Company is not required to comply with the product standards of the TMA but voluntarily does so. Similar consumer protection laws exist in state and local jurisdictions within the United States, as well as in certain foreign countries. The Company designs its products to meet the highest safety standards imposed or recommended both by government and industry regulatory authorities. TARIFFS AND DUTIES In December 1994, the United States approved a trade agreement pursuant to which import duties on toys, games, dolls and other specified items were eliminated, effective January 1, 1995, from products manufactured in all Most Favored Nation countries (including the PRC). Increases in quotas, duties, tariffs or other changes or trade restrictions which may be imposed in the future could have a material adverse effect on the Company's financial condition, operating results or ability to import products. On October 12, 2000, federal legislation was signed into law establishing Permanent Normal Trade Relations with the PRC, thereby eliminating the previous risk experienced by the Company that the PRC's Most Favored Nation status would be revoked, which could have subjected the Company to increased duties, supply disruptions and higher costs of goods. INTELLECTUAL PROPERTY Most of the Company's products and product lines are marketed and sold under trademarks, trade names and copyrights, including, without limitation: AIR GUITAR -Registered Trademark-, BIG BAM BOOM -Registered Trademark-, ELITE - -Registered Trademark-, FOREVER GIRLFRIENDS -Registered Trademark-, GEARHEAD -TM-, INSECTOR -Registered Trademark-, PRIDE & JOY - -Registered Trademark-, ROSIE -Registered Trademark-, SASSY SECRETS -TM-, STREET SAVAGE -TM-, SWEET FAITH -Registered Trademark- and TECH-LINK -Registered Trademark-. The Company considers its trademarks and trade names to be significant assets in that they provide product and brand recognition. 6 The Company customarily seeks trademark, or copyright protection, when applicable, covering its products and product lines. Several of these trademarks and copyrights relate to product lines that are significant to the Company's business and operations. While the Company believes that its rights to these properties are adequately protected, there can be no assurance that its rights can be successfully asserted in the future or will not be invalidated, circumvented or challenged. See "Risk Factors." HUMAN RESOURCES As of December 31, 2001, the Company had a total of 95 employees, of whom 47 were based in Houston and 48 were employees of DSI(HK). RISK FACTORS This Risk Factors section is written to be responsive to the Securities and Exchange Commission's "Plain English" guidelines. In this section the words "we", "ours" and "us" refer only to the Company and its subsidiaries and not any other person. CHANGING CONSUMER PREFERENCES, RELIANCE ON NEW PRODUCT INTRODUCTION. Consumer preferences are difficult to predict and the introduction of new products is critical in our industry. Our business and operating results depend largely upon the appeal of our products. A decline in the popularity of our existing products and product lines or the failure of new products and product lines to achieve and sustain market acceptance could result in lower overall revenues and margins, which in turn could have a material adverse effect on our business, financial condition, and results of operations. Our continued success in the toy industry will depend on our ability to redesign, restyle and extend our existing core products and product lines, and to develop, introduce and gain customer acceptance of new products and product lines. As a result of changing consumer preferences, individual products typically have short life cycles of two years or less. There can be no assurance that: - any of our current products or product lines will continue to be popular with consumers for any significant period of time; - any new products and product lines introduced by us will achieve an adequate degree of market acceptance, or that if such acceptance is achieved, it will be maintained for any significant period of time; - any new products' life cycles will be sufficient to permit us to recover development, manufacturing, marketing and other costs of the products. DEPENDENCE ON LIMITED NUMBER OF CUSTOMERS. A small number of our customers account for a large share of our net sales. For fiscal 2001, our five largest customers accounted for approximately 50% of our net sales. Sales to Wal-Mart, Kmart and Toys "R" Us, our three largest customers, accounted for approximately 40% of our net sales during the same period. On January 22, 2002, the Kmart Corporation ("Kmart") filed for Chapter 11 bankruptcy. Kmart was our second largest customer in 2001, comprising 10% of sales. Kmart is requiring normal trade terms from companies desiring to do business with them in 2002, and in return is offering a second-priority lien or "Trade Creditor Lien" in Kmart's owned merchandise inventory. Due to Kmart's market share we have accepted this lien position and will sell to Kmart in 2002. As Kmart is continuing business, and is indicating interest in expanding our line in 2002, it is unknown what effect, if any, Kmart's bankruptcy will have on our 2002 sales. Kmart to date has closed approximately 300 stores, reducing our distribution outlets with Kmart in 2002. We believe however, that based on Kmart's overtures and its strong position with the other primary toy distributors in the United States, the effect will not be material. We expect to continue to rely on Kmart and a relatively small number of other customers for a significant percentage of sales for the foreseeable future. If some of these customers were to cease doing 7 business with us, or to significantly reduce the amount of their purchases from us, it could have a material adverse effect on our business, financial condition and results of operations. LIQUIDITY. Borrowings under the Revolver, the Dao Heng Facility, and the discounting of customers' Letters of Credit with other banks, are utilized by us to finance accounts receivable, inventory, and other operating and capital requirements. We entered into the Revolver, on February 21, 1999, and amended the Revolver on March 30, 2001 to increase the Company's credit line from $10 million to $17.5 million. The Revolver matures March 31, 2004, and contains covenants relating to our financial condition. If we fail to maintain compliance with the financial covenants contained in the Revolver, the maturity date can or will be accelerated, among other remedies which may be pursued by the lender. The Dao Heng Facility was obtained on December 4, 2001, and is subject to periodic review, and may be canceled by the bank upon notice. The discounted letters of credit mature on shipment of goods to customers. DEPENDENCE ON INDEPENDENT DESIGNERS, LICENSES AND OTHER PROPRIETARY RIGHTS. We are dependent on concepts, technologies and other intellectual property rights licensed from third parties, such as rights to trademarks, with respect to several of our proprietary products. For each of these proprietary products and product lines, we typically enter into a license agreement with the owner of the intellectual property to permit us to use the intellectual property. These license agreements typically provide for royalty payments by us to the licensor based on the net sales of the product incorporating the licensed property. For fiscal 2001, net sales of products developed and sold under our license agreements accounted for approximately 68% of our net sales, of which approximately 13% of net sales were attributable to sales of products incorporating the KAWASAKI -Registered Trademark- trademark. The current agreement with Kawasaki expires on December 31, 2002. The Company has commenced negotiations to renew the license for a multi-year period and anticipates entering into such renewal prior to the 2002 year end. The failure to procure new license agreements, renew existing license agreements (on commercially reasonable terms, or at all), or maintain existing license agreements could have a material adverse effect on our business, financial condition and results of operations. In addition to the foregoing, we are dependent on our intellectual property rights and we cannot give assurances that we will be able to successfully protect such rights. We rely on a combination of trade secret, copyright, trademark, patent and other proprietary rights laws to protect our rights to valuable intellectual property related to our proprietary products. We also rely on license and other agreements that establish ownership rights and maintain confidentiality. We cannot assure you that such intellectual property rights can be successfully asserted in the future or will not be invalidated, circumvented or challenged. Laws of certain foreign countries in which our products may be sold do not protect intellectual property rights to the same extent as the laws of the U.S. The failure to protect our proprietary information and any successful intellectual property challenges or infringement proceedings against us could have a material adverse effect on our business, financial condition and results of operations. We do not believe that any of our products infringe on the proprietary rights of third parties in any material respect. There can be no assurance, however, that third parties will not claim infringement by us with respect to current or future products. Any such claim, with or without merit, could be time-consuming, result in costly litigation, cause product shipment delays or require us to enter into royalty or licensing agreements. Such royalty or licensing agreements, if required, may not be available on terms acceptable to us or at all, which could have a material adverse effect on our business, financial condition, and results of operations. INVENTORY MANAGEMENT. Most of our larger retail customers utilize an inventory management system to track sales of products and rely on reorders being rapidly filled by us and other suppliers rather than maintaining large product inventories. These types of systems put pressure on suppliers like us to promptly fill customer orders and also shift a significant portion of inventory risk and carrying costs from the retailer to the supplier. The limited amount of inventory carried by retailers may serve to reduce or delay retail sales of our products. In addition, the logistics of supplying more product within shorter time periods will increase the risk that we fail to achieve tight and compressed shipping schedules. These inventory management systems require us to accurately forecast demand for products. The failure to accurately predict and respond to retail demand could result in our 8 overproducing items, which could in turn result in price markdowns and increased inventory carrying costs for us, as well as underproducing more popular items. RETURNS AND MARKDOWNS. As is customary in the toy industry, we historically have permitted certain customers to return slow-moving items for credit and have allowed price reductions as to certain products then held by retailers in inventory. We expect that we will continue to make such accommodations in the future. Any significant increase in the amount of returns or markdowns could have a material adverse effect on our business, financial condition and results of operations. SEASONALITY. Our business is seasonal and therefore our annual operating results depend, in large part, on our sales during the relatively brief Christmas holiday season. A substantial portion of our net sales is made to retailers in anticipation of the Christmas holiday season. This seasonality is increasing as large toy retailers become more efficient in their control of inventory levels through quick response management techniques. This seasonal pattern requires significant use of working capital mainly to manufacture inventory during the year, prior to the Christmas holiday season, and requires accurate forecasting of demand for products during the Christmas holiday season. During fiscal 2001, 76% of the Company's net sales were made during the third and fourth fiscal quarters. Adverse business or economic conditions during these periods could adversely affect our results of operations for the full year. In addition, failure to accurately predict and respond to consumer demand may have a material adverse effect on our business, financial condition and results of operations. INTERNATIONAL OPERATIONS. Our sales and manufacturing operations outside the United States subject us to risks normally associated with international operations. Various international risks could negatively impact our international sales and manufacturing operations, which could have a material adverse effect on our business, financial condition and results of operations. For the year ended December 31, 2001, our international net revenues comprised approximately 17% of our total consolidated net revenues. We expect international sales to continue to account for a significant portion of our total revenues. In addition, we utilize third-party manufacturers principally located in the PRC. Our international sales and manufacturing operations are subject to the risks normally associated with international operations, including: - limitations, including taxes, on the repatriation of earnings; - political instability, civil unrest and economic instability; - greater difficulty enforcing intellectual property rights and weaker laws protecting such rights; - greater difficulty and expense in conducting business abroad; - complications in complying with foreign laws and changes in governmental policies; - transportation delays and interruptions; - currency conversion risks and currency fluctuations; and - the imposition of tariffs. These risks could negatively impact our international sales and manufacturing operations, which could have a material adverse effect on our business, financial condition and results of operations. During fiscal 2001, three manufacturers accounted for approximately 39% of our purchases of products. The loss of any of these manufacturers, or a substantial interruption of our manufacturing arrangements with any of these manufacturers, could cause a delay in the production of our products for delivery to our customers and could have a material adverse effect on our business, financial condition and results of operations. While we believe that our reliance on external sources of manufacturing can be shifted, over a period of time, to alternative sources of supply, there can be no assurance that alternate arrangements could be provided in a timely manner or on terms acceptable to us. Furthermore, the imposition of trade sanctions by the United States or the European 9 Union against a class of products imported by us from, or the loss of "permanent normal trade relations" status by, the PRC could significantly increase our cost of products imported into the United States or Europe. ACQUISITION RISKS. We may from time to time evaluate and pursue acquisition opportunities on terms that we consider favorable. A successful acquisition involves an assessment of the business condition and prospects of the acquisition target, which includes factors beyond our control. This assessment is necessarily inexact, and its accuracy is inherently uncertain. In connection with such an assessment, we perform a review that we believe to be generally consistent with industry practices. This review, however, will not reveal all existing or potential problems, nor will it permit a buyer to become sufficiently familiar with the acquisition target to assess fully its deficiencies. There can be no assurance that any such acquisition would be successful or that the operations of the acquisition target could be successfully integrated with our operations. Any unsuccessful acquisition could have a material adverse effect on our business, financial condition and results of operations. PRODUCT SAFETY, LIABILITY AND REGULATION. Products that have been or may be developed or sold by us may expose us to potential liability from personal injury or property damage claims by end-users of such products. We currently maintain product liability insurance coverage in amounts which we believe to be sufficient for our business risks. There can be no assurance that we will be able to maintain such coverage or obtain additional coverage on acceptable terms, or that such insurance will provide adequate coverage against all potential claims. Moreover, even if we maintain adequate insurance, any successful claim could materially and adversely affect our business, financial condition, and results of operations. In addition to the foregoing, the CPSC has the authority under certain federal laws and regulations to protect consumers from hazardous goods. The CPSC may exclude from the market goods it determines are hazardous and may require a manufacturer to repurchase such goods under certain circumstances. Some state, local and foreign governments have similar laws and regulations. In the event that such laws or regulations change or in the future we are found to have violated any such law or regulation, the sale of the relevant product could be prohibited, and we could be required to repurchase such products. COMPETITION. The toy industry is highly competitive. Many of our competitors have longer operating histories, broader product lines and greater financial resources and advertising budgets than us. In addition, the toy industry has nominal barriers to entry. Competition is based primarily on the ability to design and develop new toys, procure licenses for popular products, characters and trademarks, and successfully market products. Many of our competitors offer similar products or alternatives to our products. Our products compete with other products for retail shelf space. There can be no assurance that shelf space in retail stores will continue to be available to support our existing products or any expansion of our current products and product lines. There can be no assurance that we will be able to continue to compete effectively in this marketplace. CONTROL BY CURRENT MANAGEMENT. As of March 15, 2002, our directors and executive officers beneficially owned an aggregate of 5,829,120 shares of Common Stock (excluding convertible securities and the shares underlying same), which represents approximately 64% of the total issued and outstanding shares of Common Stock of the Company. As a result, it would be extremely difficult, if not impossible, to obtain majority support for shareholder proposals opposed by management and the Board of Directors. POSSIBLE VOLATILITY OF STOCK PRICE. The market price of the Common Stock has been and may continue to be highly volatile and has been and could be subject to wide fluctuations in response to quarterly variations in operating results, announcements of new products by us or our competitors, changes in financial estimates by securities analysts, or other events or factors. In the event our operating results are below the expectations of public market analysts and investors in one or more future quarters, it is likely that the price of the Common Stock would be materially adversely affected. In addition, general market fluctuations may adversely affect the market price of the Common Stock. 10 EXECUTIVE OFFICERS OF THE REGISTRANT The current executive officers of the Company, all of whom are appointed annually by the Board of Directors to serve at the pleasure of the Board, are as follows:
Executive Officer Name Age Position Since ---- --- -------- ----------------- Joseph S. Whitaker 61 Chief Executive Officer and President 1999 Robert L. Weisgarber 50 Chief Financial Officer 1999 Thomas W. Neville 38 Senior Vice President, Worldwide 1997 Sales Gregory A. Barth 50 Senior Vice President of Worldwide 2001 Operations, Business Planning and Logistics Chan Tit Yu (Alfred Chan) 54 Managing Director of DSI(HK) 2002 William J. Kerner 47 Vice President, 1999 Research and Development Thomas V. Yarnell 48 Administrative Vice President, 1989 Corporate Secretary and General Counsel E. Thomas Martin 58 Chairman of the Board 1999
JOSEPH S. WHITAKER has served as a director since June 1, 1999, and President and Chief Executive Officer since December 1, 2001. He joined the Company on June 1, 1999 as Senior Vice President, New Business Development. He also serves as Vice President of, and owns less than a 1% membership interest in MVII, LLC, a California limited liability company ("MVII") controlled by E. Thomas Martin, Chairman of the Board of Directors. For the five years prior to joining the Company, Mr. Whitaker operated a consulting business in La Jolla, California, providing services related to marketing, licensing and product development to the toy industry. ROBERT L. WEISGARBER has served as Chief Financial Officer of the Company since March 1999. Prior to his employment by the Company, he served as Executive Vice President and Chief Financial Officer for SteelWorks, Inc., an office products manufacturer in Des Moines, Iowa. From 1993 to 1995, he was Vice President, Administration for Texberry Container Corporation in Houston, Texas. THOMAS W. NEVILLE has served as Senior Vice President, Worldwide Sales of the Company since October 1999. He has been employed by the Company since November 1994, serving as Key Accounts Manager from November 1994 through December 1995; National Sales Manager from December 1995 through December 1997; and Vice President, Sales from December 1997 until his promotion to his current position. GREGORY A. BARTH has served as Senior Vice President of Worldwide Operations, Business Planning and Logistics since April 2001. Prior to that, Mr. Barth was President of G.A.B. Sales Consulting from 1990-1997, working for a variety of clients including the Company from April 2000 until being employed by the Company in 2001. 11 CHAN TIT YU (ALFRED CHAN) has served as the Managing Director of the Company's wholly-owned subsidiary, DSI(HK) since January 2002. From 2000 to 2002, he was Director and Chief Operating Officer for Toy Options, Ltd., a UK listed group. He served as Vice President, Product Development and Engineering for PLAYMATES Toys (HK) Ltd. from 1997 to 2000, and was Senior Director, Engineering and Quality for TYCO Hong Kong Ltd. from 1996 to 1997. WILLIAM J. KERNER has served as Vice President of Research and Development of the Company since December 1999. Prior to that, he was Senior Director of Design for Tyco Toys/Mattel, Inc., MatchBox Division from 1995 through December 1999, and Director of Product Design, Matchbox Division at Tyco from 1992 until 1995. THOMAS V. YARNELL has been an employee of the Company since February 1989, serving as Administrative Vice President since October 1989, Corporate Secretary since April 1991, and General Counsel since December 1995. E. THOMAS MARTIN has served as the Chairman of the Board of the Company since June 1, 1999. He is the sole Manager and President of MVII. Mr. Martin is President of Martin Resorts, Inc., a private California corporation which owns and operates coastal hotels in California. Mr. Martin was the Chief Executive Officer and a partner in Martin & MacFarlane, Inc. and Martin Media, L.P., national outdoor advertising companies, until their sale to Chancellor Media in September of 1998. Mr. Martin also manages various real estate ventures. He is the Chairman of the Executive Committee. 12
ITEM 2. PROPERTIES Square Type of Expiration Location Use Feet Possession Dates ------------------------------------------------------------------------------------------------------ Houston, Texas Executive Office, 71,000 Lease 8/31/02 (1) Showroom and Principal (14,000 Office; Warehouse 57,000 Warehouse) Fairfield, New Administrative Office 7,460 Lease 9/30/02 (2) Jersey New York, New Showroom 5,148 Lease 4/30/10 York Hong Kong Administrative Office and 12,877 Lease 3/23/03 Showroom Dallas, Texas Showroom 1,080 Lease 5/31/02 (3) Dallas, Texas Showroom 720 Lease 3/31/02 (4)
(1) The Company does not intend to renew this lease. The Company is in negotiations to lease approximately 16,000 square feet of office space in Houston, Texas for a term of approximately five years for executive offices, showroom and consumer services. The Company anticipates executing the lease in April, 2002 and occupying its new offices on August 1, 2002. The Company contracted during 2001 with Regal Logistics, Inc. ("Regal") in Fife, Washington to provide storage and fulfillment distribution of certain products. A warehousing transition period will occur in 2002 by maximizing inventory shipments to Regal and minimizing inventory shipments to Houston. After the expiration of the current Houston facility lease, the Regal facility will be the Company's primary U.S. distribution facility. The Company anticipates it will lease warehouse space from Regal commencing in June, 2002. (2) The Company intends to terminate this lease effective September 30, 2002 and is seeking to sublease the space until then. (3) The Company has begun negotiations to renew this lease and anticipates executing the renewal in May, 2002. (4) The Company did not renew this lease. In addition to the above listed facilities, the Company leases a small storage facility in Hong Kong, in addition to public warehouse space in Houston to accommodate fluctuating inventory needs. The foregoing properties consist of block, cinder block or concrete block buildings which the Company believes are in good condition and well maintained. 13 ITEM 3. LEGAL PROCEEDINGS The Company is involved in various legal proceedings and claims incident to the normal conduct of its business. The Company believes that such legal proceedings and claims, individually and in the aggregate, are not likely to have a material adverse effect on its financial position or results of operations. The Company maintains product liability and general liability insurance in amounts it believes to be reasonable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of shareholders during the fourth quarter of fiscal 2001. 14 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS MARKET INFORMATION The Company's Common Stock is traded on The Nasdaq Stock Market's SmallCap Market under the symbol "DSIT." Prior to August 17, 1998, the Company's Common Stock was traded on The Nasdaq National Market. The table sets forth, for the periods indicated, the reported high and low close sale prices of the Company's Common Stock as reported on The Nasdaq SmallCap Market:
High Low ---- --- Fiscal Year 2000: 1st Quarter 3.750 2.813 2nd Quarter 3.469 2.188 3rd Quarter 2.813 1.875 4th Quarter 2.844 1.188 Fiscal Year 2001: 1st Quarter 1.938 1.250 2nd Quarter 1.620 1.000 3rd Quarter 1.180 0.950 4th Quarter 1.100 0.750
On February 14, 2002, the Company received notice from the Nasdaq Stock Market Inc. that the Company's common stock had closed below the minimum $1.00 per share requirement for continued inclusion on the Nasdaq SmallCap Market under Marketplace Rule 4310(c)(4) (the "Rule"). If, prior to August 13, 2002, the Company's common stock closes at $1.00 or more for a minimum of 10 consecutive trading days, the Company will receive notification that it is in compliance with the Rule. If compliance is not demonstrated by August 13, 2002, and if the Company does not meet initial listing requirements, the Company will receive notification that its securities will be delisted. If this occurs, the Company may appeal the delisting determination to a Nasdaq Listing Qualifications Panel. STOCKHOLDERS According to the records of the Company's transfer agent, as of March 15, 2002, there were 102 holders of record of the Company's Common Stock. The Company believes that a substantially larger number of beneficial owners hold such shares in depository or nominee form. DIVIDENDS AND DISTRIBUTIONS The Company has never declared nor paid cash dividends on its Common Stock and does not anticipate paying any cash dividends on its Common Stock in the near future. In addition, the Company's credit facility prohibits the payment of dividends. INVESTMENT WARRANT On March 19, 2001, the Company issued to MVII an Investment Warrant to acquire 1.8 million shares of the Company's Common Stock, at a purchase price of $2.7 million. The Investment Warrant is exercisable in whole on in part, for a ten-year period beginning June 3, 2002. The Investment Warrant was subject to certain 15 anti-dilution adjustments. In connection with the issuance of the Investment Warrant, the Company and MVII entered into a Registration Rights Agreement, pursuant to which MVII was granted certain piggyback registration rights with respect to the shares of the Common Stock underlying the Warrant. Shares of Common Stock acquired by MVII upon exercise of the Warrant are subject to the terms of a Shareholders' and Voting Agreement dated as of April 5, 1999, among MVII and certain of the Company's other shareholders. Proceeds from the sale of the Investment Warrant were used by the Company for current working capital. The Investment Warrant was issued by the Company to MVII in reliance on the exemption from registration set forth in Section 4(2) of the Securities Act of 1933, as amended. The Company believes the Section 4(2) exemption from registration was available based upon the established criteria for effecting a private offering by virtue of the following facts, among others: (i) MVII had access to the type of information that would be included in a registration statement, (ii) MVII's principals have adequate financial means to bear the risk of MVII's additional investment in the Company and can be described as sophisticated, (iii) MVII was the only offeree in the transaction, (iv) MVII acquired the Investment Warrant for investment and not with a view toward distribution, (v) the Investment Warrant contains restrictions on resale of the Investment Warrant and the Common Stock issued upon exercise of the Investment Warrant, and (vi) no underwriters were involved nor were any underwriters' commissions paid in connection with the transactions. On January 31, 2002, at the request of NASDAQ and with the agreement of MVII, the Company issued an amended and restated Investment Warrant, which amended and restated in its entirety the Investment Warrant by removing all anti-dilution provisions. In addition, the Company and MVII entered into an Amended and Restated Registration Rights Agreement, which amended and restated in its entirety the Registration Rights Agreement, by removing all of the provisions regarding the anti-dilution provisions of the original Investment Warrant. 16 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA The following table sets forth selected consolidated financial data for the Company. The selected consolidated financial data were derived from the Company's consolidated financial statements. All dollar amounts are stated in thousands, except per share data. The information should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the financial statements and notes thereto included elsewhere in this report.
Statement of Operations Data: December 31, December 31, December 31, January 31, January 31, 2001 2000 1999 1999 1998 --------------- --------------- ------------- --------------- ------------- Net sales $ 67,906 $ 70,438 $ 47,560 $ 52,723 $ 73,624 Income (loss) before income taxes and extraordinary item (1,058) (1,326) 2,150 (1,337) (7,392) Income (loss) before extraordinary item (1,449) (849) 1,281 (1,004) (5,062) Net income (loss) (1,449) (849) 1,281 (1,004) (5,543) Basic earnings (loss) per share before extraordinary item $ (.16) $ (.09) $ .17 $ (.17) $ (.97) Basic earnings (loss) per share $ (.16) $ (.09) $ .17 $ (.17) $ (1.06) Diluted earnings (loss) per share before extraordinary item $ (.16) $ (.09) $ .16 $ (.17) $ (.97) Diluted earnings (loss) per share $ (.16) $ (.09) $ .16 $ (.17) $ (1.06) Balance Sheet Data: December 31, December 31, December 31, January 31, January 31, 2001 2000 1999 1999 1998 --------------- --------------- ------------- --------------- ------------- Working capital $ 9,144 $ 4,536 $ 6,326 $ 391 $ 6,265 Total assets 31,313 29,999 15,027 11,411 19,929 Long-term debt, including capital leases 12,500 10,755 2,393 2,541 7,495 Total liabilities 22,179 22,072 8,038 10,549 18,049 Shareholders' equity 9,134 7,927 6,989 861 1,880
17 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL The following discussion and analysis should be read in conjunction with the financial statements and notes thereto, and the information included elsewhere herein. The Company designs, develops, markets and distributes high quality, innovative dolls, toys and consumer electronics products. Core products include TECH-LINK -Registered Trademark- communications products, KAWASAKI - -Registered Trademark- electronic musical instruments, GEARHEAD -TM- remote control vehicles, the LAZERDOODLE -TM- electronic drawing toy and a full range of special feature doll brands including SASSY SECRETS -TM-, SOMERSAULT SARA - -TM-, TOO CUTE TWINS -TM-, CHILDHOOD VERSES -TM-, PRIDE & JOY -Registered Trademark-, LITTLE DARLINGS -Registered Trademark-, along with interactive plush products including KITTY KITTY KITTENS -Registered Trademark-, FRISKY KITTENS - -TM-, PUPPY PUPPY PUPPIES -Registered Trademark-, and girls' activity products, AIR NAILS SALON -TM-, and TWIST AND TWIRL BRAIDER -TM-. The Company has three major product categories: Juvenile Audio Products, Girls' Toys and Boys' Toys. JUVENILE AUDIO PRODUCTS The Juvenile Audio Product category consists of Youth Communications products and Musical Instruments. Products in the Youth Communications line include walkie-talkies, wrist watch walkie-talkies, audio products and novelty electronic products. The category brands include TECH-LINK -Registered Trademark- and MICRO LINK -TM- communications products, Harley-Davidson - -Registered Trademark- walkie-talkies and bike alarms, and the Company's new BIOSCAN -TM- ROOM GUARDIAN -TM-, and the LAZERDOODLE -TM- electronic drawing toy. The Musical Instrument line includes the branded line of KAWASAKI - -Registered Trademark- guitars, drum pads, saxophones and keyboards. GIRLS' TOYS The Girls' Toys product category includes dolls, interactive plush toys, play sets, accessories, and girls' activity toys. The Girls' Toys portfolio of brands includes SASSY SECRETS -TM-, SOMERSAULT SARA -TM-, TOO CUTE TWINS -TM-, CHILDHOOD VERSES -TM-, PRIDE & JOY -Registered Trademark-, LITTLE DARLINGS - -Registered Trademark-, along with interactive plush products including KITTY KITTY KITTENS -Registered Trademark-, FRISKY KITTENS -TM-, PUPPY PUPPY PUPPIES - -Registered Trademark-, and girls' activity products, AIR NAILS SALON -TM-, and TWIST AND TWIRL BRAIDER -TM-. BOYS' TOYS The Boys' Toys product category includes radio control and infra-red control vehicles. The brands in this product category are GEARHEAD -TM- radio control vehicles, including the INSECTOR -Registered Trademark-, and the unique ultra-articulated STREET SAVAGE -TM-. The GEARHEAD -TM- brand also includes GEARHEAD -TM- JR. infra-red control vehicles. PRODUCT INTRODUCTIONS New product introductions during 2001 included KAWASAKI Mega Chords Guitar, KAWASAKI Mega Deluxe Drum, TOO CUTE TWINS -TM-, and SUSIE SO SMART - -TM-interactive electronic dolls; KITTY KITTY KITTENS -Registered Trademark- plush toys and the unique STREET SAVAGE -TM- radio control vehicle. SIGNIFICANT ACCOUNTING POLICIES Our significant accounting policies are more fully described in Note 2 to our consolidated financial statements. Certain of our accounting policies require the application of significant judgment by management in selecting the appropriate assumptions for calculating financial estimates. By their nature, these judgments are subject to an inherent degree of uncertainty. These judgments are based on our historical experience, terms with current customers, our observance of trends in the industry, information provided by our customers and information available from other outsides sources, as appropriate. Our significant accounting policies include: 18 REVENUE RECOGNITION - The Company recognizes revenue when products are shipped and title passes to unaffiliated customers. In most cases, title transfers to our customers when the product has been presented to shipment forwarders on FOB Asia sales and when the product is picked up from our distribution facilities on domestic sales. The Securities and Exchange Commission's Staff Accounting Bulletin (SAB) No. 101, "Revenue Recognition", provides guidance on the application of generally accepted accounting principles to selected revenue recognition issues. The Company has concluded that its revenue recognition policy is appropriate and in accordance with generally accepted accounting principles and SAB No. 101. ALLOWANCE FOR DOUBTFUL ACCOUNTS - Accounts receivable are reduced by an allowance for amounts that may become uncollectible in the future. The Company's estimate for its allowance is based on two methods which are combined to determine the total amount reserved. First, the company evaluates specific accounts where we have information that the customer may have an inability to meet its financial obligations (bankruptcy, etc.). In these cases, the company uses its judgement, based on the best available facts and circumstances, and records a specific reserve for that customer against amounts due to reduce the receivable to the amount that is expected to be collected. These specific reserves are reevaluated and adjusted as additional information is received that impacts the amounts reserved. Second, a general reserve is established for all other customers based on historical collection and write-off experience. If circumstances change, the Company's estimates of the recoverability of amounts due the Company could be reduced by a material amount. ALLOWANCE FOR RETURNS AND DEFECTIVES - The Company records a provision for estimated sales returns and defectives on sales in the same period as the related revenue is recorded. Our sales to customers generally do not give them the right to return product or to cancel firm orders. However, as is common in the industry, we sometimes accept returns for stock balancing and negotiate accommodations to customers, which includes price discounts, credits and returns, when demand for specific product falls below expectations. Additionally, customers are given credit for any defective products they may have received. The allowance estimates are based on historical sales returns and defective rates, analysis of credit memo data and other known factors. If the data the Company uses to calculate these estimates does not properly reflect future returns and defectives, revenue could be overstated and future operating results adversely affected. INVENTORIES - Inventory is valued at the lower of cost or market. The Company reviews the book value of slow-moving items, discounted product lines and individual products to determine if these items are properly valued. The Company identifies these items and assesses the ability to dispose of them at a price greater than cost. If it is determined that cost is less than market value, then cost is used for inventory valuation. If market value is less than cost, then the Company establishes a reserve for the amount required to value the inventory at market. If the Company is not able to achieve its expectations of the net realizable value of the inventory at its current value, the Company would adjust its reserve accordingly. DEFERRED TAXES - The Company recognizes deferred tax assets and liabilities based on the differences between the financial statement carrying amounts and the tax bases of assets and liabilities. Generally accepted accounting principles require that we review deferred tax assets for recoverability and if needed, establish a valuation allowance for those amounts deemed unrecoverable. The review considers historical taxable income, projected future taxable income, and the expected timing of the reversals of temporary differences. Deferred tax assets of the Company are primarily the result of unused net operating loss carry-forwards and foreign tax credits which expire over a range of years. In 2001, the Company recorded a valuation allowance of $566,000 related to foreign tax credits expiring in 2002, as it was determined that it was more likely than not that these credits would not be realized. GOODWILL - The Company made an acquisition in 2000 that included a significant amount of goodwill and other intangible assets. Under generally accepted accounting principles through December 31, 2001, these assets were amortized over their estimated useful lives, and were to be tested periodically to determine if they were 19 recoverable from future operating earnings over their useful lives. We recorded goodwill amortization expense of $513,396 and $513,360, respectively in 2001 and 2000. Effective in 2002, goodwill will no longer be amortized but will be subject to at least an annual impairment test based on its estimated fair value. Other intangible assets meeting certain criteria will continue to be amortized over their useful lives and also subject to an impairment test. There are many assumptions and estimates underlying the determination, including future cash flow and operating results. Management engaged an independent company to assist in valuing the Company's goodwill at December 31, 2001. Based on this review, at this time an impairment charge is not anticipated. RESULTS OF OPERATIONS The following table sets forth the Company's results of operations as a percentage of net sales for the fiscal years indicated:
2001 2000 1999 ------------ ------------ ------------ Net sales 100.0% 100.0% 100.0% Cost of goods sold 70.7 71.1 71.6 ----- ----- ----- Gross profit 29.3 28.9 28.4 Selling, general and administrative expenses 29.6 28.9 22.8 ----- ----- ----- Operating income (loss) (0.3) 0.0 5.6 Interest expense (1.7) (2.1) (1.3) Other income 0.4 0.2 0.2 ----- ----- ----- Income (loss) before income taxes and extraordinary item (1.6) (1.9) 4.5 Benefit from (provision for) income taxes (0.5) 0.7 (1.8) ----- ----- ----- Net income (loss) (2.1)% (1.2)% 2.7% ===== ===== =====
FISCAL YEAR 2001 COMPARED TO FISCAL YEAR 2000 NET SALES. Net sales during fiscal 2001 decreased $2.5 million, or 3.6%, to $67.9 million, from $70.4 million in fiscal 2000. The decrease was due primarily to reduced sales of Boys' Toys and Juvenile Audio products, partially offset by sales of Girls' Toys. Net sales of Juvenile Audio Products decreased $1.5 million, or 5.2%, to $26.3 million during fiscal 2001, from $27.8 million during fiscal 2000. The major product groups in this category are Youth Communications and Musical Instruments, providing $14.6 million and $11.7 million respectively in 2001 sales, compared to $14.2 million and $13.6 million respectively in 2000. The Youth Communications product group increase reflects sales of EBRAIN -TM- personal communicator, introduced in fall 2001, partially offset by decreases in walkie-talkie sales, due to increased competition in non-branded products. Musical Instruments sales decreased primarily in keyboards, which is a result of decreased warehouse club business with one, non-primary customer. Net sales of Girls' Toys increased $3.5 million, or 12.4%, to $31.5 million in fiscal 2001 from $28.0 million in fiscal 2000. The sales increase in Girls' Toys was driven by the television promoted TOO CUTE TWINS -TM- doll line, the girls activity toy AIR NAILS SALON -TM- and the plush toy KITTY KITTY KITTENS -Registered Trademark-, partially offset by declines in sales of dolls in the PRIDE & JOY -Registered Trademark-, ELITE -Registered Trademark- and other general doll lines. Net sales of Boys' Toys decreased $4.1 million, or 32.4% to $8.6 million during fiscal 2001 from $12.7 million in fiscal 2000. The decrease is due primarily to the discontinuation of the BLOCKMEN -Registered Trademark- line of products sold 20 in 2000 and decreased sales of the primary 2000 R/C vehicle, INSECTOR - -Registered Trademark-, and other boys' items, partially offset by sales of the new 2001 R/C vehicle, STREET SAVAGE -TM-. Net sales of products in other categories decreased approximately $460,000 or 0.5% to $1.5 million during fiscal 2001 from $1.9 million in fiscal 2000. The decrease is attributable to lower sales of games, video phones, doorbells and other discontinued lines, partially offset by increased sales of preschool products. International net sales decreased $1.6 million, or 12.0%, to $11.7 million during fiscal 2001 from $13.3 million in fiscal 2000. The decrease reflects the strength of the U.S. dollar against foreign currencies; thereby negatively affecting sales distributors potential retail price points and margins. International net sales were 17.2% of total net sales for fiscal 2001 as compared to 18.9% of total net sales in fiscal 2000. GROSS PROFIT. Gross profit decreased approximately $400,000 or 2.0% to $19.9 million during fiscal 2001 from $20.3 million in fiscal 2000. Gross profit as a percentage of net sales increased to 29.3% during fiscal 2001 from 28.9% in fiscal 2000. The percentage increase reflects the continued focus on sales of proprietary products, such as the TOO CUTE TWINS -TM- doll, AIR NAILS SALON -TM- girls' activity toy, and the STREET SAVAGE -TM- R/C vehicle, versus lower margin, more volume-driven non-proprietary products. Proprietary products, which were 80% of our total net sales in 2001, generate a higher margin percentage. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses decreased $200,000 to $20.1 million, or 1.3%, during fiscal 2001 from $20.3 million in fiscal 2000. The decrease reflects reductions of approximately $945,000 and $846,000 in advertising and commission expenses, due to lower sales volume. Additionally, professional fees decreased $356,000, as expenses associated with the 2000 Meritus merger were non-reoccuring, along with a $120,000 decrease in various operating expenses. Partially offsetting these decreases, was an approximate $525,000 increase in employee compensation, due to employee additions and a significant increase in receivables' bad debt expense. The $1.7 million provision for uncollectible accounts receivable is primarily related to the January, 2002 bankruptcy filing of K-mart Corp. (SEE NOTE 15 TO CONSOLIDATED FINANCIAL STATEMENTS.) INTEREST EXPENSE. Interest expense decreased approximately $319,000 or 21.6% to $1.2 million in fiscal 2001 from $1.5 million during fiscal 2000. The decrease was due primarily to lower interest borrowing rates in 2001 as compared to 2000. INCOME TAXES. In fiscal 2001, the Company generated a loss before income taxes of $1.0 million compared to a $1.3 million loss before income taxes during fiscal 2000. A significant contributor to the 2001 loss was a $1.7 million provision for uncollectible accounts receivable. The provision is not included in taxable income for 2001, but will be in a future year when the underlying receivables are written-off against the provision. As a result, the Company believes its ability to use Foreign Tax Credits expiring in 2002 has been potentially negated, and therefore has recorded a $566,000 valuation allowance for the credits in 2001. NET LOSS. The Company's net loss for fiscal 2001 was approximately $1.4 million compared to a net loss of approximately $849,000 for fiscal 2000. The 2001 net loss was due in significant part to the required increase in the uncollectible receivables provision related to the Kmart bankruptcy. The $1.7 million provision offset all other gains made in reduction of selling, general and administrative expense by management in response to the reduced 2001 sales volumes from 2000. (SEE NOTE 12 TO THE CONSOLIDATED FINANCIAL STATEMENTS.) FISCAL YEAR 2000 COMPARED TO FISCAL YEAR 1999 All component changes are affected by the change in the Company's fiscal year in 1999 (fiscal 2000 reflects 12 months activity versus 11 months activity in fiscal 1999). NET SALES. Net sales during fiscal 2000 increased $22.9 million, or 48.1%, to $70.4 million, from $47.6 million in fiscal 1999. A substantial portion of this increase, $10.6 million, was due to the acquisition of Meritus and its product lines. Excluding these Meritus items, net sales increased $12.3 million or 25.8% compared to fiscal 1999, primarily due to increased sales of Girls' Toys. 21 Net sales of Juvenile Audio Products decreased $1.3 million, or 4.1%, to $27.8 million during fiscal 2000, from $29.1 million during fiscal 1999. The major product groups in this category are Youth Communications and Musical Instruments, providing $14.2 million and $13.6 million respectively in 2000 sales. Decreases occurred in both product groups in 2000, as more emphasis was placed on branded products like TECH LINK -Registered Trademark- and KAWASAKI - -Registered Trademark-, requiring customers to reposition their inventory from the non-branded product lines sold in prior years. Net sales of Girls' Toys increased $21.1 million, or 304.8%, to $28.0 million in fiscal 2000 from $7.0 million in fiscal 1999. Meritus items contributed $10.6 million of this increase. Excluding these Meritus items, Girls' Toys net sales increased $10.4 million or 251.4% compared to fiscal 1999. With respect to non-Meritus items, the sales increase in Girls' Toys was driven by the television promoted HUSH LI'L BABY -Registered Trademark- doll and the continued expansion and growth of the PRIDE AND JOY -Registered Trademark- doll line. Net sales of Boys' Toys increased $3.8 million, or 40.3% to $12.7 million during fiscal 2000 from $8.9 million in fiscal 1999. The increase reflects the successful introduction of the television promoted INSECTOR - -Registered Trademark- R/C vehicle in 2000, partially offset by decreases in sales of BLOCKMEN -Registered Trademark- and other military type products. Net sales of products in other categories decreased approximately $700,000, or 24.7%, to $1.9 million during fiscal 2000 from $2.6 million in fiscal 1999. The decrease reflects continued reduction in sales of HOPPIN' POPPIN' SPACEBALLS -Registered Trademark- and other hand-held and outdoor games, as well as a decrease in sales of the TALKING DOORBELL -Registered Trademark- products introduced in fiscal 1998. International net sales increased $2.4 million, or 21.7%, to $13.3 million during fiscal 2000 from $10.9 million in fiscal 1999. International net sales were 18.9% of total net sales for fiscal 2000 as compared to 22.9% of total net sales in fiscal 1999. GROSS PROFIT. Gross profit increased $6.8 million, or 50.3%, to $20.3 million during fiscal 2000 from $13.5 million in fiscal 1999. Gross profit as a percentage of net sales increased to 28.9% during fiscal 2000 from 28.4% in fiscal 1999. The percentage increase reflects the strategic emphasis placed on proprietary products such as PRIDE & JOY -Registered Trademark- and HUSH LI'L BABY -Registered Trademark- dolls, the INSECTOR -Registered Trademark- R/C vehicle, and the successful branding of our TECH-LINK -Registered Trademark- walkie-talkie lines in addition to the inclusion of the Meritus doll lines. Proprietary products have a higher margin, and as a result of the sales emphasis now comprise an increased percentage of our total net sales. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses increased $9.5 million to $20.3 million, or 87.7%, during fiscal 2000 from $10.8 million in fiscal 1999. The increase included major increases in television and other marketing costs of $3.4 million and approximately $385,000, respectively to support sales of our proprietary products. In addition, the merger with Meritus added employee costs of $2.4 million. Other operating costs associated with the New Jersey office and associated with the increased development activity in Girls' Toys were also a substantial part of the increase. Professional fees, including attorney and accounting costs, increased approximately $550,000, a portion of which is directly related to the Meritus merger. A downturn in the general retail climate required the Company to make an additional provision for noncollectible accounts of approximately $150,000. Travel and entertainment expense also increased approximately $400,000 due primarily to increased 2001 sales activity and focus on increasing the internal sales responsibility for major accounts. INTEREST EXPENSE. Interest expense increased approximately $855,000, or 138.1%, to $1.5 million in fiscal 2000 from $619,000 during fiscal 1999. The increase was due to borrowings associated with the Meritus merger and increased working capital needs to support the increased 2000 sales. INCOME TAXES. In fiscal 2000, the Company generated a loss before income taxes of $1.3 million compared to a $2.1 million profit before income taxes during fiscal 1999. As a result, the Company generated a tax benefit of approximately $477,000 during fiscal 2000 compared to a tax expense of approximately $869,000 in fiscal 1999. The Company expects to realize its 2000 tax benefits from net operating loss carry forwards and foreign income tax credits by the reduction of tax liabilities on taxable earning in future years. 22 NET INCOME (LOSS). The Company's net loss for fiscal 2000 was approximately $849,000 compared to a net income of $1.3 million for fiscal 1999. The 2000 net loss was due, in part, to less than expected sales of our television promoted products in relation to television advertising costs and fourth quarter inventory close-outs of BLOCKMEN -Registered Trademark- and other products introduced in prior years. As discussed above, the gains made by the Company in net sales and gross profit were exceeded by substantial increases in selling, general and administrative expenses. In addition, the financial condition of several customers required a higher than normal provision for uncollectible accounts receivable. LIQUIDITY AND CAPITAL RESOURCES The Company historically has funded its operations and capital requirements by cash generated from operations and borrowings. The Company's primary capital needs have consisted of acquisitions of inventory, financing accounts receivable and capital expenditures for product development. The Company's operating activities used net cash of $3.4 million during fiscal 2001, consisting primarily of increases in accounts receivable and decreases in accounts payable. Net cash used in investing activities during fiscal 2001 was approximately $525,000 and was mostly due to capital expenditures. Net cash provided by financing activities was $4.1 million in 2001 and was a result of proceeds from the issuance of common stock warrants and borrowing under revolving lines of credit, net of payments on long-term debt. The Company's working capital at December 31, 2001 was $9.2 million and unrestricted cash was approximately $285,000. The seasonal nature of the toy business results in complex working capital needs. The Company's working capital needs, which the Company generally satisfies through short-term borrowings, are greatest in the last two fiscal quarters. To manage these working capital requirements, the Company maintains the Dao Heng Facility and the Revolver. Additionally, the Company discounts customers' letters of credit at several other Hong Kong banks. As of December 31, 2001, the Company and Sunrock amended the Revolver to revise the future covenants and restrictions required by the Revolver. Management believes the Company will be able to maintain compliance with such covenants in the future. On March 19, 2001, the Company issued to MVII an Investment Warrant to acquire 1.8 million shares of the Company's Common Stock at a purchase price of $2.7 million. The Investment Warrant is exercisable, in whole or in part, for a ten-year period beginning June 3, 2002. Proceeds from the sale of the Investment Warrant were used by the Company for current working capital. The Investment Warrant was amended and restated in its entirety on January 31, 2002, to remove all anti-dilution provisions at the request of Nasdaq. The Company has budgeted approximately $1.3 million for capital expenditures for fiscal 2002 consisting primarily of purchases of tools and molds and information technology systems. As of March 19, 2002 the Company had additional aggregate borrowing capacity of approximately $300,000 under the Revolver and the Dao Heng Credit Facility. Based on projected fiscal 2002 operating results, the Company believes cash flows from operations and available borrowings under the Revolver and the Dao Heng Credit Facility will be sufficient to meet the Company's operating cash requirements and fund its anticipated capital expenditures. However, there can be no assurance the Company will meet its projected operating results. In connection with any future cash needs or acquisition opportunities, the Company may incur additional debt or issue additional equity or debt securities depending on market conditions and other factors. In a series of related transactions with MVII that occurred between April and June of 1999, the Company received $5 million in exchange for the sale of approximately 2.5 million shares of the Company's Common Stock. The Company used those funds to finance the normal business operations of the Company. In connection with the acquisition of Meritus, the Company borrowed $5 million from MVII. The debt is evidenced by a promissory note dated January 7, 2000 (the "MVII Note"). The MVII Note bears interest at a rate of prime plus 2%, matures on July 1, 2004 and is subordinate to the Revolver. The proceeds from the MVII Note 23 were used primarily to facilitate the merger with Meritus, including the satisfaction of Meritus' debt, described below. On March 6, 2002, pursuant to the terms of the Revolver and the MVII Note, the Company reborrowed $500,000 of the original principal that the Company had paid on the MVII Note. The proceeds were used to finance the normal business operations of the Company. The Company is obligated to make future minimum royalty payments under certain of its license agreements. As of December 31, 2001, the Company was required to make an aggregate of approximately $150,000 in payments of guaranteed royalties under certain licenses in fiscal 2002 and $225,000 thereafter through fiscal 2003. RECENT ACCOUNTING PRONOUNCEMENTS SFAS No. 141 entitled "BUSINESS COMBINATIONS" was issued in June 2001 and became effective July 1, 2001. SFAS No. 141 requires that all business combinations be accounted for using the purchase method of accounting, which requires that acquisitions be recorded at fair value as of the date of acquisition. The pooling-of-interests method of accounting allowed under prior standards, which reflected business combinations using historical financial information, is now prohibited. In June 2001, the FASB issued SFAS No. 142 entitled "GOODWILL AND OTHER INTANGIBLE ASSETS", which became effective on January 1, 2002. Under SFAS No. 142, existing goodwill will no longer be amortized, but will be tested for impairment using a fair value approach. SFAS No. 142 requires goodwill to be tested for impairment at a level referred to as a reporting unit, generally one level lower than reportable segments. SFAS No. 142 requires us to perform the first goodwill impairment test on all reporting units within six months of adoption. The first step is to compare the fair value with the book value of a reporting unit. If the fair value of the reporting unit is less than its book value, the second step will be to calculate the impairment loss, if any. Any impairment loss from the initial adoption of SFAS No. 142 will be recognized as a change in accounting principle. After the initial adoption, we will test goodwill for impairment on an annual basis and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Management engaged an independent company to assist in valuing the Company's goodwill at December 31, 2001. Based on this review, at this time an impairment change is not anticipated. In June 2001, the FASB issued SFAS No. 143, "ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS". This Statement addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. Due to the nature of our business, this new accounting pronouncement is not expected to have a significant impact on our reported results of operations and financial condition. In August 2001, the FASB issued SFAS No. 144, "ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS," which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This statement supersedes SFAS No. 121, "ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF" and the accounting and reporting provisions of APB Opinion No. 30, "REPORTING THE RESULTS OF OPERATIONS - REPORTING THE EFFECTS OF A DISPOSAL OF A BUSINESS AND EXTRAORDINARY, UNUSUAL AND INFREQUENTLY OCCURRING EVENTS AND TRANSACTIONS," for the disposal of a segment of a business. This Statement also amends ARB No. 51, "CONSOLIDATED FINANCIAL STATEMENTS," to eliminate the exception to consolidation for a subsidiary for which control is likely to be temporary. SFAS No. 144 became effective on January 1, 2002, and interim periods within fiscal 2003, with early application encouraged. The provisions of this Statement generally are to be applied prospectively. 24 MERITUS ACQUISITION Effective January 7, 2000, the Company acquired Meritus by way of merger. Pursuant to the terms of the merger, the Company acquired all of the issued and outstanding stock of Meritus for 533,208 shares of the Company's Common Stock and $2.8 million in other consideration paid to the shareholders of Meritus. Contemporaneously with the merger, the Company satisfied $4.4 million of Meritus' debt. The merger was accounted for using the purchase method; therefore the Company recorded the acquired assets at their fair market value, generating a significant amount of goodwill. (SEE NOTE 2 TO THE CONSOLIDATED FINANCIAL STATEMENTS.) As a result of the merger, the Company added the BABY BEANS -Registered Trademark- brand soft bean bag dolls, FOREVER GIRL FRIENDS -Registered Trademark- brand accessories for 11-1/2" fashion dolls, and LITTLE DARLINGS - -Registered Trademark- brand value-priced action feature dolls to its product offerings, as welL as the ELITE DOLLS -TM- brand, which was created by Meritus specifically to manufacture and market "LIFETIME PLAY DOLLS -TM-," a line of exquisite 18" dolls and accessories suitable for playing or collecting. INFLATION The Company does not believe that inflation in the United States, Europe or Asia in recent years has had a significant effect on its results of operations. YEAR 2000 During 1999, the Company concluded its efforts to address the Year 2000 issue. In addition to a review of the Company's management information software ("MIS"), EDI software, and local area network and personal computer operating systems, readiness reviews were completed on customers and vendors. The Company did not experience any Year 2000 issues with its internal operating systems or with its customers or vendors. In addition, the Company did not experience any loss in revenues due to the Year 2000 issue. CAUTIONARY STATEMENT Certain written and oral statements made or incorporated by reference from time to time by the Company or its representatives in this Form 10-K, other filings or reports with the Securities and Exchange Commission, press releases, conferences, or otherwise, are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. The Company is including this Cautionary Statement to make applicable and take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 for any such forward-looking statements. Forward-looking statements can be identified by the use of terminology such as "believe," "anticipate," "expect," "estimate," "may," "will," "should," "project," "continue," "plans," "aims," "intends," "likely," or other words or phrases of similar terminology. Management cautions you that forward-looking statements involve risks and uncertainties which may cause actual results to differ materially from the forward-looking statements. For a discussion of some of the factors that may cause actual results to differ materially from those suggested by forward-looking statements, please read carefully the information under Item 1, "Risk Factors", of this Form 10-K. In addition to the Risk Factors and other important factors detailed herein and from time to time in other reports filed by the Company with the Securities and Exchange Commission, including Forms 8-K, 10-Q, and 10-K, the following important factors could cause actual results to differ materially from those suggested by any forward-looking statements. MARKETPLACE RISKS - Increased competitive pressure, both domestically and internationally, which may negatively affect the sales of the Company's products; - Changes in public and consumer taste, which may negatively affect the sales of the Company's products; 25 - Significant changes in the play patterns of children, whereby they are increasingly attracted to more developmentally advanced products at younger ages, which may affect brand loyalty and the perceived value of and demand for the Company's products; and - Possible weaknesses in economic conditions, both domestically and internationally, which may negatively affect the sales of the Company's products and the costs associated with manufacturing and distributing these products. FINANCING CONSIDERATIONS - Currency fluctuations, which may affect the Company's reportable income; significant changes in interest rates, both domestically and internationally, which may negatively affect the Company's cost of financing both its operations and investments. OTHER RISKS - Changes in laws or regulations, both domestically and internationally, including those affecting consumer products or trade restrictions, which may lead to increased costs or interruption in normal business operations of the Company; - Future litigation or governmental proceedings, which may lead to increased costs or interruption in normal business operations of the Company; and - Labor disputes, which may lead to increased costs or disruption of any of the Company's operations. The risks included herein and in Item 1 "Risk Factors" are not exhaustive. Other sections of this Form 10-K may include additional factors which could materially and adversely impact the Company's business, financial condition, and results of operations. Moreover, the Company operates in a very competitive and rapidly changing environment. New risk factors emerge from time to time and it is not possible for management to predict all such risk factors on the Company's business, financial condition or results of operations or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. None. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA See "Index to Consolidated Financial Statements and Schedules" included on page F-1 for information required under this Item 8. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 26 PART III GENERAL Information required by Item 10 relating to the executive officers of the Company appears under the heading "Executive Officers of the Registrant" in Part I herein. Information required by Item 10 relating to members of the Company's Board of Directors, as well as information required by Items 11 through 13, is hereby incorporated by reference to the information under the headings "Election of Directors," "Section 16(a) Beneficial Ownership Reporting Compliance," "Executive Compensation," "Compensation of Certain Named Executive Officers," "Management-Employment and Related Agreements," and "Certain Relationships and Related Transactions" in the Company's definitive Proxy Statement to be filed pursuant to Regulation 14A and anticipated to be filed within 120 days after the end of the Company's fiscal year ended December 31, 2001. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) 1. Financial Statements. Reference is made to the Index on page F-1 for a list of all financial statements filed as part of this Report. (a) 2. and (d) Financial Statement Schedules. Reference is made to the Index on page F-1 for a list of all financial statement schedules filed as part of this Report. (a) 3. and (c) Exhibits. Reference is made to the Exhibit Index on page E-1 for a list of all exhibits filed as part of this Report. (b) Reports on Form 8-K. The Company filed a Form 8-K dated October 12, 2001, (filed on October 24, 2001) for the purpose of reporting the resignation of Michael J. Lyden from his positions as President and Chief Executive Officer, and member of the Board of Directors of the Company. 27 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. DSI Toys, Inc. Dated: April 1, 2002 By: /s/ JOSEPH S. WHITAKER ------------------------------------------------ Joseph S. Whitaker President, Chief Executive Officer and Director Dated: April 1, 2002 By: /s/ ROBERT L. WEISGARBER ------------------------------------------------ Robert L. Weisgarber Chief Financial 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 in the capacities and on the dates indicated. SIGNATURE TITLE DATE --------- ----- ---- /s/ E. THOMAS MARTIN Chairman April 01, 2002 - --------------------------------- --------------------------- E. Thomas Martin /s/ M.D. DAVIS Director April 01, 2002 - --------------------------------- --------------------------- M.D. Davis /s/ JOSEPH N. MATLOCK Director April 01, 2002 - --------------------------------- --------------------------- Joseph N. Matlock /s/ ROBERT L. BURKE Director April 01, 2002 - --------------------------------- --------------------------- Robert L. Burke /s/ JOHN MCSORLEY Director April 01, 2002 - --------------------------------- --------------------------- John McSorley /s/ WALTER S. REILING Director April 01, 2002 - --------------------------------- --------------------------- Walter S. Reiling 28 DSI TOYS, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
Page ---- FINANCIAL STATEMENTS Report of Independent Accountants F-2 Consolidated Balance Sheet at December 31, 2001 and 2000 F-3 Consolidated Statement of Operations for fiscal years 2001, 2000 and 1999 F-4 Consolidated Statement of Cash Flows for fiscal years 2001, 2000 and 1999 F-5 Consolidated Statement of Shareholders' Equity for fiscal years 2001, 2000 and 1999 F-6 Notes to Consolidated Financial Statements F-7 SCHEDULE II. Valuation and Qualifying Accounts and Reserves S-1
All other schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto. F-1 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders of DSI Toys, Inc. In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of DSI Toys, Inc. and its subsidiaries (the "Company") at December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. PricewaterhouseCoopers LLP Houston, Texas March 29, 2002 F-2 DSI TOYS, INC. CONSOLIDATED BALANCE SHEET
DECEMBER 31, DECEMBER 31, 2001 2000 -------------------- ------------------- ASSETS Current Assets: Cash $ 284,637 $ 177,682 Restricted cash 150,000 Accounts receivable, net 8,767,550 6,522,883 Inventories 6,739,920 6,687,195 Prepaid expenses and other current assets 1,981,592 1,740,945 Deferred income taxes 893,000 385,000 ---------------- --------------- Total current assets 18,666,699 15,663,705 Property and equipment, net 1,769,284 2,415,084 Deferred income taxes 1,312,000 1,780,000 Goodwill, net 9,241,128 9,754,524 Other assets 323,624 385,827 ---------------- --------------- $ 31,312,735 $ 29,999,140 ================ =============== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable and accrued liabilities $ 6,580,780 $ 7,901,290 Current portion of long-term debt 1,120,650 1,689,911 Current portion of long-term debt due to a related party 1,751,485 1,424,478 Income taxes payable 69,638 112,325 ---------------- --------------- Total current liabilities 9,522,553 11,128,004 Long-term debt 9,210,390 6,464,268 Long-term debt due to a related party 3,289,552 4,291,037 Deferred income taxes 156,642 188,849 ---------------- --------------- Total liabilities 22,179,137 22,072,158 ---------------- --------------- Commitments and Contingencies (Note 11) Shareholders' equity: Preferred stock, $.01 par value, 5,000,000 shares authorized, none issued or outstanding Common stock, $.01 par value, 35,000,000 authorized, 9,066,365 shares issued and outstanding 90,664 90,664 Additional paid-in capital 5,173,465 5,173,465 Common stock warrants 2,802,500 102,500 Accumulated other comprehensive loss (70,928) (27,062) Retained earnings 1,137,897 2,587,415 ---------------- --------------- Total shareholders' equity 9,133,598 7,926,982 ---------------- --------------- $ 31,312,735 $ 29,999,140 ================ ===============
See accompanying notes to consolidated financial statements. F-3 DSI TOYS, INC. CONSOLIDATED STATEMENT OF OPERATIONS
FISCAL YEAR ------------------------------------------------------------ 2001 2000 1999 ------------------ ------------------ ------------------ Net sales $ 67,906,409 $ 70,438,531 $ 47,560,024 Cost of goods sold 47,985,126 50,120,552 34,046,112 ---------------- ---------------- ---------------- Gross profit 19,921,283 20,317,979 13,513,912 Selling, general and administrative expenses 20,103,335 20,367,165 10,848,624 ---------------- ---------------- ---------------- Operating income (loss) (182,052) (49,186) 2,665,288 Interest expense (1,155,092) (1,473,909) (618,994) Other income 278,529 196,661 103,302 ---------------- ---------------- ---------------- Income (loss) before income taxes (1,058,615) (1,326,434) 2,149,596 Benefit from (provision for) income taxes (390,903) 477,448 (868,605) ---------------- ---------------- ---------------- Net income (loss) $ (1,449,518) $ (848,986) $ 1,280,991 ================ ================ ================ BASIC EARNINGS PER SHARE Earnings (loss) per share $ (0.16) $ (0.09) $ 0.17 ================ ================ ================ Weighted average shares outstanding 9,066,365 9,053,382 7,688,964 ================ ================ ================ DILUTED EARNINGS PER SHARE Earnings (loss) per share $ (0.16) $ (0.09) $ 0.16 ================ ================ ================ Weighted average shares outstanding 9,066,365 9,053,382 7,803,403 ================ ================ ================
See accompanying notes to consolidated financial statements. F-4 DSI TOYS, INC CONSOLIDATED STATEMENT OF CASH FLOWS
FISCAL YEAR --------------------------------------------------------- 2001 2000 1999 ----------------- ----------------- ----------------- Cash flows from operating activities: Net income (loss) $ (1,449,518) $ (848,986) $ 1,280,991 Adjustments to reconcile net income (loss) to net cash provided (used) by operating activities: Depreciation 1,334,392 1,551,632 728,951 Amortization and write-off of debt discount and issuance costs 42,583 24,927 36,799 Amortization of goodwill 513,396 513,360 Provision for doubtful accounts 1,717,931 222,021 65,528 Loss (gain) on sale or abandonment of equipment (25,957) 32,173 727 Deferred income taxes (72,207) (893,491) 722,340 Changes in assets and liabilities, excluding acquisitions: Restricted cash 150,000 Accounts receivable (3,962,598) (2,413,654) (2,403,862) Inventories (52,725) (954,186) (1,487,536) Income taxes payable (42,687) (316,402) 156,807 Prepaid expenses (240,647) (507,859) (287,174) Accounts payable and accrued liabilities (1,320,510) 1,039,373 (3,030,004) ------------- ------------- ------------- Net cash used in operating activities (3,408,547) (2,551,092) (4,216,433) Cash flows from investing activities: Cash used for acquisition of Meritus (884,033) Capital expenditures (766,921) (1,249,944) (1,087,446) Proceeds from sale of equipment 104,286 225 Decrease in other assets 137,120 273,087 125,408 ------------- ------------- ------------- Net cash used in investing activities (525,515) (1,860,890) (961,813) Cash flows from financing activity: Net borrowing (repayments) under revolving lines of credit (613,604) 4,046,472 329,085 Net borrowings on long-term debt 2,790,465 400,684 12,741 Net borrowings (repayments) on long-term debt due to related parties (674,478) 4,025,515 Payments of assumed Meritus debt (4,382,541) Net proceeds from issuance of common stock 4,873,548 Net proceeds from issuance of warrants 2,700,000 Debt and stock issue costs (117,500) 35,000 (85,433) ------------- ------------- ------------- Net cash provided by financing activities 4,084,883 4,125,130 5,129,941 Effect of exchange rate changes on cash (43,866) (14,436) (26,922) ------------- ------------- ------------- Net increase (decrease) in cash 106,955 (301,288) (75,227) Cash and cash equivalents, beginning of year 177,682 478,970 554,197 ------------- ------------- ------------- Cash and cash equivalents, end of year $ 284,637 $ 177,682 $ 478,970 ============= ============= =============
See accompanying notes to consolidated financial statements. F-5 DSI TOYS, INC. CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
ACCUMULATED COMMON STOCK ADDITIONAL OTHER ---------------------- PAID-IN COMPREHENSIVE RETAINED TREASURY SHARES AMOUNT CAPITAL WARRANTS INCOME(LOSS) EARNINGS STOCK TOTALS ----------- ---------- ------------- ---------- --------------- ------------ -------------- --------- Balance, January 31, 1999 8,719,000 $ 87,190 $ 21,162,568 $ 102,500 $ 14,296 $ 2,155,410 $(22,660,592) $ 861,372 Comprehensive income: Net income 1,280,991 1,280,991 Foreign currency translation adjustments Net of tax (26,922) (26,922) ----------- Comprehensive income 1,254,069 Issuance of 2,458,491 common shares from the treasury (15,479,229) 20,479,229 5,000,000 Options exercised (518,189) 621,968 103,779 Stock issuance cost (230,231) (230,231) --------- -------- ------------ ----------- ---------- ----------- ------------ ----------- Balance, December 31, 1999 8,719,000 87,190 4,934,919 102,500 (12,626) 3,436,401 (1,559,395) 6,988,989 Comprehensive loss: Net Loss (848,986) (848,986) Foreign Currency translation adjustments net of tax (14,436) (14,436) ----------- Comprehensive Loss (863,422) Issuance of 347,365 common shares and 185,843 common shares from the treasury 347,365 3,474 238,546 1,559,395 1,801,415 --------- -------- ------------ ----------- ---------- ----------- ------------ ----------- Balance, December 31, 2000 9,066,365 90,664 5,173,465 102,500 (27,062) 2,587,415 7,926,982 Comprehensive loss: Net Loss (1,449,518) (1,449,518) Foreign Currency translation adjustments net of tax (43,866) (43,866) ----------- Comprehensive (1,493,384) Loss Warrants Issued 2,700,000 2,700,000 --------- -------- ------------ ----------- ---------- ----------- ------------ ----------- Balance, December 31, 2001 9,066,365 $ 90,664 $ 5,173,465 $ 2,802,500 $ (70,928) $ 1,137,897 $ $ 9,133,598 ========= ======== ============ =========== ========== =========== ============ ===========
See accompanying notes to consolidated financial statements. F-6 DSI TOYS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - ORGANIZATION: DSI Toys, Inc. (the "Company") was incorporated under the laws of the State of Texas in November 1970. The Company markets and distributes a variety of toys and children's consumer electronics both within the United States and internationally, primarily to retailers. The Company's products are manufactured primarily in the People's Republic of China. Effective May 1, 1997, the Company's Articles of Incorporation were amended to (i) authorize the issuance of 5,000,000 shares of $.01 par value preferred stock, (ii) change the par value of common stock to $.01 and (iii) reduce the authorized shares of common stock to 20,000,000 shares. On June 3, 1997, the Company completed its initial public offering (the "Offering") of 2,500,000 shares of common stock, which provided the Company net proceeds of $17.7 million. All of the net proceeds were used to repay debt of the Company. In connection with the Offering, the Company issued warrants to purchase 250,000 shares of common stock to the lead underwriters. Such warrants are exercisable at $10.80 per share and expire May 28, 2002. Effective May 28, 1999, the Company's Articles of Incorporation were amended to increase the authorized shares of common stock to 35,000,000 shares. Effective June 1, 1999, the Company consummated transactions with MVII, LLC ("MVII") pursuant to a Stock Purchase and Sale Agreement dated April 15, 1999. As a result of those transactions, MVII made a total investment of $12 million in the Company's common stock, $5 million of which was paid directly to the Company for the purchase of 2,458,491 shares of common stock. On March 19, 2001, the Company issued to MVII an Investment Warrant to acquire 1.8 million shares of the Company's Common Stock, in exchange for a cash purchase price of $2.7 million. The Investment Warrant is exercisable for no additional consideration, in whole or in part, for a ten-year period beginning June 4, 2002. Proceeds from the sale of the Investment Warrant were used by the Company for current working capital. NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: BASIS OF PRESENTATION The accompanying consolidated financial statements include the accounts of wholly-owned subsidiaries DSI(HK) Limited, Meritus Limited, and RSP Limited. All significant intercompany transactions have been eliminated in consolidation. FISCAL YEAR The Company's fiscal year is the year ending December 31 of the calendar year mentioned. Prior to December 31, 1999, the terms "fiscal year" and "fiscal" refer to January 31 of the following calendar year mentioned (e.g., a reference to fiscal 1998 was a reference to the fiscal year ended January 31, 1999). CASH EQUIVALENTS The Company considers investments with original maturity dates of three months or less from the date of purchase to be cash equivalents. Restricted cash, held as a compensating balance under a revolving loan supported by letters of credit is not considered a cash equivalent. F-7 REVENUE RECOGNITION Revenues are recognized upon shipment of product by the Company, or in the case of FOB Asia sales, by the manufacturer, and, at that point, legal responsibility and title pass to the buyer. The Company provides an allowance for doubtful accounts and accrues for returns and discounts using a percentage of gross sales based on historical experience. Provision is made currently for estimated returns of defective and slow-moving merchandise, price protection and customer allowances and is included as a reduction of accounts receivable and revenues. INVENTORIES Inventories consist of finished goods and supplies and are stated at the lower of cost or market, with cost determined on a first-in, first-out basis. The Company provides an allowance for obsolete inventory when appropriate to reflect current market value. PROPERTY AND EQUIPMENT Property and equipment are recorded at cost. Maintenance and repairs are charged to operations, and replacements or betterments are capitalized. Property or equipment sold, retired, or otherwise disposed of is removed from the accounts, and any gains or losses thereon are included in operations. Depreciation is recorded over the estimated useful lives of the related assets using the straight-line method for molds and leasehold improvements and an accelerated method, which approximates the straight line method, for all other assets. DEBT ISSUANCE COSTS AND DEBT DISCOUNT Debt issuance costs and debt discount are amortized over the term of the related debt on a straight-line basis. ADVERTISING The cost of producing media advertising is capitalized as incurred and expensed in the period in which the advertisement is first shown. During interim periods, media communications costs are accrued in relation to sales when the advertising is clearly implicit in the related sales arrangement. In any event, all media communication costs are expensed in the fiscal year incurred. All other advertising costs are expensed in the period incurred. Television advertising expense totaled $2,500,000, $3,621,000 and $275,000 during fiscal 2001, 2000 and 1999, respectively. Prepaid television advertising production costs of $130,000 and $101,000 respectively are included in prepaid expenses at December 31, 2001 and 2000. The Company entered into advertising barter transactions in which the Company recorded $730,000, $529,000 and $311,000 in advertising expenses in fiscal 2001, 2000 and 1999, respectively. In addition, prepaid expenses at December 31, 2000 included $200,000 in bartered, prepaid 2001 print advertising. There is no bartered prepaid advertising expense at December 31, 2001. Management believes these amounts approximate fair value. INCOME TAXES The Company accounts for deferred income taxes using the liability method which provides for the recognition of deferred tax assets and liabilities based upon temporary differences between the tax basis of assets and liabilities and their carrying value for financial reporting purposes. Deferred tax expense or benefit is the result of changes in deferred tax assets and liabilities during the period. In estimating future tax consequences, all expected future events are considered other than enactments of changes in the tax law or rates. U.S. deferred income taxes are provided on the undistributed earnings of the wholly-owned subsidiaries. F-8 FOREIGN CURRENCY TRANSLATIONS The Company's foreign subsidiary uses the local currency as the functional currency. Accordingly, assets and liabilities of the Company's foreign subsidiary are translated using the exchange rate in effect at the balance sheet date, while income and expenses are translated using average rates. Translation adjustments are reported as a separate component of shareholders' equity. FAIR VALUE OF FINANCIAL INSTRUMENTS The Company's financial instruments recorded on the balance sheet include cash and cash equivalents, accounts receivable, accounts payable and debt. Due to their short maturity, the fair value of cash and cash equivalents, accounts receivable and accounts payable approximates carrying value. The fair value of the Company's debt approximates the carrying amount of the debt as it is at variable market rates. CONCENTRATION OF CREDIT RISK AND EXPORT SALES Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of trade receivables. The Company sells its products principally to retail discount stores and toy stores. Five customers comprise a significant portion of the Company's sales (50% in 2001), and therefore, receivables from one or all of these customers may, at any point in time, comprise a large portion of the Company's total receivables, providing an increased concentration of credit risk. Additionally, the customer base is primarily located in the United States, though overall the Company's customer base is large and geographically dispersed across the globe. The Company performs ongoing credit evaluations of its customers to minimize credit risk, and for the majority of its FOB Asia sales, the Company obtains letters of credit from its customers supporting the accounts receivable. (See Note 12). USE OF ESTIMATES The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the period. Because of the inherent uncertainties in their process, actual results could differ from such estimates. Management believes that the estimates are reasonable. IMPAIRMENT OF ASSETS The Company reviews for the impairment of long-lived assets, including goodwill, whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Goodwill has been amortized over 20 years using the straight-line method in 2001 and 2000. In 2002, the Company will adopt, Statement of Financial Accounting Standards, No. 142, "Goodwill and Other Intangible Assets", which eliminates amortization of goodwill beginning in January 2002 and requires an annual impairment test based on its estimated fair value, using future discounted cash flow and other factors. The initial valuation will be done as of December 31, 2001, with any impairment recorded in 2002. The Company engaged an independent company to assist in this fair value assessment. Based on this review, at this time an impairment adjustment is not anticipated. EARNINGS PER SHARE The Company reports both basic earnings per share, which is based on the weighted average number of common shares outstanding, and diluted earnings per share, which is based on the weighted average number of common shares as well as all dilutive potential common shares outstanding. Stock options and warrants are the only potentially dilutive shares the Company has outstanding at December 31, 2001. The 729,500 shares and 866,500 shares, respectively of common stock options and F-9 warrants outstanding were not included in the diluted earnings per share calculation during fiscal 2001 and 2000, because the options and warrants would be anti-dilutive. During fiscal 1999, the Company's warrants, for which the exercise price was less than the average market price of the common shares, were included in the computation of diluted earnings per share, increasing the weighted average number of shares outstanding by 114,439 shares. The Company's remaining 996,500 shares of common stock options and warrants were not included in the calculation because the exercise price of the options and warrants were greater than the average market price of the common shares. STOCK-BASED COMPENSATION PLANS The Company applies Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and related interpretations in accounting for its plans and the disclosure-only provision of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS 123) in disclosures regarding the plan. RECENT ACCOUNTING PRONOUNCEMENTS SFAS No. 141 entitled "BUSINESS COMBINATIONS" was issued in June 2001 and became effective July 1, 2001. SFAS No. 141 requires that all business combinations be accounted for using the purchase method of accounting, which requires that acquisitions be recorded at fair value as of the date of acquisition. The pooling-of-interests method of accounting allowed under prior standards, which reflected business combinations using historical financial information, is now prohibited. In June 2001, the FASB issued SFAS No. 142 entitled "GOODWILL AND OTHER INTANGIBLE ASSETS" which became effective on January 1, 2002. Existing goodwill will no longer be amortized, but will be tested for impairment using a fair value approach. SFAS No. 142 requires goodwill to be tested for impairment at a level referred to as a reporting unit, generally one level lower than reportable segments. SFAS No. 142 requires the Company to perform the first goodwill impairment test on all reporting units within six months of adoption. The first step is to compare the fair value with the book value of a reporting unit. If the fair value of the reporting unit is less than its book value, the second step will be to calculate the impairment loss, if any. Any impairment loss from the initial adoption of SFAS No. 142 will be recognized as a change in accounting principle. After the initial adoption, the Company will test goodwill for impairment on an annual basis and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Management engaged an independent company to assist in valuing the Company's goodwill at December 31, 2001. Based on this review, at this time an impairment adjustment is not anticipated. In June 2001, the FASB issued SFAS No. 143, "ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS". This Statement addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. Due to the nature of our business, this new accounting pronouncement is not expected to have a significant impact on our reported results of operations and financial condition. In August 2001, the FASB issued SFAS No. 144, "ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS," which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This statement supersedes SFAS No. 121, "ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF" and the accounting and reporting provisions of APB Opinion No. 30, "REPORTING THE RESULTS OF OPERATIONS - REPORTING THE EFFECTS OF A DISPOSAL OF A BUSINESS AND EXTRAORDINARY, UNUSUAL AND INFREQUENTLY OCCURRING EVENTS AND TRANSACTIONS," for the disposal of a segment of a business. This Statement also amends ARB No. 51, "CONSOLIDATED FINANCIAL STATEMENTS," to eliminate the exception to consolidation for a subsidiary for which control is likely to be temporary. SFAS No. 144 became effective on January 1, 2002, and interim periods within fiscal 2003, with early application encouraged. The provisions of this Statement generally are to be applied prospectively. The Company has not determined the effect, if any, adoption of SFAS No. 144 will have on the financial position and results of operations. F-10 NOTE 3 - ACCOUNTS RECEIVABLE: Accounts receivable consist of the following:
December 31, 2001 December 31, 2000 ---------------------- ----------------------- Trade receivables $ 12,717,550 $ 9,642,883 Provisions for: Discounts and markdowns (1,472,706) (1,670,229) Return of defective goods (777,294) (1,029,771) Doubtful accounts (1,700,000) (420,000) ---------------- ----------------- Accounts receivable, net $ 8,767,550 $ 6,522,883 ================ =================
The 2001 provision for doubtful accounts includes $1,650,000 related to trade receivables due from K-mart Corp., which filed for Chapter 11 bankruptcy on January 22, 2002 (see Note 15). NOTE 4 - PROPERTY AND EQUIPMENT: Property and equipment consist of the following:
Estimated useful December 31, 2001 December 31, 2000 ----------------------- --------------------- --------------------- Molds 3 years $ 5,509,743 $ 5,175,410 Equipment, furniture and fixtures 5-7 years 1,826,150 2,030,612 Leasehold improvements 10 years or lease term 1,221,473 1,188,693 Automobiles 3-5 years 31,678 83,981 ------------- --------------- 8,589,044 8,478,696 Less: accumulated depreciation (6,819,760) (6,063,612) ------------- --------------- $ 1,769,284 $ 2,415,084 ============= ===============
NOTE 5 - ACCOUNTS PAYABLE AND ACCRUED LIABILITIES: Accounts payable and accrued liabilities consist of the following:
December 31, 2001 December 31, 2000 ----------------------- ----------------------- Trade payables $ 3,447,888 $ 5,053,214 Accrued royalties 1,512,586 1,023,633 Accrued compensation and commissions 679,540 714,411 Other 940,766 1,110,032 ---------------- ------------------ $ 6,580,780 $ 7,901,290 ================ ==================
F-11 NOTE 6 - NOTES PAYABLE: Indebtedness consists of the following:
December 31, 2001 December 31, 2000 ----------------------- ----------------------- PRIMARY DEBT Bank revolving line of credit for $17.5 million with a commercial bank, collateralized by all of the Company's U.S. accounts receivable, intangibles, equipment, fixtures, and inventory, and 65% of the common stock of DSI(HK) Limited, principal due on March 31, 2004; interest at prime plus .75% (5.5% at December 31, 2001) $ 9,210,390 $ 6,419,925 Revolving bank loan drawn against an $8 million line of credit, collateralized by customers' letters of credit and $150,000 cash; interest at prime (9.5% at December 31, 2000) 1,631,415 Short-term loans from 3 banks discounted and collateralized by specific customer's letters of credit; interest ranging from 4.75% to 5.15%. 1,080,235 Other 40,415 102,839 --------------- ---------------- 10,331,040 8,154,179 Less: current portion 1,120,650 1,689,911 --------------- ---------------- $ 9,210,390 $ 6,464,268 =============== ================
The bank revolving credit facility (the "Revolver") includes a $17.5 million revolving line of credit commitment, subject to availability under a borrowing base calculated by reference to the level of eligible accounts receivable and inventory, as defined in the agreement. The Revolver matures on March 31, 2004. Interest on borrowings outstanding under the Revolver is payable monthly in arrears at an annual rate equal to prime plus .75%. In addition, an unused line fee at an annual rate equal to .50% applied to the amount by which $17.5 million exceeds the average daily principal balance during the month and a collateral management fee of $2,500 is payable monthly. The Revolver contains certain restrictive covenants and conditions among which are prohibition on payment of dividends, limitations on further indebtedness, restrictions on dispositions and acquisition of assets, limitations on advances to third parties and compliance with minimum net worth and net income amounts and designation as the "Senior Indebtedness" as relates to the related party debt described below. F-12
RELATED PARTY DEBT December 31, 2001 December 31, 2000 ------------------ ----------------------- ----------------------- Promissory Note of $1,690,000 to Walter S. and Susan Reiling, collateralized by a $868,000 Letter of Credit, subordinated to other debt, payable in quarterly installments of $108,500 through January 7, 2005; including interest at 10.0375%. $ 1,191,037 $ 1,415,515 Promissory Note of $5,000,000 to MVII, Inc., subordinated to the Revolver, payable in monthly installments of $75,000 through July 2004 plus interest at prime plus 2% (6.75% at December 31, 2001). Additionally, under certain conditions as stipulated by the Revolver a $300,000 payment may be made on March 31 each year. 3,850,000 4,300,000 --------------- ---------------- 5,041,037 5,715,515 Less: current portion 1,751,485 1,424,478 --------------- ---------------- $ 3,289,552 $ 4,291,037 --------------- ----------------
The $868,000 Letter of Credit collateralizing the $1,690,000 promissory note, is provided for the benefit of the Company by MVII. Expense associated with the letter of credit are reimbursed to MVII by the Company. Payment to MVII on the $5,000,000 promissory note is subject to the terms of a subordination agreement between MVII and the Revolver bank, which places restrictions on payment to MVII, based on the borrowing capacity available to the Company under the Revolver. The Company's ability to meet its maturing debt and other cash requirements is dependent on the continuation of sufficient lending arrangements, additional cash infusions, and/or cash from operations. In connection with any future cash needs or acquisition opportunities, the Company may incur additional debt or issue additional equity or debt securities depending on market conditions, as well as other factors. However, there can be no assurance the Company will meet its projected operating results. F-13 NOTE 7 - INCOME TAXES: The components of income (loss) before provision for (benefit from) income taxes by fiscal year were as follows:
2001 2000 1999 ------------------ ------------------ ------------------ Domestic $ (3,908,923) $ (4,167,128) $ (408,523) Foreign 2,850,308 2,840,694 2,558,119 -------------- -------------- ------------- $ (1,058,615) $ (1,326,434) $ 2,149,596 -------------- -------------- -------------
The provision for income taxes (benefit) by fiscal year is as follows:
2001 2000 1999 ------------------ ------------------ ------------------ Current: Federal $ (106,641) Foreign 363,992 $ 324,473 253,829 ------------ ---------- ------------ 363,992 324,473 147,188 ------------ ---------- ------------ Deferred: Federal (40,000) (949,000) 702,000 Foreign 66,911 147,079 19,417 ------------ ---------- ------------ 26,911 (801,921) 721,417 ------------ ---------- ------------ $ 390,903 $ (477,448) $ 868,605 ------------ ---------- ------------
The difference between income taxes (benefit) at the statutory federal and the effective income tax rates by fiscal year is as follows:
2001 2000 1999 ----------------- ---------------- ---------------- Taxes (benefit) computed at statutory rate $ (359,929) $ (450,987) $ 734,000 Expired foreign tax credits 44,000 U.S. Permanent items 191,002 190,256 Split Dollar Life Insurance (592,577) Reserve against foreign tax credits 566,474 371,654 87,000 Other, net (6,644) 4,206 3,605 ------------ ----------- ----------- $ 390,903 $ (477,448) $ 868,605 ------------ ----------- -----------
F-14 Deferred tax assets (liabilities) are comprised of the following:
December 31, 2001 December 31, 2000 --------------------- --------------------- Net operating loss carry forward $ 610,000 $ 1,179,000 Allowance for doubtful accounts 578,000 136,000 Inventory valuation adjustments 29,000 38,000 Depreciation 259,000 135,000 Accruals for inventory returns and markdowns 133,000 169,000 Foreign and alternative minimum tax credits 1,753,000 1,636,000 Other 57,000 64,000 ------------- ------------- Gross deferred tax assets 3,419,000 3,357,000 Less valuation allowance (566,000) (372,000) ------------- ------------- Net deferred tax assets 2,853,000 2,985,000 ------------- ------------- Unremitted earnings of foreign subsidiary (648,000) (820,000) Depreciation (156,642) (188,849) Other (99,118) ------------- ------------- Gross deferred tax liabilities (903,760) (1,008,849) ------------- ------------- Net deferred tax assets (liabilities) $ 1,949,240 $ 1,976,151 ------------- -------------
The Internal Revenue Service regulations restrict the utilization of U.S. net operating loss carryforwards and other tax attributes such as foreign tax credits for any company in which an "ownership change" as defined in Section 382 of the Internal Revenue Code has occurred. In June of 1999, the Company had a Section 382 change in ownership. As a result, the Company's U.S. net operating losses and tax credits are subject to limitation of approximately $1,230,000 per year. For the current fiscal year, this limitation did not impact the Company's utilization of U.S. net operating losses and foreign tax credits. At December 31, 2001, the Company has approximately $1,671,000 in foreign tax credit carryforwards which expire between December 31, 2001 through December 31, 2006. The Company also has approximately $82,000 in alternative minimum tax credit carryforwards which do not expire. With the exception of approximately $566,000 of foreign tax credits expiring during the tax year December 31, 2002, the Company believes that the foreign and alternative minimum tax credit carryforwards will be available to reduce future federal income tax liabilities, and has recorded the related tax benefit as a non-current deferred tax asset. The Company has federal net operating loss carryforwards (NOL) of approximately $610,000 which expire in 2020. The Company's state net operating loss carryforward is not significant. The benefit from utilization of net operating loss carryforwards could be subject to limitations if significant ownership changes occur in the Company. The Company's ability to realize the entire benefit of its deferred tax asset requires that the Company achieve certain future earnings levels prior to the expiration of its foreign tax credit and NOL carryforwards. The Company could be required to record a valuation allowance for a portion or all of its deferred tax asset if market conditions deteriorate and future earnings are below, or projected to be below, its current estimates. NOTE 8 - EMPLOYEE BENEFIT PLAN: The Company maintains a 401(k) Plan (the Plan) for the benefit of its U.S. employees. The Company may, at its discretion, provide funds to match employee contributions to the Plan. The Company contributed approximately $63,000, $54,000 and $27,000 in fiscal 2001, 2000 and 1999, respectively, as employer matching contributions to employee contributions. F-15 NOTE 9 - THE STOCK OPTION PLAN AND WARRANTS: The Company has reserved 388,888 common shares for issuance upon exercise of warrants issued to a bank. Such warrants are currently exercisable at a purchase price of $2 per share and expire December 11, 2005. In connection with the Offering, the Company issued warrants to purchase 250,000 shares of common stock. Such warrants are exercisable at $10.80 per share and expire May 28, 2002. On March 19, 2001, the Company issued to MVII an Investment Warrant to acquire 1.8 million shares of the Company's Common Stock at a purchase price of $2.7 million. The Investment Warrant is exercisable, in whole or in part, for a ten-year period beginning June 4, 2002. Proceeds from the sale of the Investment Warrant were used by the Company for current working capital. In May 1997, the Board adopted the DSI Toys, Inc. 1997 Stock Option Plan (the 1997 Plan) whereby certain employees may be granted stock options, appreciation rights or awards related to the Company's common stock. Additionally, the Company may grant nonstatutory stock options (as defined in the 1997 Plan) to nonemployee board members. The Board authorized 600,000 shares to be available for grant pursuant to the 1997 Plan. Options expire no later than ten years from the date of grant. Additional awards may be granted under the 1997 Plan in the form of cash, stock or stock appreciation rights. The stock appreciation right awards may consist of the right to receive payment in cash or common stock. Any award may be subject to certain conditions, including continuous service with the Company or achievement of business objectives. In May 1999, the 1997 Plan was amended to authorize 900,000 shares to be available for grant. In May 2000, the 1997 Plan was amended to authorize 1,200,000 shares to be available for grant. A summary of the option activity under the 1997 Plan, as amended, follows:
Number of Weighted Average Outstanding Options Option Price ---------------------- --------------------- Options outstanding at January 31, 1999 603,000 $ 7.10 Granted 685,500 3.13 Exercised (74,666) 1.39 Surrendered (467,334) 7.73 -------- Options outstanding at December 31, 1999 746,500 3.63 Granted 142,500 3.19 Surrendered (22,500) 5.40 -------- Options outstanding at December 31, 2000 866,500 3.51 Granted 103,000 3.13 Surrendered (240,000) 3.29 -------- Options outstanding at December 31, 2001 729,500 $ 3.55 --------
F-16 The weighted average fair value at date of grant for options granted during fiscal 2001, 2000 and 1999 was $3.13, $3.19 and $3.13 respectively. Vesting periods for options granted range from immediate to seven years from the date of grant in increments between 5% and 90% per year. Options outstanding at December 31, 2001 are as follows:
Weighted Weighted Weighted Number of Average Average Number of Average Outstanding Exercise Remaining Exercisable Exercise Option Price Options Price Contractual Life Options Price - ----------------- --------------- --------------- -------------------- --------------- --------------- $3.125 - 3.49 667,500 $ 3.14 8 225,300 $ 3.13 8.00 62,000 $ 8.00 6 18,800 $ 8.00 ------- ------- 729,500 244,100 ------- -------
The Company applies APB 25 and related interpretations in accounting for its stock option plan. Accordingly, no compensation cost has been recognized by the Company for this plan. The following unaudited pro forma data is calculated as if compensation cost for the 1997 Plan was determined based upon the fair value at the grant date for awards under the plan consistent with the methodology prescribed under SFAS 123 for fiscal years 2001, 2000 and 1999:
2001 2000 1999 ---------------- ---------------- ---------------- Pro forma net earnings (loss) $ (1,769,418) $ (1,089,412) $ 1,000,150 Pro forma basic earnings (loss) per common share $ (0.20) $ (0.12) $ 0.13 Pro forma diluted earnings (loss) per common share $ (0.20) $ (0.12) $ 0.13
The fair value of each option granted is estimated on the date of grant using the Black-Scholes options-repricing model with the following weighted average assumptions used for grants in fiscal 2001, 2000 and 1999: expected volatility of 80% in fiscal 2001, 80% in fiscal 2000 and 104% in fiscal 1999, risk-free interest rate of 4.64% to 6.37%, no dividend yield and an expected life of seven years. NOTE 10 - RELATED PARTY TRANSACTIONS: The Company leases its office and warehouse in Houston from an entity owned by the previous sole shareholder of the Company. Rent expense on these leases was approximately $367,000, $325,000 and $199,000 respectively for fiscal 2001, 2000, and 1999. Management believes that the rental rates approximate fair market value. On June 11, 1999, the Company entered into a consulting agreement with a director (and former CEO), for a term of three years. Compensation for the three year term is $450,000 payable in equal monthly installments of $12,500. On January 7, 2000, the Company borrowed $5,000,000 from MVII, LLC (a California limited liability company controlled by the Chairman, and including certain other directors) evidenced by a Promissory Note. The Note, which bears interest at a rate of prime plus 2% per annum, requires monthly interest payments from the date of the Note and principal payments beginning June 1, 2000, subject to subordination terms of the Revolver (see Note 6). On March 6, 2002, pursuant to the terms of the Revolver and the MVII Note, the Company reborrowed $500,000 of the original principal that the Company had paid on the MVII Note. The proceeds were used to finance normal business operations of the Company. F-17 Also on January 7, 2000, as discussed in Note 15, the Company merged with Meritus Industries, Inc. Pursuant to the merger terms, one of Meritus' primary shareholders was subsequently elected to the Board. In addition to the stock received in the transaction, the shareholder received $1.1 million in cash and a note receivable for $1.7 million. The note, bearing interest at 10.0375% per annum, requires quarterly principal and interest payments beginning April 1, 2000. Additional related party transactions are described in Notes 1, 11 and 16. NOTE 11 - COMMITMENTS AND CONTINGENCIES: In the normal course of business, the Company is involved in product and intellectual property issues which sometimes result in litigation. It is the opinion of management that the ultimate resolution of such matters will not have a material adverse effect on the Company's financial position, results of operations or cash flows, taken as a whole. The Company leases its facilities under various operating leases which expire from 2001 to 2010. Rent expense, including amounts paid to a related party, for fiscal 2001, 2000, and 1999 amounted to $966,971, $1,008,183 and $573,000, respectively. Aggregate minimum rental commitments under non-cancelable leases are as follows for the specified fiscal years: 2002 872,929 2003 270,759 2004 167,316 2005 167,316 2006 167,316 Thereafter thru 2010 557,720 --------------------- $ 2,203,356 =====================
The lease for the Company's primary executive offices, showroom and warehouse expires August 31, 2002. The Company is in negotiations to lease for about five years approximately 16,000 square feet of office space in Houston, Texas for executive offices, showroom and consumer services. The Company anticipates occupying its new offices on August 1, 2002. The Company is in negotiations to lease approximately 75,000 square feet of warehouse space in Fife, Washington. The Company anticipates signing the lease in June, 2002. Royalty expense under licensing agreements aggregated approximately $3,310,000, $2,989,000 and $1,829,000, in fiscal 2001, 2000 and 1999, respectively. At December 31, 2001, minimum guaranteed royalties payable under these agreements of $150,000 in fiscal 2002 and $225,000 through 2003, are included in accrued royalties payable and prepaid expenses and other assets. The Company has employment agreements with executives at December 31, 2001 that aggregate $750,000, are adjusted annually by the CPI change, and expire in the next 15-35 months. In fiscal 2000, the Company terminated its obligations for current and future insurance premium payments on certain life insurance policies. In prior years, the Company paid premiums for the policies owned by the Tommy and JoBeth Moss Joint Life Insurance Trust, (the "Trust"), and was entitled to repayment of the advanced premiums, plus related cumulative interest, upon the death of JoBeth Moss. The Company agreed to forgo the cumulative amounts due the Company in exchange for the Trust extinguishing the future obligations for insurance premium payments. The premiums recorded for general and administrative expense in 1999 were approximately $243,000. F-18 NOTE 12 - SEGMENT INFORMATION: The Company designs, develops, markets and distributes a variety of toys and children's consumer electronics. These product lines are grouped into three major categories which represent the Company's operating segments, as follows: Juvenile Audio Products, including walkie-talkies, pre-school audio products, pre-teen audio products and musical toys; Girls' Toys, including dolls, play sets and accessories; and Boys' Toys, including radio control vehicles, action figures and western and military action toys. These operating segments all have similar economic characteristics: the marketing of children's products. Based on these similarities, the Company's products can be aggregated into one reportable segment for purposes of this disclosure. The Company sells its products through (i) the Hong Kong operation, where products are shipped directly from contract manufacturers to the Company's customers, and (ii) the United States operation, where products are shipped from the Company's warehouse in Houston to its customers. Financial information for fiscal 2001, 2000, and 1999 for the U.S. and Hong Kong operations is as follows:
United States Hong Kong Consolidated ------------------- ------------------- ------------------- FISCAL 2001: Net sales $ 31,859,743 $ 36,046,666 $ 67,906,409 Operating income (loss) (632,616) 450,564 (182,052) Depreciation expense 469,033 865,359 1,334,392 Capital expenditures 121,657 645,264 766,921 Total assets at fiscal year end $ 27,622,660 $ 3,690,075 $ 31,312,735 FISCAL 2000: Net sales $ 27,147,848 $ 43,290,683 $ 70,438,531 Operating income (loss) (682,572) 633,386 (49,186) Depreciation expense 733,186 818,446 1,551,632 Capital expenditures 237,752 1,012,192 1,249,944 Total assets at fiscal year end $ 26,528,128 $ 3,471,012 $ 29,999,140 FISCAL 1999: Net sales $ 16,419,628 $ 31,140,396 $ 47,560,024 Operating income (loss) (1,527,874) 4,139,162 2,665,288 Depreciation expense 265,790 463,161 728,951 Capital expenditures 256,354 831,092 1,087,446 Total assets at fiscal year end $ 11,134,140 $ 3,893,226 $ 15,027,366
F-19 Sales to major customers that exceeded 10% of the Company's total net sales consist of the following for the specified fiscal years (See Note 15):
2001 2000 1999 ----------------- ---------------- ----------------- Wal-Mart 21% 18% 21% Kmart 10% Toys "R" Us 12%
Approximately 17% of the Company's sales were exports to foreign countries during fiscal 2001, and 19% and 23% during fiscal 2000 and 1999, respectively. NOTE 13 - SUPPLEMENTAL CASH FLOW INFORMATION: Additional cash flow information by fiscal year is as follows:
2001 2000 1999 --------------- ------------------ --------------- Cash paid (received) for: Interest $ 1,107,486 $ 1,104,296 $ 334,932 Income taxes $ 385,926 $ 753,199 $ (8,636) Noncash activities included in the following: Accounts receivable write-offs (recoveries) $ 438,089 $ (11,769) $ 2,777 Acquisition of Meritus: Property, plant and equipment acquired $ (748,730) Accounts receivable and other assets acquired (838,563) Liabilities assumed 7,475,172 Note payable issued to the Sellers 1,690,000 Common stock issued (including treasury shares) 1,801,415 Goodwill resulting from Meritus acquisition (10,263,327) -------------- Net cash paid for Meritus acquisition $ (884,033) ==============
F-20 NOTE 14 - QUARTERLY FINANCIAL INFORMATION (UNAUDITED):
FISCAL QUARTER ENDED ----------------------------------------------------------------- 3/31/01 6/30/01 9/30/01 12/31/01 ---------------- --------------- ---------------- ---------------- Net sales $ 6,721,223 $ 9,416,184 $ 29,927,783 $ 21,841,219 Operating income (loss) (2,188,188) (2,070,282) 3,531,705 544,713 Income (loss) before income taxes (2,421,792) (2,314,578) 3,312,353 365,402 Net income (loss) (1,549,947) (1,481,330) 1,981,289 (399,530) Basic earnings (loss) per share $ (0.17) $ (0.16) $ 0.22 $ (0.04) Diluted earnings (loss) per share $ (0.17) $ (0.16) $ 0.22 $ (0.04)
FISCAL QUARTER ENDED ------------------------------------------------------------------ 3/31/00 6/30/00 9/30/00 12/31/00 --------------- ---------------- --------------- ---------------- Net sales $ 6,914,462 $ 13,582,505 $29,915,591 $ 20,025,973 Operating income (loss) (1,735,467) 362,744 2,598,974 (1,275,437) Income (loss) before income taxes (1,995,260) 3,287 2,312,891 (1,647,352) Net income (loss) (1,276,913) 2,049 1,480,251 (1,054,373) Basic earnings (loss) per share $ (0.14) $ 0.00 $ 0.16 $ (0.12) Diluted earnings (loss) per share $ (0.14) $ 0.00 $ 0.16 $ (0.12) ------------------------------------------------------------------
FISCAL QUARTER ENDED ------------------------------------------------------------------ 4/30/99 7/31/99 10/31/99 12/31/99 --------------- ---------------- ---------------- --------------- Net sales $ 3,927,695 $ 14,646,943 $ 22,466,132 $ 6,519,254 Operating income (loss) (631,394) 472,609 2,867,621 (43,548) Income (loss) before income taxes (741,246) 373,555 2,672,381 (155,094) Net income (loss) (498,285) 215,188 1,686,437 (122,349) Basic earnings (loss) per share $ (0.08) $ 0.03 $ 0.20 $ (0.01) Diluted earnings (loss) per share $ (0.08) $ 0.03 $ 0.19 $ (0.01)
NOTE 15 - SUBSEQUENT EVENTS On January 22, 2002, the Kmart Corporation (Kmart) filed for Chapter 11 bankruptcy. At December 31, 2001, the Company's receivables included $1,653,548 due from Kmart, all of which were still outstanding at the date of filing. Based on the listing of Kmart's unsecured debt and financial position contained in the filing, the Company does not anticipate that any of the outstanding balance will be recovered. Accordingly, the Company has recorded an allowance for doubtful accounts in 2001 equal to the entire December 31, 2001 Kmart outstanding balance, or $1,653,548. Kmart was the Company's second largest customer in 2001, comprising 10% of sales. Kmart is requiring normal trade terms from companies desiring to do business with them in 2002, offering a F-21 second-priority lien or "Trade Creditor Lien" in Kmart's owned merchandise inventory. Due to Kmart's market share, the Company has accepted this lien position and will sell to Kmart in 2002. On March 6, 2002, pursuant to the terms of the Revolver and the MVII Note, the Company reborrowed $500,000 of the original principal that the Company paid on the MVII Note. The proceeds were used to finance normal business operations of the Company. As of December 31, 2001, the Company and Sunrock amended the Revolver to revise the future covenants and restrictions required by the Revolver. Management believes the Company will be able to maintain compliance with such covenants in the future. F-22 NOTE 16 - BUSINESS COMBINATION On January 7, 2000, the Company acquired by way of a merger all of the issued and outstanding stock of Meritus Industries, Inc. ("Meritus") in exchange for (i) 600,000 unregistered shares of the Company's common stock, less 66,792 shares of the Company's common stock, which shares were initially held by the Company and payable to Walter and Susan Reiling (the "Reilings") upon satisfaction of certain post-closing conditions as set forth in the Closing and Holdback Agreement between the parties; (ii) $884,034 in cash; and (iii) the Company's Subordinated Secured Promissory Note for $1,690,000 paid to the Reilings, who were the sole shareholders of Meritus. At the end of the holdback period (June 7, 2000), the post-closing conditions were not satisfied and none of the held back (66,792) shares was paid to the Reilings. The market value of the shares issued was $1,081,415 and was satisfied by the issuance of 347,365 shares of new stock and 185,843 shares in treasury stock. Contemporaneously with the merger, the Company satisfied approximately $4.4 million of Meritus' debt. The acquisition was accounted for utilizing the purchase method; therefore the Company recorded the acquired assets at their estimated fair market value. Goodwill generated by the transaction has been amortized over 20 years using the straight-line method in 2001 and 2000. In 2002, and thereafter the market value of the goodwill will be evaluated annually and an impairment charge recorded if appropriate in accordance with Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets". Commensurate with the merger, the Company borrowed $5,000,000 from MVII, LLC, a California limited liability company controlled by E. Thomas Martin ("MVII"), evidenced by a promissory note dated January 7, 2000. The proceeds from the note were used for the payment of the Meritus debt discussed above. PRO FORMA RESULTS OF OPERATIONS Presented below is a pro forma statement of operations for fiscal year ended December 1999. The proforma reflects the combined operations of the Company and Meritus as if the merger of the Company and Meritus occurred on January 1, 1998.
FISCAL 1999 ----------------------------------------------------------------- DSI MERITUS COMBINED (UNAUDITED) (UNAUDITED) ------------------- ------------------ -------------------- Net sales $ 47,560,024 $ 15,813,170 $ 63,373,194 Net income (loss) $ 1,280,991 $ (2,000,870) $ (719,879) Basic earnings per share Earnings per shares $ 0.17 $ (0.09) Weighted average shares outstanding $ 7,688,964 8,222,172 Diluted earnings per share Earnings per share $ 0.16 $ (0.09) Weighted average shares outstanding $ 7,803,403 8,336,611
F-23 DSI TOYS, INC. AND SUBSIDIARY VALUATION AND QUALIFYING ACCOUNTS AND RESERVES (SCHEDULE II) (IN THOUSANDS)
Balance Charged Balance Charged Balance Charged Balance at to costs at to costs at to costs at January and December and December and December Description 31, 1999 expenses Deductions 31, 1999 expenses Deductions 31, 2000 expenses Deductions 31, 2001 ----------- -------- -------- ---------- -------- -------- ---------- -------- -------- ---------- -------- Reserves deducted from assets: Trade receivables 123 66 (3) 186 222 12 420 1,718 (438) 1,700 Discounts and markdowns 1,384 1,041 (1,696) 729 1,339 (398) 1,670 1,558 (1,755) 1,473 Return of defective goods 408 2,400 (1,726) 1,082 1,837 (1,889) 1,030 1,012 (1,265) 777 Inventory 100 100 379 (129) 350 412 (392) 370 ----- ----- ------ ----- ----- ---------- ----- ----- ------ ----- 1,915 3,607 (3,425) 2,097 3,777 (2,404) 3,470 4,700 (3,850) 4,320 ===== ===== ====== ===== ===== ========== ===== ===== ====== =====
S-1 EXHIBIT INDEX 2.1 Articles/Certificate of Merger of Meritus Industries, Inc. into the Company, dated January 7, 2000 (filed as Exhibit 2.2 to the Company's Form 8-K dated January 7, 2000), incorporated herein by reference. 3.1 Amended and Restated Articles of Incorporation of the Company. (1) 3.1.1 Amendment to Amended and Restated Articles of Incorporation of the Company (filed as Exhibit 3.1.1 to the Company's Form 10-Q for the quarterly period ended April 30, 1999), incorporated herein by reference. (3) 3.2 Amended and Restated Bylaws of the Company. (1) 3.3 Amendment to Amended and Restated Bylaws of the Company. (1) 4.1 Form of Common Stock Certificate. (1) 4.2 Form of Warrant Agreement among the Company and Representatives to purchase 250,000 shares of common stock. (1) 4.3 Common Stock Purchase Warrant No. A-1 dated December 11, 1995, issued to Hibernia Corporation to purchase 388,888 shares of common stock. (1) 4.4 Registration Rights Agreement by and between the Company and Hibernia Corporation. (1) 4.5 Registration Rights Agreement by and between the Registrant and Tommy Moss. (1) 4.6 Form of Investment Warrant by and between the Company and MVII, LLC, dated March 19, 2001(filed as Exhibit 4.6 to the Company's Form 10-K for the fiscal year ended December 31, 2000), incorporated herein by reference. 4.7 Registration Rights Agreement by and between the Company and MVII, LLC, dated March 19, 2001 (files as Exhibit 4.7 to the Company's Form 10-K for the fiscal year ended December 31, 2000), incorporated herein by reference. 4.8* Amended and Restated Investment Warrant by and between the Company and MVII, LLC, dated January 31, 2002. 4.9* Amended and Restated Registration Rights Agreement by and between the Company and MVII, LLC dated January 31, 2002. 10.1 1997 Stock Option Plan. (1) 10.2 Agreement for Sale of Stock between Rosie Acquisition, L.L.C. and DSI Acquisition, Inc. and Diversified Specialists, Inc. and Tommy Moss, dated December 11, 1995. (1) 10.3 Employment Agreement dated December 11, 1995 by and between the Company and M.D. Davis. (1) 10.4 Employment Agreement dated December 11, 1995 by and between the Company and Richard R. Neitz. (1) 10.5 Employment Agreement dated December 11, 1995 by and between the Company and Yau Wing Kong. (1) E-1 10.6 Employment Agreement dated December 11, 1995 by and between the Company and Dale Y. Chen. (1) 10.7 Employment Agreement dated December 11, 1995 by and between the Company and Thomas V. Yarnell. (1) 10.8 Employment Agreement dated March 16, 1997 by and between the Company and J. Russell Denson. (1) 10.9 Letter Loan Agreement between the Company and Bank One, Texas, N.A. dated December 11, 1995, evidencing a revolving line of credit and a term note (the "Bank One Letter Loan Agreement"). (1) 10.10 First Amendment to Bank One Letter Loan Agreement, dated January 31, 1996. (1) 10.11 Second Amendment to Bank One Letter Loan Agreement, dated August 1, 1996. (1) 10.12 Third Amendment to Bank One Letter Loan Agreement, dated November 14, 1996. (1) 10.13 Fourth Amendment to Bank One Letter Loan Agreement, dated January 31, 1997. (1) 10.14 Fifth Amendment to Bank One Letter Loan Agreement, dated January 31, 1997. (1) 10.15 Line of Credit Facility with State Street Bank and Trust Company, Hong Kong Branch, dated April 1, 1997, evidencing a $5,000,000 line of credit. (1) 10.16 Underwriting Agreement dated May 28, 1997 among the Company, the Tommy Moss Living Trust, Hibernia Corporation and Tucker Anthony Incorporated and Sutro & Co. Incorporated (filed as Exhibit 10.1 to the Company's Form 10-Q for the quarterly period ended April 30, 1997), incorporated herein by reference. 10.17 Warrant Agreement dated May 28, 1997 by and among the Company, Tucker Anthony Incorporated and Sutro & Co. Incorporated (filed as Exhibit 10.2 to the Company's Form 10-Q for the quarterly period ended April 30, 1997), incorporated herein by reference. 10.18 Renewal and Modification of Line of Credit Facility with State Street Bank and Trust Company, Hong Kong Branch, dated June 6, 1997, evidencing an $8,000,000 line of credit (filed as Exhibit 10.1 to the Company's Form 10-Q for the quarterly period ended July 31, 1997), incorporated herein by reference. 10.19 Debenture by DSI(HK) Limited to State Street Bank and Trust Company, Hong Kong Branch, dated July 29, 1997 (filed as Exhibit 10.2 to the Company's Form 10-Q for the quarterly period ended July 31, 1997), incorporated herein by reference. 10.20 Amended and Restated Bank One Letter Loan Agreement, dated October 22, 1997 (filed as Exhibit 10.1 to the Company's Form 10-Q for the quarterly period ended October 31, 1997), incorporated herein by reference. 10.21 First Amendment to Amended and Restated Bank One Letter Loan Agreement, dated January 31, 1998 (filed as Exhibit 10.21 to the Company's Form 10-K for the annual period ended January 31, 1998), incorporated herein by reference. 10.22 Second Amendment to Amended and Restated Bank One Letter Loan Agreement, dated September 30, 1998 (filed as Exhibit 10.22 to the Company's Form 10-Q for the quarterly period ended October 31, 1998), incorporated herein by reference. 10.23 Employment Agreement dated August 20, 1998 by and between the Company and Howard G. Peretz. (2) E-2 10.24 Loan and Security Agreement by and between the Company and Sunrock Capital Corp. dated February 2, 1999. (2) 10.25 Stock Pledge Agreement by and between the Company and Sunrock Capital Corp. dated February 2, 1999. (2) 10.26 Assignment of Deposit Account by and between the Company and Sunrock Capital Corp. dated February 2, 1999. (2) 10.27 Trademark Security Agreement by and between the Company and Sunrock Capital Corp. dated February 2, 1999. (2) 10.28 Patent Collateral Assignment by and between the Company and Sunrock Capital Corp. dated February 2, 1999. (2) 10.29 Stock Purchase and Sale Agreement dated April 15, 1999 by and between the Company and MVII, LLC (filed as Exhibit 2 to the Company's Schedule 14D-9 filed by the Company on April 22, 1999), incorporated herein by reference. 10.30 Stock Purchase and Sale Agreement, dated April 15, 1999, between the Company and MVII, LLC (filed as Exhibit 99.2 to the Schedule 14D-9 filed by the Company on April 22, 1999), incorporated herein by reference. 10.31 Shareholders' and Voting Agreement dated April 15, 1999, by and among the Company, MVII, LLC, certain management shareholders of the Company and a limited partnership controlled by a management shareholder (filed as Exhibit 99.4 to the Schedule 14D-9 filed by the Company on April 22, 1999), incorporated herein by reference. 10.32 Registration Rights Agreement dated April 15, 1999, by and among the Company, MVII, LLC, certain management shareholders of the company and a limited partnership controlled by a management shareholder (filed as Exhibit 99.5 to the Schedule 14D-9 filed by the Company on April 22, 1999), incorporated herein by reference. 10.33 Irrevocable Proxy dated April 15, 1999, between MVII, LLC and Conrad. (3) 10.34 Irrevocable Proxy dated April 15, 1999, between MVII, LLC and Davis. (3) 10.35 Irrevocable Proxy dated April 15, 1999, between MVII, LLC and Matlock. (3) 10.36 Irrevocable Proxy dated April 15, 1999, between MVII, LLC and Rust Capital. (3) 10.37 Irrevocable Proxy dated April 15, 1999, between MVII, LLC and Smith. (3) 10.38 Consulting Agreement dated June 1, 1999, between the Company and Davis. (3) 10.39 Amendment dated May 5, 1999, to Loan and Security Agreement, dated as of February 2, 1999, by and between Sunrock Capital Corp. and the Company. (3) 10.40 Amendment No. 1 dated June 30, 1999, to Loan and Security Agreement, by and between Sunrock Capital Corp. and the Company. (4) 10.41 Employment Agreement dated June 17, 1999 by and between the Company and Michael J. Lyden. (4) 10.42 Employment Agreement dated June 1, 1999, by and between the Company and Joseph S. Whitaker. (4) 10.43 Amendment to 1997 Stock Option Plan dated May 24, 1999. (4) E-3 10.44 Restated Employment Agreement dated December 31, 1999, by and between DSI(HK) Limited and Yau Wing Kong (filed as Exhibit 10/44 to the Company's Form 10-K for the 11 month period ended December 31, 1999), and incorporated herein by reference. 10.45 Agreement and Plan of Merger between Meritus Industries, Inc. et al. and the Company, dated October 7, 1999 (filed as Exhibit 10.45 to the Company's Form 10-Q for the quarterly period ended October 31, 1999), incorporated herein by reference. 10.46 Closing and Holdback Agreement dated January 7, 2000, by and between the Company and Meritus Industries, Inc., et al. (filed as Exhibit 2.3 to the Company's Form 8-K dated January 7, 2000), incorporated herein by reference. 10.47 Shareholders' and Voting Agreement dated January 7, 2000, by and among the Company, MVII, LLC and Walter S. and Susan Reiling (filed as Exhibit 10.1 to the Company's Form 8-K dated January 7, 2000), incorporated herein by reference. 10.48 Limited Irrevocable Proxy dated January 7, 2000, between MVII, LLC and Walter S. and Susan Reiling (filed as Exhibit 10.2 to the Company's Form 8-K dated January 7, 2000), incorporated herein by reference. 10.49 Registration Rights Agreement dated January 7, 2000, by and between the Company and Walter S. and Susan Reiling (filed as Exhibit 10.3 to the Company's Form 8-K dated January 7, 2000), incorporated herein by reference. 10.50 Subordinated Secured Promissory Note dated January 7, 2000, from the Company to Walter S. and Susan Reiling (filed as Exhibit 10.4 to the Company's Form 8-K dated January 7, 2000), incorporated herein by reference. 10.51 Promissory Note dated January 7, 2000, from the Company to MVII, LLC (filed as Exhibit 10.5 to the Company's Form 8-K dated January 7, 2000), incorporated herein by reference. 10.52 Amendment No. 2 dated January 7, 2000, to Loan and Security Agreement, by and between Sunrock Capital Corp. and the Company (filed as Exhibit 10.6 to the Company's Form 8-K dated January 7, 2000), incorporated herein by reference. 10.53 Employment Agreement dated January 7, 2000, by and between the Company and Beth Reiling (filed as Exhibit 10.7 to the Company's Form 8-K dated January 7, 2000), incorporated herein by reference. 10.54 Employment Agreement dated January 7, 2000, by and between the Company and Joseph Reiling (filed as Exhibit 10.8 to the Company's Form 8-K dated January 7, 2000), incorporated herein by reference. 10.55 Amendment No. 2 to DSI Toys, Inc. 1997 Stock Option Plan (filed as Exhibit 10.11 to the Company's Form 10-Q for the quarterly period ended June 30, 2000), incorporated herein by reference. 10.56 Amendment No. 3 dated July 14, 2000, to Loan and Security Agreement, by and between Sunrock Capital Corp. and the Company (filed as Exhibit 10.12 to the Company's Form 10-Q for the period ended June 30, 2000), incorporated herein by reference. 10.57 Amendment No. 4 dated March 30, 2001, to Loan and Security Agreement, by and between Sunrock Capital Corp. and the Company (filed as Exhibit 10.57 to the Company's Form 10-K for the annual period ended December 31, 2000), incorporated herein by reference. E-4 10.58 Employment Agreement dated April 1, 2001, but executed April 23, 2001, by and between the Company and Gregory A. Barth (filed as Exhibit 10.2 to the Company's Form 10-Q for the quarterly period ended March 31, 2001), incorporated herein by reference. 10.59 Amendment No. 5 to Loan and Security Agreement, dated August 13, 2001, by and between Sunrock Capital Corp. and the Company (filed as Exhibit 10.3 to the Company's Form 10-Q for the quarterly period ended June 30, 2001), incorporated herein by reference. 10.60 Amendment No. 6 to Loan and Security Agreement, dated August 13, 2001, by and between Sunrock Capital Corp. and the Company (filed as Exhibit 10.4 to the Company's Form 10-Q for the quarterly period ended June 30, 2001), incorporated herein by reference. 10.61* First Amendment to Employment Agreement by and between the Company and Joseph S. Whitaker, dated December 1, 2001. 10.62* Line of Credit Facility with Dao Heng Bank Limited evidencing a $6,000,000 line of credit, dated December 4, 2001. 10.63* Memorandum of Re-borrowing of Principal by and between the Company and MVII, LLC, dated March 6, 2002. 10.64* Amendment No. 7 dated March 20, 2002, to Loan and Security Agreement by and between Sunrock Capital Corp. and the Company. 10.65* Unconditional Guaranty Agreement dated March 20, 2002, by the Company and Dao Heng Bank Limited. 10.66* Amendment No. 8 dated March 29, 2002, to Loan and Security Agreement by and between Sunrock Capital Corp. and the Company. 21* Subsidiaries. 99.1 DSI Toys, Inc. Audit Committee of the Board of Directors, Charter, adopted by the Board of Directors on May 23, 2000 (filed as Exhibit 99.1 to the Company's Form 10-Q for the period ended June 30, 2000), incorporated herein by reference. 99.2 Amendment No. 1 to the Audit Committee of the Board of Directors Charter, adopted by the Board of Directors on March 31, 2001 (filed as Exhibit 99.2 to the Company's Form 10-K for the fiscal year ended December 31, 2000), incorporated herein by reference. (1) Filed as a part of the Registrant's Registration Statement on Form S-1 (No. 333-23961) and incorporated herein by reference. (2) Filed as the indicated numbered exhibit to the Company's Form 10-K for the annual period ended January 31, 1999, and incorporated herein by reference. (3) Filed as the indicated numbered exhibit to the Company's Form 10-Q for the quarterly period ended April 30, 1999, and incorporated herein by reference. (4) Filed as the indicated numbered exhibit to the Company's Form 10-Q for the quarterly period ended July 31, 1999, and incorporated herein by reference. * Filed herewith E-5 EX-4.8 3 a2074077zex-4_8.txt EXHIBIT 4.8 EXHIBIT 4.8 THIS INVESTMENT WARRANT AND THE SECURITIES ISSUABLE UPON THE CONVERSION HEREOF HAVE BEEN ACQUIRED FOR INVESTMENT AND HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933. THEY MAY NOT BE SOLD, OFFERED FOR SALE, PLEDGED, HYPOTHECATED OR OTHERWISE TRANSFERRED EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933, OR AN OPINION OF COUNSEL SATISFACTORY TO THE COMPANY THAT REGISTRATION IS NOT REQUIRED UNDER SUCH ACT OR UNLESS SOLD PURSUANT TO RULE 144 UNDER SUCH ACT. Dated January 31, 2002 Void after June 3, 2012 AMENDED AND RESTATED INVESTMENT WARRANT DSI TOYS, INC. THIS AMENDED AND RESTATED INVESTMENT WARRANT OF DSI TOYS, INC. (HEREINAFTER THE "INVESTMENT WARRANT") AMENDS AND RESTATES IN ITS ENTIRETY THAT CERTAIN INVESTMENT WARRANT OF DSI TOYS, INC. (THE "COMPANY") MADE IN FAVOR OF MVII, LLC, A CALIFORNIA LIMITED LIABILITY COMPANY (THE "HOLDER"), DATED MARCH 19, 2001, WHICH IS HEREBY TERMINATED, CANCELED AND REPLACED BY THIS INVESTMENT WARRANT. THIS CERTIFIES THAT, for cash paid in the amount of TWO MILLION SEVEN HUNDRED THOUSAND AND NO/100 DOLLARS ($2,700,000.00) (the "PURCHASE PRICE") on or about March 19, 2001, the Holder is entitled to receive from the Company, at any time or from time to time during the period specified in Paragraph 2, ONE MILLION EIGHT HUNDRED THOUSAND (1,800,000) fully paid and nonassessable shares of the Company's common stock, $0.01 par value per share (the "COMMON STOCK"). The term "OPTION SHARES," as used herein, refers to the shares of Common Stock receivable hereunder. The term "DEEMED CONVERSION PRICE," as used herein is $1.50 per Option Share and refers to the price per share paid by the Holder for the right to receive the Option Shares in accordance with the terms of this Investment Warrant. This Investment Warrant is subject to the following terms, provisions, and conditions: 1. MANNER OF CONVERSION; ISSUANCE OF CERTIFICATES. Subject to the provisions set forth herein, this Investment Warrant may be converted by any Holder and/or its registered assigns, in whole or in part, by the surrender of this Investment Warrant together with a completed conversion agreement in the form attached to this Investment Warrant (the "CONVERSION AGREEMENT"), to the Company during normal business hours on any business day at the Company's principal executive offices (or such other office or agency of the Company as it may designate by notice to the Holder). Page 1 The Option Shares received upon conversion shall be deemed to be issued to the Holder, as the record owner of such shares, as of the close of business on the date on which this Investment Warrant shall have been surrendered and the completed Conversion Agreement shall have been delivered. Certificates for the Option Shares shall be delivered to the Holder within a reasonable time, not to exceed three business days after this Investment Warrant shall have been so converted. The certificates so delivered shall be in such denominations as may be requested by the Holder and shall be registered in the name of the Holder or such other name as shall be designated by such Holder. 2. PERIOD OF CONVERSION. This Investment Warrant may be converted, at the option of the Holder, in whole or in part, at any time from and after June 3, 2002, until 5:00 p.m., Central time, June 3, 2012 (the "EXERCISE PERIOD"), unless it expires and terminates earlier as provided herein. 3. CERTAIN AGREEMENTS OF THE COMPANY. The Company hereby covenants and agrees as follows: a. SHARES TO BE FULLY PAID. All Option Shares will, upon issuance in accordance with the terms of this Investment Warrant, be validly issued, fully paid and nonassessable and free from all taxes, liens and charges with respect to the issue thereof. b. RESERVATION OF SHARES. During the Exercise Period, the Company shall at all times have authorized, and reserved for the purpose of issuance upon exercise of this Investment Warrant, a sufficient number of shares of Common Stock to provide for the conversion of this Investment Warrant. c. SUCCESSORS AND ASSIGNS. This Investment Warrant will be binding upon any entity succeeding to the Company by merger, consolidation or acquisition of all or substantially all of the Company's assets. 4. CONSOLIDATION, MERGER OR SALE. From and after the date of this Investment Warrant, in case of any consolidation of the Company with, or merger of the Company into, any other corporation, or in case of any sale or conveyance of all or substantially all of the assets of the Company other than in connection with a plan of complete liquidation of the Company, then as a condition of such consolidation, merger or sale or conveyance, adequate provision will be made whereby the Holder of this Investment Warrant will have the right to acquire and receive such shares of stock, securities or assets as may be issued or payable with respect to or in exchange for the number of shares of Common Stock immediately acquirable and receivable had this Investment Warrant been converted at that time had such consolidation, merger or sale or conveyance not taken place. "Common Stock" for the purposes of this Paragraph 4, includes the Common Stock or shares resulting from any subdivision or combination of such Common Stock, or in the case of any reorganization, reclassification, consolidation, merger or sale of the character referred to in this Paragraph, the stock or other securities or property provided for in such Paragraph. Page 2 5. ISSUE TAX. The issuance of certificates for Option Shares upon the conversion of this Investment Warrant shall be made without charge to the Holder or such shares for any issuance tax or other costs in respect thereof, provided that the Company shall not be required to pay any tax that may be payable in respect of any transfer involved in the issuance and delivery of any certificate in a name other than the Holder of this Investment Warrant. 6. NO RIGHTS OR LIABILITIES AS A SHAREHOLDER. This Investment Warrant shall not entitle the Holder to any voting rights or other rights as a shareholder of the Company. No provision of this Investment Warrant, and no mere enumeration herein of the rights or privileges of the Holder, shall give rise to any liability of such Holder, whether such liability is asserted by the Company or creditors of the Company. 7. TRANSFER AND REPLACEMENT OF INVESTMENT WARRANT. a. RESTRICTION ON TRANSFER. This Investment Warrant and the rights granted to the Holder are transferable, in whole or in part, upon surrender of this Investment Warrant, together with a properly executed assignment in the form attached hereto, at the office of the Company referred to in Paragraph 7(d) below, PROVIDED, HOWEVER, that any transfer or assignment shall be subject to the conditions set forth in Paragraph 7(e). Until due presentment for registration of transfer on the books of the Company, the Company may treat the registered Holder as the owner and Holder of this Investment Warrant for all purposes, and the Company shall not be affected by any notice to the contrary. b. REPLACEMENT OF INVESTMENT WARRANT. Upon receipt of evidence reasonably satisfactory to the Company of the loss, theft, destruction, or mutilation of this Investment Warrant and, in the case of any such loss, theft, or destruction, upon delivery of an indemnity agreement reasonably satisfactory in form and amount to the Company, or, in the case of any such mutilation, upon surrender and cancellation of this Investment Warrant, the Company, at its expense, will execute and deliver, in lieu thereof, a new Investment Warrant of like tenor. c. CANCELLATION, PAYMENT OF EXPENSES. Upon the surrender of this Investment Warrant in connection with any transfer or replacement as provided in Paragraph 7, this Investment Warrant shall be promptly canceled by the Company. The Company shall pay all taxes (other than securities transfer taxes) and all other expenses (other than legal expenses, if any, incurred by the Holder) in connection with the preparation, execution, and delivery of Investment Warrants pursuant to this Paragraph 7. Page 3 D. REGISTER. The Company shall maintain, at its principal executive offices (or such other office of the Company as it may designate by notice to the Holder), a register for this Investment Warrant, in which the Company shall record the name and address of the person in whose name this Investment Warrant has been issued, as well as the name and address of each transferee and each prior owner of this Investment Warrant. e. EXERCISE OR TRANSFER WITHOUT REGISTRATION. If, at the time of the surrender of this Investment Warrant in connection with any conversion, transfer, or exchange of this Investment Warrant, this Investment Warrant (or in the case of any exercise, the Option Shares issuable hereunder) shall not be registered under the Securities Act and under applicable state securities or blue sky laws, the Company may require, as a condition of allowing such exercise, transfer, or exchange (i) that the Holder or transferee of this Investment Warrant, as the case may be, furnish to the Company a written opinion of counsel, which opinion and counsel are reasonably acceptable to the Company, to the effect that such exercise, transfer, or exchange may be made without registration under said Act and under applicable state securities or blue sky laws, and (ii) that the Holder or transferee execute and deliver to the company an investment letter in form and substance acceptable to the Company. The first Holder of this Investment Warrant, by taking and holding the same, represents to the Company that such Holder is acquiring this Investment Warrant for investment and not with a view to the distribution thereof. f. LEGEND. The Option Shares issued upon exercise of this Investment Warrant shall contain a legend stating that their transfer is subject to restriction as set forth in section 7(e) of this Investment Warrant and shall further contain the following legend: "THESE SECURITIES ARE SUBJECT TO CERTAIN RIGHTS AND RESTRICTIONS CONTAINED IN A SHAREHOLDERS' AND VOTING AGREEMENT OF DSI TOYS, INC. DATED AS OF APRIL 15, 1999, COPIES OF WHICH ARE ON FILE AT THE PRINCIPAL OFFICE OF THE COMPANY. A COPY OF SUCH AGREEMENT WILL BE FURNISHED WITHOUT CHARGE TO THE HOLDER OF THIS CERTIFICATE UPON RECEIPT BY THE COMPANY AT ITS PRINCIPAL OFFICE OF A WRITTEN REQUEST FROM THE HOLDER REQUESTING SUCH COPIES." 8. NOTICES. All notices, requests and other communications required or permitted to be given or delivered hereunder to the Holder of this Investment Warrant shall be in writing, and shall be personally delivered, or shall be sent by certified or registered mail or by recognized overnight mail courier, postage prepaid and addressed to such Holder at the address shown for such Holder on the books of the Company, or at such other address as shall have been furnished to the Company by notice from such Holder. All notices, requests, and other communications required or permitted to be given or delivered hereunder to the Company shall be in writing, and shall be personally delivered, or shall be sent by certified or registered mail or by recognized overnight courier, postage Page 4 prepaid and addressed to the office of the Company at 1100 W. Sam Houston Parkway North, Suite A, Houston, Texas 77043, Attention: President, or at such other address as shall have been furnished to the Holder of this Investment Warrant by notice from the Company. Any such notice, request or other communication may be sent by facsimile, but shall in such case be subsequently confirmed by a writing personally delivered or sent by certified or registered mail or by recognized overnight mail courier as provided above. All notices, requests and other communications shall be deemed to have been given either at the time of the receipt thereof by the person entitled to receive such notice at the address of such person for purposes of this Paragraph 8 or, if mailed by registered or certified mail or with a recognized overnight mail courier upon deposit with the United States Post Office or such overnight mail courier, if postage is prepaid and the mailing is properly addressed, as the case may be. 9. GOVERNING LAW. THIS INVESTMENT WARRANT SHALL BE GOVERNED AND CONSTRUED AND ENFORCED IN ALL RESPECTS IN ACCORDANCE WITH THE LAWS OF THE STATE OF TEXAS WITHOUT REGARD TO THE BODY OF LAW CONTROLLING CONFLICTS OF LAW. 10. MISCELLANEOUS. a. AMENDMENTS. This Investment Warrant may only be amended by an instrument signed by the Company and the Holder. b. DESCRIPTIVE HEADINGS. The descriptive headings of the several paragraphs of this Investment Warrant are inserted for purposes of reference only, and shall not affect the meaning or construction of any of the provisions of this Investment Warrant. c. SEVERABILITY AND SAVINGS CLAUSE. If any one or more of the provisions contained in this Investment Warrant is for any reason (i) objected to, contested, or challenged by any court, government authority, agency, department, commission or instrumentality of the United States or any state or political subdivision thereof, or any securities industry self-regulatory organization (collectively, "GOVERNMENTAL AUTHORITY"), or (ii) held to be invalid, illegal, or unenforceable in any respect, the Company and the Holder agree to negotiate in good faith to modify such objected to, contested, challenged, invalid, illegal, or unenforceable provision. It is the intention of the Company and the Holder that there shall be substituted for such objected to, contested, challenged, invalid, illegal, or unenforceable provision a provision as similar to such provision as may be possible and yet be acceptable to any objecting Governmental Authority and be valid, legal and enforceable. Further, should any provisions of this Investment Warrant ever be reformed or rewritten by a judicial body, those provisions as rewritten will be binding, but only in that jurisdiction, on the Holder and the Company as if contained in the original Investment Warrant. The invalidity, illegality, or unenforceability of any one or more provisions of this Investment Warrant will not affect the validity and enforceability of any other provisions of this Investment Warrant. Page 5 IN WITNESS WHEREOF, the undersigned has executed this Investment Warrant as of the date first set forth above. DSI TOYS, INC. By: /s/ ROBERT L. WEISGARBER --------------------------------- Name: ROBERT L. WEISGARBER ------------------------------- Title: CHIEF FINANCIAL OFFICER ------------------------------ Page 6 [FORM OF ASSIGNMENT] (TO BE EXECUTED BY THE REGISTERED HOLDER IF SUCH HOLDER DESIRES TO TRANSFER THE INVESTMENT WARRANT) FOR VALUE RECEIVED, ___________________________ hereby sells, assigns and transfer unto Name: ----------------------------------- Address: ----------------------------------- Taxpayer ID/Social Security No.: ----------------------------------- the accompanying Investment Warrant, together with all right, title and interest therein, and does hereby irrevocably constitute and appoint: attorney, to transfer the accompanying Investment Warrant on the books of the Company, with full power of substitution. The transferee's tax identification or social security number is: ______________________________. Dated: ___________________, 200__. [HOLDER] By: ----------------------------- Name: ----------------------------- Title: ----------------------------- NOTICE The signature to the foregoing Assignment must correspond to the name as written upon the face of the accompanying Investment Warrant or any prior assignment thereof in every particular, without alteration or enlargement or change whatsoever. Page 7 [FORM OF CONVERSION AGREEMENT] (TO BE EXECUTED BY THE REGISTERED HOLDER IF SUCH HOLDER DESIRES TO CONVERT THE INVESTMENT WARRANT) To: ----------------------------- The undersigned hereby irrevocably elects to convert the accompanying Investment Warrant to receive _________ shares of Common Stock issuable thereunder and requests that certificates for such shares be issued in the name of: Name: --------------------------- Address: --------------------------- Taxpayer ID/Social Security No.: --------------------------- The undersigned represents that it is acquiring the shares of Common Stock for its own account and not with a view to distributions, and it will not sell these shares unless they have been registered under the Securities Act of 1933 or an exemption from such registration requirement is available. If such number of shares of Common Stock shall not be all the shares of Common Stock into which the accompanying Investment Warrant may be converted, a new Investment Warrant for the balance remaining of such shares of Common Stock shall be registered in the name of and delivered to: Name: --------------------------- Address: --------------------------- Taxpayer ID/Social Security No.: --------------------------- Dated:_______________________, 200__. [HOLDER] By: ----------------------------- Name: ----------------------------- Title: ----------------------------- NOTICE The signature to the foregoing Election must correspond to the name as written upon the face of the accompanying Investment Warrant or any prior assignment thereof in every particular, without alteration or enlargement or change whatsoever. Page 8 EX-4.9 4 a2074077zex-4_9.txt EXHIBIT 4.9 EXHIBIT 4.9 AMENDED AND RESTATED REGISTRATION RIGHTS AGREEMENT This Amended and Restated Registration Rights Agreement (this "Agreement"), dated as of January 31, 2002, is made by and between DSI Toys, Inc., a Texas corporation (the "Company"), and MVII, LLC, a California limited liability company ("MVII"). This Agreement amends and restates in its entirety that certain Registration Rights Agreement between the Company and MVII dated as of March 19, 2001, which is hereby terminated, canceled and replaced by this Agreement. RECITALS: WHEREAS, in exchange for a contribution to the capital of the Company in the amount of $2,700,000 on or about March 19, 2001, the Company has issued to MVII a certain Amended and Restated Investment Warrant (the "Investment Warrant") dated as of the date hereof granting MVII the right to convert such Investment Warrant into shares of common stock, par value $.01 per share, of the Company (the "Common Stock") during the conversion period set forth therein; and WHEREAS, the Company and MVII desire to enter into this Agreement to provide for the registration with the Securities and Exchange Commission (the "Commission"), under certain circumstances, of the Common Stock into which the Investment Warrant may be converted by MVII. AGREEMENT: NOW, THEREFORE, in consideration of the premises and the mutual agreements herein set forth, the parties hereto agree as follows: 1. REGISTRABLE SECURITIES. For purposes of this Agreement "Registrable Securities" shall mean the shares of Common Stock issuable upon conversion of the Investment Warrant. As to any particular Registrable Securities, once issued such securities shall cease to be Registrable Securities when (a) a registration statement with respect to the sale of such securities shall have become effective under the Securities Act of 1933, as amended (the "Securities Act") and such securities shall have been disposed of in accordance with such registration statement, (b) they shall have been distributed to the public pursuant to Rule 144 (or any successor provision) under the Securities Act, (c) they shall have been otherwise transferred, new certificates for them not bearing a legend restricting further transfer shall have been delivered by the Company and subsequent disposition of them shall not require registration or qualification under the Securities Act or any state law in force at the time a transferee proposes to sell or otherwise dispose of the Registrable Securities, or (d) they shall have ceased to be outstanding. 2. REGISTRATION RIGHTS. (a) RIGHT TO PIGGYBACK. If the Company proposes to register any of its securities under the Securities Act (other than a registration on Form S-4 or Form S-8, any other form used solely in connection with an employee benefit or stock ownership plan, or any successor similar Page 1 forms or any other form not available for registering the Registrable Securities for sale to the public) and the registration form to be used may be used for the registration of the Registrable Securities (a "Piggyback Registration"), then the Company will give prompt written notice to MVII of its intention to effect such a registration (each a "Piggyback Notice"). Subject to subparagraphs (i) and (ii) below, the Company will include in such registration all Registrable Securities which MVII requests that the Company include in such registration by written notice given to the Company within fifteen (15) days after the date of sending of the Piggyback Notice. (i) PRIORITY ON PRIMARY REGISTRATIONS. If a Piggyback Registration relates to an underwritten public offering of equity securities by the Company and the managing underwriters advise the Company in writing that in their opinion the number of securities requested (and consented to) to be included in such registration exceeds the number which can be sold in an orderly manner in such offering within a price range acceptable to the Company, the Company will include in such registration: (A) first, the securities proposed to be sold by the Company; (B) second, the shares of Common Stock owned by MVII (the "Prior Shares") subject to registration rights granted pursuant to that certain Registration Rights Agreement dated June 1, 1999; (C) third, the shares of Common Stock owned by the DSI Group (as such term is defined in the Registration Rights Agreement dated June 1, 1999) (the "DSI Group Shares"); (D) fourth, the Reiling Shares (as such term is defined in that certain Registration Rights Agreement dated January 7, 2000; (E) fifth, the Registrable Securities; and (F) sixth, other securities requested to be included in such registration. (ii) PRIORITY ON SECONDARY REGISTRATIONS. If a Piggyback Registration relates to an underwritten public offering of equity securities by holders of the Company's securities and the managing underwriters advise the Company in writing that in their opinion the number of securities requested (and consented to) to be included in such registration exceeds the number which can be sold in an orderly manner within a price range acceptable to the holders initially requesting such registration, the Company will include in such registration: (A) first, the securities requested to be included therein by the holders requesting such registration, (B) second, the Prior Shares, (C) third, the DSI Group Shares, (D) fourth, the Reiling Shares, and (E) fifth, the Registrable Securities. (b) EXPENSES. All expenses incurred in connection with effecting each registration pursuant to Section 2 hereof (other than underwriting fees, disbursements, discounts and commissions relating to Registrable Securities, which shall be borne by the holder of such Registrable Securities, and fees and disbursements of counsel retained by such holder, which shall be borne by such holder), including, without limitation, in each case, all registration, filing and securities exchange fees; all fees and expenses of complying with securities or blue sky laws; all word processing, duplicating and printing expenses, messenger, delivery and shipping expenses; fees and disbursements of the accountants and counsel for the Company including the expenses of any special audits or "cold comfort" letters or opinions required by or incident to such registrations; and premiums and other costs of policies of insurance against liabilities arising out of the public offering of the Registrable Securities and any fees and disbursements of underwriters not relating to Registrable Securities) shall be borne by equally by the Company and MVII. Page 2 3. REGISTRATION PROCEDURES. Whenever MVII has requested that any Registrable Securities be registered pursuant to this Agreement in compliance with the requirements of Section 2 herein: (a) the Company will use its best efforts to effect the registration and the sale of such Registrable Securities in accordance with the intended method of distribution thereof and will as expeditiously as possible; (i) prepare and file with the Commission a registration statement with respect to such Registrable Securities and use its best efforts to cause such registration statement to become effective, provided that before filing a registration statement or prospectus or any amendments or supplements thereto, the Company will furnish to the counsel selected by MVII copies of all such documents proposed to be filed; (ii) prepare and file with the Commission such amendments and supplements to such registration statement and the prospectus used in connection therewith as may be necessary to keep such registration statement effective: (A) with respect to a registration statement on Form S-1, for a period of up to thirty days, and (B) with respect to a registration statement on any other form, for a period of up to six months; and comply with the provisions of the Securities Act with respect to the disposition of all securities covered by such registration statement during such period in accordance with the intended methods of distribution by the sellers thereof set forth in such registration statement; (iii) furnish to MVII such number of conformed copies of such registration statement and of each such amendment and supplement thereto (in each case including all exhibits), such number of copies of the prospectus contained in such registration statement (including each preliminary prospectus and any summary prospectus) and any other prospectus filed under Rule 424 under the Securities Act, and such other documents, as MVII may reasonably request; (iv) use its best efforts to register or qualify such Registrable Securities under such other securities or blue sky laws of such jurisdictions as MVII reasonably requests and do any and all other acts or things which may be reasonably necessary or advisable to enable MVII to consummate the disposition in such jurisdictions of the Registrable Securities owned by MVII, provided that the Company will not be required (A) to qualify generally to do business in any jurisdiction where it would not otherwise be required to qualify but for this subparagraph, (B) to subject itself to taxation in any such jurisdiction, or (C) to consent to general service of process in any such jurisdiction; (v) furnish to MVII a copy, or, upon request, a signed counterpart, addressed to MVII (and the underwriters, if any) of (A) an opinion of counsel for the Company, dated the effective date of such registration statement (or, if such registration includes an underwritten public offering, dated the date of the closing under the underwriting agreement), and (B) a "comfort" letter addressed to the underwriters, dated the effective date of such registration Page 3 statement (or, if such registration includes an underwritten public offering, dated the date of the closing under the underwriting agreement), signed by the independent public accountants who have audited the Company's financial statements included in such registration statement, covering substantially the same matters with respect to such registration statement (and the prospectus included therein) and, in the case of the accountants' letter, with respect to events subsequent to the date of such financial statements, as are customarily covered in opinions of issuer's counsel and in accountants' letters delivered to the underwriters in underwritten public offerings of securities and, in the case of the accountants' letter, such other financial matters, and, in the case of the legal opinion such other legal matters, as MVII (or the underwriters, if any) may reasonably request; (vi) notify MVII, at any time when a prospectus relating thereto is required to be delivered under the Securities Act, of the happening of any event as a result of which the prospectus included in such registration statement contains an untrue statement of a material fact or omits any fact necessary to make the statements therein, in light of the circumstances under which they are made, not misleading, and, at the request of MVII, the Company will prepare a supplement or amendment to such prospectus so that, as thereafter delivered to the purchasers of such Registrable Securities, such prospectus will not contain an untrue statement of a material fact or omit to state any fact necessary to make the statements therein, in light of the circumstances under which they are made, not misleading, or of the determination by the Company that a post-effective amendment to a registration statement would be required under the Securities Act, and, at the request of MVII, the Company will prepare and file a post-effective amendment to the registration statement as required under the Securities Act. (vii) cause all such Registrable Securities to be listed on each securities exchange on which similar securities issued by the Company are then listed and to be qualified for trading on each system on which similar securities issued by the Company are from time to time qualified; (viii) provide a transfer agent and registrar for all such Registrable Securities not later than the effective date of such registration statement and thereafter maintain such a transfer agent and registrar; (ix) enter into such customary agreements and take all such other actions as the underwriters, if any, reasonably request in order to expedite or facilitate the disposition of such Registrable Securities; (x) make available for inspection by any underwriter participating in any disposition pursuant to such registration statement and any attorney, accountant or other agent retained by any such underwriter, all financial and other records, pertinent corporate documents and properties of the Company, and causes the Company's officers, directors, employees and independent accountants to supply all information reasonably requested by any such underwriter, attorney, accountant or agent in connection with such registration statement; provided that any person to whom such information is provided shall agree to keep it confidential and use it only in connection with such offering; Page 4 (xi) otherwise use its best efforts to comply with all applicable rules and regulations of the Commission, and make available to its security holders, as soon as reasonably practicable, an earnings statement covering the period of at least twelve months beginning with the first day of the Company's first full calendar quarter after the effective date of the registration statement, which earnings statement shall satisfy the provisions of Section 11(a) of the Securities Act and Rule 158 thereunder; and (xii) in the event of the issuance of any stop order suspending the effectiveness of a registration statement, or of any order suspending or preventing the use of any related prospectus or suspending the qualification of any Registrable Securities included in such registration statement for sale in any jurisdiction, the Company will use its reasonable best efforts promptly to obtain the withdrawal of such order. (b) The Company shall not be required to include any Registrable Securities in any registration unless MVII furnishes to the Company in writing such information with respect to MVII and the distribution of such Registrable Securities as the Company may from time to time reasonably request in writing and as shall be required by law or the Commission in connection therewith. (c) If any such registration or comparable statement refers to MVII by name or otherwise as the holder of any securities of the Company, MVII shall have the right to require (i) the inclusion in such registration statement of language, in form and substance reasonably satisfactory to MVII, to the effect that the holding of such securities by MVII is not to be construed as a recommendation by MVII of the investment quality of the Company's securities covered thereby and that such holding does not imply that MVII will assist in the meeting any future financial requirements of the Company, or (ii) in the event that such reference to MVII is not required by the Securities Act or any similar federal statute then in force, the deletion of the reference to MVII; provided, that the respect to this clause (ii) MVII shall furnish to the Company an opinion of counsel to such effect, which opinion and counsel shall be reasonably satisfactory to the Company. (d) MVII agrees that upon receipt of any notice from the Company of the happening of any event of the kind described in the subdivision (a)(vi) of this Section 3, such person will forthwith discontinue such person's disposition of Registrable Securities pursuant to the registration statement relating to such Registrable Securities until such person's receipt of the copies of the supplemented or amended prospectus contemplated by subdivision (a)(vi) of this Section 3 and, if so directed by the Company, will deliver to the Company (at the Company's expense) all copies, other than permanent file copies, then in such person's possession of the prospectus relating to such Registrable Securities current at the time of receipt of such notice. Nothing contained in this Agreement shall be deemed to require the Company to disclose any information that, in the good faith opinion of the management of the Company, is not yet required to be disclosed and would not be in the best interests of the Company to disclose. Page 5 4. UNDERWRITTEN OFFERINGS. If the Company at any time proposes to register any of its securities under the Securities Act as contemplated by Section 2 hereof and such securities are to be distributed by or through one or more underwriters, the Company will, if requested by MVII as provided in Section 2 hereof, arrange for such underwriters to include in the securities to be distributed by such underwriters all of the Registrable Securities to be offered and sold by MVII. 5. PREPARATION; REASONABLE INVESTIGATION. In connection with the preparation and filing of each registration statement under the Securities Act pursuant to the provisions hereof, the Company will give MVII and one counsel or firm of counsel and one accountant or firm of accountants representing MVII the opportunity to participate in the preparation of such registration statement, each prospectus included therein or filed with the Commission, and each amendment thereof or supplement thereto, and will give MVII such access to its books and records and such opportunities to discuss the business of the Company with its officers and the independent public accountants who have certified its financial statements as shall be necessary, in the opinion of MVII's counsel, to conduct a reasonable investigation within the meaning of the Securities Act. 6. INDEMNIFICATION. (A) INDEMNIFICATION BY THE COMPANY. IN THE EVENT ANY REGISTRABLE SECURITIES ARE INCLUDED IN A REGISTRATION STATEMENT HEREUNDER, TO THE EXTENT PERMITTED BY LAW, THE COMPANY WILL, AND HEREBY DOES, INDEMNIFY AND HOLD HARMLESS THE HOLDER OF SUCH REGISTRABLE SECURITIES, ITS DIRECTORS AND OFFICERS, EACH OTHER PERSON WHO PARTICIPATES AS AN UNDERWRITER IN THE OFFERING OR SALE OF SUCH SECURITIES AND EACH OTHER PERSON, IF ANY, WHO CONTROLS THE HOLDER OR ANY SUCH UNDERWRITER WITHIN THE MEANING OF THE SECURITIES ACT, AGAINST ANY LOSSES, CLAIMS, DAMAGES OR LIABILITIES, JOINT OR SEVERAL, TO WHICH THE HOLDER OR ANY SUCH DIRECTOR OR OFFICER OR UNDERWRITER OR CONTROLLING PERSON MAY BECOME SUBJECT UNDER THE SECURITIES ACT OR OTHERWISE, INSOFAR AS SUCH LOSSES, CLAIMS, DAMAGES OR LIABILITIES (OR ACTIONS OR PROCEEDINGS, WHETHER COMMENCED OR THREATENED, IN RESPECT THEREOF) ARISE OUT OF OR ARE BASED UPON ANY UNTRUE STATEMENT OR ALLEGED UNTRUE STATEMENT OF ANY MATERIAL FACT CONTAINED IN ANY REGISTRATION STATEMENT UNDER WHICH SUCH SECURITIES WERE REGISTERED UNDER THE SECURITIES ACT, ANY PRELIMINARY PROSPECTUS, FINAL PROSPECTUS OR SUMMARY PROSPECTUS CONTAINED THEREIN, OR ANY AMENDMENT OR SUPPLEMENT THERETO, OR ANY OMISSION OR ALLEGED OMISSION TO STATE THEREIN A MATERIAL FACT REQUIRED TO BE STATED THEREIN OR NECESSARY TO MAKE THE STATEMENTS THEREIN NOT MISLEADING, AND THE COMPANY WILL REIMBURSE SUCH HOLDER AND EACH SUCH DIRECTOR, OFFICER, UNDERWRITER AND CONTROLLER PERSON FOR ANY LEGAL OR ANY OTHER EXPENSES REASONABLY INCURRED BY THEM IN CONNECTION WITH INVESTIGATING OR DEFENDING ANY SUCH LOSS, CLAIM, LIABILITY, ACTION OR PROCEEDING; PROVIDED, THAT THE COMPANY SHALL NOT BE LIABLE IN ANY SUCH CASE TO THE Page 6 EXTENT THAT ANY SUCH LOSS, CLAIM, DAMAGE, LIABILITY (OR ACTION OR PROCEEDING IN RESPECT THEREOF) OR EXPENSE ARISES OUT OF OR IS BASED UPON AN UNTRUE STATEMENT OR ALLEGED UNTRUE STATEMENT OR OMISSION OR ALLEGED OMISSION MADE IN SUCH REGISTRATION STATEMENT, ANY SUCH PRELIMINARY PROSPECTUS, FINAL PROSPECTUS, SUMMARY PROSPECTUS, AMENDMENT OR SUPPLEMENT IN RELIANCE UPON AND IN CONFORMITY WITH WRITTEN INFORMATION FURNISHED TO THE COMPANY BY THE HOLDER EXPRESSLY FOR USE IN THE PREPARATION THEREOF, AND PROVIDED FURTHER THAT THE COMPANY SHALL NOT BE LIABLE TO ANY PERSON WHO PARTICIPATES AS AN UNDERWRITER IN THE OFFERING OR SALE OF REGISTRABLE SECURITIES OR ANY OTHER PERSON WHO CONTROLS SUCH UNDERWRITER WITHIN THE MEANING OF THE SECURITIES ACT, IN ANY SUCH CASE TO THE EXTENT THAT ANY SUCH LOSS, CLAIM, DAMAGE, LIABILITY (OR ACTION OR PROCEEDINGS IN RESPECT THEREOF) OR EXPENSE ARISES OUT OF SUCH PERSON'S FAILURE TO SEND OR GIVE A COPY OF THE FINAL PROSPECTUS, AS THE SAME MAY BE THEN SUPPLEMENTED OR AMENDED, TO THE PERSON ASSERTING AN UNTRUE STATEMENT OR ALLEGED UNTRUE STATEMENT OR OMISSION OR ALLEGED OMISSION AT OR PRIOR TO THE WRITTEN CONFIRMATION OF THE SALE OF REGISTRABLE SECURITIES TO SUCH PERSON IF SUCH STATEMENT OR OMISSION WAS CORRECTED IN SUCH FINAL PROSPECTUS. SUCH INDEMNITY SHALL REMAIN IN FULL FORCE AND EFFECT REGARDLESS OF ANY INVESTIGATION MADE BY OR ON BEHALF OF THE HOLDER OR ANY SUCH DIRECTOR, OFFICER, UNDERWRITER OR CONTROLLING PERSON AND SHALL SURVIVE THE TRANSFER OF SUCH SECURITIES BY THE HOLDER. (B) INDEMNIFICATION BY THE HOLDERS. THE COMPANY MAY REQUIRE, AS A CONDITION TO INCLUDING ANY REGISTRABLE SECURITIES IN ANY REGISTRATION STATEMENT FILED PURSUANT TO SECTION 3 HEREOF, THAT THE COMPANY SHALL HAVE RECEIVED AN UNDERTAKING SATISFACTORY TO IT FROM THE HOLDER OF SUCH REGISTRABLE SECURITIES, TO INDEMNIFY AND HOLD HARMLESS (IN THE SAME MANNER AND TO THE SAME EXTENT AS SET FORTH IN SUBDIVISION (A) OF THIS SECTION 6) EACH UNDERWRITER, EACH PERSON WHO CONTROLS SUCH UNDERWRITER WITHIN THE MEANING OF THE SECURITIES ACT, THE COMPANY, EACH DIRECTOR OF THE COMPANY, EACH OFFICER OF THE COMPANY AND EACH OTHER PERSON, IF ANY, WHO CONTROLS THE COMPANY WITHIN THE MEANING OF THE SECURITIES ACT, WITH RESPECT TO ANY STATEMENT OR ALLEGED STATEMENT IN OR OMISSION OR ALLEGED OMISSION FROM SUCH REGISTRATION STATEMENT, ANY PRELIMINARY PROSPECTUS, FINAL PROSPECTUS OR SUMMARY PROSPECTUS CONTAINED THEREIN, OR ANY AMENDMENT OR SUPPLEMENT THERETO, IF SUCH STATEMENT OR ALLEGED STATEMENT OR OMISSION OR ALLEGED OMISSION WAS MADE IN RELIANCE UPON AND IN STRICT CONFORMITY WITH WRITTEN INFORMATION FURNISHED TO THE COMPANY BY THE HOLDER EXPRESSLY FOR USE IN THE PREPARATION OF SUCH REGISTRATION STATEMENT, PRELIMINARY PROSPECTUS, FINAL PROSPECTUS, SUMMARY PROSPECTUS, AMENDMENT OR SUPPLEMENT; PROVIDED THAT THE HOLDER SHALL Page 7 NOT BE LIABLE TO THE COMPANY OR ANY PERSON WHO PARTICIPATES AS AN UNDERWRITER IN THE OFFERING OR SALE OF REGISTRABLE SECURITIES OR ANY OTHER PERSON, IF ANY, WHO CONTROLS SUCH UNDERWRITER WITHIN THE MEANING OF THE SECURITIES ACT, IN ANY SUCH CASE TO THE EXTENT THAT ANY SUCH LOSS, CLAIM, DAMAGE, LIABILITY (OR ACTION OR PROCEEDING IN RESPECT THEREOF) OR EXPENSE ARISES OUT OF SUCH PERSON'S FAILURE TO SEND OR GIVE A COPY OF THE FINAL PROSPECTUS, AS THE SAME MAY BE THEN SUPPLEMENTED OR AMENDED, TO THE PERSON ASSERTING AN UNTRUE STATEMENT OR ALLEGED UNTRUE STATEMENT OR OMISSION OR ALLEGED OMISSION AT OR PRIOR TO THE WRITTEN CONFIRMATION OF THE SALE OF REGISTRABLE SECURITIES TO SUCH PERSON IF SUCH STATEMENT OR OMISSION WAS CORRECTED IN SUCH FINAL PROSPECTUS. SUCH INDEMNITY SHALL REMAIN IN FULL FORCE AND EFFECT, REGARDLESS OF ANY INVESTIGATION MADE BY OR ON BEHALF OF ANY UNDERWRITER, THE COMPANY OR ANY SUCH DIRECTOR, OFFICER OR CONTROLLING PERSON AND SHALL SURVIVE THE TRANSFER OF SUCH SECURITIES BY THE HOLDER. IN NO EVENT SHALL THE LIABILITY OF THE HOLDER UNDER THIS SECTION 6(B) BE GREATER IN AMOUNT THAN THE DOLLAR AMOUNT OF THE PROCEEDS RECEIVED BY THE HOLDER UPON THE SALE OF THE REGISTRABLE SECURITIES GIVING RISE TO SUCH INDEMNIFICATION OBLIGATION. (C) NOTICES OF CLAIMS, ETC. PROMPTLY AFTER RECEIPT BY AN INDEMNIFIED PARTY OF NOTICE OF THE COMMENCEMENT OF ANY ACTION OR PROCEEDING INVOLVING A CLAIM REFERRED TO IN THE PRECEDING SUBDIVISIONS OF THIS SECTION 6, SUCH INDEMNIFIED PARTY WILL, IF A CLAIM IN RESPECT THEREOF IS TO BE MADE AGAINST AN INDEMNIFYING PARTY, GIVE WRITTEN NOTICE TO THE LATTER OF THE COMMENCEMENT OF SUCH ACTION; PROVIDED THAT THE FAILURE OF ANY INDEMNIFIED PARTY TO GIVE NOTICE AS PROVIDED HEREIN SHALL NOT RELIEVE THE INDEMNIFYING PARTY OF ITS OBLIGATIONS UNDER THE PRECEDING SUBDIVISIONS OF THIS SECTION 6, EXCEPT TO THE EXTENT THAT THE INDEMNIFYING PARTY IS ACTUALLY PREJUDICED BY SUCH FAILURE TO GIVE NOTICE. IN CASE ANY SUCH ACTION IS BROUGHT AGAINST AN INDEMNIFIED PARTY, UNLESS IN SUCH INDEMNIFIED PARTY'S REASONABLE JUDGMENT A CONFLICT OF INTEREST BETWEEN SUCH INDEMNIFIED AND INDEMNIFYING PARTIES MAY EXIST IN RESPECT OF SUCH CLAIM, THE INDEMNIFYING PARTY SHALL BE ENTITLED TO PARTICIPATE IN AND TO ASSUME THE DEFENSE THEREOF, JOINTLY WITH ANY OTHER INDEMNIFYING PARTY SIMILARLY NOTIFIED TO THE EXTENT THAT IT MAY WISH, WITH COUNSEL REASONABLY SATISFACTORY TO SUCH INDEMNIFIED PARTY, AND AFTER NOTICE FROM THE INDEMNIFYING PARTY TO SUCH INDEMNIFIED PARTY OF ITS ELECTION SO TO ASSUME THE DEFENSE THEREOF, THE INDEMNIFYING PARTY SHALL NOT BE LIABLE TO SUCH INDEMNIFIED PARTY FOR ANY LEGAL OR OTHER EXPENSES SUBSEQUENTLY INCURRED BY THE LATTER IN CONNECTION WITH THE DEFENSE THEREOF OTHER THAN REASONABLE COSTS OF INVESTIGATION. NO INDEMNIFYING PARTY SHALL, WITHOUT THE CONSENT OF THE INDEMNIFIED PARTY, CONSENT TO ENTRY OF ANY JUDGMENT OR ENTER INTO ANY Page 8 SETTLEMENT WHICH DOES NOT INCLUDE AS AN UNCONDITIONAL TERM THEREOF THE GIVING BY THE CLAIMANT OR PLAINTIFF TO SUCH INDEMNIFIED PARTY OF A FULL RELEASE FROM ALL LIABILITY IN RESPECT TO SUCH CLAIM OR LITIGATION. (D) OTHER INDEMNIFICATION. INDEMNIFICATION SIMILAR TO THAT SPECIFIED IN THE PRECEDING SUBDIVISIONS OF THIS SECTION 6 (WITH APPROPRIATE MODIFICATIONS) SHALL BE GIVEN BY THE COMPANY AND THE HOLDER WITH RESPECT TO ANY REQUIRED REGISTRATION OR OTHER QUALIFICATION OF SECURITIES UNDER ANY FEDERAL OR STATE LAW OR REGULATION OF ANY GOVERNMENTAL AUTHORITY OTHER THAN THE SECURITIES ACT. (E) INDEMNIFICATION PAYMENTS. THE INDEMNIFICATION REQUIRED BY THIS SECTION 6 SHALL BE MADE BY PERIODIC PAYMENTS OF THE AMOUNT THEREOF DURING THE COURSE OF THE INVESTIGATION OR DEFENSE, AS AND WHEN BILLS ARE RECEIVED OR EXPENSE, LOSS, DAMAGE OR LIABILITY IS INCURRED. (F) CONTRIBUTION. IF THE INDEMNIFICATION PROVIDED FOR IN THIS SECTION 6 FROM THE INDEMNIFYING PARTY IS UNAVAILABLE TO AN INDEMNIFIED PARTY HEREUNDER IN RESPECT OF ANY LOSSES, CLAIMS, DAMAGES, LIABILITIES OR EXPENSES REFERRED TO HEREIN, THEN THE INDEMNIFYING PARTY, IN LIEU OF INDEMNIFYING SUCH INDEMNIFIED PARTY, SHALL CONTRIBUTE TO THE AMOUNT PAID OR PAYABLE BY SUCH INDEMNIFIED PARTY AS A RESULT OF SUCH LOSS, CLAIMS, DAMAGES, LIABILITIES OR EXPENSES IN SUCH PROPORTION AS IS APPROPRIATE TO REFLECT THE RELATIVE FAULT OF THE INDEMNIFYING PARTY AND INDEMNIFIED PARTIES IN CONNECTION WITH THE ACTIONS WHICH RESULTED IN SUCH LOSSES, CLAIMS, DAMAGES, LIABILITIES OR EXPENSES, AS WELL AS ANY OTHER RELEVANT EQUITABLE CONSIDERATIONS. THE RELATIVE FAULT OF SUCH INDEMNIFYING PARTY AND INDEMNIFIED PARTIES SHALL BE DETERMINED BY REFERENCE TO, AMONG OTHER THINGS, WHETHER ANY ACTION IN QUESTION, INCLUDING ANY UNTRUE STATEMENT OF MATERIAL FACT OR OMISSION OR ALLEGED OMISSION TO STATE A MATERIAL FACT, HAS BEEN MADE BY, OR RELATES TO INFORMATION SUPPLIED BY, SUCH INDEMNIFYING PARTY OR INDEMNIFIED PARTIES, AND THE PARTIES' RELATIVE INTENT, KNOWLEDGE, ACCESS TO INFORMATION AND OPPORTUNITY TO CORRECT OR PREVENT SUCH ACTION. THE AMOUNT PAID OR PAYABLE BY A PARTY AS A RESULT OF THE LOSSES, CLAIMS, DAMAGES, LIABILITIES AND EXPENSES REFERRED TO ABOVE SHALL BE DEEMED TO INCLUDE, SUBJECT TO THE LIMITATIONS SET FORTH IN SECTION 6(C) HEREOF, ANY LEGAL OR OTHER FEES OR EXPENSES REASONABLY INCURRED BY SUCH PARTY IN CONNECTION WITH ANY INVESTIGATION OR PROCEEDING. THE PARTIES HERETO AGREE THAT IT WOULD NOT BE JUST AND EQUITABLE IF CONTRIBUTION PURSUANT TO THIS SECTION 6(F) WERE DETERMINED BY PRO Page 9 RATA ALLOCATION OR BY ANY OTHER METHOD OF ALLOCATION WHICH DOES NOT TAKE ACCOUNT OF THE EQUITABLE CONSIDERATIONS REFERRED TO IN THE IMMEDIATELY PRECEDING PARAGRAPH. NOTWITHSTANDING THE PROVISIONS OF THIS SECTION 6(F), NO UNDERWRITER SHALL BE REQUIRED TO CONTRIBUTE ANY AMOUNT IN EXCESS OF THE AMOUNT BY WHICH THE TOTAL PRICE AT WHICH THE REGISTRABLE SECURITIES UNDERWRITTEN BY IT AND DISTRIBUTED TO THE PUBLIC WERE OFFERED TO THE PUBLIC EXCEEDS THE AMOUNT OF ANY DAMAGES WHICH SUCH UNDERWRITER HAS OTHERWISE BEEN REQUIRED TO PAY BY REASON OF SUCH UNTRUE OR ALLEGED UNTRUE STATEMENT OR OMISSION OR ALLEGED OMISSION, AND THE HOLDER SHALL BE REQUIRED TO CONTRIBUTE ANY AMOUNT IN EXCESS OF THE AMOUNT BY WHICH THE TOTAL PRICE AT WHICH THE REGISTRABLE SECURITIES WERE OFFERED TO THE PUBLIC EXCEEDS THE AMOUNT OF ANY DAMAGES WHICH THE HOLDER HAS OTHERWISE BEEN REQUIRED TO PAY BY REASON OF SUCH UNTRUE STATEMENT OR OMISSION. NO PERSON GUILTY OF FRAUDULENT MISREPRESENTATION (WITHIN THE MEANING OF SECTION 11(F) OF THE SECURITIES ACT) SHALL BE ENTITLED TO CONTRIBUTION FROM ANY PERSON WHO WAS NOT GUILTY OF SUCH FRAUDULENT MISREPRESENTATION. IF INDEMNIFICATION IS AVAILABLE UNDER THIS SECTION 6, THE INDEMNIFYING PARTIES SHALL INDEMNIFY EACH INDEMNIFIED PARTY TO THE FULL EXTENT PROVIDED IN SECTION 6(A) THROUGH SECTION 6(E) HEREOF WITHOUT REGARD TO THE RELATIVE FAULT OF SAID INDEMNIFYING PARTY OR INDEMNIFIED PARTY OR OTHER EQUITABLE CONSIDERATION PROVIDED FOR IN THIS SECTION 6(F). 7. FORMS. All references herein to particular forms of registration statements are intended to include, and shall be deemed to include, references to all successor forms which are intended to replace, or to apply to similar transactions as, the forms herein referenced. 8. TRANSFER OF REGISTRATION RIGHTS. The registration rights granted hereunder may be transferred by MVII at any time, in whole or in part, without the consent of the Company and the terms and provisions set forth in this Agreement shall be binding upon and inure to the benefit of and be enforceable by the respective successors and assigns of MVII, whether so expressed or not. Notwithstanding the foregoing provisions of this Section 8, the registration rights granted hereunder with respect to any Registrable Securities may not be transferred if (a) a registration statement with respect to the disposition of such Registrable Securities shall have become effective under the Securities Act and such Registrable Securities shall have been disposed of pursuant to such effective registration statement, or (b) such Registrable Securities shall have been sold under circumstances in which all of the applicable conditions of Rule 144 (or any similar provisions then in force) under the Securities Act are met. 9. MISCELLANEOUS. (a) NOTICES. All notices, consents, and other communications under this Agreement shall be in writing and shall be delivered personally or by facsimile transmission (with a Page 10 copy sent by overnight delivery service or by first class certified or registered mail) or by overnight delivery service or 72 hours after having been mailed by first class certified or registered mail, return receipt requested, postage prepaid: If to the Company, at DSI Toys, Inc., 1100 W. Sam Houston Parkway N., Suite A, Houston, Texas 77043, Attention: President (fax: 713/365-9911), or at such other address or addresses as may have been furnished in writing by the Company to MVII, with a copy to Carrington, Coleman, Sloman & Blumenthal, L.L.P., 200 Crescent Court, Suite 1500, Dallas, TX 75201, Attention: Gregg R. Cannady, Esq. (fax: 214/855-1333). If to MVII, at MVII, LLC, 654 Osos Street, San Luis Obispo, CA 93401, Attention: E. Thomas Martin (fax: 805/545-7590) or at such other address or addresses as may have been furnished in writing by MVII to the Company, with a copy to Andre, Morris & Buttery, 1304 Pacific Street, San Luis Obispo, CA 93401, Attention: J. Todd Mirolla, Esq. (fax: 805/543-0752). Notices provided in accordance with this paragraph (a) shall be deemed delivered upon personal delivery or two business days after deposit in the mail. (b) REMEDIES. Any person having rights under any provision of this Agreement to enforce such rights specifically to recover damages caused by reason of any breach of any provision of this Agreement and to exercise all other rights granted by law. The parties hereto agree and acknowledge that money damages may not be an adequate remedy for any breach of the provisions of this Agreement and that any party may in its sole discretion apply to any court of law or equity of competent jurisdiction (without posting any bond or other security) for specific performance and for other injunctive relief in order to enforce or prevent violation of the provisions of this Agreement. (c) AMENDMENTS AND WAIVERS. Except as otherwise provided herein, no amendment, modification, termination or cancellation of this Agreement shall be effective unless made in writing signed by all of the parties hereto. (d) SEVERABILITY. The invalidity or unenforceability of any provision of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement. (e) ENTIRE AGREEMENT. This Agreement embodies the entire agreement and understanding between the parties hereto with respect to the subject matter hereof and supersedes all prior agreements and understandings relating to such subject matter. (f) HEADINGS. The headings of this Agreement are for convenience only and do not constitute a part of this Agreement. (g) GOVERNING LAW. The construction, validity and interpretation of this Agreement will be governed by the internal laws of the State of Texas without giving effect to any choice of law or conflict of law provision or rule (whether of the State of Texas or any other Page 11 jurisdiction) that would cause the application of the laws of any jurisdiction other than the State of Texas. (h) FURTHER ASSURANCES. Each party to this Agreement hereby covenants and agrees, without the necessity of any further consideration, to execute and deliver any and all such further documents and take any and all such other actions as may be necessary or appropriate to carry out the intent and purposes of this Agreement and to consummate the transactions contemplated hereby. (i) COUNTERPARTS. This Agreement may be executed in one or more counterparts, each of which shall be deemed to be an original, but all of which shall be one and the same documents. Page 12 IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement as of the day and year first above written. THE COMPANY: DSI TOYS, INC., a Texas corporation By: /s/ ROBERT L. WEISGARBER ----------------------------------- Name: ROBERT L. WEISGARBER --------------------------------- Title: CHIEF FINANCIAL OFFICER --------------------------------- MVII: MVII, LLC, a California limited liability company By: /s/ E. THOMAS MARTIN ----------------------------------- Name: E. THOMAS MARTIN ---------------------------------- Title: MANAGER --------------------------------- Page 13 EX-10.61 5 a2074077zex-10_61.txt EXHIBIT 10.61 EXHIBIT 10.61 FIRST AMENDMENT TO EMPLOYMENT AGREEMENT This First Amendment ("First Amendment") to the Employment Agreement by and between DSI Toys, Inc. ("Employer") and Joseph S. Whitaker ("Employee") is hereby made to be effective the 1st day of December, 2001. WITNESSETH 1. Employer and Employee entered into that certain Employment Agreement dated June 1, 2001 ("Agreement"). 2. Employer and Employee mutually agree to hereby amend certain terms and provisions of said Employment Agreement. ARTICLE I 1.1 Effective December 1, 2001, the position set forth in Paragraph 1.2 of the Agreement is President and Chief Executive Officer. 1.2 The term as set forth in Paragraph 1.3 of the Agreement is hereby extended and shall end on November 30, 2004. ARTICLE II 2.1 Effective December 1, 2001, the base salary as set forth in Paragraph 2.1 of the Agreement shall be One Hundred Eighty Thousand Dollars ($180,000.00) per year. 2.1(a) Effective December 1, 2001, Paragraph 2.1 (a) of the Agreement is hereby restated in its entirety as follows: "At a minimum, the Base Salary shall be adjusted annually on December 1, commencing December 1, 2002, to reflect any increase in the Consumer Price Index - All Urban Wage Earners (the "Index"). The Base Salary will not be adjusted downward to reflect any decrease in the Index 2.2 Effective December 1, 2001, the automobile allowance set forth in Paragraph 2.10 of the Agreement shall be Seven Hundred Fifty Dollars ($750.00) per month. EXCEPT and as herein altered, changed and amended the Agreement remains in full force and effect. IN WITNESS WHEREOF, the Parties have executed this First Amendment in duplicate originals to be effective the 1st day of December, 2001. EMPLOYER EMPLOYEE DSI Toys, Inc. By: /s/ THOMAS V. YARNELL /s/ JOSEPH S. WHITAKER -------------------------------------- --------------------------- Thomas V. Yarnell Joseph S. Whitaker Vice President / General Counsel EX-10.62 6 a2074077zex-10_62.txt EXHIBIT 10.62 Exhibit 10.62 DAOHENGBANK PRIVATE & CONFIDENTIAL 4 December 2001 Our Ref : D/P/CBD/0294/01 DSI (HK) Limited Room 1401, 14/F., New T & T Centre, Harbour City, Tsim Sha Tsui, Kowloon Dear Sir(s) /Madam(s), BANKING FACILITY (IES) We refer to our recent discussions and are pleased to inform you that the following facility(ies) (the "Facility") will be made available to you on the specific terms and conditions outlined herein subject to our review from time to time. The Facility would be deemed to be continued on the same terms and conditions until and unless notice to the otherwise is advised to you.
FACILITY (IES) LIMIT (S) TERMS & CONDITIONS 1. Negotiation of USD6, 000,000.00 Export Bills under LC with discrepancies + Packing Loan 1a. within facility item 1, Packing Loan (USD2, 100, 000.00) Against lodgement of valid export Letters of Credit Issued by Banks acceptable to us. Maximum advance will be limited to 35% of the value of each L/C and tenor within 90 days or L/C expiry date, whichever is earlier; and will be repayable from the proceeds on negotiation of the relative export bills.
OTHER TERMS AND CONDITIONS Upon availability of the above Facility, debenture in favour of State Street Bank & Trust Company must be released. The Facility is for financing the FOB sales of DSI (HK) Limited only and not the domestic sales of DSI Toys, Inc.. Arrangement fee for HKD10,000.00 will be charged, payable upon acceptance of this letter. Thereafter, unless and until the Facility is terminated or as otherwise advised to you, a review fee at the same amount or such other amount as we may at our entire discretion determine will be charged on a yearly basis. The Facility is subject to our overriding right of withdrawal and repayment on demand including the right to call for cash cover on demand for prospective and contingent liabilities. The nature and the amount of the Facility granted or to be granted by us may be varied to such category(ies) and to such smaller or larger extent as we may at our absolute discretion determine from time to time with or without notice to you. The rates of interest, fees and commission on the Facility is subject to fluctuation at our absolute discretion determined from time to time with or without notice to you and payable to the debit of your account with us. Late payment/settlement of any loan/advance with specified due/repayment date will be subject to an overdue interest charge at our then prevailing rate. For the Facility adopting the prime rate, deposit rate or other specified rate(s) as the basis of interest rate determination, in the event that the prevailing interbank offer rate (HIBOR for Hong Kong Dollar loans, and LIBOR or SIBOR for loans in other currencies) is higher than the prime rate, deposit rate or other specified rate(s), we may at our entire discretion and without notice to you adopt the prevailing interbank offer rate in lieu of the prime rate, deposit rate or other specified rate(s) as the basis of interest rate determination. As security for the above Facility, we require a corporate guarantee for USD6,000,000.00 from DSI Toys, Inc.. Please let us have the certified true copy of extract from the minutes of a meeting of the board of directors of DSI Toys, Inc. in relation to its extending the said guarantee to our Bank as security for the Facility granted or to be granted to DSI (HK) Limited by our Bank. All legal costs and expenses incurred in connection with the preparation of security documentation of the above security and all incidental attendances thereto will be for your account. By accepting this offer letter, you undertake and confirm that : (a) annual bills business of not less than USD10,000,000.00 to be enrouted to us, (b) at present, neither you nor any of the following parties have any relationship with the Bank's directors or employees: 1) in case you are a limited company, any of your shareholders and directors; 2) in case you are a partnership, any of your partners; or 3) in case the Facility is secured by guarantee(s) or security provided by other parties, any of such guarantor(s) or security provider(s); and that you will notify the Bank promptly in writing if you or any of the above parties (if any) become so related. Your company is required to submit the latest annual audited (and, at our discretion, half yearly unaudited) financial statements for our records within six months from the relevant year end or half year end date of your financial year. To signify your acceptance of the above terms and conditions as well as your authorization to us to proceed as above indicated, please sign and return to us the duplicate copy of this letter together with the enclosed documents as per attached schedule supported by a certified true copy of extract from the minutes of a meeting of your board of directors. The Facility will be available subject to all security documents being executed to our satisfaction. This offer expires on 21 days from the date hereof. Yours faithfully, for DAO HENG BANK LIMITED /s/ ROGER WONG /s/ DORIS TAM - --------------------------------- ---------------------------------- Roger Wong Doris Tam Manager Senior Manager Asset Risk Management Division Corporate Banking The above Facility and terms and conditions are acknowledged and accepted by /s/ ALFRED CHAN -------------------------------------- DSI (HK) Limited ALFRED CHAN MANAGING DIRECTOR Signature Verified /s/ CHRIS K.W. MAK ------------------- (AUTHORIZED SIGNATURE) NAME OF BANK OFFICER (CHRIS K.W. MAK) EX-10.63 7 a2074077zex-10_63.txt EXHIBIT 10.63 EXHIBIT 10.63 MEMORANDUM OF REBORROWING OF PRINCIPAL This Memorandum of Reborrowing of Principal ("Memorandum") is entered into as of the 6th day of March, 2002, by and between DSI Toys, Inc. ("DSI"), a Texas corporation, and MVII, LLC ("MVII"), a California limited liability company. RECITALS A. A Promissory Note dated January 7, 2000, in the original principal amount of $5,000,000.00 (the "Original Principal") was executed by DSI payable to the order of MVII (the "MVII Note"). The current principal balance of the MVII Note is $3,850,000.00. B. DSI desires to reborrow up to $600,000.00 of the Original Principal that has been paid on the MVII Note. MVII desires to re-loan such amount to DSI. C. The Loan and Security Agreement dated February 2, 1999, as amended from time to time, (the "Loan Agreement") by and between DSI and Sunrock Capital Corp., a Delaware corporation ("Sunrock") sets forth, in Section 9.9(c), that "Borrower shall be permitted to reborrow principal amounts paid on the MVII Note from time to time, PROVIDED, THAT, the outstanding principal amount of the MVII Note shall not exceed the original principal amount of the MVII Note; PROVIDED, FURTHER, THAT, the stated interest rate of such indebtedness shall not be increased, the frequency of payments shall not be increased and the principal amount of the MVII Note, as increased from time to time, shall be payable no more frequently than monthly or in amounts greater than the amounts permitted by clause (ii) (B) above. Borrower shall promptly provide written notice to Lender of an increase in the outstanding principal amount of the MVII Note pursuant to the authority granted in this SECTION 9.9(C)." NOW, THEREFORE, in consideration of the premises herein contained and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties, intending to be legally bound, agree as follows: 1. As of March 6, 2002, DSI shall reborrow from MVII, and MVII shall re-loan to DSI, a sum up to $600,000.00 (the "Reborrowed Amount"), representing DSI's reborrowing of a portion of the Original Principal that was previously paid by DSI to MVII in accordance with the MVII Note. The Reborrowed Amount is loaned pursuant to all the terms and obligations set forth in the MVII Note, and shall be added to the existing principal balance of the MVII Note. 2. The parties acknowledge that the Reborrowed Amount is subject to the terms and conditions of the MVII Note, as well as all the terms and conditions of that certain Subordination Agreement dated January 7, 2000, by and among E. Thomas Martin, MVII and Sunrock, together with any and all amendments thereto. 3. DSI represents and warrants to MVII that all conditions to DSI's right to borrow the Reborrowed Amount, including but not limited to those set forth in the Loan Agreement, have been satisfied. 4. The parties agree that they will execute such other instruments and documents as are or may become necessary to carry out the intent and purpose of this Memorandum, and/or to evidence DSI's indebtedness to MVII for the Reborrowed Amount. IN WITNESS WHEREOF, this Memorandum has been duly executed in triplicate originals as of the day and date first written hereinabove. DSI TOYS, INC. By: /s/ ROBERT L. WEISGARBER --------------------------- Robert L. Weisgarber CFO MVII, LLC By: /s/ E. THOMAS MARTIN --------------------------- E. Thomas Martin Manager Acknowledged this _____ day of March, 2002. SUNROCK CAPITAL CORP. By: /s/ Y. RENEE' HANNAH --------------------------- Name: Y. RENEE' HANNAH ------------------------- Title: Account Executive ------------------------ EX-10.64 8 a2074077zex-10_64.txt EXHIBIT 10.64 Exhibit 10.64 AMENDMENT NO. 7 TO LOAN AND SECURITY AGREEMENT THIS AMENDMENT NO. 7 TO LOAN AND SECURITY AGREEMENT (this "AMENDMENT"), is entered into on and as of this 20th day of March, 2002, by and between SUNROCK CAPITAL CORP., a Delaware corporation ("LENDER"), and DSI TOYS, INC., a Texas corporation ("BORROWER"). RECITALS A. Borrower and Lender have entered into that certain Loan and Security Agreement, dated as of February 2, 1999 (as the same has been, and may hereafter be, amended, modified, supplemented or restated from time to time, the "LOAN AGREEMENT"). B. Borrower desires to guaranty a portion of the obligations owing by DSI (HK) Limited pursuant to that certain Banking Facility Letter dated as of December 4, 2001, executed by Dao Heng Bank Limited and DSI (HK) Limited. NOW, THEREFORE, in consideration of the premises herein contained herein and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties, intending to be legally bound, agree as follows: ARTICLE I DEFINITIONS 1.01 Capitalized terms used in this Amendment, to the extent not otherwise defined herein, shall have the same meanings as in the Loan Agreement, as amended hereby. ARTICLE II AMENDMENTS 2.01 AMENDMENT TO EVENTS OF DEFAULT. Effective as of the date hereof, SECTION 10.1 is hereby amended by amending and restating SECTION 10.1(N) in its entirety to read as follows and by adding new Section 10.1(o), in each case as follows: "(n) DSI (HK) Limited shall fail to maintain its existing credit facility with Dao Heng Bank Limited or one or more other credit facilities for the benefit of DSI (HK) Limited acceptable to Lender, in either case upon such terms and conditions as Lender may find adequate to provide financing for the continued operations of DSI (HK) Limited in the manner then conducted. (o) Any claim or demand for payment or performance shall be made on, or asserted against, Borrower in respect of any guarantee or other agreement executed by Borrower in connection with any credit facility maintained by DSI (HK) Limited, including, but not limited to, any claim under Borrower's partial guaranty of any 1 indebtedness incurred, or to be incurred, by DSI (HK) and owing to Dao Heng Bank Limited." 2.02 AMENDMENT TO SCHEDULE 9.10. Effective as of the date hereof, SCHEDULE 9.10 to the Loan Agreement is hereby amended and restated to read in its entirety in the form hereto attached as EXHIBIT A. ARTICLE III RATIFICATIONS, REPRESENTATIONS, WARRANTIES AND COVENANTS 3.01 RATIFICATIONS. Except as expressly amended hereby, the terms and provisions of the Loan Agreement are ratified and confirmed and shall continue in full force and effect. Borrower and Lender agree that the Loan Agreement, as amended hereby, and each agreement and instrument executed in connection herewith, are, and shall continue to be, legal, valid, binding and enforceable in accordance with their respective terms. 3.02 REPRESENTATIONS AND WARRANTIES. Borrower hereby represents and warrants to Lender that (a) the execution, delivery and performance of this Amendment has been authorized by all requisite corporate action on the part of Borrower and does not violate the Articles of Incorporation or Bylaws of Borrower; (b) the representations and warranties contained in the Loan Agreement, are true and correct on and as of the date hereof; (c) as of the date hereof no Event of Default under the Loan Agreement is continuing and no event or condition exists that with the giving of notice or the lapse of time, or both, would be an Event of Default; and (d) Borrower is in full compliance with all covenants and agreements contained in the Loan Agreement and each agreement and instrument entered into in connection therewith. 3.03 PAYMENT OF LEGAL AND OTHER EXPENSES. As provided in the Loan Agreement, Borrower agrees to pay on demand all costs and expenses incurred by Lender in connection with the preparation, negotiation and execution of this Amendment, including, without limitation, the costs and fees of Lender's legal counsel, and all costs and expenses incurred by Lender in connection with the enforcement or preservation of any rights under the Loan Agreement, as amended hereby, or any agreement, document or instrument executed in connection therewith. The fee, costs and expenses referred to in this SECTION 3.03 may be charged by Lender to Borrower's loan account at the option of Lender. ARTICLE IV MISCELLANEOUS PROVISIONS 4.01 SURVIVAL OF REPRESENTATIONS AND WARRANTIES. All representations and warranties made herein and in the Loan Agreement shall survive the execution and delivery of this Amendment, and no investigation by Lender shall affect the representations and warranties or the right of Lender to rely upon them. 4.02 REFERENCE TO LOAN AGREEMENT. The Loan Agreement, as amended hereby, and all other agreements, documents or instruments now or hereafter executed and delivered pursuant to the terms thereof are hereby amended so that any reference in the Loan Agreement or such 2 other agreements, documents and instruments shall mean a reference to the Loan Agreement, as amended hereby. 4.03 SEVERABILITY. Any provision of this Amendment held by a court of competent jurisdiction to be invalid or unenforceable shall not impair or invalidate the remainder of this Amendment and the effect thereof shall be confined to the provision so held to be invalid or unenforceable. 4.04 SUCCESSORS AND ASSIGNS. This Amendment is binding upon and shall inure to the benefit of Lender and Borrower and their respective successors and assigns, except Borrower may not assign or transfer any of its rights or obligations hereunder without the prior written consent of Lender. 4.05 COUNTERPARTS. This Amendment may be executed in one or more counterparts, each of which when so executed shall be deemed to be an original, but all of which when taken together shall constitute one and the same instrument. 4.06 HEADINGS. The headings, captions, and arrangements used in this Amendment are for convenience only and shall not affect the interpretation of this Amendment. 4.07 APPLICABLE LAW. THIS AMENDMENT AND ALL OTHER LOAN DOCUMENTS EXECUTED PURSUANT HERETO SHALL BE DEEMED TO HAVE BEEN MADE AND TO BE PERFORMABLE IN AND SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF TEXAS. 4.08 FINAL AGREEMENT. THE FINANCING AGREEMENTS (INCLUDING THE LOAN AGREEMENT AND THIS AMENDMENT), AS AMENDED HEREBY, REPRESENT THE ENTIRE EXPRESSION OF THE PARTIES WITH RESPECT TO THE SUBJECT MATTER HEREOF ON THE DATE THIS AMENDMENT IS EXECUTED. THE FINANCING AGREEMENTS, AS AMENDED HEREBY, MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES. THERE ARE NO UNWRITTEN ORAL AGREEMENTS BETWEEN THE PARTIES. NO MODIFICATION, RESCISSION, WAIVER, RELEASE OR AMENDMENT OF ANY PROVISION OF THIS AMENDMENT SHALL BE MADE, EXCEPT BY A WRITTEN AGREEMENT SIGNED BY BORROWER AND LENDER. 4.09 RELEASE. BORROWER HEREBY ACKNOWLEDGES THAT IT HAS NO DEFENSE, COUNTERCLAIM, OFFSET, CROSS-COMPLAINT, CLAIM OR DEMAND OF ANY KIND OR NATURE WHATSOEVER THAT CAN BE ASSERTED TO REDUCE OR ELIMINATE ALL OR ANY PART OF ITS LIABILITY TO REPAY THE OBLIGATIONS (AS DEFINED IN THE LOAN AGREEMENT) OR TO SEEK AFFIRMATIVE RELIEF OR DAMAGES OF ANY KIND OR NATURE FROM LENDER. BORROWER HEREBY VOLUNTARILY AND KNOWINGLY RELEASES AND FOREVER DISCHARGES LENDER, ITS PREDECESSORS, AGENTS, EMPLOYEES, SUCCESSORS AND ASSIGNS, FROM ALL POSSIBLE CLAIMS, 3 DEMANDS, ACTIONS, CAUSES OF ACTION, DAMAGES, COSTS, EXPENSES, AND LIABILITIES WHATSOEVER, KNOWN OR UNKNOWN, ANTICIPATED OR UNANTICIPATED, SUSPECTED OR UNSUSPECTED, FIXED, CONTINGENT, OR CONDITIONAL, AT LAW OR IN EQUITY, ORIGINATING IN WHOLE OR IN PART ON OR BEFORE THE DATE THIS AMENDMENT IS EXECUTED, WHICH THE BORROWER MAY NOW OR HEREAFTER HAVE AGAINST LENDER, ITS PREDECESSORS, AGENTS, EMPLOYEES, SUCCESSORS AND ASSIGNS, IF ANY, AND IRRESPECTIVE OF WHETHER ANY SUCH CLAIMS ARISE OUT OF CONTRACT, TORT, VIOLATION OF LAW OR REGULATIONS, OR OTHERWISE, AND ARISING FROM ANY LOANS (AS DEFINED IN THE LOAN AGREEMENT), INCLUDING, WITHOUT LIMITATION, ANY CONTRACTING FOR, CHARGING, TAKING, RESERVING, COLLECTING OR RECEIVING INTEREST IN EXCESS OF THE HIGHEST LAWFUL RATE APPLICABLE, THE EXERCISE OF ANY RIGHTS AND REMEDIES UNDER THE LOAN AGREEMENT OR ANY FINANCING AGREEMENT, DOCUMENT OR INSTRUMENT ENTERED INTO IN CONNECTION THEREWITH. Executed as of the day and year set forth first above. DSI TOYS, INC. By: /s/ R. L. WEISGARBER ----------------------------- Name: R. L. WEISGARBER --------------------------- Title: CFO -------------------------- SUNROCK CAPITAL CORP. By: /s/ Y. RENEE' HANNAH ----------------------------- Name: Y. RENEE' HANNAH --------------------------- Title: ACCOUNT EXECUTIVE -------------------------- 4 EXHIBIT A SCHEDULE 9.10 Existing Loans, Advances and Guarantees DSI TOYS, INC.: LOANS: None ADVANCES: Employee travel advances Employee travel advances in ordinary course of business GUARANTEES: Kawasaki minimum royalty guarantee $600,000.00 Discovery communications, Inc. royalty guarantee $210,000.00 Continuing Guarantee, limited to $6,000,000, by DSI Toys, Inc. to Dao Heng Bank Limited, a Hong Kong banking and financial institution on the Banking Facility Letter dated as of December 4, 2001, by and between Dao Heng Bank Limited and DSI (HK) Limited EX-10.65 9 a2074077zex-10_65.txt EXHIBIT 10.65 Exhibit 10.65 EXECUTION VERSION UNCONDITIONAL GUARANTY AGREEMENT THIS UNCONDITIONAL GUARANTY AGREEMENT (this "GUARANTY AGREEMENT") is executed as of March 20, 2002 by DSI TOYS, INC., a Texas corporation ("GUARANTOR") for the benefit of DAO HENG BANK LIMITED, a Hong Kong banking and financial institution ("LENDER"). R E C I T A L S A. DSI (HK) Limited, a company incorporated under the laws of Hong Kong ("BORROWER") and Lender have executed a Banking Facility Letter dated as of December 4, 2001 (as the same may be amended, extended, supplemented, or restated, the "FACILITY LETTER"). Borrower is a wholly-owned subsidiary of Guarantor. B. Guarantor will benefit, either directly or indirectly, from Borrower's execution of the Facility Letter. C. It is expressly understood among Borrower, Guarantor, and Lender that the execution and delivery of this Guaranty Agreement is a condition precedent to Lender's obligations to extend credit under the Facility Letter. D. In Guarantor's judgment, the value of the consideration received and to be received by it under the Facility Letter is reasonably worth at least as much as its liability and obligation under this Guaranty, and such liability and obligation may reasonably be expected to benefit Guarantor either directly or indirectly. NOW, THEREFORE, as an inducement to Lender to enter into the Facility Letter and to extend such credit under the Facility to Borrower as Lender may from time to time agree to extend, and for other good and valuable consideration, the receipt and legal sufficiency of which are hereby acknowledged, Guarantor hereby guarantees payment of the Guaranteed Debt (hereinafter defined) and hereby agrees as follows: SECTION 1. DEFINITIONS 1.01. DEFINITIONS. For the purpose of this Guaranty Agreement, unless the context otherwise requires, the following terms shall have the meanings assigned to them in this SECTION 1 or recital above or in the first paragraph hereof (each of which is incorporated herein by reference): "BUSINESS DAY" means any day of the year on which commercial banks are generally open for business in Hong Kong (except a Saturday or Sunday). "FACILITY" means the definition assigned to the term "FACILITY" in the Facility Letter. "GUARANTEED DEBT" means (a) all principal, interest, attorneys' fees, commitment fees, fees, liabilities for costs and expenses, and indebtedness and liabilities of Borrower to Lender at any time created or arising in connection with or under the Facility and the Facility Letter, and under any renewals, modifications, increases and extensions of the Facility and Facility Letter; and (b) all costs, expenses and fees, including but not limited to court costs and attorneys' fees, arising in connection with the collection of any or all amounts, indebtedness and liabilities of Borrower to Lender described in item (A) of this definition in this SECTION 1.01. 1 "GUARANTOR CLAIMS" means all debts and liabilities of Borrower to Guarantor, including, without limitation, all rights and claims of Guarantor against Borrower (arising as a result of subrogation or otherwise) as a result of Guarantor's payment of all or a portion of the Guaranteed Debt, whether such debts and liabilities now exist or are hereafter incurred or arise, or whether the obligations of Borrower thereon be direct, contingent, primary, secondary, several, joint and several, or otherwise, and irrespective of whether such debts or liabilities be evidenced by note, contract, open account, or otherwise, and irrespective of the person or persons in whose favor such debts or liabilities may, at their inception, have been, or may hereafter be created, or the manner in which they have been or may hereafter be acquired by Guarantor. "HONG KONG" means the Hong Kong Special Administrative Region of The People's Republic of China. SECTION 2 NATURE AND SCOPE OF GUARANTY 2.01. GUARANTY OF PAYMENT; NATURE OF GUARANTY; LIMITATION ON LIABILITY. Guarantor hereby irrevocably and unconditionally guarantees to Lender and its successors and assigns the due and punctual payment of the Guaranteed Debt. Guarantor hereby irrevocably and unconditionally covenants and agrees that it is liable for the Guaranteed Debt as primary obligor. This Guaranty Agreement is intended to be an irrevocable, absolute, continuing guaranty of payment and is not a guaranty of collection, and Lender may enforce Guarantor's obligations hereunder without first suing, or enforcing its rights or remedies against, Borrower or any other obligor, or enforcing or collecting any present or future collateral security for the Guaranteed Debt. This Guaranty Agreement may not be revoked or rescinded by Guarantor. Notwithstanding anything to the contrary contained herein, the liability of Guarantor to Lender under this Guaranty Agreement shall not exceed the principal amount of US$6,000,000, PLUS all interest, attorney's fees, and other costs and expenses referred to in SECTIONS 1.01 and 2.04 hereof. 2.02. GUARANTEED DEBT NOT REDUCED BY OFFSET. The Guaranteed Debt guaranteed hereby, and the liabilities and obligations of Guarantor to Lender hereunder, shall not be reduced, discharged or released because or by reason of any existing or future offset, claim or defense of Borrower, or any other party, against Lender or against payment of the Guaranteed Debt, whether such offset, claim or defense arises in connection with the Guaranteed Debt (or the transactions creating the Guaranteed Debt) or otherwise. 2.03. PAYMENT BY GUARANTOR. If all or any part of the Guaranteed Debt shall not be punctually paid when due, whether at maturity or earlier by acceleration or otherwise, Guarantor shall, immediately upon demand by Lender, and without presentment, protest, notice of protest, notice of nonpayment, notice of intention to accelerate or acceleration or any other notice whatsoever, pay in lawful money of the United States of America, the amount due on the Guaranteed Debt to Lender at Lender's office set forth in SECTION 6.02 hereof or such other location as directed in writing by Lender. Such demand(s) may be made at any time coincident with or after the time for payment of all or part of the Guaranteed Debt, and may be made from time to time with respect to the same or different items of Guaranteed Debt. Such demand shall be deemed made, given and received in accordance with SECTION 6.02 hereof. 2.04. PAYMENT OF EXPENSES. In the event that Guarantor should breach or fail to timely perform any provisions of this Guaranty Agreement, Guarantor shall, immediately upon demand by Lender, pay Lender all costs and expenses (including court costs and reasonable attorneys' fees) incurred by Lender in the enforcement hereof or the preservation of Lender's rights hereunder. The covenant contained in this SECTION 2.04 shall survive the payment of the Guaranteed Debt. 2 2.05. NO DUTY TO PURSUE OTHERS. It shall not be necessary for Lender (and Guarantor hereby waives any rights which Guarantor may have to require Lender), in order to enforce such payment by Guarantor, first to: (i) institute suit or exhaust its remedies against Borrower or others liable on the Guaranteed Debt or any other person, (ii) enforce Lender's rights against any security which shall ever have been given to secure the Guaranteed Debt, (iii) enforce Lender's rights against any other guarantors of the Guaranteed Debt, (iv) join Borrower or any others liable on the Guaranteed Debt in any action seeking to enforce this Guaranty Agreement, (v) exhaust any remedies available to Lender against any security which shall ever have been given to secure the Guaranteed Debt, or (vi) resort to any other means of obtaining payment of the Guaranteed Debt. Lender shall not be required to mitigate damages or take any other action to reduce, collect or enforce the Guaranteed Debt. Further, Guarantor expressly waives each and every right to which it may be entitled by virtue of the suretyship law of the state of Texas, including without limitation, any rights pursuant to RULE 31, TEXAS RULES OF CIVIL PROCEDURE, ARTICLES 1986 AND 1987, REVISED CIVIL STATUTES OF TEXAS AND CHAPTER 34 OF THE TEXAS BUSINESS AND COMMERCE CODE. 2.06. WAIVER OF NOTICES, ETC. Guarantor agrees to the provisions of the Facility Letter, and hereby waives notice of: (i) any loans or advances made by Lender to Borrower, (ii) acceptance of this Guaranty Agreement, (iii) any amendment or extension of the Facility Letter or of any other instrument or document pertaining to all or any part of the Guaranteed Debt, (iv) the execution and delivery by Borrower and Lender of any other loan or credit agreement or of Borrower's execution and delivery of any promissory notes or other documents in connection therewith, (v) the occurrence of any breach by Borrower or event of default in connection with the Guaranteed Debt, and any instruments, agreements or security documents with respect thereto, (vi) Lender's transfer or disposition of the Guaranteed Debt, or any part thereof, (vii) sale or foreclosure (or posting or advertising for sale or foreclosure) of any collateral for the Guaranteed Debt, (viii) protest, proof of nonpayment or default by Borrower, or (ix) any other action at any time taken or omitted by Lender, and, generally, all demands and notices of every kind in connection with this Guaranty Agreement, the Facility Letter, and any documents or agreements evidencing, securing or relating to any of the Guaranteed Debt and the obligations hereby guaranteed. 2.07. EFFECT OF BANKRUPTCY, OTHER MATTERS. In the event that, pursuant to any insolvency, bankruptcy, reorganization, receivership or other debtor relief law, or any judgment, order or decision thereunder, or for any other reason: (i) Lender must rescind or restore any payment, or any part thereof, received by Lender in satisfaction of the Guaranteed Debt, as set forth herein, any prior release or discharge from the terms of this Guaranty Agreement given to Guarantor by Lender shall be without effect, and this Guaranty Agreement shall remain in full force and effect; or (ii) Borrower shall cease to be liable to Lender for any of the Guaranteed Debt (other than by reason of the indefeasible payment in full thereof by Borrower), the obligations of Guarantor under this Guaranty Agreement shall remain in full force and effect. It is the intention of Lender and Guarantor that Guarantor's obligations hereunder shall not be discharged except by Guarantor's performance of such obligations and then only to the extent of such performance. Without limiting the generality of the foregoing, it is the intention of Lender and Guarantor that the filing of any bankruptcy or similar proceeding by or against Borrower or any other person or party obligated on any portion of the Guaranteed Debt shall not affect the obligations of Guarantor under this Guaranty Agreement or the rights of Lender under this Guaranty Agreement, including, without limitation, the right or ability of Lender to pursue or institute suit against Guarantor for the entire Guaranteed Debt. 2.08. FINANCIAL INFORMATION. Guarantor agrees to deliver to Lender, balance sheets, profit and loss statements, reconciliations of capital and surplus, changes in financial condition, schedules of sources and application of funds, and other financial information of Guarantor as shall be required by Lender, not later than sixty (60) days after the end of each second fiscal quarter and each fiscal year of Guarantor, 3 which statements shall be certified by an independent certified public accounting firm acceptable to Lender. SECTION 3 ADDITIONAL EVENTS AND CIRCUMSTANCES NOT REDUCING OR DISCHARGING GUARANTOR'S OBLIGATIONS Guarantor hereby consents and agrees to each of the following, and agrees that Guarantor's obligations under this Guaranty Agreement shall not be released, diminished, impaired, reduced or adversely affected by any of the following, and waives any common law, equitable, statutory or other rights (including without limitation rights to notice) which Guarantor might otherwise have as a result of or in connection with any of the following: 3.01. MODIFICATIONS, ETC. Any renewal, extension, increase, modification, alteration or rearrangement of all or any part of the Guaranteed Debt, or of the Facility Letter or other document, instrument, contract or understanding between Borrower and Lender, or any other parties, pertaining to the Guaranteed Debt; 3.02. ADJUSTMENT, ETC. Any adjustment, indulgence, forbearance or compromise that might be granted or given by Lender to Borrower or Guarantor; 3.03. CONDITION, COMPOSITION OR STRUCTURE OF BORROWER OR GUARANTOR. The insolvency, bankruptcy, arrangement, adjustment, composition, structure, liquidation, disability, dissolution or lack of power of Borrower or any other party at any time liable for the payment of all or part of the Guaranteed Debt; or any dissolution of Borrower or Guarantor, or any sale, lease or transfer of any or all of the assets of Borrower or Guarantor, or any changes in name, business, location, composition, structure or changes in the shareholders, partners or members (whether by accession, secession, cessation, death, dissolution, transfer of assets or other matter) of Borrower or Guarantor; or any reorganization of Borrower or Guarantor; 3.04. INVALIDITY OF GUARANTEED DEBT. The invalidity, illegality or unenforceability of all or any part of the Guaranteed Debt, or any document or agreement executed in connection with the Guaranteed Debt, for any reason whatsoever, including without limitation the fact that (i) the Guaranteed Debt, or any part thereof, exceeds the amount permitted by law, (ii) the act of creating the Guaranteed Debt or any part thereof is ULTRA VIRES, (iii) the officers or representatives executing documents or otherwise creating the Guaranteed Debt acted in excess of their authority, (iv) the Guaranteed Debt violates applicable usury laws, (v) the Borrower has valid defenses, claims or offsets (whether at law, in equity or by agreement) which render the Guaranteed Debt wholly or partially uncollectible from Borrower, (vi) the creation, performance or repayment of the Guaranteed Debt (or the execution, delivery and performance of any document or instrument representing part of the Guaranteed Debt or executed in connection with the Guaranteed Debt, or given to secure the repayment of the Guaranteed Debt) is illegal, uncollectible or unenforceable, or (vii) the Facility Letter or other documents or instruments pertaining to the Guaranteed Debt have been forged or otherwise are irregular or not genuine or authentic. 3.05. RELEASE OF OBLIGORS. Any full or partial release of the liability of Borrower on the Guaranteed Debt or any part thereof, or of the Guarantor, or any other person or entity now or hereafter liable, whether directly or indirectly, jointly, severally, or jointly and severally, to pay, perform, guarantee or assure the payment of the Guaranteed Debt or any part thereof, it being recognized, acknowledged and agreed by Guarantor that Guarantor may be required to pay the Guaranteed Debt in full without assistance or support of any other party, and Guarantor has not been induced to enter into this Guaranty Agreement on the basis of a contemplation, belief, understanding or agreement that other parties will be liable to perform the Guaranteed Debt, or that Lender will look to other parties to perform the Guaranteed Debt; 4 notwithstanding the foregoing, Guarantor does not hereby waive or release (expressly or impliedly) any rights of subrogation, reimbursement or contribution which it may have, after payment in full of the Guaranteed Debt, against others liable on the Guaranteed Debt; Guarantor's rights of subrogation and reimbursement are, however, subordinate to the rights and claims of Lender; 3.06. OTHER SECURITY. The taking or accepting of any other security, collateral or guaranty, or other assurance of payment, for all or any part of the Guaranteed Debt; 3.07. RELEASE OF COLLATERAL, ETC. Any release, surrender, exchange, subordination, deterioration, waste, loss or impairment (including without limitation negligent, willful, unreasonable or unjustifiable impairment) of any collateral, property or security, at any time existing in connection with, or assuring or securing payment of, all or any part of the Guaranteed Debt; 3.08. CARE AND DILIGENCE. The failure of Lender or any other party to exercise diligence or reasonable care or act, fail to act or comply with any duty in the administration, preservation, protection, enforcement, sale application, disposal or other handling or treatment of all or any part of Guaranteed Debt or any collateral, property or security at any time securing any portion thereof, including, without limiting the generality of the foregoing, the failure to conduct any foreclosure or other remedy fairly or in such a way so as to obtain the best possible price or a favorable price or otherwise act or fail to act; 3.09. STATUS OF LIENS. The fact that any collateral, security, security interest or lien contemplated or intended to be given, created or granted as security for the repayment of the Guaranteed Debt shall not be properly perfected or created, or shall prove to be unenforceable or subordinate to any other security interest or lien, it being recognized and agreed by Guarantor that Guarantor is not entering into this Guaranty Agreement in reliance on, or in contemplation of the benefits of, the validity, enforceability, collectibility or value of any of the collateral for the Guaranteed Debt; notwithstanding the foregoing, Guarantor does not hereby waive or release (expressly or impliedly) any right to be subrogated to the rights of Lender in any collateral or security for the Guaranteed Debt after payment in full of the Guaranteed Debt; Guarantor's rights of subrogation are, however, subordinate to the rights, claims, liens and security interests of Lender; 3.10. OFFSET. The Guaranteed Debt guaranteed hereby, and the liabilities and obligations of Guarantor to Lender hereunder, shall not be reduced, discharged or released because of or by reason of any existing or future right of offset, claim or defense of Borrower against Lender, or any other party, or against payment of the Guaranteed Debt, whether such right of offset, claim or defense arises in connection with the Guaranteed Debt (or the transactions creating the Guaranteed Debt) or otherwise; 3.11. MERGER. The reorganization, merger or consolidation of Borrower or Guarantor into or with any other corporation or entity; 3.12. PREFERENCE. Any payment by Borrower to Lender is held to constitute a preference under bankruptcy laws, or for any reason Lender is required to refund such payment or pay such amount to Borrower or someone else; or 3.13. OTHER ACTIONS TAKEN OR OMITTED. Any other action taken or omitted to be taken with respect to the Facility Letter, the Guaranteed Debt, or the security and collateral therefor, whether or not such action or omission prejudices Guarantor or increases the likelihood or risk that Guarantor will be required to pay the Guaranteed Debt pursuant to the terms hereof; it is the unambiguous and unequivocal intention of Guarantor that Guarantor shall be obligated to pay the Guaranteed Debt when due, notwithstanding any occurrence, circumstance, event, action, or omission whatsoever, whether 5 contemplated or uncontemplated, and whether or not otherwise or particularly described herein, except for the full and final payment and satisfaction of the Guaranteed Debt. SECTION 4 REPRESENTATIONS AND WARRANTIES To induce Lender to enter into the Facility Letter and extend credit under the Facility to Borrower, Guarantor represents and warrants to Lender that: 4.01. BENEFIT. Guarantor is the parent company and the beneficial owner of all the issued shares of Borrower and has received, or will receive, direct or indirect benefit from the making of this Guaranty and the Guaranteed Debt. 4.02. FAMILIARITY AND RELIANCE. Guarantor is familiar with, and has independently reviewed books and records regarding, the financial condition of the Borrower and is familiar with the value of any and all collateral intended to be created as security for the payment of the Guaranteed Debt; HOWEVER, Guarantor is not relying on such financial condition or the collateral as an inducement to enter into this Guaranty Agreement. 4.03. NO REPRESENTATION BY LENDER. Neither Lender nor any other party has made any representation, warranty or statement to Guarantor in order to induce the Guarantor to execute this Guaranty Agreement. 4.04. GUARANTOR'S FINANCIAL CONDITION. As of the date hereof, and after giving effect to this Guaranty Agreement and the contingent obligation evidenced hereby, Guarantor is, and will be, solvent, and has and will have assets which, fairly valued, exceed its obligations, liabilities and debts. 4.05. DIRECTORS' DETERMINATION OF BENEFIT. The board of directors of Guarantor, acting pursuant to a duly called and constituted meeting, after proper notice, or pursuant to a valid unanimous consent, has determined that this Guaranty directly or indirectly benefits Guarantor and is in the best interests of Guarantor. 4.06. LEGALITY. The execution, delivery and performance by Guarantor of this Guaranty Agreement and the consummation of the transactions contemplated hereunder: (i) have been duly authorized by all necessary corporate and stockholder action of Guarantor, and (ii) do not, and will not, contravene or conflict with any law, statute or regulation whatsoever to which Guarantor is subject or constitute a default (or an event which with notice or lapse of time or both would constitute a default) under, or result in the breach of, any indenture, mortgage, deed of trust, charge, lien, or any contract, agreement or other instrument to which Guarantor is a party or which may be applicable to Guarantor or any of its assets, or violate any provisions of its Certificate of Incorporation, Bylaws or any other organizational document of Guarantor; this Guaranty Agreement is a legal and binding obligation of Guarantor and is enforceable in accordance with its terms, except as limited by bankruptcy, insolvency or other laws of general application relating to the enforcement of creditors' rights. 4.07 ORGANIZATION AND GOOD STANDING. Guarantor: (i) is, and will continue to be, a corporation duly organized and validly existing in good standing under the laws of the State of Texas, and (ii) possesses all requisite authority, power, licenses, permits and franchises necessary to own its assets, to conduct its business and to execute and deliver and comply with the terms of this Guaranty Agreement. 4.08. SURVIVAL. All representations and warranties made by Guarantor herein shall survive the execution hereof. 6 SECTION 5 SUBORDINATION OF CERTAIN INDEBTEDNESS 5.01. SUBORDINATION OF GUARANTOR CLAIMS. Until the Guaranteed Debt shall be paid and satisfied in full and Guarantor shall have performed all of its obligations hereunder, Guarantor shall not receive or collect, directly or indirectly, from Borrower or any other party any amount upon the Guarantor Claims. 5.02. CLAIMS IN BANKRUPTCY. In the event of receivership, bankruptcy, reorganization, arrangement, debtor's relief, or other insolvency proceedings involving Borrower as debtor, Lender shall have the right to prove its claim in any such proceeding so as to establish its rights hereunder and receive directly from the receiver, trustee or other court custodian dividends and payments which would otherwise be payable upon Guarantor Claims. Guarantor hereby assigns such dividends and payments to Lender. Should Lender receive, for application upon the Guaranteed Debt, any such dividend or payment which is otherwise payable to Guarantor, and which, as between Borrower and Guarantor, shall constitute a credit upon the Guarantor Claims, then upon payment to Lender in full of the Guaranteed Debt, Guarantor shall become subrogated to the rights of Lender to the extent that such payments to Lender on the Guarantor Claims have contributed toward the liquidation of the Guaranteed Debt, and such subrogation shall be with respect to that proportion of the Guaranteed Debt which would have been unpaid if Lender had not received dividends or payments upon the Guarantor Claims. 5.03. PAYMENTS HELD IN TRUST. In the event that, notwithstanding SECTIONS 5.01 and 5.02 above, Guarantor should receive any funds, payment, claim or distribution which is prohibited by such Sections, Guarantor agrees to hold in trust for Lender, in kind, all funds, payments, claims or distributions so received, and agrees that he shall have absolutely no dominion over such funds, payments, claims or distributions so received except to pay them promptly to Lender, and Guarantor covenants promptly to pay the same to Lender. 5.04. LIENS SUBORDINATE. Guarantor agrees that any liens, security interests, judgment liens, charges or other encumbrances upon Borrower's assets securing payment of the Guarantor Claims shall be and remain inferior and subordinate to any liens, security interests, judgment liens, charges or other encumbrances upon Borrower's assets securing payment of the Guaranteed Debt, regardless of whether such encumbrances in favor of Guarantor or Lender presently exist or are hereafter created or attach. Without the prior written consent of Lender, Guarantor shall not: (i) exercise or enforce any creditor's right it may have against Borrower, or (ii) foreclose, repossess, sequester or otherwise take steps or institute any action or proceedings (judicial or otherwise, including without limitation the commencement of, or joinder in, any liquidation, bankruptcy, rearrangement, debtor's relief or insolvency proceeding) to enforce any liens, mortgages, deeds of trust, security interest, collateral rights, judgments or other encumbrances on assets of Borrower held by Guarantor. 5.05. NOTATION OF RECORDS. All promissory notes, accounts receivable ledgers or other evidences of the Guarantor Claims accepted by or held by Guarantor shall contain a specific written notice thereon that the indebtedness evidenced thereby is subordinated under the terms of this Guaranty Agreement. 7 SECTION 6 MISCELLANEOUS 6.01. WAIVER. No failure to exercise, and no delay in exercising, on the part of Lender, any right hereunder shall operate as a waiver thereof, nor shall any single or partial exercise thereof preclude any other or further exercise thereof or the exercise of any other right. The rights of Lender hereunder shall be in addition to all other rights provided by law. No modification or waiver of any provision of this Guaranty Agreement, nor consent to departure therefrom, shall be effective unless in writing and no such consent or waiver shall extend beyond the particular case and purpose involved. No notice or demand given in any case shall constitute a waiver of the right to take other action in the same, similar or other instances without such notice or demand. 6.02 NOTICE. Any notice, demand, request or other communication which any party hereto may be required or may desire to give hereunder shall be in writing and shall be deemed to be effective (a) if by telecopy or other facsimile transmission, on the day and time on which delivered to such party at the address, or telecopy number specified below; (b) if by mail, on the day which it is received after being deposited, first class postage prepaid, return receipt requested, addressed to such a party at the address specified below; or (c) if by FedEx or other reputable express mail service, on the next Business Day (or the second Business Day, in the case of international delivery) following the delivery to such express mail service for next Business Day delivery, addressed to such party at the address set forth below: If to Guarantor: DSI Toys, Inc. 1100 West Sam Houston Parkway North Houston, Texas 77043 United States of America Telephone: 713-365-9900 Fax: 713-365-9911 Attention: Mr. Thomas V. Yarnell If to Lender: Dao Heng Bank Limited 16th Floor, The Center 99 Queen's Road Central Hong Kong, SAR Telephone: 852-2218-8125/852-2218-8136 Fax: 852-2285-3068 Attention: Ms. Catherine Ng and Ms. Doris Tam Any party may change its address for purposes of this Guaranty Agreement by giving notice of such change to the other party pursuant to this SECTION 6.02. 6.03. GOVERNING LAW; WAIVER OF VENUE; WAIVER OF JURY TRIAL. This Guaranty Agreement has been prepared, and is intended to be performed in the State of Texas, United States of America, and the substantive laws of such state shall govern the validity, construction, enforcement and interpretation of this Guaranty Agreement. For purposes of this Guaranty Agreement and the resolution of disputes hereunder, Guarantor hereby irrevocably submits and consents to, and waives any objection to, the non-exclusive jurisdiction of the courts of the State of Texas located in Harris County, Texas and of the federal court located in the Southern Judicial District of Texas, Houston Division. GUARANTOR HEREBY WAIVES TRIAL BY JURY IN ANY SUIT, ACTION OR PROCEEDING BROUGHT 8 IN CONNECTION WITH THIS GUARANTY AGREEMENT OR THE FACILITY LETTER, WHICH WAIVER IS INFORMED AND VOLUNTARY. 6.04. INVALID PROVISIONS. If any provision of this Guaranty Agreement is held to be illegal, invalid, or unenforceable under present or future laws effective during the term of this Guaranty Agreement, such provision shall be fully severable and this Guaranty Agreement shall be construed and enforced as if such illegal, invalid or unenforceable provision had never comprised a part of this Guaranty Agreement, and the remaining provisions of this Guaranty Agreement shall remain in full force and effect and shall not be affected by the illegal, invalid or unenforceable provision or by its severance from this Guaranty Agreement, unless such continued effectiveness of this Guaranty Agreement, as modified, would be contrary to the basic understandings and intentions of the parties as expressed herein. 6.05. ENTIRETY AND AMENDMENTS. This Guaranty Agreement embodies the entire agreement between the parties and supersedes all prior agreements and understandings, if any, relating to the subject matter hereof, and this Guaranty Agreement may be amended only by an instrument in writing executed by an authorized officer of the party against whom such amendment is sought to be enforced. 6.06. PARTIES BOUND; ASSIGNMENT. This Guaranty Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors, assigns and legal representatives; PROVIDED, HOWEVER, that Guarantor may not, without the prior written consent of Lender, assign any of its rights, powers, duties or obligations hereunder. 6.07. HEADINGS. Section headings are for convenience of reference only and shall in no way affect the interpretation of this Guaranty Agreement. 6.08. MULTIPLE COUNTERPARTS. This Guaranty Agreement may be executed in any number of counterparts, all of which taken together shall constitute one and the same agreement, and any of the parties hereto may execute this Guaranty Agreement by signing any such counterpart. 6.09. RIGHTS AND REMEDIES. If Guarantor becomes liable for any indebtedness owing by Borrower to Lender, by endorsement or otherwise, other than under this Guaranty Agreement, such liability shall not be in any manner impaired or affected hereby and the rights of Lender hereunder shall be cumulative of any and all other rights that Lender may ever have against Guarantor. The exercise by Lender of any right or remedy hereunder or under any other instrument, or at law or in equity, shall not preclude the concurrent or subsequent exercise of any other right or remedy. 6.10 PAYMENTS. All sums payable under this Guaranty Agreement shall be paid in immediately available funds, without offset, in lawful money of the United States of America. Payment by check or draft shall not constitute payment in immediately available funds until the required amount is actually received by Lender in full. REMAINDER OF PAGE INTENTIONALLY BLANK. SIGNATURE PAGE FOLLOWS. 9 EXECUTED as of the day and year first above written. GUARANTOR: DSI TOYS, INC. By: /s/ ROBERT L. WEISGARBER ----------------------------------- Name: Robert L. Weisgarber Title: CFO STATE OF TEXAS Section Section COUNTY OF HARRIS Section This instrument was acknowledged before me on this 20th day of March, 2002, by Robert L. Weisgarber, as an CFO of DSI Toys, Inc. /s/ LINDA FELD -------------------------------------------- Notary Public in and for the State of Texas (CORPORATE SEAL) EX-10.66 10 a2074077zex-10_66.txt EXHIBIT 10.66 EXHIBIT 10.66 AMENDMENT NO. 8 TO LOAN AND SECURITY AGREEMENT THIS AMENDMENT NO. 8 TO LOAN AND SECURITY AGREEMENT (this "AMENDMENT"), is entered into as of March 29, 2002, to be effective for all purposes as of December 31, 2001, by and between SUNROCK CAPITAL CORP., a Delaware corporation ("LENDER"), and DSI TOYS, INC., a Texas corporation ("BORROWER"). RECITALS A. Borrower and Lender have entered into that certain Loan and Security Agreement, dated as of February 2, 1999 (as the same has been, and may hereafter be, amended, modified, supplemented or restated from time to time, the "LOAN AGREEMENT"). B. The Borrower and Lender have agreed to amend and modify the Loan Agreement as set forth below, subject to the terms, conditions and limitations in the Loan Agreement and this Amendment. NOW, THEREFORE, in consideration of the premises herein contained and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties, intending to be legally bound, hereby agree as follows: ARTICLE I DEFINITIONS 1.01 Capitalized terms used in this Amendment, to the extent not otherwise defined herein, shall have the same meanings as in the Loan Agreement, as amended hereby. ARTICLE II AMENDMENTS 2.01 DEFINITION OF EIGHTH AMENDMENT. SECTION 1 of the Loan Agreement is hereby amended by adding the following SUBSECTION 1.34: "1.34 "Eighth Amendment" shall mean that certain Amendment No. 8 to Loan and Security Agreement, executed as of March 29, 2002, to be effective for all purposes as of December 31, 2001, by and between Lender and Borrower." 2.02 DEFINITION OF OVERADVANCE FACILITY. SECTION 1 of the Loan Agreement is hereby amended by adding the following SUBSECTION 1.35: "1.35 "Overadvance Facility" shall mean the Loans made under SECTION 2.2(b) of the Loan Agreement." 2.03 AMENDMENT TO SEASONAL INVENTORY ADVANCES. SECTION 2.2 of the Loan Agreement is hereby amended and restated to read in its entirety as follows: "2.2 SEASONAL INVENTORY ADVANCES. (a) In addition to the Loans permitted under Section 2.1 above and 2.2(b) below, but subject to, and upon the terms and conditions contained herein (including, without limitation, the provisions set forth in Sections 2.4 and 2.5 below), Lender agrees to make Loans to Borrower from time to time up to the lesser of: (1) the Maximum Credit LESS Loans extended under Section 2.1 above; and (2) (i) during the period commencing January 1, 2002, and extending through June 30, 2002, (A) ten percent (10%) of the Value of Eligible Inventory; and (B) ten percent (10%) of the Value of Eligible In-Transit Inventory; or (ii) during the period commencing January 1, 2003, and extending through June 30, 2003, the sum of: (A) ten percent (10%) of the Value of Eligible Inventory; and (B) ten percent (10%) of the Value of Eligible In-Transit Inventory; or (iii) during the period commencing January 1, 2004, and extending through June 30, 2004, the sum of: (A) ten percent (10%) of the Value of Eligible Inventory; and (B) ten percent (10%) of the Value of Eligible In-Transit Inventory (All Loan amounts calculated pursuant to Section 2.2(a)(2)(i) through (iii), inclusive, shall be subject to reduction for all applicable Availability Reserves); and (b) In addition to the Loans permitted under SECTIONS 2.1 and 2.2(a) above and notwithstanding the provisions of Section 2.4 to the contrary, but otherwise subject to, and upon the terms and conditions contained herein (including, without limitation, the provisions set forth in Sections 2.4 and 2.5 below), Lender agrees to allow overadvances to remain outstanding up to, but not greater than, the following amounts during the following periods: (i) $500,000 during the period commencing March 28, 2002, and ending on June 7, 2002; (ii) $375,000 during the period commencing June 8, 2002, and ending June 14, 2002; (iii) $250,000 during the period commencing June 15, 2002, and ending June 21, 2002; and (iv) $125,000 during the period commencing June 22, 2002, and ending June 28, 2002. No overdvances shall remain outstanding pursuant to this Section 2.2(b) from and after June 29, 2002. In addition to the other rights and remedies available to Lender upon the occurrence of any Default or Event of Default, Lender may demand immediate payment of any amounts outstanding pursuant to this Section 2.2(b) upon the occurrence and during the continuation of any Default or Event of Default without exercising any other rights or remedies or otherwise limiting the rights of Lender otherwise pursuant to this Agreement or applicable law." 2.04 AMENDMENT TO INTEREST AND FEES. SECTION 3.1 of the Loan Agreement is hereby amended and restated to read in its entirety as follows: "3.1 INTEREST. (a) Borrower shall pay to Lender interest on the outstanding principal amount of the non-contingent Obligations, other than the Overadvance Facility, at the rate of three quarters of one percent (.75%) per annum in excess of the Prime Rate, except that, at Lender's option, without notice, Borrower shall pay to Lender interest at the lesser of (A) the Maximum Legal Rate and (B) the Prime Rate, plus four percent (4%): (i) on the non-contingent Obligations for (1) the period from and after the date of termination or non-renewal hereof until such time as Lender has received full and final payment of all such Obligations (notwithstanding entry of any judgment against Borrower), and (2) the period from and after the date of the occurrence of an Event of Default for so long as such Event of Default is continuing as determined by Lender and (ii) on the Loans at any time outstanding in excess of the amounts available to Borrower under Section 2 (whether or not such excess(es), arise or are made with or without Lender's knowledge or consent and whether made before or after an Event of Default). (b) Borrower shall pay to Lender interest on the outstanding principal amount of the Overadvance Facility at the rate of two an three quarters of one percent (2.75%) per annum in excess of the Prime Rate, except that, at Lender's option, without notice, Borrower shall pay to Lender interest at the lesser of (A) the Maximum Legal Rate and (B) the Prime Rate, plus four percent (4%): (i) on the Overadvance Facility for (1) the period from and after the date of termination or non-renewal hereof until such time as Lender has received full and final payment of all such Obligations (notwithstanding entry of any judgment against Borrower), and (2) the period from and after the date of the occurrence of an Event of Default for so long as such Event of Default is continuing as determined by Lender and (ii) on the Loans made under the Overadvance Facility at any time outstanding in excess of the amounts available to Borrower under Section 2 (whether or not such excess(es), arise or are made with or without Lender's knowledge or consent and whether made before or after an Event of Default). (c) All interest shall be payable by Borrower to Lender monthly in arrears not later than the first day of each calendar month and shall be calculated on the basis of a three hundred sixty (360) day year and actual days elapsed. The interest rates set forth in Sections 3.1(a) and 3.1(b) shall increase or decrease by an amount equal to each increase or decrease in the Prime Rate effective as of the date on which the applicable increase or decrease in the Prime Rate shall be published in the printed version of the Wall Street Journal (Eastern Edition, New York Metro) or such other publication as Lender may select in accordance with the terms hereof. All interest accruing hereunder on and after an Event of Default or termination or non-renewal hereof shall be payable on demand. In no event shall charges constituting interest payable by Borrower to Lender exceed the maximum amount or the rate permitted under any applicable law or regulation, and if any part or provision of this Agreement is in contravention of any such law or regulation, such part or provision shall be deemed amended to conform thereto. No agreements, conditions, provisions or stipulations contained in this Agreement or any other instrument, document or agreement between Borrower and Lender or default of Borrower, or the exercise by Lender of the right to accelerate the payment of the maturity of principal and interest, or to exercise any option whatsoever contained in this Agreement or any other Financing Agreement, or the arising of any contingency whatsoever, shall entitle Lender to contract for, charge, or receive, in any event, interest exceeding the maximum rate of interest permitted by applicable state or federal law in effect from time to time (hereinafter "Maximum Legal Rate"). In no event shall Borrower be obligated to pay interest exceeding such Maximum Legal Rate and all agreements, conditions or stipulations, if any, which may in any event or contingency whatsoever operate to bind, obligate or compel Borrower to pay a rate of interest exceeding the Maximum Legal Rate, shall be without binding force or effect, at law or in equity, to the extent only of the excess of interest over such Maximum Legal Rate. In the event any interest is contracted for, charged or received in excess of the Maximum Legal Rate ('"Excess"), Borrower acknowledges and stipulates that any such contract, charge, or receipt shall be the result of an accident and bona fide error, and that any Excess received by Lender shall be applied, first, to reduce the principal then unpaid hereunder; second, to reduce the other Obligations; and third, returned to Borrower, it being the intention of the parties hereto not to enter at any time into a usurious or otherwise illegal relationship. Borrower recognizes that, with fluctuations in the Prime Rate and the Maximum Legal Rate, such a result could inadvertently occur. By the execution of this Agreement, Borrower covenants that (i) the credit or return of any Excess shall constitute the acceptance by Borrower of such Excess, and (ii) Borrower shall not seek or pursue any other remedy, legal or equitable, against Lender, based in whole or in part upon contracting for, charging or receiving of any interest in excess of the maximum authorized or receiving of any interest in excess of the maximum authorized by applicable law. For the purpose of determining whether or not any Excess has been contracted for, charged or received by Lender, all interest at any time contracted for, charged or received by Lender in connection with this Agreement shall be amortized, prorated, allocated and spread in equal parts during the entire term of this Agreement." 2.05 AMENDMENT TO NET WORTH. SECTION 9.14 of the Loan Agreement is hereby amended and restated to read in its entirety as follows: "9.14 NET WORTH. The Borrower will not permit its Net Worth to be less than the following respective amounts at the following respective dates:
DATE MINIMUM NET WORTH
12/31/01 $ 9,000,000 03/31/02 $ 6,500,000 06/30/02 $ 5,500,000 09/30/02 $ 8,500,000 12/31/02 $10,000,000 03/31/03 $ 7,500,000 06/30/03 $ 6,500,000 09/30/03 $ 9,500,000 12/31/03 $11,000,000 03/31/04 $8,500,000"
2.06 AMENDMENT TO NET INCOME. SECTION 9.19 of the Loan Agreement is hereby amended and restated to read in its entirety as follows: "9.19 NET INCOME. The Borrower will not permit its Net Income to be less than the following respective cumulative amounts for the periods ended as of the following respective dates, each of which dates shall be a date of determination for purposes of the definition of Net Income set forth at SUBSECTION 1.31 hereof:
DATE Net Income 12/31/01 ($1,500,000) 03/31/02 ($2,500,000) 06/30/02 ($3,500,000) 09/30/02 ($500,000) 12/31/02 $1,000,000 03/31/03 ($2,500,000) 06/30/03 ($3,500,000) 09/30/03 ($500,000) 12/31/03 $1,000,000 03/31/04 ($2,500,000)"
ARTICLE III ADDITIONAL DEFAULTS 3.01 ACKNOWLEDGEMENT OF AVAILABILITY RESTRICTIONS. Borrower acknowledges and agrees that the Overadvance Facility does not create "excess availability" for advances of Loans as calculated under SECTION 2.1 of the Loan Agreement, and that the ability to make principal payments pursuant to SECTION 9.9(c) of the Loan Agreement is subject to the limitations set forth in SECTION 9.9(c) of the Loan Agreement, including the payment in full of the Overadvance Facility. Any payment of indebtedness in violation of SECTION 9.9(c) of the Loan Agreement will result in an immediate Event of Default under the Loan Agreement and the other Financing Agreements. The Lender will have all of the rights and remedies provided in the Loan Agreement, the other Financing Agreements, the Uniform Commercial Code and other applicable law, all of which rights and remedies may be exercised without notice to or consent by the Borrower or any Obligor. 3.02 SUBORDINATION AGREEMENT. Borrower's failure to deliver to Lender an amendment to the Subordination Agreement, together with corresponding amendments to the Loan Agreement, on or before May 31, 2002, executed by E. Thomas Martin and MVII (as such term is defined in the Loan Agreement) and acknowledged by Borrower, which amendment shall be in a form satisfactory to Lender and shall (a) eliminate payments of the subordinated debt owing to such persons at all times prior to payment in full of the Overadvance Facility and (b) contain such other and additional limitations on the payment of the principal portion of the subordinated indebtedness from and after May 31, 2002, as shall be acceptable to Lender at its sole option, will result in an immediate Event of Default under the Loan Agreement and the other Financing Agreements. The Lender will have all of the rights and remedies provided in the Loan Agreement, the other Financing Agreements, the Uniform Commercial Code and other applicable law, all of which rights and remedies may be exercised without notice to or consent by the Borrower or any Obligor. ARTICLE IV CONDITIONS TO EFFECTIVENESS This Amendment shall become effective upon satisfaction of the following conditions: (a) the execution of this Amendment by Borrower and Lender. (b) payment by Borrower of all fees and expenses required to be paid by Borrower pursuant to Section 5.03 of this Amendment. ARTICLE V RATIFICATIONS, REPRESENTATIONS, WARRANTIES AND COVENANTS 5.01 RATIFICATIONS. Except as expressly amended hereby, the terms and provisions of the Loan Agreement are ratified and confirmed and shall continue in full force and effect. Borrower and Lender agree that the Loan Agreement, as amended hereby, and each agreement and instrument executed in connection herewith, shall continue to be legal, valid, binding and enforceable in accordance with their respective terms. 5.02 REPRESENTATIONS AND WARRANTIES. Borrower hereby represents and warrants to Lender that (a) the execution, delivery and performance of this Amendment has been authorized by all requisite corporate action on the part of Borrower and does not violate the Articles of Incorporation or Bylaws of Borrower; (b) the representations and warranties contained in the Loan Agreement, are true and correct on and as of the date hereof; (c) upon the effectiveness of this Amendment, no Event of Default under the Loan Agreement is continuing and no event or condition exists that with the giving of notice or the lapse of time, or both, would be an Event of Default; and (d) Borrower is in full compliance with all covenants and agreements contained in the Loan Agreement and each agreement and instrument entered into in connection therewith (assuming execution and delivery of this Amendment). 5.03 FEE PAYABLE TO LENDER PAYMENT OF LEGAL AND OTHER EXPENSES. Upon the execution of this Amendment by Lender, Borrower hereby agrees to pay to Lender a commitment fee in the amount of $15,000.00, which may be charged by Lender to Borrower's loan account without further agreement or consent of Borrower. In addition and as provided in the Loan Agreement, Borrower agrees to pay on demand all costs and expenses incurred by Lender in connection with the preparation, negotiation and execution of this Amendment, including, without limitation, the costs and fees of Lender's legal counsel, and all costs and expenses incurred by Lender in connection with the enforcement or preservation of any rights under the Loan Agreement, as amended hereby, or any agreement, document or instrument executed in connection therewith. ARTICLE VI MISCELLANEOUS PROVISIONS 6.01 SURVIVAL OF REPRESENTATIONS AND WARRANTIES. All representations and warranties made herein and in the Loan Agreement shall survive the execution and delivery of this Amendment, and no investigation by Lender shall affect the representations and warranties or the right of Lender to rely upon them. 6.02 REFERENCE TO LOAN AGREEMENT. The Loan Agreement, as amended hereby, and all other agreements, documents or instruments now or hereafter executed and delivered pursuant to the terms thereof are hereby amended so that any reference in the Loan Agreement or such other agreements, documents and instruments shall mean a reference to the Loan Agreement, as amended hereby. 6.03 SEVERABILITY. Any provision of this Amendment held by a court of competent jurisdiction to be invalid or unenforceable shall not impair or invalidate the remainder of this Amendment and the effect thereof shall be confined to the provision so held to be invalid or unenforceable. 6.04 SUCCESSORS AND ASSIGNS. This Amendment is binding upon and shall inure to the benefit of Lender and Borrower and their respective successors and assigns, except Borrower may not assign or transfer any of its rights or obligations hereunder without the prior written consent of Lender. 6.05 COUNTERPARTS. This Amendment may be executed in one or more counterparts, each of which when so executed shall be deemed to be an original, but all of which when taken together shall constitute one and the same instrument. 6.06 HEADINGS. The headings, captions, and arrangements used in this Amendment are for convenience only and shall not affect the interpretation of this Amendment. 6.07 APPLICABLE LAW. THIS AMENDMENT AND ALL OTHER LOAN DOCUMENTS EXECUTEDPURSUANT HERETO SHALL BE DEEMED TO HAVE BEEN MADE AND TO BE PERFORMABLE IN AND SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF TEXAS. 6.08 FINAL AGREEMENT. THE FINANCING AGREEMENTS (INCLUDING THE LOAN AGREEMENT AND THIS AMENDMENT), AS AMENDED HEREBY, REPRESENT THE ENTIRE EXPRESSION OF THE PARTIES WITH RESPECT TO THE SUBJECT MATTER HEREOF ON THE DATE THIS AMENDMENT IS EXECUTED. THE FINANCING AGREEMENTS, AS AMENDED HEREBY, MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES. THERE ARE NO UNWRITTEN ORAL AGREEMENTS BETWEEN THE PARTIES. NO MODIFICATION, RESCISSION, WAIVER, RELEASE OR AMENDMENT OF ANY PROVISION OF THIS AMENDMENT SHALL BE MADE, EXCEPT BY A WRITTEN AGREEMENT SIGNED BY BORROWER AND LENDER. 6.09 RELEASE. BORROWER HEREBY ACKNOWLEDGES THAT IT HAS NO DEFENSE, COUNTERCLAIM, OFFSET, CROSS-COMPLAINT, CLAIM OR DEMAND OF ANY KIND OR NATURE WHATSOEVER THAT CAN BE ASSERTED TO REDUCE OR ELIMINATE ALL OR ANY PART OF ITS LIABILITY TO REPAY THE OBLIGATIONS (AS DEFINED IN THE LOAN AGREEMENT) OR TO SEEK AFFIRMATIVE RELIEF OR DAMAGES OF ANY KIND OR NATURE FROM LENDER. BORROWER HEREBY VOLUNTARILY AND KNOWINGLY RELEASES AND FOREVER DISCHARGES LENDER, ITS PREDECESSORS, AGENTS, EMPLOYEES, SUCCESSORS AND ASSIGNS, FROM ALL POSSIBLE CLAIMS, DEMANDS, ACTIONS, CAUSES OF ACTION, DAMAGES, COSTS, EXPENSES, AND LIABILITIES WHATSOEVER, KNOWN OR UNKNOWN, ANTICIPATED OR UNANTICIPATED, SUSPECTED OR UNSUSPECTED, FIXED, CONTINGENT, OR CONDITIONAL, AT LAW OR IN EQUITY, ORIGINATING IN WHOLE OR IN PART ON OR BEFORE THE DATE THIS AMENDMENT IS EXECUTED, WHICH THE BORROWER MAY NOW OR HEREAFTER HAVE AGAINST LENDER, ITS PREDECESSORS, AGENTS, EMPLOYEES, SUCCESSORS AND ASSIGNS, IF ANY, AND IRRESPECTIVE OF WHETHER ANY SUCH CLAIMS ARISE OUT OF CONTRACT, TORT, VIOLATION OF LAW OR REGULATIONS, OR OTHERWISE, AND ARISING FROM ANY LOANS (AS DEFINED IN THE LOAN AGREEMENT), INCLUDING, WITHOUT LIMITATION, ANY CONTRACTING FOR, CHARGING, TAKING, RESERVING, COLLECTING OR RECEIVING INTEREST IN EXCESS OF THE HIGHEST LAWFUL RATE APPLICABLE, THE EXERCISE OF ANY RIGHTS AND REMEDIES UNDER THE LOAN AGREEMENT OR ANY FINANCING AGREEMENT, DOCUMENT OR INSTRUMENT ENTERED INTO IN CONNECTION THEREWITH. [Signature Page Follows] Executed as of the day and year first written above. DSI TOYS, INC. By: /s/ R. L. WEISGARBER ----------------------------- Name: R. L. WEISGARBER --------------------------- Title: CFO -------------------------- SUNROCK CAPITAL CORP. By: /s/ THOMAS M. ROMANOWSKI ----------------------------- Name: THOMAS M. ROMANOWSKI --------------------------- Title: SVP -------------------------- EX-21 11 a2074077zex-21.txt EXHIBIT 21 Exhibit 21 SUBSIDIARIES Subsidiary Jurisdiction of Organization ---------- ---------------------------- DSI(HK) Limited Hong Kong Meritus Industries Limited Hong Kong RSP Products Limited Hong Kong Elite Dolls Limited Hong Kong -----END PRIVACY-ENHANCED MESSAGE-----