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:
JANUARY 31, 1998 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 stock held by non-affiliates of
the Registrant as of April, 27, 1998 was $7,632,763. As of April 27, 1998, there
were 6,000,000 shares of common stock, $.01 par value, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement for the registrant's 1998 Annual
Meeting of Stockholders to be held on June 23, 1998 are incorporated by
reference in Part III of this Form 10-K.
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TABLE OF CONTENTS
Page
Safe Harbor Statement..........................................................1
Part I
Item 1. Business............................................................1
Item 2. Properties.........................................................10
Item 3. Legal Proceedings..................................................11
Item 4. Submission of Matters to a Vote of Security Holders................11
Part II
Item 5. Market for Registrant's Common Equity and Related Shareholder
Matters.......................................................12
Item 6. Selected Consolidated Financial Data...............................13
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.........................................14
Item 8. Financial Statements and Supplementary Data........................18
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure..........................................18
Part III
Item 10. Directors and Executive Officers of the Registrant.................19
Item 11. Executive Compensation.............................................19
Item 12. Security Ownership of Certain Beneficial Owners and Management.....19
Item 13. Certain Relationships and Related Transactions.....................19
Part IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K...19
Signatures ..............................................................20
Index to Consolidated Financial Statements and Schedule......................F-1
Index to Exhibits............................................................E-1
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SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM
ACT OF 1995: STATEMENTS IN THIS REPORT THAT ARE NOT HISTORICAL FACTS, INCLUDING
STATEMENTS ABOUT PLANS AND EXPECTATIONS REGARDING PRODUCTS AND OPPORTUNITIES,
DEMAND AND ACCEPTANCE OF NEW AND EXISTING PRODUCTS, CAPITAL RESOURCES AND FUTURE
FINANCIAL CONDITION AND RESULTS ARE FORWARD-LOOKING. FORWARD-LOOKING STATEMENTS
INVOLVE RISKS AND UNCERTAINTIES, WHICH MAY CAUSE THE COMPANY'S ACTUAL RESULTS IN
FUTURE PERIODS TO DIFFER MATERIALLY AND ADVERSELY FROM THOSE EXPRESSED. THESE
UNCERTAINTIES AND RISKS INCLUDE CHANGING CONSUMER PREFERENCES, LACK OF SUCCESS
OF NEW PRODUCTS, LOSS OF THE COMPANY'S CUSTOMERS, LIQUIDITY OF THE COMPANY,
COMPETITION, AND OTHER FACTORS DISCUSSED IN THIS REPORT AND FROM TIME TO TIME IN
THE COMPANY'S FILINGS WITH THE SECURITIES AND EXCHANGE COMMISSION.
EXCEPT AS OTHERWISE INDICATED, REFERENCES TO THE "COMPANY" REFER TO DSI
TOYS, INC. AND ITS WHOLLY OWNED SUBSIDIARY, DSI (HK) LTD. ("DSI(HK)"). THE TERMS
"FISCAL YEAR" AND "FISCAL" REFER TO THE COMPANY'S FISCAL YEAR WHICH IS THE YEAR
ENDING JANUARY 31 OF THE FOLLOWING CALENDAR YEAR MENTIONED (E.G., A REFERENCE TO
FISCAL 1997 IS A REFERENCE TO THE FISCAL YEAR ENDED JANUARY 31, 1998).
PART I
ITEM 1. BUSINESS
GENERAL
The Company designs, develops, markets and distributes toys and
children's consumer electronics. The Company's core product categories are (i)
juvenile audio products, including walkie-talkies, pre-school audio products,
pre-teen audio products and musical toys; (ii) girls' toys, including dolls,
play sets and accessories; and (iii) boys' toys, including radio-controlled
vehicles, action figures and western and military action toys. Founded in 1970,
the Company historically was principally a supplier of non-proprietary toys to
deep discount stores and regional drug store chains. With the addition of new
senior management personnel in 1990, the Company began to market its product
line to major toy retailers by emphasizing packaging and developing in-house
brands. Further, in fiscal 1993, the Company began to emphasize the development
and marketing of proprietary products, consisting of toys developed by the
Company incorporating concepts licensed from outside inventors, products
designed in-house, products for which the Company owns the mold and products
incorporating trademarks licensed to the Company.
Traditionally a supplier of juvenile audio products and boys' toys, the
Company has diversified its product offerings over the last three fiscal years,
primarily through its expansion into the girls' toys category with the
introduction of the Rosie(R) doll in fiscal 1995, into radio-controlled vehicles
with the introduction of the Kawasaki(R) Ninja(R) Supergyro(TM) motorcycle in
fiscal 1997, and into action games with the introduction of Hoppin' Poppin'
Spaceballs(TM) in fiscal 1997.
The Company offers several licensed products under the Kawasaki(R)
brand name, including radio-controlled vehicles and musical instruments. The
Company also has developed and currently is marketing products incorporating
several in-house brand names, including Digi-Tech(TM) (walkie-talkies), LA
Rock(R) (musical toys and audio products), American Frontier(TM) (western role
play toys), and My Music Maker(R) (musical toys and pre-school audio products).
The Company believes that it is the leading supplier of walkie-talkies to the
top five United States toy retailers.
The Company sells primarily to retailers, including mass merchandising
discounters such as Wal-Mart, Kmart and Target, specialty toy stores such as
Toys "R" Us, Kay-Bee Toy & Hobby and F.A.O. Schwarz, and deep discount stores
such as Family Dollar Stores, Inc., Consolidated Stores Corporation and Value
City Department Stores, Inc. Although the
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Company's sales have been made primarily to customers based in the United
States, international net sales accounted for approximately 19.4% of the
Company's net sales during fiscal 1997.
Approximately 61.2% of the Company's net sales (by dollar volume) were
made FOB Asia during fiscal 1997. Products sold FOB Asia are shipped directly to
customers from the factory and are not carried by the Company in inventory. The
Company also maintains an inventory of certain products in its Houston, Texas
facilities, principally to support sales by the Company's customers. In
addition, the Company's Houston facilities maintain inventory to support the
Company's television-promoted proprietary products.
PRODUCTS
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 1997 1996 1995
------ ------ ------
Juvenile audio products .......................... 50.2% 49.5% 46.3%
Girls' toys ...................................... 31.0 40.8 33.5
Boys' toys ....................................... 9.8 6.0 13.5
Other ............................................ 9.0 3.7 6.7
------ ------ ------
Total ................................... 100.0% 100.0% 100.0%
====== ====== ======
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 a critical and ongoing concern.
The Company develops both proprietary and non-proprietary products. The
Company's proprietary product lines currently consist of products (i) that are
licensed from outside inventors and designers, (ii) that incorporate trademarks
licensed by the Company, (iii) that are designed in-house or (iv) for which the
Company owns the mold to manufacture the toy. For each product in the fourth
proprietary category, the Company or the inventor owns the intellectual property
of the design, and the Company owns the required tooling, dies and molds
necessary to manufacture the product. Proprietary toys accounted for
approximately 58%, 59% and 51% of the Company's net sales for fiscal 1997, 1996
and 1995, respectively. The Company's proprietary products generally yield
higher gross margins to the Company than non-proprietary toys.
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 product introductions on the basis of the Company's
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
Digi-Tech(TM) and LA Rock(R). Non-proprietary products accounted for
approximately 42%, 41%, and 49% of the Company's net sales for fiscal 1997,
1996, and 1995, respectively.
LICENSE AGREEMENTS
The Company enters into license agreements with toy inventors and
designers that give the Company the right to manufacture and market a product or
technology invented or designed by the inventor. In return, the Company agrees
to pay to the inventor a percentage of net sales of the Company's product that
is based on the inventor's product or technology. Typically, this annual royalty
ranges from 4% to 7% of net sales. Sales of products that are based on products
or technology acquired by the Company from the inventor thereof, such as the
Rosie(R) doll, accounted for approximately 46%, 41%, and 31% of the Company's
net sales during fiscal 1997, 1996, and 1995, respectively. The acquisition of
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licenses typically requires the payment of non-refundable advances and/or
guaranteed minimum royalties.
The Company has a license agreement with Kawasaki Motors Corp., USA
authorizing the Company to use the Kawasaki(R) brand name in connection with
several different products, including the Kawasaki(R) Ninja(R) Supergyro(TM)
Motorcycle.
As of January 31, 1998, minimum future guaranteed payments by the
Company under licenses aggregated approximately $15,000.
The Company does not rely significantly upon licenses of characters and
trademarks from entertainment companies. During fiscal 1997, sales of toys that
were the subject of license agreements with entertainment companies accounted
for less than 1% of the Company's net sales.
CUSTOMERS
The Company made sales to over 400 different customers in approximately
40 countries during fiscal 1997. 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 1997 1996 1995
------ ------ ------
United States ............................ 80.6% 81.4% 82.5%
Europe ................................... 10.8 9.2 8.1
Canada and Mexico ........................ 4.2 3.7 4.2
Australia and New Zealand ................ 2.4 2.4 2.7
South and Central America ................ 1.2 1.7 1.5
Asia ..................................... 0.3 1.4 0.7
Middle East and Africa ................... 0.5 0.2 0.3
------ ------ ------
Total ................................ 100.0% 100.0% 100.0%
====== ====== ======
The Company's principal customers are retailers, including mass
merchandising discounters such as Wal-Mart, Kmart and Target, specialty toy
stores such as Toys "R" Us, Kay Bee Toy & Hobby and F.A.O. Schwarz, 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 57.4% of the Company's net sales in fiscal
1997. Toys "R" Us (22.2%) and Wal-Mart (16.6%) each accounted for more than 10%
of the Company's net sales during the same period. For the prior two fiscal
years, the only customers that accounted for more than 10% of the Company's net
sales were Wal-Mart (19.5%), Kmart (13.7%) and Toys "R" Us (12.0%) for fiscal
1996, and Wal-Mart (17.2%) and Kmart (12.7%) for fiscal 1995. During fiscal
1997, 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 57.3% compared to 54.5% during fiscal
1996 and 44.9% during fiscal 1995. The Company does not have long-term
contractual arrangements with its customers.
SALES AND MARKETING
The Company's selling strategy consists of supporting the marketing and
sales efforts of its executive management with a combination 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 at the Company's showrooms in Hong Kong, New York and Dallas during
the times when major, international toy shows are taking place in those cities
(Hong Kong in January, June and September/October, Dallas in
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January, and New York in February). The Company also maintains a showroom at its
headquarters in Houston.
The Company historically has permitted certain customers to return
slow-moving items for credit or has provided price protection by making any
price reductions effective as to certain products then held by retailers in
inventory. The Company expects that it will continue to make such accommodations
in the future.
In international markets, the Company generally sells its products to
independent distributors. These distributors retain their own sales
representatives and product showrooms at which products such as the Company's
are marketed and sold. The Company also makes some sales directly to
international retailers, principally as a result of contacts made at the
Company's showrooms.
ADVERTISING
The Company currently allocates a majority of its advertising budget to
television promotion. The Company utilized a television campaign for the first
time in fiscal 1995 in connection with the introduction of the Rosie(R) doll.
The Company increased its television advertising budget in fiscal 1996 and
fiscal 1997, using television commercials to promote the Rosie(R) and Pattie(R)
dolls in fiscal 1996, and Rosie(R), Baby Pick Me Up(TM), Dreamie Sweets(R), and
Hoppin Poppin' Spaceballs(TM) in fiscal 1997. The Company intends to continue to
utilize a promotional strategy that includes advertising of certain proprietary
products; however, spending on television advertising in fiscal 1998 is expected
to be significantly reduced. Although a majority of the Company's advertising
budget is allocated to television, the Company continues to expend a portion of
its advertising budget to promote its products through retail catalogs,
advertisement in trade magazines, and cooperative promotional efforts of
retailers.
MANUFACTURING
The Company annually contracts with over 30 independent manufacturers
located principally in the Peoples' Republic of China (the "PRC") within a
200-mile radius of Hong Kong for the manufacturing of its products. The Company
may use more than one manufacturer to produce a single product. The only
manufacturers that accounted for more than 10% of the Company's purchases of
products during fiscal 1997 were GMT Industrial Ltd. (29.1%), which manufactured
walkie-talkie and musical toy products for the Company, Loyal Technology Co.
Ltd. (15.1%), which manufactured certain walkie-talkies and radios and Jetwin
Toys Co., Ltd. (13.6%), which manufactured Rosie(R), Baby Pick Me Up(TM) and
Pattie(R) dolls. 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, quality of merchandise, price and
the ability of the manufacturer to meet the Company's or its customers' timing
requirements for delivery. 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 its orders are
booked.
The Company's Hong Kong 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 acrylic 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.
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DISTRIBUTION
The Company distributes its products either through FOB Asia sales or
through direct sales made from inventory maintained at its Houston facilities.
For FOB Asia sales, the customer places its order and shipping instructions, and
the toys are then manufactured and shipped directly to the customer or its
freight consolidator from the factory. Following the October 1993 acquisition by
DSI(HK) of certain assets of its Hong Kong distributor, the Company has used its
Hong Kong personnel to conduct the FOB Asia business.
Basic, continuous stock toys that are offered by retailers on a
year-round basis generally are shipped to customers by the Company from its
inventory in Houston. In addition, certain faster-selling toys are often shipped
directly to major customers for seasonal selling and are stocked by the Company
in Houston 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's
television-promoted proprietary products generally are shipped to customers from
the Company's inventory in Houston.
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 Houston inventory, the Company participates in the EDI programs of
most of its customers who have established an EDI program, including Kmart,
Wal-Mart, 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.
COMPETITION
The toy industry is highly competitive. Dun & Bradstreet categorizes
over 1,000 companies as toy manufacturers. Competitive factors include product
appeal, new product development, price and order fulfillment. The Company
competes with many companies that have greater financial resources and
advertising budgets than the Company. The largest United States toy companies
are Mattel, Inc. and Hasbro, Inc., and the Company considers Alaron, Inc.,
Galoob Toys Inc., Play-By-Play Toys & Novelties, Inc., Toy Biz, Inc., and Yes!
Entertainment Corporation 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.
SEASONAL PATTERNS
The toy industry is very seasonal with the holiday selling season
representing over two-thirds of annual sales at retail. To accommodate this peak
selling season, holiday toy lines are introduced early in the first quarter at
toy shows in Hong Kong, Dallas and New York. Generally, retailers commit to
their holiday season purchases that will be shipped FOB Asia during the first
two calendar quarters and those orders are shipped from Asia to the retailers'
distribution centers on a scheduled basis from May through September. During the
last three fiscal years, an average of 87% of the Company's annual Hong
Kong-based sales have occurred between the months of May through October. Sales
from Houston historically have tended to occur closer to the holiday season to
provide peak holiday season inventory to certain large retailers and to ship to
smaller retailers that have not chosen to purchase products FOB Asia. During the
last three fiscal years, an average of 59% of the Company's annual Houston-based
sales have occurred during the months of August through November.
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
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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 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 certain foreign countries. The Company designs its
products to meet the highest safety standards imposed or recommended either by
government or industry regulatory authorities. To date, the Company has not been
found to be in material violation of any governmental product standard with
respect to the Company's products.
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 ("MFN") 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. In particular, the
Company's costs would be increased if the PRC's MFN status is revoked. The loss
of MFN status for the PRC would result in substantial duties on the cost of toy
products manufactured in the PRC and imported into the United States and would
most likely adversely affect Company's financial condition and results of
operations.
In 1996, the United States government proposed retaliatory trade
sanctions against the PRC, which would have included increased duties on
selected products, but would not have included the Company's products
originating in the PRC. The United States and PRC eventually agreed on
settlement terms avoiding these sanctions. Any future imposition of trade
sanctions by the United States and subsequent retaliatory actions by the PRC
government could result in supply disruptions and higher merchandise costs to
the Company. The Company could attempt to mitigate the effects of an increase in
duties by shifting its manufacturing to other countries, but there can be no
assurance that the Company would be successful in this regard or that the
Company would not be adversely affected.
INTELLECTUAL PROPERTY
The Company has been utilizing the mark "DSI" since 1991, believes it
has common law trademark rights to the mark, and has filed a trademark
application with the United States Patent and Trademark Office. The Company
believes it has the rights to use the mark in the manner in which it is
currently used.
The Company has certain United States registered trademarks for various
products and product categories currently being marketed including: Air
Guitar(R), Escort(R), LA Rock(R), My Music Maker(R), and Rosie(R). The Company
believes it has the rights to use these marks for the product lines on which
they are currently used.
The Company believes it has trademark rights with respect to certain
additional products and product lines, including American Frontier(TM),
BlockMen(TM), Digi-Tech(TM) Hoppin' Poppin' Spaceballs(TM), and Mad World(TM) in
the United States. The Company believes it has the rights to use these marks for
the product lines on which they are, or will be, used.
HUMAN RESOURCES
As of January 31, 1998, the Company had a total of 70 employees, of
whom 41 are employees of DSI(HK) and are based in Hong Kong and 29 are employees
of DSI and are based in Houston. Of the Houston based employees, 4 are engaged
in sales and marketing, 4 are involved in design and development, 6 are involved
in warehousing and distribution and 15 are involved in finance and
administration. Of the Hong Kong based employees, 8 are engaged in sales and
merchandising, 12 are
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engaged in engineering, including product quality assurance and quality control,
12 are involved in finance and administration and 9 are involved in shipping and
distribution. None of the Company's employees is subject to a collective
bargaining agreement. The Company has experienced no work stoppages and believes
that its labor relations are satisfactory.
RISK FACTORS
CHANGING CONSUMER PREFERENCES, RELIANCE ON NEW PRODUCT INTRODUCTION. As
a result of changing consumer preferences, many toys are successfully marketed
for only one or two years, if at all. There can be no assurance that (i) any of
the Company's current successful products or product lines will continue to be
popular with consumers for any significant period of time or (ii) new products
and product lines introduced by the Company will achieve an acceptable degree of
market acceptance, or that if such acceptance is achieved, it will be maintained
for any significant period of time. Furthermore, sales of the Company's existing
products are expected to decline over time and may decline at rates faster than
expected. The Company's success is dependent upon the Company's ability to
enhance existing product lines and develop new products and product lines. The
failure of the Company's new products and product lines to achieve and sustain
market acceptance and to produce acceptable margins could have a material
adverse effect on the Company's financial condition and results of operations.
DEPENDENCE ON LIMITED NUMBER OF CUSTOMERS. For fiscal 1997, the
Company's five largest customers accounted for 57.4% of the Company's net sales.
Sales to Toys "R" Us, Wal-Mart and Kmart, the Company's three largest customers,
aggregated 48.4% of the Company's net sales during the same period. The Company
expects to continue to rely on a relatively small number of customers for a
significant percentage of sales for the foreseeable future. Because a large
portion of the Company's sales are concentrated in the Company's three largest
customers and these customers represent a significant share of the market for
toy sales to consumers, the loss of any one of them as a customer, or a
significant reduction in sales to any one of them, would have a material adverse
effect on the Company's financial condition and results of operations. See
"Business--Customers".
LIQUIDITY. Effective January 31, 1998, the Company amended its $10
million revolving credit facility with Bank One, Texas, N.A. (the "Revolver").
Borrowings under the Revolver are utilized by the Company to finance accounts
receivable, inventory, and other operating and capital requirements. The
Revolver matures March 31, 1999 and contains covenants relating to the financial
performance and condition of the Company. The Company anticipates that it will
be able to extend the maturity of the Revolver or refinance the indebtedness
thereunder prior to its scheduled maturity. There can be no assurance, however,
that the Company will be able to extend the maturity of or refinance the
indebtedness under the Revolver or that any extension or refinancing will be on
terms comparable to those contained in the Revolver. In addition, if the
Company's results of operations cause the Company to fail to maintain compliance
with the financial covenants contained in the Revolver, the maturity date will
be accelerated. Such failure would likely adversely impact the terms on which
the Company could extend or refinance the Revolver, or limit the Company's
ability to extend or refinance the Revolver at all.
DEPENDENCE ON INDEPENDENT DESIGNERS, LICENSES AND OTHER PROPRIETARY
RIGHTS. For most of its proprietary products, the Company is dependent on
concepts, technologies and other intellectual property rights licensed from
third parties, such as rights to trademarks. For each of these proprietary
products and product lines, the Company typically enters into a license
agreement with the owner of the intellectual property to permit the Company to
use the intellectual property. These license agreements typically provide for
royalty payments by the Company to the licensor based on the net sales of the
product incorporating the licensed property. For fiscal 1997, net sales of
products developed and sold under the Company's license agreements accounted for
53.5% of the Company's net sales, including 17.7% of the Company's net sales
attributable to sales of products incorporating the Kawasaki(R) trademark. The
Company's existing license agreements generally have terms ranging from 2 to 30
years.
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The Company's license agreement with Kawasaki Motors Corp., USA expires in
December 1998. The Company is currently in negotiations for a four-year
extension of this license agreement. There can be no assurance that the Company
will be able to procure new license agreements, renew existing license
agreements (on commercially reasonable terms, or at all), or that existing
license agreements will not be terminated. The Company's license agreements may
contain restrictions on products manufactured and permitted sales territories,
and may give the licensor the right to approve the manufacturer to be utilized
by the Company to produce the product. Certain of the Company's license
agreements are non-exclusive. Licenses that overlap the Company's licenses with
respect to products, geographic areas and markets have been and may continue to
be granted to competitors of the Company. See "Business--License Agreements".
In addition to rights licensed from third parties, the Company also
relies on a combination of design patent, copyright, trademark and trade secret
protection and non-disclosure agreements with employees to establish and protect
the proprietary rights that the Company has in its products. There can be no
assurance that the Company's competitors will not independently develop or
acquire proprietary technologies that are substantially equivalent or superior
to those of the Company. There also can be no assurance that the measures
adopted by the Company to protect its proprietary rights will be adequate to do
so. The ability of the Company's competitors to develop or acquire technologies
or other proprietary rights equivalent or superior to those of the Company or
the inability of the Company to enforce its proprietary rights could have a
material adverse effect on the Company.
The Company does not believe that any of its 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 the
Company 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 the Company to enter into royalty or
licensing agreements. Such royalty or licensing agreements, if required, may not
be available on terms acceptable to the Company or at all, which could have a
material adverse effect on the business, results of operations and financial
condition of the Company.
INVENTORY MANAGEMENT. Most of the Company's largest retail customers
utilize an inventory management system to track sales of products and rely on
reorders being rapidly filled by the Company and other suppliers rather than
maintaining large product inventories. These types of systems put pressure on
suppliers like the Company to promptly fill customer orders and also shift some
of the inventory risk from the retailer to suppliers. Production of excess
products by the Company to meet anticipated retailer demand could result in
price markdowns and increased inventory carrying costs for the Company.
Similarly, if the Company fails to predict consumer demand for a product, it may
not be able to deliver an adequate supply of products on a timely basis and
will, as a result, lose sales opportunities. See "Business--Distribution".
RETURNS AND MARKDOWNS. The Company historically has permitted certain
customers to return slow-moving items for credit or has provided price
protection by making any price reductions effective as to certain products then
held by retailers in inventory. The Company expects that it will continue to be
required to make such accommodations in the future. Any significant increase in
the amount of returns or markdowns could have a material adverse effect on the
Company's financial condition and results of operations. See "Business--Sales
and Marketing".
SEASONALITY AND QUARTERLY FLUCTUATIONS. The Company's sales are
seasonal in that a substantial portion of net sales is made to retailers in
anticipation of the Christmas holiday season. During fiscal 1997, 73.9% of the
Company's net sales were made during the Company's second and third fiscal
quarters (May through October) in connection with retail sales for the Christmas
holiday season. Adverse business or economic conditions during these periods
could adversely affect results of operations for the full year. The Company's
financial results for a particular quarter may not be indicative of results for
an entire year, and the Company's revenues and/or expenses will vary from
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quarter to quarter. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Seasonality" and "Business--Seasonal
Patterns".
RELIANCE ON MANUFACTURERS BASED IN HONG KONG AND CHINA, TRADE
RELATIONS. To date, most of the Company's products have been manufactured by
Hong Kong manufacturers at facilities located in the PRC. According to reports
published by the TMA, the PRC is the world's largest producer of toys. The
Company does not have any long-term contracts with its manufacturers. In the
event of any such disruption or other political or economic change in Hong Kong
or the PRC affecting the Company's business, the Company would be required to
seek alternate manufacturing sources. The Company currently does not have in
place plans or arrangements for securing alternate manufacturing sources in the
event that its present relationships with manufacturers prove impracticable to
maintain, and there can be no assurance that there would be sufficient
alternative facilities to meet the increased demand for production that would
likely result from a disruption of manufacturing operations in the PRC.
Furthermore, such a shift to alternate facilities would likely result in
increased manufacturing costs and could subject the Company's products to
increased duties, tariffs or other restrictions. During fiscal 1997, three
manufacturers accounted for approximately 57.8% of the Company's purchases of
products. The loss of any one of these manufacturers, or a substantial
interruption of the Company's manufacturing arrangements with any one of these
manufacturers, could cause a delay in production of the Company's products for
delivery to its customers and could have a material adverse effect on the
Company. While the Company believes that alternate manufacturers exist, there
can be no assurance that alternate arrangements could be provided in a timely
manner or on terms acceptable to the Company. See "Business--Manufacturing" and
"Business--Tariffs and Duties".
Currently, the PRC has MFN trade status. As such, most toys imported
into the United States from the PRC are not subject to import duties. Recently,
however, the United States and the PRC have at times been at odds over trade
policies. There can be no assurance that in the future trade relations between
the United States and the PRC will not deteriorate or that the MFN status of the
PRC will not be altered or revoked such that, as a result, the United States
would impose duties or other trade sanctions that would affect the cost of toys
imported from the PRC. Increases in quotas, duties, tariffs or other changes or
trade restrictions which may be imposed in the future would have a material
adverse effect on the Company's financial condition, operating results or
ability to import products. In particular, the Company's costs would be
increased if the PRC's MFN status is revoked. The loss of MFN status for the PRC
would result in substantial duties on the cost of toy products manufactured in
the PRC and imported into the United States and would most likely adversely
affect Company's financial condition and results of operations. The imposition
of such duties could have a material adverse effect on the Company. See
"Business--Tariffs and Duties".
GENERAL RISKS OF FOREIGN OPERATIONS. Foreign operations are generally
subject to risks such as transportation delays and interruptions, political and
economic disruptions, the imposition of tariffs and import and export controls,
difficulties in staffing and managing foreign operations, longer payment cycles,
problems in collecting accounts receivable, changes in governmental policies,
restrictions on the transfer of funds, currency fluctuations and potentially
adverse tax consequences. While the Company to date has not experienced any
material adverse effects due to its foreign operations, there can be no
assurance that such events will not occur in the future. Any growth of the
Company's international operations will subject the Company to greater exposure
to risks of foreign operations. The occurrence of such an event, particularly
one affecting the Company's relations with its manufacturers in the PRC, would
have a material adverse effect on the Company.
RELIANCE ON KEY PERSONNEL. The Company's future success will be
dependent on the continued efforts of Richard R. Neitz, President and Chief
Operating Officer, J. Russell Denson, Executive Vice President and Chief
Financial Officer, and Yau Wing Kong ("Tommy Yau"), Managing Director of
DSI(HK). The Company has entered into employment and non-competition agreements
with such individuals. The loss of the services of any such individuals could
have a material adverse effect on the
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Company. The Company does not maintain key man insurance on the lives of any of
these individuals. The Company's success is also dependent on the Company's
ability to attract and/or retain key managerial, sales, marketing, product
development and other personnel. There can be no assurance that the Company will
be successful in attracting and/or retaining such personnel.
PRODUCT SAFETY AND LIABILITY, REGULATION. Products that have been or
may be developed or sold by the Company may expose the Company to potential
liability from personal injury or property damage claims by end-users of such
products. The Company has never been and is not presently a defendant in any
product liability lawsuit; however, there can be no assurance that such a suit
will not be brought in the future against the Company. The Company currently
maintains product liability insurance coverage in the amount of $2.0 million per
occurrence, with a $5.0 million excess product liability policy. There can be no
assurance that the Company 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 the Company
maintains adequate insurance, any successful claim could materially and
adversely affect the reputation and prospects of the Company, as well as divert
management time. 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 the Company is found in the future to have violated any
such law or regulation, the sale of the relevant product could be prohibited and
the Company could be required to repurchase such products. See
"Business--Government and Industry Regulation".
COMPETITION. The toy industry is highly competitive. Many of the
Company's competitors have longer operating histories, broader product lines and
greater financial resources and advertising budgets than the Company. 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 the Company's competitors offer similar products or alternatives to the
Company's products. The Company's 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 the Company's existing products or any
expansion of the Company's products and product lines. There can be no assurance
that the Company will be able to continue to compete effectively in this
marketplace. See "Business--Competition".
CONTROL BY CURRENT MANAGEMENT. As of January 31, 1998, the directors
and officers of the Company and their affiliates beneficially owned, or had the
right to vote, in the aggregate approximately 34% of the outstanding Common
Stock. As a result of such persons' ownership and/or control of Common Stock and
their directorship and management positions, they have significant influence
over all matters requiring approval by the shareholders of the Company,
including the election 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 the Company or its competitors,
changes in financial estimates by securities analysts, or other events or
factors. In the event that the Company's 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 Company's Common Stock will be
materially adversely affected. General market fluctuations may adversely affect
the market price of the Company's Common Stock.
ITEM 2. PROPERTIES
The Company's principal executive offices and showroom and principal
warehouse are located in Houston, Texas, where the Company occupies
approximately 14,000 square feet of office and showroom
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space and 32,000 square feet of dock-high warehouse space. The Company leases
this space pursuant to a lease that terminates on August 31, 2002. The base
rental for this lease is currently $17,227 per month ($4.49 per square foot on
an annual basis). The lease provides for an annual increase in rent based on
projected cost of living and tax escalation adjustments.
The Company leases a 2,200 square foot showroom in the Toy Center
building in New York at 200 Fifth Avenue. This lease commenced on January 1,
1993 and will terminate on April 30, 2003. The base rental for this lease is
$6,026 per month ($32.87 per square foot on an annual basis), subject to cost of
living and tax escalations. The facility is staffed only during toy shows and
specially scheduled customer showings.
The Company leases 7,178 square feet of office and showroom space in
Hong Kong under a lease that commenced on March 23, 1998 and terminates in
March 2001. The base rental for the lease term is $26,034 per month based on
current currency exchange rates ($43.52 per square foot on an annual basis).
The Company is leasing 1,080 square feet of showroom space in the World
Trade Center Building in Dallas, Texas for a three-year term that began on June
1, 1996. The base rental for this lease is currently $956 per month ($10.62 per
square foot on an annual basis).
The Company leases a small storage facility in Hong Kong and a small
office in Bentonville, Arkansas. From time to time, the Company rents short-term
warehouse space in Houston to accommodate fluctuating storage needs.
ITEM 3. LEGAL PROCEEDINGS
On February 27, 1997, a former independent sales representative for
the Company sued the Company and the Estate of Tommy Moss for additional
royalties and sales commissions in Probate Court No. 3 of Harris County, Texas.
The representative also is seeking to recover exemplary damages, interest,
costs and attorneys' fees. Although the Company believes that it has fulfilled
its obligations to this representative and intends to defend against the claims,
there can be no assurance as to the outcome of this lawsuit.
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 stockholders during the fourth
quarter of fiscal 1997.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION
The Company's Common Stock is traded on The Nasdaq Stock Market's
National Market under the symbol "DSIT". The table sets forth, for the periods
indicated, the reported high and low close sale prices of the Company's Common
Stock since May 29, 1997, the date of the Company's initial public offering, as
reported on the Nasdaq National Market:
HIGH LOW
------ ------
Fiscal Year 1997:
2nd Quarter ................. 8-1/16 7-1/16
3rd Quarter ................. 9-7/8 4-7/16
4th Quarter ................. 4-9/16 1-1/2
STOCKHOLDERS
According to the records of the Company's transfer agent, as of April
27, 1998, there were 94 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 to date 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.
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ITEM 6. SELECTED 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 for per share data:
<TABLE>
<CAPTION>
Year Ended January 31,
---------------------------------------------------------------------------
Statement of Operations Data: 1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Net sales ......................................... $ 73,624 $ 63,219 $ 63,146 $ 45,219 $ 36,734
Income (loss) before income taxes
and extraordinary item .......................... (7,034) 3,371 3,776 1,473 526
Income (loss) before extraordinary item ........ (4,705) 2,151 2,327 969 362
Net income (loss) ................................. (5,186) 2,151 2,327 969 362
Basic earnings (loss) per share
before extraordinary item ......................... $ (.91) $ .61 $ .66 $ .28 $ .10
Basic earnings (loss) per share ................... $ (1.00) $ .61 $ .66 $ .28 $ .10
Diluted earnings (loss) per share
before extraordinary item ......................... $ (.91) $ .58 $ .66 $ .28 $ .10
Diluted earnings (loss) per share ................. $ (1.00) $ .58 $ .66 $ .28 $ .10
<CAPTION>
January 31,
---------------------------------------------------------------------
Balance Sheet Data: 1998 1997 1996 1995 1994
------- -------- -------- ------ ------
Working capital ....................................... $ 6,265 $ 2,621 $ 3,510 $2,121 $1,569
Total assets .......................................... 21,207 15,316 16,402 9,822 7,137
Long-term debt, including capital leases .............. 7,495 14,203 18,188 17 --
Total liabilities ..................................... 18,049 24,738 27,984 4,675 2,958
Shareholders' equity (deficit) ........................ 3,159 (9,422) (11,582) 5,147 4,179
</TABLE>
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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 related notes contained elsewhere herein.
The Company designs, develops, markets and distributes a variety of
toys and children's consumer electronics. The Company's core product categories
are (i) juvenile audio products, including walkie-talkies, pre-school audio
products, pre-teen audio products and musical toys; (ii) girls' toys, including
dolls, play sets and accessories; and (iii) boys' toys, including radio control
vehicles, action figures and western and military action toys. Historically, the
majority of the Company's sales have been made to customers based in the United
States. All of the Company's international sales are denominated in United
States dollars. Therefore, the Company is not subject to exchange rate risk with
respect to international sales.
In December 1995, a series of transactions (the "Recapitalization") was
consummated whereby the Company repurchased 77.7% of the then outstanding Common
Stock from the then sole shareholder of the Company for $22.2 million and issued
2,719,000 shares of Common Stock to a group of new investors for $3.8 million.
The Recapitalization resulted in the incurrence of an aggregate of $17.9 million
of additional indebtedness. The stock purchased by the Company from its former
sole shareholder is held as treasury stock. On June 3, 1997, the Company
completed its initial public offering of 2,500,000 shares of its Common Stock,
which resulted in net proceeds to the Company of $17.7 million. All of the net
proceeds were used to repay debt of the Company.
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:
<TABLE>
<CAPTION>
1997 1996 1995
------ ------ ------
<S> <C> <C> <C>
Net sales ................................................................................ 100.0% 100.0% 100.0%
Cost of goods sold ....................................................................... 75.1 66.5 68.8
------ ------ ------
Gross profit ............................................................................. 24.9 33.5 31.2
Selling, general and administrative expenses ............................................. 32.9 24.6 23.1
Former sole shareholder bonus ............................................................ -- -- 1.6
------ ------ ------
Operating income (loss) .................................................................. (8.0) 8.9 6.5
Interest expense, net .................................................................... 1.8 4.1 1.1
Other income ............................................................................. (0.3) (0.5) (0.6)
------ ------ ------
Income (loss) before income taxes and extraordinary item ................................. (9.5) 5.3 6.0
Provision for (benefit from) income taxes ................................................ (3.1) 1.9 2.3
------ ------ ------
Income (loss) before extraordinary item .................................................. (6.4) 3.4 3.7
Extraordinary item (net of tax) .......................................................... (0.6) -- --
------ ------ ------
Net income (loss) ........................................................................ (7.0) 3.4 3.7
====== ====== ======
</TABLE>
FISCAL YEAR 1997 COMPARED TO 1996
NET SALES. Net sales during fiscal 1997 increased $10.4 million, or
16.5%, to $73.6 million, from $63.2 million in fiscal 1996.
Net sales of juvenile audio products increased $5.6 million, or 18.0%,
to $37.0 million during fiscal 1997, from $31.3 million during fiscal 1996. This
increase was due primarily to increased sales of walkie talkies. Net sales of
girls' toys decreased $3.0 million, or 11.6%, to $22.8 million during fiscal
1997, from $25.8 million during fiscal 1996. The decrease was due to decreased
sales of dolls primarily
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<PAGE>
related to softness of large doll sales industry-wide. Net sales of boys' toys
increased $3.5 million, or 91.6%, to $7.2 million during fiscal 1997 from $3.8
million during fiscal 1996. The growth in net sales of boys' toys was primarily
attributable to the newly introduced Kawasaki(R) Ninja(R) Supergyro(TM)
Motorcycle. Net sales of products in other categories increased $4.3 million, or
183.5%, to $6.6 million during fiscal 1997, from $2.3 million during fiscal
1996. This increase was due primarily to the introduction of the Hoppin' Poppin'
Spaceballs(TM) game.
International net sales increased $2.5 million, or 21.0%, to $14.3
million during fiscal 1997 from $11.8 million in fiscal 1996. The growth was due
primarily to increased net sales to the United Kingdom, Canada, France, Spain,
and Australia and partially offset by decreased net sales to Germany and Japan.
International net sales were 19.4% of total sales for fiscal 1997 as compared to
18.6% of total sales in fiscal 1996.
GROSS PROFIT. Gross profit decreased $2.9 million, or 13.5%, to $18.3
million during fiscal 1997 from $21.2 million in fiscal 1996. Gross profit as a
percentage of net sales decreased to 24.9% during fiscal 1997 from 33.5% in
fiscal 1996. Such decrease was related primarily to the decrease in sales of
TV-promoted dolls, which generally have higher margins, and close-out sales of
the doll inventory at less than cost.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased $8.7 million, or 55.7%, to $24.3 million
during fiscal 1997 from $15.6 million in fiscal 1996. The increase resulted
primarily from television advertising expenses related to the introduction of
several new products. The Company produced commercials and purchased significant
airtime for four products for fiscal 1997 as compared to two products for the
prior fiscal year.
INTEREST EXPENSE. As a result of debt repayment using the net proceeds
of the Company's initial public offering, interest expense decreased $1.2
million to $1.4 million during fiscal 1997 from $2.6 million in fiscal 1996.
OTHER INCOME. Other income decreased $113,000, to $232,000 during
fiscal 1997 from $345,000 during fiscal 1996. This decrease was due primarily to
decreased interest income on certain insurance proceeds.
EXTRAORDINARY ITEM. As a result of debt repayment using the net
proceeds of the Company's initial public offering, $481,000 of debt issuance
cost (net of tax) was written off.
INCOME TAXES. In fiscal 1997, the Company incurred a loss before income
taxes and extraordinary item of $7 million which resulted in a benefit from
income taxes of $2.3 million compared to a $1.2 million provision for income
taxes during fiscal 1996.
NET INCOME (LOSS). As a result of the foregoing factors, the Company's
net loss for fiscal year 1997 was $5.2 million compared to net income of $2.2
million for fiscal 1996.
FISCAL YEAR 1996 COMPARED TO 1995
NET SALES. Net sales increased $73,000, or 0.1%, to $63.2 million
during fiscal 1996, from $63.1 million during fiscal 1995.
Net sales of juvenile audio products increased $2.1 million, or 7.0%,
to $31.3 million during fiscal 1996, from $29.2 million during fiscal 1995. Net
sales of girls' toys increased $4.6 million, or 21.7%, to $25.8 million during
fiscal 1996, from $21.2 million during fiscal 1995, due to the introduction of a
new doll, Pattie(R). These new sales were partially offset by a decline in sales
of the Rosie(R) doll. The net sales increases in the juvenile audio and girls'
toys categories were mostly offset by a decrease in net sales of boys' toys of
$4.7 million, or 55.3%, to $3.8 million during fiscal 1996, from $8.5 million
during fiscal 1995. Net sales of boys' toys decreased primarily as a result of a
decline in popularity of
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action figures and toy tool sets. Net sales of products in other categories
decreased $1.9 million, or 45.2%, to $2.3 million during fiscal 1996, from $4.2
million during fiscal 1995.
International net sales increased $739,000, or 6.7%, to $11.8 million
for fiscal 1996 from $11.0 million in fiscal 1995. International net sales
increased as a percentage of total net sales to 18.6% for fiscal 1996 from 17.5%
for fiscal 1995.
GROSS PROFIT. Gross profit was 33.5% of net sales during fiscal 1996,
compared to 31.2% during fiscal 1995. During fiscal 1996, gross profit increased
$1.5 million primarily due to (i) increased sales of proprietary products, which
generally have higher gross margins, and (ii) lower shipping costs.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses were approximately $15.6 million, or 24.6% of net sales,
during fiscal 1996, compared to approximately $14.6 million, or 23.1% of net
sales, during fiscal 1995. The increase in expenses resulted principally from an
increase of approximately $2.9 million in advertising costs related to the
introduction of the Pattie(R) doll during fiscal 1996. The increase in
advertising costs was partially offset by a decrease in professional and
consulting fees. The Company incurred approximately $1.9 million of selling,
general and administrative expenses during fiscal 1995 in connection with the
Recapitalization.
INTEREST EXPENSE. Interest expense increased $1.9 million, or 270.9%,
to $2.6 million during fiscal 1996 from $701,000 during fiscal 1995. This
increase was due primarily to the Recapitalization which occurred in the fourth
quarter of fiscal 1995, which resulted in the incurrence of an aggregate of
$17.9 million of additional indebtedness. See "General".
INCOME TAXES. Provision for income taxes decreased $229,000, or 15.8%,
to $1.2 million during fiscal 1996 from $1.4 million during fiscal 1995. The
Company's effective income tax rate was 36.2% for fiscal 1996, compared to 38.4%
for fiscal 1995. The decrease in the effective tax rate related principally to
certain nondeductible items and other matters relating to the Recapitalization
incurred in fiscal 1995.
NET INCOME. As result of the foregoing factors, net income decreased
$176,000, or 7.6% to $2.1 million during fiscal 1996 from $2.3 million during
fiscal 1995, and decreased as a percentage of net sales to 3.4% during fiscal
1996 from 3.7% during fiscal 1995.
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 $9.8 million during
fiscal 1997, consisting primarily of the net loss and a net increase in
inventories, accounts receivable and income taxes receivable, partially offset
by increases in accounts payable and accrued liabilities and prepaid expense.
Net cash used in investing activities during the fiscal 1997 was $252,000 and
was the net result of decreases in other assets and the repayment of an
insurance receivable from a shareholder offset by capital expenditures. Net cash
provided by financing activities was $8.9 million during fiscal 1997 and
represented net borrowings under revolving lines of credit, payments on
long-term debt, and net proceeds from a public offering. The Company's working
capital at January 31, 1998 was $6.3 million and unrestricted cash was $384,000.
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 first two fiscal
quarters. To manage these working capital requirements, the Company maintains a
line of credit facility (the "Hong Kong Credit Facility") with State Street Bank
and Trust Company, Hong Kong Branch, and the Revolver with Bank One, Texas, N.A.
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As a result of losses incurred in the third and fourth quarters of
fiscal 1997, the Company was not in compliance with certain of the covenants
contained in the Revolver. However, effective January 31, 1998, the Company
renegotiated certain terms, including the applicable covenants, of the Revolver.
The renegotiated terms include interest at the bank's prime rate and maturity at
March 31, 1999. The maximum loan limit remains at $10 million, subject to the
availability of sufficient, eligible inventory and accounts receivable.
The Company's anticipated fiscal 1998 operating cash requirements
include payment of approximately $5 million related to television advertisements
run in November and December 1997. Such amount is due to two media companies and
is being paid in monthly installments from March through October 1998. The
Company has budgeted approximately $600,000 for capital expenditures, consisting
primarily of purchases of tools and molds, for fiscal 1998.
At April 30, 1998, the Company had an additional borrowing capacity of
an aggregate of $3.6 million under the Revolver and the Hong Kong Credit
Facility. Based on projected fiscal 1998 operating results, the Company believes
that cash flows from operations and the available borrowings under the Revolver
and the Hong Kong Credit Facility will be sufficient to meet the Company's
operating cash requirements and fund the Company's anticipated capital
expenditures. However, there can be no assurance that the Company will meet its
projected operating results, and accordingly, the Company is considering all of
its financing alternatives. 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.
As part of the Company's strategy, the Company will evaluate potential
acquisitions of other toy businesses or product lines that the Company believes
would complement its existing business. The Company has no present understanding
or agreement with respect to any acquisition.
SEASONALITY
The toy industry is very seasonal with the Christmas holiday season
representing over two-thirds of total annual retail toy sales. The Company has
experienced this seasonal pattern in its net sales. To accommodate this peak
selling season, holiday toy lines are introduced early in the first calendar
quarter. Retailers generally commit to their holiday season purchases during the
first two calendar quarters and those orders are generally shipped to the
retailers' distribution centers on a scheduled basis from May through October.
During fiscal 1997, 73.9% of the Company's net sales were made during the
Company's second and third fiscal quarters (May through October), generally in
connection with retail sales for the Christmas holiday season. As a result of
the seasonality of the Company's business, the Company expects that it will
incur a loss in the first quarter and fourth quarter of each fiscal year even in
years in which the Company is profitable for the entire year.
INFLATION
The Company does not believe that inflation in the United States or
Europe in recent years has had a significant effect on its results of
operations.
YEAR 2000
The Company is currently utilizing internal resources to identify the
potential impact of the year 2000 on the processing of date-sensitive
information by the Company's computerized information and support systems. The
Company expects to complete this process during fiscal 1998. Once it has
identified the consequences of the year 2000 on its operations, the Company will
take whatever steps it can to minimize the impact. The year 2000 problem is the
result of software that uses two digits (rather than four) to define the
applicable year. Any software or hardware that utilizes date-sensitive coding
may recognize a date using "00" as the year 1900 rather than the year 2000,
which could result in miscalculations or system failures. At this time, the
Company is unable to assess the potential impact of the problem or to determine
whether the costs of addressing potential problems will have a material
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<PAGE>
adverse impact on the Company's financial position, results of operations, or
cash flows in future periods. Even if the Company is able to resolve such
processing issues in a timely manner, there is no guarantee that the Company's
manufacturers or customers will do so. The failure by the Company's
manufacturers to resolve such issues could, among other things, result in
production delays, which could cause the Company to fail to meet customer
orders. Failure by the Company's customers to resolve such issues could, among
other things, delay the processing of orders or affect the financial health of
such customers. If the Company, its customers or manufacturers are unable to
adequately resolve such processing issues in a timely manner, the Company's
operations and financial results may be adversely affected. Because the
resources available to address the year 2000 problem are scarce, to the extent
the Company identifies problems that require the services of third parties, it
will most likely incur additional expenses in its attempts to address such
problems.
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.
-18-
<PAGE>
PART III
Information required by Items 10 through 13 is hereby incorporated by
reference to the captions "Principal Shareholders," Election of Directors,"
Management" and Certain Relationships and Related Transactions" in the Company's
definitive Proxy Statement to be filed pursuant to Regulation 14A anticipated to
be filed within 120 days after the end of the Company's fiscal year ended
January 31, 1998.
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
No reports on Form 8-K were filed by the Company during the
three months ended January 31, 1998.
-19-
<PAGE>
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 30, 1998 By:/s/ M. D. DAVIS
M. D. Davis
Chairman and Chief Executive Officer
Dated: April 30, 1998 By:/s/ J. RUSSELL DENSON
J. Russell Denson
Executive Vice President and Chief
Financial Officer (Principal
Financial and Accounting 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/RICHARD R. NEITZ President, Chief April 30, 1998
Richard R. Neitz Operating Officer and Director
/S/BARRY B. CONRAD Director April 30, 1998
Barry B. Conrad
/S/JACK R. CROSBY Director April 30, 1998
Jack R. Crosby
/S/JOSEPH N. MATLOCK Director April 30, 1998
Joseph N. Matlock
/S/DOUGLAS A. SMITH Director April 30, 1998
Douglas A. Smith
-20-
<PAGE>
DSI TOYS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE
<TABLE>
<CAPTION>
PAGE
FINANCIAL STATEMENTS
<S> <C>
Report of Independent Accountants F-2
Consolidated Balance Sheet at January 31, 1998 and 1997 F-3
Consolidated Statement of Operations for fiscal years 1997, 1996 and 1995 F-4
Consolidated Statement of Cash Flows for fiscal years 1997, 1996, and 1995 F-5
Consolidated Statement of Shareholders' Equity (Deficit) for fiscal years 1997, 1996, and 1995 F-6
Notes to Consolidated Financial Statements F-7
SCHEDULES
II. Valuation and Qualifying Accounts and Reserves S-1
</TABLE>
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
<PAGE>
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 subsidiary at January 31, 1998 and 1997, and the results of
their operations and their cash flows for each of the three years in the period
ended January 31, 1998, in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with generally accepted auditing standards 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 the opinion expressed
above.
PRICE WATERHOUSE LLP
Houston, Texas
March 20, 1998, except as to Note 6
which is as of April 30, 1998
F-2
<PAGE>
DSI TOYS, INC.
CONSOLIDATED BALANCE SHEET
<TABLE>
<CAPTION>
JANUARY 31, JANUARY 31,
1998 1997
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash ........................................................................... $ 383,690 $ 1,501,992
Restricted cash ................................................................ 150,000 150,000
Accounts receivable, net ....................................................... 8,008,288 3,231,789
Due from shareholder ........................................................... -- 151,667
Advances to shareholder (life insurance premiums) .............................. -- 511,765
Inventories .................................................................... 6,437,418 4,615,087
Income tax receivable .......................................................... 642,264 --
Prepaid expenses ............................................................... 894,704 1,462,189
Deferred income taxes .......................................................... 183,000 362,000
------------ ------------
Total current assets ...................................................... 16,699,364 11,986,489
Property and equipment, net .......................................................... 1,252,572 1,190,498
Advances to shareholder (life insurance premiums) .................................... 1,278,401 920,987
Deferred income taxes ................................................................ 1,752,000 --
Deferred debt issuance costs ......................................................... -- 679,906
Other assets ......................................................................... 224,783 537,868
------------ ------------
$ 21,207,120 $ 15,315,748
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities ....................................... $ 9,740,201 $ 6,259,101
Current portion of long-term debt .............................................. 585,783 2,755,789
Income taxes payable ........................................................... 108,630 193,211
Deferred income taxes .......................................................... -- 158,000
------------ ------------
Total current liabilities ................................................. 10,434,614 9,366,101
Long-term debt ....................................................................... 7,495,000 8,203,108
Notes payable -- shareholder ......................................................... -- 6,000,000
Deferred income taxes ................................................................ 119,000 1,169,000
------------ ------------
Total liabilities ......................................................... 18,048,614 24,738,209
Shareholders' equity (deficit):
Preferred stock, $.01 par value, 5,000,000 shares authorized,
none issued or outstanding ................................................ -- --
Common stock, $.01 par value, 20,000,000 shares authorized,
8,719,000 shares issued, 6,000,000 shares outstanding .................... 87,190 62,190
Additional paid-in capital ..................................................... 21,162,568 3,443,093
Common stock warrants .......................................................... 102,500 100,000
Cumulative translation adjustment .............................................. 29,187 9,498
Retained earnings .............................................................. 4,437,653 9,623,350
------------ ------------
25,819,098 13,238,131
Less: treasury stock, 2,719,000 shares, at cost ................................ (22,660,592) (22,660,592)
------------ ------------
Total shareholders' equity (deficit) ...................................... 3,158,506 (9,422,461)
Commitments and contingencies (Note 11)
------------ ------------
$ 21,207,120 $ 15,315,748
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE>
DSI TOYS, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
FISCAL YEAR
----------------------------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Net sales ..................................................... $ 73,624,398 $ 63,219,212 $ 63,146,080
Costs of goods sold ........................................... 55,285,501 42,023,044 43,428,075
------------ ------------ ------------
Gross profit .................................................. 18,338,897 21,196,168 19,718,005
Selling, general and administrative expenses .................. 24,245,064 15,569,422 14,624,519
Former sole shareholder bonus ................................. -- -- 1,000,000
------------ ------------ ------------
Operating income (loss) ....................................... (5,906,167) 5,626,746 4,093,486
Interest expense .............................................. 1,360,067 2,599,942 700,986
Other income .................................................. (231,968) (344,469) (383,801)
------------ ------------ ------------
Income (loss) before income taxes
and extraordinary item .................................... (7,034,266) 3,371,273 3,776,301
Provision for (benefit from) income taxes ..................... (2,329,323) 1,220,000 1,449,677
------------ ------------ ------------
Income (loss) before extraordinary item ....................... (4,704,943) 2,151,273 2,326,624
Extraordinary item (net of tax) ............................... (480,754) -- --
------------ ------------ ------------
Net income (loss) ............................................. $ (5,185,697) $ 2,151,273 $ 2,326,624
============ ============ ============
BASIC EARNINGS PER SHARE
Earnings (loss) per share before
extraordinary item ...................................... $ (0.91) $ 0.61 $ 0.66
Extraordinary item ........................................ (0.09) -- --
------------ ------------ ------------
Earnings (loss) per share ................................. $ (1.00) $ 0.61 $ 0.66
============ ============ ============
Weighted average shares outstanding ....................... 5,205,479 3,500,000 3,500,000
============ ============ ============
DILUTED EARNINGS PER SHARE
Earnings (loss) per share before
extraordinary item ...................................... $ (0.91) $ 0.58 $ 0.66
Extraordinary item ........................................ (0.09) -- --
------------ ------------ ------------
Earnings (loss) per share ................................. $ (1.00) $ 0.58 $ 0.66
============ ============ ============
Weighted average shares outstanding ....................... 5,205,479 3,739,146 3,500,000
============ ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
DSI TOYS, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
FISCAL YEAR
-------------------------------------------------
1997 1996 1995
------------ ----------- ------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) ...................................................... $ (5,185,697) $ 2,151,273 $ 2,326,624
Adjustments to reconcile net income (loss) to net cash
provided (used) by operating activities:
Depreciation and amortization ........................................ 661,517 596,332 830,667
Loss on early retirement of debt ..................................... 480,754 -- --
Amortization and write-off of
debt discount and issuance costs .................................. 199,152 163,057 38,998
Provision for doubtful accounts ...................................... 145,096 62,160 88,012
Gain on sale of equipment ............................................ (3,865) (12,511) --
Deferred income taxes ................................................ (2,781,000) 686,605 162,275
Changes in assets and liabilities:
Accounts receivable ............................................... (4,921,595) 941,715 (1,775,791)
Due from shareholder .............................................. 151,667 667,616 (613,367)
Inventories ....................................................... (1,822,331) (1,205,125) (1,544,972)
Income taxes receivable/payable ................................... (726,845) (121,663) (96,722)
Prepaid expenses .................................................. 567,485 (332,183) (208,762)
Accounts payable and accrued liabilities .......................... 3,481,100 766,398 2,755,415
------------ ----------- ------------
Net cash provided (used) by operating activities ............... (9,754,562) 4,363,674 1,962,377
Cash flows from investing activities:
Capital expenditures ................................................... (726,691) (284,260) (383,446)
Proceeds from sale of equipment ........................................ 6,965 24,037 --
Life insurance premiums paid for shareholder ........................... (357,413) (289,676) (369,441)
Repayments by shareholder .............................................. 511,764 -- --
Decrease (increase) in other assets .................................... 313,085 (392,552) 10,065
------------ ----------- ------------
Net cash used in investing activities .......................... (252,290) (942,451) (742,822)
Cash flows from financing activities:
Net borrowings (repayments) under revolving lines of credit ............ 4,551,304 (2,088,225) 5,183,399
Proceeds from long-term debt ........................................... -- -- 10,000,000
Payments on long-term debt ............................................. (13,429,418) (2,499,790) (522,280)
Net proceeds from issuance of common stock ............................. 17,744,475 -- 3,502,783
Proceeds from issuance of warrants ..................................... 2,500 -- --
Purchase of treasury shares ............................................ -- -- (16,208,742)
Debt and stock issue costs ............................................. -- -- (879,259)
------------ ----------- ------------
Net cash provided (used) by financing activities ............... 8,868,861 (4,588,015) 1,075,901
Effect of exchange rate changes on cash .................................... 19,689 8,329 1,746
------------ ----------- ------------
Net increase (decrease) in cash ............................................ (1,118,302) (1,158,463) 2,297,202
Cash and cash equivalents, beginning of year ............................... 1,501,992 2,660,455 363,253
------------ ----------- ------------
Cash and cash equivalents, end of year ..................................... $ 383,690 $ 1,501,992 $ 2,660,455
============ =========== ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
DSI TOYS, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
Common Stock Additional Cumulative
----------------- Paid-in Translation Retained Treasury
Shares Amount Capital Warrants Adjustment Earnings Stock Total
--------- ------- ------------ -------- -------- ----------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Balance, January 31, 1995 ...... 3,500,000 $ 350 $ 2,150 -- $ (577) $ 5,145,453 -- $ 5,147,376
Net Income ................. -- -- -- -- -- 2,326,624 -- 2,326,624
Purchase of 2,719,000 shares
of treasury stock ........ -- -- -- -- -- -- $(22,151,850) (22,151,850)
Stock purchase costs ....... -- -- -- -- -- -- (508,742) (508,742)
Issuance of common stock ... 2,719,000 272 3,799,728 -- -- -- -- 3,800,000
Stock issuance costs ....... -- -- (297,217) -- -- -- -- (297,217)
Change in cumulative
translation adjustment ... -- -- -- -- 1,746 -- -- 1,746
Warrants issued ............ -- -- -- $100,000 -- -- -- 100,000
--------- ------- ------------ -------- -------- ----------- ------------ ------------
Balance, January 31, 1996 ...... 6,219,000 622 3,504,661 100,000 1,169 7,472,077 (22,660,592) (11,582,063)
Net Income ................. -- -- -- -- -- 2,151,273 -- 2,151,273
Change in cumulative
translation adjustment ... -- -- -- -- 8,329 -- -- 8,329
Change in par value of
common stock ............. -- 61,568 (61,568) -- -- -- -- --
--------- ------- ------------ -------- -------- ----------- ------------ ------------
Balance, January 31, 1997 ...... 6,219,000 62,190 3,443,093 100,000 9,498 9,623,350 (22,660,592) (9,422,461)
Net loss ................... -- -- -- -- -- (5,185,697) -- (5,185,697)
Issuance of common stock ... 2,500,000 25,000 18,475,000 -- -- -- -- 18,500,000
Stock issuance costs ....... -- -- (755,525) -- -- -- -- (755,525)
Change in cumulative
translation adjustment ... -- -- -- -- 19,689 -- -- 19,689
Warrants issued ............ -- -- -- 2,500 -- -- -- 2,500
--------- ------- ------------ -------- -------- ----------- ------------ ------------
Balance, January 31, 1998 ...... 8,719,000 $87,190 $ 21,162,568 $102,500 $ 29,187 $ 4,437,653 $(22,660,592) $ 3,158,506
========= ======= ============ ======== ======== =========== ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
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 China.
In December 1995, the Company sold newly issued common stock representing
77.7% of its common stock to a group of new investors through Rosie Acquisition,
L.L.C. ("RAC") pursuant to a recapitalization transaction (the
"Recapitalization"). In connection with the Recapitalization, the Company issued
2,719,000 new shares of common stock to RAC in exchange for $3.8 million in
cash. Also in connection therewith, the Company purchased 2,719,000 shares of
the common stock of the Company from the previous sole shareholder for
approximately $22.2 million. The previous sole shareholder died on November 19,
1996. Any references to the previous sole shareholder includes references to his
estate. The purchase price was funded through (a) cash paid from borrowing of
$10.6 million from banks pursuant to a five-year bank note, a six-year
subordinated note and a bank revolving line of credit; (b) the issuance to the
previous sole shareholder of a $6 million subordinated note and a $1.3 million
promissory note; (c) the transfer of land to the previous sole shareholder with
a cost of approximately $452,000; and (d) approximately $3.8 million in cash
obtained from the sale of common stock to RAC. The subordinated bank note
carries warrants to purchase 388,888 shares of common stock of the Company at an
exercise price of $2.00 per share. In connection with the purchase of treasury
stock, the Company incurred approximately $509,000 in costs and fees, which were
included as the cost of the stock, and approximately $879,000 in debt issuance
costs.
In January 1996, the Company received a note from the previous sole
shareholder of approximately $1.3 million in satisfaction of the balance
receivable from the previous sole shareholder. Such note was offset against the
aforementioned $1.3 million note issued to the previous sole shareholder in
connection with the Recapitalization.
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.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
BASIS OF PRESENTATION
The accompanying consolidated financial statements include the accounts of
DSI (HK) Ltd., a wholly owned subsidiary. All significant intercompany
transactions have been eliminated in consolidation.
These financial statements reflect the historical basis of the Company's
assets and liabilities. No adjustments have been made to reflect an allocation
of the purchase price paid by RAC for its 77.7% interest in the Company.
FISCAL YEAR
The terms "fiscal year" and "fiscal" refer to the Company's fiscal year
which is the year ending January 31 of the following calendar year mentioned
(e.g., a reference to fiscal 1997 is a reference to the fiscal year ended
January 31, 1998).
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
<PAGE>
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.
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.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. 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 for all other
assets.
DEBT ISSUANCE COSTS AND DEBT DISCOUNT
Debt issuance costs and debt discount incurred in connection with the
Recapitalization in 1995 were being amortized over the terms of the related
debt. As a result of the debt repayment using the proceeds of the Offering, the
Company recorded an extraordinary charge of $481,000 (net of tax) related to the
write-off of unamortized debt issuance and discount costs associated with the
retired debt.
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 adver-
tising expense totaled $13.5 million, $6.0 million and $3.1 million during fis-
cal 1997, 1996 and 1995, respectively. At January 31, 1997, prepaid television
advertising production costs of $451,000, are included in prepaid expenses.
There were no such costs included in prepaid expenses at January 31, 1998.
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.
Deferred income taxes are provided on the undistributed earnings of DSI (HK)
Ltd.
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.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income"
and SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information". These statements, which are effective for
F-8
<PAGE>
fiscal years beginning after December 15, 1997, establish standards for the
reporting and display of comprehensive income and the disclosure requirements
related to segments.
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.
Concentrations of credit risk with respect to trade receivables are limited due
to the large number of customers comprising the Company's customer base and
their geographic dispersion. 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.
Sales to major customers that exceeded 10% of the total net sales
consist of the following for the specified fiscal years:
1997 1996 1995
---- ---- ----
Toys "R" Us .............. 22% 12% 9%
Wal-Mart ................. 17% 19% 17%
Kmart .................... 10% 14% 13%
Approximately 19% of the Company's sales were exports to foreign countries
during fiscal 1997 and 1996 and approximately 17% during fiscal 1995.
USE OF ESTIMATES
The preparation of financial statements in accordance with generally
accepted accounting principles 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 whenever events
or changes in circumstances indicate that the carrying amount of an asset may
not be recoverable. An impairment loss would be recognized when estimated future
cash flows expected to result from the use of the asset and its eventual
disposition is less than its carrying amount. The Company has not identified any
such impairment losses.
EARNINGS PER SHARE
The Company adopted Statement of Financial Accounting standard No. 128,
"Earnings per Share" ("SFAS 128") during the fourth quarter of fiscal 1997. SFAS
requires the Company to report 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. All prior years'
earnings per share data in the accompanying consolidated financial statements
have been restated to reflect the provisions of SFAS 128.
Stock options and warrants are the only potentially dilutive shares the
Company has outstanding at January 31, 1998. Warrants to purchase common stock
were dilutive in fiscal 1996.
STOCK-BASED COMPENSATION PLANS
The Company applies Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees" (APB25) and related interpretations in accounting
for its plans.
RECLASSIFICATIONS
The accompanying consolidated financial statements include
reclassifications from financial statements issued in previous years.
F-9
<PAGE>
NOTE 3 - ACCOUNTS RECEIVABLE:
Accounts receivable consist of the following as of January 31:
1998 1997
------------ -----------
Trade receivables ....................... $ 10,999,014 $ 4,324,723
Provisions for:
Discounts and markdowns ............... (1,956,722) (770,825)
Return of defective goods ............. (829,674) (217,328)
Doubtful accounts ..................... (204,330) (104,781)
------------ -----------
Accounts receivable, net ................ $ 8,008,288 $ 3,231,789
============ ===========
NOTE 4 - PROPERTY AND EQUIPMENT:
Property and equipment consist of the following as of January 31:
<TABLE>
<CAPTION>
ESTIMATED USEFUL LIVES 1998 1997
---------------------- ---------- ----------
<S> <C> <C> <C>
Molds 3 years $2,300,345 $1,749,229
Equipment, furniture and fixtures 5-7 years 1,486,254 1,350,189
Leasehold improvements 10 years or lease term 879,429 848,079
Automobiles 3-5 years 84,216 84,258
---------- ----------
4,750,244 4,031,755
Less: accumulated depreciation and
amortization 3,497,672 2,841,257
---------- ----------
$1,252,572 $1,190,498
========== ==========
</TABLE>
NOTE 5 - ACCOUNTS PAYABLE AND ACCRUED LIABILITIES:
Accounts payable and accrued liabilities consist of the following as of
January 31:
1998 1997
---------- ----------
Trade payables ............................... $7,518,710 $4,566,650
Accrued royalties ............................ 968,267 301,442
Accrued compensation and commissions ......... 553,608 765,277
Other ........................................ 699,616 625,732
---------- ----------
$9,740,201 $6,259,101
========== ==========
NOTE 6 - NOTES PAYABLE
Indebtedness consists of the following as of January 31:
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
Bank revolving line of credit for $10 million ("Revolver")
secured by all of the Company's U.S. accounts receivable,
intangibles, equipment, fixtures and inventory and 65%
of the common stock of DSI (HK) Ltd., principal due on
March 31, 1999; interest at prime ....................... $ 7,495,000 $ 3,055,000
F-10
<PAGE>
Revolving bank loan drawn against an $8 million line of
credit, secured by a customer's letter of credit and
$150,000 cash, interest at prime ........................ 577,945 484,979
Subordinated bank note due January 31, 2002, net of related
unamortized debt discount of $81,082 (a) ................ 1,418,918
Bank note (a) ................................................ 5,000,000
Subordinated note payable to shareholder (a) ................. 6,000,000
Subordinated note payable to shareholder (a) ................. 1,000,000
Other ........................................................ 7,838
----------- -----------
8,080,783 16,958,897
Less: current portion ........................................ 585,783 2,755,789
----------- -----------
$ 7,495,000 $14,203,108
=========== ===========
</TABLE>
- -------------
(a) repaid in connection with the Offering
As a result of the loss incurred in fiscal 1997, the Company was not in
compliance with certain of the covenants contained in the Revolver. However,
effective January 31, 1998, the Company renegotiated certain terms of the
Revolver. The renegotiated terms include interest at the bank's prime rate,
maturity at March 31, 1999, and maintenance of certain financial covenants.
NOTE 7 - INCOME TAXES:
The components of income (loss) before provision for (benefit from) income
taxes by fiscal year were as follows:
1997 1996 1995
------------ ----------- ----------
Domestic ............ $(11,784,930) $ (898,344) $ 613,724
Foreign ............. 4,750,664 4,269,617 3,162,577
------------ ----------- ----------
$ (7,034,266) $ 3,371,273 $3,776,301
============ =========== ==========
The provision for income taxes (benefit) by fiscal year is as follows:
1997 1996 1995
------------ ----------- ----------
Current:
Federal ........ $ (299,000) $ (185,605) $ 630,000
State .......... -- (14,000) 72,000
Foreign ........ 750,677 733,000 585,402
------------ ----------- ----------
451,677 533,395 1,287,402
------------ ----------- ----------
Deferred:
Federal ........ (2,742,000) 657,605 208,000
State .......... -- (11,000) --
Foreign ........ (39,000) 40,000 (45,725)
------------ ----------- ----------
(2,781,000) 686,605 162,275
------------ ----------- ----------
(2,329,323) 1,220,000 1,449,677
Tax on Extraordinary
Item (Current Federal) (270,000) -- --
------------ ----------- ----------
$ (2,599,323) $ 1,220,000 $1,449,677
============ =========== ==========
F-11
<PAGE>
The difference between income taxes (benefit) at the statutory federal and
the effective income tax rates by fiscal year is as follows:
1997 1996 1995
----------- ----------- ----------
Taxes (benefit) computed at
statutory rate ....................... $(2,391,000) $ 1,146,000 $1,283,942
State income taxes net of
federal benefit ...................... -- (16,000) 47,000
Nondeductible items ................... -- 13,000 54,000
Other, net ............................ 61,677 77,000 64,735
----------- ----------- ----------
$(2,329,323) $ 1,220,000 $1,449,677
=========== =========== ==========
Deferred tax assets (liabilities) are comprised of the following at
January 31:
1998 1997
----------- -----------
Allowance for doubtful accounts ................ $ 63,000 $ 37,000
Inventory valuation adjustments ................ 31,000 20,000
Depreciation ................................... 101,000 63,000
Reserve for lease cancellation ................. -- 52,000
Accrued liabilities ............................ -- 97,000
Accruals for inventory returns and markdowns ... 89,000 92,000
Foreign and alternative minimum tax credits .... 1,535,000 45,000
Net operating loss carryforward ................ 1,124,000 --
Other .......................................... 155,000 19,000
----------- -----------
Gross deferred tax assets ................. 3,098,000 425,000
----------- -----------
Unremitted earnings of foreign subsidiary ...... (1,163,000) (1,225,000)
Prepaid expenses ............................... -- (158,000)
Depreciation ................................... (119,000) (7,000)
----------- -----------
Gross deferred tax liabilities ............ (1,282,000) (1,390,000)
----------- -----------
Net deferred tax assets (liabilities) .......... $ 1,816,000 $ (965,000)
=========== ===========
At January 31, 1998, the Company has a net operating loss carryforward of
$3.3 million which will expire if not utilized by January 31, 2013 and a $1.5
million foreign tax credit carryforward which will expire if not utilized by
January 31, 2003. The Company believes that these carryforwards will be
available to reduce future federal income tax liabilities and has recorded the
tax benefit of these carryforwards as noncurrent deferred tax assets. The
Company's net operating loss carryforward for state purposes is not significant.
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 $31,000 and $105,000 in
fiscal 1997 and 1996, respectively, as employer matching contributions to
employee contributions. There was no such matching contribution to the Plan for
fiscal 1995.
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 (subject to adjustment) and expire December 11,
2005.
F-12
<PAGE>
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.
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 to nonemployee
board members. The Board has 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.
During fiscal 1997, options to purchase 533,000 shares of common stock were
granted with an exercise price of $8.00 per share. The weighted average fair
value at date of grant for options granted during fiscal 1997 was $8.00 per
option. As of January 31, 1998, 533,000 options were outstanding with a weighted
average remaining term of nine years and a weighted average exercise price of
$8.00 per share. At January 31, 1998, options to purchase 52,325 shares were
exercisable. Vesting periods for granted options range from immediate to seven
years from the date of grant and in increments between 5% per year and 90% per
year.
The Company applies APB 25 and related interpretations in accounting for
its stock option plans. Accordingly, no compensation cost has been recognized
for these plans. Had compensation cost for the Company's option plan been
determined based upon the fair value at the grant dates for awards under the
1997 Plan consistent with the method set forth under SFAS No. 123, "Accounting
for Stock-Based Compensation", the Company's net loss for fiscal 1997 would have
been increased by $408,000, or $.08 per basic and diluted share.
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 year 1997: expected volatility of
70%, risk-free interest rate of 5.74% to 6.52%, no dividend yield and an
expected life of seven years.
NOTE 10 - RELATED PARTY TRANSACTIONS:
Prior to the Recapitalization, the Company periodically advanced cash and
made payments on behalf of the shareholder of the Company and related entities.
At January 31, 1997, the outstanding balance receivable from the shareholder was
$151,667. The Company recorded interest income of $14,000, $12,000 and $114,000
for fiscal 1997, 1996 and 1995, respectively, related to such receivable.
The Company recorded bonuses to the former sole shareholder of $1,000,000
for fiscal 1995.
The Company entered into a consulting agreement with the shareholder to
serve as a consultant to the Company for three years for annual compensation of
$300,000. The consulting agreement also required the Company to maintain health
and disability insurance policies for the benefit of the shareholder for the
term of his life. Pursuant to the agreement, the Company agreed to maintain the
shareholder's office space for his use for the term of the agreement and to
provide for 180 days the services of certain Company employees for his outside
business, provided that such services shall not exceed 30% of the time of each
of such employees. This agreement terminated upon the shareholder's death on
November 19, 1996.
As compensation for consulting services rendered in connection with the
Recapitalization, the Company paid the Vice Chairman of the Board the sum of
$240,000 in three equal payments on January 1, 1998, 1997 and 1996.
The Company paid a fee and out-of-pocket expenses aggregating $415,000 to a
consulting firm for services related to the Recapitalization. A director of the
Company is the co-founder and managing partner of the consulting firm.
The Company paid $100,000 to a partnership controlled by a director of the
Company upon completion of the Offering.
The Company leases its office and warehouse from an entity owned by the
previous sole shareholder of the Company. Rent expense on these leases was
$217,000 each year for fiscal 1997, 1996 and 1995. Management believes that the
rental rates approximate fair market value.
F-13
<PAGE>
The Company pays insurance premiums for certain life insurance policies
owned by the Tommy and JoBeth Moss Joint Life Insurance Trust, and is entitled
to repayment of the advanced premiums upon the death of JoBeth Moss. The
receivables related to these policies as of January 31, 1998 and 1997 amounted
to $1,278,401 and $1,432,752, respectively, and are collateralized by the
related insurance policies. The Trust is restricted from borrowing against the
policies until the receivable is satisfied in full.
Additional related party transactions are described in Notes 1, 6 and 11.
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 or results of
operations taken as a whole.
The Company leases its facilities under various operating leases which
expire from 1998 to 2003. Rent expense, including amounts paid to a related
party, for fiscal 1997, 1996 and 1995 amounted to $693,000, $687,000 and
$695,000, respectively. Aggregate minimum rental commitments under noncancelable
leases are as follows for the specified fiscal years:
1998 ................................................ $ 542,751
1999 ................................................ 587,327
2000 ................................................ 583,475
2001 ................................................ 324,426
2002 ................................................ 135,965
Thereafter .......................................... --
----------
$2,173,944
==========
Royalty expense under licensing agreements aggregated $3,069,000,
$1,578,000 and $1,439,000 in fiscal 1997, 1996 and 1995, respectively. At
January 31, 1998, minimum guaranteed royalties payable under these agreements in
fiscal 1998 and thereafter of $15,000 are included in accrued royalties payable
and prepaid expenses.
NOTE 12 - SEGMENT INFORMATION:
The Company's operations are in one industry segment: the sale of toys
primarily to major retailers. The Company sells its products through (i) the
Hong Kong operation, where products are shipped directly from contract
manufacturers to DSI's customers, and (ii) the United States operation, where
products are shipped from DSI's warehouse in Houston to its customers.
Financial information for fiscal 1997, 1996 and 1995 for the U.S. and
Hong Kong operations is as follows:
<TABLE>
<CAPTION>
United States Hong Kong Consolidated
------------ ----------- ------------
<S> <C> <C> <C>
FISCAL 1997:
Net sales ....................... $ 28,550,033 $45,074,365 $ 73,624,398
Operating income (loss) ......... (8,722,057) 2,815,890 (5,906,167)
Identifiable assets at fiscal
year end ...................... 14,215,603 3,135,853 17,351,456
FISCAL 1996:
Net sales ....................... 27,970,378 35,248,834 63,219,212
Operating income ................ 3,033,677 2,593,069 5,626,746
Identifiable assets at fiscal
year end ...................... 8,856,950 3,666,537 12,523,487
FISCAL 1995:
Net sales ....................... 27,724,986 35,421,094 63,146,080
F-14
<PAGE>
Operating income ................ 2,754,818 1,338,668 4,093,486
Identifiable assets at fiscal
year end ...................... 8,638,776 4,615,507 13,254,283
</TABLE>
NOTE 13 - SUPPLEMENTAL CASH FLOW INFORMATION:
Additional cash flow information by fiscal year is as follows:
1997 1996 1995
---------- ---------- ----------
Cash paid for:
Interest ........................... $ 379,063 $2,360,538 $ 656,117
Income taxes ....................... 1,139,929 655,058 1,851,890
Noncash activities included the
following:
Accounts receivable write-off ...... $ 45,932 $ 25,188 $ 147,995
Purchase of treasury stock
from former sole shareholder
in exchange for land ............. 451,850
Purchase of treasury stock
from former sole shareholder
in exchange for notes
payable .......................... 7,300,000
Cancellation of note
payable and note receivable
from former sole shareholder ..... 1,300,000
NOTE 14 - QUARTERLY FINANCIAL INFORMATION (UNAUDITED):
<TABLE>
<CAPTION>
Fiscal Quarter Ended
4/30/97 7/31/97 10/31/97 1/31/98
----------- ----------- ------------ ------------
<S> <C> <C> <C> <C>
Net sales ......................................... $ 7,427,707 $24,382,768 $ 30,018,242 $ 11,795,681
Operating income (loss) ........................... (293,897) 2,871,310 (6,059,281) (2,424,299)
Income (loss) before income taxes
and extraordinary item .......................... (750,895) 2,622,301 (6,295,634) (2,610,038)
Net income (loss) ................................. (480,753) 1,197,519 (4,029,206) (1,873,257)
Basic earnings per share .......................... $ (.14) $ .23 $ (.67) $ (.31)
Diluted earnings per share ........................ $ (.14) $ .22 $ (.67) $ (.31)
Fiscal Quarter Ended
4/30/96 7/31/96 10/31/96 1/31/97
----------- ----------- ----------- -----------
Net sales ........................................ $ 5,855,630 $18,097,350 $29,348,377 $ 9,917,855
Operating income (loss) .......................... (545,588) 2,187,243 3,727,185 257,906
Income (loss) before income taxes ................ (1,100,455) 1,589,889 3,236,362 (354,523)
Net income (loss) ................................ (704,291) 1,027,318 2,061,688 (233,442)
Basic earnings per share ......................... $ (.20) $ .28 $ .59 $ (.07)
Diluted earnings per share ....................... $ (.20) $ .28 $ .55 $ (.07)
</TABLE>
F-15
<PAGE>
DSI TOYS, INC. AND SUBSIDIARY
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES (SCHEDULE II)
(IN THOUSANDS)
<TABLE>
<CAPTION>
Charged Charged Charged
Balance to Balance to Balance to Balance
at costs at costs at costs at
February and January and January and January
Description 1, 1995 expenses Deductions 31, 1996 expenses Deductions 31, 1997 expenses Deductions 31, 1998
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Reserves deducted from assets:
Trade receivables ....... 128 88 (148) 68 62 (25) 105 145 (46) 204
Discounts and
markdowns .............. -- 1190 (490) 700 1,037 (966) 771 2,447 (1,261) 1,957
Return of defective
goods .................. 567 492 (771) 288 801 (872) 217 2,617 (2,004) 830
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
695 1,770 (1,409) 1,056 1,900 (1,863) 1,093 5,209 (3,311) 2,991
======== ======== ======== ======== ======== ======== ======== ======== ======== ========
</TABLE>
S-1
<PAGE>
EXHIBIT INDEX
3.1 Amended and Restated Articles of Incorporation. (1)
3.2 Amended and Restated Bylaws. (1)
3.3 Amendment to Bylaws. (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)
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)
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, 995, 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. (2)
10.17 Warrant Agreement dated May 28, 1997 by and among the Company, Tucker
Anthony Incorporated and Sutro & Co. Incorporated. (3)
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. (4)
10.19 Debenture by DSI (HK) Limited to State Street Bank and Trust Company,
Hong Kong Branch, dated July 29, 1997. (5)
E-1
<PAGE>
10.20 Amended and Restated Bank One Letter Loan Agreement, dated October 22,
1997. (6)
10.21 First Amendment to Amended and Restated Bank One Letter Loan Agreement,
dated January 31, 1998.*
21 Subsidiaries. (1)
27 Financial Data Schedule.*
_________
(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 Exhibit 10.1 to the Company's Form 10-Q for the quarterly
period ended April 30, 1997, and incorporated herein by reference.
(3) Filed as Exhibit 10.2 to the Company's Form 10-Q for the quarterly
period ended April 30, 1997, and incorporated herein by reference.
(4) Filed as Exhibit 10.1 to the Company's Form 10-Q for the quarterly
period ended July 31, 1997, and incorporated herein by reference.
(5) Filed as Exhibit 10.2 to the Company's Form 10-Q for the quarterly
period ended July 31, 1997, and incorporated herein by reference.
(6) Filed as Exhibit 10.1 to the Company's Form 10-Q for the quarterly
period ended October 31, 1997, and incorporated herein by reference.
* Filed herewith.
E-2
FIRST AMENDMENT TO AMENDED AND
RESTATED LETTER LOAN AGREEMENT
THIS FIRST AMENDMENT TO AMENDED AND RESTATED LETTER LOAN AGREEMENT
("AMENDMENT") is made and entered into effective the 31st day of January, 1998,
by and between DSI TOYS, INC., a Texas corporation (herein called "BORROWER"),
BANK ONE, TEXAS, N.A., with offices in Houston, Texas (herein called "LENDER").
RECITALS:
WHEREAS, Borrower and Lender entered into an Amended and Restated Letter
Loan Agreement dated October 22, 1997 (the "LOAN AGREEMENT"; the terms defined
therein being used herein as therein defined unless otherwise defined herein);
and
WHEREAS, Borrower and Lender desire to amend certain terms and
provisions of the Loan Agreement, which include (i) modifying the maturity date
of the revolving line of credit, (ii) modifying the existing financial
covenants, and (iii) amending certain other terms and provisions of the Loan
Agreement.
AGREEMENT:
NOW, THEREFORE, in consideration of the mutual promises herein contained
and other good and valuable consideration, the receipt of which is hereby
acknowledged, Borrower and Lender hereby agree to amend the Loan Agreement as
hereinafter set forth.
1. AMENDMENT TO LOAN AGREEMENT. The Loan Agreement is, effective the
date hereof, and subject to the satisfaction of the conditions precedent set
forth in Section 2 hereof, hereby amended as follows:
(a) Section 1(a), LOAN AND LETTERS OF CREDIT, is hereby amended
by deleting the reference to the Maturity Date of "OCTOBER 22, 2000" and
substituting "MARCH 31, 1999" therefor.
(b) Section 5(a), AFFIRMATIVE COVENANTS, is hereby amended to
reflect monthly financial reporting rather than quarterly; to-wit
Section 5(a) is amended by deleting the reference to "WITHIN FORTY-FIVE
(45) DAYS AFTER THE END OF EACH FISCAL QUARTER," and substituting
"WITHIN THIRTY (30) DAYS AFTER THE END OF EACH MONTH," therefor; and
FURTHER deleting any reference to financial reporting from "QUARTER
REPORTING" to "MONTHLY REPORTING" therefor.
(c) Section 5(c), AFFIRMATIVE COVENANTS, is hereby amended by
adding the following:
"; AND (III) MONTHLY INVENTORY AND ACCOUNTS RECEIVABLE
FIELD EXAMINATION AUDITS, BEGINNING IN MARCH 1998, TO BE
PERFORMED BY AN INDEPENDENT THIRD PARTY ACCEPTABLE TO LENDER, AT
BORROWER'S SOLE COST AND EXPENSE, AND TO CONTINUE THEREAFTER
THROUGH MATURITY OF THE LOAN."
<PAGE>
(d) Section 5 of the Loan Agreement is amended by adding the
following subsection (o) thereto:
"(O) BORROWER SHALL TIMELY MAKE THE PAYMENTS TO
ADVERTISERS, AS SET FORTH IN THE SCHEDULE BELOW (WITHOUT
PREPAYMENT):
03/98.............. $525,586.20
04/98.............. $200,000.00
05/98.............. $200,000.00
06/98.............. $800,000.00
07/98.............. $800,000.00
08/98.............. $800,000.00
09/98.............. $900,000.00
10/98.............. $911,808.70
IF BORROWER CANNOT ADHERE TO ITS PAYMENT OBLIGATIONS RELATING TO
THE ADVERTISING SCHEDULE, IT AGREES THAT IT WILL PROMPTLY NOTIFY
LENDER OF THE SAME."
(e) Section 6(a), NEGATIVE COVENANTS, is hereby amended to
require a minimum Tangible Net Worth equal to the following amounts for
the following dates:
End of 03/98 ............... $ 2,200,000.00
End of 04/98 ............... $ 1,900,000.00
End of 05/98 ............... $ 1,550,000.00
End of 06/98 ............... $ 1,800,000.00
End of 07/98 ............... $ 2,500,000.00
End of 08/98 ............... $ 3,000,000.00
End of 09/98 ............... $ 3,800,000.00
End of 10/98 ............... $ 4,800,000.00
End of 11/98 ............... $ 5,100,000.00
End of 12/98 ............... $ 4,700,000.00
End of 01/99 through
Maturity Date .......... $ 4,100,000.00
<PAGE>
(f) Section 6(b), NEGATIVE COVENANTS, is hereby amended as
follows:
"(B) PERMIT ITS EBITDA (CALCULATED CUMULATIVELY COMMENCING
FEBRUARY 1, 1998) TO BE LESS THAN THE FOLLOWING AMOUNTS BY THE
FOLLOWING DATES:
End of 03/98 ................. $ (1,500,000.00)
End of 04/98 ................. $ (1,900,000.00)
End of 05/98 ................. $ (2,300,000.00)
End of 06/98 ................. $ (1,800,000.00)
End of 07/98 ................. $ (500,000.00)
End of 08/98 ................. $ 750,000.00
End of 09/98 ................. $ 2,300,000.00
End of 10/98 ................. $ 3,800,000.00
End of 11/98 ................. $ 4,300,000.00
End of 12/98 ................. $ 3,800,000.00
End of 01/99 through
Maturity Date ............ $ 3,100,000.00
(g) Section 6(c) is hereby deleted in its entirety.
(h) The "BORROWING BASE" definition on Schedule A is hereby
amended by deleting the reference to "ONE HUNDRED PERCENT (100%) OF
DOMESTIC ELIGIBLE INVENTORY" and substituting therefor "NINETY PERCENT
(90%) OF DOMESTIC ELIGIBLE INVENTORY".
2. CONDITIONS OF EFFECTIVENESS. This Amendment shall become effective
when, and only when, Lender shall have received counterparts of this Amendment
executed by Borrower, and Section 1 hereof shall become effective when, and only
when, Lender shall have additionally received all of the following:
(a) A fully executed $10,000,000.00 Modification Revolving
Promissory Note;
(b) A $25,000.00 loan commitment fee;
(c) Certificate of the Boards of Directors of Borrower
authorizing the execution, delivery and performance of this Amendment,
and the matters contemplated hereby; and
(d) Any and all other documentation as Lender may reasonably
require.
<PAGE>
3. REPRESENTATIONS AND WARRANTIES OF BORROWER. Borrower represents and
warrants as follows:
(a) That there will be no material adverse changes from and
between the Borrower's internally prepared January 31, 1998 financial
statements and the annual audited consolidated financial statements
which are being prepared by an independent certified public
accountant(s) to be dated at the close of the fiscal year, January 31,
1998. Further, Borrower represents and warrants to Lender that the
audited consolidated financial statements will be delivered to Lender by
no later than May 31, 1998, and shall include, a profit and loss
statement, balance sheet, cash flow statement, and any other matters as
Lender may reasonably request.
(b) That Borrower is duly authorized and empowered to execute,
deliver and perform this Amendment and all other instruments referred to
or mentioned herein to which it is a party, and all action on its part
requisite for the due execution, delivery and the performance of this
Amendment has been duly and effectively taken. This Amendment, when
executed and delivered, will constitute valid and binding obligations of
Borrower enforceable in accordance with its terms. This Amendment does
not violate any provisions of Borrower's Articles of Incorporation,
By-Laws, or any contract, agreement, law or regulation to which Borrower
is subject, and does not require the consent or approval of any
regulatory authority or governmental body of the United States or any
state.
(c) That the representations and warranties made by Borrower in
the Loan Agreement are true and correct as of the date of this
Amendment.
(d) No event has occurred and is continuing which constitutes an
Event of Default or would constitute an Event of Default but for the
requirement that notice be given or time elapse or both.
4. REFERENCE TO AND EFFECT ON THE SECURITY INSTRUMENTS.
(a) Upon the effectiveness of Section 1 hereof, on and after the
date hereof each reference in the Loan Agreement to "this Agreement",
"hereunder", "hereof", "herein" or words of like import, and each
reference in the other Security Instruments (hereinafter defined) to the
Loan Agreement, shall mean and be a reference to the Loan Agreement as
amended hereby.
(b) Except as specifically amended above, the Loan Agreement and
all other instruments securing or guaranteeing Borrower's obligations to
Lender (the "SECURITY INSTRUMENTS") shall remain in full force and
effect and are hereby ratified and confirmed. Without limiting the
generality of the foregoing, the Security Instruments and all collateral
described therein do and shall continue to secure the payment of all
obligations of Borrower under the Loan Agreement, as amended hereby, and
under the other Security Instruments.
(c) The execution, delivery and effectiveness of this Amendment
shall not, except as expressly provided herein, operate as a waiver of
any right, power or remedy of Lender under any of the Security
Instruments, nor constitute a waiver of any provision of
<PAGE>
any of the Security Instruments.
5. COVENANT DEVIATION AND WAIVER.
(a) As of January 31, 1998, Borrower failed to maintain
compliance with certain financial covenant requirements set forth in the
Letter Loan Agreement. Borrower has requested, and Lender has approved,
a deviation from such compliance with respect to such time period. It is
understood and agreed that Lender's consent to such deviations shall not
act as a waiver of any covenants, restrictions, rights or remedies with
respect to the Loan Agreement, but that such deviations shall apply only
to the specific matters and instances set forth hereinabove.
(b) As additional consideration for the execution, delivery and
performance of this Amendment by the parties hereto and to induce Lender
to enter into this Amendment, Borrower warrants and represents to Lender
that no facts, events, statuses or conditions exist or have existed
which, either now or with the passage of time or giving of notice, or
both, constitute or will constitute a basis for any claim or cause of
action against Lender or any defense to (i) the payment of any
obligations and indebtedness under the Notes and/or the Security
Instruments, or (ii) the performance of any of their obligations with
respect to the Notes and/or the Security Instruments, and in the event
any such facts, events, statuses or conditions exist or have existed,
Borrower unconditionally and irrevocably waives any and all claims and
causes of action against Lender and any defenses to their payment and
performance obligations in respect to the Notes and the Security
Instruments.
6. COSTS AND EXPENSES. Borrower agrees to pay on demand all costs and
expenses of Lender in connection with the preparation, reproduction, execution
and delivery of this Amendment and the other instruments and documents to be
delivered hereunder, including the reasonable fees and out-of-pocket expenses of
counsel for Lender. In addition, Borrower shall pay any and all fees payable or
determined to be payable in connection with the execution and delivery, filing
or recording of this Amendment and the other instruments and documents to be
delivered hereunder, and agrees to save Lender harmless from and against any and
all liabilities with respect to or resulting from any delay in paying or
omission to pay such fees.
7. EXECUTION IN COUNTERPARTS. This Amendment may be executed in any
number of counterparts and by different parties hereto in separate counterparts,
each of which when so executed and delivered shall be deemed to be an original
and all of which taken together shall constitute but one and the same
instrument.
8. GOVERNING LAW. This Amendment shall be governed by and construed in
accordance with the laws of the State of Texas.
9. FINAL AGREEMENT. THIS WRITTEN FIRST AMENDMENT TO AMENDED AND RESTATED
LETTER LOAN AGREEMENT REPRESENTS THE FINAL AGREEMENT BETWEEN THE PARTIES AND 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.
<PAGE>
IN WITNESS WHEREOF, the parties hereto have caused this instrument to be
duly executed in multiple counterparts, each of which is an original instrument
for all purposes, all as of the day and year first above written.
BORROWER:
DSI TOYS, INC.
By: /s/ M. D. DAVIS
Name: M. D. Davis
Title: Chief Executive Officer
LENDER:
BANK ONE, TEXAS, N.A.
By: /s/ JOHN E. ELAM
Name: John E. Elam, Jr.
Title: Vice President
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE DSI TOYS,
INC. FINANCIAL STATEMENTS AS OF AND FOR THE TWELVE MONTHS ENDED JANUARY 31, 1998
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> JAN-31-1998
<PERIOD-END> JAN-31-1998
<CASH> 383,690
<SECURITIES> 0
<RECEIVABLES> 10,999,014
<ALLOWANCES> (204,330)
<INVENTORY> 6,437,418
<CURRENT-ASSETS> 16,699,364
<PP&E> 4,750,244
<DEPRECIATION> (3,497,672)
<TOTAL-ASSETS> 21,207,120
<CURRENT-LIABILITIES> 10,434,614
<BONDS> 7,495,000
0
0
<COMMON> 87,190
<OTHER-SE> 3,071,316
<TOTAL-LIABILITY-AND-EQUITY> 21,207,120
<SALES> 73,624,398
<TOTAL-REVENUES> 73,624,398
<CGS> 55,285,501
<TOTAL-COSTS> 24,245,064
<OTHER-EXPENSES> 231,968
<LOSS-PROVISION> 145,096
<INTEREST-EXPENSE> 1,360,067
<INCOME-PRETAX> (7,034,266)
<INCOME-TAX> (2,329,323)
<INCOME-CONTINUING> (4,704,943)
<DISCONTINUED> 0
<EXTRAORDINARY> (480,754)
<CHANGES> 0
<NET-INCOME> (5,185,697)
<EPS-PRIMARY> (1.00)
<EPS-DILUTED> (1.00)
</TABLE>
