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SCHEDULE 14A INFORMATION
Proxy Statement Pursuant to Section 14(a) of the Securities Exchange Act of 1934
(Amendment No. )
Filed by the Registrant [X]
Filed by a Party other than the Registrant [ ]
Check the appropriate box:
[ ] Preliminary Proxy Statement
[ ] Confidential, for Use of the Commission Only (as permitted by
Rule 14a-6(e)(2))
[X] Definitive Proxy Statement
[ ] Definitive Additional Materials
[ ] Soliciting Material Pursuant to Section 240.14a-11(c) or Section 240.14a-12
DSI TOYS, INC.
(Name of Registrant as Specified In Its Charter)
DSI TOYS, INC.
(Name of Person(s) Filing Proxy Statement)
Payment of Filing Fee (Check the appropriate box):
[X] No fee required.
[ ] Fee computed on table below per Exchange Act Rules 14a-6(i)(1) and 0-11.
1) Title of each class of securities to which transaction applies:
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2) Aggregate number of securities to which transaction applies:
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3) Per unit price or other underlying value of transaction computed
pursuant to Exchange Act Rule 0-11:(1)
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4) Proposed maximum aggregate value of transaction:
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5) Total fee paid:
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(1) Set forth the amount on which the filing fee is calculated and state how it
was determined.
[ ] Fee paid previously with preliminary materials.
[ ] Check box if any part of the fee is offset as provided by Exchange Act
Rule 0-11(a)(2) and identify the filing for which the offsetting fee was
paid previously. Identify the previous filing by registration statement
number, or the Form or Schedule and the date of its filing.
1) Amount Previously Paid:
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2) Form, Schedule or Registration Statement No.:
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3) Filing Party:
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4) Date Filed:
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DSI TOYS, INC.
1100 WEST SAM HOUSTON PARKWAY (NORTH)
HOUSTON, TEXAS 77043
NOTICE OF ANNUAL MEETING OF SHAREHOLDERS
TO BE HELD ON MAY 24, 1999
To the Shareholders of
DSI Toys, Inc.:
The annual meeting of shareholders of DSI Toys, Inc. a Texas
corporation (the "Company"), will be held on Monday, May 24, 1999, at 1:30 p.m.,
local time, at the Company's corporate offices, 1100 West Sam Houston Parkway,
North, Houston, Texas, 77043 for the following purposes:
1. To elect two directors to the class of directors whose
three-year term will expire in 2002.
2. To consider and vote upon the following proposals described
more fully in the accompanying Proxy Statement:
(i) Proposal One: Approval and ratification of the
Stock Purchase and Sale Agreement dated April 15, 1999 between
the Company and MVII, LLC and the transactions contemplated
thereunder, including the sale by the Company to MVII, LLC of
up to an aggregate of 2,498,491 shares of common stock, par
value $.01 per share, of the Company (the "Transactions").
(ii) Proposal Two: Approval of an amendment to the
Company's Amended and Restated Articles of Incorporation that
would increase the number of authorized shares of Common Stock
of the Company from 20,000,000 shares to 35,000,000 shares.
(iii) Proposal Three: Ratification of the appointment
of four directors by the remaining directors to fill vacancies
on the Board upon consummation of the Transactions, which
vacancies will be created by certain resigning directors.
(iv) Proposal Four: Adoption and approval of a
proposal to amend the Company's Stock Option plan (a) to
increase from 600,000 to 900,000 the aggregate number of
shares of Common Stock of the Company reserved for issuance
under the Plan and (b) to make certain conforming changes.
3. To transact such other business as may properly come before
the meeting or any adjournment thereof.
The Board of Directors has fixed the close of business on April 28,
1999 as the record date for the determination of shareholders entitled to notice
of and to vote at the annual meeting or any adjournment thereof. Only holders of
record of Common Stock at the close of business on the record date are entitled
to notice of and to vote at the meeting. A complete list of such shareholders
will be available for examination at the offices of the Company in Houston,
Texas during normal business hours for a period of 10 days prior to the meeting.
A record of the Company's activities during fiscal 1998 and financial
statements for the fiscal year ended January 31, 1999 are contained in the
accompanying 1998 Annual Report and Form 10-K. The Annual Report and Form 10-K
does not form any part of the material for solicitation of proxies.
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All shareholders are cordially invited to attend the meeting.
Shareholders are urged, whether or not they plan to attend the meeting, to sign,
date and mail the enclosed proxy or voting instruction card in the postage-paid
envelope provided. If a shareholder who has returned a proxy attends the meeting
in person, such shareholder may revoke the proxy and vote in person on all
matters submitted at the meeting.
By Order of the Board of Directors
/s/ THOMAS V. YARNELL
Thomas V. Yarnell
Corporate Secretary
Houston, Texas
May 7, 1999
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DSI TOYS, INC.
1100 WEST SAM HOUSTON PARKWAY (NORTH)
HOUSTON, TEXAS 77043
PROXY STATEMENT
FOR ANNUAL MEETING OF SHAREHOLDERS
TO BE HELD ON MAY 24, 1999
BACKGROUND
This proxy statement is furnished to shareholders of DSI Toys, Inc.
(the "Company") in connection with the solicitation by the Board of Directors of
the Company of proxies for use at the annual meeting of shareholders to be held
at the time and place and for the purposes set forth in the accompanying notice.
The approximate date of mailing of this proxy statement and the accompanying
proxy or voting instruction card is May 10, 1999.
On April 15, 1999, the Company entered into definitive agreements with
MVII, LLC, a limited liability company formed under the laws of the State of
California (the "Purchaser"), which provide for, among other things, the sale by
the Company to the Purchaser of up to an aggregate of 2,498,491 shares of
common stock, par value $.01 per share ("Common Stock" or "Shares"). Pursuant to
the Stock Purchase and Sale Agreement (the "Stock Purchase Agreement") dated
April 15, 1999, between the Company and the Purchaser, the Purchaser purchased
566,038 shares of Common Stock from the Company (the "Initial Funding Shares")
on April 15, 1999, and agreed to commence a tender offer to purchase up to
1,600,000 shares of Common Stock for $4.38 per share from the Company's
shareholders upon the terms and conditions set forth in its Offer to Purchase
dated April 21, 1999, and in the related Letter of Transmittal (the "Tender
Offer"). Subject to receipt of shareholder approval and certain other
conditions, the Purchaser has also agreed to purchase 1,792,453 shares of Common
Stock, subject to upward adjustments not to exceed in the aggregate 140,000
shares of Common Stock, from the Company (the "Second Funding Shares").
In connection with the Stock Purchase Agreement, the Company, the
Purchaser and certain shareholders of the Company also entered into a
shareholders' and voting agreement, pursuant to which, immediately upon the
closing of the sale of the Second Funding Shares and the consummation of the
Tender Offer, the Purchaser shall be entitled to designate four directors to
serve on the Board of Directors of the Company. See "Proposal One: Approval of
the Transactions -- Description of the Transactions -- Shareholders' and Voting
Agreement." In connection therewith, each of Messrs. Barry B. Conrad, Richard
R. Neitz, Jack R. Crosby and Douglas A. Smith have agreed to tender their
resignations from the Board of Directors of the Company effective as of the
closing of the sale of the Second Funding Shares. At such time, E. Thomas
Martin, Robert L. Burke, Joseph S. Whitaker and John McSorley (the "Director
Designees") will be appointed in accordance with the Bylaws of the Company to
fill such vacancies and to serve in their stead until the Company's next annual
meeting of shareholders and until their successors are duly qualified and
elected. Accordingly, the Company is requesting that shareholders ratify the
appointment of the Director Designees.
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Under the rules of the National Association of Securities Dealers, Inc.
("NASD"), companies that are listed on the Nasdaq SmallCap Market must obtain
shareholder approval prior to issuing shares of common stock where such issuance
would result in a change of control of the company. Accordingly, the Company
must seek shareholder approval for the transactions contemplated by the Stock
Purchase Agreement.
At the meeting, shareholders will be asked to consider and vote upon
the following proposals (the "Proposals"), as well as upon the election of two
directors to the class of directors whose three-year term will expire in 2002
(who will tender their resignations from the Board of Directors of the Company
effective as of the closing of the sale of the Second Funding Shares) and upon
such other business as may properly come before the meeting or any adjournment
thereof :
(i) approval and ratification of the Stock Purchase
Agreement and the transactions contemplated thereunder, including the
sale by the Company to the Purchaser of up to an aggregate of 2,498,491
additional shares of Common Stock;
(ii) approval of an amendment to the Company's Amended and
Restated Articles of Incorporation that would increase the number of
authorized shares of Common Stock of the Company from 20,000,000 shares
to 35,000,000 shares; and
(iii) ratification of the appointment of four directors by
the remaining directors to fill vacancies on the Board upon
consummation of the transactions contemplated by the Stock Purchase
Agreement, which vacancies will be created by certain resigning
directors.
(iv) adoption and approval of a proposal to amend the
Company's Stock Option plan (a) to increase from 600,000 to 900,000 the
aggregate number of shares of Common Stock of the Company reserved for
issuance under the Plan and (b) to make certain conforming changes.
The effectiveness of Proposals (i) and (iii) above is conditioned upon,
among other things, the approval or ratification, as applicable, of both
Proposal (i) and Proposal (iii). Accordingly, the failure of the shareholders to
approve either of those Proposals will result in the ineffectiveness of both of
those Proposals.
GENERAL
PROXY CARDS
If a proxy card is enclosed, it serves to appoint proxies for record
holders of Common Stock, of the Company. Shares represented by a proxy in such
form, duly executed and returned to the Company and not revoked, will be voted
at the meeting in accordance with the directions given. If no direction is made,
the proxy will be voted FOR the Proposals and FOR election of the directors
named in the proxy. Any shareholder giving a proxy may revoke it at any time
before it is voted by communicating such revocation in writing to the Secretary
of the Company or by executing and delivering a later-dated proxy.
The cost of soliciting proxies will be borne by the Company. The
Company may retain a proxy solicitation firm to solicit proxies from brokers,
banks, nominees, institutional holders and individual holders for use at the
meeting. In addition, the Company may use certain of its officers and employees
(who will receive no special compensation therefor) to solicit proxies in person
or by telephone, facsimile, telegraph or similar means.
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VOTING PROCEDURES AND TABULATION
The Company will appoint one or more inspectors of election to act at
the meeting and to make a written report thereof. Prior to the meeting, the
inspectors will sign an oath to perform their duties in an impartial manner and
according to the best of their ability. The inspectors will ascertain the number
of shares outstanding and the voting power of each, determine the shares
represented at the meeting and the validity of proxies and ballots, count all
votes and ballots, and perform certain other duties as required by law.
With regard to the election of directors, votes may be cast in favor of
or withheld from each nominee. Votes that are withheld will be excluded entirely
from the vote and will have no effect. Abstentions may be specified on the other
proposals to be acted upon and will be counted as present for purposes of
determining the existence of a quorum regarding such items of business.
Abstentions on such proposals will have the effect of a negative vote.
Shares referred to as "broker non-votes" (shares held by brokers or
nominees as to which they have no discretionary authority to vote on a
particular matter and have received no instructions from the beneficial owners
or persons entitled to vote thereon), if any, are counted as shares that are
present and entitled to vote for purposes of determining the presence of a
quorum. However, for purposes of determining the outcome of any matter requiring
discretionary authority to vote, broker non-votes will be treated as not voting
with respect to that matter (even though those shares are considered present for
quorum purposes and may be entitled to vote on other matters). For matters
requiring the affirmative vote of a plurality of the shares of Common Stock
present or represented at the meeting, broker non-votes will have no effect on
the outcome of the vote. For matters requiring the affirmative vote of a
majority of the shares of Common Stock outstanding or of a majority of the
shares of Common Stock present or represented at the meeting and entitled to
vote, broker non-votes will have the effect of votes against such proposal.
RECORD DATE AND VOTING SECURITIES
The only voting security of the Company outstanding is its Common
Stock. Only holders of record of Common Stock at the close of business on April
28, 1999, the record date for the meeting, are entitled to notice of and to vote
at the meeting. On the record date for the meeting, there were 6,566,038
shares of Common Stock outstanding and entitled to be voted at the meeting. A
majority of such shares, present in person or represented by proxy, is necessary
to constitute a quorum. Each share of Common Stock is entitled to one vote.
ELECTION OF DIRECTORS
The Articles of Incorporation and Bylaws of the Company provide for
three classes of directors, with approximately one-third of the directors
constituting the Board being elected each year to serve a three-year term.
Pursuant to the Company's Bylaws, the number of directors has been established
by resolution of the Board at six.
The Board of Directors has nominated Jack R. Crosby and Barry B. Conrad
from the class of directors whose term expires at the 1999 annual meeting for
re-election as directors of the Company to serve three-year terms expiring in
2002. In connection with the transactions contemplated by the Stock Purchase
Agreement, Messrs. Crosby and Conrad, as well as Messrs. Richard R. Neitz and
Douglas A. Smith, have agreed to tender their resignations from the Board of
Directors of the Company effective as of the closing of the sale of the Second
Funding Shares, at which time the Director Designees will be appointed by the
remaining directors to fill such vacancies and to serve in their stead. See
"Proposal One: Approval of the Transactions -- Description of the Transactions
- -- Shareholders' and Voting Agreement" and "Proposal Three: Ratification of
Appointment of Director Designees."
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The directors nominated for election this year will be elected by a
plurality of the shares of Common Stock present in person or represented by
proxy at the meeting and entitled to vote. All duly submitted and unrevoked
proxies in the form enclosed will be voted for the nominees selected by the
Board of Directors, except where authorization so to vote is withheld.
Information with respect to the directors nominated for election this
year, and the directors whose terms do not expire at the 1999 annual meeting, is
presented below. None of the entities identified in such information is
affiliated with the Company.
NOMINEES FOR DIRECTOR
JACK R. CROSBY, Mr. Crosby is the founder and Chairman of
age 72, director since 1995 Rust Capital, Ltd., a small business
investment partnership headquartered in
Texas. Mr. Crosby has co-founded and/or
financed two private venture capital funds
and has been one of the co-founders of eight
multiple system cable companies. He was the
founder, and, through February, 1998, CEO of
Tescorp, Inc., a publicly traded company
which owns and operates cable television
systems in Argentina. He is the Chairman of
the Board and CEO of CinemaStar Luxury
Theaters, Inc. He also serves on board of
directors of National Dentex Corporation.
BARRY B. CONRAD, Mr. Conrad is a co-founder and Managing
age 58, director since 1995 Partner of Conrad/Collins Merchant Banking
Group Ltd., a Dallas, Texas-based merchant
bank formed in 1988 that is active in
leveraged buyouts of middle-market companies
in the southwestern United States. Mr.
Conrad has extensive investment banking
experience. He was Chairman of the Board of
NEI WebWorld, Inc. through December 1998.
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CLASS WHOSE TERM EXPIRES IN 2000
JOSEPH N. MATLOCK, Mr. Matlock has spent the majority of his
age 50, director since 1995 career in the financial services industry,
beginning in 1973 with Texas Commerce
Bank-Houston (now Chase Bank of Texas,
N.A.). From January 1986 to September 1988,
Mr. Matlock served as Chairman, Chief
Executive Officer and President of Franklin
Savings Association in Austin, Texas; and
from September 1988 through September 1994,
he served as Chief Executive Officer,
President and a director of Franklin Federal
(now Norwest). From September 1994 to the
present he has been engaged in the merchant
banking and consulting business. From
January 1996 to March 1998, he served as
Executive Vice President and Director of
Business and Community Relations for Bank of
America. From September 1994 to the present,
he has served as President (and was the
founder) of Afford America, Inc. which
provides home ownership for low income
families. From July 1997 to present he has
served as Chairman of Austin Jet
International. He is currently involved in
several other merchant banking activities,
including GTX (an "E" Commerce Business to
Business Company) and the United States Polo
Association Official Apparel Company
(holding the master licensing agreement for
Latin America and Europe).
M. D. DAVIS Mr. Davis has served as the Chairman of the
age 64, director since 1995 Board and Chief Executive Officer of the
Company since December 1995. Prior to
joining the Company, Mr. Davis spent
eighteen years with Ernst & Whinney in
Houston, where, as a partner, he headed the
healthcare practice. He left Ernst & Whinney
in 1981 when he purchased Southwest Medical
Packaging, Inc. This company was sold to
Cooper Vision, Inc. (now Cooper Company,
Inc.) in 1985 and later to Alcon
Laboratories, Inc. in 1989. During this
time, Mr. Davis maintained senior management
positions at both companies. In 1990, Mr.
Davis and another employee acquired
Southwest Medical Packaging, Inc. from Alcon
Laboratories. In June 1994, this company was
sold to Maxxim Medical, Inc. From June 1994
until December 1995, Mr. Davis was engaged
in personal investment activities.
CLASS WHOSE TERM EXPIRES IN 2001
RICHARD R. NEITZ Mr. Neitz has served as President of the
age 50, director since 1995 Company since March 1992 and Vice President,
Marketing and Product Development from March
1990 to March 1992. He has served as Chief
Operating Officer since December 1995. Prior
to joining the Company in 1990, Mr. Neitz
served in various management and marketing
positions with Main Street Ltd., Joseph
Markovits, Inc., Toys "R" Us and McCrory
Stores. Mr. Neitz is a director of the Toy
Manufacturers of America (TMA) and a trustee
of the American Toy Institute, each a trade
association.
DOUGLAS A. SMITH Mr. Smith has been President of Vanguard
age 47, director since 1996 Investment Company, which has been active in
leveraged buy-out and management of middle
market companies, since 1983. He serves on
the board of directors of Steelworks, Inc.,
Blocksom & Co., Vanguard Investment Company,
Everest Group, and Vanguard Enterprises,
Inc.
THE BOARD RECOMMENDS THAT SHAREHOLDERS VOTE "FOR" THE ELECTION OF ITS NOMINEES
FOR DIRECTOR.
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PROPOSAL ONE
APPROVAL AND RATIFICATION OF THE TRANSACTION
At the meeting shareholders are being asked to vote upon and approve
the Stock Purchase Agreement and the transactions contemplated thereunder,
including the sale by the Company to the Purchaser of up to an aggregate of
2,498,491 shares of Common Stock (the "Transactions"). The affirmative vote of
the holders of at least a majority of the shares of Common Stock present and
entitled to vote on this proposal is required to approve the Transactions.
THE PURCHASER
The Purchaser is a newly formed California limited liability company
organized in connection with the transactions contemplated by the Stock Purchase
Agreement,. The Purchaser is wholly owned by E. Thomas Martin ("Mr. Martin") and
his wife, Noreen Martin (collectively, the "Martins"), who own ninety-nine
percent (99%) of the membership interests of the Purchaser, as community
property, and Joseph S. Whitaker and his wife, Myraline Whitaker (collectively,
the "Whitakers"), who own one percent (1%) of the membership interests of the
Purchaser as community property. See "Security Ownership of Certain Beneficial
Owners and Management" for information regarding the ownership of Common Stock
by the Martins and the Whitakers. Mr. Martin is the sole Manager and President
of the Purchaser. While the Purchaser does not have a board of directors, it has
executive officers responsible for its day-to-day operations. Joseph S. Whitaker
serves as the Vice President of the Purchaser. There are no executive officers
of the Purchaser other than Messrs. Martin and Whitaker.
DESCRIPTION OF TRANSACTIONS
On April 15, 1999, the Company entered into agreements relating to,
among other things: (i) the sale by the Company to the Purchaser of 566,038
shares of Common Stock on April 15, 1999, (ii) subject to, among other things,
the receipt of shareholder approval, the sale by the Company to the Purchaser of
up to an aggregate of 1,932,453 additional shares of Common Stock, (iii) certain
shareholders' and voting agreements, (iv) registration rights relating to the
Common Stock acquired by the Purchaser and (v) the Tender Offer.
The terms of the Stock Purchase Agreement and the related agreements
with the Purchaser are summarized below. The following descriptions of the
various Transaction documents are only summaries thereof and are qualified in
their entirety by reference to such documents which are attached hereto or in
the Company's Schedule 14D-9 filed with the Securities and Exchange Commission
(the "Commission") on April 22, 1999 (the "Schedule 14D-9").
Stock Purchase and Sale Agreement
The following is a summary of certain portions of the Stock Purchase
Agreement. The summary is qualified in its entirety by reference to the Stock
Purchase Agreement which is attached hereto as Annex A and is incorporated
herein by reference. Capitalized terms not otherwise defined below shall have
the meaning set forth in the Stock Purchase Agreement.
The Common Stock Acquisitions. The Company has agreed to sell to the
Purchaser, and the Purchaser has agreed to purchase from the Company, an
aggregate of 2,358,491 Shares (subject to upward adjustments not to exceed in
the aggregate 140,000 Shares) for an aggregate purchase price of $5,000,000, in
two separate sales
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transactions of 566,038 Shares and 1,792,453 Shares (subject to upward
adjustments not to exceed in the aggregate 140,000 Shares), respectively. The
closing of the sale of the Initial Funding Shares (the "Initial Closing") was
consummated concurrently with the execution of the Stock Purchase Agreement on
April 15, 1999. Simultaneously with the Initial Closing, the Company, the
Purchaser, certain management shareholders of the Company and a limited
partnership controlled by a management shareholder of the Company (the
"Management Shareholders") entered into a Shareholders' and Voting Agreement and
a Registration Rights Agreement, each dated April 15, 1999, and the Purchaser
and the Management Shareholders entered into Side Letter Agreements dated April
15, 1999.
The upward adjustments to the number of Second Funding Shares are not
to exceed in the aggregate 140,000 Shares and are dependent upon two issues: (i)
the Company meeting certain working capital requirements as of the date of the
closing of the sale of the Second Funding Shares (the "Second Closing"), and
(ii) the consummation of certain transactions resolving a dispute with the
estate of the Company's former controlling shareholder. The Stock Purchase
Agreement provides that, if as of the date of the Second Closing, the working
capital of the Company is less than $1,000,000, then the number of Second
Funding Shares shall be increased by the excess of $1,000,000 over such amount
of working capital, based upon a per Share price of $2.00, not to exceed 40,000
Shares in the aggregate. The Stock Purchase Agreement further provides that if
the Company and the Management Shareholders shall not have consummated a
transaction with all necessary parties to resolve any disputes with the estate
of the Company's former controlling shareholder and related parties on or prior
to June 30, 1999, then the Company shall issue to the Purchaser an additional
100,000 Shares on the date of the Second Closing or on July 1, 1999, if the
Second Closing occurs prior to June 30, 1999.
The Second Closing is to occur on or before July 1, 1999, or such date
as the Company and the Purchaser shall agree in writing. The Second Closing is
conditioned upon the consummation of the Purchaser's acquisition of 1,600,000
Shares pursuant to the Tender Offer, it being the understanding of the parties
that the Second Closing shall occur simultaneously with the consummation of the
Tender Offer. The conditions to the Second Closing also include: (i) the prior
approval of the Company's shareholders, at a shareholder's meeting to be called
by the Company (the "Shareholders Meeting"), of the sale of the Second Funding
Shares (which approval is contemplated by Proposal One); (ii) the expiration or
termination of any waiting period applicable to the transactions contemplated by
the Stock Purchase Agreement under the Hart-Scott-Rodino Antitrust Improvements
Act of 1976, as amended, and the rules and regulations thereunder (the "HSR
Act"); (iii) the truth and accuracy at the Second Closing of the representations
and warranties made by the parties in the Stock Purchase Agreement, subject to
certain qualifications; (iv) the performance by the parties of their respective
obligations under the Stock Purchase Agreement, subject to certain
qualifications; and (v) other conditions, including those customary to
transactions similar to those contemplated by the Stock Purchase Agreement.
The Tender Offer. Pursuant to the terms of the Stock Purchase
Agreement, the Purchaser was required to commence the Tender Offer no later than
five business days after the date of the Stock Purchase Agreement. The
obligations of the Purchaser to accept for payment, and pay for, any Shares
tendered pursuant to the Tender Offer are subject only to the conditions set
forth in Section 14 of the Purchaser's Offer to Purchase dated April 21, 1999
(the "Offer Conditions") (any of which may be waived in whole or in part by the
Purchaser in its sole discretion), including there being validly tendered and
not withdrawn prior to the expiration of the Tender Offer at least 1,600,000
Shares (the "Minimum Tender Condition"). The Purchaser may increase the Offer
Price and may make any other changes in the terms and conditions of the Tender
Offer; except that the Purchaser may not without the Company's prior written
consent: (i) reduce the number of Shares subject to the Tender Offer; (ii)
reduce the Offer Price; (iii) add to the Offer Conditions; (iv) except as
provided in the next sentence, extend the Tender Offer; or (v) change the form
of consideration payable in the Tender Offer. The Purchaser may, without the
consent of the Company, (i) extend the Tender Offer, if at the scheduled or
extended expiration date of the Tender Offer any of the Offer Conditions shall
not be satisfied or waived, until such time as such conditions are satisfied or
waived, (ii) extend the Tender Offer for any period required by any rule,
regulation, interpretation or position of the Commission or the staff thereof
applicable to the Tender Offer, and (iii) extend the Tender Offer for any reason
on one or more occasions for an aggregate period of not more than 20 business
days beyond the latest expiration date that would otherwise be permitted under
clause (i) or (ii) of this sentence, in each case subject to the right of the
Purchaser or the Company to terminate the Stock Purchase Agreement pursuant to
the
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terms thereof. The Purchaser is not obligated to keep the Tender Offer open
until the Shareholders Meeting occurs. If the parties' obligations to close the
sale of the Second Funding Shares are terminated as discussed below, the
Purchaser may elect, in its sole discretion, to continue to conduct the Tender
Offer.
Subject to the Offer Conditions, the Purchaser is required to accept
for payment, purchase, and pay for, in accordance with the terms of the Tender
Offer, up to 1,600,000 Shares validly tendered and not properly withdrawn
pursuant to the Tender Offer at the earliest time following expiration of the
Tender Offer that all conditions to the Tender Offer and its consummation have
been satisfied or waived by the Purchaser. The Offer Conditions are for the sole
benefit of the Purchaser and may be asserted by the Purchaser regardless of the
circumstances giving rise to any such condition (including without limitation,
any action or inaction by the Purchaser) or may be waived by the Purchaser, in
whole or in part at any time and from time to time, in the Purchaser's sole
discretion.
Pursuant to the Stock Purchase Agreement, on April 22, 1999, the
Company filed with the Commission and mailed to its shareholders, a
Solicitation/Recommendation Statement on Schedule 14D-9 containing the
recommendation of the Board of Directors that the Company's shareholders accept
the Tender Offer and tender their Shares in the Tender Offer.
The Shareholders Meeting. The Stock Purchase Agreement requires the
Company to call and hold, as soon as practicable, the Shareholders Meeting for
the purpose of voting on the approval of the sale of the Second Funding Shares
and the adoption and approval of the Stock Purchase Agreement and the Articles
of Amendment to the Company's Amended and Restated Articles of Amendment
described in further detail below. The Company agreed that the proxy materials
for the Shareholders Meeting would contain the recommendation of the Board of
Directors that the shareholders approve the Transactions.
Amendment to Articles of Incorporation. At the Second Closing, the
Company shall file the Articles of Amendment (as defined herein) with the
Secretary of State of the State of Texas if such Articles of Amendment have been
approved by the shareholders at the Shareholders Meeting, in accordance with the
Company's governing instruments and applicable law. See "Proposal Two: Approval
of Articles of Amendment."
Representations and Warranties. The Stock Purchase Agreement contains
various customary representations and warranties of the parties, including
representations by the Company as to the Company's organization and
qualification, capital structure, authority to enter into the Stock Purchase
Agreement and to consummate the transactions contemplated thereby, required
consents and approvals, filings made by the Company with the Commission
(including financial statements included in the documents filed by the Company
with the Commission), absence of material adverse changes, absence of
litigation, employee benefit plans, environmental laws and regulations,
intellectual property, tax matters and the inapplicability of certain state
takeover statutes.
The Purchaser has also made customary representations and warranties to
the Company, including, but not limited to, representations and warranties as to
organization, authority to enter into the Stock Purchase Agreement and to
consummate the transactions contemplated thereby, required consents and
approvals and financing.
Conduct of Business of the Company. The Stock Purchase Agreement
provides that until the Second Closing, the business of the Company and each of
its subsidiaries will be conducted in the ordinary and usual course of business.
Accordingly, without the Purchaser's approval, neither the Company nor any of
its subsidiaries may, prior to the Second Closing, engage or agree to engage in
an enumerated list of actions generally characterized as being outside the
ordinary and usual course of business. Such actions requiring the Purchaser's
approval include, among other things (but subject to certain exceptions stated
in the Stock Purchase Agreement): (i) issuing equity securities other than under
specified circumstances; (ii) making any new grants or awards under any employee
benefit plans; (iii) compromising any claims or litigation, or entering into any
agreements for indebtedness or other agreements; or (iv) making new commitments
for capital expenditures in excess of specified levels.
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Other Potential Bidders and Transactions. Pursuant to the terms of the
Stock Purchase Agreement, the Company may not, and the Company is required to
use its best efforts to not permit any of its subsidiaries and their respective
directors, officers, employees, attorneys, financial advisors, agents or other
representatives to, directly or indirectly, solicit, initiate or knowingly
encourage (including by way of furnishing information) any bona fide proposal or
offer (other than a proposal or offer by the Purchaser or any of the Purchaser's
affiliates), or any expression of interest relating to any actual or potential
merger, consolidation or other business combination involving the Company or any
of its subsidiaries or any acquisition in any manner (including, without
limitation, by tender or exchange offer) of a substantial equity interest in, or
a substantial portion of the assets of, the Company or any of its subsidiaries
(individually, a "Takeover Proposal" and collectively the "Takeover Proposals").
Notwithstanding the foregoing, the Stock Purchase Agreement permits the
Company to engage in discussions or negotiations with, and furnish information
to, any person that makes a written Takeover Proposal in respect of which the
Board of Directors of the Company concludes in good faith if consummated would
constitute a Superior Proposal (as defined herein), but only if the Board of
Directors of the Company concludes in good faith on the basis of the advice of
its outside counsel that the failure to take such action would be inconsistent
with the fiduciary obligations of the Board under applicable law. A "Superior
Proposal" is defined as a Takeover Proposal, on terms which a majority of the
members of the Board of Directors of the Company determines in good faith, and
based on the advice of outside counsel, to be more favorable to the Company and
its shareholders than the transactions contemplated by the Stock Purchase
Agreement and any revised transaction proposed by the Purchaser in response to a
Superior Proposal being made. The Purchaser has the right to be notified of the
material terms of any Takeover Proposal, including the identity of the person
making such Takeover Proposal, as soon as practicable but no later than the date
on which such Takeover Proposal is presented to the Board of Directors. If the
Company's Board of Directors determines in good faith that a Takeover Proposal
constitutes a Superior Proposal, the Company may not terminate the Stock
Purchase Agreement until a period of at least five business days has elapsed
after delivery to the Purchaser of such determination by the Board of Directors,
during which time the Company is required to provide the Purchaser a reasonable
opportunity to propose a modification of the terms and conditions of the Stock
Purchase Agreement so that a business combination between the Company and the
Purchaser may be effected. If, after such period, the Company's Board of
Directors continues to believe in good faith that such Takeover Proposal
constitutes a Superior Proposal and simultaneously therewith or not later than
90 business days thereafter the Company enters into a definitive acquisition,
merger or similar agreement to effect such Superior Proposal, then the Company
may terminate the Stock Purchase Agreement, in which event the Company would be
required to pay Purchaser $1 million in cash (the "Termination Fee").
The Purchaser has the right to terminate the Stock Purchase Agreement
in the event, among other things the Board of the Directors of the Company shall
have recommended to the shareholders any Takeover Proposal (other than by the
Purchaser or any of Purchaser's affiliates) or shall have resolved to do so, in
which event, upon the acceptance of any such proposal, the Company would be
required to pay the Termination Fee.
Termination. The Stock Purchase Agreement may be terminated upon the
mutual written consent of the Company and the Purchaser, or by either the
Company or the Purchaser if: (i) there has been a breach by the other party of
any representation or warranty made as of the date of the Stock Purchase
Agreement that is not qualified by reference to a Material Adverse Effect (as
defined below), the effect of which has a Company Material Adverse Effect or a
Buyer Material Adverse Effect, as the case may be; (ii) there has been a breach
by the other party of any representation or warranty made as of the date of the
Stock Purchase Agreement that is qualified by reference to a Material Adverse
Effect, in each case, which breach has not been cured (if capable of being
cured) within 15 business days after receipt by the breaching party of written
notice of the breach; (iii) as a result of the failure of any of the Offer
Conditions, the Tender Offer shall have terminated or expired in accordance with
its terms without the Purchaser having accepted for payment any Shares pursuant
to the Tender Offer; (iv) the Purchaser shall not have accepted for payment any
Shares pursuant to the Tender Offer prior to July 1, 1999; provided, however,
that with respect to Subsections (iii) and (iv) hereof, the right to terminate
the Stock Purchase Agreement shall not be available to any party whose failure
to perform any of its obligations
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<PAGE> 13
under the Stock Purchase Agreement results in the failure of any such condition
or if the failure of such condition results from facts or circumstances that
constitute a breach of a representation or warranty under the Stock Purchase
Agreement by such party; (v) the Second Closing and the consummation of the
Tender Offer have not been effected on or prior to the close of business on July
1, 1999, whether such date is before or after the date of approval of the
Company's shareholders; provided, however, that the right to terminate the Stock
Purchase Agreement pursuant to this part (v) of this paragraph shall not be
available to any party whose failure to fulfill any obligation of the Stock
Purchase Agreement has been the cause of, or resulted in, the failure of the
Second Closing to have occurred on or prior to such date; (vi) any court or
other government or an agency, bureau, board, commission, court, department,
official, political subdivision, tribunal or other instrumentality of any
government, whether federal, state, or local, domestic or foreign (a
"Governmental Entity"), having jurisdiction over a party to the Stock Purchase
Agreement shall have issued an order, decree or ruling or taken any other action
permanently enjoining, restraining or otherwise prohibiting the transactions
contemplated by the Stock Purchase Agreement and such order, decree, ruling or
other action shall have become final and nonappealable; or (vii) 10 business
days elapse after all the conditions to the Company's and the Purchaser's
obligations to close the sale of the Second Funding Shares shall have been
satisfied or waived and the Second Closing shall not have occurred through no
fault of the terminating party.
The Company may terminate the Stock Purchase Agreement if: (i) the
Purchaser shall have failed to comply in any material respect with any of its
respective covenants or agreements contained in the Stock Purchase Agreement
required to be complied with prior to the date of such termination, which
failure to comply has not been cured within 15 business days after written
notice of such failure; (ii) the Company's shareholders shall not approve the
Stock Purchase Agreement and the transactions contemplated thereby at a duly
called and noticed shareholders meeting at which a quorum is present in person
or by proxy, or any adjournment thereof prior to June 21, 1999; or (iii) the
Board of Directors of the Company shall determine in good faith that a Takeover
Proposal constitutes a Superior Proposal; provided, however, that the Company
may not terminate the Stock Purchase Agreement pursuant to part (iii) of this
paragraph, unless (A) five business days shall have elapsed after delivery to
the Purchaser of a written notice of such determination by such Board of
Directors and at all reasonable times during such five business-day period the
Company shall have provided the Purchaser a reasonable opportunity, to propose a
modification of the terms and conditions of the Stock Purchase Agreement so that
a business combination between the Company and the Purchaser may be effected,
and (B) at the end of such five business-day period such Board of Directors
shall continue to believe in good faith that such Takeover Proposal constitutes
a Superior Proposal and simultaneously therewith or not later than 90 business
days thereafter the Company shall enter into a definitive acquisition, merger or
similar agreement to effect such Superior Proposal.
The Purchaser may terminate the Stock Purchase Agreement if: (i) the
Company shall have failed to comply in any material respect with any of its
covenants or agreements contained in the Stock Purchase Agreement required to be
complied with prior to the date of such termination, which failure to comply has
not been cured within 15 business days after written notice of such failure;
(ii) the Company shall not have duly called and noticed a shareholders meeting
to be held no later than June 4, 1999 (subject to adjournment) within the notice
period required by the Company's governing instruments and applicable law; (iii)
the shareholders shall not approve the Stock Purchase Agreement and the
transactions contemplated by the Stock Purchase Agreement at a duly called and
noticed shareholders meeting at which a quorum is present in person or by proxy,
or any adjournment thereof prior to June 21, 1999; (iv) the Board of Directors
of the Company shall not have recommended the Stock Purchase Agreement and the
transactions contemplated thereby to the Company's shareholders as contemplated
by the Stock Purchase Agreement, or shall have resolved not to make such
recommendations, or shall have modified in a manner adverse to the Purchaser or
rescinded its recommendations to the shareholders, or shall have modified or
rescinded its approval of the Stock Purchase Agreement or the transactions
contemplated thereby, or shall have resolved to do any of the foregoing; (v) the
Board of Directors of the Company shall have recommended to the shareholders any
Takeover Proposal (other than by the Purchaser or any of its affiliates) or
shall have resolved to do so; (vi) a tender offer or exchange offer for 20% or
more of the outstanding shares of capital stock of the Company is commenced, and
the Board of Directors of the Company fails to recommend against acceptance of
such tender offer or exchange offer by its shareholders within the 10 business
day period (or such shorter period) required by Section 14e-2 of the Exchange
Act
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<PAGE> 14
(the taking of no position by the expiration of such ten business day period (or
such shorter period) with respect to the acceptance of such tender offer or
exchange offer by its shareholders constituting such a failure); or (vii) the
Company or any of its subsidiaries, without having received prior written
consent from the Purchaser, shall have entered into, authorized, recommended,
proposed, or publicly announced its intention to enter into, authorize,
recommend or propose to its shareholders an agreement, arrangement,
understanding or letter of intent with any person (other than the Purchaser or
any of its affiliates) to (A) effect a merger or consolidation or similar
transaction involving the Company or any of its subsidiaries, (B) purchase,
lease, or otherwise acquire all or a substantial portion of the assets of the
Company or any of its subsidiaries, or (C) purchase or otherwise acquire
(including by way of merger, consolidation, share exchange or similar
transaction) beneficial ownership of securities representing twenty percent
(20%) or more of the voting power of the Company (in each case other than any
such merger, consolidation, purchase, lease or other transaction involving only
the Company and one or more of its subsidiaries or involving only any two or
more of its subsidiaries).
"Material Adverse Effect" as defined in the Stock Purchase Agreement
means, when used in connection with the Company or the Purchaser, any change or
effect that: (i) has had, or is reasonably likely to have a materially adverse
impact on the business, operations, or results of operations, assets or
condition (financial or otherwise) of such party or any of its subsidiaries; or
(ii) substantially impairs or delays the consummation of the transactions
contemplated by the Stock Purchase Agreement, but, in either such event, shall
not include (A) any change or effect that results from conditions, events or
circumstances generally affecting the industries in which the Company or the
Purchaser operate or the economy in general, (B) any action or change
specifically permitted or required by the provisions of the Stock Purchase
Agreement, or (C) the transactions contemplated by this Agreement or the
announcement hereof, provided, however, a Material Adverse Effect will be deemed
to include the circumstances set forth in (i) or (ii) above if those
circumstances are caused by any suit, action, cause or proceeding brought by any
third party seeking injunctive relief, damages, or any other relief concerning
the transactions contemplated by the Stock Purchase Agreement.
Transaction Expenses. Pursuant to the terms of the Stock Purchase
Agreement, except for the Termination Fee which shall be borne by the Company,
all costs and expenses incurred in connection with the Stock Purchase Agreement
and the transactions contemplated thereby shall be paid by the party incurring
such costs and expenses; provided, however, that: (i) all expenses incurred in
connection with the filing fees and printing and mailing costs of the Schedule
14D-1 and the other documents required to be filed with the Commission in
connection with the Stock Purchase Agreement, including the Tender Offer, are to
be shared equally be the Purchaser and the Company, and (ii) all filing fees and
other costs incurred by any of the parties in connection with the HSR Act are to
be borne by the Company.
Use of Proceeds. Pursuant to the terms of the Stock Purchase Agreement,
the Company is required to apply the proceeds from the sale of the Initial
Funding Shares to the reduction of the Company's indebtedness to Sunrock Capital
Corp. The net proceeds to be received by the Company from the sale by the
Company of the Second Funding Shares to the Purchaser under the Stock Purchase
Agreement shall be used for the purpose of expanding the Company's operations,
repaying indebtedness and such other items as the Board of Directors may approve
from time to time.
The Side Letter Agreements
The following is a summary of the material terms of the Side Letter
Agreements between the Purchaser and each of the Management Shareholders. This
summary is not a complete description of the terms and conditions thereof and is
qualified in its entirety by reference to the full text thereof, a copy of the
form of which has been filed with the Commission as an exhibit to the Schedule
14D-9.
Under the Side Letter Agreements, each of the Management Shareholders
has agreed, if the Minimum Tender Condition is not met as of the initial
scheduled expiration date of the Tender Offer, to tender such number of the
Management Shareholder's Shares pursuant to the terms of the Tender Offer,
except where such sales in response to the Tender Offer might result in
liability under Section 16(b) of the Exchange Act, so that the number of Shares
tendered by such Management Shareholder and all other shareholders of the
Company shall
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<PAGE> 15
meet the Minimum Tender Condition. Each Management Shareholder may tender up to
the full amount of such person's Shares in the Tender Offer, even if the Minimum
Condition is otherwise met, subject to the pro rata reduction as described in
Section 1 of the Purchaser's Offer to Purchase dated April 21, 1999. Because the
Management Shareholders collectively own more than 1,600,000 Shares, the tender
by the Management Shareholders of all their Shares will cause the Minimum Tender
Condition to be satisfied. Each of the Management Shareholders has agreed that
he shall not, directly or indirectly, solicit, initiate or knowingly encourage
(including by way of furnishing information), entertain or consider any Takeover
Proposal from any person other than the Purchaser or engage in or continue
discussions or negotiations relating to any Takeover Proposal, except that such
Management Shareholder shall not be restricted from acting in his capacity as a
director in responding to a Takeover Proposal as permitted in the Stock Purchase
Agreement.
The Management Shareholders are M. D. Davis, Rust Capital, Ltd., a
limited partnership controlled by Jack R. Crosby, Douglas A. Smith, Joseph N.
Matlock and Barry B. Conrad.
The Shareholders' and Voting Agreement
The following is a summary of the material terms of the Shareholders'
and Voting Agreement dated April 15, 1999 (the "Shareholders' Agreement") by and
among the Company, the Purchaser and the Management Shareholders. This summary
is not a complete description of the terms and conditions thereof and is
qualified in its entirety by reference to the full text thereof, which has been
filed with the Commission as an exhibit to the Schedule 14D-9.
Voting Agreement. Under the Shareholders' Agreement, which is
conditioned and effective upon the Second Closing, the Management Shareholders
shall have the right to nominate two of the total number of directors of the
Company and the Purchaser shall have the right to nominate the remaining number
of directors. The initial nominees of the Management Shareholders under the
Shareholders' Agreement are Joseph N. Matlock and M. D. Davis and the initial
nominees of the Purchaser under the Shareholders' Agreement are E. Thomas
Martin, Robert L. Burke, Joseph S. Whitaker and John McSorley. The parties to
the Shareholders' Agreement are required to vote the number of Shares they own
for the election of the individuals nominated by the Purchaser and the
Management Shareholders in accordance with the Shareholders' Agreement.
In connection with the Shareholders' Agreement, each of the Management
Shareholders has executed an irrevocable proxy appointing the Purchaser as proxy
and authorizing the Purchaser to vote such Management Shareholder's Shares for
the election of the directors to the Board of Directors in accordance with the
Shareholders' Agreement. Such irrevocable proxies further designate the
Purchaser as a proxy for each Management Shareholder with respect to all other
matters of the Company subject to a vote of the Company's shareholders;
provided, however, that each Management Shareholder has retained the right to
vote his Shares with respect to matters concerning (i) a dissolution of the
Company, or (ii) the sale of all or substantially all of the assets of the
Company which requires a vote of shareholders under applicable law, the issuance
by the Company of Common Stock in such amount that the rules of the exchange on
which the Company's stock is listed requires shareholder approval, or a merger
of the Company with another entity which requires a vote of shareholders under
applicable law. The irrevocable proxies are conditioned upon and are to become
effective upon the Second Closing.
Right of First Refusal. Pursuant to the terms of the Shareholders'
Agreement, effective as of April 15, 1999, the Purchaser has a right of first
refusal with respect to the sale, transfer or other disposition (a "Transfer")
of Shares owned by each of the Management Shareholders. If a Management
Shareholder wishes to Transfer Shares other than in a transaction effected on
the Nasdaq Stock Market or any stock exchange or over-the-counter trading system
on which the Shares are traded (a "Public Transfer"), the Purchaser will have an
option for five business days after receiving notice of the proposed Transfer
and the terms thereof (a "Seller Notice") to purchase the Shares at the same
price and on the same terms as specified in the Seller Notice. If the Purchaser
does not exercise its option with respect to one hundred percent (100%) of the
Shares specified in the Seller Notice (or less than 100% if permitted under the
terms of the Seller Notice), then the Management
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Shareholder may transfer such Shares (or remaining Shares in the event the
Purchaser exercises its option to purchase less than 100% of the Shares as
permitted in the Seller Notice) free of the right of first refusal and voting
agreement on the terms specified in the Seller Notice (or at a higher price with
no material change in the other terms), provided such Transfer is consummated
within 180 days of the date of the Seller Notice.
If a Management Shareholder wishes to make a Public Transfer of Shares,
the Purchaser will have an option to purchase such Shares on the same terms
specified in the Public Transfer Notice (defined below) for three business days
after receiving notice of such proposed transfer, which notice shall contain the
maximum number of Shares the Management Shareholder intends to sell during the
following 60 days, and the minimum price at such Shares may be sold (the "Public
Transfer Notice"). If the Purchaser does not purchase 100% of the Shares subject
to the Public Transfer Notice, the Management Shareholder may sell the balance
of the Shares specified in the Public Transfer Notice at a price not less than
the price specified in the Public Transfer Notice free of the right of first
refusal and voting agreement, provided than any such Shares not Transferred
within 60 days of the date of the Public Seller Notice shall again be subject to
the Purchaser's right of first refusal under the Shareholders' Agreement.
Notwithstanding the foregoing, under the Shareholders' Agreement, each
Management Shareholder may pledge Shares held by it as collateral for
indebtedness provided that the pledgee party agrees to be bound by all of the
terms and conditions of the Purchaser's rights of first refusal under the
Shareholders' Agreement. In addition, pursuant to the terms of the Shareholders'
Agreement, the Purchaser grants to the Management Shareholders a right of
participation with respect to future sales by the Purchaser of Shares where such
sales occur in any one transaction or series of related transactions in which
more than 40% of the total number of Shares standing in the Purchaser's name as
of the date of the Second Closing are Transferred.
The Shareholders' Agreement and the irrevocable proxies executed in
connection therewith will be terminated upon the earlier of: (i) the termination
of the Stock Purchase Agreement in the event the Second Closing does not occur;
(ii) the fifth anniversary of the date of the Second Closing; (iii) the written
consent of the Company, the Purchaser and a majority in interest of the
Management Shareholders; or (iv) the dissolution of the Company.
The Registration Rights Agreement
The following is a summary of the material terms of the Registration
Rights Agreement dated April 15, 1999, by and among the Company, the Purchaser
and the Management Shareholders (the "Registration Rights Agreement"). This
summary is not a complete description of the terms and conditions thereof and is
qualified in its entirety by reference to the full text thereof, which has been
filed with the Commission as an exhibit to the Schedule 14D-9.
The Registration Rights Agreement was entered into concurrently with
the Stock Purchase Agreement. The Registration Rights Agreement provides, among
other things, that the Purchaser (and certain of its transferees) has the right
by written notice (a "Demand Notice") to require the company to file a
Registration Statement under the Securities Act where such Demand Notice covers
the registration of at least 250,000 Shares purchased by the Purchaser from the
Company under the Stock Purchase Agreement; provided, however, this right may
not be exercised on more than two occasions.
Pursuant to the Registration Rights Agreement, if the Company proposes
to register any of its securities under the Securities Act (other than a
registration on Form S-4 or Form S-8, or any other form not available for
registering the Registrable Securities (as defined herein) for sale to the
public) and the registration form may be used for the registration of the
Registrable Securities (a "Piggyback Registration"), then the Company is
required to give prompt notice to the Purchaser and the Management Shareholders
of its intention to effect such a registration and include in such registration
all Registrable Securities which the Purchaser and the Management Shareholders
request to be included in such registration by written notice to the Company.
Notwithstanding the foregoing, if in a Piggyback Registration the underwriter
advises the Company that the number of securities requested to be included in
such registration exceeds the number which can be sold in an orderly manner in
such
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offer within a price range acceptable to the Company, then the Company will
include in such registration: (i) if an offering of equity securities by the
Company, first, the securities to be sold by the Company, second, the MVII
Shares (defined below), third, the DSI Group Shares (defined below), and fourth,
other securities requested to be included in such registration; and (ii) if an
offering of equity securities by holders of the Company's securities, first, the
securities requested to be included therein by the holders requesting such
registration, second, the MVII Shares, and third, the DSI Group Shares.
For purposes of the Registration Rights Agreement the term "Registrable
Securities" means: (i) the Initial Funding Shares and the Second Funding Shares,
together with any shares of Common Stock issued or issuable with respect to such
shares by way of a share dividend or share split or in connection with a
combination of shares, recapitalization, merger, consolidation or other
reorganization (the "MVII Shares"), and (ii) only with respect to a Piggyback
Registration, shares of Common Stock over which a Management Shareholder has
dispositive power as of the date of the Registration Rights Agreement, together
with any shares of Common Stock issued or issuable with respect to such shares
by way of a share dividend or share split or in connection with a combination of
shares, recapitalization, merger, consolidation or other reorganization (the
"DSI Group Shares").
The rights of the parties under the Registration Rights Agreement may
not be transferred, except that the rights of the Purchaser under such agreement
may be transferred at any time without the consent of the Company to any person
acquiring at least 250,000 of the Registrable Securities from the Purchaser or
any of its affiliates. The Registration Rights Agreement provides that expenses
relating to the registration of shares (other than underwriting expenses
relating to Registrable Securities and the selling shareholder's legal expenses)
will be paid by the Company and otherwise contains terms that are customary to
registration rights agreements of its type, including, but not limited to,
rights of indemnification and contribution.
The Consulting Agreement
The following is a summary of the material terms of the Consulting
Agreement to be entered into between the Company and M.D. Davis ("Davis") prior
to the Second Closing. This summary is not a complete description of the terms
and conditions thereof and is qualified in its entirety by reference to the full
text thereof, a copy of the form of which has been filed with the Commission as
part of an exhibit to the Schedule 14D-9.
As a condition to the Purchaser's obligation to purchase the Second
Funding Shares, the Company and Davis will enter into the Consulting Agreement
which shall be effective as of the date of the Second Closing, pursuant to which
Davis shall cease to be an employee and officer of the Company and shall provide
consulting services to the Company for a period ending on the third annual
anniversary of the date of the Second Closing. As compensation for his services
under the Consulting Agreement, Davis shall be entitled to compensation in the
amount of $450,000, payable in equal monthly installments of $12,500. Davis
shall be entitled to such compensation irrespective of a termination of the
Consulting Agreement, unless such termination is by Davis for reasons other than
a breach by the Company of its obligations under the Consulting Agreement. The
Consulting Agreement contains a non-disclosure covenant similar to the
non-disclosure covenant contained in Davis' expired employment agreement with
the Company, a copy of which is filed as a part of the Company's Registration
Statement on Form S-1 filed with the Commission on May 29, 1997.
EFFECT OF THE TRANSACTIONS ON EXISTING SHAREHOLDERS
Following the Transactions, the existing holders of the Common Stock
will continue to own the shares of Common Stock owned by them prior to the
Transactions. However, following the Transactions, the Purchaser will own of
record up to 48% of the total number of shares of Common Stock then outstanding,
the Purchaser's designees will constitute a majority of the Company's Board of
Directors, and Mr. Martin, through his control of the Purchaser, will
beneficially own up to 50% of the total number of shares of Common Stock then
outstanding. In the event the Management Shareholders do not tender any Shares
owned by them into the Tender Offer and the Minimum Tender Condition is
otherwise met, there is a possibility that, upon consummation of the
transactions contemplated by the Stock Purchase Agreement, including the Tender
Offer, the Purchaser will beneficially own up to 68%, and Mr. Martin, through
his control of the Purchaser, will
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beneficially own up to 70%, of the shares of Common Stock then outstanding, by
virtue of the Purchaser's power to vote Shares held by the Management
Shareholders pursuant to the Shareholders' Agreement and the related irrevocable
proxies. To the best of the Company's knowledge all of the Management
Shareholders currently intend to tender Shares owned by them in the Tender
Offer.
As a result of such ownership of Shares, following the Transactions the
Purchaser and Mr. Martin will have the ability to influence the business and
operations of the Company, and will have the ability to control or influence
significantly the outcome of any shareholder vote. Therefore, the Purchaser may
be in a position to control the timing and the terms upon which any acquisition
or other business combination involving the Company may occur.
FAIRNESS OPINION; REASONS FOR THE BOARD'S CONCLUSION
In connection with the Transactions, the Company retained Chaffe &
Associates, Inc. to provide financial services to the Company. Chaffe &
Associates, Inc. reviewed with the Board of Directors of the Company its
financial analysis of the sale by the Company of its Shares to the Purchaser for
an average price of $2.00 per share, assuming that the Company sells the maximum
number of shares of Common Stock under the Stock Purchase Agreement, and orally
delivered its opinion, subsequently confirmed in writing, that the sale by the
Company of its Shares to the Purchaser for an average price of $2.00 per share
as part of the Transactions was fair to the shareholders of the Company. The
full text of the written opinion of Chaffe & Associates, Inc. dated April 8,
1999, which sets forth certain assumptions made, matters considered and
limitations on the review undertaken in connection with the opinion, is attached
hereto as Annex B and is incorporated herein by reference. The opinion of Chaffe
& Associates, Inc. referred to herein does not constitute a recommendation as to
whether or not any holder of Shares should vote in favor of Proposal One. All
shareholders are urged to, and should, read the opinion of Chaffe & Associates,
Inc. carefully in its entirety.
In approving the Stock Purchase Agreement and the Transactions
contemplated thereby and recommending that all holders tender their Shares
pursuant to the Tender Offer, the Board considered a number of factors,
including the following:
(i) The Board's familiarity with, and information
provided by the Company's management as to, the business, financial condition,
results of operations, current business strategy and future prospects of the
Company, as well as the risks involved in achieving those prospects and
objectives in current industry and market conditions, the nature of the markets
in which the Company operates, the Company's position in such markets, and the
historical and current market prices for the Shares.
(ii) The terms of the Stock Purchase Agreement, including
(A) the proposed structure of the Tender Offer and the Transactions involving a
cash tender offer and (B) the fact that financing is not a condition to the
Tender Offer and the Transactions.
(iii) That the average per Share price contemplated by the
Stock Purchase Agreement, at $2.93, represented a premium of at least 30.2% to
the closing price of the Shares immediately prior to the April 9, 1999 decision
of the Board of Directors regarding the Stock Purchase Agreement.
(iv) The process engaged in by the Company's management,
which included discussions with another potential acquiror, as a result of which
the Board had what it believed to be an accurate sense of the values that could
be achieved in a third party transaction.
(v) The presentation of Mr. Chaffe and Ms. Le Breton at
the April 9, 1999 Board meeting and the opinion of Chaffe & Associates, Inc. to
the effect that, as of such date, and based on the assumptions made, matters
considered and limits of review set forth therein, the sale by the Company of
its shares to the Purchaser for an average price of $2.00 per share is fair to
the shareholders of the Company from a financial point of view.
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(vi) That the Stock Purchase Agreement permits the Company
to furnish nonpublic information to, and to participate in negotiations with,
any third party that has submitted an Acquisition Proposal that constitutes a
Superior Proposal, if the Board determines in good faith that taking such action
is necessary in the exercise of its fiduciary obligations under applicable law,
and the Stock Purchase Agreement permits the Company's Board to terminate the
Stock Purchase Agreement in certain circumstances in the exercise of its
fiduciary duties.
(vii) The termination provisions of the Stock Purchase
Agreement, which under certain circumstances could obligate the Company to pay a
termination fee of $1 million to the Purchaser, and the Board's belief that such
fees and expense reimbursement provisions would not deter a higher offer.
(viii) The likelihood that the Transactions would be
consummated, including the conditions to the Tender Offer and the closing under
the Stock Purchase Agreement.
(ix) A consideration of alternatives to the sale of the
Company, including without limitation continuing to operate the Company as a
public company and not engaging in any extraordinary transaction.
The foregoing discussion addresses the material information and factors
considered by the Board in its consideration of the Transactions. In view of the
variety of factors and the amount of information considered, the Board did not
find it practicable to provide specific assessments of, quantify or otherwise
assign relative weights to the specific factors considered in reaching its
determination. The determination to recommend that shareholders approve the
Transactions and accept the Tender Offer was made after consideration of all of
the factors taken as a whole. In addition, individual members of the Board may
have given different weights to different factors.
NASDAQ APPROVAL REQUIREMENT
Under the rules of the NASD, companies that are listed on the Nasdaq
Small Cap Market must obtain shareholder approval prior to issuing shares of
common stock where such issuance would result in a change of control of the
company. Accordingly, the Company must seek shareholder approval for the
Transactions. If shareholder approval is not obtained, either the Company or the
Purchaser may terminate the Stock Purchase Agreement pursuant to the terms
thereof. Because in the event shareholder approval is not obtained the Company
would be prohibited under the terms of its Nasdaq listing agreement from
consummating the Transactions in a manner which would result in a change of
control of the Company, the Company would be required either to terminate the
Stock Purchase Agreement or reach agreements with the Purchaser regarding
appropriate amendments to the terms of the Transactions.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" APPROVAL OF PROPOSAL ONE.
16
<PAGE> 20
PROPOSAL TWO
APPROVAL OF THE ARTICLES OF AMENDMENT
The Amended and Restated Articles of Incorporation of the Company as
presently in effect provide that the authorized capital of the Company consists
of 25,000,000 shares, consisting of 20,000,000 shares of common stock, par value
$0.01 per share, and 5,000,000 shares of preferred stock, par value $0.01 per
share. As of April 23, 1999, there were 6,566,038 shares of Common Stock issued
and outstanding, which shares were held by approximately 91 owners of record.
Upon consummation of the Transactions, there will be 8,498,491 shares of Common
Stock issued and outstanding (assuming (i) there are upward adjustments in the
aggregate of 140,000 Shares to the number of Second Funding Shares and (ii) no
other Shares are issued).
In connection with the Transactions, the Board of Directors has
adopted, and proposes that the shareholders of the Company approve, an amendment
to the Amended and Restated Articles of Incorporation of the Company that would
increase the number of authorized shares of Common Stock of the Company from
20,000,000 shares to 35,000,000 shares (the "Articles of Amendment"). The
affirmative vote of the holders of at least a majority of the outstanding shares
of Common Stock entitled to vote on this proposal is required to approve the
Articles of Amendment. If approved by the shareholders, such increases in the
number of authorized shares of Common Stock will become effective upon the
filing with the Secretary of State of the State of Texas of an amendment to the
Company's Restated Articles of Incorporation setting forth such increase.
The Board of Directors believes that it is desirable to have additional
authorized shares of Common Stock available for issuance for purposes of raising
additional capital, for use in connection with acquisitions, stock dividends,
stock splits, and incentive compensation and other employee benefit plans and
for other general corporate purposes. Having additional authorized shares of
Common Stock available for issuance in the future would provide the Company with
greater flexibility in pursuing such corporate purposes and would allow
additional shares to be issued without the expense and delay associated with the
need under certain circumstances to call a special meeting of the shareholders
for purposes of approving an amendment to the Amended and Restated Articles of
Incorporation. The Articles of Amendment, if approved, will be filed on the date
of the Second Closing. Other than in connection with the Transactions, the
Company has no present plan or intention to issue any additional shares of
Common Stock, except for shares which have been reserved for issuance in
connection with stock options and currently outstanding warrants.
The additional shares of Common Stock for which authorization is sought
would be part of the existing class of Common Stock and, if and when issued,
would have the same rights and privileges as the shares of Common Stock
presently outstanding. If the Articles of Amendment are approved at the meeting,
generally no shareholder approval would be necessary for the issuance of all or
any portion of the additional shares of Common Stock unless required by law or
any rules or regulations to which the Company is subject or by the policies of
Nasdaq or any stock exchange on which the shares of stock of the Company may be
listed. Depending upon the consideration per share received by the Company for
any subsequent issuance of Common Stock, such issuance could have a dilutive
effect on those shareholders who paid a higher consideration per share for their
stock. Also, future issuances of Common Stock will increase the number of
outstanding shares, thereby decreasing the percentage ownership in the Company
(for voting, distributions and all other purposes) represented by existing
shares of Common Stock. The availability for issuance of the additional shares
of Common Stock may be viewed as having the effect of discouraging an
unsolicited attempt by another person or entity to acquire control of the
Company. Although the Board of Directors has no present intention of doing so,
the Company's authorized but unissued Common Stock could be issued in one or
more transactions that would make a takeover of the Company more difficult or
costly, and therefore less likely. The holders of Common Stock do not have
preemptive rights in connection with the issuance of additional shares of Common
Stock.
If the Articles of Amendment are adopted, the first sentence of Article
Four of the Company's Amended and Restated Articles of Incorporation will be
amended to read in its entirety as follows:
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<PAGE> 21
"The aggregate number of shares that the corporation shall
have the authority to issue is 40,000,000 shares, consisting of
35,000,000 shares of Common Stock, par value $0.01 per share, and
5,000,000 shares of Preferred Stock, par value $0.01 per share."
THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" APPROVAL OF PROPOSAL TWO.
PROPOSAL THREE
RATIFICATION OF APPOINTMENT OF DIRECTOR DESIGNEES
Pursuant to the Shareholders' Agreement, immediately upon the closing
of the sale of the Second Funding Shares and the consummation of the Tender
Offer, the Purchaser shall be entitled to designate four directors to serve on
the Board of Directors of the Company. See "Proposal One: Approval of the
Transactions -- Description of the Transactions -- Shareholders' and Voting
Agreement." In connection therewith, each of Messrs. Barry B. Conrad, Richard R.
Neitz, Jack R. Crosby and Douglas A. Smith have agreed to tender their
resignations from the Board of Directors of the Company effective as of the
closing of the sale of the Second Funding Shares. At such time, E. Thomas
Martin, Robert L. Burke, Joseph S. Whitaker and John McSorley will be appointed
by the remaining directors to fill such vacancies and to serve in their stead
for the appropriate remaining terms and until their successors are duly
qualified and elected. Accordingly, the Company believes it is appropriate to
request that shareholders ratify the appointment of the Director Designees,
although no such shareholder vote is required and the failure of the
shareholders to approve this proposal will not affect such appointments. The
affirmative vote of the holders of at least a majority of the shares of Common
Stock present and entitled to vote on this proposal is required to ratify the
appointment of the Director Designees.
Information with respect to the Director Designees is presented below.
None of the entities identified in such information, other than the Purchaser,
is affiliated with the Company.
DIRECTOR DESIGNEES
E. THOMAS MARTIN, Mr. Martin is the sole Manager and President
age 55 of the Purchaser. Since January 1999, he has
also served as President of Martin Resorts,
Inc. a company engaged in the business of
owning and managing resort properties and
based in San Luis Obispo, California. From
October 1991 through July 1998, Mr. Martin
served as President of MW Sign Corp., an
outdoor advertising company based in Paso
Robles, California, and from February 1976
to July 1998, Mr. Martin served as President
of Martin & McFarlane, Inc., another outdoor
advertising business. He also serves as a
director of Martin Resorts, Inc. and
Americorp.
ROBERT L. BURKE, Mr. Burke has been an educator with the Lake
age 55 Oswego School District in Lake Oswego,
Oregon since September 1993.
JOSEPH S. WHITAKER, Mr. Whitaker currently serves as a Vice
age 58 President of the Purchaser. For the past
five years, Mr. Whitaker has operated a
consulting business as a sole proprietorship
in La Jolla, California, providing services
related to marketing, licensing and product
development.
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<PAGE> 22
JOHN MCSORLEY, Mr. McSorley has served as President of
age 53 Double Bogey, LLC, a California limited
liability company engaged in investments and
located in San Rafael, California, since
December 1996. From November 1989 to October
1996, Mr. McSorley served as chief operating
officer and general partner of BayCom
Partners LP, a California limited
partnership.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" RATIFICATION OF PROPOSAL THREE.
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<PAGE> 23
PROPOSAL FOUR
APPROVAL OF AMENDMENTS TO 1997 STOCK OPTION PLAN
GENERAL
The DSI Toys, Inc. 1997 Stock Option Plan (the "Plan") was adopted by
the Board of Directors of the Company and its shareholders on May 1, 1997, prior
to the initial public offering of the Company's Common Stock. At a meeting of
the Board of Directors of the Company in April 1999, the Board of Directors
adopted a proposal to amend the Plan to (i) increase from 600,000 to 900,000 the
aggregate number of shares of Common Stock of the Company reserved for issuance
under the Plan and (ii) to make certain conforming changes. The proposal to
amend the Plan is subject to shareholder approval. The affirmative vote of the
holders of at least a majority of the shares of Common Stock present and
entitled to vote on this proposal is required to adopt and approve the proposal
to amend the Plan.
The purpose of the Plan is to foster and promote the financial success
of the Company by, among other things, enabling key employees to participate in
the long-term growth and financial success of the Company. The Plan is
administered by the Company's compensation committee, which is composed of three
non-employee directors. Any employee or director of the Company is eligible to
receive grants of stock options under the Plan.
All stock options granted under the Plan will have an exercise price
per share to be determined by the compensation committee, provided that the
exercise price per share under each stock option shall not be less than the fair
market value of the Common Stock at the time the stock option is granted (110%
of such fair market value in the case of incentive stock options granted to a
shareholder who owns 10% or more of the Company's Common Stock). The maximum
term for all stock options granted under the Plan is 10 years (5 years in the
case of an incentive stock option granted to a shareholder who owns 10% or more
of the Company's Common Stock). Stock options granted to the non-employee
directors are not intended to qualify as "incentive stock options" within the
meaning of Section 422A of the Internal Revenue Code of 1986, as amended (the
"Code").
The Board of Directors may at any time terminate, amend or modify the
Plan; provided, however, that no such action of the Board of Directors, without
the approval of the shareholders of the Company, may increase the total number
of shares of Common Stock which may be issued under the Plan, decrease the
minimum incentive stock option exercise price, extend the period during which
options may be granted pursuant to the Plan, or change the class of individuals
eligible to be granted options. No amendment to the Plan shall, without the
consent of an optionee, affect such optionee's rights under an option previously
granted.
REASONS AND PRINCIPAL EFFECTS OF THE PROPOSAL
Increase in Number of Shares. As of April 23, 1999, there were 51,000
shares of Common Stock available for future awards under the Plan. The primary
purpose of the proposal is to allow the Company to continue to attract and
retain qualified employees by increasing by 300,000 shares the aggregate number
of shares of Common Stock that may be issued under the Plan. If the proposal is
adopted, the employees of the Company who are eligible to participate in the
Plan could receive more benefits under the Plan than they could if the proposal
is not adopted.
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<PAGE> 24
UNITED STATES FEDERAL INCOME TAX CONSEQUENCES
Incentive Options. No income will be recognized by an optionee for
federal income tax purposes upon the grant or exercise of an incentive option.
The basis of shares transferred to an optionee pursuant to the exercise of an
incentive option is the price paid for such shares. If the optionee holds such
shares for at least one year after transfer of the shares to the optionee and
two years after the grant of the option, the optionee will recognize capital
gain or loss upon sale of the shares received upon such exercise equal to the
difference between the amount realized on such sale and the exercise price.
Generally, if the shares are not held for that period, the optionee will
recognize ordinary income upon disposition in an amount equal to the excess of
the fair market value of the shares on the date of exercise over the option
price of such shares, or if less (and if the disposition is a transaction in
which loss, if any, will be recognized), the gain on disposition. Any additional
gain realized by the optionee upon such disposition will be a capital gain.
The excess of the fair market value of shares received upon the
exercise of an incentive option over the option price for such shares is an item
of adjustment for the optionee for purposes of the alternative minimum tax.
The Company is not entitled to a deduction upon the exercise of an
incentive option by an optionee. If the optionee disposes of the shares of stock
received pursuant to such exercise prior to the expiration of one year following
transfer of the shares to the optionee or two years after grant of the option,
however, the Company may deduct an amount equal to the ordinary income
recognized by the optionee upon disposition of the shares at the time such
income is recognized by the optionee.
If an optionee uses already owned shares of Common Stock to pay the
exercise price for shares under an incentive option, the resulting tax
consequences will depend upon whether such already owned shares of Common Stock
are "statutory option stock", and, if so, whether such statutory option stock
has been held by the optionee for the applicable holding period referred to in
Section 424(c)(3)(A) of the Code. In general, "statutory option stock" (as
defined in Section 424(c)(3)(B) of the Code) is any stock acquired through the
exercise of an incentive stock option, a qualified stock option, an option
granted pursuant to an employee stock purchase plan or a restricted stock
option, but not through the exercise of a nonqualified stock option. If such
stock is statutory option stock with respect to which the applicable holding
period has been satisfied, no income will be recognized by the optionee upon the
transfer of such stock in payment of the exercise price of an incentive option.
If such stock is not statutory option stock, no income will be recognized by the
optionee upon the transfer of such stock unless such stock is not substantially
vested within the meaning of the regulations under Section 83 of the Code (in
which event it appears that the optionee will recognize ordinary income upon the
transfer equal to the amount by which the fair market value of the transferred
shares exceeds their basis). If the stock used to pay the exercise price of an
incentive option is statutory option stock with respect to which the applicable
holding period has not been satisfied, the transfer of such stock will be a
disqualifying disposition described in Section 421(b) of the Code which will
result in the recognition of ordinary income by the optionee in an amount equal
to the excess of the fair market value of the statutory option stock at the time
the option covering such stock was exercised over the option price of such
stock. Under the present provisions of the Code, it is not clear whether all
shares received upon the exercise of an incentive option with already owned
shares will be statutory option stock or how the optionee's basis will be
allocated among such shares.
Nonqualified Options. No income will be recognized by an optionee for
federal income tax purposes upon the grant of a nonqualified option. Except as
described below in the case of an "insider" subject to Section 16(b) of the
Exchange Act who exercises his or her option less than six months from the date
of grant, upon exercise of a nonqualified option, the optionee will recognize
ordinary income in an amount equal to the excess of the fair market value of the
shares on the date of exercise over the option price of such shares. In the
absence of an election pursuant to Section 83(b) of the Code, an "insider"
subject to Section 16(b) of the Exchange Act who exercises a nonqualified option
less than six months from the date the option was granted will recognize income
on the date six months after the date of grant in an amount equal to the excess
of the fair market value of the shares on such date over the option price of
such shares. An optionee subject to Section 16(b) of the Exchange Act can avoid
such deferral by making an election, pursuant to Section 83(b) of the Code, no
later than 30 days after the date of exercise. Executive officers, directors and
10 percent shareholders of the Company will generally be deemed to be "insiders"
for purposes of Section 16(b) of the Exchange Act.
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<PAGE> 25
Income recognized upon the exercise of nonqualified options will be
considered compensation subject to withholding at the time such income is
recognized, and therefore, the Company or an affiliate must make the necessary
arrangements with the optionee to ensure that the amount of the tax required to
be withheld is available for payment. Nonqualified options are designed to
ensure that the Company will be entitled to a deduction equal to the amount of
ordinary income recognized by the optionee at the time of such recognition by
the optionee.
The basis of shares transferred to an optionee pursuant to exercise of
a nonqualified option is the price paid for such shares plus an amount equal to
any income recognized by the optionee as a result of the exercise of such
option. If an optionee thereafter sells shares acquired upon exercise of a
nonqualified option, any amount realized over the basis of such shares will
constitute capital gain to such optionee for federal income tax purposes.
If an optionee uses already owned shares of Common Stock to pay the
exercise price for shares under a nonqualified option, the number of shares
received pursuant to the option which is equal to the number of shares delivered
in payment of the exercise price will be considered received in a nontaxable
exchange, and the fair market value of the remaining shares received by the
optionee upon such exercise will be taxable to the optionee as ordinary income.
If such already owned shares of Common Stock are not "statutory option stock"
(which is defined in Section 424(c)(3)(B) of the Code to include any stock
acquired through the exercise of an incentive stock option, a qualified stock
option, an option granted pursuant to an employee stock purchase plan or a
restricted stock option, but not through the exercise of a nonqualified stock
option) or are statutory option stock with respect to which the applicable
holding period referred to in Section 424(c)(3)(A) of the Code has been
satisfied, the shares received pursuant to the exercise of the option will not
be statutory option stock and the optionee's basis in the number of shares
delivered in payment of the exercise price will be equal to the basis of the
shares delivered in payment. The basis of the remaining shares received upon
such exercise will be equal to the fair market value of such shares. However, if
such already owned shares of Common Stock are statutory option stock with
respect to which the applicable holding period has not been satisfied, it is not
presently clear whether such exercise will be considered a disqualifying
disposition of the statutory option stock, whether the shares received upon such
exercise will be statutory option stock or how the optionee's basis will be
allocated among the shares received.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" ADOPTION AND APPROVAL OF
PROPOSAL FOUR.
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<PAGE> 26
ADDITIONAL INFORMATION REGARDING THE BOARD OF DIRECTORS
BOARD MEETINGS AND COMMITTEES
During fiscal 1998 the Board of Directors held five (5) meetings. The
Company has standing audit, compensation, executive, and stock option
administrative committees of the Board of Directors. The Board of Directors does
not have a nominating committee. The selection of nominees for the Board of
Directors is made by the entire Board of Directors. The current members of the
committees, number of meetings held by each committee in fiscal 1998, and a
brief description of the functions performed by each committee are set forth
below:
Audit Committee (2 meetings). Joseph N. Matlock, Chairman;
M.D. Davis and Barry B. Conrad. The primary responsibilities of the
audit committee are to review with the Company's auditors the scope of
the audit procedures to be applied in conducting the annual audit and
the results of the annual audit.
Compensation Committee (4 meetings). Barry B. Conrad,
Chairman; Jack R. Crosby; Joseph N. Matlock; and Douglas A. Smith. The
primary responsibilities of the compensation committee are to review
and set the compensation levels of the officers of the Company,
including those officers who are also directors, evaluate the
performance of management, consider management succession and related
matters and administer the annual compensation plans of the Company.
Executive Committee (2 meetings). M.D. Davis, Chairman;
Barry B. Conrad and Joseph N. Matlock. The primary responsibilities of
the executive committee are to advise the Company's officers and to act
on certain matters at times between meetings of the full board of
directors.
Stock Option Administrative Committee (4 meetings). Barry B.
Conrad, Chairman; Jack R. Crosby, Joseph N. Matlock and Douglas A.
Smith. The primary responsibility of the committee is to administer the
Stock Option Plan, including the granting of options.
Compensation Committee Interlocks and Insider Participation. The
current members of the compensation committee identified above were the only
persons who served on such committee during fiscal 1998. No officer or employee
of the Company is a member of the Company's compensation committee. No member of
the Board of Directors of the Company or its compensation committee serves as a
member of the Board of Directors or compensation committee of an entity that has
one or more executive officers serving as a member of the Company's Board of
Directors or compensation committee.
COMPENSATION OF DIRECTORS
Annual Retainer and Other Fees and Expenses. Non-employee directors are
paid an annual retainer of $20,000. The Company also reimburses directors for
travel, lodging and related expenses they may incur in attending Board and
committee meetings.
Non-Employee Director Stock Options. Under the 1997 Stock Option Plan
(the "Stock Option Plan"), which was approved and ratified by shareholders on
May 1, 1997, non-employee directors may from time to time at the discretion of
the Stock Option Committee, receive a grant of an option to purchase Common
Stock of the Company. The options are granted at an exercise price as determined
by the Committee and are exercisable, as determined by the Committee, from time
to time over a period of ten years from grant date, unless sooner terminated as
described in the Stock Option Plan.
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<PAGE> 27
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth as of April 23, 1999 the beneficial
ownership of Common Stock by (i) each director of the Company, each named
executive officer listed in the Summary Compensation Table appearing in this
proxy statement, each Director Designee and all directors and executive officers
as a group and (ii) the only other persons who were known to the Company to be
the beneficial owners of more than five percent of the outstanding shares of
Common Stock.
<TABLE>
<CAPTION>
COMMON STOCK
BENEFICIALLY OWNED (1)
---------------------------
NUMBER PERCENT OF
NAME OF SHARES CLASS
- ---- --------- ----------
<S> <C> <C>
Directors
M.D. Davis 534,945 (2) 8.07%
Richard R. Neitz 178,500 (2) 2.72%
Barry B. Conrad 107,674 (2) 1.64%
Jack R. Crosby 429,115 (2)(3) 6.53%
Joseph N. Matlock 336,110 (2) 5.12%
Douglas A. Smith 381,849 (2) 5.81%
Named Executive Officers (excluding
any director named above) and Group
Howard G. Peretz 2,500 (2) *
Tommy Yau 86,000 (2) 1.31%
J Russell Denson (4) 171,000 (2) 2.54%
Stuart J. Drell (5) 6,000 (2) *
All current directors and executive officers 2,136,026 (6) 32.11%
as a group (11 persons)
Director Designees
E. Thomas Martin 4,238,491 (7)(8) (8)
Robert L. Burke -- --
Joseph S. Whitaker 2,000 *
John McSorley -- --
Certain Other Beneficial Owner
MVII, LLC 4,098,491 (8) (8)
</TABLE>
* Represents less than 1%.
(1) Unless otherwise indicated, the beneficial owner has sole voting and
investment power with respect to all Shares listed.
(2) Includes Shares attributable to shares of Common Stock not outstanding but
subject to options currently exercisable, or exercisable within 60 days, as
follows: Mr. Davis -- 60,000 Shares; Mr. Neitz -- 6,000 Shares; Mr. Conrad
-- 2,000 Shares; Mr. Crosby -- 2,000 Shares; Mr. Matlock -- 2,000 Shares;
Mr. Smith -- 2,000 Shares; Mr. Peretz -- 2,500 Shares; Mr. Yau -- 6,000
Shares; Mr. Denson -- 170,000 Shares; and Mr. Drell -- 6,000 Shares.
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<PAGE> 28
(3) Includes 427,115 Shares owned of record by Rust Capital, Ltd., as to which
Mr. Crosby is founder and Chairman.
(4) Mr. Denson left the Company effective February 28, 1999.
(5) Mr. Drell passed away on April 15, 1999, and beneficial ownership for Mr.
Drell is given as of that date.
(6) Includes 85,500 Shares not outstanding but subject to options currently
exercisable or options exercisable within 60 days. Does not include Shares
owned by Mr. Denson and Mr. Drell.
(7) Includes 140,000 shares of Common Stock owned beneficially and of record by
Mr. Martin. Mr. Martin and his wife, Noreen Martin, own ninety-nine percent
(99%) of the membership interests of the Purchaser, MVII, LLC. Mr. Martin
is the sole Manager and the President of the Purchaser.
(8) Includes 566,038 Shares purchased by the Purchaser (which is controlled by
Mr. Martin) from the Company on April 15, 1999. Also includes Shares
beneficially owned, but not currently owned of record, by the Purchaser, as
follows: 1,600,000 Shares which the Management Shareholders have agreed to
tender into the Tender Offer pursuant to the Side Letter Agreements;
1,792,453 Shares which the Purchaser has agreed to purchase pursuant to the
Stock Purchase Agreement; and 140,000 Shares representing the maximum
upward adjustments of the number of Second Funding Shares under the Stock
Purchase Agreement. Upon consummation of the transactions contemplated by
the Stock Purchase Agreement, including the Tender Offer, the Purchaser
will be the record and beneficial owner of 48%, and Mr. Martin (through his
control of the Purchaser) will be the beneficial owner of 50%, of the total
number of shares of the Common Stock then outstanding (assuming (i) there
are upward adjustments in the aggregate of 140,000 Shares to the number of
Second Funding Shares and (ii) no other Shares are issued). Pursuant to the
Shareholders' Agreement, each of the Management Shareholders has executed
an irrevocable proxy appointing the Purchaser as proxy and authorizing the
Purchaser to vote such Management Shareholder's Shares with respect to all
Company-related matters subject to a shareholders vote, subject to certain
exceptions, effective as of the closing of the sale of the Second Funding
Shares. Both the voting agreement in the Shareholders' Agreement and the
irrevocable proxies are conditioned upon and have an effective date of the
Second Closing. In the event the Management Shareholders do not tender any
Shares owned by them into the Tender Offer and the Minimum Tender Condition
is otherwise met, there is a possibility that, upon consummation of the
transactions contemplated by the Stock Purchase Agreement, including the
Tender Offer, the Purchaser will be the beneficial owner of 5,820,184 (68%)
and Mr. Martin (through his control of the Purchaser) will be the
beneficial owner of 5,960,184 (70%) of the shares of Common Stock then
outstanding (assuming (i) there are upward adjustments in the aggregate of
140,000 Shares to the number of Second Funding Shares and (ii) no other
Shares are issued), by virtue of the Purchaser's power to vote Shares held
by the Management Shareholders pursuant to the Shareholders' Agreement and
the irrevocable proxies. To the best of the Company's knowledge, all of the
Management Shareholders currently intend to tender Shares owned by them
into the Offer. The number of Shares in the table above does not include
the Shares with respect to which the Purchaser may acquire the right to
vote pursuant to the Shareholders' Agreement and the irrevocable proxies.
See "Proposal One: Approval of the Transactions -- Description of the
Transactions."
The respective addresses of the holders of five percent or more of the
Common Stock of the Company are as follows: M.D. Davis, 13606 Taylorcrest,
Houston, Texas 77079; Jack R. Crosby, 327 Congress Avenue, Suite 350 Austin,
Texas 78701; Joseph N. Matlock, 4307 Farhills Drive, Austin, Texas 78731;
Douglas A. Smith, 6829 Golf Drive, Dallas, Texas 75205; and the Purchaser and E.
Thomas Martin, 654 Osos Street, San Luis Obispo, California 93401.
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<PAGE> 29
EXECUTIVE COMPENSATION
The following report of the compensation committee on executive
compensation and the information herein under "Executive
Compensation--Performance Graph" shall not be deemed to be "soliciting material"
or to be "filed" with the Commission or subject to the Commission's proxy rules,
except for the required disclosure herein, or to the liabilities of Section 18
of the Securities Exchange Act of 1934 (the "Exchange Act"), and such
information shall not be deemed to be incorporated by reference into any filing
made by the Company under the Securities Act of 1933 or the Exchange Act.
REPORT OF THE COMPENSATION COMMITTEE
ON EXECUTIVE COMPENSATION
The Compensation and Stock Option Administrative Committees (collectively
the "Committee") of the Board of Directors are currently composed entirely of
outside, non-employee directors. The Compensation Committee reviews and sets the
compensation levels of the Company's Chief Executive Officer ("CEO") and other
executives, evaluates the performance of management, and considers management
succession and related matters. The Stock Option Administrative Committee
administers the Stock Option Plan. All decisions by the Committee relating to
the compensation of executive officers are reviewed by the full Board.
The Company has retained the services of The Penicle Group, a management
and compensation consulting firm, to assist the Committee in the performance of
its responsibilities. The Committee considers information with respect to the
reasonableness of compensation paid to senior officers of the Company, as well
as all employees of the Company and its subsidiaries in managerial positions.
The Committee also takes into account how compensation compares to compensation
paid by competitors in the Company's industry as well as the performance of the
Company.
Compensation Policies and Programs
The compensation policies of the Company, set by management and supported
by the Committee, focus on enhancing shareholder value. Specific policies are
designed to attract, motivate and retain persons of high quality who will have
the skill, training and dedication to assist the Company to achieve its
corporate goals. The executive compensation program for fiscal 1998 consisted of
three elements: base salary, annual incentive bonus, and long-term incentive
through the granting of stock options pursuant to the Stock Option Plan.
Base Salary: Base salary for executive officers is determined principally
by competitive factors and the marketplace. The policy of the Committee is
generally to set base salary levels for positions at approximately the median
levels determined from survey information for positions deemed comparable by the
Committee.
Annual Incentive Bonus: The compensation policy of the Company is that a
part of the annual compensation of each officer be related to and contingent
upon the performance of the Company, as well as the individual contribution of
each officer.
Long-term Incentive Compensation: It is also the compensation policy of the
Company to use stock options as a means of furnishing longer-term incentive to
officers and other employees of the Company and its subsidiary. Under the Stock
Option Plan, which was approved by shareholders in 1997, the Company has
flexibility in creating options.
26
<PAGE> 30
On August 20, 1998, Howard G. Peretz was granted stock options that were
based on his responsibilities and relative position in the Company. All stock
options in 1998 were granted with an exercise price of fair market value at the
date of grant. Except as noted below, the stock options vest over seven
anniversary dates commencing April 5, 1999 and each April 5 thereafter through
April 5, 2004. Five percent of the stock options vest each April 5, 1999-2002;
fifteen percent vest on April 5, 2003 and 2004 and fifty percent vest on August
30, 2004. In the first fiscal year beginning in fiscal 1999 (if any) in which
the Company's common stock trades above $2.00 for 10 consecutive trading days,
then, at the end of that fiscal year, 33-1/3% of the options, less the portion
that vested on April 5 of that fiscal year, vest. In the first subsequent fiscal
year (if any) in which the Company's common stock trades above $4.00 for 10
consecutive trading days, then, at the end of that fiscal year, 33-1/3% of the
options, less the portion that vested on April 5 of that fiscal year, vest. In
the first subsequent fiscal year (if any) in which the Company's common stock
trades above $6.00 for 10 consecutive trading days, then, at the end of that
fiscal year, the remaining options vest.
Stock options to purchase 20,000 shares of Common Stock were granted to Mr.
J. Russell Denson in fiscal 1998. In connection with Mr. Denson's departure from
the Company, all outstanding options held by him terminate on August 31, 1999,
if not exercised before such date.
FISCAL 1998 COMPENSATION OF CEO
The 1998 salary of the CEO, M.D. Davis, of $150,000 was determined by an
employment agreement negotiated in good faith and entered in effective December
11, 1995, the term of which expired on December 31, 1998. The compensation
amount was based upon the job description and time commitment of the position as
set forth in the Agreement. The Compensation Committee believes that Mr. Davis'
compensation level is appropriate.
TAX DEDUCTIBILITY OF EXECUTIVE COMPENSATION
Section 162(m) of the Internal Revenue Code contains provisions which could
limit the deductibility of certain compensation payments to the Company's
executive officers. The Company believes that any compensation realized in
connection with the exercise of stock options granted by the Company will
continue to be deductible as performance-based compensation. The policy of the
Company is to design its compensation programs generally to preserve the tax
deductibility of compensation paid to its executive officers. The Committee
could determine, however, taking into consideration the burdens of compliance
with Section 162(m) and other relevant facts and circumstances, to pay
compensation that is not fully deductible, if the Committee believes such
payments are in the Company's best interests.
SUMMARY
The members of the Committee believe that linking executive compensation to
corporate performance results in a better alignment of compensation with
corporate goals and shareholder interests. As performance goals are met or
exceeded, resulting in increased value to shareholders, executive officers are
to be rewarded commensurately. The members of the Committee believe that
compensation levels during fiscal 1998 adequately reflect the compensation goals
and policies of the Company. No executive compensation increases have been
announced, and none are planned for fiscal 1999.
Barry B. Conrad
Jack R. Cosby
Joseph N. Matlock
Douglas A. Smith
27
<PAGE> 31
The following table sets forth certain summary information concerning the
compensation awarded to, earned by or paid to the Chief Executive Officer of the
Company, and the five (including one employee of a subsidiary) other highest
paid executive officers of the Company (collectively, the "named executive
officers") for the years indicated.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
ANNUAL COMPENSATION LONG-TERM COMPENSATION
----------------------- ------------------------------------
NAME AND PRINCIPAL FISCAL OTHER ANNUAL STOCK OPTION/SARS ALL OTHER
POSITION YEAR SALARY BONUS COMPENSATION (NUMBER OF SHARES)(1) COMPENSATION
------------------ ------ -------- ----- ------------ --------------------- -------------
<S> <C> <C> <C> <C> <C> <C>
M. D. Davis, 1998 $150,000 $ -- $ -- -- $ 3,202 (2)(3)
Chairman and Chief 1997 150,000 -- -- 60,000 3,274 (2)(3)
Executive Officer 1996 150,000 500 -- -- 9,500 (2)
Richard R. Neitz, 1998 225,000 -- -- -- 5,174 (2)(3)
President and Chief 1997 225,000 -- -- 60,000 4,462 (2)(3)
Operating Officer 1996 225,000 500 -- -- 10,100 (2)(3)
Howard G. Peretz, 1998 80,538 -- 114,800 (5) 50,000 150 (2)
Senior Vice President (4) -- -- --
Tommy Yau, Managing 1998 180,000(6) -- -- -- --
Director - DSI (HK) 1997 180,000(6) -- -- 60,000 --
Limited 1996 180,000(6) 9,500(6) -- -- --
Russell Denson, 1998 180,000 -- -- 20,000 3,714 (2)(3)
former Executive Vice 1997 145,000 -- -- 150,000 359 (2)(3)
President and Chief
Financial Officer(7)
Stuart J. Drell, 1998 175,000 -- 22,751(9) -- 3,242 (2)(3)
former Senior Vice 1997 29,167 -- -- -- --
President (8)
</TABLE>
(1) Options represent the right to purchase shares of Common Stock at a fixed
price per share.
(2) Includes Company contributions or other allocations to defined contribution
plan, as follows: Mr. Davis -- $2,500, $2,375 and $9,500 for fiscal 1998,
1997 and 1996, respectively; Mr. Neitz -- $2,500, $1,579 and $9,500 for
fiscal 1998, 1997 and 1996, respectively; Mr. Denson -- $3540 and $210 for
fiscal 1998 and 1997, respectively; and Mr. Drell -- $2,792.
31
28
<PAGE> 32
(3) Includes life insurance premiums as follows: Mr. Davis --$702 and $899 for
fiscal 1998 and 1997, respectively; Mr. Neitz -- $2,674, $2,883 and $600
for fiscal 1998, 1997 and 1996, respectively; Mr. Peretz: $150; Mr. Denson
-- $174 and $149 for fiscal 1998 and 1997, respectively; and Mr. Drell --
$450.
(4) Mr. Peretz was engaged as a consultant in April 1998 and became an employee
of the Company on August 20, 1998.
(5) Consists of (i) $50,000 moving allowance and (ii) $64,800 in consulting
fees paid prior to August 20, 1998.
(6) Pursuant to Mr. Yau's employment agreement dated December 11, 1995, he is
paid HK $116,000 per month which, based on average exchange rates,
translates to US $180,000 per annum. Mr. Yau was paid a bonus of HK $73,483
for fiscal 1996, which, based on average exchange rates at the time,
translates to US $ 9,500.
(7) Mr. Denson became an employee of the Company in March 1997 and left the
Company effective February 28, 1998.
(8) Mr. Drell became an employee of the Company in December 1997 and passed
away on April 15, 1999.
(9) Consists of interim travel and lodging allowance.
The following table sets forth certain information with respect to options
to purchase Common Stock granted during the year ended January 31, 1999 to each
of the named executive officers.
OPTION/SAR GRANTS IN FISCAL 1998
<TABLE>
- --------------------------------------------------------------------------------------------------------
POTENTIAL REALIZABLE VALUE
% OF AT ASSUMED ANNUAL RATES OF
NUMBER TOTAL PER STOCK PRICE APPRECIATION
OF OPTIONS SHARE FOR OPTION TERM(2)
OPTIONS/SARS GRANTED TO EXERCISE EXPIRATION --------------------------
NAME GRANTED EMPLOYEES PRICE(1) DATE 5% 10%
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Howard G. Peretz 50,000(3) 61% $ 1.14 8/19/08 $ 35,847 $ 90,843
- --------------------------------------------------------------------------------------------------------
J. Russell Denson 20,000(4) 24% $ 1.94 5/11/08(4) 24,401 61,837
- --------------------------------------------------------------------------------------------------------
</TABLE>
(1) All grants were made at the average fair market value as of the date of
grant.
(2) The "potential realizable value" shown will be achieved only if the options
have been held for the full ten years and the stock price has appreciated
at the assumed rate. For the named executive officers, the value is
calculated from the option price per share of options granted in fiscal
year 1997. Potential realizable value is listed for illustration purposes
only. The values disclosed are not intended to be and should not be
interpreted as representations or projections of future value of Company
stock or of the stock price.
(3) Consists of incentive stock options for 50,000 Shares vesting as follows:
5% on each of April 5, 1999; April 5, 2000; April 5, 2001; and April 5,
2002; 15% on each of April 5, 2003 and April 5, 2004; and 50% on August 30,
2004. Subject to accelerated vesting (see "Executive Compensation --
Compensation Policies and Program").
(4) Consists of non-qualified stock options for 20,000 Shares. Mr. Denson left
the Company effective February 28, 1999, and in connection therewith all
options were vested on such date and will expire on August 31, 1999, unless
sooner exercised.
29
<PAGE> 33
The following table sets forth certain information with respect to the
exercise of options to purchase Common Stock and SARs during the year ended
January 31, 1999, and the unexercised options held at January 31, 1999 and the
value thereof, by each of the named executive officers.
AGGREGATED OPTION EXERCISES IN FISCAL 1998
AND 1/31/99 OPTION VALUES
<TABLE>
<CAPTION>
SHARES NUMBER OF SECURITIES VALUE OF UNEXERCISED
ACQUIRED UNDERLYING OPTIONS/SARS IN-THE-MONEY OPTIONS/SARS
ON EXERCISE AT 1/31/99 (SHARES) AT FISCAL YEAR END
(NUMBER VALUE -------------------------- --------------------------
NAME OF SHARES) REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
----- ----------- -------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
M.D. Davis 0 $ 0 6,000 54,000 $ 0 $ 0
Richard R. Neitz 0 0 6,000 54,000 0 0
Howard G. Peretz 0 0 0 50,000 0 0
Tommy Yau 0 0 6,000 54,000 0 0
J. Russell Denson(1) 0 0 35,166 134,834 0 0
Stuart J. Drell(2) 0 0 6,000 54,000 0 0
</TABLE>
(1) Mr. Denson left the Company effective February 28, 1999, and in connection
therewith all options were vested as of such date and will expire on August
31, 1999, unless sooner exercised.
(2) Mr. Drell passed away on April 15, 1999. All non-vested options terminated
upon his death, and vested options expire April 15, 2000.
EMPLOYMENT AND RELATED AGREEMENTS
As a condition to the Purchaser's obligation to purchase the Second
Funding Shares, the Company and M.D. Davis will enter into the Consulting
Agreement which shall be effective as of the date of the Second Closing,
pursuant to which Mr. Davis shall cease to be an employee and officer of the
Company and shall provide consulting services to the Company for a period ending
on the third annual anniversary of the date of the Second Closing. As
compensation for his services under the Consulting Agreement, Mr. Davis shall be
entitled to compensation in the amount of $450,000, payable in equal monthly
installments of $12,500. Mr. Davis shall be entitled to such compensation
irrespective of a termination of the Consulting Agreement, unless such
termination is by Mr. Davis for reasons other than a breach by the Company of
its obligations under the Consulting Agreement. The Consulting Agreement
contains a non-disclosure covenant similar to the non-disclosure covenant
contained in Mr. Davis' expired employment agreement with the Company, a copy of
which is filed as a part of the Company's Registration Statement on Form S-1
filed with the Commission on May 29, 1997.
The Company has entered into an employment agreement with Richard R.
Neitz. Pursuant to this agreement, Mr. Neitz will be employed as President and
Chief Operating Officer until January 31, 2000 and will be paid an annual salary
of $225,000 (which salary may be raised at the discretion of the Board of
Directors). Beginning with fiscal 1996, Mr. Neitz is entitled to a fiscal
year-end performance bonus equal to 2% of the Company's total pre-tax income,
provided that such pre-tax income exceeds $5.8 million. The agreement
30
<PAGE> 34
contains non-disclosure, non-competition and non-solicitation provisions
applicable during the term of employment under the agreement and until one year
after termination of employment. Upon termination of Mr. Neitz's employment
without cause the Company must continue to pay Mr. Neitz his salary for a period
of six months (in the event the non-competition provisions are enforced, the
Company is obligated to pay an additional one-year salary during the non-compete
period) following termination and must pay a pro-rated performance bonus.
DSI (HK) has entered into an employment agreement with Tommy Yau, pursuant
to which he will be employed as Managing Director of DSI (HK) until January 31,
2000 and will be paid a monthly salary of HK $116,000 (approximately US $15,000
based on currency exchange rates). Beginning with fiscal 1996, Mr. Yau is
entitled to a fiscal year-end performance bonus equal to 2% of the Company's
total pre-tax income, provided that such pre-tax income exceeds $5.8 million.
The agreement contains non-disclosure, non-competition and non-solicitation
provisions applicable during the term of employment under the agreement and
until one year after termination of employment. Upon termination of Mr. Yau's
employment without cause the Company must continue to pay Mr. Yau his salary for
a period of six months (in the event the non-competition provisions are
enforced, the Company is obligated to pay an additional one-year salary during
the non-compete period) following termination and must pay a pro-rated
performance bonus.
The Company has entered into an employment agreement with Howard G.
Peretz. Pursuant to this agreement, Mr. Peretz will be employed as Senior Vice
President - Marketing and Strategic Planning until August 19, 2001 and will be
paid an annual salary of $180,000 during the first year of the contract, with a
guaranteed raise of $10,000 per year for the remaining two years of the contract
(which salary may be raised at the discretion of the Board of Directors). Mr.
Peretz is entitled to participate in the Company's fiscal year-end performance
bonus program on an executive level determined by the Board of Directors. The
agreement contains non-disclosure, non-competition and non-solicitation
provisions applicable during the term of employment under the agreement and
until one year after termination of employment. Upon a sale of all or
substantially all of the assets of the Company, or upon a merger or
consolidation in which the Company is not the survivor, Mr. Peretz's stock
options to purchase 50,000 shares of Common Stock will immediately vest and will
expire thirty days thereafter if not exercised. Upon termination of Mr. Peretz's
employment without cause the Company must continue to pay Mr. Peretz his salary
for a period of six months (in the event the non-competition provisions are
enforced, the Company is obligated to pay an additional one-year salary during
the non-compete period) following termination and must pay a pro-rated
performance bonus.
The Company has entered into similar employment agreements with its other
executive officers.
31
<PAGE> 35
PERFORMANCE GRAPH
The following graph sets forth the cumulative total shareholder return for
the Common Stock, the Standard & Poor's 500 Index and a Competitor Group Index
since May 29, 1997 (the date on which the Common Stock was first traded on the
Nasdaq Market).
COMPARISON OF CUMULATIVE TOTAL RETURN (1)
AMONG DSI TOYS, INC., STANDARD & POOR'S 500 INDEX
AND COMPETITOR GROUP INDEX (2)
[GRAPH]
<TABLE>
<CAPTION>
5/29/97 1/31/98 1/31/99
------- ------- -------
<S> <C> <C> <C>
DSI Toys, Inc. $100 $ 30 $ 21
Peer Group $100 $103 $ 88
Standard & Poor's 500 Index $100 $124 $164
</TABLE>
(1) Total return assuming reinvestment of dividends. Assumes $100 invested on
May 29, 1997 in Common Stock, the Standard & Poor's 500 Index and a Company
constructed competitor group index.
(2) In accordance with the SEC's rules, the Company has elected to select a
group of peer companies on an industry basis for comparison purposes. The
competitor group is composed of 10 industry participants: Empire of
Carolina, Inc., Equity Marketing, Inc., Grand Toys International Inc.,
Jakks Pacific Inc., Janex International, Inc., Just Toys Inc., Marvel
Enterprises Inc. (formerly named ToyBiz, Inc.), Play by Play Toys &
Novelties, Inc., Racing Champions Corp., Toymax International, Inc. Total
return calculations were weighted according to the respective company's
market capitalization. Two companies that were included in the 1997 peer
group index are not included in the 1998 peer group index because one
(Galoob Toys Inc.) was acquired by another company and another (Yes!
Entertainment Corporation) has filed a voluntary bankruptcy petition under
Chapter 11 and has been delisted by Nasdaq.
32
<PAGE> 36
CERTAIN TRANSACTIONS
Information concerning certain transactions involving the Company, the
Purchaser, the Director Designees and certain directors and executive officers
of the Company is described above in "Background," "Proposal One: Approval of
the Transactions" and "Proposal Three: Ratification of Appointment of Director
Designees."
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Exchange Act requires directors and officers of
the Company, and persons who own more than 10 percent of the Common Stock, to
file with the Commission initial reports of ownership and reports of changes in
ownership of such stock. Directors, officers and beneficial owners of more than
10 percent of the Common Stock are required by Commission regulations to furnish
the Company with copies of all Section 16(a) forms they file.
To the Company's knowledge, based solely on a review of the copies of
such reports furnished to the Company and written representations that no other
reports were required, during the year ended January 31, 1999, all Section 16(a)
filing requirements applicable to its directors, officers, and beneficial owners
of more than 10 percent of its Common Stock were met.
AUDITORS
PricewaterhouseCoopers LLP has audited the Company's financial
statements since September 1, 1992. Representatives of PricewaterhouseCoopers
LLP are expected to be present at the meeting to respond to appropriate
questions from the shareholders and will be given the opportunity to make a
statement should they desire to do so. The Board of Directors will take action
after consummation of the Transactions to appoint the accountant to audit the
financial statements of the Company for the year ending January 31, 2000.
SHAREHOLDER PROPOSALS AND OTHER MATTERS
Shareholder proposals for inclusion in the Company's proxy materials in
connection with the 2000 annual meeting of shareholders must be received by the
Company at its office in Houston, Texas, addressed to the Secretary of the
Company, no later than January 11, 2000, in accordance with Rule 14a-8 under the
Exchange Act.
With respect to shareholder proposals which are not intended to be
included in the Company's proxy statement, the Bylaws of the Company provide
that notice of any such shareholder proposal must be received at the Company's
principal executive office not less than 80 days prior to the annual meeting,
or, in the event that the date of the meeting was not publicly announced by the
Company in the manner specified in the Bylaws more than 90 days prior to the
meeting, not later than the close of business on the tenth day following the day
on which the date of the meeting was publicly announced.
The cost of soliciting proxies will be borne by the Company. The
Company may retain a proxy solicitation firm to solicit proxies from brokers,
banks, nominees, institutional holders and individual holders for use at the
meeting. In addition, the Company may use certain of its officers and employees
(who will receive no special compensation therefor) to solicit proxies in person
or by telephone, facsimile, telegraph or similar means.
33
<PAGE> 37
The Board of Directors does not intend to present any other matter at
the meeting and knows of no other matters that will be presented. However, if
any other matter comes before the meeting, the persons named in the enclosed
proxy intend to vote thereon in accordance with their best judgment.
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
The Company's 1998 annual report is being mailed to shareholders
concurrently with this proxy statement. The following items contained in the
1998 annual report are hereby incorporated by reference into this proxy
statement: Item 7, Management's Discussion and Analysis of Financial Condition
and Results; Item 9, Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure; and the audited financial statements and
schedules of the Company.
DSI TOYS, INC.
/s/ M.D. DAVIS
M.D. Davis
Chairman and
Chief Executive Officer
Houston, Texas
May 7, 1999
<PAGE> 38
ANNEX A
STOCK PURCHASE AND SALE AGREEMENT
by and between
DSI TOYS, INC.,
and
MVII, LLC
Dated as of April 15, 1999
<PAGE> 39
This STOCK PURCHASE AND SALE AGREEMENT ("Agreement") is entered into by
and between MVII, LLC, a limited liability company formed under the laws of the
State of California ("Buyer"), and DSI Toys, Inc., a Texas corporation (the
"Company"). This Agreement is made with specific reference to the following
facts:
RECITALS:
A. WHEREAS, the Company owns and operates a business engaged in
the development, manufacturing and distribution of toys and
children's consumer electronics;
B. WHEREAS, the Board of Directors of the Company has approved
the sale of five hundred sixty-six thousand thirty-eight
(566,038) shares (the "Initial Funding Shares") of common
stock, par value $.01 per share, of the Company (the "Common
Stock" or the "Shares"), on the Initial Closing Date (as that
term is defined herein) and an additional one million seven
hundred ninety-two thousand four hundred fifty- three
(1,792,453) Shares (the "Second Funding Shares") on the Second
Closing Date (as that term is defined herein) plus a potential
upward adjustment of an additional one hundred forty thousand
(140,000) Shares as provided herein, by the Company to Buyer,
on the terms and subject to the conditions set forth in this
Agreement;
C. WHEREAS, the Board of Directors of the Company has approved
the acquisition of up to one million six hundred thousand
(1,600,000) shares of Common Stock (the "Tendered Shares") by
Buyer from the Company's shareholders (the "Shareholders"), on
the terms and subject to the conditions set forth in this
Agreement;
D. WHEREAS, in furtherance of such acquisition, Buyer proposes to
make a tender offer (as it may be amended from time to time as
permitted under this Agreement, the "Offer") to purchase the
Tendered Shares at a purchase price of $4.38 per share (the
"Offer Price") net to the seller in cash, without interest
thereon, upon the terms and subject to the conditions set
forth in this Agreement, and the Board of Directors of the
Company has adopted resolutions approving the Offer;
E. WHEREAS, the Board of Directors has approved the terms of that
certain Shareholders' and Voting Agreement of DSI Toys, Inc.
(the "Shareholders Agreement") by and among the Company,
Buyer, and M. D. Davis, Rust Capital, Ltd., a Texas limited
partnership, Douglas A. Smith, Joseph N. Matlock, and Barry B.
Conrad (collectively, the "DSI Group"), entered into
concurrently with the execution of this Agreement, and in
connection therewith, members of the DSI Group have executed
irrevocable proxies in favor of Buyer (the "Irrevocable
Proxies"), as an inducement to Buyer and the Company to enter
into this Agreement;
F. WHEREAS, the Board of Directors has approved the terms of that
certain Registration Rights Agreement (the "Registration
Rights Agreement") (the
-2-
<PAGE> 40
Registration Rights Agreement and the Shareholders Agreement
are hereinafter collectively referred to as the "Other
Agreements") by and among the Company, Buyer, and the DSI
Group, entered into concurrently with the execution of this
Agreement as an inducement to Buyer to enter into this
Agreement; and
G. WHEREAS, the Company and Buyer desire to make certain
representations, warranties, covenants and agreements in
connection with this Agreement.
NOW, THEREFORE, in consideration of the foregoing and the mutual
covenants and agreements herein contained, the receipt and sufficiency of which
are acknowledged, and intending to be legally bound hereby, the parties agree as
follows:
ARTICLE I
PURCHASE OF SHARES
SECTION 1.1 Purchase and Sale of Initial Funding Shares. Upon the terms
and subject to the conditions set forth in this Agreement the Company shall sell
to Buyer and Buyer shall purchase from the Company the Initial Funding Shares
for a total consideration of One Million Two Hundred Thousand Dollars
($1,200,000.00) (the "Initial Funding Shares Purchase Price").
SECTION 1.2 Purchase and Sale of Second Funding Shares. Upon the terms
and subject to the conditions set forth in this Agreement the Company shall sell
to Buyer and Buyer shall purchase from the Company the Second Funding Shares for
a total consideration of Three Million Eight Hundred Thousand Dollars
($3,800,000.00) (the "Second Funding Shares Purchase Price"), subject to
adjustment pursuant to Section 1.2(a).
(a) If as of 11:59 p.m. on the Second Closing Date (as defined below)
(the "Relevant Time"), the Working Capital (as defined below), is less than the
Base Amount (as defined below), then the Second Funding Shares shall be
increased by the excess of the Base Amount over the amount of Working Capital of
the Company as of the Relevant Time, based upon a stock price of Two Dollars
($2.00) per Second Funding Share; provided that the Second Funding Shares shall
not be increased by more than forty thousand (40,000) shares. "Working Capital"
shall mean current assets less current liabilities (excluding current portion of
long-term debt). The term "Base Amount" shall mean One Million Dollars
($1,000,000.00).
(b) Within three (3) business days prior to the Second Closing Date,
the Company shall deliver to Buyer a statement (together with appropriate
schedules and other support, the "Settlement Statement") that: (i) provides
Buyer with a good faith estimate of its Working Capital as of the Relevant Time,
as adjusted, for any collections, payments or distributions to be made prior to
the Relevant Time, and (ii) calculates the increase of the Second Funding Shares
pursuant to Section 1.2(a) hereof, if applicable.
-3-
<PAGE> 41
(c) If the Settlement Statement requires any adjustments to the Second
Funding Shares as described in Section 1.2(a) and Buyer agrees with the
adjustments as set forth in the Settlement Statement, then such adjustment shall
be reflected in the amount of Second Funding Shares to be issued to Buyer on the
Second Closing Date pursuant to Section 1.3(b).
(d) Unless Buyer has notified Seller that it agrees with the
adjustments as set forth in the Settlement Statement on or before the Second
Closing Date, then on the Second Closing Date, the Company shall sell to Buyer
one million seven hundred ninety-two thousand four hundred fifty-three
(1,792,453) Shares and, if Buyer elects to challenge the amount of Working
Capital contained in the Settlement Statement, Buyer shall notify the Company of
its challenge of the amount of Working Capital in writing no later than ten (10)
business days following the Second Closing Date. If Buyer and the member of the
Company's Board of Directors appointed to represent the Company by those members
of the Company's Board of Directors who are nominated by the DSI Group (the "DSI
Representative") do not agree within ten (10) days of such challenge on any such
adjustment, Buyer shall engage Arthur Andersen, who shall conduct such tests and
procedures as it deems reasonable to finally determine the amount of Working
Capital, as applicable, on the Second Closing Date, no later than sixty (60)
days following the Second Closing Date. If Arthur Andersen determines the amount
of Working Capital of the Company as of the Relevant Time differs from that set
forth in the Settlement Statement, it shall so notify the Company and the Buyer
of such difference. If Arthur Andersen determines that the Working Capital of
the Company as of the Relevant Time is greater than the Base Amount, then this
Agreement shall continue in full force and effect without any changes to the
Second Funding Shares. If Arthur Andersen determines that the Working Capital of
the Company as of the Relevant Time is less than the Base Amount, then the
Second Funding Shares shall be increased by the excess of the Base Amount over
the amount of Working Capital of the Company as of the Relevant Time as
determined by Arthur Andersen, based upon a stock price of Two Dollars ($2.00)
per Second Funding Share, and the Company shall issue to Buyer an additional
number of Second Funding Shares that the Company should have issued on the
Second Closing Date, pursuant to Section 1.2(a) hereof, based upon the findings
of Arthur Andersen.
(e) If the Company fails to satisfy the terms of Section 5.20 below,
Buyer shall be issued the Moss Default Shares (as defined in Section 5.20
below).
SECTION 1.3 Closings.
(a) Initial Closing. The closing of the purchase and sale of
the Initial Funding Shares (the "Initial Closing") shall take place at the
offices of Thompson & Knight, 1200 Chase Tower, 600 Travis Street, Houston,
Texas 77002, at 10:00 a.m., local time, on the date hereof, or at such other
time and place as the Company and Buyer shall agree in writing (the "Initial
Closing Date"). At the Initial Closing:
(i) The Company shall deliver to Buyer: (A) one or
more certificates representing five hundred sixty-six thousand
thirty-eight (566,038) Shares, duly endorsed in blank or with duly
executed stock powers, free and clear of any Liens; (B) the Other
Agreements and the Irrevocable Proxies duly executed by the parties
thereto in the forms
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attached hereto as Exhibits 5.15, 5.16 and 1.3(a)(i)(B), respectively;
(C) those certain Side Letter Agreements executed by each of the
members of the DSI Group and the Company in the forms attached hereto
as Exhibit 1.3(a)(i)(C); (D) a favorable opinion of counsel dated as of
the Initial Closing Date in form and substance satisfactory to Buyer
and Buyer's Counsel; (E) certified copies of resolutions duly adopted
by the Company's board of directors approving this Agreement and the
transactions contemplated hereby; (F) duly executed consents of any
party having a contractual relationship with the Company or any of its
Subsidiaries and whose consent is required to be obtained to execute
this Agreement or in connection with the Initial Closing and who has
been identified as such by Company in the Seller Disclosure Letter (as
defined herein), including, but not limited to, Sunrock Capital Corp.
("Sunrock"); (G) draft copies of the consolidated balance sheet
(including related notes and schedules) and consolidated statements of
income, shareholders' equity and of cash flows to be included in the
Company's annual report on Form 10-K for the fiscal year ending January
31, 1999 (the "1998 Financial Statements"); (H) a written consent and
waiver in the form attached hereto as Exhibit 1.3(a)(i)(H) executed by
Sunrock consenting to the transactions contemplated hereby and waiving
any breaches and/or events of default arising out of or in connection
with the transactions contemplated hereby; and (I) the opinion of
Chaffe and Associates, Inc., a copy of which is attached hereto as
Exhibit 3.29.
(ii) Buyer shall deliver to the Company, (A) by wire
transfer of immediately available funds the Initial Funding Shares
Purchase Price, (B) the Other Agreements duly executed by the Buyer,
(C) a favorable opinion of counsel dated as of the Initial Closing Date
in form and substance satisfactory to the Company and the Company's
counsel, and (D) certified copies of resolutions duly adopted by the
Buyer's board of directors approving this Agreement and the
transactions contemplated hereby.
(b) Second Closing. The closing of the purchase and sale of
the Second Funding Shares (the "Second Closing") shall take place at the offices
of Thompson & Knight, 1200 Chase Tower, 600 Travis Street, Houston, Texas 77002,
at 10:00 a.m., local time, on or before July 1, 1999, as the Company and Buyer
shall agree in writing (the "Second Closing Date").
(i) The Company shall deliver to Buyer one or more
certificates representing one million seven hundred ninety-two thousand
four hundred fifty-three (1,792,453) Shares (and such additional
Shares, if any, as set forth in the Settlement Statement and agreed to
by Buyer as provided in Section 1.3(c) hereof), duly endorsed in blank
or with duly executed stock powers, free and clear of any Liens;
(ii) Buyer shall deliver by wire transfer of
immediately available funds the Second Funding Shares Purchase Price to
the Company;
(iii) The Company shall amend the Amended and
Restated Articles of Incorporation of the Company to increase the
number of authorized shares of capital stock from twenty-five million
(25,000,000) to forty million (40,000,000) pursuant to the Articles of
Amendment to the Amended and Restated Articles of Incorporation
attached hereto as
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Exhibit 1.3 (the "Articles of Amendment"), by filing the Articles of
Amendment with the Secretary of State of the State of Texas, if such
Articles of Amendment have been approved by the Shareholders at the
Shareholders Meeting (as defined herein); and
(iv) The parties shall deliver all remaining items
and perform all remaining covenants required by the terms and
conditions of this Agreement.
ARTICLE II
TENDER OFFER
SECTION 2.1 The Offer
(a) Not later than the first business day after the date of this
Agreement, Buyer will make a public announcement of the offer to purchase one
million six hundred thousand (1,600,000) Shares at the Offer Price net to the
seller in cash. Notwithstanding the foregoing, the Offer Price will be subject
to possible increase as provided in Section 2.1(b) hereof.
(b) Subject to the provisions of this Agreement, as promptly as
practicable but in no event later than five business days after the date of the
public announcement by Buyer of the Offer, Buyer shall commence the Offer. The
obligation of Buyer to commence the Offer and accept for payment, and pay for,
any Shares tendered pursuant to the Offer shall be subject only to the
conditions set forth in Exhibit 2.1 attached hereto (the "Offer Conditions")
(any of which may be waived in whole or in part by Buyer in its sole
discretion). Buyer expressly reserves the right to modify the terms of the
Offer, except that, without the prior written consent of the Company, Buyer
shall not (i) reduce the number of Shares subject to the Offer, (ii) reduce the
Offer Price, (iii) add to the Offer Conditions, (iv) except as provided in the
next sentence, extend the Offer, or (v) change the form of consideration payable
in the Offer. Notwithstanding the foregoing, Buyer may, without the consent of
the Company, (i) extend the Offer, if at the scheduled or extended expiration
date of the Offer (the initial scheduled expiration date being such date as
shall be identified in the Offer Documents (as herein defined)), any of the
Offer Conditions shall not be satisfied or waived, until such time as such
conditions are satisfied or waived, (ii) extend the Offer for any period
required by any rule, regulation, interpretation or position of the Securities
and Exchange Commission (the "SEC") or the staff thereof applicable to the
Offer, and (iii) extend the Offer for any reason on one or more occasions for an
aggregate period of not more than twenty (20) business days beyond the latest
expiration date that would otherwise be permitted under clause (i) or (ii) of
this sentence, in each case subject to the right of Buyer or the Company to
terminate this Agreement pursuant to the terms hereof. The obligation of Buyer
to accept for payment, and pay for, any Shares tendered pursuant to the Offer
shall be subject only to the conditions set forth on Exhibit 2.1 (any of which
may be waived in whole or in part by Buyer in its sole discretion). Subject to
the terms and conditions of the Offer, Buyer shall accept for payment, and pay
for, all Shares validly tendered and not withdrawn pursuant to the Offer that
Buyer becomes obligated to accept for payment, pursuant to the Offer as soon as
practicable after the expiration of the Offer.
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(c) On the date of commencement of the Offer, Buyer shall file with the
SEC a Tender Offer Statement in Schedule 14D-1 (the "Schedule 14D-1") with
respect to the Offer, which shall contain an offer to purchase and a related
letter of transmittal (such Schedule 14D-1 and the documents included therein
pursuant to which the Offer will be made, together with any supplements or
amendments thereto, the "Offer Documents"), and Buyer shall cause to be
disseminated the Offer Documents to holders of Common Stock (collectively, the
"Shareholders" and individually, a "Shareholder") as and to the extent required
by applicable federal securities laws. Buyer and the Company each agrees
promptly to correct any information provided by it for use in the Offer
Documents if and to the extent that such information shall have become false or
misleading in any material respect, and Buyer further agrees to take all steps
necessary to cause the Schedule 14D-1 as so corrected to be promptly filed with
the SEC and the other Offer Documents as so corrected to be promptly
disseminated to the Shareholders, in each case as and to the extent required by
applicable federal securities laws. The Company and its counsel shall be given
reasonable opportunity to review and comment upon the Offer Documents prior to
their filing with the SEC or dissemination to the Shareholders. Buyer agrees to
provide the Company and its counsel any comments Buyer or its counsel may
receive from the SEC or its staff with respect to the Offer Documents promptly
after the receipt of such comments.
(d) Buyer shall provide on a timely basis the funds necessary to accept
for payment, and pay for, any Shares that Buyer becomes obligated to accept for
payment, and pay for, pursuant to the Offer.
SECTION 2.2 Company Actions.
(a) The Company hereby represents that the Board of Directors of the
Company has, at a meeting duly called and held, duly adopted resolutions whereby
it: (i) determined that this Agreement, the Offer and the transactions
contemplated hereby and thereby are in the best interests of the Company and the
Shareholders, (ii) adopted and approved this Agreement, the Offer and the
transactions contemplated hereby and thereby, and (iii) resolved to recommend
that the Shareholders accept the Offer, tender their shares in response to the
Offer, and approve the sale of the Second Funding Shares by the Company to Buyer
pursuant to the terms of this Agreement. Simultaneously with the execution of
this Agreement, pursuant to the terms of the Side Letter Agreements, each of the
members of the DSI Group has agreed that if the Minimum Condition (as that term
is defined in Exhibit 2.1 attached hereto) is not met as of the initial
scheduled expiration date of the Offer, each of the members of the DSI Group
shall tender their Shares in the Offer, except where such sales in response to
the Offer might result in liability under Section 16(b) of the Securities and
Exchange Act of 1934, as amended (the "Exchange Act"), such that the number of
Shares tendered by each member of the DSI Group and non-DSI Group Shareholders,
shall meet the Minimum Condition. Nothing herein contained shall prevent any
member of the DSI Group from tendering any or all Shares over which such member
has dispositive power, even if the Minimum Condition is otherwise met, and any
such Shares so tendered shall be subject to a pro rata reduction to the same
extent as the Shares tendered by any other Shareholder.
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(b) Not later than the first business day after the date the Offer
Documents are filed with the SEC, the Company shall file with the SEC a
Solicitation/Recommendation Statement in Schedule 14D-9 with respect to the
Offer (such Schedule 14D-9, as amended from time to time, the "Schedule 14D-9")
containing the recommendations described in Section 2.2(a) hereof and will
disseminate the Schedule 14D-9 as required by Rule 14d-9 under the Exchange Act.
The Company and Buyer each agrees to correct promptly any information provided
by it for use in the Schedule 14D-9 if and to the extent that information is or
becomes incomplete or inaccurate in any material respect and the Company will
file promptly any corrected Schedule 14D-9 with the SEC and disseminate promptly
the corrected Schedule 14D-9 to the Shareholders to the extent required by the
Exchange Act or the rules thereunder. Buyer and its counsel shall be given
reasonable opportunity to review and comment upon the Schedule 14D-9 prior to
its filing with the SEC or dissemination to the Shareholders. The Company agrees
to provide Buyer and its counsel any comments the Company or its counsel may
receive from the SEC or its staff with respect to the Schedule 14D-9 promptly
after the receipt of such comments.
(c) In connection with the Offer, the Company shall cause its transfer
agent to furnish Buyer promptly with mailing labels containing the names and
addresses of the record holders of Common Stock as of a recent date and of those
persons becoming record holders subsequent to such date, together with copies of
all lists of Shareholders, security position listings and computer files and all
other information in the Company's possession or control regarding the
beneficial owners (as defined under Rule 13d-3 of the Securities Act of 1933, as
amended (the "Securities Act")) of Common Stock, and shall furnish to Buyer such
additional information and assistance (including updated lists of Shareholders,
security position listings and computer files) as Buyer may reasonably request
in communicating the Offer to the Shareholders. Subject to the requirements of
applicable law, and except for such steps as are necessary to disseminate the
Offer Documents, Buyer and its agents shall hold in confidence the information
contained in any such labels, listings and files, and will use such information
only in connection with the Offer.
SECTION 2.3 The Closing of the Offer. The closing of the Offer (the
"Offer Closing") shall occur simultaneously with and be conditioned upon the
Second Closing of the sale of the Second Funding Shares as provided in Section
1.3 hereof and the satisfaction or waiver of the conditions set forth in Exhibit
2.1 (the "Offer Closing Date"), unless another date is agreed to in writing by
the parties hereto.
SECTION 2.4 Payment for Tendered Shares.
(a) Paying Agent. Prior to the date of the consummation of the
transactions contemplated by the Offer (the "Effective Time"), Buyer shall
designate a bank or trust company or an entity which in the ordinary course of
business acts as a participation agent to act as paying agent in the Offer (the
"Paying Agent"), and, from time to time on, prior to or after the Effective
Time, Buyer shall make available to the Paying Agent cash in amounts and at the
times necessary for the payment of the purchase price for each Tendered Share
purchased (the "Tender Price") upon surrender of certificates representing
Shares (it being understood that any and all interest earned on funds made
available to the Paying Agent pursuant to this Agreement shall be turned over to
Buyer).
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(b) Payment Procedure. As soon as reasonably practicable after the
Effective Time, the Paying Agent shall mail to each holder of record of a
certificate or certificates that immediately prior to the Effective Time
represented Shares (the "Certificates"), (i) a letter of transmittal (which
shall specify that delivery shall be effected, and risk of loss and title to the
Certificates shall pass, only upon delivery of the Certificates to the Paying
Agent and shall be in a form and have such other provisions as Buyer may
reasonably specify) and (ii) instructions for use in effecting the surrender of
the Certificates in exchange for the Tender Price for such Shares surrendered.
Upon surrender of a Certificate to the Paying Agent or to such other agent or
agents as may be appointed by Buyer, together with such letter of transmittal,
duly executed, and such other documents as may reasonably be required by the
Paying Agent, the holder of such Certificate shall be entitled to receive in
exchange therefor the Tender Price for each Share theretofore represented by
such Certificate which shall have been tendered. In the event of a transfer of
ownership of Shares that is not registered in the transfer records of the
Company, payment may be made to a person other than the person in whose name the
Certificate so surrendered is registered, if such Certificate shall be properly
endorsed or otherwise be in proper form for transfer and the person requesting
such payment shall pay any transfer or other taxes required by reason of the
payment to a person other than the registered holder of such Certificate or
establish to the satisfaction of the Buyer that such tax has been paid or is not
applicable. No interest will be paid or will accrue on the cash payable upon the
surrender of any Certificate. If more than one million six hundred thousand
(1,600,000) Shares are validly tendered prior to the Effective Time and not
withdrawn, the Buyer will, upon the terms and conditions of the Offer, accept
such Shares for payment on a pro rata basis as provided by Section 14(d)(6) of
the Exchange Act and Rule 14(d) promulgated thereunder, with adjustments to
avoid purchases of fractional Shares, based upon the number of Shares validly
tendered prior to the Effective Time and not withdrawn.
SECTION 2.5 Directors.
(a) Upon the Second Closing and the Offer Closing, Buyer shall be
entitled to designate four of the six directors on the Board of Directors of the
Company. In furtherance thereof, each of Barry B. Conrad ("Conrad"), Jack R.
Crosby ("Crosby"), Richard R. Neitz ("Neitz"), and Douglas A. Smith ("Smith")
has agreed to tender his resignation as a member of the Board of Directors
effective upon the Second Closing and the Offer Closing to enable Buyer's
designees to be so elected to the Company's Board of Directors, and the Company
agrees to take all actions available to cause Buyer's designees to be so
elected. At such time, the Company shall, if requested by Buyer, also cause
persons designated by Buyer to constitute at least the same percentage as is on
the Company's Board of Directors of (i) each committee of the Company's Board of
Directors, (ii) each board of directors of each Subsidiary of the Company, and
(iii) each committee (or similar body) of each such board.
(b) The Company shall promptly take all actions required, if any,
pursuant to Section 14(f) of the Exchange Act and Rule 14f-1 promulgated
thereunder in order to fulfill its obligations with respect to Section 2.5(a)
hereof, including mailing to Shareholders the information required by such
Section 14(f) and Rule 14f-1 as is necessary to enable Buyer's designees to be
elected to the Company's Board of Directors. Buyer will supply the Company and
be solely
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responsible for any information with respect to it and its nominees, officers,
directors and affiliates required by such Section 14(f) and Rule 14f-1. The
provisions of this Section 2.5 are in addition to and shall not limit any rights
which Buyer or any of its affiliates may have as a beneficial owner of Shares as
a matter of law with respect to the election of directors or otherwise.
ARTICLE III
REPRESENTATIONS AND WARRANTIES CONCERNING THE COMPANY
The Company represents and warrants to Buyer, as follows:
SECTION 3.1 Organization, Good Standing and Qualification. Each of the
Company and its Subsidiaries is a corporation duly organized, validly existing
and in good standing under the laws of its respective jurisdiction of
organization and has all requisite corporate or similar power and authority to
own and operate its properties and assets and to carry on its business as
presently conducted and is qualified to do business and is in good standing as a
foreign corporation in each jurisdiction where the ownership or operation of its
properties or conduct of its business requires such qualification, except where
the failure to be so qualified or in good standing is not reasonably likely to
have, individually or in the aggregate, a Material Adverse Effect or prevent or
materially delay the consummation of the Offer. Section 3.1 of the disclosure
letter delivered to Buyer by the Company on or prior to entering into this
Agreement and incorporated by reference herein (the "Seller Disclosure Letter")
contains complete and correct copies of the Company's and its Subsidiaries'
certificates or articles of incorporation, as the case may be, and bylaws, each
as amended to date. The Company's and its Subsidiaries' certificates of
incorporation and bylaws so delivered are in full force and effect.
SECTION 3.2 Capital Structure. The authorized capital stock of the
Company consists of 25,000,000 shares of capital stock, 20,000,000 of which are
shares of Common Stock, and 5,000,000 of which are shares of Preferred Stock, of
which 6,000,000 shares of Common Stock and no shares of Preferred Stock were
outstanding and 2,719,000 Shares were held by the Company in its treasury, as of
the close of business on April 14, 1999. All of the outstanding Shares have been
duly authorized and are validly issued, fully paid and nonassessable and, upon
the sale thereof, the Initial Funding Shares and the Second Funding Shares will
be duly authorized, validly issued, fully paid and nonassessable. The Company
has no Shares reserved for issuance except for 603,000 Shares reserved for
issuance upon exercise of outstanding options granted under and pursuant to the
Company's Stock Option Plan, as amended from time to time (the "Stock Plan");
and 638,888 Shares reserved for issuance upon the exercise of outstanding
warrants as described in Section 32 of the Seller Disclosure Letter. Section 3.2
of the Seller Disclosure Letter contains a correct and complete list as of April
14, 1999, of each outstanding option to purchase Shares, under the Stock Plan
and pursuant to the outstanding warrants described in Section 3.2 of the Seller
Disclosure Letter (each a "Company Option"), including the holder, date of
grant, exercise price and number of Shares subject thereto, along with complete
and correct copies of the Company Options and the Stock Plan. Except as set
forth in Section 3.2 of the Seller Disclosure Letter, each of the outstanding
shares of capital stock or other securities of each of the Company's
Subsidiaries is duly authorized, validly
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issued, fully paid and nonassessable and owned by the Company, free and clear of
any Lien, right of first refusal agreement, limitation on voting rights, claim
or other encumbrance. Except as set forth in Section 3.2 of the Seller
Disclosure Letter, there are no preemptive or other outstanding rights (other
than rights accruing to the Company or its Subsidiaries), options, warrants,
conversion rights, stock appreciation rights, redemption rights, repurchase
rights, agreements, arrangements or commitments to issue or sell any shares of
capital stock or other securities of the Company or any of its Subsidiaries or
any securities or obligations convertible or exchangeable into or exercisable
for, or giving any Person a right to subscribe for or acquire, any securities of
the Company or any of its Subsidiaries, and no securities or obligations
evidencing such rights are authorized, issued or outstanding. The Company does
not have outstanding any bonds, debentures, notes or other obligations the
holders of which have the right to vote (or convertible into or exercisable for
securities having the right to vote) with the Shareholders of the Company on any
matter. There is not outstanding any contractual obligations of the Company or
any of its Subsidiaries (i) to repurchase, redeem or otherwise acquire any
shares of capital stock of the Company, or (ii) to vote or to dispose of any
shares of capital stock of any of the Subsidiaries.
SECTION 3.3 Corporate Authority; Approval and Fairness. The execution
and delivery of this Agreement by the Company and the consummation by the
Company of the transactions contemplated hereby have been duly and validly
authorized and approved by the Board of Directors of the Company and no other
corporate proceedings on the part of the Company are necessary to authorize or
approve this Agreement, or to consummate the transactions contemplated hereby
other than: (i) the approval and adoption of this Agreement and the transactions
contemplated hereby, including the approval of the sale of the Second Funding
Shares by the Company to Buyer by the affirmative vote of Shareholders holding a
majority of Shares represented in person or by proxy at a duly called meeting at
which a quorum is present or represented, and (ii) the approval of the Articles
of Amendment by the affirmative vote of Shareholders holding a majority of the
Shares then outstanding. The Board of Directors has resolved to recommend the
approval of the sale of the Second Funding Shares by the Company to Buyer and
the adoption of this Agreement and the Articles of Amendment by the
Shareholders, and has directed that the sale of the Second Funding Shares, this
Agreement and the Articles of Amendment be submitted to the Shareholders for
their approval. The Company has all corporate power and authority to enter into
this Agreement and the Other Agreements to which the Company is a party and to
consummate the transactions contemplated hereby and thereby, subject to the
approval of the Shareholders described in subsections (i) and (ii) above. This
Agreement and the Other Agreements to which the Company is a party have been
duly executed and delivered by the Company and (assuming the valid
authorization, execution and delivery of such agreement by each other party
thereto) each constitutes a valid and binding agreement of the Company,
enforceable against the Company in accordance with its terms, except that
enforceability may be limited by bankruptcy, insolvency, fraudulent transfer,
reorganization, moratorium and similar laws of general applicability relating to
or affecting creditors' rights or by principles governing the availability of
equitable remedies (the "Bankruptcy Exception").
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SECTION 3.4 Governmental Filings; No Violations.
(a) Except as set forth in Section 3.4(a) of the Seller Disclosure
Letter, other than the filings and/or notices (i) pursuant to this Agreement,
(ii) under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended
(the "HSR Act"), if applicable, and the Exchange Act and the Securities Act,
(iii) to comply with state securities or "blue-sky" laws, if any; and (iv)
required to be made with the NASDAQ, no notices, reports or other filings are
required to be made by the Company or any of its Subsidiaries with, nor are any
consents, registrations, approvals, permits or authorizations required to be
obtained by the Company or any of its Subsidiaries from, any governmental or
regulatory authority, agency, commission, body or other governmental entity,
domestic, foreign, or supranational ("Governmental Entity"), in connection with
the execution and delivery of this Agreement and the consummation by the Company
of the sale of the Initial Funding Shares and the Second Funding Shares to Buyer
and the other transactions contemplated hereby.
(b) Except for those agreements for which consents must be obtained as
set forth in Section 6.2(c) of the Seller Disclosure Letter, the execution,
delivery and performance of this Agreement by the Company does not, and the
consummation by the Company of this Agreement and the other transactions
contemplated hereby will not, constitute or result in (i) a breach or violation
of, or a default under, the articles of incorporation or bylaws of the Company
or the comparable governing instruments of any of its Subsidiaries, (ii) a
breach or violation of, or a default under, or the acceleration of any
obligations or the creation of a Lien or other encumbrance on the assets of the
Company or any of its Subsidiaries (with or without notice, lapse of time or
both) pursuant to, any loan or credit agreement, note, bond, warrant, indenture
or other instrument evidencing indebtedness for borrowed money ("Debt
Contracts") or any other agreement, lease, contract, arrangement or other
obligation ("Other Contracts") binding upon the Company or any of its
Subsidiaries or any Law (as defined in Section 3.9 below) or governmental or
non-governmental permit or license to which the Company or any of its
Subsidiaries is subject or any judgment, order or decree to which the Company or
any of its Subsidiaries or any of its properties is subject; or (iii) any change
in the rights or obligations of any party under any of the Debt Contracts or
Other Contracts, except, in the case of clause (ii) or (iii) above, for any
breach, violation, default, acceleration, creation or change that, individually
or in the aggregate, is not reasonably likely to have a Material Adverse Effect
or prevent, delay or impair the ability of the Company to consummate the
transactions contemplated by this Agreement.
(c) Except as set forth in Section 3.4(c) of the Seller Disclosure
Letter, no event has occurred or is occurring that constitutes or, but for the
giving of notice or lapse of time, or both, would constitute an event of default
by the Company or any of its Subsidiaries under any Debt Contract or Other
Contracts binding upon the Company or any of its Subsidiaries.
SECTION 3.5 Company Reports; Financial Statements. The Company has
filed all reports and other documents to be filed by it since its formation
under the Exchange Act or the Securities Act. Section 3.5 of the Seller
Disclosure Letter contains a complete list of each registration statement,
report, proxy statement or information statement (including any amendments
thereto) filed by it with the SEC (collectively, including any such reports
filed subsequent to the date hereof, the
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"Company Reports"). The Company has delivered or will deliver promptly after
filing true and correct copies of each of the Company Reports to Buyer. As of
their respective dates, the Company Reports did not, and any Company Reports
filed with the SEC subsequent to the date hereof will not, contain any untrue
statement of a material fact or omit to state a material fact required to be
stated therein or necessary in order to make the statements made therein, in
light of the circumstances in which they were made, not misleading. Each of the
Company Reports complied in all material respects with the Exchange Act and the
Securities Act, as the case may be, and the applicable rules and regulations
thereunder. To the Knowledge of the Company, each of the consolidated balance
sheets included in or incorporated by reference into the Company Reports
(including the related notes and schedules) fairly presents, or will fairly
present, in all material respects, the consolidated financial position of the
Company and each of its Subsidiaries as of its date, and each of the
consolidated statements of income, shareholders' equity and of cash flows
included in or incorporated by reference into the Company Reports (including any
related notes and schedules) (together with such consolidated balance sheets
hereinafter the "Financial Statements") fairly presents, or will fairly present,
in all material respects, the results of consolidated operations, shareholders'
equity and cash flows, as the case may be, of the Company and its Subsidiaries
for the periods set forth therein (subject, in the case of unaudited statements,
to notes and normal year-end audit adjustments that will not be material in
amount or effect), in each case in accordance with generally accepted accounting
principles ("GAAP") consistently applied during the periods involved, except as
may be noted therein.
SECTION 3.6 Absence of Certain Changes. Except as disclosed in the
Company credit reports required to be submitted by the Company, including,
without limitation, those prepared by Dun and Bradstreet and reports delivered
by the Company to the Company's lenders under any Debt Contracts (the
"Reports"), filed prior to the date hereof and as set forth in Section 3.6 of
the Seller Disclosure Letter, since October 31, 1998 (the "Financial Statement
Date"), the Company and each of its Subsidiaries have conducted their respective
businesses only in, and have not entered into or engaged in any material
transaction other than in, the ordinary and usual course of such businesses and
there has not been (a) any change in the financial condition, properties,
business or results of operations of the Company or any of its Subsidiaries or
any development or combination of developments that, individually or in the
aggregate, has had or is reasonably likely to have a Material Adverse Effect;
(b) any damage, destruction or other casualty loss with respect to any asset or
property owned, leased or otherwise used by the Company or any of its
Subsidiaries, whether or not covered by insurance, except as is not reasonably
likely to have, individually or in the aggregate, a Material Adverse Effect; (c)
any declaration, setting aside or payment of any dividend or other distribution
in respect of the capital stock of the Company, except for dividends or other
distributions on its capital stock publicly announced prior to the date hereof;
(d) any material change by the Company in accounting principles, practices or
methods; or (e) any entry by the Company or any of its Subsidiaries into any
employment, consulting, severance, termination or indemnification agreement or
arrangement with any employee or director. Since the Financial Statement Date,
except as provided for herein or as disclosed in the Company Reports filed prior
to the date hereof, there has not been any increase in the compensation payable
or that could become payable by the Company or any of its Subsidiaries to
directors, officers or key employees or any amendment of any
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of the Compensation and Benefit Plans (as defined in Section 3.8 below) other
than increases or amendments in the ordinary course.
SECTION 3.7 Litigation and Liabilities. Except as set forth in Section
3.7 of the Seller Disclosure Letter, there are no (a) civil, criminal or
administrative actions, suits, claims, hearings, investigations or proceedings
pending or, to the Knowledge of the Company, threatened against the Company or
any of its Subsidiaries or any current or former director or officer of the
Company or any of its Subsidiaries (in their capacity as such) or (b)
obligations or liabilities, whether or not accrued, contingent or otherwise,
including those relating to matters involving any Environmental Law (as defined
in Section 3.11 below), that, in the case of either clause (a) or (b),
individually or in the aggregate, are reasonably likely in either such case to
have a Material Adverse Effect or prevent or impair the ability of the Company
to consummate the transactions contemplated by this Agreement, including,
without limitation, the consummation of the Offer. Except as disclosed in the
Company Reports filed prior to the date hereof and as set forth in Section 3.7
of the Seller Disclosure Letter, there are no outstanding orders, judgments,
injunctions, awards or decrees of any Governmental Entity against the Company or
any of its Subsidiaries, any of its or their properties, assets or business, or,
to the Knowledge of the Company, any of its or their current or former directors
or officers, in their capacities as directors or officers of the Company, as
such, that is reasonably likely to have, individually or in the aggregate, a
Material Adverse Effect.
SECTION 3.8 Employee Matters.
(a) Neither the Company nor any of its Subsidiaries has any labor
contracts or collective bargaining agreements with respect to any persons
employed by or otherwise performing services for the Company or any of its
Subsidiaries. Neither the Company nor any of its Subsidiaries has engaged in any
unfair labor practice. As of the date hereof, there is no unfair labor practice
complaint pending, or to the Knowledge of the Company threatened, against the
Company or any of its Subsidiaries. There is no labor strike, dispute, slowdown,
or stoppage pending or to the Knowledge of the Company threatened, against the
Company or any of its Subsidiaries, and neither the Company nor any of its
Subsidiaries has experienced any primary work stoppage or labor difficulty
involving its employees during the last three (3) years, except in each case as
is not reasonably likely to have, individually or in the aggregate, a Material
Adverse Effect.
(b) Section 3.8(b) of the Seller Disclosure Letter is a true and
complete list of each bonus, deferred compensation, pension, retirement, profit
sharing, thrift, savings, employee stock ownership, stock bonus, stock purchase,
restricted stock, stock option, employment, termination, severance,
compensation, medical, health, welfare, fringe benefits or other plan,
agreement, policy or arrangement which the Company or any of its Subsidiaries
maintains, or as to which the Company or any of its Subsidiaries is or will be
required to make any payment for the benefit of any employee, director, former
employee or former director of the Company and its Subsidiaries (the
"Compensation and Benefit Plans"). The Company has delivered or made available
to Buyer with respect to each Compensation and Benefit Plan correct and complete
copies, where applicable, of (i) all plan documents and amendments thereto,
trust agreements and amendments thereto and insurance and annuity contracts and
policies, (ii) the current summary plan description, (iii) the
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Annual Reports (Form 5500 series) and accompanying schedules, as filed, for the
most recently completed two plan years for which such reports have been filed,
(iv) the financial statements for the most recently completed two plan years for
which statements have been prepared, (v) the most recent determination letter
issued by the Internal Revenue Service (the "IRS") and the application submitted
with respect to such letter, and (vi) all correspondence with the IRS or
Department of Labor concerning any pending controversy. Any "change of control"
or similar provisions contained in any Compensation and Benefit Plan are
specifically identified in Section 3.8(b) of the Seller Disclosure Letter.
(c) All Compensation and Benefit Plans have been administered in all
material respects in accordance with their terms and are in compliance in all
material respects with all applicable laws, including the Code and the Employee
Retirement Income Security Act of 1974, as amended ("ERISA"). Each Compensation
and Benefit Plan that is an "employee pension benefit plan" within the meaning
of Section 3(2) of ERISA (a "Pension Plan") and that is intended to be qualified
under Section 401(a) of the Code has received a favorable determination letter
from the IRS, and the Company is not aware as of the date hereof of any
circumstances likely to result in revocation of any such favorable determination
letter or of any circumstance indicating that any such plan is not so qualified
in operation. As of the date hereof, there is no pending or, to the Knowledge of
the Company, threatened litigation, claim or audit by any Person relating to the
Compensation and Benefit Plans. To the Knowledge of the Company, no prohibited
transaction described in Section 406 of ERISA or Section 4975 of the Code has
occurred which would be expected to result in material liability to the Company
or any of its Subsidiaries, assuming that, for purposes of determining
materiality, the "taxable period" within the meaning of Section 4975 of the Code
with respect to such prohibited transaction had expired as of the date hereof.
(d) As of the date hereof, no liability under Subtitle C or D of Title
IV of ERISA has been or is expected to be incurred by the Company or any
Subsidiary with respect to any ongoing, frozen or terminated "single-employer
plan," within the meaning of Section 4001(a)(15) of ERISA, currently or formerly
maintained by any of them, or the single-employer plan of any entity which is
considered one employer with the Company under Section 4001 of ERISA or Section
414 of the Code (an "ERISA Affiliate"). None of the Company, any of its
Subsidiaries and their ERISA Affiliates have contributed, or been obligated to
contribute, to a multi-employer plan under Subtitle E of Title IV of ERISA at
any time, and no liability has been or is expected to be incurred by the Company
or any Subsidiary with respect to any such plan. None of the Company, any of its
Subsidiaries or any ERISA Affiliate contributes to or maintains a Pension Plan
subject to Title IV of ERISA or has contributed to or maintained any such plan
at any time during the six-year period prior to the date hereof.
(e) All contributions required to be made under the terms of any
Compensation and Benefit Plan as of the date hereof, have been timely made or
have been reflected on the most recent consolidated balance sheet filed or
incorporated by reference in the Company Reports prior to the date hereof.
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(f) Neither the Company nor any of its Subsidiaries has any obligations
for retiree health and life benefits under any Compensation and Benefit Plan,
except as required under Part 6 of Title I of ERISA.
(g) Except as contemplated by this Agreement or disclosed in Section
3.8(g) of the Seller Disclosure Letter, the consummation of this Agreement and
the other transactions contemplated by this Agreement will not (i) entitle any
employees of the Company or its Subsidiaries to severance pay, (ii) accelerate
the time of payment or vesting or trigger any payment of compensation or
benefits under, increase the amount payable or trigger any other material
obligation pursuant to, any of the Compensation and Benefit Plans or the Stock
Plan or (iii) result in any breach or violation of, or default under, any of the
Compensation and Benefit Plans or the Stock Plan.
SECTION 3.9 Compliance with Laws; Permits. Except as set forth in the
Company Reports filed prior to the date hereof and as set forth in Section 3.9
of the Seller Disclosure Letter, the businesses of each of the Company and its
Subsidiaries are being conducted in compliance with applicable federal, state,
local and foreign laws (collectively, "Laws"), except for such violations that,
individually or in the aggregate, are not reasonably likely to have a Material
Adverse Effect or prevent or materially burden or materially impair the ability
of the Company to consummate the transactions contemplated by this Agreement.
The Company and its Subsidiaries each has all governmental permits, licenses,
franchises, variances, exemptions, orders and other governmental authorizations,
consents and approvals necessary to own or lease and operate their respective
properties and conduct its business as presently conducted except those the
absence of which are not, individually or in the aggregate, reasonably likely to
have a Material Adverse Effect or prevent or burden or impair the ability of the
Company to consummate this Agreement and the other transactions contemplated by
this Agreement.
SECTION 3.10 Takeover Statutes. No "fair price," "moratorium," "control
share acquisition" or other similar anti-takeover statute or regulation (each a
"Takeover Statute") or any applicable anti-takeover provision in the Company's
articles of incorporation, by-laws or any shareholder rights agreement, except
Article 13.03 of the Texas Business Corporation Act, is, or as of the Second
Closing Date will be, applicable to the Company, the sale of the Initial Funding
Shares and the Second Funding Shares, the Offer or the other transactions
contemplated by this Agreement. The Board of Directors of the Company has taken
all action so that Buyer will not be prohibited from entering into a "business
combination" with the Company as an "affiliated shareholder" (as those terms are
defined in Article 13.02 of the Texas Business Corporation Act) as a result of
the execution and delivery of this Agreement or the consummation of the
transactions contemplated hereby.
SECTION 3.11 Environmental Matters. Except as disclosed in the Company
Reports filed prior to the date hereof, and as set forth in Section 3.11 of the
Seller Disclosure Letter, (i) to the Knowledge of the Company, the Company and
its Subsidiaries are in compliance with all applicable Environmental Laws; (ii)
the Company and its Subsidiaries have not received any written notices from any
Governmental Entity or any other person or entity alleging the violation of any
applicable Environmental Law; (iii) the Company and its Subsidiaries are not the
subject of any court order,
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administrative order or decree arising under any Environmental Law; (iv) to the
Knowledge of the Company, there has not been a release of Hazardous Substances
(as defined below) on any of the properties owned or operated by the Company or
any of its Subsidiaries; and (v) to the Knowledge of the Company neither the
Company nor any Subsidiary has generated, stored, used, emitted, discharged or
disposed of any Hazardous Substances in violation of or giving rise to liability
under applicable Environmental Laws.
As used herein, "Environmental Law" means any federal, state, local or
foreign law, statute, ordinance, rule, regulation, code, license, permit, order,
decree or injunction relating to the protection of the environment (including
air, water, soil and natural resources), or regulating or imposing standards of
care with respect to the use, storage, handling, release or disposal of any
Hazardous Substance, including petroleum.
As used herein, "Hazardous Substance" means any substance listed,
defined, designated, regulated or classified as hazardous, toxic or radioactive
under any applicable Environmental Law, including petroleum and petroleum
products.
SECTION 3.12 Tax Matters. Except to the extent disclosed in Section
3.12 of the Seller Disclosure Letter:
(a) The Company and each of its Subsidiaries (the Company and each
Subsidiary of the Company are hereinafter referred to collectively as the
"Taxpayers" or individually "Taxpayer") has (i) prepared in good faith and duly
and timely filed (or there have been filed on its behalf) with the appropriate
Tax authorities all Tax Returns required to be filed by it on or prior to the
date hereof, and such Tax Returns are true, complete, and correct in all
material respects, except to the extent that any failure to file any Tax Return
or any inaccuracies in filed Tax Returns would not, individually or in the
aggregate, have a Material Adverse Effect and (ii) paid in full all Taxes that
are shown as due on such filed Tax Returns except for Taxes provided for in a
reserve which is adequate for the payment of such Taxes and is reflected in the
financial statements included in the Company Reports filed prior to the date
hereof or the books and records of the Company. There is no audit or other
matter in controversy with respect to any Taxes due and owing by any Taxpayer,
and there is no Tax deficiency or claim assessed or, to the best of the
Taxpayer's Knowledge, proposed or threatened (whether orally or in writing)
against any Taxpayer, other than (x) in respect of any such audits,
controversies, deficiencies, assessments, or proposed assessments that are being
contested in good faith, for which adequate reserves have been established in
accordance with GAAP or (y) would not, individually or in the aggregate, have a
Material Adverse Effect. Section 3.12 of the Seller Disclosure Letter sets forth
any contested tax liability in respect of which the amount being contested
exceeds Ten Thousand Dollars ($10,000.00).
(b) None of the Taxpayers (i) has waived any statutory period of
limitations for the assessment of any Taxes or agreed to any extension of time
with respect to a Tax assessment or deficiency other than in the case of any
such waivers or extensions in respect of an assessment or deficiency, the Tax
liability of which has been satisfied or settled, (ii) has filed a consent under
Code Section 341(f) concerning collapsible corporation, or (iii) has any
liability for the Taxes of any other
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person as defined in Section 7701(a)(1) of the Code under Treas. Reg. ss.1.502-6
(or any similar provisions of state, local, or foreign law), as a transferee,
successor or by contract (other than liability for Taxes imposed by contract
entered into in the ordinary course of business for the acquisition by a
Taxpayer of assets used in the business of the Company or stock of any entity
holding any such assets used in the business of the Company), except to the
extent that any such waiver, consent, or liability referred to in clauses (i),
(ii) and (iii), respectively, of this Section 3.12(b) would not, individually or
in the aggregate, have a Material Adverse Effect;
(c) No claim has been made since January 1, 1994 by any authority in a
jurisdiction where the Taxpayer does not file Tax Returns that a Taxpayer is or
may be subject to taxation by that jurisdiction, other than in the case of any
such claims the liability of which has been satisfied or settled;
(d) None of the assets of a Taxpayer (i) are required to be treated as
being owned by any other person pursuant to the so-called safe harbor lease
provisions of former Section 168(f)(8) of the Code, (ii) secures any debt the
interest on which is tax-exempt under Code Section 103(a), or (iii) is
tax-exempt use property within the meaning of Code Section 168(h);
(e) None of the Taxpayers has agreed to nor is it required to make any
adjustment pursuant to Code Section 481(a) by reason of a change in accounting
method initiated by any such Taxpayer and no director or executive officer of
the Company has Knowledge that the IRS has proposed any such adjustment or
change in accounting method;
(f) None of the Taxpayers has requested an extension of the time within
which to file any foreign, federal or state Tax Return for which such Tax Return
has not been filed;
(g) None of the Taxpayers has any obligation under any Tax allocation
or sharing agreement among or between the Taxpayers and the Company or any
Affiliates thereof, and after the Second Closing Date, no Taxpayer shall be a
party to, bound by or have any obligation under any Tax allocation or sharing
agreement or have any liability thereunder among or between any Taxpayer and the
Company or any Affiliates thereof for amounts due in respect of periods prior to
the Closing Date; and
(h) As a result of the transactions contemplated by this Agreement and
the Other Agreements or the transactions contemplated hereby or thereby, none of
the Taxpayers will be obligated to make a payment that would be an "excess
parachute payment" to an individual that is currently a "dissatisfied
individual" with respect to the Company as those terms are defined in Section
2806 of the Code, without regard to whether such payment is reasonable
compensation for personal services performed or to be performed in the future.
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SECTION 3.13 Intellectual Property.
(a) Section 3.13(a) of the Seller Disclosure Letter lists all
Intellectual Property Rights (as defined below) of the Company and its
Subsidiaries. To the Knowledge of the Company, the Company and/or each of its
Subsidiaries owns all right, title and interest to, or has the right to use
pursuant to a valid license, as the case may be, all Intellectual Property
Rights used in the business of the Company and its Subsidiaries as presently
conducted. All registrations for Intellectual Property Rights owned by the
Company or any Subsidiary are valid and in force. Except as disclosed in Section
3.13(a) of the Seller Disclosure Letter, all applications for registrations of
Intellectual Property Rights filed by the Company or any Subsidiary are pending
and in good standing, all without challenge of any kind. To the Knowledge of the
Company, the Intellectual Property Rights owned by the Company or any of its
Subsidiaries are valid and enforceable. Except as set forth in Section 3.13(a)
of the Seller Disclosure Letter, the Company or its Subsidiaries have the sole
and exclusive right to bring actions for infringement, misappropriation or
unauthorized use of Owned Software (as defined below) and the Intellectual
Property Rights owned by the Company and its Subsidiaries, except for any rights
that, individually or in the aggregate, are not reasonably likely to have a
Material Adverse Effect.
(b) Except as is disclosed in Section 3.13(b) of the Seller Disclosure
Letter:
(i) Neither the Company nor any of its Subsidiaries is, nor will
the Company or any of its Subsidiaries be, as a result of the
execution and delivery of this Agreement or the performance of
its obligations hereunder, in violation of any license,
sublicense, or other agreement as to which the Company or any
of its Subsidiaries is a party and pursuant to which the
Company or any of its Subsidiaries is authorized to use any
third-party Intellectual Property Rights or computer software
programs or applications;
(ii) To the Knowledge of the Company, there has been no
infringement, misappropriation, or violation of any
Intellectual Property Rights of any other person that has
occurred or results in any way from the operations of the
respective businesses of the Company or its Subsidiaries. No
claim of any infringement, misappropriation or violation of
any Intellectual Property Rights of any other person has been
made or asserted in respect of the operations of the
respective businesses of the Company or its Subsidiaries.
Neither the Company nor any of its Subsidiaries has had notice
of, nor do the executive officers of the Company have
Knowledge of any valid grounds for any bona fide claim against
the Company or its Subsidiaries that its Intellectual Property
Rights, operations, activities, products, software, equipment,
machinery or processes infringe, misappropriate or violate any
Intellectual Property Rights of any other person;
(iii) (A) The Company or its Subsidiaries has maintained and
protected the software that each owns, if any (the "Owned
Software") including, without
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limitation, all source code and system specifications
associated with such software, with such measures as are
reasonably necessary to protect the proprietary, trade secret
or confidential information contained therein; and (B) the
executive officers of the Company do not know of any
infringement, misappropriation or violation of any
Intellectual Property Rights of any other person with respect
to the Owned Software. Section 3.13(b) of the Seller
Disclosure Letter lists all Owned Software and the location of
the service codes for all Owned Software;
(iv) All employees, agents, consultants, or contractors who have
contributed to or participated in the creation or development
of inventions, discoveries, trade secrets, copyrightable
works, or ideas on behalf of the Company, any of its
Subsidiaries or any predecessor in interest thereto, if and
only if necessary to vest ownership rights in such material
with the Company and/or the Subsidiaries, either: (A) is a
party to a "work-for-hire" agreement under which the Company,
a Subsidiary (or such predecessor in interest, as applicable),
is deemed to be the original owner/author of all property
rights therein; or (B) has executed an assignment or an
agreement to assign in favor of the Company, or its Subsidiary
(or such predecessor in interest, as applicable), all right,
title and interest in such inventions, discoveries, trade
secrets, copyrightable works, or ideas.
(c) As used herein, the term "Intellectual Property Rights" shall mean:
(i) all United States and foreign patents, patent applications, continuations,
continuations-in-part, divisions, reissues, patent disclosures, extensions,
re-examinations, inventions (whether or not patentable) or improvements thereto;
(ii) all United States, state, foreign and common law trademarks, service marks,
domain names, logos, trade dress and trade names (including all assumed or
fictitious names under which the Company and each Subsidiary is conducting its
business or has within the previous five years conducted its business), whether
registered or unregistered, and pending applications to register the foregoing;
(iii) all United States and foreign copyrights, whether registered or
unregistered and pending applications to register the same; and (iv) all
confidential ideas, trade secrets, know-how, concepts, methods, processes,
formulae, reports, data, customer lists, mailing lists, business plans, or other
proprietary information.
SECTION 3.14 Brokers and Finders. Neither the Company nor any of its
officers, directors or employees has employed any broker or finder or incurred
any liability for any brokerage fees, commissions or finders' fees in connection
with this Agreement or the other transactions contemplated by this Agreement.
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SECTION 3.15 Events Subsequent to Financial Statements. Except as set
forth in Section 3.15 of the Seller Disclosure Letter, since January 31, 1998,
there has not been:
(a) Any material adverse change in the consolidated financial
condition, results of operations, business or prospective sales (meaning the
aggregate current, open purchase orders) of the Company or any of its
Subsidiaries;
(b) Any sale, lease, conveyance, license or assignment of any material
assets, tangible or intangible, of the Company or any of its Subsidiaries, other
than sales of inventory in the ordinary course of business;
(c) Any damage, destruction or property loss in excess of Fifty
Thousand Dollars ($50,000.00), individually or in the aggregate, in each
instance not covered by insurance, affecting adversely the properties or
business of the Company or any of its Subsidiaries;
(d) Any declaration or setting aside or payment of any dividend or
distribution with respect to the shares of capital stock of the Company or any
of its Subsidiaries or any redemption, purchase or other acquisition of any such
shares other than consummating the transactions contemplated and provided for in
this Agreement;
(e) Any mortgage or pledge of, or subjection to any lien, charge,
security interest or encumbrance of any kind on any of the assets, tangible or
intangible, of the Company or any of its Subsidiaries (other than liens arising
by operation of law which secure obligations which are not yet due and payable),
nor any incurrence of indebtedness or liability or assumption of obligations by
the Company or any of its Subsidiaries other than (i) those incurred in the
ordinary course of business, which would include any working capital loans
pursuant to the Company's credit line with Bank One, Sunrock and/or State Street
(ii) those which do not exceed Fifty Thousand Dollars ($50,000.00) in the
aggregate; and (iii) those incurred in the course of negotiating, documenting
and consummating the transactions contemplated and provided for in this
Agreement;
(f) Any cancellation or satisfaction by the Company or any of its
Subsidiaries of any debt or claim or advance, except for adjustments made in the
ordinary course of business, which in the aggregate, are not material other than
consummating the transactions contemplated or provided for in this Agreement;
(g) Any waiver or release other than the cancellation of open purchase
orders by customers, by the Company or any of its Subsidiaries of any right of
any material value in excess of Fifty Thousand Dollars ($50,000.00);
(h) Any sale, assignment, transfer or grant by the Company or any of
its Subsidiaries of any material rights under any concessions, leases, licenses,
agreements, patents, inventions, trademarks, trade name or copyrights other than
sales or gifts of products or advertising or other rights or releases thereof in
the ordinary course of business;
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(i) Any arrangement, agreement or undertaking entered into by the
Company or its Subsidiaries not terminable on thirty (30) days or less notice
without cost or liability (including, without limitation, any payment of or
promise to pay any bonus or special compensation or any increase in
compensation) with employees or any increase in compensation or benefits to
officers or directors of the Company or any of its Subsidiaries, other than in
the ordinary course of business or consummating the transactions contemplated or
provided for in this Agreement;
(j) Any change made or authorized in the articles of incorporation or
other charter documents or bylaws (or comparable governing instruments) of the
Company or any of its Subsidiaries other than those contemplated or provided for
in this Agreement;
(k) Any loan to or other transaction with any officer, director or
Shareholder of the Company or any of its Subsidiaries giving rise to any claim
or right of the Company or any of its Subsidiaries against any such person or of
such person against the Company or any of its Subsidiaries other than normal
recurring travel and expense advances and expense accounts made in the ordinary
course of business;
(l) Any acceleration, termination, modification or cancellation or
threat thereof by any party of any contract, lease or other agreement or
instrument, other than the cancellation or modification of open purchase orders
by customers or vendors of the Company, that individually or in the aggregate
involves in excess of Fifty Thousand Dollars ($50,000.00) to which the Company
or any of its Subsidiaries is a party or by which it is bound, which has had or
is reasonably likely to have a Material Adverse Effect on the properties or
business of the Company or any of its Subsidiaries;
(m) Any pledge or gift of any charitable or other capital contribution
outside the ordinary course of business;
(n) Any other transaction or commitment in excess of Fifty Thousand
Dollars ($50,000.00) or related transactions or commitments, other than the
modification or cancellation of open purchase orders by customers or vendors of
the Company, in the aggregate in excess of Fifty Thousand Dollars ($50,000.00)
entered into by the Company or any of its Subsidiaries which has had or is
reasonably likely to have a Material Adverse Effect on the properties or
business of the Company or any of its Subsidiaries, or other than those
contemplated or provided for in this Agreement; or
(o) Any termination, modification or cancellation of any booked open
purchase orders by any customer of the Company in excess of One Hundred Thousand
Dollars ($100,000.00) for any individual order or Two Hundred Fifty Thousand
Dollars ($250,000.00) in the aggregate by any single customer.
SECTION 3.16 Disclosure. The Company has made available to Buyer and
its officers, attorneys, accountants, and representatives true and correct
copies of all material agreements, documents, and other items listed in the
Seller Disclosure Letter and all books and records of the
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Company and its Subsidiaries, and neither this Agreement, the Seller Disclosure
Letter, nor any information, agreements, or documents delivered to or made
available to Buyer or its officers, attorneys, accountants, or representatives
pursuant to this Agreement, contain any untrue statements of a material fact or
omits to state any material fact necessary to make the statements made herein or
therein, as the case may be, not misleading.
SECTION 3.17 Real Property. Section 3.17 of the Seller Disclosure
Letter contains a complete and accurate list and brief description of all real
property owned or leased by the Company or its Subsidiaries. With respect to
each lease so set forth: (a) the lease has been validly executed and delivered
by the Company or its Subsidiaries, as applicable, and, to the Knowledge of the
Company, by the other party or parties thereto, and is in full force and effect;
(b) neither the Company nor its Subsidiary, as applicable, nor to the Knowledge
of the Company, any other party to the lease, is in material breach or default,
and no event has occurred on the part of the Company or its Subsidiaries, as
applicable or, to the Knowledge of the Company, on the part of any other party,
which, with notice or lapse of time, would constitute such a breach or default
or permit termination, modification or acceleration under the lease; (c) the
lease will continue to be binding in accordance with its terms following the
Initial Closing and the Second Closing and sale of the Shares to Buyer; (d)
neither the Company nor its Subsidiaries has repudiated and no other party to
the lease has repudiated, any provision thereof; (e) there are no written
notices of disputes, oral agreements or delayed payment programs in effect as to
the lease; and (f) all facilities leased thereunder have been approved by all
necessary Government Entities, and are in good condition, working order and
repair, ordinary wear and tear excepted.
SECTION 3.18 Tangible Property. Except as set forth in Section 3.18 of
the Seller Disclosure Letter, each of the Company and its Subsidiaries has good
and legal title to, or a valid leasehold interest in, each item of tangible
property, whether real, personal or mixed, reflected on its books and records as
owned or used by it, subject to no encumbrances, loans, security interests,
mortgages or pledges except those which arise by matter of law or in the
ordinary course of business, or which are inventory sold subsequent to the date
of entry on the books and which sales are not entered in the books of the
Company or its Subsidiaries on the date of this Agreement or the Second Closing
Date, or which are set forth in Section 3.18 of the Seller Disclosure Letter.
SECTION 3.19 Contracts. Section 3.19 of the Seller Disclosure Letter
lists the following contracts and written arrangements under which the Company
or any other person has continuing obligations or benefits, true and complete
copies of which have been delivered to Buyer, to which the Company or any of the
Subsidiaries is a party.
(a) Any contract for the lease of personal property from or to third
parties providing for lease payments in excess of Twenty-Five Thousand Dollars
($25,000.00) per annum;
(b) Any contract for the purchase or sale of raw materials,
commodities, supplies, products manufactured by the Company or any of its
Subsidiaries or other personal property or for the furnishing or receipt of
goods or services which contract calls for performance over a period of
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more than one year and/or which involves more than the sum of Fifty Thousand
Dollars ($50,000.00);
(c) Any partnership or foreign joint venture agreement;
(d) Any agreement or instrument under which the Company or any of its
Subsidiaries is or may become indebted for borrowed money in an amount
individually or in the aggregate in excess of Fifty Thousand Dollars
($50,000.00);
(e) Any employment agreement and any non-competition agreement.
Except as otherwise described in Section 3.19 of the Seller Disclosure
Letter, all material contracts and arrangements listed in Section 3.19 of the
Seller Disclosure Letter are valid and binding agreements and are in full force
and effect as to the Company and its Subsidiaries. Neither the Company nor any
of its Subsidiaries is, and no other party is in material breach or default, and
no event has occurred on the part of the Company or any of its Subsidiaries, or,
to the Company's Knowledge, on the part of any other party to any such contract
or arrangement, which with notice or lapse of time would constitute a material
breach or default or permit termination under any such contract or arrangement.
Except as set forth in Section 3.19 of the Seller Disclosure Letter, none of
such contracts or arrangements will be terminated or modified by the execution
and delivery of this Agreement, the Other Agreements, or the consummation of the
transactions contemplated hereby or thereby, nor will any of such actions result
in or constitute a breach or default under any such contracts or arrangements.
Neither the Company nor any of its Subsidiaries is a party to any verbal
contract or arrangement which, if reduced to written form, would be required to
be listed in Section 3.19 of the Seller Disclosure Letter under the terms of
this Section 3.19 other than with its representatives and vendors which are set
out in Section 3.19 of the Seller Disclosure Letter.
SECTION 3.20 Suppliers and Customers. Section 3.20 of the Seller
Disclosure Letter is a true and complete list of all suppliers of the Company
and each of the Subsidiaries to whom the Company or any of its Subsidiaries made
payments during the fiscal year ended January 31, 1999, in excess of five
percent (5%) of the Company's and the Subsidiaries' consolidated cost of goods
sold as reflected in the 1998 Financial Statements (as defined in Section
1.3(a)(i)) and all customers of the Company and each of the Subsidiaries that
paid the Company or the Subsidiary, during the fiscal year ended January 31,
1999, more than five percent (5%) of the consolidated revenues of the Company
and the Subsidiaries as reflected in the 1998 Financial Statements. Since
January 31, 1998, and until ten (10) days prior to the Second Closing Date, no
such supplier of the Company or any of the Subsidiaries has, or has indicated
that it will, stop, or decrease materially the rate of, supplying materials,
products or services to the Company or the Subsidiary, as the case may be, and
no such customer of the Company or the Subsidiaries has materially decreased or
ceased business with the Company or the Subsidiary, as the case may be, or has
indicated that it will materially decrease or cease doing business with the
Company or the Subsidiary.
SECTION 3.21 Accounts Receivable. To the Company's Knowledge, as of the
date of this Agreement, there are and as of the Second Closing Date to the
extent included in Section 3.21 of the
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Seller Disclosure Letter, there will be, properly reflected on their respective
books and records, all notes receivable and accounts receivable of the Company
and the Subsidiaries, each of which are and will be valid receivables subject to
no known setoffs or counterclaims other than normal and routine discounts,
mark-downs, returns of defective goods, doubtful accounts, credits and exchanges
of products and warranty claims, all of which are and will be consistent with
past practice. To the Company's Knowledge, except as set forth in Section 3.21
of the Seller Disclosure Letter, or except normal and routine discounts,
mark-downs, returns of defective goods, doubtful accounts, credits and exchanges
of products and warranty claims, all of which are and will be consistent with
past practice, all such receivables are collectable in the ordinary course of
business for the Company. Section 3.21 of the Seller Disclosure Letter is a
complete list of all notes receivable and accounts receivable of the Company and
its Subsidiaries as of March 31, 1999.
SECTION 3.22 Powers of Attorney. Except as set forth in Section 3.22 of
the Seller Disclosure Letter, other than for patent applications, trademark
applications and customs brokerage agreements and in security agreements for
current loans of the Company and its Subsidiaries, there are no outstanding
powers of attorney or similar instruments executed by the Company or any of the
Subsidiaries.
SECTION 3.23 Condition of Property. Each building, fixture, machine and
piece of equipment (having a net book value of Five Thousand Dollars ($5,000.00)
or more), owned or used by the Company or any of its Subsidiaries is listed in
Section 3.23 of the Seller Disclosure Letter and is in good operating condition
and repair (ordinary wear and tear excepted), and is in compliance with all
zoning, building and fire codes, except for such instances of noncompliance that
would not have or be reasonably likely to have a Material Adverse Effect. The
Company or its Subsidiaries owns and has good and legal title to, or leases
under leases which are valid and under which the Company or its Subsidiaries, or
to the Knowledge of the Company any other party thereto, are not currently in
default, all buildings, machinery, equipment and other tangible assets used in
the conduct of the Company's or such Subsidiary's business as presently
conducted, reflected in the most recent Financial Statements, and, except as set
forth in Section 3.23 of the Seller Disclosure Letter, are free and clear of all
liens, claims and encumbrances.
SECTION 3.24 Insurance. The Company and its Subsidiaries are insured
under the policies listed in Section 3.24 of the Seller Disclosure Letter. All
such policies have been in full force and effect since January 31, 1998, are in
full force and effect as of the date hereof, and will remain so through the
Second Closing Date.
SECTION 3.25 Guarantees. Except as set forth in Section 3.25 of the
Seller Disclosure Letter, neither the Company nor any of its Subsidiaries is a
guarantor or otherwise liable for any indebtedness of any other person, firm or
corporation other than endorsements for collection in the ordinary course of
business and for its Subsidiaries.
SECTION 3.26 Certain Business Relationships. Except as set forth in
Section 3.26 of the Seller Disclosure Letter, none of the present or former
directors, officers or employees of the
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Company or any of its Subsidiaries, or to the Company's Knowledge any present or
former Shareholders, owns, directly or indirectly, any interest in any business,
corporation or other entity (other than investments in publicly held companies)
which, on the date hereof or within the past twelve (12) months, has been
involved in any manner in any material business arrangement or relationship with
the Company or any of its Subsidiaries, and none of the foregoing persons owns
any property or rights, tangible or intangible, which are used in the business
of the Company or any of its Subsidiaries.
SECTION 3.27 Inventory. To the Company's Knowledge, the inventory of
the Company and its Subsidiaries (the "Inventory") as of the date of this
Agreement and as of the Second Closing Date does and will consist of goods which
are merchantable and fit for the purposes for which they were procured, and, to
the Company's Knowledge, the allowance for slow-moving, obsolete, damaged or
defective inventory reflected in the Financial Statements as of January 31,
1999, is adequate. To the Company's Knowledge, Section 3.27 of the Seller
Disclosure Letter contains a complete listing of the Inventory as of March 31,
1999, and the Company will deliver to Buyer an updated list of the Inventory as
of the Second Closing Date as of a date no sooner than three (3) calendar days
prior to the Second Closing Date.
SECTION 3.28 Questionable Payments. Neither the Company nor any of its
Subsidiaries has directly or indirectly (i) used corporate funds for unlawful
contributions, gifts, entertainment, or for other unlawful expenses relating to
political activity, (ii) made any unlawful payment to foreign or domestic
government officials or employees or to foreign or domestic political parties or
campaigns from corporate funds, (iii) violated or is in violation of any
provision or the Foreign Corrupt Practices Act of 1977 applicable to the conduct
of their business, or (iv) established or maintained any unlawful or unrecorded
fund of corporate monies or other assets.
SECTION 3.29 Opinion of Financial Advisor. The Company has delivered to
Buyer a copy of the opinion of Chaffe and Associates, Inc., dated the date
hereof, a copy of which opinion is attached hereto as Exhibit 3.29. The Company
has been authorized by Chaffe and Associates, Inc. to permit inclusion of such
opinion (and references thereto) in the Offer Documents, the Schedule 14D-9, and
the Proxy Statement.
SECTION 3.30 Information. None of the information provided or that may
be provided by the Company for use in the Schedule 14D-1, the Offer Documents,
or any other documents to be filed with the SEC or any other Governmental Entity
in connection with the transactions contemplated by this Agreement, and none of
the Proxy Statement, the Schedule 14D-9, or the statement required to be filed
pursuant to Section 2.5(b) hereof, shall, at the time filed with the SEC or such
other Governmental Entity, and, in the case of the Proxy Statement, at the time
mailed to the Company's Shareholders, or at the time of the Shareholders
Meeting, contain any untrue statement of a material fact or omit to state any
material fact required to be stated therein or necessary in order to make the
statements therein, in light of the circumstances under which they are made, not
misleading. Notwithstanding the foregoing, the Company makes no representation
or warranty with respect to any information provided or that may be provided by
Buyer specifically for use in such documents. The Schedule 14D-9, the Proxy
Statement and the statement to be filed pursuant to
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Section 2.5(b) hereof will comply as to form in all material respects with the
provisions of the Exchange Act and the rules and regulations thereunder.
ARTICLE IV
REPRESENTATIONS AND WARRANTIES OF BUYER
Buyer hereby represents and warrants the Company as follows:
SECTION 4.1 Organization, Qualification, Etc. Buyer is a limited
liability company duly organized, validly existing and in good standing under
the laws of the state of California and has the power and authority to own and
operate its properties and assets and to carry on its business as it is now
being conducted and is duly qualified to do business and is in good standing in
each jurisdiction in which the ownership of its properties or the conduct of its
business requires such qualification, except for jurisdictions in which such
failure to be so qualified or to be in good standing is not reasonably likely to
have, individually or in the aggregate, a Material Adverse Effect or prevent or
materially delay the consummation of the Offer.
SECTION 4.2 Authority Relative to this Agreement: No Violation. Buyer
has the power and authority to enter into this Agreement and to carry out its
obligations hereunder. The execution and delivery of this Agreement and the
consummation of the transactions contemplated hereby have been duly and validly
authorized by all necessary and appropriate action of Buyer. This Agreement has
been duly and validly executed and delivered by Buyer and, assuming this
Agreement has been duly and validly executed and delivered by the Company, this
Agreement constitutes a valid and binding agreement of Buyer, enforceable
against it in accordance with its terms (except insofar as enforceability may be
limited by the Bankruptcy Exception.
SECTION 4.3 Investigations: Litigation. Except as set forth in Section
4.3 of the disclosure letter delivered by the Company by Buyer on or prior to
entering into this Agreement and incorporated by reference herein (the "Buyer
Disclosure Letter"), there are no civil, criminal or administrative actions,
suits, claims, hearings, investigations or proceedings pending or, to the
Knowledge of Buyer, threatened against, Buyer or any current or former directors
or officers of Buyer or any of its Subsidiaries (in their capacities as such)
that, individually or in the aggregate, are reasonably likely to have a Material
Adverse Effect on, prevent, or impair the ability of Buyer to consummate the
transactions contemplated by this Agreement, including, without limitation, the
consummation of the Offer.
SECTION 4.4 Financing. Buyer will have available to it, at the time
required, the funds necessary to consummate the Offer, and the purchase of the
Initial Funding Shares and the Second Funding Shares.
SECTION 4.5 Information. None of the information provided or that may
be provided by Buyer for use in the Proxy Statement, the Schedule 14D-9, the
statement required to be filed
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pursuant to Section 2.5(b) hereof, or any other documents to be filed with the
SEC or any other Governmental Entity in connection with the transactions
contemplated by this Agreement, and the Schedule 14D-1, shall not, at the time
filed with the SEC, and in the case of the Proxy Statement, at the time mailed
to the Shareholders or the date of the Shareholders Meeting, contain any untrue
statement of a material fact or omit to state a material fact required to be
stated therein or necessary in order to make the statements therein, in light of
the circumstances under which they are made, not misleading. Notwithstanding the
foregoing, Buyer makes no representation or warranty with respect to any
information provided or that may be provided by the Company specifically for use
in such documents. The Schedule 14D-1 will comply as to form in all material
respects with the provisions of the Exchange Act and the rules and regulations
thereunder.
SECTION 4.6 Investment Representation. Buyer is acquiring the Initial
Funding Shares and the Second Funding Shares for its own account for investment
and not with a view to, or for sale or other disposition in connection with, any
distribution of all or any part thereof, except (i) in an offering covered by a
registration statement filed with the SEC under the Securities Act covering such
Shares or (ii) pursuant to an applicable exemption under the Securities Act. In
acquiring the Initial Funding Shares and the Second Funding Shares, Buyer is not
offering or selling, and will not offer or sell, for the Company in connection
with any distribution of the Initial Funding Shares and the Second Funding
Shares, and Buyer does not have a participation and will not participate in any
such undertaking or in any underwriting of such an undertaking except in
compliance with applicable federal and state securities laws.
SECTION 4.7 Disclosure of Information. Buyer acknowledges that it or
its representatives have been furnished with substantially the same kind of
information regarding the Company and its business, assets, results of
operation, and financial condition as would be contained in a registration
statement prepared in connection with a public sale of the Initial Funding
Shares and the Second Funding Shares. Buyer further represents that it has had
an opportunity to ask questions of and receive answers from the Company
regarding the Company and its business, assets, results of operation, and
financial condition and the terms and conditions of the issuance of the Initial
Funding Shares and the Second Funding Shares.
SECTION 4.8 Investment Experience. Buyer acknowledges that it is able
to fend for itself, can bear the economic risk of its investment in the Initial
Funding Shares and the Second Funding Shares, and has such knowledge and
experience in financial and business matters that it is capable of evaluating
the merits and risks of an investment in the Initial Funding Shares and the
Second Funding Shares. Buyer is an "accredited investor" as such term is defined
in Regulation D under the Securities Act.
SECTION 4.9 Restricted Securities. Buyer understands that the Initial
Funding Shares and the Second Funding Shares have not been registered pursuant
to the Securities Act or any applicable state securities laws, that the Initial
Funding Shares and the Second Funding Shares will be characterized as
"restricted securities" under federal securities laws, and that under such laws
and applicable regulations the Initial Funding Shares and the Second Funding
Shares cannot be sold or otherwise disposed of without registration under the
Securities Act or an exemption therefrom. In
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this connection, Buyer represents that it is familiar with Rule 144 promulgated
under the Securities Act, as currently in effect, and understands the resale
limitations imposed thereby and by the Securities Act. Stop transfer
instructions may be issued to the transfer agent for securities of the Company
(or a notation may be made in the appropriate records of the Company) in
connection with the Initial Funding Shares and the Second Funding Shares.
SECTION 4.10 Legend. It is agreed and understood by Buyer that the
certificates representing the Initial Funding Shares and the Second Funding
Shares shall each conspicuously set forth on the face or back thereof, in
addition to any legends required by applicable law or other agreement, a legend
in substantially the following form:
THE SHARES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED
PURSUANT TO THE SECURITIES ACT OF 1933, AS AMENDED, OR ANY STATE
SECURITIES LAWS. SUCH SHARES MAY NOT BE SOLD OR OTHERWISE TRANSFERRED
UNLESS THEY ARE FIRST REGISTERED PURSUANT TO THAT ACT AND APPLICABLE
STATE SECURITIES LAWS OR UNLESS THE CORPORATION RECEIVES A WRITTEN
OPINION OF COUNSEL, WHICH OPINION IS REASONABLY SATISFACTORY TO THE
CORPORATION, TO THE EFFECT THAT SUCH REGISTRATION IS NOT REQUIRED.
SECTION 4.11 Brokerage Fees. Neither Buyer nor any of its Affiliates
has retained any financial advisor, broker, agent, or finder or paid or agreed
to pay any financial advisor, broker, agent, or finder on account of this
Agreement or any transaction contemplated hereby except that Gerard, Klauer,
Mattison & Co., Inc.("GKM") has been retained as Buyer's financial advisor in
connection with the transactions contemplated hereby and Buyer may retain
additional advisors, brokers or agents as it may determine. Buyer shall
indemnify and hold harmless the Company from and against any and all losses,
claims, damages, and liabilities (including legal and other expenses reasonably
incurred in connection with investigating or defending any claims or actions)
with respect to any finder's fee, brokerage commission, or similar payment in
connection with any transaction contemplated hereby asserted by any person on
the basis of any act or statement made or alleged to have been made by Buyer or
any of its Affiliates, including the fee of GKM.
ARTICLE V
COVENANTS
SECTION 5.1 Interim Operations. The Company covenants and agrees as to
itself and each of its Subsidiaries that, through the Second Closing Date
(unless Buyer shall otherwise approve, and except as otherwise expressly
contemplated by this Agreement):
(a) The business of it and its Subsidiaries shall be conducted in the
ordinary and usual course and, to the extent consistent therewith, it and its
Subsidiaries shall use all commercially reasonable efforts to preserve its
business organization intact and maintain its existing relations and
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goodwill with customers, suppliers, distributors, creditors, lessors, employees
and business associates;
(b) Neither it nor any of its Subsidiaries shall (i) issue, sell,
pledge, dispose of or encumber any capital stock owned by it or any of its
Subsidiaries in any of its Subsidiaries or other Affiliates, except pursuant to
the exercise of existing Company Options or warrants disclosed to Buyer pursuant
to Section 3.2 hereof in accordance with their terms; (ii) amend its articles of
incorporation or by-laws (or comparable organizational documents); (iii) split,
combine or reclassify its outstanding shares of capital stock; (iv) declare, set
aside or pay any dividend payable in cash, stock or property in respect of any
capital stock other than dividends from its direct or indirect wholly-owned
Subsidiaries; or (v) repurchase, redeem or otherwise acquire, except in
connection with the payment of the exercise price of any option outstanding on
the date hereof under the Stock Plan, or permit any of its Subsidiaries to
purchase or otherwise acquire, any shares of its capital stock or any securities
convertible into or exchangeable or exercisable for any shares of its capital
stock;
(c) Neither it nor any of its Subsidiaries shall (i) issue, sell,
pledge, dispose of or encumber any shares of, or securities convertible into or
exchangeable or exercisable for, or options, warrants, calls, commitments or
rights of any kind to acquire, any shares of its capital stock of any class or
any other property or assets (other than shares issuable pursuant to options
outstanding on the date hereof under the Stock Plan or warrants outstanding on
the date hereof as described in Section 3.2 of the Seller Disclosure Letter);
(ii) purchase, transfer, lease, sell, mortgage, pledge, dispose of or encumber
any real property, or effect any improvements or expansions thereon; (iii) other
than in the ordinary and usual course of business, purchase, transfer, lease,
license, guarantee, sell, mortgage, pledge, dispose of or encumber any other
property or assets (including capital stock of any of its Subsidiaries) or incur
or modify any material indebtedness or other liability; (iv) make or authorize
or commit for any capital expenditure(s) in excess of $25,000; (v) make draws
against the Company's credit facility with Sunrock other than in the ordinary
course of business, provided however that after such time that the Company's
draws against such credit facility equal or exceed five million dollars
($5,000,000) in the aggregate, any additional draws against such credit
facility, whether in the ordinary course of business or otherwise, may not be
made without the prior approval of Buyer, which approval shall not be
unreasonably delayed or denied; or (vi) by any means, make any acquisition of,
or investment in any business, whether through the acquisition of assets or
stock of any other Person;
(d) Except as may be required by applicable law, and except as provided
in Section 5.8, neither it nor any of its Subsidiaries shall terminate,
establish, adopt, enter into, make any new grants or awards under, amend or
otherwise modify, any Compensation and Benefit Plans or increase the salary,
wage, bonus, severance, incentive or other compensation of any employees,
officers or directors;
(e) Neither it nor any of its Subsidiaries shall settle or compromise
any claims or litigation or, except in the ordinary and usual course of business
consistent with past practice, enter into any Debt Contracts or Other Contracts,
or modify, amend or terminate prior to the scheduled
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expiration thereof any of its Debt Contracts or Other Contracts or waive,
release or assign any material rights or claims;
(f) Neither it nor any of its Subsidiaries shall make any Tax election
or permit any insurance policy naming it as a beneficiary or loss-payable payee
to be amended or canceled;
(g) Neither it nor any of its Subsidiaries shall take any action, other
than reasonable and usual actions in the ordinary and usual course of business
consistent with past practice, with respect to accounting policies or
procedures;
(h) Neither it nor any of its Subsidiaries shall sell, transfer, assign
or abandon any patents, trademarks or licenses which are owned or controlled
directly or indirectly by the Company or any of its Subsidiaries except in the
ordinary and usual course of business consistent with past practice;
(i) Neither it nor any of its Subsidiaries shall license or otherwise
encumber any patents or trademarks which are owned or controlled directly or
indirectly by the Company or any of its Subsidiaries, except in the ordinary and
usual course of business;
(j) Neither it nor any of its Subsidiaries shall make any modification
to employee or customer incentives or trade policies which would reasonably be
expected to cause the Company's distributors or end-user customers to increase
purchases above those levels normally required to meet their respective needs or
cause a material increase or decrease in the Company's inventories or Working
Capital; and
(k) Neither it nor any of its Subsidiaries shall authorize or announce
an intention to do any of the foregoing, or enter into any contract, agreement,
commitment or arrangement to do any of the foregoing.
SECTION 5.2 Acquisition Proposals. From and after the date hereof, the
Company shall not, and it shall use its best efforts to not permit any of its
directors, officers, employees, attorneys, financial advisors, agents or other
representatives or those of any of its Subsidiaries to, directly or indirectly,
solicit, initiate or knowingly encourage (including by way of furnishing
information) any Takeover Proposal (as hereinafter defined) from any Person
other than Buyer, or engage in or continue discussions or negotiations relating
to any Takeover Proposal; provided, however, that the Company may engage in
discussions or negotiations with, and furnish information to, any Person that
makes a written Takeover Proposal in respect of which the Board of Directors of
the Company concludes in good faith if consummated would constitute a Superior
Proposal (as hereinafter defined), but only if the Board of Directors of the
Company shall conclude in good faith on the basis of the advice of its outside
counsel that the failure to take such action would be inconsistent with the
fiduciary obligations of such Board of Directors under applicable law; and
provided further that notwithstanding anything to the contrary herein contained,
the Board of Directors of the Company may take and disclose to the Shareholders
a position contemplated by Rule 14e-2 promulgated under the Exchange Act, comply
with Rule 14d-9 thereunder and make all disclosures required by applicable law
in connection therewith. The Company shall as soon as practicable and in any
event
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no later than the date on which such Takeover Proposal is presented to the
Company's Board of Directors notify Buyer of any Takeover Proposal received by
it or any of its directors, officers, employees, attorneys, financial advisors,
agents or other representatives or those of any of its Subsidiaries or the
receipt by the Company or any of the foregoing of any notice of any intention to
make a Takeover Proposal, including the identity of the person making such
Takeover Proposal or intending to make a Takeover Proposal and the material
terms of any such Takeover Proposal. As used in this Agreement: (i) "Takeover
Proposal" means any bona fide proposal or offer (other than a proposal or offer
by Buyer or any of its Affiliates), or any expression of interest by any Person
relating to any actual or potential merger, consolidation or other business
combination involving the Company or any of its Subsidiaries or any acquisition
in any manner (including, without limitation, by tender or exchange offer) of a
substantial equity interest in, or a substantial portion of the assets of, the
Company or any of its Subsidiaries (each being a "Material Corporate
Transaction"); and (ii) "Superior Proposal" means a bona fide proposal or offer
made by any Person concerning a Material Corporate Transaction, in each case on
terms which a majority of the members of the Board of Directors of the Company
determines in good faith, and based on the advice of outside counsel, to be more
favorable to the Company and its Shareholders than the transactions contemplated
hereby (including any revised transaction proposed by Buyer pursuant to Section
7.1(g)). During the period from the date of this Agreement through the Second
Closing Date, the Company shall not terminate, amend, modify or waive any
provision of any standstill agreement to which it or any of its Subsidiaries is
a party. During such period, the Company shall enforce, to the fullest extent
permitted under applicable law, but subject to the exercise by the Board of
Directors of the Company of their fiduciary obligations after consultation with
outside counsel, the provisions of any such agreement, including, but not
limited to, by obtaining injunctions to prevent any breaches of such agreements
and to enforce specifically the terms and provisions thereof in any court of the
United States of America or of any state having jurisdiction.
SECTION 5.3 Information Supplied. The Company and Buyer each agrees, as
to itself and its Subsidiaries, that none of the information supplied or to be
supplied by it or its Subsidiaries for inclusion or incorporation by reference
in (i) the Schedule 14D-1, the Offer Documents, the Schedule 14D-9, the Proxy
Statement, the statement required to be filed pursuant to Section 2.5(b) hereof,
or any other documents to be filed with the SEC or any other Governmental Entity
in connection with the transactions contemplated by this Agreement will, at the
time filed with the SEC, contain any untrue statement of a material fact or omit
to state any material fact required to be stated therein or necessary to make
the statements therein, in light of the circumstances under which they were
made, not misleading, and (ii) the Proxy Statement and any amendment or
supplement thereto will, at the date of mailing to the Shareholders and at the
time of the meeting of Shareholders to be held in connection with this
Agreement, contain any untrue statement of a material fact or omit to state any
material fact required to be stated therein or necessary in order to make the
statements therein, in light of the circumstances under which they were made,
not misleading.
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SECTION 5.4 Company Action. In order to consummate the transactions
contemplated hereby, the Company will, in accordance with applicable law and its
articles of incorporation and bylaws:
(a) hold a special meeting of the Shareholders (the "Shareholders
Meeting") as soon as practicable following the date of this Agreement for the
purpose of: (i) approving the sale of the Second Funding Shares by the Company
to Buyer as contemplated herein and (ii) adopting and approving this Agreement
and the Articles of Amendment;
(b) as promptly as practicable after the date of this Agreement, (i)
file with the SEC a proxy statement (the "Proxy Statement") and other proxy
soliciting materials relating to the Shareholders Meeting, (ii) respond promptly
to any comments made by the SEC with respect to the Proxy Statement or other
proxy soliciting materials, (iii) cause the Proxy Statement to be mailed to the
Shareholders at the earliest practicable time after the date of this Agreement,
and (iv) in all other respects use its best efforts to cause the Shareholders to
approve the sale of the Second Funding Shares by the Company to Buyer, and
approve and adopt this Agreement and the Articles of Amendment; and
(c) include in the Proxy Statement, the recommendation of the Board
that the Shareholders of the Company vote in favor of the sale of the Second
Funding Shares by the Company to Buyer and adopt and approve this Agreement and
the Articles of Amendment; provided, however, the Company's Board of Directors
shall not be required to make, and shall be entitled to withdraw, any such
recommendation (and cease such solicitation) if such Board concludes in good
faith on the basis of the advice of its outside counsel that the making of, or
the failure to withdraw, such recommendation would violate the fiduciary
obligations of such Board under applicable law.
Buyer and its counsel shall be given reasonable opportunity to review and
comment upon the Proxy Statement prior to its filing with the SEC or
dissemination to Shareholders of the Company. The Company agrees to provide
Buyer and its counsel any comments the Company or its counsel may receive from
the SEC or its staff with respect to the Proxy Statement promptly after the
receipt of such comments.
SECTION 5.5 Filings; Other Actions; Notification.
(a) The Company shall use its best efforts to obtain all necessary
state securities law or "blue sky" permits and approvals, if any, required in
connection with the sale of the Initial Funding Shares and the Second Funding
Shares to Buyer and to consummate the other transactions contemplated by this
Agreement and will pay all expenses incident thereto;
(b) The Company and Buyer shall cooperate with each other and use (and
shall cause their respective Subsidiaries to use) their respective best efforts
to take or cause to be taken all actions, and do or cause to be done all things,
necessary, proper or advisable on its part under this Agreement and applicable
Laws to consummate and make effective the transactions contemplated by this
Agreement as soon as practicable, including preparing and filing as promptly as
practicable
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all documentation to effect all necessary notices, reports and other filings,
responding promptly to any requests for further information and to obtain as
promptly as practicable all consents, registrations, approvals, permits and
authorizations necessary or advisable to be obtained from any third party and/or
any Governmental Entity in order to consummate the transactions contemplated by
this Agreement as promptly as practicable. Subject to applicable laws relating
to the exchange of information, Buyer and the Company shall have the right to
review in advance, and each will consult the other on, all the information
relating to Buyer or the Company, as the case may be, and any of their
respective Subsidiaries, that appear in any filing made with, or written
materials submitted to, any third party, the SEC and/or any other Governmental
Entity in connection with the transactions contemplated by this Agreement. In
exercising the foregoing right, each of the Company and Buyer shall act
reasonably and as promptly as practicable;
(c) The Company and Buyer each shall, upon request by the other,
furnish the other with all information concerning itself, its Subsidiaries,
directors, officers and Shareholders and such other matters as may be reasonably
necessary or advisable in connection with the Schedule 14D-1, the Offer
Documents, the Schedule 14D-9, the Proxy Statement, the statement required to be
filed pursuant to Section 2.5(b) hereof or any other statement, filing, notice
or application made by or on behalf of Buyer, the Company or any of their
respective Subsidiaries to any third party, the SEC and/or any other
Governmental Entity in connection with the transactions contemplated by this
Agreement;
(d) The Company and Buyer each shall keep the other apprised of the
status of matters relating to completion of the transactions contemplated
hereby, including promptly furnishing the other with copies of notice or other
communications received by Buyer or the Company, as the case may be, or any of
its Subsidiaries, from any third party, the SEC, and/or any other Governmental
Entity with respect to the transactions contemplated by this Agreement;
(e) Without limiting the generality of the undertakings pursuant to
this Section 5.5, (i) the Company and Buyer agree to provide promptly to any and
all federal, state, local or foreign court or Government Entity with
jurisdiction over enforcement of any applicable antitrust laws ("Government
Antitrust Entity") information and documents requested by any Government
Antitrust Entity or necessary, proper or advisable to permit consummation of the
transactions contemplated by this Agreement; and (ii) in connection with any
filing or submission or other action required to be made or taken by either
Buyer or the Company to effect the transactions contemplated hereby or thereby,
the Company shall not, without Buyer's prior written consent, commit to any
divestiture transaction, and, neither Buyer nor any of its Affiliates shall be
required to divest or hold separate or otherwise take or commit to take any
action that limits its freedom of action with respect to, or its ability to
retain, the Company or any portions thereof or any of the business, product
lines, properties or assets of Buyer or any of its Affiliates.
SECTION 5.6 Access. Upon reasonable notice, and except as may otherwise
be required by applicable law, the Company shall (and shall cause its
Subsidiaries to) afford Buyer's officers, employees, counsel, accountants and
other authorized representatives ("Representatives") access, during normal
business hours throughout the period prior to the Second Closing Date, to its
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properties, books, contracts and records (including its audit work papers and
related documents) and, during such period, shall (and shall cause its
Subsidiaries to) furnish promptly to Buyer all information concerning its
business, properties and personnel as may reasonably be requested, provided that
no investigation pursuant to this Section 5.6 shall affect or be deemed to
modify any representation or warranty made by the Company, and provided,
further, that the foregoing shall not require the Company to permit any
inspection, or to disclose any information, that in the reasonable judgment of
the Company, would result in the disclosure of any trade secrets of it or third
parties or violate any of its obligations with respect to confidentiality if the
Company shall have used reasonable efforts to obtain the consent of such third
party to such inspection or disclosure. All requests for information made
pursuant to this Section 5.6 shall be directed to an executive officer of the
Company or such Person as may be designated by its officers. Buyer and the
Company shall each designate two representatives to meet (either in person or by
conference telephone), on a semi-monthly basis to discuss the Company's capital
expenditures, inventory management, sales promotions, distribution arrangements,
construction projects, group purchasing organization contracts, other material
contracts, patents, licenses and such other business matters concerning the
Company's operations as are desired. All such information supplied hereunder
shall be governed by the terms of that certain Confidentiality Agreement between
the Company and E. Thomas Martin.
SECTION 5.7 Publicity. The initial press releases by Buyer and the
Company concerning this Agreement and the transactions contemplated hereby shall
be mutually agreed as to content prior to thereafter the Company and Buyer shall
consult with each other prior to issuing any press releases or otherwise making
public announcements with respect to the transactions contemplated by this
Agreement and prior to making any filings with any third party, the SEC and/or
any other Governmental Entity (including any national securities exchange) with
respect thereto, except as may be required by law or by obligations pursuant to
any listing agreement with or rules of any national securities exchange or
NASDAQ.
SECTION 5.8 Employee Benefits. For a period of one (1) year immediately
following the Second Closing, Buyer agrees to cause the Company to provide to
all active employees of the Company as of the Second Closing who continue to be
employed by the Company coverage under group medical, group dental, 401(k)
savings, disability insurance, life insurance, accidental death and disability,
and vacation plans or arrangements which are, in the aggregate, substantially
similar to the plans providing such benefits to the employees immediately prior
to the Second Closing Date.
SECTION 5.9 Fees and Expenses.
(a) Except as otherwise provided in this Section 5.9, whether or not
the transactions contemplated by this Agreement shall be consummated, all costs
and expenses incurred in connection with this Agreement and the transactions
contemplated hereby, including, without limitation, the fees and disbursements
of counsel, financial advisors, accountants, actuaries and consultants, shall be
paid by the party incurring such costs and expenses, provided that: (i) all
expenses incurred in connection with the filing fees and the printing and
mailing costs of the Schedule 14D-1, the Offer Documents, the Schedule 14D-9,
the Proxy Statement, and the statement required by Section 2.5(a) hereof shall
be shared equally by Buyer and the Company, and (ii) all
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filing fees and other costs incurred by any of the parties hereto in connection
with the HSR Act, if any, shall be borne by the Company.
(b) Notwithstanding any provisions in this Agreement to the contrary,
if the Agreement is terminated in accordance with Sections 7.1(g) or 7.1(h), the
Company shall pay Buyer $1 million simultaneously with accepting such proposal.
Nothing contained in this Section 5.9 shall be deemed to limit any
remedies available to any party for any breach of this Agreement by any other
party which such remedies shall be in addition to any amounts received by any
party pursuant to this Section 5.9; provided, however, that, with respect to any
breach by the Company of the provisions of Section 5.2 that is not the result of
bad faith on the part of the Company, Buyer's exclusive remedy in respect of
such breach shall be limited to the $1 million, and the Company shall have no
other liability to Buyer in respect of such breach.
SECTION 5.10 Takeover Statute. If any Takeover Statute is or may become
applicable to the transactions contemplated by this Agreement, then each of
Buyer and the Company and its Board of Directors, subject to applicable law,
shall grant such approvals and take such actions as are necessary so that such
transactions may be consummated as promptly as practicable on the terms
contemplated by this Agreement and otherwise act to eliminate or minimize the
effects of such statute or regulation on such transactions.
SECTION 5.11 Notification of Certain Matters. Buyer, shall give prompt
notice to the Company, and the Company shall give prompt notice to Buyer, of:
(i) the occurrence, or non-occurrence, of any event the occurrence, or
non-occurrence, of which would cause (A) any representation or warranty
contained in this Agreement to be untrue or inaccurate in any material respect
or (B) any covenant, condition or agreement contained in this Agreement not to
be complied with or satisfied in any material respect; and (ii) any failure of
Buyer or the Company, as the case may be, to comply with any covenant or
agreement to be complied with by it hereunder in any material respect; provided,
however, that the delivery of any notice pursuant to this Section 5.11 shall not
limit or otherwise affect the remedies available hereunder to the party
receiving such notice.
SECTION 5.12 Phase I Environmental Audit. Buyer may obtain at its own
expense, as soon as practicable, but in any event within thirty (30) days of the
date of this Agreement, Phase I reports pursuant to ASTM Standard E 1527-97 or
other standard environmental assessments (the "Environmental Reports") with
respect to any properties owned or leased by the Company from and environmental
engineering firm selected by Buyer. Buyer acknowledges and agrees that the
Company leases all its real property and, as a result, Buyer's ability to obtain
such Environmental Reports may be limited. If Buyer elects to obtain such
Environmental Reports, Buyer shall, promptly (but in no event later than five
(5) business days) after receipt thereof, provide a copy of such Environmental
Reports to the Company.
SECTION 5.13 Shareholder Claims. The Company shall not agree to, cause
or permit the settlement or compromise of any claim brought by any present,
former or purported holder of any
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securities of the Company prior to the Second Closing Date without prior written
consent of Buyer, which shall not be unreasonably withheld.
SECTION 5.14 Notice of Changes. The Company shall inform Buyer in
writing within five (5) days of any change, or prior to the Second Closing Date
if less than five (5) days prior to the Second Closing, which occurs or is
threatened (or if any development occurs or is threatened involving a
prospective change) in the financial condition, results of operations, business,
or prospective sales that has or may reasonably be expected to have a Material
Adverse Effect on the financial condition, results of operations, business or
prospective sales of the Company; provided, however, that the delivery of any
notice pursuant to this Section 5.14 shall not limit or otherwise affect the
remedies available hereunder to the party receiving such notice.
SECTION 5.15 Shareholders' and Voting Agreement. As a condition to the
Company's and Buyer's willingness to enter into this Agreement, the Company and
Buyer have entered into that certain Shareholders' and Voting Agreement by and
among the Company, Buyer and the DSI Group, in the form attached hereto as
Exhibit 5.15.
SECTION 5.16 Registration Rights Agreement. As a condition to Buyer's
willingness to enter into this Agreement, Buyer has entered into that certain
Registration Rights Agreement by and among Buyer, the Company, and the DSI Group
in the form attached hereto as Exhibit 5.16.
SECTION 5.17 Consulting Agreement. On or promptly following the Second
Closing, the Company and M. D. Davis ("Davis") will enter into a Consulting
Agreement (the "Consulting Agreement") in the form attached hereto as Exhibit
5.17.
SECTION 5.18 Side Letter Agreements. On or prior to the Second Closing
Date, each of the members of the DSI Group will execute a Side Letter Agreement
in the form attached hereto as Exhibit 5.18.
SECTION 5.19 Indemnification Arrangements. Buyer agrees that for the
period from the Second Closing Date until three (3) years after the Second
Closing Date Buyer shall use its best efforts (i) to cause the Company and its
Subsidiaries to maintain in effect without any reduction in scope or coverage
indemnification provisions for present and former directors, officers, employees
and agents of the Company and its Subsidiaries that are at least as favorable to
all such persons as those contained in the Company's Articles of Incorporation
and Bylaws in effect as of the date hereof; (ii) if available on commercially
reasonable terms, to cause the Company to maintain its current levels of errors
and omissions insurance coverage for its directors and officers in effect as of
the date hereof; and (iii) prevent the Company from unlawfully transferring
assets of the Company that would otherwise be available for the lawful indemnity
claims of the Company's then current and former directors, officers, employees
and agents; provided, however, nothing contained herein shall prevent or
preclude Buyer from causing or permitting the Company to enter into a
commercially reasonable transaction with a third party for the sale of all or
substantially all of the Company's assets or that involves the merger or
consolidation of the Company with another entity; and provided
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further that Buyer shall not be required to take any action that prevents Buyer
or any of Buyer's officers, directors or members from exercising any fiduciary
obligation they may have to the Company.
SECTION 5.20 Moss Estate. On or before June 30, 1999, the Company and
the DSI Group shall have consummated a transaction with all necessary parties to
resolve any disputes with the Moss Estate substantially similar to the terms and
conditions of the proposed agreement(s) identified in Section 5.20 of the Seller
Disclosure Letter (the "Moss Agreements"). If the Company and all additional
parties shall not have consummated the transactions contemplated by the Moss
Agreements on or before June 30, 1999, then the Company shall issue to Buyer on
the Second Closing Date (or on July 1, 1999, if the Second Closing Date occurs
prior to June 30, 1999), one hundred thousand (100,000) additional Shares (the
"Moss Default Shares"), for no additional consideration.
SECTION 5.21 Sunrock Agreements. There shall not occur a default or
breach, nor shall there occur any fact or circumstance, which with notice or
lapse of time would constitute a breach or default or permit termination of any
contract, loan or agreement of any type with Sunrock.
SECTION 5.22 Use of Proceeds. Immediately upon the consummation of the
Initial Closing, the Company shall apply all of the proceeds of the Initial
Funding Shares Purchase Price to the reduction of the Company's indebtedness to
Sunrock.
ARTICLE VI
CONDITIONS
SECTION 6.1 Conditions to Each Party's Obligation to Effect the Sale of
the Second Funding Shares. The respective obligation of each party to effect the
sale of the Second Funding Shares from the Company to Buyer is subject to the
satisfaction or waiver at or prior to the Second Closing Date of each of the
following conditions:
(a) Shareholder Approval. This Agreement and all transactions
contemplated herein shall have been duly approved by the Shareholders in
accordance with all applicable law and the articles of incorporation and by-laws
of Company;
(b) Regulatory Consents. Any waiting period applicable to the
consummation of the transactions contemplated by this Agreement under the HSR
Act shall have expired or been terminated and all notices, reports and other
filings required to be made prior to the Second Closing Date by the Company,
Buyer or any of their respective Subsidiaries with, and all consents,
registrations, approvals, permits and authorizations required to be obtained
prior to the Second Closing Date by the Company, Buyer or any of their
respective Subsidiaries from, any Governmental Entity (collectively,
"Governmental Consents") in connection with the execution and delivery of this
Agreement and the consummation of the other transactions contemplated hereby by
the Company
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shall have been made or obtained (as the case may be), except those that the
failure to make or to obtain are not, individually or in the aggregate,
reasonably likely to have a Material Adverse Effect on the business of the
Company or any of its Subsidiaries;
(c) Litigation. No court or Governmental Entity of competent
jurisdiction shall have enacted, issued, promulgated, enforced or entered any
law, statute, ordinance, rule, regulation, judgment, decree, injunction or other
order (whether temporary, preliminary or permanent) that is in effect and
restrains, enjoins or otherwise prohibits consummation of this Agreement and the
transactions contemplated hereby (collectively, an "Order"); and
(d) Blue Sky Approvals. The Company shall have received all state
securities and "blue sky" permits and approvals, if any, necessary to consummate
the transactions contemplated hereby.
SECTION 6.2 Conditions to Obligations of Buyer. The obligations of
Buyer to purchase the Second Funding Shares are also subject to the satisfaction
or waiver by Buyer at or prior to the Second Closing Date of the following
conditions:
(a) Representations and Warranties. Each of the representations and
warranties of the Company contained in this Agreement shall have been true and
correct when made and also shall be true and correct at and as of the Second
Closing Date as if made at and as of the Second Closing Date, except as
contemplated or permitted by this Agreement and except for such matters that,
either individually or when combined with any breach of any other representation
or warranty of the Company or any fact, circumstance, occurrence, breach or
default, or any failure to perform any covenant or obligation all as set forth
in Sections 6.2(b) or 6.2(c) hereof, are not reasonably likely to have a
Material Impact (as defined in this Section 6.2(a) below), and Buyer shall have
received a certificate signed on behalf of the Company by its Chief Executive
Officer and its Chief Financial Officer to such effect. For purposes of Sections
6.2, 6.3 and Exhibit 2.1, a "Material Impact" shall be any matter or matters
having an adverse impact or economic consequence that exceeds Three Hundred
Sixty Thousand Dollars ($360,000).
(b) Performance of Obligations of the Company. The Company shall have
performed all obligations required to be performed by it under this Agreement at
or prior to the Second Closing Date, except for such matters that, either
individually or when combined with any breach of any representation or warranty
of the Company as of the times set forth in Section 6.2(a) or any fact,
circumstance, occurrence, breach or default, or any failure to perform any
covenant or obligation all as set forth in this Section 6.2(b) and in Section
6.2(c) hereof, are not reasonably likely to have a Material Impact, and Buyer
shall have received a certificate signed on behalf of the Company by its Chief
Executive Officer and its Chief Financial Officer to such effect.
(c) Consents Under Agreements. The Company shall have obtained the
consent or approval of each Person whose consent or approval shall be required
under any Debt Contract or Other Contract to which the Company or any of its
Subsidiaries is a party, all of which are listed in Section 6.2(c) of the Seller
Disclosure Letter, and there shall not have occurred any breach or default, nor
shall there have occurred any fact or circumstance which with notice or lapse of
time would
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constitute a breach or default or permit termination of any Debt Contract or
Other Contract to which the Company or any of its Subsidiaries is a party,
except for such matters that, either individually or when combined with any
breach of any representation or warranty of the Company as of the times set
forth in Section 6.2(a) or any fact, circumstance, occurrence, breach or
default, or any failure to perform any covenant or obligation all as set forth
in Section 6.2(b) or this Section 6.2(c), are not reasonably likely to have a
Material Impact, and Buyer shall have received a certificate signed on behalf of
the Company by its Chief Executive Officer and its Chief Financial Officer to
such effect.
(d) Shareholders' and Voting Agreement. The Company, Buyer, and the DSI
Group shall have entered into the Shareholders' and Voting Agreement in the form
attached hereto as Exhibit 5.15.
(e) Davis Consulting Agreement. Davis shall have entered into the Davis
Consulting Agreement in the form attached hereto as Exhibit 5.17.
(f) Offer Conditions. The conditions specified in Exhibit 2.1 shall
have been satisfied or waived.
(g) Side Letter Agreement. Each of the members of the DSI Group shall
have executed a Side Letter Agreement in the form attached hereto as Exhibit
5.18.
(h) Opinion of Counsel. The Company shall have caused to be delivered
to Buyer a favorable opinion of counsel dated the Second Closing Date
substantially in the form attached hereto as Exhibit 6.2(h).
(i) Resignations. Each of Conrad, Crosby, Neitz, and Smith shall have
delivered his resignation from the Board of Directors of the Company effective
as of the Second Closing Date.
(j) Closing Certificates. At the Second Closing Date, the Company or
the Shareholders, as applicable, will have delivered to Buyer the following:
(i) A certificate executed on behalf of the Company by its
Chief Executive Officer and Chief Financial Officer, dated
as of the Second Closing Date, to the effect that each of
the conditions specified above in Section 6.2(a)-(c) is
satisfied in all respects;
(ii) Share certificates representing the Second Funding Shares.
(iii) Certified copies of the resolutions duly adopted by the
Company and the Shareholders approving this Agreement and
all transactions contemplated hereby; and
(iv) Such other usual and customary documents as Buyer may
reasonably request in connection with the transactions
contemplated hereby.
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(k) Environmental Reports. The Environmental Reports prepared pursuant
to Section 5.12 hereof, if any, shall not have disclosed any condition that has
or is reasonably likely to have a Material Adverse Effect on the Company or any
of its Subsidiaries.
(l) Audited Financial Statements. The Company shall have delivered to
Buyer copies of the audited consolidated balance sheet (including related notes
and schedules) and audited consolidated statements of income, shareholders
equity, and of cash flows which shall be substantially identical to the 1998
Financial Statements.
SECTION 6.3 Conditions to Obligation of the Company. The obligation of
the Company to effect this Agreement and the transactions contemplated hereby is
also subject to the satisfaction or waiver by the Company at or prior to the
Second Closing Date of the following conditions:
(a) Representations and Warranties. Each of the representations and
warranties of Buyer contained in this Agreement shall have been true and correct
when made and shall be true and correct in all material respects at and as of
the Second Closing Date as if made at and as of the Second Closing Date, in each
case except as contemplated or permitted by this Agreement and the Company shall
have received a certificate to this effect signed on behalf of Buyer by its
Chief Executive Officer and its Chief Financial Officer;
(b) Performance of Obligations of Buyer. Buyer shall have performed in
all material respects all obligations required to be performed by it under this
Agreement at or prior to the Second Closing Date and the Company shall have
received a certificate to this effect signed on behalf of Buyer by its Chief
Executive Officer and its Chief Financial Officer to such effect;
(c) Consents Under Agreements. The parties shall have obtained the
consent or approval of each Person identified in Section 6.2(c) of the Seller
Disclosure Letter whose consent or approval shall be required in order to
consummate the transactions contemplated by this Agreement, except where the
failure to obtain such consents or approvals is not, individually or in the
aggregate, reasonably likely to have material impact;
(d) Opinion of Counsel. Buyer shall have caused to be delivered to
Company a favorable opinion of counsel dated the Second Closing Date
substantially in the form attached hereto as Exhibit 6.3(d);
(e) Davis Consulting Agreement. The Company shall have entered into the
Davis Consulting Agreement in the form attached hereto as Exhibit 5.17;
(f) Purchase of Shares. Buyer shall have consummated the purchase of
the Minimum Amount of Shares validly tendered and not withdrawn pursuant to the
Offer, it being understood that the Second Closing of the sale of the Second
Funding Shares shall occur simultaneously with and be conditioned upon the Offer
Closing pursuant to Section 2.3 hereof; and
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(g) Closing Certificates. At the Second Closing, the Buyer will have
delivered to the Company the following:
(i) A certificate executed on behalf of Buyer by its Chief
Executive Officer and Chief Financial Officer, dated as of
the Second Closing Date, to the effect that each of the
conditions specified above in Section 6.3(a) and (b) is
satisfied in all respects;
(ii) The Second Funding Shares Purchase Price in immediately
available funds;
(iii) Certified copies of resolutions duly adopted by Buyer
approving this Agreement and all transactions contemplated
hereby; and
(iv) Such other usual and customary documents as the Company may
reasonably request in connection with the transactions
contemplated hereby.
ARTICLE VII
TERMINATION
SECTION 7.1 Termination. This Agreement may be terminated, and the
transactions contemplated hereby abandoned, at any time prior to the Second
Closing Date, whether before or after any approval by the Shareholders of the
matters presented in connection with this Agreement:
(a) By mutual written consent of Buyer and the Company;
(b) By Buyer, by written notice to the Company if (i) the Company shall
have failed to comply in any material respect with any of its covenants or
agreements contained in this Agreement required to be complied with prior to the
date of such termination, which failure to comply has not been cured within
fifteen (15) business days after receipt by the Company of written notice of
such failure to comply; or (ii) the Company shall not have duly called and
noticed a special shareholders meeting to be held no later than June 4, 1999
(subject to adjournment) within the notice period required by law and the
Company's articles of incorporation and bylaws; or (iii) the Shareholders shall
not approve this Agreement and the transactions contemplated by this Agreement
at a duly called and noticed special shareholders meeting at which a quorum is
present in person or by proxy, or any adjournment thereof prior to June 21,
1999;
(c) By the Company, by written notice to Buyer, if (i) Buyer shall have
failed to comply in any material respect with any of its respective covenants or
agreements contained in this Agreement required to be complied with prior to the
date of such termination, which failure to comply has not been cured within
fifteen (15) business days after receipt of Buyer of written notice of such
failure to comply; or (ii) the Shareholders shall not approve this Agreement and
the transactions contemplated by this Agreement at a duly called and noticed
special shareholders
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meeting at which a quorum is present in person or by proxy, or any adjournment
thereof prior to June 21, 1999;
(d) By either Buyer or the Company, by written notice from the
terminating party to the other party, if there has been (i) a breach by the
other party of any representation or warranty made as of the date hereof that is
not qualified by reference to a Material Adverse Effect, the effect of which has
a Company Material Adverse Effect or a Buyer Material Adverse Effect, as the
case may be, or (ii) a breach by the other party of any representation or
warranty made as of the date hereof that is qualified by reference to a Material
Adverse Effect, in each case, which breach has not been cured (if capable of
being cured) within fifteen (15) business days after receipt by the breaching
party of written notice of the breach;
(e) By either Buyer or the Company: if (i) as a result of the failure
of any of the offer conditions set forth in Exhibit 2.1 the Offer shall have
terminated or expired in accordance with its terms without Buyer having accepted
for payment any Shares pursuant to the Offer or (ii) Buyer shall not have
accepted for payment any Shares pursuant to the Offer prior to July 1, 1999;
provided, however, that the right to terminate this Agreement pursuant to this
Section 7.1(e) shall not be available to any party whose failure to perform any
of its obligations under this Agreement results in the failure of any such
condition or if the failure of such condition results from facts or
circumstances that constitute a breach of a representation or warranty under
this Agreement by such party;
(f) By either Buyer or the Company, by written notice from the
terminating party to the other party, if: (i) the Second Closing and the Offer
Closing have not been effected on or prior to the close of business on July 1,
1999, whether such date is before or after the date of approval by the
Shareholders; provided, however, that the right to terminate this Agreement
pursuant to this clause (f) shall not be available to any party whose failure to
fulfill any obligation of this Agreement has been the cause of, or resulted in,
the failure of the Second Closing to have occurred on or prior to such date; or
(ii) any court or other Governmental Entity having jurisdiction over a party
hereto shall have issued an order, decree or ruling or taken any other action
permanently enjoining, restraining or otherwise prohibiting the transactions
contemplated by this Agreement and such order, decree, ruling or other action
shall have become final and nonappealable;
(g) By the Company, by written notice to Buyer, if the Board of
Directors of the Company shall determine in good faith that a Takeover Proposal
constitutes a Superior Proposal; provided, however, that the Company may not
terminate this Agreement pursuant to this clause (g) unless (i) five (5)
business days shall have elapsed after delivery to Buyer of a written notice of
such determination by such Board of Directors and at all reasonable times during
such five (5) business-day period the Company shall have provided Buyer a
reasonable opportunity, during such five (5) business-day period, to propose a
modification of the terms and conditions of this Agreement so that a business
combination between the Company and Buyer may be effected, and (ii) at the end
of such five (5) business-day period such Board of Directors shall continue to
believe in good faith that such Takeover Proposal constitutes a Superior
Proposal and simultaneously therewith or not
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later than ninety (90) business days thereafter the Company shall enter into a
definitive acquisition, merger or similar agreement to effect such Superior
Proposal;
(h) By Buyer, by written notice to the Company, if (i) the Board of
Directors of the Company shall not have recommended this Agreement and the
transactions contemplated hereby to the Company's Shareholders as contemplated
by Sections 2.2 and 3.3 hereof, or shall have resolved not to make such
recommendations, or shall have modified in a manner adverse to Buyer or
rescinded its recommendations to the Shareholders, or shall have modified or
rescinded its approval of this Agreement or the transactions contemplated
herein, or shall have resolved to do any of the foregoing, (ii) the Board of
Directors of the Company shall have recommended to the Shareholders any Takeover
Proposal (other than by Buyer or an Affiliate of Buyer) or shall have resolved
to do so, (iii) a tender offer or exchange offer for twenty percent (20%) or
more of the outstanding shares of capital stock of the Company is commenced, and
the Board of Directors of the Company fails to recommend against acceptance of
such tender offer or exchange offer by its Shareholders within the ten (10)
business day period (or such shorter period) required by Section 14e-2 of the
Exchange Act (the taking of no position by the expiration of such ten (10)
business day period (or such shorter period) with respect to the acceptance of
such tender offer or exchange offer by its shareholders constituting such a
failure), or (iv) the Company or any of its Subsidiaries, without having
received prior written consent from Buyer, shall have entered into, authorized,
recommended, proposed, or publicly announced its intention to enter into,
authorize, recommend or propose to its Shareholders an agreement, arrangement,
understanding or letter of intent with any Person (other than Buyer or any of
its Affiliates) to (A) effect a merger or consolidation or similar transaction
involving the Company or any of its Subsidiaries, (B) purchase, lease, or
otherwise acquire all or a substantial portion of the assets of the Company or
any of its Subsidiaries or (C) purchase or otherwise acquire (including by way
of merger, consolidation, share exchange or similar transaction) beneficial
ownership of securities representing twenty percent (20%) or more of the voting
power of the Company (in each case other than any such merger, consolidation,
purchase, lease or other transaction involving only the Company and one (1) or
more of its Subsidiaries or involving only any two (2) or more of its
Subsidiaries); and
(i) By Buyer or the Company, by written notice to the other party, if
ten (10) business days elapse after all the conditions set forth in Article VI
(other than conditions that by their nature are to be satisfied at the Second
Closing) shall be satisfied or waived and the Second Closing shall not have
occurred through no fault of the terminating party.
The right of Buyer or the Company, to terminate this Agreement pursuant
to this Section 7.1 shall remain operative and in full force and effect
regardless of any investigation made by or on behalf of such party, whether
prior to or after the execution of this Agreement.
SECTION 7.2 Effect of Termination. In the event of the termination of
this Agreement by either Buyer or the Company as provided in Section 7.1, this
Agreement shall forthwith become void without any liability hereunder on the
part of the Company or Buyer or their respective directors or officers, except
for Section 5.9, Article VIII, and the last sentence of Section 5.6, which shall
survive
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any such termination; provided, however, that nothing contained in this Section
7.2 shall relieve any party hereto from any liability for any breach of this
Agreement.
SECTION 7.3 Extension: Waiver. At any time prior to the Second Closing
Date, the parties may (i) extend the time for the performance of any of the
obligations or other acts of the other parties, (ii) waive any inaccuracies in
the representations and warranties contained in this Agreement or in any
document delivered pursuant to this Agreement, or (iii) waive compliance with
any of the agreements or conditions of the other party contained in this
Agreement. Any agreement on the part of a party to any such extension or waiver
shall be valid only if set forth in any instrument in writing signed on behalf
of such party. The failure or any party to this Agreement to assert any of its
rights under this Agreement or otherwise shall not constitute a waiver of those
rights. Notwithstanding the foregoing, no failure or delay by the Company or
Buyer in exercising any right hereunder shall operate as a waiver thereof nor
shall any single or partial exercise thereof preclude any other or further
exercise of any other right hereunder.
ARTICLE VIII
SURVIVAL; INDEMNIFICATION; REMEDIES
SECTION 8.1 Survival of Representations and Warranties. All of the
representations and warranties of the Company contained in this Agreement,
except for the representations and warranties in Sections 3.7, 3.11, and 3.12,
shall survive the Second Closing hereunder and continue in full force and effect
for a period of three (3) years. The representations and warranties of the
Company in Section 3.11 shall survive the Second Closing and continue in full
force and effect for a period of six (6) years, and the representations and
warranties of the Company in Sections 3.7 and 3.12 shall survive the Second
Closing and continue in full force and effect for a period of eight (8) years.
Notwithstanding any right of Buyer to fully investigate the affairs of the
Company and notwithstanding any knowledge of facts determined or determinable by
Buyer pursuant to such investigation or right of investigation, Buyer has the
right fully to rely upon the representation, warranties and covenants of the
Company.
SECTION 8.2 Indemnification by the Company.
(a) The Company agrees to indemnify, defend and save Buyer and its
Affiliates and each of their respective officers, directors, employees, and
agents (each, a "Buyer Indemnified Party"), harmless from and against, and to
promptly pay to a Buyer Indemnified Party or reimburse a Buyer Indemnified Party
for, any and all liabilities (whether contingent, fixed or unfixed, liquidated
or unliquidated, or otherwise), obligations, deficiencies, demands, claims,
suits, actions, or causes of action, assessments, losses, costs, expenses,
interest, fines, penalties, actual or punitive damages or costs or expenses of
any and all investigations, proceedings, judgments, environmental remediations,
settlements and compromises (including reasonable fees and expenses of
attorneys, accountants and other experts) (individually and collectively,
"Losses") sustained or incurred by any Buyer Indemnified Party relating to,
resulting from, arising out of or otherwise by virtue of any
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(i) misrepresentation or breach of a warranty made in Article III or (ii)
non-compliance or breach by the Company of any of the covenants or agreements
contained in this Agreement.
(b) A Buyer Indemnified Party or Seller Indemnified Party (as herein
defined) shall be entitled to indemnification pursuant to Section 8.2(a) or
Section 8.3, as applicable, only if and to the extent that the aggregate amount
of Losses and with respect to which all claims for indemnification made pursuant
to Section 8.2(a) or Section 8.3, as applicable, exceed, in the aggregate, One
Hundred Seventy-Five Thousand Dollars ($175,000.00) (the "Deductible"),
whereupon the Company or Buyer, as applicable, shall be obligated to pay in full
all such Losses, and provided that the Buyer Indemnified Parties or Seller
Indemnified Parties, respectively, shall not be entitled to aggregate
indemnification payments pursuant to Section 8.2(a) or Section 8.3, as
applicable, in excess of Twelve Million Dollars ($12,000,000.00) (the "Cap").
SECTION 8.3 Indemnification by Buyer. From and after the Initial
Closing, Buyer agrees to indemnify, defend and save the Company and its
officers, directors, employees and agents (each a "Seller Indemnified Party"),
harmless from and against, and to promptly pay to a Seller Indemnified Party or
reimburse a Seller Indemnified Party for, any and all Losses sustained or
incurred by such Seller Indemnified Party relating to, resulting from, arising
out of or otherwise by virtue of any (i) misrepresentation or breach of warranty
made in Article IV, or (ii) non-compliance with or breach by Buyer of any of the
covenants or agreements contained in this Agreement to be performed by Buyer.
SECTION 8.4 Indemnification Procedure for Third Party Claims. In the
event that subsequent to the Initial Closing any person or entity entitled to
indemnification under this Agreement (an "Indemnified Party") asserts a claim
for indemnification or receives notice of the assertion of any claim or of the
commencement of any action or proceeding by any entity who is not a party to
this Agreement or an Affiliate of such a party (including, but not limited to
any Governmental Entity) (a "Third Party Claim") against such Indemnified Party,
against which a Party is required to provide indemnification under this
Agreement (an "Indemnifying Party"), the Indemnified Party shall give written
notice together with a statement of any available information regarding such
claim to the Indemnifying Party within thirty (30) days after learning of such
claim (or within such shorter time as may be necessary to give the Indemnifying
Party a reasonable opportunity to respond to such claim). The Indemnifying Party
shall have the right, upon written notice to the Indemnified Party (the "Defense
Notice") within thirty (30) days after receipt from the Indemnified Party of
notice of such claim, (which notice by the Indemnifying Party shall specify the
counsel it will appoint to defend such claim ("Defense Counsel")), to conduct at
its expense the defense against such claim in its own name, or if necessary in
the name of the Indemnified Party; provided, however, that the Indemnified Party
shall have the right to approve the Defense Counsel, which approval shall not be
unreasonably withheld or delayed.
(a) In the event that the Indemnifying Party shall fail to give such
notice, it shall be deemed to have elected not to conduct the defense of the
subject claim, and in such event the Indemnified Party shall have the right to
conduct such defense in good faith and to compromise and settle the claim
without prior consent of the Indemnifying Party and the Indemnifying Party will
be
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liable for all costs, expenses, settlement amounts or other Losses paid or
incurred in connection therewith.
(b) In the event that the Indemnifying Party does elect to conduct the
defense of the subject claim, the Indemnified Party will cooperate with and make
available to the Indemnifying Party such assistance and materials as may be
reasonably requested by it, all at the expense of the Indemnifying Party, and
the Indemnified Party shall have the reasonable right at its expense to
reasonably participate in the defense assisted by counsel of its own choosing at
its own expense, provided that the Indemnified Party shall have the right to
compromise and settle the claim only with the prior written consent of the
Indemnifying Party, which consent shall not be unreasonably withheld or delayed.
Without the prior written consent of the Indemnified Party, which consent shall
not be unreasonably withheld or delayed, the Indemnifying Party will not enter
into any settlement of any Third Party Claim or cease to defend against such
claim, if pursuant to or as a result of such settlement or cessation (i)
injunctive or other equitable relief would be imposed against the Indemnified
Party or its Affiliates; or (ii) such settlement or cessation would lead to
liability or create any financial or other obligation on the part of the
Indemnified Party or its Affiliates for which the Indemnified Party is not
entitled to indemnification hereunder. If a firm offer is made to settle a Third
Party Claim, which offer the Indemnifying Party is permitted to accept pursuant
to the preceding sentence, and the Indemnifying Party desires to accept and
agree to such offer, the Indemnifying Party will give written notice to the
Indemnified Party to that effect. If the Indemnified Party notifies the
Indemnifying Party that it does not wish such offer to be accepted within twenty
calendar days after its receipt of such notice, the Indemnified Party may elect
by such notice to the Indemnifying Party to continue to contest or defend such
Third Party Claim, and in such event, the maximum liability of the Indemnifying
Party as to such Third Party Claim will not exceed the amount of such settlement
offer, plus costs and expenses paid or incurred by the Indemnified Party through
the end of such twenty day period. Notwithstanding anything to the contrary
contained herein, the Indemnifying Party shall not be entitled to control, and
the Indemnified Party shall be entitled to have sole control over, the defense
or settlement of any claim to the extent that claim seeks an order, injunction
or other equitable relief against the Indemnified Party which, if successful,
could have a Material Adverse Effect on the Indemnified Party or its Affiliates
(and the cost of such defense shall constitute a Loss for which the Indemnified
Party is entitled to indemnification hereunder).
(c) Any judgment entered or settlement agreed upon in the manner
provided herein shall be binding upon the Indemnifying Party, and shall
conclusively be deemed to be an obligation with respect to which the Indemnified
Party is entitled to prompt indemnification hereunder.
SECTION 8.5 Direct Claims. It is the intent of the parties hereto that
all direct claims by an Indemnified Party against a party hereto not arising out
of Third Party Claims shall be subject to and benefit from the terms of this
Article VIII. Any claim under this Article VIII by an Indemnified Party for
indemnification other than indemnification against a Third Party Claim (a
"Direct Claim") will be asserted by giving the Indemnifying Party written notice
thereof.
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SECTION 8.6 Failure to Give Timely Notice. A failure by an Indemnified
Party to give timely, complete or accurate notice as provided in Sections 8.4 or
8.5, will not affect the rights or obligations of any party hereunder except and
only to the extent that, as a result of such failure, any party entitled to
receive such notice was deprived of its right to recover any payment under its
applicable insurance coverage or to the extent that it was otherwise damaged as
a result of such failure to give timely notice.
SECTION 8.7 Reduction of Loss. The amount of Losses payable with
respect to an indemnification claim shall be determined on an after tax basis
and reduced by receipt of payment (i) under insurance policies which are not
subject to retroactive adjustment or other reimbursement to the insurer in
respect of such payment, or (ii) from third parties not Affiliated with the
Indemnified Party, such payments (net of the expenses of the recovery thereof),
shall be credited against such Loss. No Indemnified Party shall take any action
the purpose and intent of which is to prejudice the defense of any claim subject
to indemnification hereunder or to induce a third party to assert a claim
subject to indemnification hereunder.
SECTION 8.8 Subrogation. The Indemnifying Party shall be subrogated to
the Indemnified Party's rights of recovery to the extent of any Loss satisfied
by the Indemnifying Party. The Indemnified Party shall execute and deliver such
instruments and papers as are necessary to assign such rights and assist in the
exercise thereof, including access to books and records of the Company.
SECTION 8.9 Limitations. Other than for claims of fraud or intentional
misrepresentation, after the Second Closing Date the remedies afforded under
this Article VIII shall be the exclusive remedy available to the parties hereto
seeking damages for a breach of a representation, warranty or covenant contained
herein; provided, however, nothing contained herein shall limit or restrict a
party hereto from seeking or obtaining injunctive or other equitable relief.
SECTION 8.10 Determination Procedure. The parties hereto agree that in
the event a Buyer Indemnified Party makes a claim for indemnification under this
Article VIII and Buyer and the DSI Representative cannot agree on whether such
Buyer Indemnified Party is entitled to indemnification under this Article VIII,
then, unless Buyer and the DSI Representative agree on a different mechanism for
resolving such dispute, such determination shall be submitted to a panel of
three arbitrators. Such arbitration shall be conducted in accordance with the
Federal Arbitration Act and the rules of the American Arbitration Association.
The decision of the arbitrators or a majority thereof, made in writing, shall be
final and binding upon the parties hereto as to the determination of entitlement
to indemnification. In all matters relating to claims for indemnification or
other disputes under this Agreement, the DSI Representative shall represent the
Company and Buyer shall represent itself.
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ARTICLE IX
MISCELLANEOUS AND GENERAL
SECTION 9.1 Definitions. For purposes of this Agreement:
(a) "Affiliate" of any person means another person that directly or
indirectly, through on or more intermediaries, controls, is controlled by, or is
under common control with, such first person.
(b) "Antitrust Laws" mean and include the Sherman Act, as amended, the
Clayton Act, as amended, the HSR Act, the Federal Trade Commission Act, as
amended, and all other federal, state or foreign statutes, rules, regulations,
orders, decrees, administrative and judicial doctrines and other laws that are
designed or intended to prohibit, restrict or regulate actions having the
purpose or effect of monopolization or restraint of trade.
(c) "Control" (including the terms "controlled by" and "under common
control with") means the possession, directly or indirectly, of the power to
direct or cause the direction of the management and policies of a person,
whether through the ownership of voting securities, by contract or otherwise.
(d) "Governmental Entity" means any government or an agency, bureau,
board, commission, court, department, official, political subdivision, tribunal
or other instrumentality of any government, whether federal, state or local,
domestic or foreign.
(e) "Knowledge" or "Known" A Person is deemed to have "knowledge" of a
particular fact or matter if any of its executive officers, directors or
managers (i) is actually aware of such fact or matter, or (ii) could reasonably
be expected to be aware of such fact or matter after a due diligence
investigation of such scope and extent as a reasonably prudent person would
undertake under similar facts and circumstances.
(f) "Lien" means any encumbrance, hypothecation, infringement, lien,
mortgage, pledge, restriction, security interest, title retention or other
security arrangement, or any adverse right or interest, charge or claim of any
nature whatsoever of, on, or with respect to any asset, property or property
interest; provided, however, that the term "Lien" shall not include (i) liens
for water and sewer charges and current taxes including, without limitation,
real estate taxes, not yet due and payable or being contested in good faith;
(ii) mechanics', carriers', workers', repairers', materialmen's, warehousemen's
and other similar liens arising or incurred in the ordinary course of business;
(iii) all liens approved in writing by the other party hereto; or (iv)
restrictions on transfer imposed by federal or state securities laws.
(g) "Material Adverse Effect" means, when used in connection with the
Company or Buyer, any change or effect that (i) has had, or is reasonably likely
to have a materially adverse impact on the business, operations, or results of
operations, assets or condition (financial or otherwise) of such Party or any of
its Subsidiaries, or (ii) substantially impairs or delays the
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consummation of the transactions contemplated hereby, but, in either such event,
shall not include (A) any change or effect that results from conditions, events
or circumstances generally affecting the industries in which the Company or
Buyer operate or the economy in general, (B) any action or change specifically
permitted or required by the provisions of this Agreement, or (C) the
transactions contemplated by this Agreement or the announcement hereof,
provided, however, a Material Adverse Effect will be deemed to include the
circumstances set forth in (i) or (ii) above if those circumstances are caused
by any suit, action, cause or proceeding brought by any third party seeking
injunctive relief, damages, or any other relief concerning the transactions
contemplated by this Agreement.
(h) "Party" or "Parties" means the Company on the one hand, and Buyer
on the other hand.
(i) "Person" means any natural person, firm, individual, business
trust, trust, association, corporation, partnership, joint venture, company,
unincorporated entity or Governmental Entity.
(j) "Subsidiary" or "Subsidiaries" of any Person means another Person,
an amount of the voting securities, other voting ownership or voting partnership
interests of which is sufficient to elect at least a majority of its board of
directors or other governing body (or, if there are no such voting interests,
50% or more of the equity interests of which) is owned directly or indirectly by
such first Person.
(k) "Tax" or "Taxes" means all federal, state, local and foreign taxes,
net or gross income, gross receipts, sales, use, ad valorem, transfer,
franchise, license, withholding, payroll, employment, excise, severance, stamp,
occupation, premium, personal property, real property, capital stock, profits,
social security, (or similar) unemployment, disability, registration, value
added, estimated, alternative or add-on minimum taxes, customs, duties or other
assessments of a similar nature (whether imposed directly or through
withholding), including any interest, additions to tax, or penalties applicable
thereto, imposed by a Tax authority.
(l) "Tax Returns" means all federal, state, local and foreign tax
returns, declarations, statements, reports, schedules, forms, and information
returns and any amendments thereto.
SECTION 9.2 Modification or Amendment. Subject to the provisions of the
applicable law, at any time prior to the Second Closing Date, the Parties hereto
may modify or amend this Agreement, by written agreement executed and delivered
by duly authorized officers of the respective Parties.
SECTION 9.3 Waiver of Conditions. The conditions to each of the
Parties' obligations to consummate this Agreement are for the sole benefit of
such Party and may be waived by such Party in whole or in part to the extent
permitted by applicable law.
SECTION 9.4 Counterparts. This Agreement may be executed in any number
of counterparts, each such counterpart being deemed to be an original
instrument, and all such counterparts shall together constitute the same
agreement.
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SECTION 9.5 GOVERNING LAW AND VENUE; WAIVER OF JURY TRIAL. THIS
AGREEMENT SHALL BE DEEMED TO BE MADE IN AND IN ALL RESPECTS SHALL BE
INTERPRETED, CONSTRUED AND GOVERNED BY AND IN ACCORDANCE WITH THE LAW OF THE
STATE OF TEXAS WITHOUT REGARD TO THE CONFLICT OF LAW PRINCIPLES THEREOF. The
Parties hereby irrevocably submit to the jurisdiction of the courts
of the State of Texas and the Federal courts of the United States of America
located in the State of Texas solely in respect of the interpretation and
enforcement of the provisions of this Agreement and of the documents referred to
in this Agreement, and in respect of the transactions contemplated hereby, and
hereby waive, and agree not to assert, as a defense in any action, suit or
proceeding for the interpretation or enforcement hereof or of any such document,
that it is not subject thereto or that such action, suit or proceeding may not
be brought or is not maintainable in said courts or that the venue thereof may
not be appropriate or that this Agreement or any such document may not be
enforced in or by such courts, and the Parties hereto irrevocably agree that all
claims with respect to such action or proceeding shall be heard and determined
in such a Texas State or Federal court. The Parties hereby consent to and grant
any such court jurisdiction over the person of such Parties and over the subject
matter of such dispute and agree that mailing of process or other papers in
connection with any such action or proceeding in the manner provided in Section
9.6 below or in such other manner as may be permitted by law shall be valid and
sufficient service thereof.
(a) EACH PARTY ACKNOWLEDGES AND AGREES THAT ANY CONTROVERSY WHICH MAY
ARISE UNDER THIS AGREEMENT IS LIKELY TO INVOLVE COMPLICATED AND DIFFICULT
ISSUES, AND THEREFORE EACH SUCH PARTY HEREBY IRREVOCABLY AND UNCONDITIONALLY
WAIVES ANY RIGHT SUCH PARTY MAY HAVE TO A TRIAL BY JURY IN RESPECT OF ANY
LITIGATION DIRECTLY OR INDIRECTLY ARISING OUT OF OR RELATING TO THIS AGREEMENT,
OR THE TRANSACTIONS CONTEMPLATED BY THIS AGREEMENT. EACH PARTY CERTIFIES AND
ACKNOWLEDGES THAT (i) NO REPRESENTATIVE, AGENT OR ATTORNEY OF ANY OTHER PARTY
HAS REPRESENTED, EXPRESSLY OR OTHERWISE, THAT SUCH OTHER PARTY WOULD NOT, IN THE
EVENT OF LITIGATION, SEEK TO ENFORCE THE FOREGOING WAIVER, (ii) EACH PARTY
UNDERSTANDS AND HAS CONSIDERED THE IMPLICATIONS OF THIS WAIVER, (iii) EACH PARTY
MAKES THIS WAIVER VOLUNTARILY, AND (iv) EACH PARTY HAS BEEN INDUCED TO ENTER
INTO THIS AGREEMENT BY, AMONG OTHER THINGS, THE MUTUAL WAIVERS AND
CERTIFICATIONS IN THIS SECTION 9.5.
SECTION 9.6 Notices. Any notice, request, instruction or other document
to be given hereunder by any party to the others shall be in writing and
delivered personally or sent by registered or certified mail, postage prepaid,
or by facsimile:
If to Buyer:
Attention: Tom Martin
654 Osos Street
San Luis Obispo, CA 93401
fax: 805/545-7590
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with copies to: J. Todd Mirolla, Esq.
Andre, Morris & Buttery
1304 Pacific Street
San Luis Obispo, CA 93401
fax: 805/543-0752
Gregg R. Cannady, Esq.
Carrington, Coleman, Sloman & Blumenthal, L.L.P.
200 Crescent Court, Suite 1500
Dallas, TX 75201
fax: 214/855-1333
If to Company:
Attention: President
1100 W. Sam Houston Parkway North, Suite A
Houston, TX 77043
fax: 713/365-9911
with a copy to: Michael L. Bengtson, Esq.
Thompson & Knight
1200 San Jacinto Center
98 San Jacinto Boulevard
Austin, TX 78701
fax: 512/469-6180
or to such other persons or addresses as may be designated in writing by the
Party to receive such notice as provided above.
SECTION 9.7 Entire Agreement; No Other Representations. This Agreement
(including any exhibits hereto), the Seller Disclosure Letter, the Buyer
Disclosure Letter and the Exhibits constitute the entire agreement, and
supersede all other prior agreements, understandings, representations and
warranties both written and oral, among the parties, with respect to the subject
matter hereof. EACH PARTY HERETO AGREES THAT, EXCEPT FOR THE REPRESENTATIONS AND
WARRANTIES CONTAINED IN THIS AGREEMENT, NEITHER BUYER NOR THE COMPANY MAKES ANY
OTHER REPRESENTATIONS OR WARRANTIES, AND EACH HEREBY DISCLAIMS ANY OTHER
REPRESENTATIONS OR WARRANTIES MADE BY ITSELF OR ANY OF ITS OFFICERS, DIRECTORS,
EMPLOYEES, AGENTS, FINANCIAL AND LEGAL ADVISORS OR OTHER REPRESENTATIVES, WITH
RESPECT TO THE EXECUTION AND DELIVERY OF THIS AGREEMENT OR THE TRANSACTIONS
CONTEMPLATED HEREBY, NOTWITHSTANDING THE DELIVERY OR DISCLOSURE TO THE OTHER OR
THE OTHER'S REPRESENTATIVES OF ANY
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DOCUMENTATION OR OTHER INFORMATION WITH RESPECT TO ANY ONE OR MORE OF THE
FOREGOING.
SECTION 9.8 No Third Party Beneficiaries. Except as provided in Section
5.2 and Article VIII (Indemnification), this Agreement is not intended to confer
upon any Person other than the Parties hereto any rights or remedies hereunder.
SECTION 9.9 Obligations of Buyer and of the Company. Whenever this
Agreement requires a Subsidiary of Buyer to take any action, such requirement
shall be deemed to constitute an undertaking on the part of Buyer to cause such
Subsidiary to take such action. Whenever this Agreement requires a Subsidiary of
the Company to take any action, such requirement shall be deemed to constitute
an undertaking on the part of the Company to cause such Subsidiary to take such
action.
SECTION 9.10 Severability. The provisions of this Agreement shall be
deemed severable and the invalidity or unenforceability of any provision shall
not affect the validity or enforceability of the other provisions hereof. If any
provision of this Agreement, or the application thereof to any Person or any
circumstance, is invalid or unenforceable, (a) a suitable and equitable
provision shall be substituted therefor in order to carry out, so far as may be
valid and enforceable, the intent and purpose of such invalid or unenforceable
provision and (b) the remainder of this Agreement and the application of such
provision to other Persons or circumstances shall not be affected by such
invalidity or unenforceability, nor shall such invalidity or unenforceability
affect the validity or enforceability of such provision, or the application
thereof, in any other jurisdiction.
SECTION 9.11 Interpretation. The table of contents and headings herein
are for convenience of reference only, do not constitute part of this Agreement
and shall not be deemed to limit or otherwise affect any of the provisions
hereof. Where a reference in this Agreement is made to a Section or Exhibit,
such reference shall be to a Section of or Exhibit to this Agreement unless
otherwise indicated. Whenever the words "include," "includes" or "including" are
used in this Agreement, they shall be deemed to be followed by the words
"without limitation."
SECTION 9.12 Assignment. This Agreement shall not be assignable by
operation of law or otherwise.
SECTION 9.13 Specific Performance. The Parties hereto agree that
irreparable damage would occur in the event that any of the terms or provisions
of this Agreement were not performed in accordance with their specific wording
or were otherwise breached. It is accordingly agreed that each of the Parties
hereto shall be entitled to an injunction or injunctions to prevent breaches of
this Agreement and to enforce specifically the terms and provisions hereof in
any court of the United States of America or any state having jurisdiction, such
remedy being in addition to any other remedy to which any Party may be entitled
at law or in equity.
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IN WITNESS WHEREOF, this Agreement has been duly executed and delivered
by the duly authorized officers of the Parties hereto as of the date first
written above.
[REMAINDER OF PAGE INTENTIONALLY LEFT BLANK]
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MVII, LLC
By: /s/ E. Thomas Martin
-------------------------
Name: E. Thomas Martin
-------------------------
Title: Manager
-------------------------
DSI TOYS, INC.
By: /s/ M.D. Davis
-------------------------
Name: M.D. Davis
-------------------------
Title: Chief Executive Officer
-------------------------
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ANNEX B
CHAFFE & ASSOCIATES, INC.
April 8, 1999
The Board of Directors
D S I Toys, Inc.
1100 West Sam Houston Pkwy, North
Houston, TX 77043
Members of the Board:
We understand that D S I Toys, Inc. (the "Company") proposes to enter into
a Stock Purchase and Sale Agreement (the "Agreement") with the Martin Group (the
"Buyer") upon the terms and subject to conditions set forth in the Agreement i)
to sell to the Buyer for cash 566,038 shares of the common stock of the Company
on the Initial Closing Date (as that term is defined in the Agreement) for a
total purchase price of $1,200,000; and ii) to sell to the Buyer for cash
1,792,453 shares of the common stock of the Company on the Second Closing Date
(as that term is defined in the Agreement) for a total purchase price of
$3,800,000, subject to certain adjustments as further defined in the Agreement.
The adjustments are dependent upon two issues: 1) the Company meeting certain
working capital requirements at the Second Closing Date; and 2) the consummation
of certain transactions resolving a dispute with the estate of the Company's
former owner. If the Company is unable to resolve these issues favorably, then
the adjustments may result in the issuance to the Buyer of up to an additional
140,000 shares of Company common stock at no additional cost. If the Company
issues the maximum number of shares under the Agreement, the weighted average
price per share of Company common stock to be sold in the proposed transactions
will be $2.00 (the "Minimum Share Price"). Additionally, the Buyer will make a
tender offer to purchase from stockholders 1,600,000 shares of common stock of
the Company at a purchase price of $4.38 per share net to the seller in cash
(the "Offer").
You have asked our opinion as to whether on the date hereof, from a
financial point of view, the Minimum Share Price is fair to the shareholders of
the Company.
Chaffe & Associates, Inc. ("Chaffe"), through our experience in the
securities industry, investment analysis and appraisal, and in related corporate
finance and investment banking activities, including mergers and acquisitions,
corporate recapitalization, and valuations for corporate and other purposes,
states that we are competent to provide an opinion as to the fairness of the
Minimum Share Price. Nether Chaffe nor any of our officers or employees has an
interest in the Company common stock. The fee received for the preparation and
delivery of this opinion is not dependent or contingent upon the consummation of
the proposed transactions.
In connection with rendering our opinion, Chaffe, among other things: (i)
reviewed a copy of the draft Agreement dated April 5, 1999 and the related draft
Shareholders' and Voting Agreement dated April 6, 1999; (ii) reviewed and
analyzed Company audited financial statements for the years ending January 31,
1995 through 1998 and internally prepared financial statements for the year
ending January 31, 1999, as well as other financial and operating data
concerning the Company prepared by its management, including budget projections
dated as of March 24, 1999 for fiscal year 2000; (iii) reviewed and discussed
the past and current operations, financial condition and prospects of the
Company with members of the Company's senior management; (iv) reviewed the
reported prices and trading activity for the Company common stock; (v) reviewed
and discussed the strategic rationale for the proposed transactions with members
of the Company's senior management and with a representative of the Buyer; (vi)
compared the financial performance of the Company and the prices and trading
activity of the Company common stock with those of certain comparable
publicly-traded companies and their securities; (vii) reviewed the financial
terms of certain recent comparable business combinations in the toy industry
specifically, and other industries generally; (viii) considered a number of
valuation methodologies, including among others, a discounted cash flow analysis
and a leveraged buyout model; and (ix) performance such other studies and
analyses as Chaffe deemed appropriate to this opinion.
<PAGE> 94
The Board of Directors April 8, 1999
D S I Toys, Inc. Page 2
Five shareholders who are also members of the Board of Directors of the
Company (collectively, the "DSI Group"), the Company and the Buyer propose to
enter into the Shareholders' and Voting Agreement concurrently with the
execution of the Agreement. Chaffe notes and has considered in our opinion that
the proposed transactions in conjunction with the Shareholders' and Voting
Agreement will result in a shift of control of the Company from the present
management to the Martin Group.
The Company has made no assurances that the issues relating to the issuance
of additional shares of Company common stock can be resolved favorably.
Therefore, for purposes of our analysis, Chaffe has assumed that the maximum
number of shares contemplated under the Agreement will be issued at the Minimum
Share Price.
In our review, Chaffe relied, without independent verification, upon the
accuracy and completeness of the historical and projected financial information
and all other information reviewed by us for purposes of our opinion. Chaffe did
not make or obtain an independent review of the Company's assets or liabilities,
nor was Chaffe furnished with any such appraisals. With respect to the Company's
projected financial results, Chaffe has assumed that they were reasonably
prepared on bases reflecting the Company management's best currently available
estimates and judgments of future financial performance. We have further relied
upon the assurances of the management of the Company that they are unaware of
any facts that would make the information or projections provided to us
incomplete or misleading. This opinion was necessarily based upon market,
economic and other conditions as they existed on, and could be evaluated as of
the date hereof. Chaffe expresses no opinion on the tax consequences of the
proposed transactions on the Company or its Shareholders.
It is understood that this letter is for the information of the Board of
Directors of the Company and may be included in its entirety in the Offer
Documents, S.E.C. Schedule 14D-9 and the Proxy Statement. This letter may not be
used for any other purposes without our prior written consent.
Based upon and subject to the foregoing and based upon such other matters
as we considered relevant, it is our opinion as of the date hereof, that from a
financial point of view, the Minimum Share Price, subject to the other terms and
conditions of the Agreement, is fair to the shareholders the Company.
Very truly yours,
CHAFFE & ASSOCIATES, INC.
/s/ CHAFFE & ASSOCIATES, INC.
------------------------------------
<PAGE> 95
APPENDIX 1
DSI TOYS, INC.
1100 West Sam Houston Parkway (North)
Houston, TX 77043
THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS
The undersigned hereby appoints M.D. Davis and Thomas V. Yarnell and each of
them, as the undersigned's attorneys and proxies, each with the power to appoint
his substitute, and hereby authorizes them to represent and to vote, as directed
on the reverse side hereof, all the shares of common stock of DSI TOYS, INC.
(the "Company") held of record by the undersigned on April 28, 1999, at the
annual meeting of shareholders to be held on May 24, 1999, or any adjournment
thereof.
IT IS UNDERSTOOD THAT WHEN PROPERLY EXECUTED, THIS PROXY WILL BE VOTED IN
THE MANNER DIRECTED HEREIN BY THE UNDERSIGNED SHAREHOLDER. WHERE NO CHOICE IS
SPECIFIED BY THE SHAREHOLDER, THE PROXY WILL BE VOTED FOR THE ELECTION OF
DIRECTORS PROPOSED IN ITEM 1 AND IN FAVOR OF EACH OF THE FOUR PROPOSALS IN ITEM
2.
The undersigned hereby revokes all previous proxies relating to the shares
covered hereby and confirms all that said proxy or his substitutes may do by
virtue hereof.
(To Be Signed on Reverse Side)
<PAGE> 96
Please date, sign and mail your
proxy card back as soon as possible!
Annual Meeting of Shareholders
DSI TOYS, INC.
May 24, 1999
Please Detach and Mail in the Envelope Provided
- --------------------------------------------------------------------------------
[X] Please mark your votes as in this example.
<TABLE>
<S> <C> <C>
1. ELECTION OF DIRECTORS. NOMINEES:
[ ] FOR all nominees listed at right [ ] WITHHOLD AUTHORITY to Jack R. Crosby
(except as marked to the contrary vote for all nominees listed at right Barry B. Conrad
below)
INSTRUCTION: (TO WITHHOLD AUTHORITY TO VOTE FOR ANY INDIVIDUAL NOMINEE(S), STRIKE A LINE THROUGH
THE NOMINEE'S NAME OR WRITE A ZERO ("0") IN THE SPACE FOLLOWING HIS OR HER NAME AT RIGHT.)
</TABLE>
2. Proposals
(i) PROPOSAL ONE: Approval and ratification of Stock Purchase and Sale
Agreement dated April 15, 1999 between the Company and MVII, LLC, and the
transactions contemplated thereunder (the "Transactions").
[ ] FOR [ ] AGAINST [ ] ABSTAIN
(ii) PROPOSAL TWO: Approval of an amendment to the Company's Amended and
Restated Articles of Incorporation that would increase the number of authorized
shares of Common Stock of the Company from 20,000,000 shares to 35,000,000
shares.
[ ] FOR [ ] AGAINST [ ] ABSTAIN
(iii) PROPOSAL THREE: Approval and ratification of the appointment of
E. Thomas Martin, Robert L. Burke, Joseph S. Whitaker and John McSorley as
directors by the remaining directors to fill vacancies on the Board upon
consummation of the Transactions.
[ ] FOR [ ] AGAINST [ ] ABSTAIN
(iv) PROPOSAL FOUR: Adoption and approval of a proposal to amend the
Company's Stock Option plan (a) to increase from 600,000 to 900,000 the
aggregate number of shares of Common Stock of the Company reserved for issuance
under the Plan and (b) to make certain conforming changes.
[ ] FOR [ ] AGAINST [ ] ABSTAIN
3. In his or her discretion, the Proxy is authorized to vote upon any matters
which may properly come before the Meeting or any adjournment or postponement
thereof.
PLEASE MARK, SIGN, DATE AND RETURN THE PROXY CARD PROMPTLY, USING THE ENCLOSED
ENVELOPE.
PLEASE CHECK THIS BOX IF YOU INTEND [ ]
TO BE PRESENT AT THE MEETING.
Signature:
----------------------------
Printed Name: Dated: , 1999
----------------------------- --------
Signature if held jointly:
------------------------
Printed Name: Dated: , 1999
----------------------------- --------
(Note that you should sign exactly as your name appears above.)
<PAGE> 97
APPENDIX 2
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 (the Company) at January 31, 1999 and 1998, and
the results of their operations and their cash flows for each of the three years
in the period ended January 31, 1999, 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.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Houston, Texas
April 28, 1999
<PAGE> 98
APPENDIX 3
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.
On April 15, 1999, the Company entered into a Stock Purchase Agreement
with MVII, LLC, a California limited liability company controlled by Tom Martin,
which contemplates several related transactions: (i) MVII purchased 566,038
shares of common stock from the Company for $1.2 million on April 15, 1999; (ii)
MVII commenced a tender offer to purchase up to 1.6 million shares of the
outstanding common stock of the Company at $4.38 per share in cash on April 21,
1999; and (iii) subject to shareholder and other approvals, MVII will purchase
an additional 1,792,453 shares of common stock (subject to upward adjustments
not to exceed in the aggregate 140,000 shares) from the Company for $3.8 million
simultaneously with the purchase of shares in the tender offer. Upon
consummation of the transactions, MVII will own more than 47% of the Company's
outstanding shares and will be entitled to nominate four of the six members of
the board of directors. (These transactions are described in greater detail in
the Company's Schedule 14D-9 filed with the Securities and Exchange Commission
on April 22, 1999.) All of the net proceeds of the purchase of 566,038 shares of
common stock from the Company were used to repay debt of the Company.
-1-
<PAGE> 99
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>
1998 1997 1996
----- ----- -----
<S> <C> <C> <C>
Net sales 100.0% 100.0% 100.0%
Cost of goods sold 79.8 75.1 66.5
----- ----- -----
Gross profit 20.2 24.9 33.5
Selling, general and administrative expenses 20.8 32.9 24.6
----- ----- -----
Operating income (loss) (0.6) (8.0) 8.9
Interest expense 1.6 1.8 4.1
Other income (0.2) (0.3) (0.5)
----- ----- -----
Income (loss) before income taxes and extraordinary item (2.0) (9.5) 5.3
Provision for (benefit from) income taxes 0.6 (3.1) 1.9
----- ----- -----
Income (loss) before extraordinary item (1.4) (6.4) 3.4
Extraordinary item (net of tax) -- (0.6) -
----- ----- -----
Net income (loss) (1.4) (7.0) 3.4
===== ===== =====
</TABLE>
FISCAL YEAR 1998 COMPARED TO 1997
NET SALES. Net sales during fiscal 1998 decreased $20.9 million, or
28.4%, to $52.7 million, from $73.6 million in fiscal 1997.
Net sales of juvenile audio products increased $1.3 million, or 3.5%,
to $38.3 million during fiscal 1998, from $37.0 million during fiscal 1997. The
increase was primarily attributable to continued strength in walkie-talkies and
musical keyboards, partially offset by a decline in pre-school audio products.
Net sales of girls' toys decreased $19.7 million, or 86.5%, to $3.1 million
during fiscal 1998, from $22.8 million during fiscal 1997. Sales for fiscal 1997
were driven principally by the TV promotion of three dolls (Baby Pick Me Up(R),
Dreamie Sweets(R) and Rosie(R)). Sales for 1998 were comprised principally of
sales of one new non-promoted doll (Baby Learns To Walk(TM)) and final closeouts
of 1997 doll inventory. Net sales of boys' toys increased $392,000, or 5.4%, to
$7.6 million during fiscal 1998 from $7.2 million during fiscal 1997. This
increase was attributable to the introduction of the BlockMen(TM) construction
sets and the new radio-controlled "Burnin' Thunder"(TM) car, partially offset
by a decrease in sales of the radio-controlled Kawasaki(R) Ninja(R) motorcycle.
Net sales of products in other categories decreased $2.9 million, or 43.4%, to
$3.7 million during fiscal 1998, from $6.6 million during fiscal 1997. The
decrease was due primarily to decreased sales of handheld electronic games and
Hoppin' Poppin' Spaceballs(R), an action game that was TV promoted in 1997.
International net sales decreased $3.2 million, or 22.3%, to $11.1
million during fiscal 1998 from $14.3 million in fiscal 1997. The decline was
due primarily to decreased sales of TV promotable items, principally dolls.
International net sales were 21.0% of total sales for fiscal 1998 as compared to
19.4% of total sales in fiscal 1997.
GROSS PROFIT. Gross profit decreased $7.6 million, or 41.9%, to $10.7
million during fiscal 1998 from $18.3 million in fiscal 1997. Gross profit as a
percentage of net sales decreased to 20.2% during fiscal 1998 from 24.9% in
fiscal 1997. Such decrease was primarily due to decreased sales of TV-promoted
toys, principally dolls, which generally have higher gross margins to cover the
related costs of TV advertising.
-2-
<PAGE> 100
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses decreased $13.3 million, or 54.8%, to $11.0 million
during fiscal 1998 from $24.3 million in fiscal 1997. The decrease resulted
primarily from the decreased TV advertising expense during fiscal 1998.
INTEREST EXPENSE. As a result of debt repayment using the proceeds from
the Company's initial public offering in June 1997, interest expense decreased
$485,000, or 35.7%, to $875,000 during fiscal 1998 from $1.4 million in fiscal
1997.
OTHER INCOME. Other income decreased $125,000, or 53.9%, to $107,000
during fiscal 1998 from $232,000 during fiscal 1997. In 1997, the Company
received interest income related to certain insurance proceeds. The effects of
foreign currency translation also contributed to the decrease.
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 in fiscal 1997
INCOME TAXES. In fiscal 1998, the Company incurred a loss before income
taxes and extraordinary item of $1.1 million, which resulted in a benefit from
income taxes of $333,000 compared to a $2.3 million benefit from income taxes
during fiscal 1997.
NET INCOME (LOSS). As a result of the foregoing factors, the Company's
net loss for fiscal year 1998 was $738,000 compared to a net loss of $5.2
million for fiscal 1997.
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 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(R) 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.
-3-
<PAGE> 101
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, or 46.7%, to $1.4 million during fiscal 1997 from $2.6 million in
fiscal 1996.
OTHER INCOME. Other income decreased $113,000, or 32.7%, 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.
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 provided net cash of $6.3 million
during fiscal 1998, consisting primarily of decreases in accounts receivable and
inventories, and a net decrease in income taxes receivable and payable,
partially offset by decreases in accounts payable and accrued liabilities and an
increase in prepaid expenses. Net cash used in investing activities during
fiscal 1998 was $1.3 million and was the result of capital expenditures,
increases in other assets and the payment of life insurance premiums on behalf
of a shareholder. Net cash used by financing activities was $4.8 million during
fiscal 1998 and represented net payments under revolving lines of credit. The
Company's working capital at January 31, 1999 was $391,000 and unrestricted cash
was $554,000.
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.
As a result of losses incurred in fiscal 1998, the Company was not in
compliance with certain of the covenants contained in its previous line of
credit with a commercial bank at yearend. However, on February 2, 1999, the
Company secured the Revolver. The Revolver replaces the Company's previous line
of credit. The new terms include interest at the bank's prime rate plus three
quarters of one percent (.75%) and maturity at February 2, 2002. The maximum
loan limit remains at $10 million, subject to the availability of sufficient,
eligible inventory and accounts receivable.
The Company's anticipated fiscal 1999 and 2000 operating cash
requirements include payment of approximately $2.8 million related to television
advertisements run during 1997. Such amount is due to two media companies and is
being paid in monthly installments through April 2000. The Company has budgeted
approximately $900,000 for capital expenditures, consisting primarily of
purchases of tools and molds, for fiscal 1999.
-4-
<PAGE> 102
At April 20, 1999, the Company had an additional borrowing capacity of
an aggregate of $1.6 million under the Revolver and the Hong Kong Credit
Facility. Based on projected fiscal 1999 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. If the transactions with MVII are consummated, the Company will receive
an additional equity infusion of $3.8 million.
On April 15, 1999, the Company entered into a Stock Purchase Agreement
with MVII, LLC, a California limited liability company controlled by Tom Martin,
which contemplates several related transactions: (i) MVII purchased 566,038
shares of common stock from the Company for $1.2 million on April 15, 1999; (ii)
MVII commenced a tender offer to purchase up to 1.6 million shares of the
outstanding common stock of the Company at $4.38 per share in cash on April 21,
1999; and (iii) subject to shareholder and other approvals, MVII will purchase
an additional 1,792,453 shares of common stock (subject to upward adjustments
not to exceed in the aggregate 140,000 shares) from the Company for $3.8 million
simultaneously with the purchase of shares in the tender offer. Upon
consummation of the transactions, MVII will own more than 47% of the Company's
outstanding shares and will be entitled to nominate four of the six members of
the board of directors. (These transactions are described in greater detail in
the Company's Schedule 14D-9 filed with the Securities and Exchange Commission
on April 22, 1999.)
The Company is obligated to make future minimum royalty payments under
certain of its license agreements. As of January 31, 1999, the Company was
required to make an aggregate of approximately $170,000 in payments of
guaranteed royalties under certain licenses in fiscal 1999 and $590,000
thereafter through fiscal 2002.
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 1998, 80% 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 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
Many existing computer systems and programs process transactions using
two digits rather than four digits for the year of a transaction. Unless the
hardware and/or the software has been modified, a
-5-
<PAGE> 103
significant number of those computer systems and programs may process a
transaction with a date of the year "2000" as the year "1900", which could cause
the system or the program to fail or create erroneous results before, on or
after January 1, 2000 (the "Y2K Issue").
The Company's principal computer systems consist of: (i) management
information software ("MIS") for accounts receivable, general ledger, payables,
order entry, sales reporting, inventory tracking, product distribution, and
production scheduling; (ii) electronic data interchange ("EDI") for
order-taking, invoicing and the like between the Company and its major
customers; and (iii) local area network and personal computer operating systems.
The MIS systems at the Company's Hong Kong subsidiary have been
upgraded and successfully tested to be Y2K compliant. The MIS systems at the
Company's U.S. headquarters are in the process of being upgraded, replaced and
tested. To date, the Company has completed approximately 90% of its upgrades and
replacements and approximately 50% of its testing. Completion of all remediation
and testing is expected to be completed by July 31, 1999.
The Company is currently reprogramming, or replacing, and testing the
EDI software. The Company is communicating with its customers to evaluate their
EDI Y2K compliance. The Company believes that over the upcoming months its major
customers plan to test their EDI systems for internal, intermediary and supplier
Y2K compliance. The Company would be unable to receive and invoice orders from a
customer though EDI if the customer or its EDI intermediaries were not Y2K
compliant. Although the Company does not transmit electronic orders to its
independent manufacturers, delays or non-delivery of goods to the Company could
arise from Y2K Issues affecting their businesses and presently the Company is
communicating with its independent manufacturers to evaluate their Y2K
compliance. The effect of non-compliance by independent manufacturers and other
third parties is not determinable.
The Company's local area network operating system will require upgrades
according to vendors, but such upgrades are available at minimal cost. The
Company also intends to replace personal computers and software found not to be
Y2K compliant. The Company anticipates that these replacements will be completed
by July 31, 1999.
The Company has incurred approximately $12,000 in expenses in
connection with making its computer systems and programs Y2K compliant. The
Company expects to incur additional Y2K costs of approximately $25,000 during
1999. The Company is utilizing both internal and external sources to address Y2K
Issues, and the Company anticipates Y2K compliance by July 31, 1999. All
historical and future costs have been and will continue to be funded out of
existing cash and cash flow from operations.
The failure to successfully address a material Y2K Issue could result
in an interruption in, or failure of, certain normal business activities or
operations. Such failures could materially and adversely affect the Company's
results of operations, liquidity and financial condition. Particularly because
of the uncertainty of the Y2K readiness of customers, suppliers and contractors,
the Company is unable to assess at this time whether the consequences of the Y2K
Issue will have a material impact on the Company's results of operations,
liquidity or financial condition.
The Company currently has not developed a detailed contingency plan.
The Company assesses its Y2K status regularly and will begin to develop
comprehensive contingency plans if the Company believes it will not complete the
Y2K project in a timely manner. If the Company's Y2K project is not completed on
a timely basis, or if its major customers or suppliers fail to address all of
the Y2K Issues, the Company believes it could have a material adverse impact on
the Company's operations.
The cost of Y2K compliance and the referenced completion dates are
based on management's best estimates and may be updated, as additional
information becomes available. Reference is made to the first paragraph of Part
I of this report, which addresses forward-looking statements made by the
Company.
-6-
<PAGE> 104
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
-7-
<PAGE> 105
DSI TOYS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
<TABLE>
<CAPTION>
Page
----
Financial Statements
- --------------------
<S> <C>
Report of Independent Accountants F-2
Consolidated Balance Sheet at January 31, 1999 and 1998 F-3
Consolidated Statement of Operations for fiscal years 1998, 1997 and 1996 F-4
Consolidated Statement of Cash Flows for fiscal years 1998, 1997, and 1996 F-5
Consolidated Statement of Shareholders' Equity for fiscal years 1998, 1997, and 1996 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> 106
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 (the Company) at January 31, 1999 and 1998, and
the results of their operations and their cash flows for each of the three years
in the period ended January 31, 1999, 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.
PricewaterhouseCoopers LLP
Houston, Texas
April 28, 1999
F-2
<PAGE> 107
DSI TOYS, INC.
CONSOLIDATED BALANCE SHEET
<TABLE>
<CAPTION>
JANUARY 31, JANUARY 31,
1999 1998
----------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash $ 554,197 $ 383,690
Restricted cash 150,000 150,000
Accounts receivable, net 1,069,725 8,008,288
Inventories 4,207,704 6,437,418
Income tax receivable -- 642,264
Prepaid expenses 1,503,970 894,704
Deferred income taxes 801,000 183,000
----------- -----------
Total current assets 8,286,596 16,699,364
Property and equipment, net 1,642,672 1,252,572
Advances to shareholder (life insurance premiums) 1,543,814 1,278,401
Deferred income taxes 1,117,000 1,752,000
Other assets 364,511 224,783
----------- -----------
$12,954,593 $21,207,120
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities $ 6,799,290 $ 9,740,201
Current portion of long-term debt 824,675 585,783
Income taxes payable 271,920 108,630
------------ ------------
Total current liabilities 7,895,885 10,434,614
Long-term debt 2,540,522 7,495,000
Deferred income taxes 113,000 119,000
------------ ------------
Total liabilities 10,549,407 18,048,614
Shareholders' equity:
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 87,190
Additional paid-in capital 21,162,568 21,162,568
Common stock warrants 102,500 102,500
Accumulated other comprehensive income 14,296 29,187
Retained earnings 3,699,224 4,437,653
------------ ------------
25,065,778 25,819,098
Less: treasury stock, 2,719,000 shares, at cost (22,660,592) (22,660,592)
------------ ------------
Total shareholders' equity 2,405,186 3,158,506
Commitments and contingencies (Note 11)
------------ ------------
$ 12,954,593 $ 21,207,120
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE> 108
DSI TOYS, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
FISCAL YEAR
------------------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Net sales $ 52,722,517 $ 73,624,398 $ 63,219,212
Costs of goods sold 42,058,919 55,285,501 42,023,044
------------ ------------ ------------
Gross profit 10,663,598 18,338,897 21,196,168
Selling, general and administrative expenses 10,967,001 24,245,064 15,569,422
------------ ------------ ------------
Operating income (loss) (303,403) (5,906,167) 5,626,746
Interest expense 874,907 1,360,067 2,599,942
Other income (106,881) (231,968) (344,469)
------------ ------------ ------------
Income (loss) before income taxes
and extraordinary item (1,071,429) (7,034,266) 3,371,273
Provision for (benefit from) income taxes (333,000) (2,329,323) 1,220,000
------------ ------------ ------------
Income (loss) before extraordinary item (738,429) (4,704,943) 2,151,273
Extraordinary item (net of tax) -- (480,754) --
------------ ------------ ------------
Net income (loss) $ (738,429) $ (5,185,697) $ 2,151,273
============ ============ ============
Basic earnings per share
Earnings (loss) per share before
extraordinary item $ (0.12) $ (0.91) $ 0.61
Extraordinary item -- (0.09) --
------------ ------------ ------------
$ (0.12) $ (1.00) $ 0.61
Earnings (loss) per share ============ ============ ============
Weighted average shares outstanding 6,000,000 5,205,479 3,500,000
============ ============ ============
Diluted earnings per share
Earnings (loss) per share before $ (0.12) $ (0.91) $ 0.58
extraordinary item
Extraordinary item -- (0.09) --
------------ ------------ ------------
$ (0.12) $ (1.00) $ 0.58
Earnings (loss) per share ============ ============ ============
Weighted average shares outstanding 6,000,000 5,205,479 3,739,146
============ ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE> 109
DSI TOYS, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
FISCAL YEAR
------------------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $ (738,429) $ (5,185,697) $ 2,151,273
Adjustments to reconcile net income (loss) to net cash
provided (used) by operating activities:
Depreciation 570,779 661,517 596,332
Loss on early retirement of debt -- 480,754 --
Amortization and write-off of
debt discount and issuance costs -- 199,152 163,057
Provision for doubtful accounts (17,424) 145,096 62,160
Loss (gain) on sale of equipment 200 (3,865) (12,511)
Deferred income taxes 11,000 (2,781,000) 686,605
Changes in assets and liabilities:
Accounts receivable 6,955,987 (4,921,595) 941,715
Due from shareholder -- 151,667 667,616
Inventories 2,229,714 (1,822,331) (1,205,125)
Income taxes receivable/payable 805,554 (726,845) (121,663)
Prepaid expenses (609,266) 567,485 (332,183)
Accounts payable and accrued liabilities (2,940,911) 3,481,100 766,398
------------ ------------ ------------
Net cash provided (used) by operating activities 6,267,204 (9,754,562) 4,363,674
Cash flows from investing activities:
Capital expenditures (961,304) (726,691) (284,260)
Proceeds from sale of equipment 225 6,965 24,037
Life insurance premiums paid for shareholder (265,413) (357,413) (289,676)
Repayments by shareholder -- 511,764 --
Decrease (increase) in other assets (104,728) 313,085 (392,552)
------------ ------------ ------------
Net cash used in investing activities (1,331,220) (252,290) (942,451)
Cash flows from financing activities:
Net borrowings (repayments) under revolving lines of credit (4,730,655) 4,551,304 (2,088,225)
Net borrowings (repayments) on long-term debt 15,069 (13,429,418) (2,499,790)
Net proceeds from issuance of common stock -- 17,744,475 --
Proceeds from issuance of warrants -- 2,500 --
Debt and stock issue costs (35,000) -- --
------------ ------------ ------------
Net cash provided (used) by financing activities (4,750,586) 8,868,861 (4,588,015)
Effect of exchange rate changes on cash (14,891) 19,689 8,329
------------ ------------ ------------
Net increase (decrease) in cash 170,507 (1,118,302) (1,158,463)
Cash and cash equivalents, beginning of year 383,690 1,501,992 2,660,455
------------ ------------ ------------
Cash and cash equivalents, end of year $ 554,197 $ 383,690 $ 1,501,992
============ ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE> 110
DSI TOYS, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
Accumulated
Additional Other
Common Stock Paid-in Comprehensive Retained Treasury
Shares Amount Capital Warrants Income Earnings Stock Total
--------- -------- ----------- -------- ------------- ---------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, January 31, 1996 6,219,000 $ 622 $ 3,504,661 $100,000 $ 1,169 $7,472,077 $(22,660,592) $(11,582,063)
Comprehensive income:
Net income 2,151,273 2,151,273
Foreign currency --
translation
adjustments, --
net of tax 8,329 8,329
------------
Comprehensive
income 2,159,602
------------
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)
Comprehensive loss:
Net loss (5,185,697) (5,185,697)
Foreign currency
translation
adjustments,
net of tax 19,689 19,689
------------
Comprehensive
loss (5,166,008)
------------
Issuance of common 18,500,000
stock 2,500,000 25,000 18,475,000
Stock issuance costs (755,525) (755,525)
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
Comprehensive loss:
Net loss (738,429) (738,429)
Foreign currency
translation
adjustments,
net of tax (14,891) (14,891)
------------
Comprehensive
loss (753,320)
--------- -------- ----------- -------- ------------ ---------- ------------ ------------
Balance, January 31, 1999 8,719,000 $ 87,190 $21,162,568 $102,500 $ 14,296 $3,699,224 $(22,660,592) $ 2,405,186
========= ======== =========== ======== ============ ========== ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE> 111
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 include 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 1998 is a reference to the fiscal year ended
January 31, 1999).
Cash equivalents
The Company considers investments with original maturity dates of three
months or less from the date of purchase to be cash equivalents. Restricted cash
held as a compensating balance under a revolving loan supported by letters of
credit is not considered a cash equivalent.
F-7
<PAGE> 112
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. Maintenance and repairs are
charged to operations, and replacements or betterments are capitalized. Property
or equipment sold, retired, or otherwise disposed of is removed from the
accounts, and any gains or losses thereon are included in operations.
Depreciation is recorded over the estimated useful lives of the related assets
using the straight-line method for molds and leasehold improvements and an
accelerated method for all other assets.
Debt issuance costs and debt discount
Debt issuance costs and debt discount are amortized over the term of the
related debt on a straight-line basis. As a result of the debt repayment using
the proceeds of the Offering, in 1997 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
advertising expense totaled $141,000, $13.5 million, and $6.0 million during
fiscal 1998, 1997 and 1996, respectively. There were no prepaid television
advertising production costs at January 31, 1999 and 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.
F-8
<PAGE> 113
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. (See Note 12).
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
Statement of Financial Accounting Standards No. 128, "Earnings per Share"
(SFAS 128) 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.
Stock options and warrants are the only potentially dilutive shares the
Company has outstanding at January 31, 1999. During fiscal 1998 and 1997, the
Company had 1,241,888, and 1,171,888 shares, respectively, of common stock
options and warrants outstanding which were not included in the diluted earnings
per share calculation because the options and warrants would have been
anti-dilutive.
Stock-based compensation plans
The Company applies Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees" (APB 25) and related interpretations in
accounting for its plans and the disclosure-only provision of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" (SFAS 123) in disclosures regarding the plan.
Comprehensive income
In fiscal 1998, the Company adopted Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" (SFAS 130) which establishes
new rules for the reporting and presentation of comprehensive income and its
components in a full set of financial statements. The Company's comprehensive
income is comprised of net income and foreign currency translation adjustments.
The adoption of SFAS 130 had no impact on the Company's net income or total
shareholders' equity. Prior to the adoption of SFAS 130, foreign currency
translation adjustments were reported separately in the statement of
shareholders' equity. The comprehensive income amounts in the prior fiscal
years' financial statements have been reclassified to conform to SFAS 130.
Segment information
In fiscal 1998, the Company adopted Statement of Financial Accounting
Standards No. 131, "Disclosures about Segments of an Enterprise and Related
Information" (SFAS 131). SFAS 131 supersedes SFAS 14, "Financial Reporting for
Segments of a Business Enterprise," replacing the "industry segment" approach
with the "management" approach. The management approach designates the internal
organization that is used by management for making operating decisions and
assessing performance as the source of the Company's reportable segments. SFAS
131 also requires disclosures about products and services, geographic areas and
major customers. The adoption of SFAS 131 did not affect the Company's results
of operations or financial position but did affect the disclosures of segment
information (see Note 12).
F-9
<PAGE> 114
NOTE 3 - ACCOUNTS RECEIVABLE:
Accounts receivable consist of the following as of January 31:
<TABLE>
<CAPTION>
1999 1998
---------- -----------
<S> <C> <C>
Trade receivables $2,984,619 $10,999,014
Provisions for:
Discounts and markdowns (1,383,808) (1,956,722)
Return of defective goods (407,628) (829,674)
Doubtful accounts (123,458) (204,330)
---------- -----------
Accounts receivable, net $1,069,725 $ 8,008,288
========== ===========
</TABLE>
NOTE 4 - PROPERTY AND EQUIPMENT:
Property and equipment consist of the following as of January 31:
<TABLE>
<CAPTION>
Estimated useful lives 1999 1998
---------------------- ---------- ----------
<S> <C> <C> <C>
Molds 3 years $2,978,822 $2,300,345
Equipment, furniture and fixtures 5-7 years 1,647,244 1,486,254
Leasehold improvements 10 years or lease term 997,420 879,429
Automobiles 3-5 years 84,190 84,216
---------- ----------
5,707,676 4,750,244
Less: accumulated depreciation 4,065,004 3,497,672
---------- ----------
$1,642,672 $1,252,572
========== ==========
</TABLE>
NOTE 5 - ACCOUNTS PAYABLE AND ACCRUED LIABILITIES:
Accounts payable and accrued liabilities consist of the following as of
January 31:
<TABLE>
<CAPTION>
1999 1998
---------- -----------
<S> <C> <C>
Trade payables $4,388,808 $7,518,710
Accrued royalties 776,590 968,267
Accrued compensation and commissions 973,441 553,608
Other 660,451 699,616
---------- -----------
$6,799,290 $9,740,201
========== ===========
</TABLE>
F-10
<PAGE> 115
NOTE 6 - NOTES PAYABLE
Indebtedness consists of the following as of January 31:
<TABLE>
<CAPTION>
1999 1998
---------- ----------
<S> <C> <C>
Bank revolving line of credit for $10 million with a commercial bank
collateralized by all of the Company's U.S. accounts receivable,
intangibles, equipment, fixtures and inventory and 65% of the common
stock of DSI (HK) Ltd., principal due on January 22, 1999;
interest at prime (7.75% at January 31, 1999) $2,528,000 $7,495,000
Revolving bank loan drawn against an $8 million line of credit,
collateralized by a customer's letter of credit and $150,000
cash, interest at prime (7.75% at January 31, 1999) 814,289 577,945
Other 22,908 7,838
---------- ----------
3,365,197 8,080,783
Less: current portion 824,675 585,783
---------- ----------
$2,540,522 $7,495,000
========== ==========
</TABLE>
During the third and fourth quarters of fiscal 1998, the Company was out of
compliance with certain of the covenants of the previous line of credit. As a
result, the bank accelerated maturity to January 22, 1999. On February 2, 1999,
the Company replaced the previous line of credit with another revolving credit
facility (the "Revolver").
The Revolver includes a $10 million revolving line of credit commitment,
subject to availability under a borrowing base calculated by reference to the
level of eligible accounts receivable and inventory, as defined in the
agreement. The Revolver matures on February 2, 2002. Interest on borrowings
outstanding under the Revolver is payable monthly in arrears at an annual rate
equal to prime plus .75%. In addition, an unused line fee at an annual rate
equal to .25% applied to the amount by which $10 million exceeds the average
daily principal balance during the month and a collateral management fee of
$2,000 is payable monthly.
The Revolver is collateralized by a lien on substantially all of the
Company's U.S. accounts receivable, intangibles, equipment, fixtures, inventory
and 65% of the outstanding common stock of DSI (HK) Ltd.
The Revolver contains certain restrictive covenants and conditions among
which are prohibition on payment of dividends, limitations on further
indebtedness, restrictions on dispositions and acquisition of assets,
limitations on advances to third parties and compliance with minimum net worth
amounts.
NOTE 7 - INCOME TAXES:
The components of income (loss) before provision for (benefit from) income
taxes by fiscal year were as follows:
<TABLE>
<CAPTION>
1998 1997 1996
----------- ------------ ----------
<S> <C> <C> <C>
Domestic $(2,944,103) $(11,784,930) $ (898,344)
Foreign 1,872,674 4,750,664 4,269,617
----------- ------------ ----------
$(1,071,429) $ (7,034,266) $3,371,273
=========== ============= ==========
</TABLE>
F-11
<PAGE> 116
The provision for income taxes (benefit) by fiscal year is as follows:
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Current:
Federal $ (615,358) $ (299,000) $ (185,605)
State -- -- (14,000)
Foreign 271,358 750,677 733,000
----------- ----------- -----------
(344,000) 451,677 533,395
----------- ----------- -----------
Deferred:
Federal 17,000 (2,742,000) 657,605
State -- -- (11,000)
Foreign (6,000) (39,000) 40,000
----------- ----------- -----------
11,000 (2,781,000) 686,605
----------- ----------- -----------
(333,000) (2,329,323) 1,220,000
Tax on Extraordinary Item (Current Federal) -- (270,000) --
----------- ----------- -----------
$ (333,000) $(2,599,323) $ 1,220,000
=========== =========== ===========
</TABLE>
The difference between income taxes (benefit) at the statutory federal and
the effective income tax rates by fiscal year is as follows:
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Taxes (benefit) computed at statutory rate $ (364,000) $(2,391,000) $ 1,146,000
State income taxes net of federal benefit -- -- (16,000)
Nondeductible items -- -- 13,000
Other, net 31,000 61,677 77,000
----------- ----------- -----------
$ (333,000) $(2,329,323) $ 1,220,000
=========== =========== ===========
</TABLE>
Deferred tax assets (liabilities) are comprised of the following at January
31:
<TABLE>
<CAPTION>
1999 1998
----------- -----------
<S> <C> <C>
Allowance for doubtful accounts $ 70,000 $ 63,000
Inventory valuation adjustments 19,000 31,000
Depreciation 97,000 101,000
Accruals for inventory returns and markdowns 712,000 89,000
Foreign and alternative minimum tax credits 973,000 1,535,000
Net operating loss carryforward -- 1,124,000
Other 47,000 155,000
----------- -----------
Gross deferred tax assets 1,918,000 3,098,000
----------- -----------
Unremitted earnings of foreign subsidiary -- (1,163,000)
Depreciation (113,000) (119,000)
----------- -----------
Gross deferred tax liabilities (113,000) (1,282,000)
----------- -----------
Net deferred tax assets (liabilities) $ 1,805,000 $ 1,816,000
=========== ===========
</TABLE>
At January 31, 1999, the Company has a $850,000 foreign tax credit
carryforward which will expire if not utilized by January 31, 2003. The Company
believes that the foreign and alternative minimum tax credit carryforwards will
be available to reduce future federal income tax liabilities and has recorded
the tax benefit of these carryforwards as noncurrent deferred tax assets. The
Company's net operating loss carryforward for state purposes is not significant.
F-12
<PAGE> 117
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 $35,000, $31,000 and $105,000
in fiscal 1998, 1997 and 1996, respectively, as employer matching contributions
to employee contributions.
NOTE 9 - THE STOCK OPTION PLAN AND WARRANTS:
The Company has reserved 388,888 common shares for issuance upon exercise
of warrants issued to a bank. Such warrants are currently exercisable at a
purchase price of $2 per share and expire December 11, 2005.
In connection with the Offering, the Company issued warrants to purchase
250,000 shares of common stock. Such warrants are exercisable at $10.80 per
share and expire May 28, 2002.
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.
A summary of the option activity under the 1997 Plan follows:
<TABLE>
<CAPTION>
Number of Weighted Average
Outstanding Options Option Price
------------------- ----------------
<S> <C> <C>
Options outstanding at January 31, 1997 --
Granted 533,000 $8.00
-------------------
Options outstanding at January 31, 1998 533,000 8.00
Granted 82,000 1.41
Surrendered (12,000) 8.00
-------------------
Options outstanding at January 31, 1999 603,000 7.10
===================
</TABLE>
The weighted average fair value at date of grant for options granted during
fiscal 1998 and 1997 was $1.41 and $8.00, respectively. Vesting periods for
options granted range from immediate to seven years from the date of grant in
increments between 5% and 90% per year.
Options outstanding at January 31, 1999 are as follows:
<TABLE>
<CAPTION>
Weighted Weighted Weighted
Number of Average Average Number of Average
Outstanding Exercise Remaining Exercisable Exercise
Option Price Options Price Contractual Life Options Price
- ------------ ----------- -------- ---------------- ----------- --------
<S> <C> <C> <C> <C> <C>
$1.14 - 1.59 60,000 $ 1.22 10 3,333 $ 1.59
1.94 - 2.01 22,000 1.95 10 7,333 1.95
8.00 521,000 8.00 9 194,299 8.00
----------- -----------
603,000 204,965
=========== ===========
</TABLE>
F-13
<PAGE> 118
The Company applies APB 25 and related interpretations in accounting for
its stock option plan. Accordingly, no compensation cost has been recognized by
the Company for this plan. The following unaudited pro forma data is calculated
as if compensation cost for the 1997 Plan was determined based upon the fair
value at the grant date for awards under the plan consistent with the
methodology prescribed under SFAS 123 for fiscal years 1998 and 1997:
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
Pro forma net loss $(1,323,870) $(5,593,246)
Pro forma basic loss per common share (0.22) (1.07)
Pro forma diluted loss per common share (0.22) (1.07)
</TABLE>
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 1998 and 1997: expected volatility
of 80% in fiscal 1998 and 70% in fiscal 1997, risk-free interest rate of 4.64%
to 6.52%, no dividend yield and an expected life of seven years.
NOTE 10 - RELATED PARTY TRANSACTIONS:
The Company entered into a consulting agreement with the previous sole
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 $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 1998, 1997 and 1996. Management believes that the
rental rates approximate fair market value.
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, 1999 and 1998 amounted
to $1,543,814 and $1,278,401, 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 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 1998, 1997, and 1996 amounted to $625,000, $693,000 and
$687,000, respectively. Aggregate minimum rental commitments under noncancelable
leases are as follows for the specified fiscal years:
<TABLE>
<S> <C>
1999 $ 587,327
2000 583,475
2001 324,426
2002 135,965
-----------
$ 1,631,193
===========
</TABLE>
Royalty expense under licensing agreements aggregated $1,298,000,
$3,069,000 and $1,578,000 in fiscal 1998, 1997 and 1996, respectively. At
January 31, 1999, minimum guaranteed royalties payable under these agreements in
fiscal 1999 in fiscal 1999 and thereafter through 2002 of $170,000 and $590,000,
respectively, are included in accrued royalties payable and prepaid expenses.
F-14
<PAGE> 119
NOTE 12 - SEGMENT INFORMATION:
The Company designs, develops, markets and distributes a variety of toys
and children's consumer electronics. These product lines are grouped into four
major categories which represent the Company's operating segments, as follows:
Juvenile audio products, including walkie-talkies, pre-school audio
products, pre-teen audio products and musical toys; girls' toys, including
dolls, play sets and accessories, and boys' toys, including radio control
vehicles, action figures and western and military action toys.
These operating segments all have similar economic characteristics: the
marketing of children's products. Based on these similarities, the Company's
products can be aggregated into one reportable segment for purposes of this
disclosure.
The Company sells its products through (i) the Hong Kong operation, where
products are shipped directly from contract manufacturers to 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 1998, 1997 and 1996 for the U.S. and Hong
Kong operations is as follows:
<TABLE>
<CAPTION>
United States Hong Kong Consolidated
------------- ----------- ------------
<S> <C> <C> <C>
FISCAL 1998:
Net sales $14,817,505 $37,905,012 $52,722,517
Operating income (loss) (4,110,596) 3,807,193 (303,403)
Depreciation expense 275,146 295,632 570,778
Capital expenditures 255,940 705,364 961,304
Total assets at fiscal year end 9,438,517 3,516,076 12,954,593
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)
Depreciation expense 266,914 394,603 661,517
Capital expenditures 294,613 432,078 726,691
Total assets at fiscal year end 18,071,267 3,135,853 21,207,120
FISCAL 1996:
Net sales 27,970,378 35,248,834 63,219,212
Operating income 3,033,677 2,593,069 5,626,746
Depreciation expense 236,159 360,173 596,332
Capital expenditures 183,676 100,584 284,260
Total assets at fiscal year end 11,394,682 3,921,066 15,315,748
</TABLE>
Sales to major customers that exceeded 10% of the Company's total net sales
consist of the following for the specified fiscal years:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Wal-Mart 19% 17% 19%
Toys "R" Us 11% 22% 12%
Kmart 4% 10% 14%
</TABLE>
F-15
<PAGE> 120
Approximately 21% of the Company's sales were exports to foreign countries
during fiscal 1998 and 19% during fiscal 1997 and 1996.
NOTE 13 - SUPPLEMENTAL CASH FLOW INFORMATION:
Additional cash flow information by fiscal year is as follows:
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- ----------
<S> <C> <C> <C>
Cash paid (received) for:
Interest $ 614,150 $ 379,063 $2,360,538
Income taxes (1,149,829) 1,139,929 655,058
Noncash activities included the following:
Accounts receivable write-off $ 63,946 $ 45,932 $ 25,188
</TABLE>
NOTE 14 - QUARTERLY FINANCIAL INFORMATION (UNAUDITED):
<TABLE>
<CAPTION>
Fiscal Quarter Ended
4/30/98 7/31/98 10/31/98 1/31/99
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Net sales $ 5,926,126 $17,524,808 $24,563,262 $ 4,708,321
Operating income (loss) (796,703) 626,935 2,466,318 (2,599,953)
Income (loss) before income taxes (1,008,027) 442,294 2,216,365 (2,722,061)
Net income (loss) (645,137) 271,754 1,429,788 (1,794,834)
Basic earnings (loss) per share $ (0.11) $ 0.05 $ 0.24 $ (0.30)
Diluted earnings (loss) per share $ (0.11) $ 0.05 $ 0.24 $ (0.30)
Fiscal Quarter Ended
4/30/97 7/31/97 10/31/97 1/31/98
------------ ------------ ------------ ------------
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 (loss) per share $ (0.14) $ 0.23 $ (0.67) $ (0.31)
Diluted earnings (loss) per share $ (0.14) $ 0.22 $ (0.67) $ (0.31)
</TABLE>
NOTE 15 - SUBSEQUENT EVENT:
On April 15, 1999, the Company entered into a Stock Purchase and Sale
Agreement with MVII, LLC, a California limited liability company controlled by
Tom Martin, which contemplates several related transactions: (i) MVII purchased
566,038 shares of common stock from the Company for $1.2 million on April 15,
1999; (ii) MVII commenced a tender offer to purchase up to 1.6 million shares of
the outstanding common stock of the Company at $4.38 per share in cash on April
21, 1999; and (iii) subject to shareholder and other approvals, MVII will
purchase an additional 1,792,453 shares of common stock (subject to upward
adjustments not to exceed in the aggregate 140,000 shares) from the Company for
$3.8 million simultaneously with the purchase of shares in the tender offer.
F-16
<PAGE> 121
Upon consummation of the transactions, MVII will own more than 47% of the
Company's outstanding shares and will be entitled to nominate four of the six
members of the board of directors.
F-17
<PAGE> 122
DSI TOYS, INC. AND SUBSIDIARY
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES (SCHEDULE II)
(IN THOUSANDS)
<TABLE>
<CAPTION>
Balance Charged Balance Charged Balance Charged Balance
at to costs at to costs at to costs at
January and January and January and January
Description 31, 1996 expenses Deductions 31, 1997 expenses Deductions 31, 1998 expenses Deductions 31, 1999
- ------------------- -------- -------- ---------- -------- -------- ---------- -------- -------- ---------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Reserves deducted
from assets:
Trade receivables 68 62 (25) 105 145 (46) 204 (17) (64) 123
Discounts and
markdowns 700 1,037 (966) 771 2,447 (1,261) 1,957 1,559 (2,132) 1,384
Return of
defective goods 288 801 (872) 217 2,617 (2,004) 830 2,416 (2,838) 408
-------- -------- ---------- -------- -------- ---------- -------- -------- ---------- --------
1,056 1,900 (1,863) 1,093 5,209 (3,311) 2,991 3,958 (5,034) 1,915
======== ======== ========== ======== ======== ========== ======== ======== ========== ========
</TABLE>
S-1
