-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, VlfkdYemebPDHXx5PmDNJGzpWeIHJ863Trzzdrs+ZNMfRrYqRmZxiSyzXtCZLHF1 VQuqNv1EorEcM95ethGVTQ== 0000950123-97-002847.txt : 19970401 0000950123-97-002847.hdr.sgml : 19970401 ACCESSION NUMBER: 0000950123-97-002847 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970331 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: GALOOB TOYS INC CENTRAL INDEX KEY: 0000751968 STANDARD INDUSTRIAL CLASSIFICATION: GAMES, TOYS & CHILDREN'S VEHICLES (NO DOLLS & BICYCLES) [3944] IRS NUMBER: 941716574 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-09599 FILM NUMBER: 97570791 BUSINESS ADDRESS: STREET 1: 500 FORBES BLVD CITY: SOUTH SAN FRANCISCO STATE: CA ZIP: 94080 BUSINESS PHONE: 4159521678 FORMER COMPANY: FORMER CONFORMED NAME: GALOOB LEWIS TOYS INC /DE/ DATE OF NAME CHANGE: 19920703 10-K 1 GALOOB TOYS 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 Form 10-K (Mark One) [ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED, EFFECTIVE OCTOBER 7, 1996] For the fiscal year ended December 31, 1996 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] For the transition period from _____________ to _____________ Commission file number 1-9599 ------ GALOOB TOYS, INC. (formerly known as Lewis Galoob Toys, Inc.) (Exact name of registrant as specified in its charter) Delaware 94-1716574 ------------------------------- ---------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 500 Forbes Boulevard So. San Francisco, CA 94080 - ------------------------------------------ ---------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (415)952-1678 Securities registered pursuant to Section 12(b) of the Act: Name of each exchange on Title of each class which registered ------------------- ---------------- Common Stock, Par Value $.01 Per Share New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO ----- ----- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the voting stock held by persons who are not officers or directors (or their affiliates) of the registrant, as of March 3, 1996, was approximately $300,000,000. The number of shares outstanding of each of the registrant's classes of common stock, as of March 1, 1996, was as follows: Class Number of Shares ----- ---------------- Common Stock, Par Value $.01 Per Share 18,019,864 DOCUMENTS INCORPORATED BY REFERENCE The following document has been incorporated by reference: The registrant's Proxy Statement (the "Proxy Statement") to be used in connection with its 1997 Annual Meeting of Shareholders has been incorporated into Part III. 2 PART I Item 1 Business General Founded in 1957, Galoob Toys, Inc. ("the Company") is a leading international toy company that designs, develops, markets and sells a variety of high-quality toy products in an expanding number of product categories. The Company believes it is a leading innovator in the toy industry as evidenced by its award-winning Sky Dancers(R), the world's first flying doll, introduced in late 1994; its Double Takes(TM) line of Micro Machines(R) transforming playsets, introduced in 1995; its line of Star Wars(TM)Action Fleet(TM) toys representing a new scale in the male action category; and Dragon Flyz(TM), the world's first fully articulated flying male action figure. The Company's Micro Machines line, introduced in 1987, is the most comprehensive line of miniature scale play for boys in the world, embracing traditional vehicle, military and male action play patterns. The Company's Sky Dancers line was the number-one new mini-doll brand in the United States in 1995 and the number one mini-doll in 1996. Action Fleet was the number one new mini-vehicle brand of 1996, and Pound Puppies(R) the number one new mini-doll brand of 1996. The Company's 1996 product offerings consisted of six product lines: Micro Machines, Star Wars Action Fleet, Dragon Flyz, Jonny Quest(R), Sky Dancers, and Pound Puppies. In addition to continuations and expansions of these product lines, the Company's 1997 product offerings include new product lines called All Star MVP(TM)s and Star Fairies(TM) and three new product lines based on movie entertainment properties: Men in Black(TM), a new science-fiction adventure comedy film scheduled to be released by Sony Pictures Entertainment ("Sony") in the summer of 1997; Starship Troopers(TM), a new science-fiction adventure film scheduled to be released by Sony in the fall of 1997; and Anastasia(TM), a new animated film scheduled to be released by Fox Animation ("Fox") in the fall of 1997. In connection with the scheduled release of the Special Edition of the Star Wars movie trilogy in early 1997, the Company has introduced new Star Wars Micro Machines and Action Fleet toys. The Company's products are sold in more than 50 countries worldwide. These products are principally sold direct to retailers in the United States and to toy distributors outside of the United States. Since 1993, the Company's revenues have grown approximately 112% from $134 million in 1993 to $179 million, $220 million and $285 million in 1994, 1995 and 1996, respectively. In 1996, approximately one-third of the Company's revenues were derived from international sales, which have increased approximately 94% since 1993. The Company believes its recent success has left it well positioned for future growth. The key elements of the Company's growth strategy are: (a) build the Company's core brand-Micro Machines; (b) enter new product categories; (c) expand profit margins on rising sales; (d) develop additional strategic alliances with major content providers; and (e) leverage international distribution networks. Industry Overview According to the Toy Manufacturers of America, Inc. ("TMA"), an industry trade group, total domestic shipments of toys, excluding video games and accessories, were approximately $13.9 billion in 1996. According to the TMA, the United States is the world's largest toy market, followed by Japan and Western Europe. The Company estimates that the two largest U.S. toy companies, Mattel, Inc. ("Mattel") and Hasbro, Inc. ("Hasbro") collectively hold a dominant share of the domestic non-video toy market. In addition, hundreds of smaller companies compete in the design and development of new toys, the procurement of licenses, the improvement and expansion of previously introduced products and product lines, and the marketing and distribution of toy products. 2 3 A substantial majority of the toys sold in the U.S. are manufactured, either in whole or in part, overseas where labor rates are comparatively low. The largest foreign producer markets are China and, to a lesser extent, other countries in the Far East. Toy manufacturers sell their products either directly to retailers, or to wholesalers who carry the product lines of many manufacturers. Retail toy sales have become increasingly concentrated through a small number of large chains, such as Toys "R" Us, Inc. ("Toys "R" Us"), Wal-Mart Stores, Inc. ("Wal-Mart"), Kmart Corporation, Target Stores, Inc., a division of Dayton-Hudson Corp., and Kay-Bee Toys, Inc., a division of Consolidated Stores Inc., which generally feature a large selection of toys, some at discount prices, and seek to maintain lean inventories to reduce their own inventory risk. According to the TMA, the top five U.S. toy retailers collectively hold more than half of the domestic retail market for toy sales, and their collective market share has grown in recent years. Products The Company's 1997 product offerings consist of the following: Boys' Products - - MICRO MACHINES Now in its tenth year, the Micro Machines line today comprises the most comprehensive universe of miniature play for children in the brand's history, embracing basic vehicle, military, space, sea exploration and a variety of male action play patterns. The Company continues to grow and expand its segments of Micro Machines as additions to the basic, sea exploration, space, military and licensed segments have created more than 55 playsets, 600 vehicles and 200 collections for 1997. The line has been enhanced for 1997 by the introduction of innovative new products, including the Super Auto World(TM) flagship playset in the basic segment, featuring a multi-level auto center with a service station and showroom in one; a new racing segment featuring licensed Indianapolis 500(R) vehicle collections and gift sets; vehicle collections and the Company's innovative transforming action sets based on the popular science-fiction movie properties Aliens(R), Predator(TM) and Terminator 2(R): Judgment Day; and Micro Machines Exploration(TM) playsets that float in water for play in the tub or pool. The Micro Machines line also includes products based on the popular Star Wars motion picture trilogy and on other licensed properties including Men in Black, Starship Troopers and Star Trek(R). - - STAR WARS The Company produces a wide variety of Star Wars vessels, creatures, figures, play environments and collectibles in two categories. In our traditional Micro Machines scale is a total of 55 vehicle and figure packs and 17 playsets for 1997. In our larger-scale category innovation, Action Fleet, are 11 Battle Packs(TM) (smaller vehicles or creatures with included figures), 22 larger vehicles with figures, and three large Action Fleet playsets. Among notable new Star Wars products in these categories is the Micro Machines Death Star(TM) Double Takes playset. Employing the Company's innovative Double Takes (patent pending) play pattern, the spherical Death Star battle station opens at the touch of a lever to reveal a six-level Planet Tatooine play environment. Among Action Fleet entries, The Yavin Rebel Base(TM) Action Fleet Set allows children to reenact memorable scenes from the first Star Wars movie with an interior-exterior playset replicating the command post used to launch the final attack on the Death Star. - - ACTION FLEET In 1996, the Company introduced Action Fleet, based on the successful expansion of the Company's Star Wars line. Action Fleet became the number one new mini-vehicle brand of 1996. The line consists of authentically detailed vehicles, figures and playsets that create a new scale that is larger than Micro Machines but less than half the size of traditional male action scale: five-to seven-inch-long vehicles and fully poseable, one-to-one-and-one- 3 4 half-inch-tall figures, which are compatible with separate Action Fleet playsets. The bulk of the Action Fleet range consists of the Star Wars product previously described. For 1997 the Action Fleet concept has been broadened to include vehicles, creatures and figures based on other popular science-fiction action licenses such as Starship Troopers, Aliens and Predator. New for 1997 is the Outer World Station(TM), a new Action Fleet Set for use with Action Fleet vehicles and figures and based on the Aliens motion picture. - - MEN IN BLACK In the Spring of 1997, the Company will introduce new product lines in both the traditional male action figure and Micro Machines scales, based on the characters in Columbia Pictures' and Amblin Entertainment's science fiction movie adventure comedy about a secret government organization charged with protecting the earth from criminal alien elements, scheduled to be released in the summer of 1997. The Company's Men in Black toys will include a collection of five action figures standing five inches tall, a segment of deluxe figures with spring-loaded action and surprise elements such as "exploding" body parts and rotating heads, a 12-inch-tall Alien Terrorist Edgar figure, and the Zap-Em Van(TM) playset with numerous action play features. - - STARSHIP TROOPERS In the fall of 1997, the Company plans to introduce new product lines based on the science-fiction movie adventure Starship Troopers, a large-scale epic of interplanetary war between Earth and a race of giant warrior insects. The film is being produced under an arrangement between TriStar Pictures and Walt Disney Motion Pictures Group, and is expected to be released in the fall of 1997. The Company's toy product will be released in the Micro Machines, Action Fleet, and traditional male action figure scales. Starship Troopers Micro Machines recreate in miniature the vehicles, characters and creatures from the film. In the Action Fleet segment, Deluxe Bugs and Deluxe Vehicles will each be sold with two figures and have moving parts. Battle Packs each include an action-scaled alien bug or cannon, plus three articulated figures. The Company is also offering two special remote control items, the Hopper Bug(TM) and the Drop Ship. - - ALL-STAR MVPs The Company has entered the sports collectible segment with the introduction of All-Star MVPs, five-packs of officially licensed miniature sports figures in realistic poses. NFL All-Star MVPs are micro-sized replicas of high-profile football stars from some of the premier teams in the National Football League. Similarly, NBA All-Star MVPs brings to fans of professional basketball miniature scale replicas of many of the National Basketball Association's most popular players. - - DRAGON FLYZ In 1996, the Company introduced Dragon Flyz, the first poseable flying action figures for boys, supported domestically and internationally by an independently produced animated syndicated television show which began airing in the U.S. in September 1996. Although sales of Dragon Flyz in the United States have not met expectations, Dragon Flyz is continuing in many international markets in 1997 with the introduction of new F.I.S.T. Force(TM) and Blazin' Battle Screamers(TM) flying action toys. - - JONNY QUEST The Company's Jonny Quest product line, also introduced in 1996, resulted from the Company's worldwide master toy license with Turner Home Entertainment for The Real Adventures of Jonny Quest property. The Real Adventures of Jonny Quest is based on the updated reintroduction of the 1960's animated television property from Hanna-Barbera Cartoons. The Jonny Quest line will be launching internationally in France, Germany, Spain and other international markets in 1997. 4 5 Girls' Products - - POUND PUPPIES In 1996, the Company introduced a small-scale version of Pound Puppies, the most successful plush toy line of the 1980's, creating a new miniature scale in plush toys and adding new themes to expand the line. Since its introduction, the Company's Pound Puppies quickly became the number one selling new mini-doll brand in the U.S. and, as of March 1997, the number one mini- doll brand in the United Kingdom. The line of small plush dogs and cats has been extended in 1997 with Purebreds Pound Puppies and Pound Pur-r-ries(TM), and also with Pound Bunnies(TM). Three Hideaway Playsets and three Pet Carrier playsets feature, for the first time, miniature plastic Pound Puppies and Pound Pur-r-ries in a new, even smaller scale. New Wiggle 'n Walk features a walking mommy puppy with two baby pups which follow her when her leash is pulled. - - ANASTASIA Anastasia, which will be the first animated film from Fox's The Animation Studio, re-explores the classic legend of the lost princess Anastasia, the surviving daughter of Russia's last Czar, and is scheduled for a fall 1997 release. Timed to coincide with the premiere of the film, the Company plans to introduce a full line of Anastasia products, including a new line of 11-1/2 inch-tall poseable Fashion Dolls; a Royal Fashions(TM) Collection; doll accessories including a Royal Horse and Carriage and a Music Box; four-and-three-quarter-inch-tall poseable action figures, three-inch-tall collectible figures, child-sized Pretend-and-Play Dress Up(TM) outfits, miniature Take-Along Playsets, plush puppets and plush characters, and a Huggable Anastasia soft doll. - - STAR FAIRIES The Company continues to build on the momentum of its successes in the girls' toy business by introducing Star Fairies, two-inch-tall dolls that light up and play music when they are attached to their battery-powered "magic" light wands. By pressing a button on the wand, the fairies light up and "sing." The wands come in three themes, Flower, Pegasus and Castle. Each plays its own special tune and is packaged with a pair of dolls. The Star Fairies 1997 line will also include two playsets with numerous play features. The dolls fit on posts around the playsets, causing lights to sparkle and music to play. - - SKY DANCERS First introduced in late 1994, the award-winning Sky Dancers line has been one of the most successful new girls' toy concepts in recent years. Sky Dancers was the number one selling new mini-doll brand in the United States as well as many countries around the world in 1995, and the best-selling domestic mini-doll in 1996. Sky Dancers is featured in an independently produced animated syndicated television show that began airing in the U.S. in September 1996. As expected, Sky Dancers domestic sales will decline in 1997, but the product line will continue in international markets with the introduction of New Pretty Scent(TM) Sky Dancers and Sparkle Dome(TM) Sky Dancers. Galoob Direct Products The Company established a new subsidiary, Galoob Direct, Inc. ("Galoob Direct"), in 1996. In 1997, it will sell lines of toys that will not be advertised on television by the Company. Galoob Direct will offer a wide array of products complimenting several of the Company's promoted brands, as well as one Galoob Direct exclusive brand, Dr. Seuss(TM). Under the Micro Machines brand for 1997, Galoob Direct will offer popular playsets including Orion J-22(TM), a submarine that changes into a naval command center with firing torpedoes and missiles, and FalconWing Skybase(TM), a stealth bomber that transforms into an airbase; four Hiways & Byways(R) Street Corners(TM) playsets; and the Tool Box City(TM) playset. Micro Machines Z-Bots(R), miniature collectible robots with moving parts and colorful detail, will include micro-sized Mini Z's(TM) along with three Attack Station 5 6 playsets and two Mobile Base playsets; Z-Bots Combat Vehicles; Fang Fighter(TM), a jet that transforms into a complete assault base; and Megabot(TM), a nine-inch-tall robot playset equipped with numerous action features. Additional Men in Black products from Galoob Direct include eight Bendable Figures, the MiB Role-Play Set featuring child-size Men in Black sunglasses plus an electronic Alien Communicator and two play weapons from the movie; and the Alien Blaster play weapon, fashioned after the signature weapon from the movie. Galoob Direct offers more Starship Troopers bugs and troopers for staging play scenes from the movie. A large Warrior Bug(TM) features opening jaws, monster bug sound effects, and poseable legs that can be ripped apart. Six five-and-a-half-inch-tall action figures are also available, each with a spring-fired weapon. Under the Pound Puppies brand, Galoob Direct offers Playset Pet Packs that feature additional plastic puppies and kitties for Galoob's Hideaway and Pet Carrier playsets. Pound Puppies Clip-Ons are plush puppy and kitty clips that attach to a child's notebook, clothing or hair. The Pound Puppies Veterinarian Role-Play Set includes mommy pup with two baby plush puppies. Galoob Direct will offer an extensive range of Anastasia products. In 1997, Galoob Direct will offer a number of exclusive items from The Wubbulous World of Dr. Seuss(TM), a license based on the new animated television show and also including Dr. Seuss characters. The Fabolicious Flashlight(TM) includes stencil disks to create Dr. Seuss silhouette art. The Kerzippity(TM) a key chain doubles as a zipper pull. The Plink, Plunk Coin Bank(TM) and Beautemous Bookends(TM) are adorned with well-known Dr. Seuss characters, and Pencil Toppers decorate pencils with the heads of the characters. Taffeta Funfaces(TM) are huggable pillows featuring the faces of The Cat in the Hat, Horton the elephant and the Grinch. The 'Lectro Soundtastic Bank is a battery-operated coin bank that features sound and movement when a child deposits a coin. Product Life Cycle Product attrition is a fundamental part of the life cycle of a toy. Through new product introductions, the Company has been successful in managing these product sales declines, which have averaged approximately 30% of the prior year's sales in recent years, and has grown net sales each year since 1993 at an average compounded rate of 28.5%. Furthermore, as noted above in the comments on individual product lines, international sales of a product generally continue after domestic sales have started their decline. Licensing Strategy The Company produces substantially all of its products under licenses from other parties. Some of these licenses confer rights to exploit original concepts or products developed by toy inventors and designers. Other licenses, referred to as entertainment licenses, permit the Company to design, develop, manufacture and market toys based on characters or properties which have their own popular identity, often through exposure in various media such as television programs, movies, cartoons and books. Normally most entertainment licenses extend for one to three years and are typically renewable at the option of the Company upon payment of certain minimum guaranteed payments or the attainment of certain sales levels during the initial term of the license. Licenses for original ideas from toy inventors or designers typically extend for either a set number of years or the commercial life of the product. The Company typically obtains both the domestic and international rights for the licensed products. The Company is an active participant in the market for entertainment licenses. A determination to acquire an entertainment license must usually be made before the commercial introduction of the property in which a 6 7 licensed character or property appears, and these license arrangements usually require the payment of non-refundable advances or guaranteed minimum royalties. Accordingly, the success of an entertainment licensing program is dependent upon the ability of management to assess accurately the future success and popularity of the properties that it is evaluating, to bid for products on a selective basis in accordance with such evaluation, and to capitalize on the properties for which it has obtained a license in an expeditious manner. In October 1992, the Company first obtained a license from Lucasfilm Ltd. ("Lucasfilm") to produce three collections of vehicles based on the Star Wars trilogy. As a result of the Company's continued success with the Star Wars products, Lucasfilm has extended and expanded the Company's right to produce Star Wars toys, including the innovative Action Fleet line of vehicles, figures and playsets introduced in 1996. Beginning in late January 1997, Lucasfilm released its Special Edition of the original Star Wars trilogy in theaters across the United States with enhanced digital sound and previously unreleased footage, which has had a positive impact on the sales of the Company's Star Wars products. The Company's current Star Wars license from Lucasfilm expires on December 31, 1997. The Company expects this license to be renewed for 1998. In addition, the Company is aggressively pursuing licensing rights in connection with the new Star Wars movie trilogy scheduled to be released starting in 1999. The failure to renew or obtain any part of such licensing rights could have a material adverse effect on the business, financial condition and results of operations of the Company. As part of its strategic licensing program, the Company has signed an agreement with Fox that gives the Company the exclusive worldwide first rights to license toys based on all new Fox theatrical and television properties (excluding the Fox Children's Network) to the year 2004 (including renewal rights granted to the Company). The agreement fulfills a key growth objective by forming an alliance with a powerful content provider and assures access to a continuous flow of quality entertainment properties from Twentieth-Century Fox Film Corporation, Fox Animation Studios, Twentieth-Century Fox Television, Fox Broadcasting Company, Fox Family Films, Fox 2000 Pictures, and Fox Searchlight Pictures. Pursuant to this agreement, the Company will produce toys based on the full-length animated feature film Anastasia due to be released in the fall of 1997. In addition to the Fox agreement, Sony Signatures Licensing has awarded the Company the worldwide master toy license for Columbia Pictures' and Amblin Entertainment's science fiction adventure comedy Men in Black, which is scheduled to be released in the summer of 1997. In addition, the Company has also been awarded the worldwide master toy license by Sony for TriStar Pictures' science fiction adventure Starship Troopers, which is being produced under an arrangement between TriStar Pictures and the Walt Disney Motion Pictures Group and is scheduled to be released in the fall of 1997. The Company pays royalties to its licensors which typically range from 2% to 20% of net sales. The Company also frequently guarantees payment of a minimum royalty. As of December 31, 1996 minimum future guaranteed payments aggregated approximately $3,589,000. Royalties expense totaled approximately $27,458,000, $16,326,000 and $13,498,000 for the years ended December 31, 1996, 1995 and 1994, respectively. As a result of increased competition among toy companies for licenses, in certain instances the Company has paid, and may in the future be required to pay, higher royalties and higher minimum guaranteed payments in order to obtain attractive properties for the development of product lines. Sales, Marketing and Distribution Domestic The Company markets and sells its products throughout the world, with sales to customers in the United States aggregating 69%, 63% and 66% of consolidated net sales in 1996, 1995 and 1994, respectively. The Company sells its products in the United States directly to specialty toy retailers, discount and chain stores, catalog and mail order companies, department stores, variety stores and independent distributors that purchase the products directly from the Company and ship them to retail outlets. In 1996 and 1995, Toys "R" 7 8 Us accounted for approximately 23% and 20% of the Company's consolidated net sales, respectively. Wal-Mart accounted for approximately 13% and 11% of consolidated net sales in 1996 and 1995, respectively. The Company has a sales staff of 6 people, supplemented by several manufacturer's representative organizations in the United States that act as independent contractors. The Company's sales staff and the manufacturer's representatives offer the Company's products through the use of samples and promotional materials at toy shows and by making regular customer sales calls. The Company presents its products directly to key retail accounts. The Company also directly introduces and markets to customers new products and extensions to previously marketed product lines by participating in the major trade shows in New York, Dallas, Hong Kong and Europe and through the maintenance of showrooms in New York City and Dallas. Manufacturers' representatives utilized by the Company receive commissions, which were approximately 1.0%, 0.8% and 1.0% of net sales in 1996, 1995 and 1994, respectively. The Company utilizes warehouse facilities primarily in Union City, California for storage of its products. During 1997, these operations are moving to a new warehouse facility in Southern California. The Company does not sell its products on consignment and ordinarily accepts returns only for defective merchandise. Returns have historically not been significant. In certain instances, where retailers are unable to resell the quantity of products which they have purchased from the Company, the Company may, in accordance with industry practice, assist retailers in selling such excess inventory by offering credits and other price concessions. International The Company has an extensive international sales program. In conjunction with its wholly-owned subsidiary Galco International Toys, N.V. ("Galco"), located in Hong Kong, the Company actively sells its products in over 50 countries and sells directly to approximately 60 separate, independent toy distributors, each of which is domiciled in the respective country to which sales are made. While the dollar volume of international sales accounted for approximately one-third of total Company sales in 1996, approximately 42% of all of the Company's toys sold were shipped to countries outside the United States. This is because international sale prices to distributors are significantly lower than U.S. domestic sale prices to retail accounts, since international distributors are responsible for all importation, warehousing, marketing, promotional and selling costs. The Company believes that it has significantly reduced many of the risks associated with international sales by dealing with leading toy distributors in certain of its markets and by requiring the Company's distributors to advertise and promote the Company's products in their markets, to pay for the Company's products through letters of credit, and to bear the cost of transportation as well as the risk of damage or loss upon delivery to the distributors in the Far East. The Company's risks are further reduced because its distributors bear the cost and risk of carrying inventory in the Company's products and the credit risk of collecting receivables from their retail customers. Sales by the Company to foreign customers are ordinarily denominated in U.S. dollars and, accordingly, the Company's revenues are not affected by fluctuations in monetary exchange rates. However, the value of the U.S. dollar in relation to the value of other currencies of the countries into which the Company's products are sold may have a positive or negative impact on the Company's sales volume over time, depending on the change in relationship of the respective currencies, because the Company's products compete with products for which wholesale prices are denominated in the local currency. Advertising and Promotion The Company's advertising and promotion expenses are significant. Although a portion of the Company's advertising budget is expended for newspaper advertising, magazine advertising, catalogs and other promotional materials, the Company allocates the bulk of its advertising budget to television. As is common practice in the 8 9 toy industry, the Company advertises on national network, syndicated, cable and local spot television. The Company often pre-tests advertisements to evaluate their effectiveness on the target market. The bulk of the Company's advertising and promotions occur in the early spring leading up to Easter and the fall season leading up to Christmas. The Company's retail customers also provide advertising for the Company's products and may, from time to time, receive a credit allowance in connection with such advertising. With respect to entertainment licenses, the Company believes it benefits from advertising and promotion from the major studios with respect to their entertainment properties and their promotion tie-ins. Research and Development The Company employs its own designers and engineers and also utilizes the services of independent designers and engineers on an ongoing basis. The Company presents its designers with toy concepts licensed or, to a lesser extent, originated by it, and the designers create renderings of the proposed product. Designs are then presented to the Company's engineers, who, using the renderings, perform mechanical drawings and engineering services and create prototypes for new products. Prototypes for proposed products are continuously reviewed by the Company's management, including representatives of marketing, sales and manufacturing, prior to final acceptance. Licensors of entertainment properties usually retain the rights to approve the products being marketed by the Company. The Company spent approximately $10,210,000, $7,886,000, and $7,288,000 on research and development activities in 1996, 1995 and 1994, respectively, in each case exclusive of amounts paid to certain inventors and designers who receive royalties as licensors. Such amounts do not include approximately $12,367,000, $12,388,000 and $7,149,000 incurred in 1996, 1995 and 1994, respectively, for tooling and package design. Manufacturing The Company's products are manufactured to its specifications by nonaffiliated third party manufacturers, usually located in the Far East. Over 90% of the Company's products were produced in China in 1996. These manufacturers are responsible for all aspects of the production of the Company's products in accordance with Company product specifications. In addition, the manufacturers must comply with the Company's Code of Business Conduct, which requires vendors and their subcontractors to meet certain worker health, safety and quality-of-life conditions in order to do business with the Company. The Company's manufacturing is currently performed by 21 manufacturers, some of whom derive a substantial percentage of their business from the Company. During the last four years, the Company has reduced the number of its manufacturers and concentrated its sourcing of products on a limited number of high quality manufacturers. In 1996, four companies manufactured approximately 85% of the Company's products and a single group, Harbour Ring, produced approximately 31% of the Company's products. The Company believes that its relationships with Harbour Ring and its other key manufacturers are excellent. The Company, through its wholly-owned subsidiary Galco, maintains close contact with the Company's manufacturers and subcontractors and monitors the quality of the products produced. Galco's employees arrange with manufacturers for the production, shipment and delivery of products, monitor the quality of the products produced, and undertake certain elements of the design and development of new products. Decisions related to the choice of manufacturer are based on price, quality of merchandise, reliability and the ability of a manufacturer to meet the Company's timing requirements for delivery. Generally, tooling is owned by the Company but may be utilized by different manufacturers if the need arises for alternate sources of production. Changes in tariffs could have an adverse effect on the cost of goods imported from China. While China is currently accorded Most Favored Nation ("MFN") status by the United States, this status (which was last renewed in June 1996) is subject to annual review and could be revoked prospectively for any given year. Current MFN tariffs on toys imported into the United States are zero, and the loss of MFN status for China would result in a substantial increase in tariffs applicable to toys imported from China. This increase in duty would be large 9 10 enough that it could have a material adverse effect on the Company's business, financial condition and results of operations. Products shipped from China to other countries would not be affected by China's loss of MFN status with the United States without similar actions being taken by the other importing countries. Moreover, many other toy companies also source products from China and could be affected to similar degrees. The Company can also be subject to the imposition of retaliatory tariffs or other import restrictions as a result of a trade dispute between China and the United States. Generally, trade negotiations over matters in dispute between the two countries have been difficult but have been resolved without the imposition of trade retaliation. In the past, proposed retaliation by the United States has not included increased tariffs or other trade restrictions applicable to toys imported from China. It is possible, however, that some future trade dispute could result in substantial increases in tariffs or other restrictions on imports, such as quotas, of toys from China. These increased tariffs or other restrictions could be imposed under Section 301 of the Trade Act of 1974, as amended, whether or not the trade dispute itself involved toys. Such increased tariffs or other trade restrictions could have a material adverse effect on the Company's business, financial condition and results of operations. The impact on the Company of any political or economic unrest or disruptions in China, the loss of China's MFN status or the imposition of retaliatory trade restrictions on products manufactured in China would depend on several factors, including, but not limited to, the Company's ability to (i) procure alternative manufacturing sources satisfactory to the Company, (ii) retrieve its tooling located in China, (iii) relocate its production in sufficient time to meet demand, and (iv) pass cost increases likely to be incurred as a result of such factors to the Company's customers through product price increases. As a result, any political or economic unrest or disruptions in China, the loss of China's MFN status or the imposition of retaliatory trade restrictions on products manufactured in China could have a material adverse effect on the Company's business, financial condition and results of operations. Transactions in which the Company purchases goods from manufacturers are mostly denominated in Hong Kong dollars and, accordingly, fluctuations in Hong Kong monetary exchange rates may have an impact on cost of goods. However, in recent years, the value of the Hong Kong dollar has had a continuing stable relationship to the value of the U.S. dollar and the Company has not experienced any significant foreign currency fluctuations. Inflationary pressures in China could have an effect on the cost of product sourced from China. The principal raw materials used in the production and sale of the Company's products are plastics and paper products. The Company believes that an adequate supply of raw materials used in the manufacture of its products are readily available from existing and alternate sources. Intellectual Property Rights Most of the Company's products are copyrighted and sold under trademarks owned by or licensed to the Company. In addition, certain products incorporate patented devices or designs. The Company or its licensors customarily seek protection of major product patents, trademarks and copyrights in the United States and certain other countries. These intellectual property rights can be significant assets of the Company. Although the Company believes it is adequately protected, the loss of certain of its rights for particular product lines may have a material adverse effect on its business, financial condition and results of operations. Competition The toy industry is highly competitive. The Company competes with several larger domestic and foreign toy companies, such as Hasbro and Mattel, and many smaller companies in all aspects of its business, including the design and development of new toys, the procurement of licenses, the improvement and expansion of previously introduced products and product lines, and the marketing and distribution of its products including obtaining adequate retail shelf space. Some of these companies have longer operating histories, broader product lines and greater financial resources and advertising budgets than the Company. In addition, it is common in the toy industry for companies to market products which are similar to products being successfully marketed by 10 11 competitors. The Company believes that the strength of its management team, the quality of its products, its relationships with inventors, designers and licensors, its distribution channels and its overhead and operational controls allow the Company to compete effectively in the marketplace. Seasonality and Backlog Toy industry sales are highly seasonal and driven by disproportionate customer demand for toys to be sold during the Christmas holiday season. Approximately two-thirds of the Company's shipments typically occur in the second half of the year. As a result, the Company's operating results vary significantly from quarter to quarter within any given year. Orders placed with the Company for shipment are cancelable until the time of shipment. The combination of seasonal demand and the potential for order cancellation makes accurate forecasting of future sales difficult and causes the Company to believe backlog may not be an accurate indicator of the Company's future sales. Similarly, comparison between fiscal periods of successive years may not be indicative of results of operations for any given full year. The seasonality creates significant peaks in working capital requirements. Government Regulations The Company is subject to the provisions of, among other laws, the Federal Hazardous Substances Act and the Federal Consumer Product Safety Act. These laws empower the CPSC to protect consumers from hazardous toys and other articles. The CPSC has the authority to exclude from the market articles which are found to be unsafe or hazardous and can require a manufacturer to recall such products under certain circumstances. Similar laws exist in some states and cities in the United States and in Canada and Europe. The Company's products are designed and tested to meet or exceed all applicable regulatory and voluntary toy industry safety standards. The Company emphasizes the safety and reliability of its products and has established a strong quality assurance and control program to meet the Company's objective of delivering high quality, safe products. The Company believes that all of its products meet or exceed applicable safety standards in the United States and other jurisdictions. Employees As of December 31, 1996, the Company had 235 employees, 138 in the United States and 97 in the Far East. Seven of the Company's warehouse employees, some of whom are employed only on a seasonal basis, are subject to a collective bargaining agreement which expires May 31, 1998. The Company believes that its labor relations are satisfactory. Item 2 Properties The Company's principal executive offices are located at 500 Forbes Boulevard, South San Francisco, California, where the Company owns a building with approximately 136,000 square feet. The Company occupies approximately 67,000 square feet of office space and leases the remaining approximately 69,000 square feet of warehouse space to third parties. The Company also has 125,000 square feet of warehouse space at Union City, California, under a lease which expires in 1997. Beginning in 1997, the Company has signed a new lease, which expires in 2002, for approximately 432,000 square feet of warehouse space in Ontario, California. This warehouse space will replace the warehouse space in Union City, California. This lease includes an option to extend the expiration date to 2007. The Company has a showroom, consisting of approximately 17,200 square feet, which is located at 1107 Broadway, New York, New York, under a lease that expires in 2006, a showroom, consisting of approximately 1,000 square feet, which is located in Dallas, Texas, under a lease that expires in 2000, and office and warehouse space in Hong Kong consisting of approximately 30,000 square feet under leases which expire at varying dates through 1998. Management believes that its current facilities are suitable and adequate for the Company's business as currently conducted. The Company's properties will be expanded as necessary to support future growth levels in the Company's business. 11 12 Item 3 Legal Proceedings Licensing Litigation In June 1995, the Company filed a declaratory judgement action in United States District Court for the Northern District of California. The suit names Clemens V. Hedeen, Jr., Patti Jo Hedeen, and various affiliated entities, as defendants, and seeks a determination that the Company is not obligated to pay royalties to the defendants under their license agreement on certain specific products sold under the Company's "Micro Machines" name and trademark. The defendants filed a cross-complaint for breach of this license agreement claiming damages for past royalties allegedly due but not paid under the license agreement, and claiming entitlement to additional royalties on future sales of such products. The defendants also are asking the court to order that the Company cease the manufacture and sale of certain portions of the Micro Machines product line, and convey to the defendants certain rights to the Micro Machines product line, including patent and trademark rights. The defendants also claim the license agreement to be terminated for the non-payment of the royalties at issue. The defendants filed a motion for summary judgment, which was denied by the court in late 1995. The Company's complaint has been amended to address additional issues between the parties. Although there can be no assurance of the outcome of this matter, the Company believes that it has meritorious factual and legal claims in connection with this matter. In October 1995, the Company filed a breach of contract action in the United States District Court for the Northern District of California. The suit names Abrams Gentile Entertainment Inc. and Up, Up and Away as defendants, and alleges damages for the licensing, marketing and sale of products that are in violation of the Company's rights as licensee under its Sky Dancers and Dragon Flyz license agreements with Abrams Gentile Entertainment, Inc. The defendants have filed a number of counterclaims, including breach of contract, interference with contractual relationships, misappropriation of copyright, unfair competition and trade libel. The Company's attempt to obtain a partial temporary restraining order was denied by the court in December 1995 on the basis that equitable relief was not appropriate and that the Company could be adequately compensated through legal damages. Although there can be no assurances of the outcome of this matter if it goes to trial, the Company believes that it has meritorious factual and legal claims in connection with this matter. The Company has reached an agreement in principle to settle and amicably resolve all open issues in this litigation, subject to final documentation. The settlement will not result in additional liabilities to the Company, and the Company's rights under the license agreements will be preserved. Manufacturer Litigation In January 1991, the Company, through its wholly owned subsidiary, Galco, filed a lawsuit in Hong Kong against Kader Industrial Co., Ltd. ("Kader"), alleging damages suffered by both Galco and the Company as a result of Kader's defective manufacturing of two lead doll items for the Company's Bouncin' Babies toy line in 1990. Kader filed counterclaims alleging breach of 17 individual contracts. In August 1996, the trial court rendered a decision in favor of Kader on the general issue of liability in this matter, including an award of damages based on Kader's counterclaims which was approximately $250,000, plus prejudgment interest. In addition, the court awarded certain litigation costs to Kader, the amount of which will be determined in future proceedings and could substantially exceed the amount of the damages awarded. In the opinion of management of the Company, none of three above matters of litigation is likely to have a material adverse effect on the business, financial condition and results of operations of the Company. Item 4 Submission of Matters to a Vote of Security Holders The Company's Annual Meeting of Shareholders was held on November 4, 1996 and November 22, 1996. At the Annual Meeting, the following matters were approved by the shareholders: 12 13 1. The election of Paul A. Gliebe, Jr. to the Board of Directors for a term expiring at the 1997 Annual Meeting of Shareholders and until the election and qualification of his successor and the election of S. Lee Kling and Andrew J. Cavanaugh to the Board of Directors for terms expiring at the 1999 Annual Meeting of Shareholders and until the election and qualification of their successors. There were 12,846,359 votes in favor of Mr. Gliebe and 444,788 withheld. There were 12,849,559 votes in favor of Mr. Kling and 441,588 withheld. There were 12,850,459 votes in favor of Mr. Cavanaugh and 440,688 withheld. Mark D. Goldman, Scott R. Heldfond and Roger J. Kowalsky are other directors of the Company whose terms continue after the meeting. 2. The amendment to the Company's Certificate of Incorporation to change the name of the Company to Galoob Toys, Inc. There were 13,247,350 votes in favor, 6,245 votes against and 37,552 abstentions. 3. The approval of the 1996 Long-Term Compensation Plan. There were 10,342,340 votes in favor, 167,839 votes against and 81,061 abstentions. 4. The approval of the 1996 Share Incentive Plan. There were 5,727,907 votes in favor, 5,466,193 votes against and 76,436 abstentions. 5. The ratification of the appointment of Price Waterhouse LLP as the Company's independent accountants for fiscal 1997. There were 13,132,535 votes in favor, 119,119 votes against and 39,493 abstentions. 13 14 PART II Item 5 Market for the Registrant's Common Equity and Related Stockholder Matters The Common Stock of the Company is listed on the NYSE under the symbol GAL. The following table sets forth the high and low closing sale prices for the Common Stock, as reported on the NYSE, Composite Tape. The reported last sale of Common Stock on the NYSE on March 21, 1997, was $16.
Fiscal Year High Low ----------- ---- --- 1996 First Quarter................................... $20 1/4 $10 1/2 Second Quarter.................................. 28 1/4 18 7/8 Third Quarter................................... 30 1/2 22 3/8 Fourth Quarter.................................. 33 1/4 14 1995 First Quarter................................... $ 7 3/4 $ 5 1/4 Second Quarter.................................. 8 3/8 6 Third Quarter................................... 9 1/2 6 1/2 Fourth Quarter.................................. 13 3/4 9 1/4
As of March 21, 1997, there were approximately 1,200 holders of record of the Common Stock, excluding beneficial owners of shares registered in nominee or street name. The Company has not declared or paid any cash dividends on the Common Stock since its initial public offering in 1984. The Board of Directors of the Company has no current plans to pay cash dividends on the Common Stock. The Company's existing credit facility prevents the Company from paying cash dividends on the Common Stock without consent of its lender. See "Management's Discussion and Analysis of Financial Condition and Results of Operations-Liquidity, Financial Resources and Capital Expenditures." In addition, future dividend policy will depend on the Company's earnings, capital requirements, financial condition and other factors considered relevant by the Board of Directors. 14 15 Item 6. Selected Financial Data
(in thousands, except per share data) Years ended December 31, ---------------------------------------------------------------------- 1996 1995 1994 1993 1992 --------- -------- -------- --------- --------- Statements of Operations Data: Net revenues ....................... $ 284,905 $220,044 $178,792 $ 134,334 $ 166,280 ========= ======== ======== ========= ========= Net earnings (loss) ................ 18,451 9,399 18,424 (10,924) (2,447) Preferred stock dividends: Paid .......................... 6 -- -- -- 782 In arrears .................... 15 3,127 3,127 3,127 2,345 Charge related to exchange of ...... -- preferred stock for common .... 24,279 -- -- -- -- --------- -------- -------- --------- --------- Net earnings (loss) applicable to common shares ................. $ (5,849) $ 6,272 $ 15,297 $ (14,051) $ (5,574) ========= ======== ======== ========= ========= Net earnings (loss)per common share: Primary ........................ $ (0.41) $ 0.60 $ 1.51 $ (1.47) $ (0.59) ========= ======== ======== ========= ========= Fully diluted .................. $ (0.41) $ 0.60 $ 1.41 $ (1.47) $ (0.59) ========= ======== ======== ========= ========= Number of common shares and common share equivalents outstanding - average .......... 14,289 10,451 10,111 9,548 9,400
At December 31, --------------------------------------------------------------------- 1996 1995 1994 1993 1992 --------- -------- -------- --------- --------- Balance Sheet Data: Working capital .................... $ 134,394 $ 54,670 $ 53,219 $ 30,813 $ 27,070 Total assets ....................... 196,905 120,084 100,766 71,005 71,604 Long-term debt ..................... 20 14,000 18,414 18,608 4,944 Shareholders' equity ............... 149,791 54,172 44,768 22,162 32,246
15 16 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Overview From 1990 through 1993, the Company had a period of declining revenues and suffered net losses. Commencing in 1991, the Company installed a new management team and began implementing a recovery plan designed to reposition the Company, return the Company to profitablity and enable it to capitalize on its growth strategy. The recovery plan focused on three key goals: (i) to restore and expand the Company's core business of the Micro Machines product line, (ii) to focus on growth opportunities in new product areas such as the male action figure category and girls' product lines and (iii) to reduce the Company's cost structure and lower its break-even point. Due to the relatively long lead time for new products and product lines in the toy industry, the recovery plan was designed to turn the Company around for a three-year period and return the Company to profitability in 1994. Since 1993, the Company's revenues have grown approximately 112% from approximately $134 million in 1993 to approximately $285 million in 1996. In addition, from 1994 to 1996, the Company had record sales and net earnings during the important fourth quarter of each year. The Company believes that its operating performance over the past three years demonstrates that its recovery plan has succeeded and that the Company is now well positioned for future growth. The successful implementation of its recovery plan has enabled the Company to restructure its balance sheet to improve its liquidity and cash flow. In March 1995, the Company renegotiated its existing credit facility to extend the maturity by two years, increase availability from $40 million to $60 million and decrease the annual interest rate by one percent. In February 1996, the Company gave notice of its intention to redeem its 8% Convertible Subordinated Debentures due 2000 (the "Debentures"). As a result, the $14 million aggregate principal amount of outstanding Debentures was converted into an aggregate of approximately 1.5 million shares of Common Stock. In addition, in March 1996, an offer by the Company to exchange shares of its Common Stock for its outstanding shares of Depositary Convertible Exchangeable Preferred Stock (the "Depositary Shares") resulted in 98% of the holders of Depositary Shares converting such shares into an aggregate of approximately 3.3 million shares of Common Stock. The remainder of such Depositary Shares were either redeemed or converted into Common Stock in June 1996. As a result of the foregoing, the Company reduced its outstanding indebtedness and the aggregate liquidation preference of preferred stock outstanding by approximately $51 million, increased shareholders' equity by approximately $12 million, reduced annual interest payments by $1.1 million and eliminated annual preferred stock dividend obligations of $3.1 million. Disclosure Regarding Forward-Looking Statements All statements other than statements of historical fact included in this Form 10-K Report, including, without limitation the statements under "Management's Discussion and Analysis of Financial Condition and Results of Operations" are, or may be deemed to be, forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. Important factors that could cause actual results to differ materially from those discussed in such forward-looking statements ("Cautionary Statements") include: the demand for the Company's products, the Company's dependence on timely development, introduction and customer acceptance of new products; possible weakness of the Company's markets; the impact of competition on revenues, margins and pricing; the effect of currency fluctuations; other risks and uncertainties as may be disclosed from time to time in the Company's public announcements; the gross national product in the United States and other countries, which also influences demand for the Company's products; customer inventory levels; and the cost and availability of raw materials. All subsequent written and oral forward-looking statements attributable to the Company or persons acting on behalf of one or both of them are expressly qualified in their entirety by such Cautionary Statements. 16 17 Results of Operations The following table sets forth certain operating data (as a percentage of the Company's net revenues) for the years ended December 31, 1996, 1995 and 1994:
Years Ended December 31 ------------------------------- 1996 1995 1994 ------ ------ ------ Net revenues ........................................ 100.0% 100.0% 100.0% Cost of products sold ............................... 50.6 55.3 53.5 ----- ----- ----- Gross margin ........................................ 49.4 44.7 46.5 Advertising and promotion expenses .................. 15.3 14.2 17.1 Other selling and administrative expenses ......................... 12.6 13.6 12.5 Royalties, research and development expenses ........ 13.2 11.0 11.7 ----- ----- ----- Earnings from operations ............................ 8.3 5.9 5.2 Net proceeds from Nintendo award .................... -- -- 6.8 Interest expense .................................... (1.1) (1.5) (1.5) Other income, net ................................... 0.2 0.2 0.2 Provision for income taxes .......................... (0.9) (0.3) (0.4) ----- ----- ----- Net earnings ........................................ 6.5% 4.3% 10.3% ===== ===== =====
Net earnings (loss) have been affected by certain unusual, non-recurring items. A comparison of the net earnings (loss) per common share and the net earnings per common share adjusted to exclude unusual items is set forth below.
Years Ended December 31 ------------------------------ 1996 1995 1994 -------- -------- -------- Net earnings (loss) per common share on a primary basis, as reported ............................................ $(.41) $0.60 $1.51 Net earnings per common share on a primary basis, adjusted to exclude unusual items ...................... $1.20 $0.60 $0.34
The unusual items excluded are as follows: net proceeds from Nintendo award of $11.8 million (after taxes) in 1994, and a one-time charge related to the exchange of preferred stock for common stock of $24.3 million in 1996. Years ended December 31, 1996 and 1995 Net revenues in 1996 were $284.9 million which represented a 29% increase from 1995 net revenues of $220.0 million. The growth in net sales in 1996 was attributable to domestic sales which increased 41%, rising to $196.7 million. International sales increased 10% to $88.2 million, reflecting a strong fourth quarter of 1996. The Company's worldwide sales of boys' toys increased 74% in 1996 as compared to 1995. The growth in net sales of boys' toys for 1996 was primarily attributable to Micro Machines growth and new product introductions. Worldwide sales of Micro Machines, led by the recently introduced Star Wars Action Fleet, an extensive line of Star Wars vessels, playsets, and miniature action figures, increased by 58% versus 1995. United States retail sales success of Micro Machines continued, reaching its sixteenth consecutive quarter of growth. New product introductions started in March 1996 when the Company initiated sales of Dragon Flyz, a line of flying articulated action figures plus vehicles and accessories, and continued in June 1996 when the Company initiated sales of Jonny Quest, a line of vehicles and miniature figures based on characters from the TV show. This increase was partially offset by the anticipated decrease in international sales of boys' toys based on Biker Mice from Mars. 17 18 The Company's worldwide sales of girls' toys decreased 20% in 1996 as compared to 1995. A decrease in the sales of Sky Dancers and My Pretty DollHouse was partially offset by an increase generated by the new Pound Puppies line. Gross margins were $140.6 million in 1996, an increase of $42.3 million from 1995. This increase was due to higher sales volume and an increase in the gross margin rate to 49.4% in 1996 from 44.7% in 1995. The increase in the gross margin rate was primarily attributable to the following: (i) economies of scale associated with the efficient utilization of tooling, (ii) reduced product costs, (iii) a change in the product mix, and (iv) a different mix of sales between domestic and international markets. The Company's gross margin rate on domestic sales is significantly greater than foreign sales because the Company's prices on foreign sales are lower than on domestic sales as the foreign customer is responsible for the cost of importing and promoting the products. Advertising and promotion expenses were $43.5 million, or 15.3% of net revenues, in 1996 as compared to $31.2 million, or 14.2% of net revenues, in 1995. The higher expenses were primarily a result of a planned increase in domestic television advertising expenses and the higher percentage relates to the different mix of domestic and international sales. Other selling and administrative expenses were $35.8 million in 1996 as compared to $29.9 million in 1995. The increase in expenses principally resulted from higher freight and commission expenses due to the growth in sales, legal expenses and personnel costs as planned. However, other selling and administrative expenses as a percentage of net revenues decreased to 12.6% in 1996 from 13.6% in 1995. Royalties, research and development expenses were $37.7 million in 1996 as compared to $24.2 million in 1995. The increase in 1996 was due to higher royalty expenses associated with increased sales volume and the write-off of royalty advances associated with discontinued products, as well as increased research and development expenses associated with the expansion of the Company's lines of toys. Interest expense was $3.2 million in 1996 as compared to $3.4 million in 1995. The decrease was due primarily to lower average borrowings outstanding during 1996. The 8% Convertible Subordinated Debentures originally due November 30, 2000 (the "Debentures") were eliminated by being converted to common stock in the first quarter of 1996, eliminating the interest payments thereunder. Credit line borrowings were repaid in the fourth quarter from the proceeds of the Company's Common Stock offering. The provision for income taxes was $2.5 million, or 11.9% of earnings before taxes, in 1996 as compared to $0.6 million, or 6.0% of earnings before taxes, in 1995. The current year tax rate is lower than the federal statutory rate primarily due to the effect of the utilization of net operating loss carryforwards and federal tax credits. At December 31, 1995, the Company had net operating loss carryforwards of approximately $7.3 million and unused federal tax credits of approximately $1.8 million available to reduce taxes in future periods. Years ended December 31, 1995 and 1994 Net revenues in 1995 were $220.0 million which represented a 23% increase from 1994 net revenues of $178.8 million. The strong sales growth for 1995 was attributable to two principal factors: (i) record international sales of $80.7 million, an increase of 35% from 1994, and (ii) an increase in worldwide sales of girls' toys by more than 500% to $88.0 million, which represented 40% of net revenues as compared to only 8% of net revenues in 1994. The girls' toys line increase was due to the introduction of the popular Sky Dancers flying dolls and the My Pretty DollHouse line of miniature houses and accessories. The Company's boys' toys business declined 22% in 1995 as compared to 1994 as a result of the discontinuance of the Biker Mice from Mars line to domestic retailers and a decline in consumer demand for the Z-Bots and Power Rangers segments of Micro Machines. The Company had anticipated such discontinuance of and sales declines in these products. However, the Company's worldwide Micro Machines sales in 1995, 18 19 excluding Z-Bots and Power Rangers, grew by 15% over 1994. Micro Machines, through the fourth quarter of 1995, had twelve consecutive quarters of U.S. retail sales growth. Gross margin was $98.3 million in 1995, an increase of 18.2% or $15.1 million from 1994. The increase was due to higher sales volume offset slightly by a lower gross margin rate. The gross margin rate decreased to 44.7% in 1995 from 46.5% in 1994 due mainly to three factors. First, tooling and packaging design costs were a higher percentage of net revenues in 1995 as compared to 1994 in support of the Company's expanded product line. Second, international sales as a percentage of worldwide revenues were higher in 1995 compared to 1994. Third, sharp price increases on plastics and packaging materials in the third and fourth quarters of 1995 occurred too late in the year for the Company to pass such increases on to its customers. The reduced gross margin rate was partially offset by the elimination of duty on toys imported into the United States from China. Advertising and promotion expenses were $31.2 million or 14.2% of net revenues in 1995 as compared to $30.6 million or 17.1% of net revenues in 1994. The decrease in advertising and promotion expenses as a percentage of net revenues was a result of higher marketing efficiencies domestically, coupled with the effects of the higher sales growth rate internationally where the Company's distributors absorb their own advertising costs. Other selling and administrative expenses were $29.9 million in 1995 as compared to $22.4 million in 1994. The increase in expenses was due mainly to higher planned personnel costs as a result of the Company's growth and product line expansion, higher freight costs, and higher legal expenses. Royalties, research and development expenses increased to $24.2 million in 1995 as compared to $20.8 million in 1994. The increase in 1995 was due to higher royalty expenses associated with increased sales volume as well as increased research and development expenses due to expansion of the number of product lines. Although total operating expenses increased by $11.5 million in 1995 as compared to 1994, operating expenses as a percentage of net revenues declined to 38.8% in 1995 from 41.3% in 1994. Earnings from operations were $13.0 million, an increase of 39% from 1994 earnings from operations of $9.3 million, reflecting the growth of net revenues of 23% and lower operating expenses as a percentage of net revenues. In 1994, the net proceeds of $12.1 million from the Nintendo award represents the receipt of the Company's share of proceeds from its litigation with Nintendo of America Inc. The amount was reflected in 1994 results and had no impact on 1995 results. Interest expense was $3.4 million in 1995 as compared to $2.6 million in 1994. The increase was due primarily to higher average borrowings needed to fund working capital to support higher sales, offset by a slightly lower interest rate in 1995 as compared to 1994 on the Company's revolving credit facility. Income tax expense for 1995 and 1994 includes provisions for federal, state and foreign income taxes, after taking into account the available net operating loss carryforwards from prior years. At December 31, 1995, the Company has federal net operating loss carryforwards of approximately $7.3 million and unused federal tax credits of approximately $1.8 million available to reduce taxes in future periods. Liquidity, Financial Resources and Capital Expenditures Demand for the Company's products is greatest in the third and fourth quarters of the year. As a result collections of accounts typically peak in the fourth quarter and early first quarter of the following year. Due to the seasonality of its revenues and collections, the Company's working capital requirements are usually highest during the fourth quarter of each year. On March 31, 1995, the Company entered into an amended and restated loan and security agreement (the "Credit Agreement") with Congress Financial Corporation (Central) (the "Lender"). The Credit Agreement extends through March 31, 1997 and provides a revolving line of credit of $40 million secured by substantially 19 20 all the assets of the Company, with provision to increase the line to $60 million at the option of the Company. Borrowing availability is determined by a formula based on qualified assets. Borrowings under the Credit Agreement are secured by a lien on substantially all of the assets of the Company. The annual interest rate is equal to the prime rate of CoreStates Bank N.A. as announced from time to time plus 1%. At December 31, 1996, there were no loans outstanding and $60 million was available to borrow under the Credit Agreement. On February 28, 1997, the Company signed an initial commitment letter for a $200 million credit facility with BT Commercial Corporation, a unit of Bankers Trust New York Corporation ("BT Facility"). The commitment is subject to certain conditions, and it is expected that an agreement can be finalized within 60 days. The Congress Credit Agreement has been extended while the new agreement is being finalized. During 1996, the Company used $15.0 million of cash in its operating activities. This usage resulted from increases in accounts receivable, inventories, tooling and related costs, prepaid expenses, deferred tax and other assets, offset by net earnings, and increases in accounts payable, accrued expenses and income and deferred taxes payable. Working capital was $134.4 million at December 31, 1996 compared to $54.7 million at December 31, 1995. The ratio of current assets to current liabilities was 3.9 to 1.0 at December 31, 1996 compared to 2.1 to 1.0 at December 31, 1995. Capital expenditures for 1996 were approximately $2.3 million. The Company had no material commitments for capital expenditures at December 31, 1996. The Company believes that its cash flow from operations, cash on hand and borrowings under a new credit agreement now being negotiated will be sufficient to meet its working capital and capital expenditure requirements and provide the Company with adequate liquidity to meet its anticipated operating needs for the foreseeable future. The Company is aggressively pursuing the renewal and extension of its current Star Wars license as well as licenses in connection with the expected release of the new Star Wars trilogy in 1999. If the Company is successful in extending its current license and adding new licenses for additional Star Wars product lines, the Company may need significant additional capital to pay for such license rights as well as to finance expenditures to support new Star Wars product lines. Should the expected new $200 million BT Facility be insufficient for these needs, the Company believes that additional financing can be arranged. There can be no assurance that the Company will be successful in obtaining licenses related to the new Star Wars trilogy. The failure to renew or obtain any part of such licensing rights could have a material adverse effect on the business, financial condition and results of operations of the Company. Recent Accounting Pronouncement The FASB issued a new standard, SFAS No. 123, "Accounting for Stock-Based Compensation," which contains a fair value-based method for valuing stock-based compensation that entities may use, which measures compensation cost at the grant date based on the fair value of the award. Compensation is then recognized over the service period, which is usually the vesting period. Alternatively, the standard permits entities to continue accounting for employee stock options and similar equity instruments under APB Opinion 25, "Accounting for Stock Issued to Employees." Entities that continue to account for stock options using APB Opinion 25 are required to make pro forma disclosures of net income and earnings per share, as if the fair value-based method of accounting defined in SFAS No. 123 had been applied. The Company has determined to continue to account for stock options using APB Opinion 25 and has made the required pro forma disclosures in the notes to its consolidated financial statements. The Company adopted this new standard for the year ending December 31, 1996. 20 21 Impact of Inflation The cost of the Company's operations is influenced to the extent of any price increases in the cost of raw materials. In management's opinion, other than the sharp increases in prices of plastics and packaging materials experienced in the third and fourth quarters of 1995, general inflation did not have a material impact on the Company's business in 1996 and 1995. The Company did not implement any substantial price increases in 1996 or 1995 on continuing product lines. Item 8. Financial Statements and Supplementary Data The Consolidated Financial Statements and Financial Statement Exhibits are listed in Item 14(a) and are included herein. Item 9. Changes in and Disagreements with Accountants and Accounting and Financial Disclosure Not Applicable. 21 22 PART III Item 10. Directors and Executive Officers of the Registrant (a) Identification of Directors The section entitled "Election of Directors" contained in the Proxy Statement is hereby incorporated by reference. (b) Identification of Executive Officers The executive officers and their respective positions are as follows:
Name Age Position ---- --- -------- Mark D. Goldman.................... 46 President, Chief Executive Officer and Director William G. Catron.................. 51 Executive Vice President, General Counsel, Chief Administrative Officer and Secretary Loren H. Hildebrand................ 57 Executive Vice President, Sales Ronald D. Hirschfeld............... 46 Executive Vice President, International Sales & Marketing Roger J. Kowalsky.................. 62 Executive Vice President, Chief Financial Officer and Director Gary J. Niles...................... 57 Executive Vice President, Marketing and Product Acquisition Louis R. Novak..................... 49 Executive Vice President and Chief Operating Officer Jay B. Foreman..................... 34 Senior Vice President of Galoob and Senior Vice President and Managing Director of Galoob Direct, Inc. H. Alan Gaudie..................... 56 Senior Vice President, Finance and Assistant Secretary Ronnie Soong....................... 50 Managing Director of Galco International Toys, N.V. Terrell (Mark) Taylor.............. 55 Senior Vice President, Product Design
Mark D. Goldman, a Director of the Company, has served as President and Chief Executive Officer of the Company since June 1991. From 1987 to 1991, Mr. Goldman served as Executive Vice President and Chief Operating Officer. Prior to 1987, Mr. Goldman served in various executive capacities at Ages Entertainment Software, Inc. (formerly Sega Enterprises, Inc.) and Mattel, Inc. William G. Catron has served as Executive Vice President, General Counsel and Chief Administrative Officer since May 1992 and as Corporate Secretary of the Company since June 1995. From 1985 to 1992, Mr. Catron was Senior Vice President, Assistant General Counsel for Paramount Pictures Corporation. Prior to 1985, Mr. Catron served in various executive capacities at Ages Entertainment Software, Inc. (formerly Sega Enterprises, Inc.) and Mattel, Inc. Loren H. Hildebrand has served as Executive Vice President, Sales of the Company since April 1994. From 1992 to 1994, Mr. Hildebrand was president of Creative Consultants and from 1991 to 1992 he was Executive Vice President of Bandai U.S. Inc., a toy manufacturer. From 1989 to 1992, Mr. Hildebrand was Executive Vice President and a partner in Toy Soldiers, Inc., a start-up company. Prior to 1989, Mr. Hildebrand was a consultant for Worlds of Wonder and Executive Vice President, Sales, Merchandising and Distribution for Mattel, Inc. Ronald D. Hirschfeld has served as Executive Vice President, International Sales and Marketing of the Company since February 1994. From 1989 to 1994, Mr. Hirschfeld served as Senior Vice President, 22 23 International Sales and Marketing. Prior to 1989, Mr. Hirschfeld served as Senior Vice President, International Operations from 1987 to 1989 and has held various positions with the Company since 1978. Roger J. Kowalsky has served as Executive Vice President and Chief Financial Officer of the Company since June 1996 and as a Director of the Company since June 1994. From 1989 to 1996, Mr. Kowalsky served as Director of the Vermont Studio Center, an organization dedicated to visual artists and writers. From 1983 to 1986, Mr. Kowalsky served as Senior Vice President, Finance & Administration for Yale Materials Handling Corporation. Prior to such time, from 1969 to 1982, Mr. Kowalsky worked at Pullman Inc., rising to Executive Vice President, Finance and Administration and President of Pullman Trailmobile, a subsidiary of Pullman, Inc. Gary J. Niles has served as Executive Vice President, Marketing and Product Acquisition of the Company since February 1992. From 1989 to 1992, Mr. Niles served as Senior Vice President, Toy Boys Division. Before joining the Company, Mr. Niles was an executive with U.A.C., Ltd., a division of Universal Matchbox, Revell Incorporated and Ages Entertainment Software, Inc. (formerly Sega Enterprises, Inc.) Louis R. Novak has served as Executive Vice President and Chief Operating Officer of the Company since February 1992. From 1989 to 1992, Mr. Novak served as Senior Vice President, Operations. From 1986 to 1989 he was Senior Vice President, Worldwide Product Operations for Coleco Industries, Inc. Prior to 1986, Mr. Novak was an executive with All American Gourmet Company, Inc., a manufacturer of frozen food products, and for Mattel, Inc. Jay B. Foreman has been Senior Vice President of Galoob Toys, Inc. and Senior Vice President and Managing Director of Galoob Direct, Inc., since May 1996. From 1992 to 1996, Mr. Foreman served as Executive Vice President-U.S. Operations of Play By Play Toys and Novelties, Inc. From 1990 until 1992, Mr. Foreman served as Co-General Manager of the Toys and Novelties Division of Pizza Management, Inc. H. Alan Gaudie has served as Senior Vice President, Finance of the Company since April 1992 and Assistant Secretary since June 1995. From 1985 to 1992, Mr. Gaudie served as Corporate Controller, Vice President, Senior Vice President and acting Chief Financial Officer. Ronnie Soong has served as Managing Director of Galco since May 1995. From 1993 to 1995, Mr. Soong served as General Manager of Galco. From 1989 to 1993, Mr. Soong was General Manager of Zindart Industrial Co., Ltd. Prior to 1989, Mr. Soong was the General Manager of Buddy L (HK) Ltd. and an executive with the Ertl Company in Taiwan from 1987 to 1989. Terrell (Mark) Taylor has served as Senior Vice President, Product Design of the Company since November 1995. From 1988 to 1995, Mr. Taylor served as Senior Vice President, Product Design for Mattel, Inc. From 1987 to 1988, Mr. Taylor served as Vice President with Entertech/LJN Toys. Prior to 1987, Mr. Taylor served in various executive capacities at Playmates Toys, Tomy Toys, and Mattel, Inc. In addition, Mr. Taylor was a principal partner with Taylor/Salari Design. 23 24 Item 11. Executive Compensation The section entitled "Executive Compensation" contained in the Proxy Statement is hereby incorporated by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management The section entitled "Security Ownership of Management" contained in the Proxy Statement is hereby incorporated by reference. Item 13. Certain Relationships and Related Transactions The section entitled "Executive Compensation" contained in the Proxy Statement is hereby incorporated by reference. 24 25 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K Index to Financial Statements The following consolidated financial statements and schedules of the Company and its subsidiaries are included as Part II, Item 8 of this Report: (a) 1. Financial Statements Page Report of Independent Accountants F-1 Consolidated Financial Statements: Consolidated Balance Sheets - December 31, 1996 and December 31, 1995 F-2 Consolidated Statements of Operations for the years ended December 31, 1996, 1995 and 1994 F-3 Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 1996, 1995 and 1994 F-4 Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1995 and 1994 F-5 Notes to Consolidated Financial Statements F-6 to F-17 (a) 2. Financial Statement Schedules Schedule II - Valuation and Qualifying Accounts and Reserves for the years ended December 31, 1996, 1995 and 1994 S-1
All other schedules have been omitted because they are inapplicable or not required, or the information is included in the consolidated financial statements or notes thereto. 25 26 (a) 3. Exhibits -------- 3.1(a)(1) Certificate of Incorporation. 3.1(b)(1) Amendment to Certificate of Incorporation. 3.2(2) Bylaws. 4.1(3) Form of Certificate for Shares of Common Stock of Company. 4.2(a)(4) Warrant Agreement, dated as of December 11, 1991, by and between the Company and Shereff, Friedman, Hoffman and Goodman, LLP. 4.2(b)(4) Warrant Agreement, dated as of November 17, 1993, by and between the Company and Gerard Klauer Mattison & Co., Inc. 4.3(5) Form of Rights Agreement, dated as of January 17, 1990, between the Company and Mellon Securities Trust Company. 10.1(a)(6)* Amended and Restated 1984 Employee Stock Option Plan. 10.1(b)(7)* 1994 Senior Management Stock Option Plan. 10.1(c)(8)* Form of Agreement between each of Mark Goldman, William Catron, Lou Novak, Gary Niles, Mark Shepherd, Ronald Hirschfeld and H. Alan Gaudie and the Company. 10.1(d)(9)* Form of Amendment No. 1 between each of Mark Goldman, William Catron, Lou Novak, Gary Niles, Mark Shepherd, Ronald Hirschfeld and H. Alan Gaudie and the Company. 10.1(e)(10) 1995 Non-Employee Directors' Stock Option Plan. 10.1(f)* Galoob Toys, Inc. 1996 Long Term Compensation Plan 10.1(g)* Galoob Toys, Inc. 1996 Share Incentive Plan 10.2(10)* Lewis Galoob Toys, Inc. Savings and Retirement Plan (Formerly the Lewis Galoob Toys, Inc. Profit Sharing) (Amendment and Restatement effective January 1, 1987). 10.3(9)* Severance Agreement, dated October 27, 1994, between Mark Goldman and the Company. 10.4(a)(11)* Agreement, dated July 15, 1995, between William G. Catron and the Company. 10.4(b)(11)* Agreement, dated July 15, 1995, between Loren Hildebrand and the Company. 10.4(c)(11)* Agreement, dated July 15, 1995, between Ronald Hirschfeld and the Company. 10.4(d)(11)* Agreement, dated July 15, 1995, between Gary J. Niles and the Company. 10.4(e)(11)* Agreement, dated July 15, 1995, between Louis R. Novak and the Company. 10.5(e)(9) Amended and Restated Loan and Security Agreement, dated as of March 31, 1995, by and among the Company and Congress Financial Corporation (Central). 10.6(a)(12) License Agreement, dated June 16, 1986, by and between Funmaker, as Licensor and the Company, as Licensee. 10.7(a)(13) License Agreement, dated May 4, 1990, by and among the Company as Licensee, Codemasters Software Company, Ltd. and America Corporation, Limited. 10.7(b)(13) Amendment No. 1 dated June 1991 to License Agreement dated May 4, 1990. 10.7(c)(13) Amendment No. 2 dated December 23, 1991 to License Agreement, dated May 4, 1990. 10.7(d)(13) European License Agreement, dated December 23, 1991, by and between Codemasters Software Company, Ltd. and the Company. 10.7(e)(13) Third Amendment to United States License and First Amendment to European License, dated November 4, 1992. 10.7(f)(9) Fourth Amendment to United States License Agreement, dated October 14, 1994. 10.8(12) Agreement of Purchase and Sale, dated October 22, 1986, by and between AT Building Company, as Seller, and the Company, as Buyer. 10.9(a)(2) Lease Agreement, dated March 12, 1987, by and between Lincoln Alvarado and Patrician Associates, Inc., as Lessor, and the Company, as Lessee. 10.9(b)(14) Amendment No. 1 to Lease Agreement. 10.9(c)(10) Lease Agreement, dated December 1, 1995, by and between 200 Fifth Avenue Associates, as Lessor, and the Company, as Lessee. 10.9(d) Lease Agreement, dated December 3, 1996, between Prudential Insurance Company of America as Lessor and the Company, as Lessee. 26 27 11 Statement of Computation of Per Share Earnings. 21 Subsidiaries of the Company. 23.1 Consent of Independent Public Accountants. 27 Financial Data Schedule - -------------------- (1) Incorporated by reference to the Company's Amendment No. 2 to the Registration Statement on Form S-1, filed with the Commission on November 8, 1996. (2) Incorporated by reference to the Company's Amendment No. 1 to Registration Statement on Form 8-B, filed with the Securities and Exchange Commission (the "Commission") on January 11, 1988. (3) Incorporated by reference to the Company's Registration Statement on Form S-3, filed with the Commission on February 26, 1990. (4) Incorporated by reference to the Company's Form 10-K for the fiscal year ended December 31, 1993, filed with the Commission on March 31, 1994. (5) Incorporated by reference to the Company's Registration Statement on Form 8-A, filed with the Commission on January 23, 1990. (6) Incorporated by reference to the Company's Registration Statement on Form S-8, Registration No. 33-56585, filed with the Commission on November 23, 1994. (7) Incorporated by reference to the Company's Registration Statement on Form S-8, Registration No. 33-56587, filed with the Commission on November 23, 1994. (8) Incorporated by reference to the Company's Registration Statement on Form S-8, Registration No. 33-56589, filed with the Commission on November 23, 1994. (9) Incorporated by reference to the Company's Form 10-K for the fiscal year ended December 31, 1994, filed with the Commission on March 31, 1995. (10) Incorporated by reference to the Company's Form 10-K for the fiscal year ended December 31, 1995, filed with the Commission on March 11 1996. (11) Incorporated by reference to the Company's Registration Statement on Form S-1, Registration No. 333-00743, filed with the Commission on February 6, 1996. (12) Incorporated by reference to the Company's Form 10-K for the fiscal year ended December 31, 1986, filed with the Commission on March 31, 1987. (13) Incorporated by reference to the Company's Form 10-K for the fiscal year ended December 31, 1992, filed with the Commission on March 31, 1993. (14) Incorporated by reference to the Company's Form 10-K for the fiscal year ended December 31, 1991, filed with the Commission on March 30, 1992. * Indicates exhibits relating to executive compensation. All other schedules are omitted because they are not applicable or the required information is shown in the Company's consolidated financial statements or the notes thereto. 27 28 Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. GALOOB TOYS, INC. (Registrant) By: /s/ Mark D. Goldman -------------------------- Mark D. Goldman President, Chief Executive Officer Dated: March 31, 1997 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature Title Date - --------- ----- ---- /s/ Mark D. Goldman President, Chief March 31, 1997 - --------------------------------- Executive Officer and Mark D. Goldman Director /s/ Scott R. Heldfond Director March 31, 1997 - --------------------------------- Scott R. Heldfond /s/ Paul A. Gliebe, Jr. Director March 31, 1997 - --------------------------------- Paul A. Gliebe, Jr. /s/ S. Lee Kling Director March 31, 1997 - --------------------------------- S. Lee Kling /s/ Andrew Cavanaugh Director March 31, 1997 - --------------------------------- Andrew Cavanaugh /s/ Roger J. Kowalsky Executive Vice President, Finance, March 31, 1997 - --------------------------------- Chief Financial Officer and Director Roger Kowalsky
28 29 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders of Galoob Toys, Inc. In our opinion, the consolidated financial statements listed in the index appearing under Item 14(a)(1) and (2) on page 25 present fairly, in all material respects, the financial position of Galoob Toys, Inc. and its subsidiaries at December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. PRICE WATERHOUSE LLP San Francisco, California January 31, 1997 F-1 30 GALOOB TOYS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (in thousands, except shares)
December 31, --------------- 1996 1995 --------- --------- ASSETS Current Assets: Cash and cash equivalents $ 27,920 $ 2,030 Accounts receivable, net 102,322 68,402 Inventories 19,974 17,491 Tooling and related costs 15,436 8,311 Prepaid expenses and other assets 12,361 10,348 Deferred tax asset 2,404 -- --------- --------- Total Current Assets 180,417 106,582 Land, Building and Equipment, net 10,472 8,913 Indebtedness from Related Party 950 -- Other Assets 5,066 4,589 --------- --------- Total Assets $ 196,905 $ 120,084 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities: Notes payable $ -- $ 15,071 Accounts payable 19,655 17,141 Accrued expenses 24,680 14,547 Income taxes payable 1,671 731 Current portion of long-term debt 17 4,422 --------- --------- Total Current Liabilities 46,023 51,912 Long-term Debt 20 14,000 Deferred Tax Liability 1,071 -- --------- --------- Total Liabilities 47,114 65,912 --------- --------- Shareholders' Equity: Preferred stock Authorized 1,000,000 shares Issued and outstanding 183,950 shares of $17 Convertible Exchangeable Preferred Stock at $200 liquidation value -- 36,790 per share in 1995 Common stock, par value $.01 per share Authorized 50,000,000 shares Issued and outstanding 17,919,864 shares in 1996 and 10,089,961 shares in 1995 179 101 Additional paid-in capital 170,291 31,579 Retained earnings (deficit) (20,232) (13,851) Cumulative translation adjustment (447) (447) --------- --------- Total Shareholders Equity 149,791 54,172 --------- --------- Total Liabilities and Shareholders' Equity $ 196,905 $ 120,084 ========= =========
The accompanying notes are an integral part of these Consolidated Financial Statements. F-2 31 GALOOB TOYS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share amounts)
Years ended December 31, ------------------------ 1996 1995 1994 --------- --------- --------- Net revenues $ 284,905 $ 220,044 $ 178,792 Costs of products sold 144,282 121,742 95,636 --------- --------- --------- Gross margin 140,623 98,302 83,156 --------- --------- --------- Operating expenses: Advertising and promotion 43,515 31,240 30,616 Other selling and administrative 35,776 29,860 22,433 Royalties, research and development 37,668 24,213 20,785 --------- --------- --------- Total operating expenses 116,959 85,313 73,834 --------- --------- --------- Earnings from operations 23,664 12,989 9,322 Net proceeds from Nintendo award -- -- 12,124 Interest expense (3,183) (3,429) (2,609) Other income, net 455 439 365 --------- --------- --------- Earnings before income taxes 20,936 9,999 19,202 Provision for income taxes 2,485 600 778 --------- --------- --------- Net earnings 18,451 9,399 18,424 Preferred stock dividends: Paid 6 -- -- In arrears 15 3,127 3,127 Charge related to the exchange of preferred stock for common 24,279 -- -- --------- --------- --------- Net earnings (loss) applicable to common shares $ (5,849) $ 6,272 $ 15,297 ========= ========= ========= Average common shares outstanding 14,289 10,451 10,111 Net earnings (loss) per common share: Primary $ (0.41) $ 0.60 $ 1.51 Fully Diluted (0.41) 0.60 1.41
The accompanying notes are an integral part of these Consolidated Financial Statements. F-3 32 GALOOB TOYS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (in thousands, except shares)
Preferred Stock Common Stock --------------- ------------ Shares Amts Shares Amts ------------ ------------ ------------ ------------ Balance at 12/31/93 183,950 $ 36,790 9,559,357 $ 96 Net earnings -- -- -- -- Common stock issued, net -- -- 47,000 1 Termination of 1992 Plan -- -- 449,732 4 Common stock received in exchange for shares issued and canceled -- -- (1,000) -- Cumulative translation adj. and other -- -- -- -- ------------ ------------ ------------ ------------ Balance at 12/31/94 183,950 36,790 10,055,089 101 Net earnings -- -- -- -- Common stock issued, net -- -- 58,751 -- Common stock received in exchange for shares issued and canceled -- -- (11,202) -- Reclamation of shares -- -- (12,677) -- ------------ ------------ ------------ ------------ Balance at 12/31/95 183,950 36,790 10,089,961 101 Net earnings -- -- -- -- Common stock issued, net -- -- 2,492,679 24 Conversion of preferred stock to common stock (182,290) (36,458) 3,359,432 34 Redemption of preferred stock (1,660) (332) -- -- Conversion of debentures to common stock -- -- 1,511,872 15 Costs associated with preferred stock exchange and debenture conversion -- -- -- -- Warrants exercised -- -- 490,280 5 Common stock received in exchange for shares issued and canceled -- -- (24,360) -- Tax benefits from stock plans -- -- -- -- ------------ ------------ ------------ ------------ Balance at 12/31/96 0 $ 0 17,919,864 $ 179 ============ ============ ============ ============ Additional Retained Cumulative Paid-In Earnings Translation Capital (Deficit) Adjustment Total ------- ------- ----------- ------ Balance at 12/31/93 $ 27,293 $ (41,596) $ (421) $ 22,162 Net earnings -- 18,424 -- 18,424 Common stock issued, net 161 -- -- 162 Termination of 1992 Plan 4,042 -- -- 4,046 Common stock received in exchange for shares issued and canceled 10 (10) -- -- Cumulative translation adj. and other -- -- (26) (26) ------------ ------------ ------------ ------------ Balance at 12/31/94 31,506 (23,182) (447) 44,768 Net earnings -- 9,399 -- 9,399 Common stock issued, net 228 -- -- 228 Common stock received in exchange for shares issued and canceled (155) (68) -- (223) Reclamation of shares -- -- -- -- ------------ ------------ ------------ ------------ Balance at 12/31/95 31,579 (13,851) (447) 54,172 Net earnings -- 18,451 -- 18,451 Common stock issued, net 62,334 -- -- 62,358 Conversion of preferred stock to common stock 60,703 (24,279) -- -- Redemption of preferred stock (11) (118) -- (461) Conversion of debentures to common stock 13,479 -- -- 13,494 Costs associated with preferred stock exchange and debenture conversion (1,282) -- -- (1,282) Warrants exercised 2,515 -- -- 2,520 Common stock received in exchange for shares issued and canceled (76) (435) -- (511) Tax benefits from stock plans 1,050 -- -- 1,050 ------------ ------------ ------------ ------------ Balance at 12/31/96 $ 170,291 $ (20,232) $ (447) $ 149,791 ============ ============ ============ ============
The accompanying notes are an integral part of these Consolidated Financial Statements. F-4 33 GALOOB TOYS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands, except shares)
Years ended December 31, ------------------------ 1996 1995 1994 ---- ---- ---- CASH FLOW FROM OPERATING ACTIVITIES: Net earnings $ 18,451 $ 9,399 $ 18,424 Adjustments to reconcile net earnings to net cash used in operating activities: Depreciation 751 528 628 Changes in assets and liabilities: Accounts receivable (33,920) (10,519) (24,500) Inventories (2,483) (667) (3,845) Tooling and related costs (7,125) 68 (3,359) Prepaid expenses and other current assets (2,013) (4,856) 1,849 Accounts payable 2,514 2,168 4,140 Accrued expenses 10,460 (392) 67 Income and deferred taxes payable 3,061 232 217 Deferred tax and other assets (4,664) (3,026) (168) -------- -------- -------- Net cash (used in) provided by operating activities (14,968) (7,065) (6,547) -------- -------- -------- CASH FLOW FROM INVESTING ACTIVITIES: Investment in land, building and equipment, net (2,310) (1,041) (466) -------- -------- -------- Net cash (used in) provided by investing activities (2,310) (1,041) (466) -------- -------- -------- CASH FLOW FROM FINANCING ACTIVITIES: Net borrowings (repayments) under notes payable (15,071) 8,100 6,971 Repayments under long-term debt agreements (4,385) (194) (194) Proceeds from issuance of common stock, net 64,367 5 162 Redemption of preferred stock (461) -- -- Cost associated with the conversion of debenture and the preferred shares exchange (1,282) -- -- Other, net -- -- (26) -------- -------- -------- Net cash provided by (used in) financing activities 43,168 7,911 6,913 -------- -------- -------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 25,890 (195) (100) CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 2,030 2,225 2,325 -------- -------- -------- CASH AND CASH EQUIVALENTS AT END OF YEAR $ 27,920 $ 2,030 $ 2,225 ======== ======== ======== Supplemental disclosure of cash flow information: Cash paid for interest $ 3,231 $ 3,050 $ 2,656 Cash paid for income taxes $ 1,747 $ 390 $ 822
SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITY During the year ended December 31, 1996, $14,000 of the Company's 8% convertible subordinated debentures were converted into 1,511,872 shares of its common stock. Deferred loan costs and accrued interest amounting to approximately $505, net, were charged against additional paid-in capital. (See Note J.) During the year ended December 31, 1996, 1,822,899 depositary shares of the Company's preferred stock were exchanged for 3,359,432 shares of its common stock. (See Note N.) In 1994, the Company issued 449,732 shares of common stock in connection with the termination of the 1992 Senior Management Stock Option Plan. (See Note O.) The accompanying notes are an integral part of these Consolidated Financial Statements. F-5 34 GALOOB TOYS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 1996, 1995 and 1994 NOTE A - Summary of Significant Accounting Policies Organization and Business Galoob Toys, Inc. and subsidiaries (formerly known as Lewis Galoob Toys, Inc.) ("the Company") has been engaged in business since 1957 and was originally incorporated in California on November 6, 1968 and reincorporated in Delaware on August 28, 1987. The Company is engaged in the design, development, marketing and distribution of high quality toys worldwide. The Company's products are primarily manufactured in the People's Republic of China ("China"). Consolidation The consolidated financial statements include the accounts of the Company and its subsidiaries, principally Galco International Toys, N.V. ("Galco") and Galoob Direct, Inc. All significant intercompany accounts have been eliminated in consolidation. Certain amounts in the financial statements of prior years have been reclassified to conform with the current year's presentation. Revenue Recognition The Company records a transaction as a sale when inventory is shipped to the customer and title passes. The Company provides for returns and allowances using a percentage of gross sales, based on historical experience. Foreign Currency Translation The financial statements of Galco have been translated into U.S. dollars in accordance with Statement of Financial Accounting Standards ("SFAS") No. 52, Foreign Currency Translation. All asset and liability accounts have been translated using rates of exchange in effect at the balance sheet date. Revenues and expenses are translated at the weighted average of exchange rates in effect during the year. Gains or losses from foreign currency translation adjustments are charged or credited directly to a separate component of shareholders' equity. Use of Estimates The preparation of financial statements in conformity 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 reporting period. Actual results could differ from those estimates. Cash and Cash Equivalents Cash equivalents consist primarily of money market funds invested in U.S. Government securities and other high quality U.S. money market securities. Concentration of Credit Risk Accounts receivable primarily represent balances due from customers. The Company performs credit evaluations of each of its customers and maintains allowances for potential credit losses. Such losses have generally been within management's expectations. Inventories Inventories are stated at lower of cost (first-in, first-out) or market. Tooling and Related Costs Costs incurred for tooling and package design are deferred and amortized over the life of the products, which range from one to two years. F-6 35 GALOOB TOYS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years ended December 31, 1996, 1995 and 1994 Prepaid Expenses Prepaid expenses include costs such as those incurred in the creation of television commercials which are deferred and expensed in the period first aired. Prepaid expenses also include prepaid insurance, prepaid samples, prepaid advertising media, and royalty advances. Land, Building and Equipment Land, building and equipment are stated at cost. Depreciation is provided using the straight-line method over the estimated useful lives of the respective assets. Amortization of leasehold improvements is provided using the straight-line method over the estimated useful lives of the assets, or the term of the applicable lease, whichever is less. Estimated useful lives are 35 years for building and building improvements, 1 to 12 years for leasehold improvements, 5 years for office furniture, fixtures and equipment (including computer equipment), and 3 to 6 years for vehicles. For the year ended December 31, 1995, the Company implemented SFAS No. 121 "Accounting for the Impairment of Long-Lived Assets". Implementation of SFAS No. 121 had no material impact on the Company's financial condition or results of operations. Research and Development Research and development is expensed as it is incurred. Total expenses for the years ended December 31, 1996, 1995 and 1994 were $10,210,000, $7,886,000 and $7,288,000, respectively. Income Taxes The Company accounts for income taxes in accordance with SFAS 109, "Accounting for Income Taxes". SFAS 109 prescribes an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company's financial statements or tax returns. In estimating future tax consequences, SFAS 109 generally considers all expected future events other than enactments of changes in the tax law or rates. Earnings Per Share Primary earnings per share is based on the net earnings (loss) applicable to common shares, after providing for the dividends paid or in arrears on the preferred stock and charges related to the conversion of preferred stock to common stock, for the year divided by the weighted average number of common and common equivalent shares outstanding. The dilutive effect of common stock equivalents, such as stock options and warrants, is calculated using the treasury stock method. Stock options and warrants were dilutive for 1995 and 1994. Fully diluted earnings per share for the year ended 1994 includes the effect of the assumed conversion of the $17 Convertible Exchangeable Preferred Stock and the 8% Convertible Subordinated Debentures into common stock. Fully diluted earnings per share for the year ended December 31, 1995 was the same as primary earnings per share since the effect of the assumed conversion is anti-dilutive. Recent Accounting Pronouncement In 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based Compensation", which defines a fair value-based method for valuing stock-based compensation that entities may use, which measures compensation cost at the grant date based on the fair value of the award. Compensation is then recognized over the service period, which is usually the vesting period. Alternatively, the standard permits entities to continue accounting for employee stock options and similar equity instruments under APB Opinion 25, "Accounting for Stock Issued to Employees". Entities that continue to account for stock options using APB Opinion 25 are required to make pro forma disclosures of net income and earnings per share, as if the fair value-based method of accounting defined in SFAS No. 123 had been applied. The Company has determined to continue to account for stock options using APB Opinion 25 and has made the required pro forma disclosures in these notes. See Note O. F-7 36 GALOOB TOYS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years ended December 31, 1996, 1995 and 1994 NOTE B - Accounts Receivable, Net
(in thousands) December 31, 1996 1995 ---- ---- Trade receivables $ 111,049 $ 76,834 Provisions for: Advertising allowances (7,514) (5,800) Return of defective goods (700) (700) Markdowns and discounts (1,086) (2,975) Doubtful accounts (597) (507) --------- --------- Net trade receivables 101,152 66,852 Other receivables 1,170 1,550 --------- --------- $ 102,322 $ 68,402 ========= ========= NOTE C - Inventories (in thousands) December 31, 1996 1995 --------- --------- Finished goods $ 19,667 $ 17,023 Raw materials and parts 307 468 --------- --------- $ 19,974 $ 17,491 ========= ========= NOTE D - Land, Building and Equipment, Net (in thousands) December 31, 1996 1995 --------- --------- Land and building $ 9,851 $ 9,567 Office furniture, fixtures and equipment 5,579 4,646 Leasehold improvements 1,026 1,267 Vehicles 133 104 --------- --------- 16,589 15,584 Accumulated depreciation (6,117) (6,671) --------- --------- $ 10,472 $ 8,913 ========= =========
NOTE E - Notes Payable On March 31, 1995, the Company entered into an amended and restated loan and security agreement (the "New Agreement") with Congress Financial Corporation (Central) (the "Lender"). The New Agreement extends through March 31, 1997 and provides a line of credit of $40 million, with provision to increase the line to $60 million at the option of the Company. Borrowing availability is determined by a formula based on qualified assets. The interest is generally prime rate plus 1%. In consideration for entering into the New Agreement, the Company paid a $100,000 fee; additional fees of $100,000 were paid in 1996 when the Company exercised its option to increase the line. The Company has also agreed to pay an unused line fee of 0.25% and certain management fees. The deferred loan fee is included in other assets and is being amortized using a straight-line method over the term of the loan. The Company was in compliance with all debt covenants at December 31,1996. F-8 37 GALOOB TOYS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years ended December 31, 1996, 1995 and 1994 The maximum outstanding borrowings, average outstanding balances and weighted average rates of interest for notes payable were as follows:
(in thousands) 1996 1995 ---- ---- Maximum outstanding at month end $43,202 $30,235 Average outstanding amount during the year 23,969 14,211 Weighted average interest rate for the year 9.6% 10.4%
NOTE F - Income Taxes Earnings before income taxes and the provision for income taxes are as follows:
(in thousands) Years ended December 31, 1996 1995 1994 -------- -------- -------- Earnings before income taxes: Domestic $ 20,396 $ 9,288 $ 18,861 Foreign 540 711 341 -------- -------- -------- $ 20,936 $ 9,999 $ 19,202 ======== ======== ======== Provision for income taxes: Current: Federal $ 2,078 $ 187 $ 490 State 1,689 278 201 Foreign 51 135 87 -------- -------- -------- 3,818 600 778 Deferred: Federal (1,159) -- -- State (174) -- -- Foreign -- -- -- -------- -------- -------- $ 2,485 $ 600 $ 778 ======== ======== ========
F-9 38 GALOOB TOYS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years ended December 31, 1996, 1995 and 1994 Deferred tax liabilities (assets) consist of the following:
(in thousands) December 31, 1996 1995 1994 ------- ------- ------- Prepaid expenses $ 2,321 $ 2,475 $ 1,586 Other temporary differences 1,024 766 705 ------- ------- ------- Gross deferred tax liabilities 3,345 3,241 2,291 ------- ------- ------- Accrued expenses (1,232) (613) (939) Defectives provision (285) (245) (315) Other temporary differences (3,161) (3,244) (2,970) Net operating loss carryforwards -- (2,567) (4,037) Research and development tax credit carryforward -- (765) (765) Other -- (1,027) (944) ------- ------- ------- Gross deferred tax assets (4,678) (8,461) (9,970) ------- ------- ------- Deferred tax assets valuation allowance -- 5,220 7,679 ------- ------- ------- $(1,333) $ -- $ -- ======= ======= =======
No deferred tax valuation allowance was required at December 31, 1996 since the net deferred tax assets are considered realizable. Valuation allowances were provided in 1994 and 1995 when realization was uncertain. The net change in the valuation allowance for deferred tax assets was a decrease of $5,220,000, $2,459,000, and $6,140,000 in 1996, 1995 and 1994, respectively. The provision for income taxes differs from the provisions determined by applying the applicable U.S. statutory federal income tax rates to pretax income as a result of the following differences:
Years ended December 31, ------------------------ 1996 1995 1994 ---- ---- ---- Federal income taxes at the U.S. statutory rate 35.0% 35.0% 35.0% Increase (decrease) in income taxes resulting from: Effects of U.S. and foreign income taxes on foreign operations 0.2 (1.1) (0.2) State income taxes, net of loss carryforwards, less federal tax benefits 5.1 2.8 0.9 Benefit of reversing temporary differences for which benefits were not previously recorded -- (20.9) -- Loss carryback/carryforward utilized (15.0) (13.8) (31.6) Tax credits/carryforward utilized (16.4) -- -- Other 3.0 4.0 -- ------ ------ ------ 11.9% 6.0% 4.1% ====== ====== ======
F-10 39 GALOOB TOYS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years ended December 31, 1996, 1995 and 1994 No domestic deferred taxes have been provided on unremitted earnings of the foreign subsidiary. All such earnings are expected to be permanently reinvested in the subsidiary. Undistributed earnings for which the Company has not provided taxes, which may be payable on distribution, were approximately $5,200,000 as of December 31, 1996. No foreign taxes will be withheld on the distribution of the untaxed earnings. NOTE G - Leases The Company leases its domestic warehouse and showroom facilities, and its facilities in Hong Kong. The leases have been classified as operating leases and are for terms expiring at various dates through 2006. The Company has a lease option on a new domestic warehouse to renew for one five-year term, renewable in the year 2002. Future minimum lease payments for all noncancellable operating leases as of December 31, 1996 (in thousands) are as follows:
Years ending December 31, 1997 $ 2,001 1998 2,260 1999 1,804 2000 1,718 2001 1,779 Thereafter 2,313 ----------- $ 11,875 ===========
Net rental expense for the years ended December 31, 1996, 1995 and 1994 was $1,965,000, $1,988,000 and $1,515,000, respectively. NOTE H - Royalty Contracts The Company has future minimum royalty guarantee payments as of December 31, 1996 (in thousands) as follows:
Years ending December 31, 1997 $2,489 1998 600 1999 500 -------- $3,589 --------
NOTE I - Accrued Expenses
(in thousands) December 31, ------------ 1996 1995 ---- ---- Accrued royalties $10,797 $ 6,003 Accrued compensation and commissions 6,484 4,814 Other accrued expenses 7,399 3,730 ------- ------- $24,680 $14,547 ======= =======
During 1995, the Company settled with the United States Customs Service ("Customs") regarding the audit of duty due on importations of goods into the United States of the years 1988 through 1991. The Company adequately provided for the amount settled with Customs. F-11 40 GALOOB TOYS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years ended December 31, 1996, 1995 and 1994 NOTE J - Long-Term Debt
(in thousands) December 31, ------------ 1996 1995 ------- ------- 8% Convertible Subordinated Debentures due and payable on November 30, 2000, interest paid semi-annually $ -- $14,000 Mortgage secured by headquarters land and building, payable in monthly installments of $55,314 (principal and interest) through November 30, 1996 when the remaining outstanding balance was paid, interest rate 10.3% -- 4,422 Capital lease obligation 37 -- ------- ------- 37 18,422 Current portion (17) (4,422) ------- ------- $ 20 $14,000 ======= =======
On November 17, 1993, the Company issued in a private placement $14 million in principal amount of 8% Convertible Subordinated Debentures (the "8% Debentures"), at par, with interest paid semi-annually. In connection with the 8% Debentures, the Company paid a commission to its investment bankers of $560,000 and issued warrants for 150,000 shares, which were valued at $525,000 and recorded as additional paid-in capital. In February 1996, the Company issued a call for the redemption of its 8% Debentures. This call resulted in the conversion on March 15, 1996, of all $14,000,000 8% Debentures at $9.26 per share and the issuance of 1,511,872 new shares of common stock. Unamortized debt issuance costs of $833,000 were charged against additional paid-in-capital on conversion of the 8% Debentures. NOTE K - Major Customers The Company had transactions with one customer, Toys "R" Us, Inc. that accounted for approximately 23%, 20% and 21% of net revenues in 1996, 1995 and 1994, respectively. Wal-Mart accounted for approximately 13% and 11% of net revenues in 1996 and 1995, respectively. NOTE L - Profit Sharing Plan The Company has a 401(k) profit sharing plan covering all non-union full-time employees. The plan is qualified under Section 401(a) of the Internal Revenue Code so that contributions to the plan by the Company are not taxable until distributed to employees. Contributions under the plan are at the discretion of the Board of Directors and are subject to the amounts allowable under applicable provisions of the Internal Revenue Code. No Company contributions have been made in 1996, 1995 or 1994. NOTE M - Litigation On May 17, 1990, the Company filed a complaint against Nintendo of America, Inc. ("Nintendo") seeking a declaratory judgment and injunctive relief in the United States District Court, Northern District of California (the "District Court"). This complaint sought confirmation of the Company's right to market, distribute and sell its Game Genie product. On June 1, 1990, Nintendo filed a complaint in the same District Court alleging copyright and trademark infringement and seeking a preliminary and permanent injunction and unspecified damages. On April 11, 1994, Nintendo paid the Company $16.1 million representing the full damage award plus interest and related costs. The Company retained approximately $12.1 million of this amount, and the Company's Game Genie licensors were paid the remaining $4.0 million. Notwithstanding such payment, on June 20, 1994, Nintendo filed a petition for a Writ of Certiorari with the United States Supreme Court, which asked the Supreme Court to review the damage award on a discretionary basis. On October 3, 1994, the Supreme Court rejected Nintendo's petition and affirmed Galoob's right to the full damage award. There is no further basis for appeal by Nintendo. F-12 41 GALOOB TOYS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years ended December 31, 1996, 1995 and 1994 Nintendo's original trademark claim and the Company's original anti-trust cross-claim against Nintendo were severed from the copyright claims that were adjudicated on July 3, 1991. On January 18, 1995 these claims were dismissed with prejudice by Nintendo and Galoob, respectively. The Nintendo Game Genie infringement lawsuit is now complete. The Company is involved in various other litigation and legal matters which are being defended and handled in the ordinary course of business. None of these matters is expected to result in outcomes having a material adverse effect on the Company's consolidated financial position or results of operation. NOTE N - Shareholders' Equity In 1989, the Company issued 183,950 authorized shares of $17 Convertible Exchangeable Preferred Stock with a $200 liquidation value (the "Preferred Stock") and deposited them with a U.S. Bank (the "Depositary") and sold in a public offering an aggregate of 1,839,500 Depositary Convertible Exchangeable Preferred Shares (the "Depositary Shares") at a price of $20 per share. Each Depositary Share represented 1/10th share of Preferred Stock and had a cumulative dividend rate of $1.70 per annum, payable quarterly, and could be converted into common stock at the option of the holders at an initial price of $16.875 per share of common stock. On July 1, 1992, the Company discontinued payment of dividends on the Depositary Shares. In February 1996, the Company offered to exchange 1.85 shares of its common stock for each Depositary Share outstanding. This inducement offer was accepted by the owners of 98% of the Depositary Shares resulting in the issuance of 3,336,433 shares of common stock on March 29, 1996. Generally accepted accounting principles require a non-cash charge to reduce Net Earnings Applicable to Common Shares in the calculation of Earnings Per Share for the fair value of the securities issued in excess of the existing conversion rate of approximately 1.185 common shares per Depositary Share. This non-cash charge amounted to $24,279,000. Without this charge, the Company would have reported net earnings per common share of $1.20 as compared to the reported net loss per common share of $0.41 in the year ended December 31, 1996. The balance of the Depositary Shares were converted at the specified 1.185 exchange rate or redeemed by the Company in June 1996. In 1990, the Company adopted a Stockholder Rights Plan and declared a dividend distribution of one Right for each outstanding share of common stock. Each Right will entitle holders of the Company's common stock to buy one-thousandth of a share of Series A Preferred Stock of the Company at an exercise price of $43.00, subject to adjustment. The Rights will be exercisable only if a person or group acquires beneficial ownership of 20% or more of the common stock (other than pursuant to certain transactions involving the Company) (an "Acquiring Person") or announces a tender or exchange offer that would result in such person or group beneficially owning 20% or more of the common stock (other than a tender or exchange offer for all outstanding shares at a price determined by the non-affiliated directors to be fair). If any person becomes the beneficial owner of 20% or more of the common stock (other than pursuant to certain transactions involving the Company or a tender or exchange offer for all outstanding shares at a price determined by the non-affiliated directors to be fair), or an Acquiring Person engages in certain "self-dealing" transactions including a merger in which the Company is the surviving corporation, each Right not owned by such Acquiring Person will enable its holder to purchase, at the Right's then-current exercise price, shares of the common stock (or, in certain circumstances, cash, property or other securities of the Company) having a value of twice the Right's exercise price. In addition, if the Company is acquired in a merger or other business combination transaction in which the Company is not the surviving corporation, or if the Company sells or transfers 50% or more of its assets or earning power, each Right not owned by such Acquiring Person will entitle its holder to purchase, at the Right's then-current exercise price, common shares of the acquiring company having a value of twice the Right's exercise price. The Rights will expire January 17, 2000 or they may be redeemed by the Company at $.01 per share prior to that date. The Rights do not have voting or dividend rights and, until they become exercisable, have no dilutive effect on the earnings of the Company. NOTE O - Stock Compensation Plans The Company has four stock compensation plans: the 1984 Employee Stock Option Plan, the 1994 Senior Management Option Plan, the 1995 Non-Employee Directors Stock Option Plan, and the 1996 Share Incentive Plan. The aggregate number of common shares available under these plans are 1,589,997, 800,000, 160,000 and 1,850,000, respectively. There were 1,994,029 and F-13 42 GALOOB TOYS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years ended December 31, 1996, 1995 and 1994 442,437 shares available for future grants under the terms of the Company's stock option plans at December 31, 1996 and 1995, respectively. Stock options outstanding have a term of 10 years and are non-qualified options. An option becomes exercisable at such times and in such installments as set by the Compensation Committee of the Board of Directors. Certain options granted to senior management have vesting schedules that depend on the achievement of designated prices for the Company's common stock and the passage of specific time periods. The following table summarizes information about stock option activity for the three years ended December 31, 1996:
Weighted Number of Average Exercise Options Price Per Share ------- --------------- Outstanding at December 31, 1993 1,075,399 4.93 Granted 961,000 8.50 Exercised 97,000 4.06 Canceled 807,500 5.33 - --------------------------------- --------- Outstanding at December 31, 1994 1,131,899 7.75 Granted 336,000 6.63 Exercised 60,575 3.68 Canceled 77,232 7.56 - --------------------------------- --------- Outstanding at December 31, 1995 1,330,092 7.67 Granted 380,908 22.38 Exercised 138,750 7.00 Canceled 82,500 6.41 - --------------------------------- --------- Outstanding at December 31, 1996 1,489,750 11.57 =========
The following table summarizes information about stock options outstanding at December 31, 1996:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ------------------- ------------------- Range of Weighted Weighted Weighted Exercise Number Average Average Exercise Number Average Exercise Prices Outstanding Life (1) Price Per Share Exercisable Price Per Share - ----------------------------------------------------------------------------------------------------------------------------------- $3.00-9.00 1,094,842 7.2 $ 7.80 1,028,176 $ 7.91 10.25-16.00 50,000 9.0 12.44 32,500 11.26 20.50-30.63 344,908 9.5 23.39 57,408 21.25 --------- --------- 1,489,750 7.8 $ 11.57 1,118,084 $ 8.69
(1) Weighted Average remaining contractual life in years. There were 929,228 and 683,399 options exercisable at weighted average exercise prices per share of $8.11 and $7.58 at December 31, 1995 and 1994, respectively. As permitted by Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS No. 123), effective for 1996, the Company continues to account for stock compensation costs in accordance with the provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees". Had compensation cost been determined based on the fair value at the grant dates for awards under the Company's stock plans in accordance with SFAS No. 123, net income would have been reduced by $1.2 million ($0.09 per share) and $0.6 million ($0.05 per share) in 1996 and 1995, respectively. As required by SFAS No. 123, the fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions for 1996 and 1995, respectively: historical dividend yield of 0% in both years; an expected life of 4.4 years; historical volatility of 60% and 65% and a risk-free rate of return of 6.3% and 6.1%. The weighted-average fair values of the options granted during 1996 and 1995 were $12.22 and $3.74 per share, respectively. On July 7, 1988, in consideration for entering into a credit agreement, the Company issued warrants to purchase shares of common stock; in 1996 the remaining outstanding warrants for 392,866 shares were exercised at $4.44 per share. On December 11, 1991, the Company issued warrants to purchase 25,000 shares of common stock at $4.375 per share; all these warrants were exercised in 1996. On November 17, 1993, the Company issued warrants relating to the 8% Debentures to purchase 150,000 shares of common stock at $9.50 per share; warrants for 75,000 shares were exercised in 1996 and warrants for 75,000 shares remain outstanding at December 31, 1996. F-14 43 GALOOB TOYS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years ended December 31, 1996, 1995 and 1994 NOTE P - Related Party Transactions On August 29, 1996, Mark D. Goldman, President, Chief Executive Officer and Director of the Company, borrowed $950,000 in connection with the purchase of a personal residence and executed a note payable to the Company, which is secured by a second mortgage on such residence. The note will bear no interest unless Mr. Goldman's employment with the Company is terminated and, at such time, the note will bear interest at one percent per annum in excess of the Prime Rate charged by Citibank F.S.B. During the term of Mr. Goldman's employment with the Company, in accordance with the Internal Revenue Code of 1986, as amended ("the Code"), interest will be imputed at the applicable federal rate as determined under the Code. Commencing on the first day of September 1996, principal in the amount of $100 is payable on the first of each month. The balance of the principal shall be paid on the earlier to occur of (i) August 30, 2006 or (ii) one year from the date Mr. Goldman's employment with the Company is terminated. Until May 1996, the Company had retained the legal services of Shereff, Friedman, Hoffman & Goodman, LLP. A partner of Shereff, Friedman, Hoffman & Goodman, LLP was one of the Company's directors until June 1, 1996. The total fees paid to Shereff, Friedman, Hoffman & Goodman, LLP in 1996, 1995 and 1994 were approximately $0.2 million, $0.3 million and $0.4 million, respectively, exclusive of the director's fees paid to Martin Nussbaum, a partner in the firm of Shereff, Friedman, Hoffman & Goodman, LLP, as compensation for his service as Chairman of the Executive Committee of the Board of Directors. The Company has retained the insurance brokerage services of Aon Risk Services ("Aon") in recent years. One of the Company's directors was previously the President and Chief Executive Officer of Rollins Real Estate/Investment, a division of Aon. The total amount of insurance premiums paid to Aon in 1996, 1995 and 1994 were approximately $1.2 million, $1.3 million and $1.4 million, respectively. In 1994, the Company sold its minority interest in Galoob Toys Canada, Inc., which continues to act as the Company's distributor in Canada and which accounted for less than 5% of the Company sales. NOTE Q - Disclosure About Fair Value of Financial Instruments The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value: o Current Assets and Current Liabilities The carrying value of cash, cash equivalents, accounts receivables, short-term borrowings, accounts payable and accrued expenses approximate fair value because of their short maturity. * Indebtedness from Related Party The carrying value of indebtedness from related party is stated at the face value of the note. The fair value of the note at December 31, 1996 was $483,000 based on a discounted cash flow basis. F-15 44 NOTE R - Segment Information The Company's operations are in one industry segment: the sale of toys primarily to major retail outlets. The Company operates in two primary geographic areas, the U.S. and Europe, and there are no sales between geographic areas. Information about the Company's operations in different geographic locations are as follows:
(in thousands) 1996 1995 1994 ---- ---- ---- United States Non-affiliated customer revenue $ 196,735 $ 139,373 $ 119,702 Earnings from operations 16,930 8,229 6,440 Identifiable assets 177,439 111,639 87,653 Foreign Non-affiliated customer revenue 88,170 80,671 59,090 Earnings from operations 6,734 4,760 2,882 Identifiable assets 19,466 8,445 13,113 Consolidated Net revenues 284,905 220,044 178,792 Earnings from operations 23,664 12,989 9,322 Net proceeds from Nintendo award -- -- 12,124 Interest expense (3,183) (3,429) (2,609) Other income, net 455 439 365 --------- --------- --------- Earnings before income taxes 20,936 9,999 19,202 Identifiable assets $ 196,905 $ 120,084 $ 100,766
F-16 45 NOTE S - Quarterly Financial Data (Unaudited) Quarterly financial data for 1996 and 1995 are summarized in the following table:
(in thousands, except per share amounts) Net Net Earnings Net Gross Earnings (Loss) Per Revenues Margin (Loss) Common Share -------- ------ ------ ------------ 1996 1st Quarter $ 37,522 $ 15,931 $ (4,115) $ (2.71) 2nd Quarter 49,201 22,511 387 .02 3rd Quarter 88,547 42,957 9,269 .57 4th Quarter 109,635 59,224 12,910 .74 1995 1st Quarter $ 33,341 $ 11,649 $ (4,171) $ (0.49) 2nd Quarter 38,219 13,105 (4,087) (0.48) 3rd Quarter 65,518 28,617 6,837 0.58 4th Quarter 82,966 44,931 10,820 0.93
F-17 46 SCHEDULE II GALOOB TOYS, INC. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS AND RESERVES (in thousands)
Additions Balance at Charged to Balance Beginning Costs and at end Description of Period Expenses Deductions of Period ----------- --------- -------- ---------- --------- Year ended 12/31/96 Provisions for returns and allowance $ 9,982 $15,115 $13,073 $12,024 Year ended 12/31/95 Provisions for returns and allowance 8,097 12,707 10,822 9,982 Year ended 12/31/94 Provisions for returns and allowance 5,249 11,979 9,131 8,097
S-1 47 EXHIBIT INDEX ------------- Exhibit No. Description - ----------- ----------- 3.1(a)(1) Certificate of Incorporation. 3.1(b)(1) Amendment to Certificate of Incorporation. 3.2(2) Bylaws. 4.1(3) Form of Certificate for Shares of Common Stock of Company. 4.2(a)(4) Warrant Agreement, dated as of December 11, 1991, by and between the Company and Shereff, Friedman, Hoffman and Goodman, LLP. 4.2(b)(4) Warrant Agreement, dated as of November 17, 1993, by and between the Company and Gerard Klauer Mattison & Co., Inc. 4.3(5) Form of Rights Agreement, dated as of January 17, 1990, between the Company and Mellon Securities Trust Company. 10.1(a)(6)* Amended and Restated 1984 Employee Stock Option Plan. 10.1(b)(7)* 1994 Senior Management Stock Option Plan. 10.1(c)(8)* Form of Agreement between each of Mark Goldman, William Catron, Lou Novak, Gary Niles, Mark Shepherd, Ronald Hirschfeld and H. Alan Gaudie and the Company. 10.1(d)(9)* Form of Amendment No. 1 between each of Mark Goldman, William Catron, Lou Novak, Gary Niles, Mark Shepherd, Ronald Hirschfeld and H. Alan Gaudie and the Company. 10.1(e)(10) 1995 Non-Employee Directors' Stock Option Plan. 10.1(f)* Galoob Toys, Inc. 1996 Long Term Compensation Plan 10.1(g)* Galoob Toys, Inc. 1996 Share Incentive Plan 10.2(10)* Lewis Galoob Toys, Inc. Savings and Retirement Plan (Formerly the Lewis Galoob Toys, Inc. Profit Sharing) (Amendment and Restatement effective January 1, 1987). 10.3(9)* Severance Agreement, dated October 27, 1994, between Mark Goldman and the Company. 10.4(a)(11)* Agreement, dated July 15, 1995, between William G. Catron and the Company. 10.4(b)(11)* Agreement, dated July 15, 1995, between Loren Hildebrand and the Company. 10.4(c)(11)* Agreement, dated July 15, 1995, between Ronald Hirschfeld and the Company. 10.4(d)(11)* Agreement, dated July 15, 1995, between Gary J. Niles and the Company. 10.4(e)(11)* Agreement, dated July 15, 1995, between Louis R. Novak and the Company. 10.5(e)(9) Amended and Restated Loan and Security Agreement, dated as of March 31, 1995, by and among the Company and Congress Financial Corporation (Central). 10.6(a)(12) License Agreement, dated June 16, 1986, by and between Funmaker, as Licensor and the Company, as Licensee. 10.7(a)(13) License Agreement, dated May 4, 1990, by and among the Company as Licensee, Codemasters Software Company, Ltd. and America Corporation, Limited. 10.7(b)(13) Amendment No. 1 dated June 1991 to License Agreement dated May 4, 1990. 10.7(c)(13) Amendment No. 2 dated December 23, 1991 to License Agreement, dated May 4, 1990. 10.7(d)(13) European License Agreement, dated December 23, 1991, by and between Codemasters Software Company, Ltd. and the Company. 10.7(e)(13) Third Amendment to United States License and First Amendment to European License, dated November 4, 1992. 10.7(f)(9) Fourth Amendment to United States License Agreement, dated October 14, 1994. 10.8(12) Agreement of Purchase and Sale, dated October 22, 1986, by and between AT Building Company, as Seller, and the Company, as Buyer. 10.9(a)(2) Lease Agreement, dated March 12, 1987, by and between Lincoln Alvarado and Patrician Associates, Inc., as Lessor, and the Company, as Lessee. 10.9(b)(14) Amendment No. 1 to Lease Agreement. 10.9(c)(10) Lease Agreement, dated December 1, 1995, by and between 200 Fifth Avenue Associates, as Lessor, and the Company, as Lessee. 10.9(d) Lease Agreement, dated December 3, 1996, between Prudential Insurance Company of America as Lessor and the Company, as Lessee. 48 11 Statement of Computation of Per Share Earnings. 21 Subsidiaries of the Company. 23.1 Consent of Independent Public Accountants. 27 Financial Data Schedule - -------------------- (1) Incorporated by reference to the Company's Amendment No. 2 to the Registration Statement on Form S-1, filed with the Commission on November 8, 1996. (2) Incorporated by reference to the Company's Amendment No. 1 to Registration Statement on Form 8-B, filed with the Securities and Exchange Commission (the "Commission") on January 11, 1988. (3) Incorporated by reference to the Company's Registration Statement on Form S-3, filed with the Commission on February 26, 1990. (4) Incorporated by reference to the Company's Form 10-K for the fiscal year ended December 31, 1993, filed with the Commission on March 31, 1994. (5) Incorporated by reference to the Company's Registration Statement on Form 8-A, filed with the Commission on January 23, 1990. (6) Incorporated by reference to the Company's Registration Statement on Form S-8, Registration No. 33-56585, filed with the Commission on November 23, 1994. (7) Incorporated by reference to the Company's Registration Statement on Form S-8, Registration No. 33-56587, filed with the Commission on November 23, 1994. (8) Incorporated by reference to the Company's Registration Statement on Form S-8, Registration No. 33-56589, filed with the Commission on November 23, 1994. (9) Incorporated by reference to the Company's Form 10-K for the fiscal year ended December 31, 1994, filed with the Commission on March 31, 1995. (10) Incorporated by reference to the Company's Form 10-K for the fiscal year ended December 31, 1995, filed with the Commission on March 11 1996. (11) Incorporated by reference to the Company's Registration Statement on Form S-1, Registration No. 333-00743, filed with the Commission on February 6, 1996. (12) Incorporated by reference to the Company's Form 10-K for the fiscal year ended December 31, 1986, filed with the Commission on March 31, 1987. (13) Incorporated by reference to the Company's Form 10-K for the fiscal year ended December 31, 1992, filed with the Commission on March 31, 1993. (14) Incorporated by reference to the Company's Form 10-K for the fiscal year ended December 31, 1991, filed with the Commission on March 30, 1992. * Indicates exhibits relating to executive compensation. All other schedules are omitted because they are not applicable or the required information is shown in the Company's consolidated financial statements or the notes thereto. EX-10.1.F 2 LONG-TERM COMPENSATION PLAN 1 GALOOB TOYS, INC. 1996 LONG TERM COMPENSATION PLAN 1. Purpose. Galoob Toys, Inc. 1996 Long Term Compensation Plan (the "Plan") has been adopted for the purposes of enhancing shareholder value over the long term by providing meaningful financial rewards to executive management for exceptional performance as measured by the achievement of rigorous long-term goals. 2. Performances Period and Measurement Standard. The Plan shall cover the financial performance period of July 1, 1996 through December 31, 1998 (the "Performance Period"). Performance shall be measured by reported earnings per share for Galoob Toys, Inc. (the "Company") during the Performance Period ("Earnings per Share"). Earnings Per Share for this purpose will be "fully diluted" or "diluted" Earnings Per Share, whichever may be applicable under generally accepted accounting principles for the particular reporting period. The reported Earnings Per Share amount used for measuring performance under the Plan shall reflect adjustments due to: (a) any extraordinary gains or losses, as defined under generally accepted accounting principles ("GAAP"); (b) gains or losses resulting from one-time adjustments due to changes in tax law or GAAP; and (c) any other extraordinary, unusual, or non-recurring gains or losses which are quantified and identified separately in footnotes to the annual financial statements or in "Management's Discussion and Analysis of Financial Conditions and Results of Operation" appearing in an applicable annual report to shareholders of the Company. 3. Participation. The Compensation Committee (the "Committee") of the Board of Directors shall select and designate in writing those members of executive management who shall be eligible to participate in the Plan no later than September 28, 1996. Each person designated a participant shall be notified in writing of his or her eligibility to participate in the Plan and of the dollar amount of his or her Target Award Opportunity (as described below). 4. Target Award Opportunities. Each participant shall have a target award opportunity equal to 300% of his or her annualized salary as of July 1, 1996 (a "Target Award 2 Opportunity"); provided, however, no participant shall receive an award in excess of $1.875 million under the Plan with respect to the Performance Period. The extent, if any, to which this Target Award Opportunity will result in a monetary payment will depend on the degree of achievement of certain Earnings Per Share goals during the Performance Period. 5. Earnings Per Share Goal and Payment Schedule. The Earnings Per Share performance standard for the Plan shall be cumulative Earnings Per Share, as reported quarterly during the Performance Period. Upon reaching a 75% threshold level of % of Plan Achievement (set forth below), the % of Target Award Opportunity Earned (set forth below) shall begin to increase pro rata up to the next higher % of Target Award Opportunity Earned. The following schedule sets forth the amounts to be paid to Plan participants upon the Company's achievement of certain cumulative Earnings Per Share during the Performance Period: Plan Achievement (Cumulative Earnings Per Share for % of 7/1/96 Target Award Through % of Plan Opportunity 12/31/98) Achievement Earned --------- ----------- ------ $6.98 150% 125% $4.65 100 100 $3.49 75 50 ----- ------------ --- $3.49 less than 90 0 6. Payment Terms. Prior to the time any payments to Plan Participants are made pursuant to the Plan and in all events prior to March 30, 1999, the Committee shall certify the cumulative Earnings Per Share for the Performance Period in writing and direct the Company to make the appropriate payment, if any, to each participant and/or to establish a deferred payment account in the name of a participant, provided such participant has filed a valid deferral payment election with the Committee no later than June 30, 1998. Each participant shall be notified by the Company prior to April 1, 1998 of the conditions governing any deferral accounts and delayed payments, including the interest or investment return rates terms which shall be available. 2 3 7. Termination of Employment. (a) Termination of employment with the Company for any reason prior to January 1, 1999 shall result in full forfeiture of a participant's right to any payment under the Plan, except in the event of a participant's death or disability or as otherwise determined by the Committee. In the event of termination of employment due to death or disability of a participant prior to January 1, 1999, the participant, or the executor or administrator of the estate of the deceased participant, or the person or persons to whom the deceased participant's rights hereunder shall pass by will or the laws of descent or distribution shall be entitled to a pro rata payment, within 30 days of such termination of employment, based upon the participant's actual period of service during the Performance Period. (b) For purposes of this Section 7, the "pro rata payment amount" shall be determined by multiplying (x) the product obtained by multiplying the participant's Target Award Opportunity by (y) the quotient obtained by dividing (a) the cumulative Earnings Per Share during the Performance Period through the date of death or disability, as the case may be, by (b) $4.65. 8. Plan Administration. (a) Authority-The Committee shall be responsible for overseeing the administration of the Plan and accordingly has full power to interpret the Plan and to adopt such rules and regulations and guides for carrying out the Plan as it may deem necessary or proper. All decisions shall be made solely in the best interests of the Company and in keeping with the purposes of the Plan. The Committee's powers include, but are not limited to, selecting participants, establishing such additional terms and conditions governing the Plan as it deems appropriate, adopting any and all modifications, amendments, procedures and regulations, and making all other determinations as it deems appropriate for the administration of this Plan. All decisions made by the Committee shall be final and binding on all persons affected by such decisions. (b) Plan Amendment and Termination-The Committee may amend or terminate the Plan in its sole discretion. 3 4 9. Miscellaneous. The following provisions are generally applicable to the Plan: (a) Non-transferability-No interest in the Plan shall be assignable or transferable other than by will or by laws of descent and distribution, or by power of attorney if a participant is deemed incompetent. (b) Tax Withholding-The Company shall have the right to deduct from any payment made under the Plan a sufficient amount, as may be applicable, to cover any statutory withholding tax requirements or to take such other action as may be necessary to satisfy any such tax withholding obligations. (c) Other Plan "Compensation"-No payments under the Plan shall be deemed a part of any participant's regular, recurring compensation for purposes of calculating payments or benefits from any other Company benefit, compensation, severance or similar plan. (d) No Right to Benefit or to Employment-Except as designated by the Committee, no person shall have any right to participate under this Plan, and no participant, by virtue of participation in the Plan shall have a right to be retained as an employee of the Company. (e) Binding Arbitration-Any dispute or disagreement regarding participation and a participant's claim under the Plan shall be settled solely by arbitration in accordance with the applicable rules of the American Arbitration Association. (f) Unfunded Plan-The Plan shall be unfunded and shall not create (or be construed to create) a trust or a separate fund or funds. The Plan shall not establish any fiduciary relationship between the Company and any participant or beneficiary of a participant. To the extent any person holds any obligation of the Company by participation in the Plan, such obligation shall merely constitute a general unsecured liability to the Company and accordingly shall not confer upon such person any right, title or interest in any assets of the Company. (g) Effective Date-The Plan shall be effective as of July 29, 1996, the date on which the Plan was adopted by the Committee (the "Effective Date"), provided that 4 5 the Plan is approved by the stockholders of the Company at an annual meeting or any special meeting of stockholders of the Company within 12 months of the Effective Date, and such approval of stockholders shall be a condition to the right of each participant to receive a Target Award Opportunity hereunder. 5 EX-10.1.G 3 SHARE INCENTIVE PLAN 1 GALOOB TOYS, INC. 1996 SHARE INCENTIVE PLAN 1. Purpose. Galoob Toys, Inc. 1996 Share Incentive Plan (the "Plan") is intended to provide incentives which will attract, retain and motivate highly competent persons as key employees of Galoob Toys, Inc. (the "Company") and of any subsidiary corporation now existing or hereafter formed or acquired, by providing them opportunities to acquire shares of the common stock, par value $.01 per share, of the Company ("Common Stock") or to receive monetary payments based on the value of such shares pursuant to the Benefits (as defined below) described herein. Furthermore, the Plan is intended to assist in aligning the interests of the Company's key employees to those of its stockholders. 2. Administration. (a) The Plan will be administered by a committee (the "Committee") appointed by the Board of Directors of the Company from among its members (which may be the Compensation Committee), and shall be comprised solely of not less than two members who shall be (i) "Non-Employee Directors" within the meaning of Rule 16b-3(b)(3) (or any successor rule) promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and (ii) unless otherwise determined by the Board of Directors, "outside directors" within the meaning of Section 162(m) of the Internal Revenue Code of 1986, as amended (the "Code"). The Committee is authorized, subject to the provisions of the Plan, to establish such rules and regulations as it deems necessary for the proper administration of the Plan and to make such determinations and interpretations and to take such action in connection with the Plan and any Benefits (as defined below) granted hereunder as it deems necessary or advisable. All determinations and interpretations made by the Committee shall be binding and conclusive on all participants and their legal representatives. No member of the Board of the Directors, no member of the Committee and no employee of the Company shall be liable for any act or failure to act hereunder, except in circumstances involving his or her bad faith, gross negligence or willful misconduct, or for any act or failure to act hereunder by any other member or employee or by any agent to whom duties in connection with the administration of this 2 Plan have been delegated. The Company shall indemnify members of the Committee and any agent of the Committee who is an employee of the Company, against any and all liabilities or expenses to which they may be subjected by reason of any act or failure to act with respect to their duties on behalf of the Plan, except in circumstances involving such person's bad faith, gross negligence or willful misconduct. (b) The Committee may delegate to one or more of its members, or to one or more agents, such administrative duties as it may deem advisable, and the Committee, or any person to whom it has delegated duties as aforesaid, may employ one or more persons to render advice with respect to any responsibility the Committee or such person may have under the Plan. The Committee may employ such legal or other counsel, consultants and agents as it may deem desirable for the administration of the Plan and may rely upon any opinion or computation received from any such counsel, consultant or agent. Expenses incurred by the Committee in the engagement of such counsel, consultant or agent shall be paid by the Company, or the subsidiary or affiliate whose employees have benefitted from the Plan, as determined by the Committee. 3. Participants. Participants will consist of such key employees of the Company and any subsidiary corporation of the Company as the Committee in its sole discretion determines to be significantly responsible for the success and future growth and profitability of the Company and whom the Committee may designate from time to time to receive Benefits under the Plan. Designation of a participant in any year shall not require the Committee to designate such person to receive a Benefit in any other year or, once designated, to receive the same type or amount of Benefit as granted to the participant in any other year. The Committee shall consider such factors as it deems pertinent in selecting participants and in determining the type and amount of their respective Benefits. 4. Type of Benefits. Benefits under the Plan may be granted in any one or a combination of (a) Stock Options, (b) Stock Appreciation Rights, (c) Stock Awards, (d) Performance Awards and (e) Stock Units (each as described below, and collectively, the "Benefits"). Stock Awards, Performance Awards and Stock Units may, as determined by the Committee in its discretion, constitute Performance-Based 2 3 Awards, as described in Section 11 below. Benefits shall be evidenced by agreements (which need not be identical) in such forms as the Committee may from time to time approve; provided, however, that in the event of any conflict between the provisions of the Plan and any such agreements, the provisions of the Plan shall prevail. 5. Common Stock Available Under the Plan. The aggregate number of shares of Common Stock that may be subject to Benefits, including Stock Options, granted under this Plan shall be 1,850,000 shares of Common Stock, which may be authorized and unissued or treasury shares, subject to any adjustments made in accordance with Section 12 hereof. The maximum number of shares of Common Stock with respect to which Benefits may be granted or measured to any individual participant under the Plan during the term of the Plan shall not exceed 500,000, provided, however, that the maximum number of shares of Common Stock with respect to which Stock Options and Stock Appreciation Rights may be granted to an individual participant under the Plan during the term of the Plan shall not exceed 500,000 (in each case, subject to adjustments made in accordance with Section 12 hereof). Other than those shares of Common Stock subject to Benefits that are cancelled or terminated as a result of the Committee's exercise of its discretion with respect to Performance-Based Awards as provided for in Section 11, any shares of Common Stock subject to a Stock Option or Stock Appreciation Right which for any reason is cancelled or terminated without having been exercised, any shares subject to Stock Awards, Performance Awards or Stock Units which are forfeited, any shares subject to Performance Awards settled in cash or any shares delivered to the Company as part of full payment for the exercise of a Stock Option or Stock Appreciation Right shall again be available for Benefits under the Plan. The preceding sentence shall apply only for purposes of determining the aggregate number of shares of Common Stock subject to Benefits and shall not apply for purposes of determining the maximum number of shares of Common Stock subject to Benefits (including the maximum number of shares of Common Stock subject to Stock Options and Stock Appreciation Rights) that any individual participant may receive. 6. Stock Options. Stock Options will consist of awards from the Company that will enable the holder to purchase a specific number of shares of Common Stock, at set terms and at a fixed purchase price. Stock Options may be "incentive stock options" ("Incentive Stock Options"), within the 3 4 meaning of Section 422 of the Code, or Stock Options which do not constitute Incentive Stock Options ("Nonqualified Stock Options"). The Committee will have the authority to grant to any participant one or more Incentive Stock Options, Nonqualified Stock Options, or both types of Stock Options (in each case with or without Stock Appreciation Rights). Each Stock Option shall be subject to such terms and conditions consistent with the Plan as the Committee may impose from time to time, subject to the following limitations: (a) Exercise Price. Each Stock Option granted hereunder shall have such per-share exercise price as the Committee may determine at the date of grant; provided, however, subject to subsection (d) below, that the per-share exercise price shall not be less than 100% of the Fair Market Value (as defined below) of the Common Stock on the date the option is granted. (b) Payment of Exercise Price. The option exercise price may be paid in cash or, in the discretion of the Committee determined at the date of grant, by the delivery of shares of Common Stock of the Company then owned by the participant, by the withholding of shares of Common Stock for which a Stock Option is exercisable, or by a combination of these methods. In the discretion of the Committee determined at the date of grant, payment may also be made by delivering a properly executed exercise notice to the Company together with a copy of irrevocable instructions to a broker to deliver promptly to the Company the amount of sale or loan proceeds to pay the exercise price. To facilitate the foregoing, the Company may enter into agreements for coordinated procedures with one or more brokerage firms. The Committee may prescribe any other method of paying the exercise price that it determines to be consistent with applicable law and the purpose of the Plan, including, without limitation, in lieu of the exercise of a Stock Option by delivery of shares of Common Stock of the Company then owned by a participant, providing the Company with a notarized statement attesting to the number of shares owned, where, upon verification by the Company, the Company would issue to the participant only the number of incremental shares to which the participant is entitled upon exercise of the Stock Option. In determining which methods a participant may utilize to pay the exercise 4 5 price, the Committee may consider such factors as it determines are appropriate. (c) Exercise Period. Stock Options granted under the Plan shall be exercisable at such time or times and subject to such terms and conditions as shall be determined by the Committee; provided, however, that no Stock Option shall be exercisable later than ten years after the date it is granted. All Stock Options shall terminate at such earlier times and upon such conditions or circumstances as the Committee shall in its discretion set forth in such option agreement at the date of grant. (d) Limitations on Incentive Stock Options. Incentive Stock Options may be granted only to participants who are key employees of the Company or subsidiary corporation of the Company at the date of grant. The aggregate market value (determined as of the time the option is granted) of the Common Stock with respect to which Incentive Stock Options are exercisable for the first time by a participant during any calendar year (under all option plans of the Company) shall not exceed $100,000. For purposes of the preceding sentence, (i) Incentive Stock Options will be taken into account in the order in which they are granted and (ii) Incentive Stock Options granted before 1987 shall not be taken into account. Incentive Stock Options may not be granted to any participant who, at the time of grant, owns stock possessing (after the application of the attribution rules of Section 424(d) of the Code) more than 10% of the total combined voting power of all outstanding classes of stock of the Company or any subsidiary corporation of the Company, unless the option price is fixed at not less than 110% of the Fair Market Value of the Common Stock on the date of grant and the exercise of such option is prohibited by its terms after the expiration of five years from the date of grant of such option. Notwithstanding anything to the contrary contained herein, no Incentive Stock Option may be exercised later than ten years after the date it is granted. 7. Stock Appreciation Rights. The Committee may, in its discretion, grant Stock Appreciation Rights to the holders of any Stock Options granted hereunder. In addition, Stock Appreciation Rights may be granted independently of, and without relation to, options. A Stock Appreciation Right 5 6 means a right to receive a payment, in cash, Common Stock or a combination thereof, in an amount equal to the excess of (x) the Fair Market Value, or other specified valuation, of a specified number of shares of Common Stock on the date the right is exercised over (y) the Fair Market Value, or other specified valuation (which shall be no less than the Fair Market Value), of such shares of Common Stock on the date the right is granted, all as determined by the Committee; provided, however, that if a Stock Appreciation Right is granted retroactively in tandem with or in substitution for a Stock Option, the designated Fair Market Value in the award agreement may be the Fair Market Value on the date such Stock Option was granted. Each Stock Appreciation Right shall be subject to such terms and conditions as the Committee shall impose from time to time. 8. Stock Awards. The Committee may, in its discretion, grant Stock Awards (which may include mandatory payment of bonus incentive compensation in stock) consisting of Common Stock issued or transferred to participants with or without other payments therefor as additional compensation for services to the Company. Stock Awards may be subject to such terms and conditions as the Committee determines appropriate, including, without limitation, restrictions on the sale or other disposition of such shares, the right of the Company to reacquire such shares for no consideration upon termination of the participant's employment within specified periods, and may constitute Performance-Based Awards, as described below. The Committee may require the participant to deliver a duly signed stock power, endorsed in blank, relating to the Common Stock covered by such an Award. The Committee may also require that the stock certificates evidencing such shares be held in custody or bear restrictive legends until the restrictions thereon shall have lapsed. The Stock Award shall specify whether the participant shall have, with respect to the shares of Common Stock subject to a Stock Award, all of the rights of a holder of shares of Common Stock of the Company, including the right to receive dividends and to vote the shares. 9. Performance Awards. (a) Performance Awards may be granted to participants at any time and from time to time, as shall be determined by the Committee. Performance Awards may, as determined by the Committee in its sole discretion, constitute Performance-Based Awards. The Committee shall have complete discretion in determining 6 7 the number, amount and timing of awards granted to each participant. Such Performance Awards may be in the form of shares of Common Stock or Stock Units. Performance Awards may be awarded as short-term or long-term incentives. With respect to those Performance Awards that are intended to constitute Performance-Based Awards, the Committee shall set performance targets at its discretion which, depending on the extent to which they are met, will determine the number and/or value of Performance Awards that will be paid out to the participants, and may attach to such Performance Awards one or more restrictions. Performance targets may be based upon, without limitation, Company-wide, divisional and/or individual performance. (b) With respect to those Performance Awards that are not intended to constitute Performance-Based Awards, the Committee shall have the authority at any time to make adjustments to performance targets for any outstanding Performance Awards which the Committee deems necessary or desirable unless at the time of establishment of goals the Committee shall have precluded its authority to make such adjustments. (c) Payment of earned Performance Awards shall be made in accordance with terms and conditions prescribed or authorized by the Committee. The participant may elect to defer, or the Committee may require or permit the deferral of, the receipt of Performance Awards upon such terms as the Committee deems appropriate. 10. Stock Units. (a) The Committee may, in its discretion, grant Stock Units to participants hereunder. Stock Units may, as determined by the Committee in its sole discretion, constitute Performance-Based Awards. The Committee shall determine the criteria for the vesting of Stock Units. A Stock Unit granted by the Committee shall provide payment in shares of Common Stock at such time as the award agreement shall specify. Shares of Common Stock issued pursuant to this Section 10 may be issued with or without other payments therefor as may be required by applicable law or such other consideration as may be determined by the Committee. The Committee shall determine whether a participant granted a Stock Unit shall be entitled to a Dividend Equivalent Right (as defined below). 7 8 (b) Upon vesting of a Stock Unit, unless the Committee has determined to defer payment with respect to such unit or a Participant has elected to defer payment under subsection (c) below, shares of Common Stock representing the Stock Units shall be distributed to the participant unless the Committee, with the consent of the participant, provides for the payment of the Stock Units in cash or partly in cash and partly in shares of Common Stock equal to the value of the shares of Common Stock which would otherwise be distributed to the participant. (c) Prior to the year with respect to which a Stock Unit may vest, the participant may elect not to receive Common Stock upon the vesting of such Stock Unit and for the Company to continue to maintain the Stock Unit on its books of account. In such event, the value of a Stock Unit shall be payable in shares of Common Stock pursuant to the agreement of deferral. (d) A "Stock Unit" means a notational account representing one share of Common Stock. A "Dividend Equivalent Right" means the right to receive the amount of any dividend paid on the share of Common Stock underlying a Stock Unit, which shall be payable in cash or in the form of additional Stock Units. 11. Performance-Based Awards. Certain Benefits granted under the Plan may be granted in a manner such that the Benefits qualify for the performance-based compensation exemption of Section 162(m) of the Code ("Performance-Based Awards"). As determined by the Committee in its sole discretion, either the granting or vesting of such Performance-Based Awards are to be based upon one or more of the following factors: net sales, pretax income before allocation of corporate overhead and bonus, budget, earnings per share, net income, division, group or corporate financial goals, return on stockholders' equity, return on assets, attainment of strategic and operational initiatives, appreciation in and/or maintenance of the price of the Common Stock or any other publicly-traded securities of the Company, market share, gross profits, earnings before interest and taxes, earnings before interest, taxes, dividends and amortization, economic value-added models and comparisons with various stock market indices, reductions in costs or any combination of the foregoing. With respect to Performance-Based Awards, (i) the Committee shall establish in writing (x) the objective performance-based goals 8 9 applicable to a given period and (y) the individual employees or class of employees to which such performance-based goals apply no later than 90 days after the commencement of such period (but in no event after 25% of such period has elapsed) and (ii) no Performance-Based Awards shall be payable to or vest with respect to, as the case may be, any participant for a given period until the Committee certifies in writing that the objective performance goals (and any other material terms) applicable to such period have been satisfied. With respect to any Benefits intended to qualify as Performance-Based Awards, after establishment of a performance goal, the Committee shall not revise such performance goal or increase the amount of compensation payable thereunder (as determined in accordance with Section 162(m) of the Code) upon the attainment of such performance goal. Notwithstanding the preceding sentence, the Committee may reduce or eliminate the number of shares of Common Stock or cash granted or the number of shares of Common Stock vested upon the attainment of such performance goal. 12. Adjustment Provisions; Change in Control. (a) If there shall be any change in the Common Stock of the Company, through merger, consolidation, reorganization, recapitalization, stock dividend, stock split, reverse stock split, split up, spinoff, combination of shares, exchange of shares, dividend in kind or other like change in capital structure or distribution (other than normal cash dividends) to stockholders of the Company, an adjustment shall be made to each outstanding Stock Option and Stock Appreciation Right such that each such Stock Option and Stock Appreciation Right shall thereafter be exercisable for such securities, cash and/or other property as would have been received in respect of the Common Stock subject to such Stock Option or Stock Appreciation Right had such Stock Option or Stock Appreciation Right been exercised in full immediately prior to such change or distribution, and such an adjustment shall be made successively each time any such change shall occur. In addition, in the event of any such change or distribution, in order to prevent dilution or enlargement of participants' rights under the Plan, the Committee will have authority to adjust, in an equitable manner, the number and kind of shares that may be issued under the Plan, the exercisability and vesting provisions of such Benefits, the number and 9 10 kind of shares subject to outstanding Benefits, the exercise price applicable to outstanding Benefits, and the Fair Market Value of the Common Stock and other value determinations applicable to outstanding Benefits. Appropriate adjustments may also be made by the Committee in the terms of any Benefits under the Plan to reflect such changes or distributions and to modify any other terms of outstanding Benefits on an equitable basis, including modifications of performance targets and changes in the length of performance periods. In addition, other than with respect to Stock Options, Stock Appreciation Rights and other awards intended to constitute Performance-Based Awards, the Committee is authorized to make adjustments to the terms and conditions of, and the criteria included in, Benefits in recognition of unusual or nonrecurring events affecting the Company or the financial statements of the Company, or in response to changes in applicable laws, regulations, or accounting principles. Notwithstanding the foregoing, (i) any adjustment with respect to an Incentive Stock Option shall comply with the rules of Section 424(a) of the Code, and (ii) in no event shall any adjustment be made which would render any Incentive Stock Option granted hereunder other than an incentive stock option for purposes of Section 422 of the Code. (b) In the event of a Change in Control (as defined below), the Committee, in its discretion, may take such actions as it deems appropriate with respect to outstanding Benefits, including, without limitation, accelerating the exercisability or vesting of such Benefits. The Committee, in its discretion, may determine that, upon the occurrence of a Change in Control of the Company, each Stock Option and Stock Appreciation Right outstanding hereunder shall terminate within a specified number of days after notice to the holder, and such holder shall receive, with respect to each share of Common Stock subject to such Stock Option or Stock Appreciation Right, an amount equal to the excess of the Fair Market Value of such shares of Common Stock immediately prior to the occurrence of such Change in Control over the exercise price per share of such Stock Option or Stock Appreciation Right; such amount to be payable in cash, in one or more kinds of property (including the property, if any, payable in the transaction) or in a 10 11 combination thereof, as the Committee, in its discretion, shall determine. For purposes of this Section 12(b), a "Change in Control" of the Company shall be deemed to have occurred upon any of the following events: (A) A person or entity or group of persons or entities, acting in concert, shall become the direct or indirect beneficial owner (within the meaning of Rule 13d-3 of the Exchange Act) of securities of the Company representing twenty-five percent (25%) or more of the combined voting power of the issued and outstanding common stock of the Company (a "Significant Owner"), unless such shares are originally issued to such Significant Owner by the Company; or (B) The majority of the Company's Board of Directors is no longer comprised of the incumbent directors who constitute the Board of Directors on the Effective Date (as hereinafter defined) and any other individual(s) who becomes a director subsequent to the date of this Agreement whose initial election or nomination for election as a director, as the case may be, was approved by at least a majority of the directors who comprised the incumbent directors as of the date of such election or nomination; or (C) The Company's Common Stock shall cease to be publicly traded; or (D) A sale of all or substantially all of the assets of the Company; or (E) The Board of Directors shall approve any merger, consolidation, or like business combination or reorganization of the Company, the consummation of which would result in the occurrence of any event described in clause (B) or (C) above, and such transaction shall have been consummated. 13. Transferability. Each Benefit granted under the Plan to a participant shall not be transferable otherwise than by will or the laws of descent and distribution, and shall be exercisable, during the participant's lifetime, only by the participant. In the event of the death of a participant, each Stock Option or Stock Appreciation Right theretofore granted to him or her shall be exercisable 11 12 during such period after his or her death as the Committee shall in its discretion set forth in such option or right at the date of grant and then only by the executor or administrator of the estate of the deceased participant or the person or persons to whom the deceased participant's rights under the Stock Option or Stock Appreciation Right shall pass by will or the laws of descent and distribution. Notwithstanding the foregoing, at the discretion of the Committee, an award of a Benefit other than an Incentive Stock Option may permit the transferability of a Benefit by a participant solely to the participant's spouse, siblings, parents, children and grandchildren or trusts for the benefit of such persons or partnerships, corporations, limited liability companies or other entities owned solely by such persons, including trusts for such persons, subject to any restriction included in the award of the Benefit. 14. Other Provisions. The award of any Benefit under the Plan may also be subject to such other provisions (whether or not applicable to the Benefit awarded to any other participant) as the Committee determines, at the date of grant, appropriate, including, without limitation, for the installment purchase of Common Stock under Stock Options, for the installment exercise of Stock Appreciation Rights, to assist the participant in financing the acquisition of Common Stock, for the forfeiture of, or restrictions on resale or other disposition of, Common Stock acquired under any form of Benefit, for the acceleration of exercisability or vesting of Benefits in the event of a change in control of the Company, for the payment of the value of Benefits to participants in the event of a change in control of the Company, or to comply with federal and state securities laws, or understandings or conditions as to the participant's employment in addition to those specifically provided for under the Plan. 15. Fair Market Value. For purposes of this Plan and any Benefits awarded hereunder, Fair Market Value shall be the closing price of the Company's Common Stock on the date of calculation (or on the last preceding trading date if Common Stock was not traded on such date) if the Company's Common Stock is readily tradeable on a national securities exchange or other market system, and if the Company's Common Stock is not readily tradeable, Fair Market Value shall mean the amount determined in good faith by the Committee as the fair market value of the Common Stock of the Company. 12 13 16. Withholding. All payments or distributions of Benefits made pursuant to the Plan shall be net of any amounts required to be withheld pursuant to applicable federal, state and local tax withholding requirements. If the Company proposes or is required to distribute Common Stock pursuant to the Plan, it may require the recipient to remit to it or to the corporation that employs such recipient an amount sufficient to satisfy such tax withholding requirements prior to the delivery of any certificates for such Common Stock. In lieu thereof, the Company or the employing corporation shall have the right to withhold the amount of such taxes from any other sums due or to become due from such corporation to the recipient as the Committee shall prescribe. The Committee may, in its discretion and subject to such rules as it may adopt (including any as may be required to satisfy applicable tax and/or non-tax regulatory requirements), permit an optionee or award or right holder to pay all or a portion of the federal, state and local withholding taxes arising in connection with any Benefit consisting of shares of Common Stock by electing to have the Company withhold shares of Common Stock having a Fair Market Value equal to the amount of tax to be withheld, such tax calculated at rates required by statute or regulation. 17. Tenure. A participant's right, if any, to continue to serve the Company as a director, officer, employee, or otherwise, shall not be enlarged or otherwise affected by his or her designation as a participant under the Plan. 18. Unfunded Plan. Participants shall have no right, title, or interest whatsoever in or to any investments which the Company may make to aid it in meeting its obligations under the Plan. Nothing contained in the Plan, and no action taken pursuant to its provisions, shall create or be construed to create a trust of any kind, or a fiduciary relationship between the Company and any participant, beneficiary, legal representative or any other person. To the extent that any person acquires a right to receive payments from the Company under the Plan, such right shall be no greater than the right of an unsecured general creditor of the Company. All payments to be made hereunder shall be paid from the general funds of the Company and no special or separate fund shall be established and no segregation of assets shall be made to assure payment of such amounts except as expressly set forth in the Plan. The Plan is not intended to be subject to the Employee Retirement Income Security Act of 1974, as amended. 13 14 19. No Fractional Shares. No fractional shares of Common Stock shall be issued or delivered pursuant to the Plan or any Benefit. The Committee shall determine whether cash, or Benefits, or other property shall be issued or paid in lieu of fractional shares or whether such fractional shares or any rights thereto shall be forfeited or otherwise eliminated. 20. Duration, Amendment and Termination. No Benefit shall be granted more than ten years after the Effective Date; provided, however, that the terms and conditions applicable to any Benefit granted prior to such date may thereafter be amended or modified by mutual agreement between the Company and the participant or such other persons as may then have an interest therein. Also, by mutual agreement between the Company and a participant hereunder, under this Plan or under any other present or future plan of the Company, Benefits may be granted to such participant in substitution and exchange for, and in cancellation of, any Benefits previously granted such participant under this Plan, or any other present or future plan of the Company. The Committee may amend the Plan from time to time or suspend or terminate the Plan at any time. However, no action authorized by this Section 20 shall reduce the amount of any existing Benefit or change the terms and conditions thereof without the participant's consent. No amendment of the Plan shall, without approval of the stockholders of the Company, (i) increase the total number of shares which may be issued under the Plan or the maximum number of shares with respect to Stock Options, Stock Appreciation Rights and other Benefits that may be granted to any individual under the Plan or (ii) modify the requirements as to eligibility for Benefits under the Plan; provided, however, that no amendment may be made without approval of the stockholders of the Company if the amendment will disqualify any Incentive Stock Options granted hereunder. 21. Governing Law. This Plan, Benefits granted hereunder and actions taken in connection herewith shall be governed and construed in accordance with the laws of the State of Delaware (regardless of the law that might otherwise govern under applicable Delaware principles of conflict of laws). 14 15 22. Effective Date. (a) The Plan shall be effective as of July 29, 1996, the date on which the Plan was adopted by the Committee (the "Effective Date"), provided that the Plan is approved by the stockholders of the Company at an annual meeting or any special meeting of stockholders of the Company within 12 months of the Effective Date, and such approval of stockholders shall be a condition to the right of each participant to receive any Benefits hereunder. Any Benefits granted under the Plan prior to such approval of stockholders shall be effective as of the date of grant (unless, with respect to any Benefit, the Committee specifies otherwise at the time of grant), but no such Benefit may be exercised or settled and no restrictions relating to any Benefit may lapse prior to such stockholder approval, and if stockholders fail to approve the Plan as specified hereunder, any such Benefit shall be cancelled. (b) This Plan shall terminate on July 28, 2006 (unless sooner terminated by the Committee). 15 EX-10.9.D 4 LEASE AGREEMENT 1 EXHIBIT 10.9(d) LEASE between THE PRUDENTIAL INSURANCE COMPANY OF AMERICA and GALOOB TOYS, INC., a Delaware corporation December 3, 1996 2 TABLE OF CONTENTS Page LEASE....................................................................1 1. Parties.........................................................1 2. Premises........................................................1 3. Term............................................................1 3.1 Term.......................................................1 3.2 Delay in Possession........................................1 3.3 Early Possession...........................................2 4. Rent............................................................2 4.1 Base Rent..................................................2 4.2 Rent Commencement Date.....................................2 5. Security Deposit................................................2 6. Use.............................................................3 6.1 Use .......................................................3 6.2 Compliance with Law........................................3 6.3 Condition of Premises......................................4 7. Maintenance, Repairs and Alterations............................5 7.1 Lessee's Obligations.......................................5 7.2 Surrender..................................................6 7.3 Lessor's Rights............................................6 7.4 Lessor's Obligations.......................................7 7.5 Alterations and Additions..................................9 8. Insurance; Indemnity...........................................14 9. Damage or Destruction..........................................19 9.1 Definitions...............................................19 9.2 Partial Damage -- Insured Loss............................19 9.3 Partial Damage -- Uninsured Loss..........................20 9.4 Total Destruction.........................................20 9.5 Damage Near End of Term...................................20 9.6 Abatement of Rent; Lessee's Remedies......................21 9.7 Termination -- Advance Payments...........................22 9.8 Waiver....................................................22 10. Real Property Taxes............................................22 10.1 Payment of Taxes.........................................22 10.2 Definition of "Real Property Tax"........................22 10.3 Joint Assessment.........................................23 10.4 Additional Provisions Regarding Real Property Taxes......23 10.5 Personal Property Taxes..................................24 11. Utilities......................................................24 -i- 3 12. Assignment and Subletting......................................24 12.1 Lessor's Consent Required................................24 12.2 Procedure................................................24 12.3 Lessees Other Than Individuals...........................26 12.4 Lessee Affiliate.........................................26 12.5 No Release of Lessee.....................................26 12.6 Assignment to Lessor.....................................27 12.7 Attorney's Fees..........................................27 12.8 Certain Permitted Subleases..............................27 12.9 Deemed Approval..........................................28 13. Defaults; Remedies.............................................28 13.1 Defaults.................................................28 13.2 Remedies.................................................29 13.3 Default by Lessor........................................31 13.4 Late Charges.............................................31 13.5 Impounds.................................................32 14. Condemnation...................................................32 15. Broker's Commissions...........................................33 16. Estoppel Certificate...........................................34 17. Lessor's Liability.............................................35 18. Severability...................................................35 19. Interest on Past-due Obligations...............................35 20. Time of Essence................................................36 21. Additional Rent................................................36 22. Incorporation of Prior Agreements; Amendments..................36 23. Notices........................................................36 24. Waivers........................................................37 25. No Recording...................................................37 26. Holding Over...................................................37 27. Cumulative Remedies............................................38 28. [Intentionally Omitted]........................................38 29. Binding Effect; Choice of Law..................................38 30. Subordination..................................................38 -ii- 4 31. Attorney's Fees................................................39 32. Lessor's Access................................................39 33. Auctions.......................................................39 34. Signs..........................................................39 35. Merger.........................................................40 36. Consents.......................................................40 37. [Intentionally Omitted]........................................40 38. Quiet Possession...............................................40 39. Options........................................................40 39.1 Definition...............................................40 39.2 Options Personal. ......................................41 39.3 Option...................................................41 39.4 C.P.I. Adjusted Option Rent..............................41 39.5 Effect of Default on Options.............................42 40. [Intentionally Omitted]........................................43 41. Security Measures..............................................43 42. Easements......................................................43 43. Performance Under Protest......................................43 44. Authority......................................................43 45. Cashier's Checks...............................................43 46. Amendments to Lease............................................44 47. Storage Tanks..................................................44 48. Lessee's Covenants Regarding Hazardous Materials...............44 48.1 Lessor's Prior Consent...................................44 48.2 Compliance with Hazardous Materials Laws.................45 48.3 Hazardous Materials Removal..............................46 48.4 Notices..................................................46 48.5 Indemnification of Lessor................................47 48.6 Preexisting Conditions...................................47 49. Rail Spur......................................................47 50. Early Entry By Lessee and Lessee's Work........................47 51. Lessor's Work..................................................48 -iii- 5 52. Delay in Completion of Lessor's Work...........................49 Exhibit "A" Premises (Paragraph 2) Exhibit "B" Schedule of Reports -iv- 6 LEASE 1. Parties. This Lease, dated, for reference purposes only, December 3, 1996, is made by and between THE PRUDENTIAL INSURANCE COMPANY OF AMERICA, a New Jersey corporation ("Lessor") and GALOOB TOYS, INC., a Delaware corporation ("Lessee"). 2. Premises. Lessor hereby leases to Lessee and Lessee leases from Lessor for the term, at the rental, and upon all of the conditions set forth herein, that certain real property (and all improvements thereon) situated in the County of Los Angeles, State of California, commonly known as 5431 Philadelphia Street, Ontario, California and consisting of an approximately 432,308 square foot building (the "Building") and adjacent land and more particularly delineated on Exhibit "A" attached hereto and by this reference incorporated herein. Said real property including the land and all improvements thereon, is herein called "the Premises". 3. Term. 3.1 Term. The term of this Lease (the "Lease Term") shall be for five (5) years commencing on May 1, 1997 (the "Commencement Date"), and ending on April 30, 2002, unless sooner terminated pursuant to any provision hereof. The Lease Term is subject to extension for a 5-year option term in accordance with Paragraph 39 of this Lease. 3.2 Delay in Possession. Notwithstanding the later Commencement Date, Lessee shall be given possession of the Premises on the first business day after the date of full execution and delivery of this Lease (the "Execution Date"). If for any reason Lessor fails to deliver possession of the Premises to Lessee by the Date (the "Early Access Date") that is 30 days after the Execution Date, Lessor shall not be subject to liability therefor, nor shall such failure affect the validity of this Lease, but the Rent Commencement Date (defined in Paragraph 4.2) shall be postponed for one day for each day of delay in delivery of possession of the Premises to Lessee beyond the Early Access Date. Notwithstanding the foregoing, if Lessor shall not have delivered possession of the Premises within sixty (60) days following the Execution Date, Lessee may, at Lessee's option, by notice in writing to Lessor within thirty (30) days following such 60-day period, cancel this Lease, in which event the parties shall be discharged from all obligations hereunder; provided further, however, that if such written notice of Lessee is not received by Lessor within said 30-day period, Lessee's right to cancel this Lease hereunder shall terminate and be of no further force or effect. Lessee acknowledges that after delivery of possession to Lessee, Lessor shall continue to have the right to enter the Premises to perform Lessor's Work (as defined in -1- 7 Paragraph 51) and otherwise as permitted by this Lease. Lessee further acknowledges that due to Lessor's construction of Lessor's Work there will exist disruption of and interference with Lessee's use of the Premises. No such disruption or interference or presence on the Premises by Lessor or its contractors to perform Lessor's Work shall be deemed to be a failure by Lessor to deliver possession. 3.3 Early Possession. Lessee's use and occupancy of the Premises prior to the Commencement Date shall be subject to all provisions hereof, provided, however, Lessee shall have no obligation to pay Base Rent (as defined below) until the Rent Commencement Date. From and after the date of commencement of Lessee's early occupancy and use of the Premises, Lessee shall be responsible for payment of all costs and expenses (other than Base Rent) payable by Lessee under this Lease. 4. Rent. 4.1 Base Rent. From and after the Rent Commencement Date (as defined in Paragraph 4.2), Lessee shall pay to Lessor as rent for the Premises, monthly payments of $112,400.00("Base Rent"), in advance, on the first day of each month of the term hereof. Lessee shall pay Lessor upon the execution hereof $112,400.00 as rent for May, 1997. Rent for any period during the term hereof which is for less than one month shall be a pro rata portion of the monthly installment. Rent shall be payable in lawful money of the United States to Lessor at the address stated herein or to such other persons or at such other places as Lessor may designate in writing, without any offset or deduction. 4.2 Rent Commencement Date. Provided that (i) possession of the Premises is delivered to Lessee upon the Early Access Date of this Lease as set forth in Paragraph 3.2 and (ii) all of Lessor's Work is substantially completed (as defined in Paragraph 52) prior to the Lessor Completion Date (as defined in Paragraph 52), Lessee's obligation to pay Base Rent shall commence on May 1, 1997 (the "Rent Commencement Date"). The Rent Commencement Date is subject to postponement in accordance with the terms of Paragraphs 3.2 and 52 of this Lease. If the Rent Commencement Date is postponed in accordance with the terms of this Lease, Lessee shall have no obligation to pay Base Rent hereunder until such postponed date. Lessor and Lessee agree that for tax reporting purposes, none of the Base Rent in periods in which the Base Rent is not being abated shall be allocated to any other period. 5. Security Deposit. Lessee shall deposit with Lessor upon execution hereof $112,400.00 ("Security Deposit"), as security for Lessee's faithful performance of Lessee's obligations hereunder. If Lessee fails to pay rent or other charges due hereunder, or otherwise defaults with respect to any provision of this Lease, Lessor may use, apply or retain all or any portion of -2- 8 said deposit for the payment of any rent or other charge in default or for the payment of any other sum to which Lessor may become obligated by reason of Lessee's default, or to compensate Lessor for any loss or damage which Lessor may suffer thereby. If Lessor so uses or applies all or any portion of said deposit following the occurrence of an Event of Default, Lessee shall within ten (10) days after written demand therefor deposit cash with Lessor in an amount sufficient to restore said deposit to the full amount hereinabove stated and Lessee's failure to do so shall be material breach of this Lease. If Lessee exercises its option pursuant to Paragraph 39, and the monthly rent during the Option Period (as defined below) is greater than the initial Security Deposit, Lessee shall thereupon deposit with Lessor an additional security deposit so that the amount of security deposit held by Lessor shall at all times bear the same proportion to current rent as the original security deposit bears to the original monthly rent set forth in Paragraph 4 hereof. Lessor shall not be required to keep said deposit separate from its general accounts. If Lessee performs all of Lessee's obligations hereunder, said deposit, or so much thereof as has not theretofore been applied by Lessor, shall be returned, without payment of interest or other increment for its use, to Lessee (or, at Lessor's option, to the last assignee, if any, of Lessee's interest hereunder) at the expiration of the term hereof, and after Lessee has vacated the Premises. No trust relationship is created herein between Lessor and Lessee with respect to said Security Deposit. 6. Use. 6.1 Use. The Premises shall be used and occupied for warehousing and distribution of toys and related products and for purposes consistent with the class and character of the Premises and in compliance with applicable laws, rules and regulations (including zoning requirements). It is acknowledged that the Premises include, without limitation, each of the following facilities, all of which are included as permitted uses under this Lease: warehouse space, executive and administrative offices, computer rooms, lunch room, conference rooms, copy/mail rooms, restrooms/locker rooms. 6.2 Compliance with Law. Subject to the terms of this Paragraph 6.2 and except as otherwise set forth in this Lease, Lessee shall, at Lessee's expense, comply promptly with all applicable codes, statutes, ordinances, rules, regulations, orders, covenants and restrictions of record, and requirements in effect during the term or any part of the term hereof relating in any way to the Premises. Lessee shall not use nor permit the use of the Premises in any manner that will tend to create waste or a nuisance. Notwithstanding anything to the contrary herein, (i) in no event will the terms of this Paragraph 6.2 be deemed or construed to relieve Lessor from any of its obligations to repair or maintain the Premises as required under this Lease, and (ii) -3- 9 the obligations of Lessee and Lessor with respect to any repairs, maintenance, replacements or capital improvements which are expected to cost in excess of $100,000 for any single project (each, a "Major Project") which is not Lessee Caused Compliance Work (as defined below) shall be governed by Paragraphs 7.4(e) and 7.4(f). It is further agreed that Lessee's obligations under this Paragraph 6.2 shall not be applicable in the event of casualty or condemnation, which events will be governed by the terms of Paragraph 9 and 14 of this Lease. As used herein, "Lessee Caused Compliance Work" shall mean work made necessary by Lessee's particular use of the Premises (as compared with general permitted uses), any alteration of the Premises by Lessee or any Event of Default by Lessee under this Lease. 6.3 Condition of Premises. (a) Lessor shall deliver the Premises to Lessee clean and free of debris on the date provided for in Paragraph 3.2 and Lessor further warrants to Lessee that the ESFR sprinkler system, the roof membrane and HVAC systems shall be in good condition and good working order as of the date Lessee first occupies the Premises and as of the date of completion of Lessor's Work. In the event that it is determined that this warranty has been violated, then it shall be the obligation of Lessor, after receipt of written notice from Lessee setting forth with specificity the nature of the violation, to promptly, at Lessor's sole cost, rectify such violation. Lessee's failure to give such written notice to Lessor within ninety (90) days after the earlier of the Lease Commencement Date or the date on which Lessee first occupies the Premises for business purposes shall cause the conclusive presumption that Lessor has complied with all of Lessor's obligations under this Paragraph 6.3(a); provided that nothing in this sentence shall limit Lessor's obligations under Paragraph 7.4. Lessee shall also receive the benefit of any warranty or other similar assurance issued in connection with the completion of Lessor's Work. (b) Subject to Lessor's obligation to complete all of Lessor's Work and perform its other obligations under this Lease throughout the Lease Term, Lessee agrees to accept the Premises subject to all applicable zoning, municipal, county and state laws, ordinances and regulations governing and regulating the use of the Premises, and any covenants or restrictions or easements of record, and accepts this Lease subject thereto and to all matters disclosed by any exhibits attached hereto or otherwise disclosed in writing to Lessee prior to the Execution Date. Lessee acknowledges that neither Lessor nor Lessor's agent has made any representation or warranty as to the present or future suitability of the Premises for the conduct of Lessee's business. Lessor hereby represents and warrants that it has no actual knowledge of any violations of any laws, rules, regulations or restrictions applicable to the Premises existing as of the Execution Date. Lessor further represents that to Lessor's -4- 10 actual knowledge (i) true and complete copies of all reports, studies, and evaluations pertaining to the Premises have been delivered to Lessee and (ii) there exist no other reports or studies relating to the Premises except those listed in Exhibit "B" or being prepared pursuant to Paragraph 6.3(c) (collectively, the "Reports"). As used in this Paragraph 6.3(c), reference to "Lessor's actual knowledge" means and refers to written notices actually received by, or to facts in question being actually known (as opposed to imputed, inquiry or constructive knowledge) to Mark Harryman (an employee of Lessor's managing agent), without any due diligence or duty of inquiry. Lessor shall have no duty of investigation with respect to any representation made to its actual knowledge. (c) Delivery of Reports. Prior to December 15, 1996, Lessor shall provide Lessee with reports prepared by reputable, qualified contractors certifying that the ESFR sprinkler system, the roof membrane, mechanical dock leveler equipment and the HVAC systems are in good condition and repair, and in compliance with applicable laws, rules and regulations. Lessee acknowledges that the contractors listed in Exhibit "B" and ACS (an HVAC contractor) satisfy the required qualifications of this Paragraph 6.3(c). 7. Maintenance, Repairs and Alterations. 7.1 Lessee's Obligations. (a) Subject to the terms and conditions of Para graph 7.4 and as otherwise set forth in this Lease, Lessee shall keep in good order, condition and repair the interior of the Premises and every nonstructural part thereof (whether or not such portion of the Premises requiring repair, or the means of repairing the same are reasonably or readily accessible to Lessee, and whether or not the need for such repairs occurs as a result of Lessee's use, any prior use, the elements or the age of such portion of the Premises) including, without limiting the generality of the foregoing, all plumbing, heating, ventilation and air conditioning (HVAC) systems (Lessee shall procure and maintain, at Lessee's expense, an air conditioning system maintenance contract) electrical, lighting facilities and equipment within the Premises, fixtures, walls (interior and exterior), ceilings, roofs (excluding any structural work or work relating to the roof membrane which Lessor is to perform pursuant to Paragraph 7.4), floors, windows, doors, plate glass and skylights located within the Premises, and all driveways, parking lots, fences and signs located on the Premises and sidewalks and parkways adjacent to the Premises. (b) Lessee shall maintain the Premises as provided in Paragraph 7.1(a) and in accordance with the requirements of any covenants or restrictions as may from time to time be applicable to the Premises, provided that Lessee has received reasonable -5- 11 advance notice of such requirements. Lessee, in keeping the Premises in good order, condition and repair, shall exercise and perform good maintenance practices and any damage or deterioration shall not be deemed "ordinary wear and tear" if the same could have been prevented by good maintenance practice. Subject to the terms and conditions of Paragraphs 7.4, Lessee's obligations shall include restorations, replacements or renewals when necessary and when determined not to be due to ordinary wear and tear, in order to keep the Premises and all improvements thereon or a part thereof in good order, condition and state of repair. Subject to Paragraph 8 (Insurance) and Paragraph 9 (Casualty), Lessee shall make all repairs whatsoever on the Premises to the extent necessitated by the negligence, misconduct or fault of Lessee, or its employees, agents, licensees or contractors (each, a "Lessee Party"). (c) If Lessor shall have painted the exterior of the Building during the initial term of this Lease (which shall be done, if at all, at Lessor's sole cost and expense), Lessor shall have the right to require Lessee to repaint the exterior of the Building once during the Option Period (as defined below) (d) Lessee shall cause the roof to be maintained pursuant to a roof maintenance contract with a reputable, qualified roof contractor approved by Lessor. In addition, Lessor reserves the right on 30 days' notice to Lessee to procure and maintain a roof maintenance contract with a reputable, qualified roof contractor and, if Lessor so elects, Lessee shall reimburse Lessor upon demand for the cost thereof, not to exceed the costs for those services generally charged in the area where the Premises are located for comparable work on comparable buildings. 7.2 Surrender. On the last day of the Lease Term,, or on any sooner termination, Lessee shall surrender the Premises to Lessor broom-clean and free of debris and in reasonable working order and condition, ordinary wear and tear excepted. Lessee shall repair any damage to the Premises occasioned by the installation or removal of Lessee's trade fixtures, furnishings and equipment. Notwithstanding anything to the contrary otherwise stated in this Lease, upon termination of this Lease, Lessee shall leave the air lines, power panels, electrical distribution systems, mechanical systems, lighting fixtures, air conditioning, plumbing, heating (including space heaters) and fencing on the Premises in good condition and operating order, and Lessee shall upon demand pay to Lessor that portion of the cost to restore such items to good condition and operating order as may be reasonably allocable to Lessee's tenancy. 7.3 Lessor's Rights. If Lessee fails to perform Lessee's obligations under this Paragraph 7, or under any other paragraph of this Lease, Lessor may at its option (but shall, not be required to) enter upon the Premises after ten (10) days' prior -6- 12 written notice to Lessee (except in the case of an emergency, in which case no notice shall be required), perform such obligations on Lessee's behalf, and the cost thereof together with interest thereon at the Interest Rate (as defined below) shall become due and payable as additional rental to Lessor together with Lessee's next rental installment. Without limiting the foregoing, in the event Lessee fails to appropriately maintain the HVAC system, Lessor reserves the right to procure and maintain HVAC system contract and if Lessor so elects, Lessee shall reimburse Lessor upon demand for the cost thereof, not to exceed the costs for those services generally charged in the area where the Premises are located for comparable work on comparable buildings 7.4 Lessor's Obligations. (a) Except for the obligations of Lessor under Paragraphs 6.2(a) and 6.3(a) (relating to Lessor's warranty), Paragraph 9 (relating to destruction of the Premises), under Paragraph 14 (relating to condemnation of the Premises), Paragraphs 7.4(b), 7.4(c), 7.4(d), 7.4(e), 7.4(f) and 7.4(g))and Paragraph 51, it is intended by the parties hereto that Lessor have no obligation, in any manner whatsoever, to repair and maintain the Premises nor the Building located thereon nor the equipment therein, all of which obligations are intended to be that of the Lessee under Paragraph 7.1 hereof. Lessee expressly waives the benefit of any statute now or hereinafter in effect which would otherwise afford Lessee the right to make repairs at Lessor's expense or to terminate this Lease because of Lessor's failure to keep the Premises in good order, condition and repair. (b) Structural Components. Lessor shall maintain and repair the structural components of the Building on the Premises, including exterior walls, foundations and structural portions of the roof, but excluding the floors, subject to normal wear and tear, except to the extent the need for such maintenance or repair arises because of the negligence, misconduct or fault of Lessee or any Lessee Party. (c) Replacement of HVAC System Units. Prior to December 15, 1996, the HVAC system shall be certified as being in good condition and repair. If any of the HVAC system units needs to be replaced or retrofitted to comply with legal requirements relating to the phase-out of CFCs during the term of the Lease, Lessor shall cause that replacement or retrofit to be made at Lessor's sole cost and expense subject to reimbursement from Lessee as provided in Paragraph 7.4(f). (d) Roof. During the initial 5 year term of this Lease, Lessor shall be responsible for any replacement of the roof membrane, except to the extent that replacement is due to (i) Lessee's failure to properly maintain and repair the roof and/or (ii) the negligence, misconduct or fault of Lessee or any Lessee Party (collectively, "Lessee's Fault"). With respect to -7- 13 any replacement of the roof membrane during the Option Period, Lessor shall cause such replacement work to be made at Lessor's sole cost and expense, except to the extent that replacement is due to Lessee's Fault, subject to reimbursement from Lessee as provided in Paragraph 7.4(f). The need for any replacement of the roof membrane shall be determined by Lessor in good faith based on advice from a reputable roof contractor. (e) Certain Major Projects. If maintenance of the Building involves any Major Project that is not (a) Lessee Caused Compliance Work, (b) work that would otherwise be the obligation of Lessor under any of Paragraphs 7.4(b), 7.4(c), 7.4(d) or 7.4(g), or (c) required due to the negligence, misconduct or fault of Lessee or any Lessee Party, Lessor shall cause such Major Project to be made at Lessor's sole cost and expense, subject to reimbursement from Lessee as provided in Paragraph 7.4(f). (f) Lessee's Contribution. With respect to any replacement or retrofitting of the HVAC systems pursuant to Paragraph 7.4(c), any replacement of the roof membrane during the Option Period pursuant to Paragraph 7.4(d), or any Major Project which is not Lessee Caused Compliance Work, the obligation of Lessee to pay a portion of the cost of such item (each, a "Major Item") shall be governed by this Paragraph 7.4(f). Lessee shall pay Lessor within 15 days after demand from Lessor a sum ("Lessee's Contribution"), equal to the product of (i) an amount equal to the cost to Lessor of the applicable Major Item multiplied by (ii) a fraction (not to exceed one) the numerator of which is the number of months remaining in the term of the Lease after Lessor completes the Major Item and the denominator of which is the number of months in the useful life of the Major Item, as reasonably determined by Lessor. If Lessor's demand for reimbursement is made prior to Lessee's exercise of its option for the Option Period, and Lessee thereafter exercises that option, then Lessor may recalculate Lessee's Contribution as to each Major Item to account for the increase in the number of months in the term due to the addition of the Option Period and Lessee shall pay Lessor within 15 days of demand that recalculated Lessee's Contribution to the extent not previously paid by Lessee to Lessor. (g) Earthquake Retrofitting. Lessor shall be responsible for any earthquake retrofitting of the Building structure required by applicable laws during the initial term of this Lease or the Option Period. (h) Lessee Right to Make Repairs and Deduct Costs. If Lessee provides written notice to Lessor of an event or circumstance which requires the action of Lessor with respect to repair and/or maintenance of the structural elements of the Premises, and Lessor's failure to commence such action within 5 business days will result in a material, adverse impact on -8- 14 Lessee's business in the Premises, and Lessor fails to commence such action within 2 business days after receipt of such written notice, then Lessee may proceed to take the required action upon delivery of an additional written notice to Lessor specifying that Lessee is taking such required action and, if such action was required under the terms of this Lease to be taken by Lessor, then Lessee shall be entitled to prompt reimbursement by Lessor for Lessee's reasonable costs and expenses in taking such action as provided in this Paragraph (unless, pursuant to this Lease, Lessee is responsible for the cost of such repair). If Lessor delivers a written objection to Lessee within 30 days after receipt of an invoice by Lessee for its costs of taking action which Lessee claims should have been taken by Lessor, which objection may be that Lessor was not required to perform the action, the action was unnecessary and/or the costs expended by Lessee were excessive, or does not respond to Lessee's demand, the matter shall be resolved by arbitration as provided in this Paragraph. Lessor and Lessee shall select an arbitrator acceptable to them to resolve the dispute. If the parties are unable to agree on an arbitrator within 15 days after a request by either party to arbitrate, then either party may petition the Presiding Judge of the Los Angeles Superior Court to select a single arbitrator. The arbitrator shall be qualified pursuant to the rules of the American Arbitration Association and the arbitration shall be conducted in accordance with the rules of the American Arbitration Association. The costs of such arbitration shall be paid for by the losing party unless it is not clear that there is a "losing" party, in which event the costs of arbitration shall be shared equally. If Lessor fails to pay such amounts (if any) as determined by such arbitration to be due Lessee within 30 days after written demand, then Lessee shall be entitled to deduct the reasonable costs and expense determined by arbitration to be due Lessee from the rent next coming due. 7.5 Alterations and Additions. (a) Lessee shall not, without Lessor's prior written consent make any alterations, improvements, additions, or Utility Installations in, on or about the Premises, except for nonstructural alterations not exceeding $40,000 in cumulative costs during the term of this Lease or $10,000 as to any single project (collectively, the "Threshold Amounts"). In any event, whether or not in excess of either of the Threshold Amounts, Lessee shall make no material change or alteration to the exterior of the Premises nor the exterior of the Building(s) on the Premises without Lessor's prior written consent. As used in Paragraph 7.5, the term "Utility Installation" shall mean carpeting, window coverings, air lines, power panels, electrical distribution systems, lighting fixtures, space heaters, air conditioning, plumbing and fencing. If Lessee intends to perform work at the Premises which is expected to cost in excess of either Threshold Amount, Lessor may require Lessee to provide Lessor, at Lessee's sole cost and expense, a lien and completion -9- 15 bond in an amount equal to one and one-half times the estimated cost of such improvements, to insure Lessor against any liability for mechanic's and materialmen's liens and to insure completion of the work. (b) Any alterations, improvements, additions, or Utility Installations made by Lessee during the term of this Lease shall be done in a good and workmanlike manner and of good and sufficient materials, and Lessee shall, within thirty (30) days after completion of such alteration, improvements, addition or Utility Installation, provide Lessor with as-built plans and specifications for same. Notwithstanding anything contained in this Lease to the contrary, Paragraphs 7.5(d)(1)(ii) and (iii) shall apply to non-structural alterations, improvements, additions or Utility Installations (other than racking, shelving and temporary partitions) not exceeding either of the Threshold Amounts in cost. (c) Any alterations, improvements, additions or Utility Installations in, or about the Premises that Lessee shall desire to make and which require the consent of the Lessor under the terms of this Paragraph 7.5 shall be presented to Lessor in written form, with proposed detailed plans. If Lessor shall give its consent, the consent shall be conditioned upon satisfaction of all of the requirements set forth in Paragraph 7.5(d) below. (d) For any additions, alterations, improvements, or Utility Installations requiring Lessor's prior written consent: (1) Lessee shall: (i) Request Lessor's approval in writing at least thirty (30) days prior to proposed construction. (ii) Employ a California licensed architect, contractor and structural engineer in connection with the proposed construction if the work is structural or, in the case of non-structural work, if the employment of such person is appropriate in connection with the work being performed and the cost of such work exceeds $10,000.00. (iii) Be fully responsible for the acts of Lessee's consultants, employees, contractors, sub contractors, invitees and agents, and cause them to fully comply with any applicable terms of this Lease and documents referred to by this Lease and all applicable laws, rules and regulations. (iv) Enter into written agreements with an architect and general contractor on standard American Institute of Architects (AIA) form or reasonable -10- 16 equivalent for the contract itself as well as payment schedules, change order, etc. Copies of executed agreements will be forwarded to Lessor promptly following execution. (v) Cause to be obtained an applicable building permit for any and all construction and modifications, and construct the additions and alterations and perform the construction work in accordance with all applicable laws, including without limitation the Americans With Disabilities Act. (2) Lessee's architect shall: (i) Be licensed by the State of California. (ii) Design and specify within the para meters of approved building specifications or have received specific written exceptions from the Lessor. (iii) Secure Lessor's written approval before submitting plans to the general contractor for bidding or to governmental agencies for approval. (iv) Secure Lessor's written approval of any changes or alternates to the plans recommended by the general contractor or required by governmental agencies. (v) Submit a copy of the final application for permit and issued permit to Lessor. (vi) Incorporate the building standard details supplied by Lessor onto the drawings. (vii) Submit final plans for Lessor's written approval prior to construction. (viii) Be available for final inspection with Lessor at job completion. (ix) Secure Lessor's written approval of details of any changes in specifications or finishes during construction. (x) Provide samples and specifications as required by Lessor. (xi) Sign off on the as-built drawings as the Architect's certification that the improvements have, in fact, been built as per the Architect's design. -11- 17 (3) Lessee's general contractor and/or subcontractors shall: (i) Be licensed by the State of California. (ii) Have substantial experience providing similar quality and quantity of improvements. Work history shall be provided to Lessor prior to being awarded contract. (iii) Have a bonding capacity equal to or exceeding the valuation of the job. Lessor may, at its sole option, require the job to be bonded. (iv) Maintain in full force and effect, throughout the duration of its performance under the contract with the Lessee, a Worker's Compensation insurance policy and a Commercial General Liability insurance policy issued by an insurer satisfactory to Lessor with liability coverage of not less than $1,000,000.00 for personal injury and $500,000.00 to cover property damage. The Commercial General Liability insurance policy shall include assumption of contractual liability. Certificates of insurance containing a thirty (30) day cancellation clause shall be furnished to Lessor prior to commencement of performance under the construction contract naming Lessor (The Prudential Insurance Company of America) and its managing agent (currently Cushman & Wakefield of California, Inc.) as additional insureds. (v) Provide a construction schedule to Lessor prior to commencement of work and weekly written progress reports. (vi) Warrant the Contractor's work and that of the Contractor's subcontractors, for a minimum of one (1) year. (vii) Provide Lessor with as-built drawings of all improvements. (e) All approvals by Lessor, as provided for in this Paragraph 7.5, shall not be unreasonably withheld. All requests to be submitted to Lessor shall be submitted through Lessor's managing agent. If Lessor shall give its consent, the consent shall be deemed conditioned upon the compliance by Lessee in a prompt and expeditious manner of all conditions of all permits obtained pursuant to Paragraph 7.5(d) above. Lessor agrees not to unreasonably withhold, condition or delay its consent or -12- 18 response to any requests or submissions made by Lessee under this Paragraph 7.5. (f) Lessee shall pay, when due, all claims for labor or materials furnished or alleged to have been furnished to or for Lessee at or for use in the Premises, which claims are or may be secured by any mechanics' or materialmen's lien against the Premises or any interest therein. Lessee shall give Lessor not less than ten (10) business days' notice prior to the commencement of any work in the Premises, and Lessor shall have the right to post notices of non-responsibility in or on the Premises as provided by law. If Lessee shall, in good faith, contest the validity of any such lien, claim or demand, then Lessee shall, at its sole expense defend itself and Lessor against the same and shall pay and satisfy any such adverse judgment that may be rendered thereon before the enforcement thereof against the Lessor or the Premises, upon the condition that if Lessor shall require, Lessee shall furnish to Lessor a surety bond satisfactory to Lessor in an amount equal to such contested lien claim or demand indemnifying Lessor against liability for the same and holding the Premises free from the effect of such lien or claim. In addition, Lessor may require Lessee to pay Lessor's attorneys fees and costs in participating in such action if Lessor shall decide it is in its best interest to do so. (g) Unless otherwise agreed in writing, Lessor may require that any or all alterations, improvements, additions or Utility Installations made or installed by Lessee or any Lessee Party be removed by the expiration or earlier termination of this Lease, notwithstanding their installation may have been consented to by Lessor, and that the Premises be restored to their prior condition. Should Lessee make any alterations, improvements, additions or Utility Installations without the prior approval of Lessor, Lessor may require that Lessee remove any or all of the same. Prior to commencing any addition, alteration or improvement, Lessee may request that Lessor waive Lessee's obligation to remove such addition, alteration or improvement at the end of the Lease Term. Any such waiver must be in writing and shall only apply to the additions, alterations or improvements described therein. (h) Unless Lessor requires their removal, as set forth in Paragraph 7.5(g), and except as set forth below in Paragraph 7.5(h), all alterations, improvements, additions and Utility Installations (whether or not such Utility Installations constitute trade fixtures of Lessee), which may be made on the Premises, shall become the property of Lessor and remain upon and be surrendered with the Premises at the expiration of the Lease Term. Notwithstanding the provisions of this Paragraph 7.5(h), any of Lessee's machinery and equipment and all alterations, improvements and Utility Installations made by Lessee, other than those affixed to the Premises so that they cannot be removed without material and irreparable damage to the Premises, shall -13- 19 remain the property of Lessee and may be removed by Lessee subject to the provisions of Paragraph 7.2. 8. Insurance; Indemnity. (a) Subject to the waiver of subrogation contained in this Lease, Lessee hereby agrees to indemnify, defend and hold harmless Lessor, its successors, assigns, subsidiaries, directors, officers, agents and employees from and against any and all damage, loss, liability or expense including, but not limited to, attorney's fees and legal costs suffered by same directly or by reason of any claim, suit or judgment brought by or in favor of any person or persons for damage, loss or expense due to, but not limited to, bodily injury, including death resulting any time therefrom, and property damage sustained by such person or persons which arises out of, is occasioned by or in any way attributable to the use or occupancy of the Premises by the Lessee, the acts or omission of the Lessee, its agents, employees or any other contractors brought onto said Premises by the Lessee, or any breach or default in the performance of any obligation on Lessee's part to be performed under the terms of this Lease, except to the extent caused by the negligence or wilful misconduct of Lessor, its employees, agents or contractors. If any action or proceeding is brought against Lessor by reason of any such claim, Lessee, upon notice from Lessor, shall defend same at Lessee's expense by counsel reasonably satisfactory to Lessor. Lessor and Lessee agree that Lessor's belief that a conflict of interest exists shall be deemed a reasonable basis for Lessor to object to such counsel. Such loss or damage shall include, but not be limited to, any injury or damage to Lessor's personnel (including death resulting any time therefrom) on the Premises. Lessee agrees that the obligations assumed herein shall survive the termination of this Lease. (b) Lessee hereby agrees to maintain and to cause its contractors occupying or performing work in the Premises from time to time to maintain in full force and effect at all times during the term of this Lease (or, in the case of contractors, during the period of such occupancy or term of work in the Premises), at no cost to Lessor, for the protection of Lessee, Lessor and Lessor's property manager, as their interest may appear, policies of insurance issued by a responsible carrier or carriers to Lessor which afford the following coverages: (i) Workers' Compensation with statutory limits as required by the State of California. -14- 20 (ii) Employers' Liability insurance with the following minimum limits: Bodily injury by disease per person $1,000,000 Bodily injury by accident policy limit $1,000,000 Bodily injury by disease policy limit $1,000,000 (iii) Property insurance on a special causes of loss insurance form (excluding earthquake and flood) covering any and all personal property of Lessee including but not limited to improvements, betterments, furniture, fixtures, Utility Installations, and equipment in an amount not less than their full replacement cost, with a deductible not to exceed $50,000. This policy should contain a waiver of subrogation. (iv) Commercial General Liability Insurance including Broad Form Property Damage and Contractual Liability with the following minimum limits: General Aggregate $2,000,000 Products/Completed Operations Aggregate $2,000,000 Each Occurrence $1,000,000 Personal & Advertising Injury $1,000,000 Medical Payments $5,000 per person (v) Umbrella/Excess Liability on a following form basis with the following minimum limits: General Aggregate $10,000,000 Each Occurrence $10,000,000 The limits of said insurance in this Paragraph 8(b)(i) shall not however, limit the liability of Lessee hereunder. (c) Lessor shall at all times during the term of this Lease, maintain the following property insurance with respect to the Premises: (i) a policy or policies of all-risk property insurance, issued by and binding upon an insurance company having a rating of at least A-VIII as set forth in the most current issue of "A.M. Best's Insurance Guide," insuring for the full replacement cost of the Building on the Premises. Lessor shall not be obligated to insure, and shall not assume any liability or risk of loss for, any of Lessee's furniture, equipment, machinery, goods, supplies, utility installations, improvements, or alterations upon the Premises. This policy shall contain an agreed -15- 21 amount endorsement and be written with no coinsurance. Lessor may, but shall not be obligated to, obtain earthquake and flood insurance. (ii) Rent insurance on an all-risk basis in an amount equal to all that is called for under Paragraph 4 of this Lease (Base Rent and any additional rents payable under this Lease including tax and insurance costs) for a period of at least twelve (12) months commencing with the date of loss. (iii) Boiler and machinery insurance in an amount satisfactory to Lessor on a comprehensive coverage form. Lessor may elect to have reasonable deductibles in connection with the insurance specified in Paragraph 8(c), and Lessee shall be liable for such deductible amount; provided that with respect to the deductible under any policy of earthquake insurance maintained by Lessor, Lessee shall be liable and responsible for that deductible amount up to a maximum amount equal to 50% of the total deductible amount. If the earthquake loss exceeds an amount equal to 50% of the total deductible amount, Lessor shall be responsible for that excess deductible. Notwithstanding the foregoing, if the Lease is terminated pursuant to Paragraph 9, Lessee shall not be liable for the deductible amount with respect to the casualty resulting in that termination of the Lease. (d) The party required to carry insurance as required hereunder shall deliver to the other party prior to the time such insurance is first required to be carried, and thereafter at least twenty (20) days prior to expiration of such policy, certificates of insurance evidencing the above coverage with limits not less than those specified above. Insurance required hereunder shall be in companies holding a "General Policyholders Rating" of at least A-VIII as set forth in the most current issue of "A.M. Best's Insurance Guide." With respect to policies to be carried by Lessee, such Certificates with the exception of Worker's Compensation, shall name Lessor, and its property manager as additional insureds. With respect to the liability insurance policies to be carried by Lessor, such Certificates shall name Lessee as additional insured. Further, all Certificates shall expressly provide that no less than thirty (30) days prior written notice shall be given to the party not carrying such insurance in the event of material alteration to or cancellation of the coverage evidenced by such Certificates. -16- 22 (e) Upon demand, Lessee shall provide Lessor, at Lessee's expense, with such increased amount of existing insurance and such other insurance coverage in such limits as Lessor may require in its sole judgement to afford Lessor adequate protection, but in no event will Lessee be required to carry insurance in excess of the types and amounts of insurance typically carried by lessees of buildings of comparable class, size and quality in the same general location as the Building. (f) From and after the date upon which the Lessor transfers its interest in this Lease such that neither The Prudential Insurance Company of America nor any entity directly or indirectly controlled or managed by The Prudential Insurance Company of America is the Lessor under this Lease, Lessor shall be obligated to obtain competitive bids on all insurance to be obtained by Lessor under this Lease and to secure that insurance from the qualified bidder or bidders with the lowest premiums for comparable insurance coverage from insurers meeting the requirements of this Lease. (g) Lessor makes no representation that the limits of liability specified to be carried by Lessee under the term of this Lease are adequate to protect Lessee against Lessee's undertaking under this Paragraph 8 and in the event Lessee believes that any such insurance coverage called for under this Lease is insufficient, Lessee shall provide, at its own expense, such additional insurance as Lessee deems adequate. (h) Anything in this Lease to the contrary notwithstanding, Lessor and Lessee hereby waive and release each other of and from any and all rights of recovery, claims, action or cause of action, against each other, their agents, officers and employees, for any loss or damage that may occur to the Premises, improvements to the building of which the Premises are a part, personal property (building contents) within the building on the Premises, any furniture, equipment, machinery, goods or supplies not covered by this Lease which Lessee may bring or obtain upon the Premises or any additional improvements which Lessee may construct on the Premises, by reason of fire, the elements or any other cause which could be insured against under the terms of all risk property insurance policies, regardless of cause or origin, including negligence of Lessor or Lessee and their agents, officers and employees. Because this Paragraph will preclude the assignment of any claim mentioned in it by way of subrogation (or otherwise) to an insurance company (or any other person) each party to this Lease agrees immediately to give to each insurance company, written notice of the terms of the mutual waivers contained in this Paragraph, and to have the insurance policies properly endorsed if necessary to prevent the invalidation of the insurance coverages by reason of the mutual waivers contained in this Paragraph. Lessee also waives and releases Lessor, its agents, officers and employees of and from any and all rights of -17- 23 recovery, claim, action or cause of action for any loss or damage to the extent insured against under any other policies of insurance carried by Lessee. (i) Lessee shall pay to Lessor during the term hereof, additional rent in the amount of any premiums for the insurance obtained under Paragraphs 8(c)(i), 8(c)(ii), and 8(c)(iii). Lessee shall pay any such premiums to Lessor within thirty (30) days after receipt by Lessee of a copy of the premiums statement or other satisfactory evidence of the amount due. If the insurance policies maintained hereunder cover other improvements in addition to the Premises, Lessor shall also deliver to Lessee a statement of the amount of such premiums attributable to the Premises and showing in reasonable detail the manner in which such amount was computed. If the term of this Lease shall not expire concurrently with the expiration of the period covered by such insurance, Lessee's liability for premiums shall be prorated on an annual basis. (j) Lessor may also maintain commercial general liability insurance in addition to, and not in lieu of, the commercial general liability insurance required to be maintained by Lessee. Lessee shall be named as an additional insured therein. If Lessor maintains such insurance, Lessee shall pay to Lessor during the term of this Lease additional rent in the amount of any premiums for such insurance in the same manner as provided in the second sentence of Paragraph 8(i). All insurance to be carried by Lessee shall be primary to and not contributory with any similar insurance carried by Lessor, whose insurance shall be considered excess insurance only. (k) Lessor shall not be liable for injury or damage to the person or goods, wares, merchandise or other property of Lessee, Lessee's employees, contractors, invitees, customers, or any other person in or about the Premises, whether such damage or injury is caused by or results from fire, steam, electricity, gas, water or rain, or from the breakage, leakage, obstruction or other defects of pipes, fire sprinklers, wires, appliances, plumbing, air conditioning or lighting fixtures, or from any other cause, whether said injury or damage results from conditions arising upon the Premises or upon other portions of the building of which the Premises are a part, from other sources or places, and regardless of whether the cause of such damage or injury or the means of repairing the same is accessible or not. Notwithstanding Lessor's negligence or breach of this Lease, Lessor shall under no circumstances be liable for injury to Lessee's business or for any loss of income or profit therefrom. Notwithstanding anything in the first sentence of this Paragraph 8(k) to the contrary, but subject to Paragraph 8(h), nothing in this Lease shall limit Lessor's liability for injuries to natural persons or damage to property to the extent caused by the negligence or willful misconduct of Lessor. Nothing contained herein is intended to, or shall be deemed or construed to limit -18- 24 or otherwise affect any rights of Lessor or Lessee to claim or receive the benefit of any available insurance proceeds attributable to an event or circumstance affecting the Premises. 9. Damage or Destruction. 9.1 Definitions. (a) "Premises Partial Damage" shall herein mean damage or destruction to the Premises to the extent that the cost of repair is less than 25% of the then replacement cost of the Premises. "Premises Building Partial Damage" shall herein mean damage or destruction to the building of which the Premises are a part to the extent that the cost of repair is less than 25% of the then replacement cost of such building as a whole. (b) "Premises Total Destruction" shall herein mean damage or destruction to the Premises to the extent that the cost of repair is 25% or more of the then replacement cost of the Premises. "Premises Building Total Destruction" shall herein mean damage or destruction to the building of which the Premises are a part to the extent that the cost of repair is 25% or more of the then replacement cost of such building as a whole. (c) "Insured Loss" shall herein mean damage or destruction which was caused by an event required to be covered by the insurance described in Paragraph 8. 9.2 Partial Damage -- Insured Loss. Subject to the provisions of Paragraphs 9.4, 9.5 and 9.6, if at any time during the term of this Lease there is damage which is an Insured Loss and which falls into the classification of Premises Partial Damage or Premises Building Partial Damage, then Lessor shall, at Lessor's expense, repair such damage, but not Lessee's fixtures, equipment or tenant improvements unless the same have become a part of the Premises pursuant to Paragraph 7.5 hereof as soon as reasonably possible and this Lease shall continue in full force and effect. Notwithstanding the above, if the insurance proceeds received by Lessor are not sufficient to effect such repair, Lessor shall give notice to Lessee of the amount required in addition to the insurance proceeds to effect such repair. Lessee may contribute the required amount to Lessor within ten days after Lessee has received notice from Lessor of the shortage in the insurance. When Lessee shall contribute such amount to Lessor, Lessor shall make such repairs as soon as reasonably possible and this Lease shall continue in full force and effect. Lessee shall in no event have any right to reimbursement for any such amounts so contributed. In the event Lessee does not elect to contribute the amount of the insurance shortfall within ten days of written notice from Lessor, as provided in Paragraph 9.2, Lessor may elect within thirty (30) days after Lessee's failure to contribute the amount of the insurance shortfall either to (a) fund the shortfall itself, in which event Lessor shall -19- 25 proceed with the repair and restoration, or (b) terminate this Lease. 9.3 Partial Damage -- Uninsured Loss. Subject to the provisions of Paragraphs 9.4, 9.5 and 9.6, if at any time during the term of this Lease there is damage which is not an Insured Loss and which falls within the classification of Premises Partial Damage or Premises Building Partial Damage, unless caused by a negligent or willful act of Lessee (in which event Lessee shall make the repairs at Lessee's expense to the extent that damage was caused by Lessee), Lessor may at Lessor's option either (i) repair such damage as soon as reasonably possible at Lessor's expense, in which event this Lease shall continue in full force and effect, or (ii) give written notice to Lessee within thirty (30) days after the date of the occurrence of such damage of Lessor's intention to cancel and terminate this Lease, as of the date of the occurrence of such damage. In the event Lessor elects to give such notice of Lessor's intention to cancel and terminate this Lease, Lessee shall have the right within ten (10) days after the receipt of such notice to give written notice to Lessor of Lessee's intention to repair such damage at Lessee's expense, without reimbursement from Lessor, in which event this Lease shall continue in full force and effect, and Lessee shall proceed to make such repairs as soon as reasonably possible. If Lessee does not give such notice within such 10-day period this Lease shall be canceled and terminated as of the date of the occurrence of such damage. 9.4 Total Destruction. If at any time during the term of this Lease there is damage, whether or not an Insured Loss, (including destruction required by any authorized public authority), which falls into the classification of Premises Total Destruction or Premises Building Total Destruction, this Lease shall automatically terminate as of the date of such total destruction. 9.5 Damage Near End of Term. (a) If at any time during the last twelve (12) months of the term of this Lease there is damage which would cost in excess of $250,000.00 to repair, whether or not an Insured Loss, which falls within the classification of the Premises Partial Damage, either Lessee or Lessor may at its option, cancel and terminate this Lease as of the date of occurrence of such damage by giving written notice to the other party of its election to do so within 30 days after the date of occurrence of such damage. (b) Notwithstanding Paragraph 9.5(a) in the event that Lessee has an option to extend or renew this Lease, and the time within which said option may be exercised has not yet expired, Lessee shall exercise such option, if it is to be exercised at all, no later than 30 days after the occurrence of an Insured Loss falling with the classification of Premises Partial Damage -20- 26 during the last six months of the term of this Lease. If Lessee duly exercises such option during said 30 day period, Lessor shall, at Lessor's expense, repair such damage as soon as reasonably possible and this Lease shall continue in full force and effect, provided Lessee after notice from Lessor first deposits with Lessor any shortfall in necessary funds. In the event Lessee does not elect to contribute the amount of the insurance shortfall within ten days of written notice from Lessor, as provided in Paragraph 9.5(b), Lessor may elect within thirty (30) days after Lessee's failure to contribute the amount of the insurance shortfall either to (a) fund the shortfall itself, in which event Lessor shall proceed with the repair and restoration, or (b) terminate this Lease. If Lessee fails to exercise such option during said 30 day period, then Lessor may at Lessor's option terminate and cancel this Lease as of the expiration of said 30 day period by giving written notice to Lessee of Lessor's election to do so within 20 days after the expiration of said 30 day period, notwithstanding any term or provision in the grant of option to the contrary. 9.6 Abatement of Rent; Lessee's Remedies. (a) In the event of damage described in Paragraphs 9.2, 9.3 or 9.5 and Lessor or Lessee repairs or restores the Premises pursuant to the provisions of Paragraph 9, the rent payable hereunder for the period during which such damage, repair or restoration continues shall be abated in proportion to the degree to which Lessee's use of the Premises is impaired (until such impairment no longer exists). Except for abatement of rent, if any, Lessee shall have no claim against Lessor for any damage suffered by reason of any such damage, destruction, repair or restoration. (b) If Lessor shall be obligated to repair or restore the Premises under the provisions of Paragraph 9 and shall not commence such repair or restoration within 90 days after such obligations shall accrue, Lessee may at Lessee's option cancel and terminate this Lease by giving Lessor written notice of Lessee's election to do so at any time prior to the commencement of such repair or restoration. In such event this Lease shall terminate as of the date of such notice. (c) If any repair or restoration that Lessor shall be obligated to or shall elect to undertake under the provisions of this Paragraph 9 is estimated by Lessor's architect to take more than 270 days from the event of damage to complete, either party at such party's election, may cancel and terminate this Lease by giving the other party written notice of the electing party's election to do so at any time prior to the commencement of such repair or restoration. In such event, this Lease shall terminate as of the date of such notice. Lessor agrees to cause its architect to provide its estimate of the time necessary to -21- 27 complete the repair or restoration within 60 days after the damage or destruction. (d) If Lessor shall be obligated to repair or restore the Building under the provisions of this Paragraph 9 and shall not complete such repair or restoration within one year (subject to extension for delays beyond the control of Lessor, including without limitation delays in obtaining permits) after the damage or destruction, Lessee may at Lessee's option cancel and terminate this Lease by giving Lessor written notice of Lessee's election to do so at any time prior to the Lessor's completion of such repair or restoration. In such event, this Lease shall terminate as of the date of such notice. Lessee's right to terminate this Lease pursuant to this Paragraph 9.6(d) shall be the sole right and remedy of Lessee against Lessor, and Lessor shall have no other liability to Lessee for damages, specific performance or otherwise in connection with any such failure to complete such repair or restoration. 9.7 Termination -- Advance Payments. Upon termination of this Lease pursuant to Paragraph 9, an equitable adjustment shall be made concerning advance rent and any advance payments made by Lessee to Lessor. Lessor shall, in addition, return to Lessee so much of Lessee's security deposit as has not theretofore been applied by Lessor. 9.8 Waiver. Lessor and Lessee waive the provisions of any statutes which relate to termination of leases when leased property is destroyed and agree that such event shall be governed by the terms of this Lease. 10. Real Property Taxes. 10.1 Payment of Taxes. Lessee shall pay the real property tax, as defined in Paragraph 10.2, applicable to the Premises during the term of this Lease. All such payments shall be made at least ten (10) days prior to the delinquency date of such payment. Lessee shall promptly furnish Lessor with satisfactory evidence that such taxes have been paid. If any such taxes paid by Lessee shall cover any period of time prior to or after the expiration of the term hereof, Lessee's share of such taxes shall be equitably prorated to cover only the period of time within the tax fiscal year during which this Lease shall be in effect, and Lessor shall reimburse Lessee to the extent required. If Lessee shall fail to pay any such taxes, Lessor shall have the right to pay the same, in which case Lessee shall repay such amount to Lessor with Lessee's next rent installment together with interest at the Interest Rate. 10.2 Definition of "Real Property Tax". As used herein, the term "real property tax" shall include any form of real estate tax or assessment, general, special, ordinary or extra ordinary, and any license fee, commercial rental tax, improvement -22- 28 bond or bonds, levy or tax (other than inheritance, personal income or estate taxes) imposed on the Premises by any authority having the direct or indirect power to tax, including any city, state or federal government, or any school, agricultural, sanitary, fire, street, drainage or other improvement district thereof, as against any legal or equitable interest of Lessor in the Premises or in the real property of which the Premises are a part, as against Lessor's right to rent or other income there from, and as against Lessor's business of leasing the Premises. The term "real property tax" shall also include any tax, fee, levy, assessment or charge (a) in substitution of, partially or totally, any tax, fee, levy, assessment or charge hereinabove included within the definition of "real property tax," or (b) the nature of which was hereinbefore included within the definition of "real property tax," or (c) which is imposed for a service or right not charged prior to June 1, 1978, or, if previously charged, has been increased since June 1, 1978, or (d) which is imposed as a result of a transfer, either partial or total, of Lessor's interest in the Premises or which is added to a tax or charge hereinbefore included within the definition of real property tax by reason of such transfer, or (e) which is imposed by reason of this transaction, any modifications or changes hereto, or any transfers hereof. 10.3 Joint Assessment. If the Premises are not separately assessed, Lessee's liability shall be an equitable proportion of the real property taxes for all of the land and improvements included within the tax parcel assessed, such proportion to be determined by Lessor from the respective valuations assigned in the assessor's work sheets or such other information as may be reasonably available. Lessor's reasonable determination thereof, in good faith (and based upon a commercially reasonable review of available data and materials), shall be conclusive. 10.4 Additional Provisions Regarding Real Property Taxes. Lessor shall have the option to pay the real property taxes, and in such case, Lessee shall, as additional rent for the Premises, pay for cost of all real property taxes paid hereunder. If Lessor pays the real property taxes, Lessee shall, within ten (10) days following demand by Lessor, reimburse Lessor for the cost of the real property taxes so paid. Lessor shall have the right to (and upon Lessee's reasonable request agrees to) contest or appeal any real property taxes or assessments applicable to the Premises and to seek a reduction in the assessed valuation of the Premises (collectively, "Tax Contests"). Any refund of real property taxes resulting from any such Tax Contest shall be applied first to reimburse Lessor for its costs and expenses in connection with the Tax Contest (including, without limitation attorneys' fees and the costs of consultants) and then, out of and to the extent of the balance of such refund, Lessor shall reimburse to Lessee the portion of such reduction attributable to the Premises and the term of this Lease, if previously paid by Lessee. -23- 29 10.5 Personal Property Taxes. (a) Lessee shall pay prior to delinquency all taxes assessed against and levied upon trade fixtures, furnishings, equipment and all other personal property of Lessee contained in the Premises or elsewhere. When reasonably possible, Lessee shall cause said trade fixtures, furnishings, equipment and all other personal property to be assessed and billed separately from the real property of Lessor. (b) If any of Lessee's said personal property shall be assessed with Lessor's real property, Lessee shall pay Lessor the taxes attributable to Lessee within 10 days after receipt of a written statement setting forth the taxes applicable to Lessee's property. 11. Utilities. Lessee shall pay for all water, gas, heat, light, power, telephone and other utilities and services supplied to the Premises, together with any taxes thereon. If any such services are not separately metered to Lessee, Lessee shall pay a reasonable proportion to be determined by Lessor of all charges jointly metered with other premises. 12. Assignment and Subletting. 12.1 Lessor's Consent Required. Lessee shall not voluntarily or by operation of law assign, transfer, mortgage, sublet, or otherwise transfer or encumber all or any part of Lessee's interest in this Lease or in the Premises, without Lessor's prior written consent, which Lessor shall not unreasonably withhold or delay. Lessor shall respond to Lessee's request for consent hereunder in a timely manner and any attempted assignment, transfer, mortgage, encumbrance or subletting without such consent shall be void, and shall constitute a noncurable breach of this Lease, without the need for notice to Lessee under Paragraph 13.1. 12.2 Procedure. If at any time or from time to time during the term of this Lease, Lessee desires to assign or sublet all or any part of Lessee's interest in this Lease or in the Premises, Lessee shall give prior written notice to Lessor setting forth the terms of the proposed assignment or subletting and the space so proposed to be assigned or sublet. Such assignment or sublease shall be subject to, without limitation, all the conditions in Paragraph 12 and the following conditions: (a) The assignment or sublease shall be on the terms set forth in the notice given to Lessor. Any subsequent material changes or modifications or reduction in effective sublease rental by more than 10% will require Lessor's prior written consent. -24- 30 (b) Lessee acknowledges that Lessor's agreement to lease these Premises to Lessee at the rent and terms stated herein is made in material reliance upon Lessor's evaluation of this particular Lessee's background, experience and ability, as well as the nature of the use of the Premises by this Lessee as set forth in Paragraph 6. In the event that Lessee shall request Lessor's written consent to assign or sublease the Premises as required in Paragraphs 12.1 and 12.2 hereof, then each such request for consent shall be accompanied by the following: (i) Financial statements of the proposed assignee or sublessee; (ii) A statement of the specific uses for which the Premises will be utilized by the proposed assignee or sublessee; and (iii) Preliminary plans prepared by an architect or civil engineer for all alterations to the Premises that are contemplated to be made by Lessee, the proposed assignee or sublessee. (c) No assignment or sublease shall be valid and no assignee or sublessee shall take possession of the Premises assigned or subleased until an executed counterpart of such assignment or sublease has been delivered to Lessor. (d) No sublessee or assignee shall have a right further to sublet or assign. (e) Fifty percent (after deduction of reasonable real estate brokerage commission paid by Lessee) of any sums or other economic consideration received by Lessee as a result of such assignment or subletting (except rental or other payments received which are attributable to amortization of the cost of leasehold improvements other than building standard tenant improvements made to the assigned or sublet portion of the Premises by Lessor) whether denominated rentals under the assignment or sublease or otherwise, which exceed, in the aggregate, the total sums which Lessee is obligated to pay Lessor under this Lease (prorated to reflect obligations allocable to that portion of the Premises subject to such assignment or sublease) shall be payable to Lessor as additional rental under this Lease without affecting or reducing any other obligation of Lessee hereunder. In the event of subletting of only a portion of the Premises, in calculating whether the rent received by Lessee exceeds the rent payable under this Lease, the rent payable under the Lease shall be prorated according to the square footage involved in order to reflect the rent applicable to the space sublet. The provisions of this Paragraph 12.2(e) shall not apply to any sublease permitted under Paragraph 12.4 or Paragraph 12.8 of this Lease. -25- 31 12.3 Lessees Other Than Individuals. (a) If Lessee is a partnership, a transfer of any interest of a general partner, a withdrawal of any general partner from the partnership, or the dissolution of the partner ship, shall be deemed to be an assignment of this Lease. (b) If Lessee is a corporation, unless Lessee is a public corporation whose stock is regularly traded on a national stock exchange, or is regularly traded in the over-the-counter market and quoted on NASDAQ, any sale or other transfer of a percentage of capital stock of Lessee which results in a change of controlling persons, or the sale or other transfer of substantially all of the assets of Lessee, shall be deemed to be an assignment of this Lease. 12.4 Lessee Affiliate. Notwithstanding any other provision of this Paragraph 12, Lessee may assign or sublet the Premises, or any portion thereof, without Lessor's consent, to any corporation which controls, is controlled by or is under common control with Lessee, or to any corporation resulting from the merger or consolidation with Lessee, or to any person or entity which acquires all the assets of Lessee as a going concern of the business that is being conducted on the Premises, provided that said assignee assumes, in full, the obligations of Lessee under this Lease. Any such assignment shall not, in any way, affect or limit the liability of Lessee under the terms of this Lease even if after such assignment or subletting the terms of this Lease are materially changed or altered without the consent of Lessee, the consent of whom shall not be necessary. 12.5 No Release of Lessee. Regardless of Lessor's consent, any subletting or assignment shall not (a) be effective without the express written assumption by such assignee or sublessee of the obligations of Lessee under this Lease, (b) release Lessee of any of Lessee's obligations hereunder or (c) alter the primary liability of Lessee to pay the rent and to perform all other obligations to be performed by Lessee hereunder. The acceptance of rent by Lessor from any other person shall not be deemed to be a waiver by Lessor of any provision hereof or any default by Lessee. Consent to one assignment or subletting shall not be deemed consent to any subsequent assignment or subletting. In the event of default by any assignee of Lessee or any successor of Lessee, in the performance of any of the terms hereof, Lessor may proceed directly against Lessee without the necessity of exhausting remedies against said assignee. Lessor may consent to subsequent assignments or subletting of this Lease or amendments or modifications to this Lease with assignees of Lessee, without notifying Lessee, or any successor of Lessee, and without obtaining its or their consent thereto and such action shall not relieve Lessee of liability under this Lease. -26- 32 12.6 Assignment to Lessor. The terms of this Paragraph 12.3 shall apply only to amounts Lessor is entitled to receive under this Lease and not to any amounts which a sublessee may be obligated to pay to Lessee which are in excess of the amounts Lessee is obligated to pay under this Lease. Subject to the foregoing, Lessee hereby assigns and transfers to Lessor all of Lessee's interest in all rentals and income arising from any sublease heretofore or hereafter made by Lessee, and Lessor may collect such rent and income and apply same toward Lessee's obligations under this Lease; provided however, that until an Event of Default shall occur in the performance of Lessee's obligations under this Lease, and subject to Paragraph 12.2(e) Lessee may receive, collect and enjoy the rents accruing under such sub lease. Lessor shall not, by reason of this or any other assignment of such sublease to Lessor nor by reason of the collection of the rents from a sublessee, be deemed liable to the sublessee for any failure of Lessee to perform and comply with any of Lessee's obligations to such sublessee under such sublease. Lessee hereby irrevocably authorizes and directs any such sublessee, upon receipt of a written notice from Lessor stating that an Event of Default exists in the performance of Lessee's obligations under this Lease, to pay to Lessor the rents due and to become due under the sublease. Lessee agrees that such sublessee shall have the right to rely upon any such statement and request from Lessor, and that such sublessee shall pay such rents to Lessor without any obligation or right to inquire as to whether such an Event of Default exists and notwithstanding any notice from or claim from Lessee to the contrary. Lessee shall have no right or claim against such sublessee or Lessor for any such rents so paid by said sublessee to Lessor, subject to the terms of this Paragraph 12.6. 12.7 Attorney's Fees. In the event Lessee shall assign or sublet the Premises or request the consent of Lessor to any assignment or subletting or if Lessee shall request the consent of Lessor for any act Lessee proposes to do, then Lessee shall pay Lessor's reasonable attorneys' fees incurred in connection therewith, such attorneys' fees not to exceed $350.00 for each such request. Notwithstanding the foregoing, the parties agree that a payment of $750.00 is a reasonable fee for Lessor's review of Lessee's request to assign or sublease. The provisions of this Paragraph 12.7 shall not apply to any sublease or assignment permitted under Paragraph 12.4 or Paragraph 12.8 of this Lease. 12.8 Certain Permitted Subleases. Notwithstanding anything in this Lease to the contrary, Lessee may sublease up to 150,000 square feet in the Premises in the aggregate without Lessor's prior consent; provided that (a) Lessee gives Lessor notice of and a copy of each such sublease within 20 days after it is executed, (b) the terms of all such subleases expire prior to the third anniversary of the Commencement Date, and (c) the subleases are subject to all of the terms and conditions of this Lease. -27- 33 12.9 Deemed Approval. In the event Lessor fails to respond at all to any written request for consent of a sublease of less than all of the Premises within 10 business days of actual receipt of that request by Lessor, the same shall be deemed approved; provided that such written request for consent shall (a) conspicuously state that pursuant to Paragraph 12.9 of the Lease, Lessor's failure to respond within that 10-business day period shall result in Lessor's being deemed to have given its approval, (b) have been delivered in accordance with this Lease, and (c) contain the information required under Paragraph 12.2 (other than the plans described in Paragraph 12.2(b)(iii), which need only be provided at that time if those plans then exist). 13. Defaults; Remedies. 13.1 Defaults. The occurrence of any one or more of the following events shall constitute a material default and breach of this Lease by Lessee (each, following the giving of notice and the passage of the cure period afforded hereunder, an "Event of Default"): (a) The vacating or abandonment of the Premises by Lessee; provided that the vacating of the Premises by Lessee shall be an Event of Default only in the event it results in an impairment or limitation on the insurance coverage for the Premises, and the abandonment of the Premises by Lessee shall be an Event of Default only in the event Lessee, pursuant to California Civil Code Section 1951.3, shall have been deemed to have abandoned the Premises. (b) The failure by Lessee to make any payment of rent or any other payment required to be made by Lessee hereunder, as and when due, where such failure shall continue for a period of ten (10) days after written notice thereof from Lessor to Lessee. In the event that Lessor serves Lessee with a Notice to Pay Rent or Quit pursuant to applicable Unlawful Detainer statutes, such Notice to Pay Rent or Quit shall also constitute the notice required by this subparagraph so long as the Notice to Pay Rent or Quit provides for the 10 days to cure required hereunder in lieu of the 3 days provided in the applicable Unlawful Detainer statutes. (c) The failure by Lessee to observe or perform any of the covenants, conditions or provisions of this Lease to be observed or performed by Lessee, other than described in para graph (b) above, where such failure shall continue for a period of 30 days after written notice thereof from Lessor to Lessee; provided, however, that if the nature of Lessee's default is such that more than 30 days are reasonably required for its cure, then Lessee shall not be deemed to be in default if Lessee commenced such cure within said 30-day period and thereafter diligently prosecutes such cure to completion. To the extent permitted by law, said thirty (30) day notice shall constitute the sole and -28- 34 exclusive notice required to be given to Lessee under applicable unlawful detainer statutes. (d) (i) The making by Lessee of any general arrangement or assignment for the benefit of creditors; (ii) Lessee becomes a "debtor" as defined in 11 U.S.C. ss. 101 or any successor statute thereto (unless, in the case of a petition filed against Lessee, the same is dismissed within 60 days); (iii) the appointment of a trustee or receiver to take possession of substantially all of Lessee's assets located at the Premises or of Lessee's interest in this Lease, where possession is not restored to Lessee within 60 days; or (iv) the attachment, execution or other judicial seizure of substantially all of Lessee's assets located at the Premises or of Lessee's interest in this Lease, where such seizure is not discharged within 60 days. Provided, however, in the event that any provision of this Paragraph 13.1(d) is contrary to any applicable law, such provision shall be of no force or effect. (e) The discovery by Lessor that any financial statement given to Lessor by Lessee, any assignee of Lessee, any subtenant of Lessee, any successor in interest of Lessee or any guarantor of Lessee's obligations hereunder, and any of them, was materially false and that such financial statement was known by Lessee or the other parties who delivered it to be materially false at the time it was delivered. 13.2 Remedies. If Lessee fails to perform any affirmative duty or obligation of Lessee under this Lease, within ten (10) days after written notice to Lessee (or in case of an emergency, without notice), Lessor may at its option (but without obligation to do so), perform such duty or obligation on Lessee's behalf including but not limited to the obtaining of reasonably required bonds, insurance policies, or governmental licenses, permits or approvals. The costs and expenses of any such performance by Lessor shall be due and payable by Lessee to Lessor upon invoice therefor. In the event of an Event of Default by Lessee, as defined in Paragraph 13.1, with or without further notice or demand, and without limiting Lessor in the exercise of any right or remedy which Lessor may have by reason of such breach, Lessor may: (a) Terminate Lessee's right to possession of the Premises by any lawful means, in which case this Lease and the term hereof shall terminate and Lessee shall immediately surrender possession of the Premises to Lessor. In such event Lessor shall be entitled to recover from Lessee: (i) the worth at the time of the award of the unpaid rent which had been earned at the time of termination; (ii) the worth at the time of award of the amount by which the unpaid rent which would have been earned after termination until the time of award exceeds the amount of such rental loss that the Lessee proves could have been reasonably avoided; (iii) the worth at the time of award of the -29- 35 amount by which the unpaid rent for the balance of the term after the time of award exceeds the amount of such rental loss that the Lessee proves could be reasonably avoided,; and (iv) any other amount necessary to compensate Lessor for all the detriment proximately caused by the Lessee's failure to perform its obligations under this Lease or which in the ordinary course of things would be likely to result therefrom, including but not limited to the cost of recovering possession of the Premises, expenses of reletting, including necessary renovation and alteration of the Premises, reasonable attorneys' fees, and that portion of the leasing commission paid by Lessor applicable to the unexpired term of this Lease. The worth at the time of award of the amount referred to in provisions (i) and (ii) of the prior sentence shall be calculated based on an interest rate equal to the Interest Rate. The worth at the time of award of the amount referred to in provision (iii) of the prior sentence shall be computed by discounting such amount at the discount rate of the Federal Reserve Bank of San Francisco at the time of award plus one percent. Efforts by Lessor to mitigate damages caused by Lessee's breach of this Lease shall not waive Lessor's right to recover damages under this Paragraph. If termination of this Lease is obtained through the provisional remedy of unlawful detainer, Lessor shall have the right to recover in such proceeding the unpaid rent and damages as are recoverable therein, or Lessor may reserve therein the right to recover all or any part thereof in a separate suit for such rent and/or damages. If a notice and grace period required under Paragraphs 13.1(b), (c) or (d) was not previously given, a notice to pay rent or quit, or to perform or quit, as the case may be, given to Lessee under any statute authorizing the forfeiture of leases for unlawful detainer shall also constitute the applicable notice for grace period purposes required by subparagraphs 13.1(b), (c) or (d). In such case, the applicable grace period under Paragraphs 13.1(b), (c) or (d) and under the unlawful detainer statute shall run concurrently after the one such statutory notice, and the failure of Lessee to cure the default within the greater of the two such grace periods shall constitute both an unlawful detainer and breach of this Lease entitling Lessor to the remedies provided for in this Lease and/or by said statute. (b) Continue the Lease and Lessee's right to possession in effect (in California under California Civil Code Section 1951.4) after Lessee's breach and abandonment and recover the rent as it becomes due, provided Lessee has the right to sublet or assign, subject only to reasonable limitations. See Paragraphs 12 and 36 for the limitations on assignment and subletting which limitations Lessee and Lessor agree are reason able. Acts of maintenance or preservation, efforts to relet the Premises, or the appointment of a receiver to protect the Lessor's interest under the Lease, shall not constitute a termination of the Lessee's right to possession. -30- 36 (c) Pursue any other remedy now or hereafter available to Lessor under the laws or judicial decisions of the State of California. Unpaid installments of rent and other unpaid monetary obligations of Lessee under the terms of this Lease shall bear interest from the date due at the Interest Rate. (d) The expiration or termination of this Lease and/or the termination of Lessee's right to possession shall not relieve Lessee from liability under any indemnity provisions of this Lease as to matters occurring or accruing during the term hereof or by reason of Lessee's occupancy of the Premises. 13.3 Default by Lessor. Lessor shall not be in default unless Lessor fails to perform obligations required of Lessor within a reasonable time, but in no event later than thirty (30) days after written notice by Lessee to Lessor and to the holder of any first mortgage or deed of trust encumbering the Premises whose name and address shall have theretofore been furnished to Lessee in writing, specifying wherein Lessor has failed to perform such obligation; provided, however, that if the nature of Lessor's obligation is such that more than thirty (30) days are required for performance then Lessor shall not be in default if Lessor commences performance within such 30-day period and thereafter diligently prosecutes the same to completion. Any damages or judgments arising out of Lessor's default of its obligations under this Lease shall be satisfied only out of Lessor's interest and estate in the Premises, and Lessor shall have no personal liability beyond such interest and estate with respect to such damages or judgments. 13.4 Late Charges. Lessee hereby acknowledges that late payment by Lessee to Lessor of rent and other sums due hereunder will cause Lessor to incur costs not contemplated by this Lease, the exact amount of which will be extremely difficult to ascertain. Such costs include, but are not limited to, processing and accounting charges, and late charges which may be imposed on Lessor by the terms of any mortgage or trust deed encumbering the Premises. Accordingly, if any installment of rent or any other sum due from Lessee shall not be received by Lessor or Lessor's designee within ten (10) days after such amount shall be due, then, without any requirement for notice to Lessee, Lessee shall pay to Lessor a late charge equal to 5% of such overdue amount. The parties hereby agree that such late charge represents a fair and reasonable estimate of the costs Lessor will incur by reason of late payment by Lessee. Acceptance of such late charge by Lessor shall in no event constitute a waiver of Lessee's default with respect to such overdue amount, not prevent Lessor from exercising any of the other rights and remedies granted hereunder. In the event that a late charge is payable hereunder, whether or not collected, for three (3) consecutive installments of rent, then rent shall automatically become due and payable quarterly in advance, rather than monthly, notwith- -31- 37 standing Paragraph 4 or any other provision of this Lease to the contrary. 13.4.1 Notice Before Late Charge. Notwithstanding the provisions of Paragraph 13.4, the 5% late charge described in Paragraph 13.4 shall not be imposed with respect to the first late payment during the term unless the applicable payment due from Lessee is not received by Lessor or Lessor's designee within ten (10) days following written notice from Lessor that such payment was not received when due. Following the first such written notice from Lessor during the term (and regardless of whether such payment is then received within such 10-day period), a late charge will be imposed without notice (as set forth in Paragraph 13.4) for any subsequent payment due from Lessee which is not received within ten (10) days of this due date. 13.5 Impounds. In the event that a late charge is payable hereunder, whether or not collected, for three (3) consecutive installments of rent or any other monetary obligation of Lessee under the terms of this Lease, Lessee shall pay to Lessor, if Lessor shall so request, in addition to any other payments required under this Lease, a monthly advance installment, payable at the same time as the monthly rent, as estimated by Lessor, for real property tax and insurance expenses on the Premises which are payable by Lessee under the terms of this Lease. Such fund shall be established to insure payment when due, before delinquency, of any or all such real property taxes and insurance premiums. If the amounts paid to Lessor by Lessee under the provisions of this paragraph are insufficient to discharge the obligations of Lessee to pay such real property taxes and insurance premiums as the same become due, Lessee shall pay to Lessor, upon Lessor's demand, such additional sums necessary to pay such obligations. All moneys paid to Lessor under this paragraph may be intermingled with other moneys of Lessor and shall not bear interest. In the event of a default in the obligations of Lessee to perform under this Lease, then any balance remaining from funds paid to Lessor under the provisions of this paragraph may, at the option of Lessor, be applied to the payment of any monetary default of Lessee in lieu of being applied to the payment of real property tax and insurance premiums. 14. Condemnation. If the Premises or any portion thereof are taken under the power of eminent domain, or sold under the threat of the exercise of said power (all of which are herein called "condemnation"), this Lease shall terminate as to the part so taken as of the date the condemning authority takes title or possession, whichever first occurs. If more than 10% of the floor area of the building on the Premises, or more than 25% of the land area of the Premises which is not occupied by any building, is taken by condemnation, Lessee may, at Lessee's option, to be exercised in writing only within ten (10) days -32- 38 after Lessor shall have given Lessee written notice of such taking (or in the absence of such notice, within ten (10) days after the condemning authority shall have taken possession) terminate this Lease as of the date the condemning authority takes such possession. If Lessee does not terminate this Lease in accordance with the foregoing, this Lease shall remain in full force and effect as to the portion of the Premises remaining, except that the rent shall be reduced in the proportion that the floor area of the building taken bears to the total floor area of the building situated on the Premises. No reduction of rent shall occur if the only area taken is that which does not have a building located thereon. Any award for the taking of all or any part of the Premises under the power of eminent domain or any payment made under threat of the exercise of such power shall be the property of Lessor, whether such award shall be made as compensation for diminution in value of the leasehold or for the taking of the fee, or as severance damages; provided, however, that Lessee shall be entitled to any award for loss of or damage to Lessee's trade fixtures and removable personal property. In the event that this Lease is not terminated by reason of such condemnation, Lessor shall to the extent of net severance damages received by Lessor in connection with such condemnation, over and above the legal and other expenses incurred by Lessor in the condemnation matter, repair any damage to the Premises caused by such condemnation except to the extent that Lessee has been reimbursed therefor by the condemning authority. Lessee may pay any amount in excess of such net severance damages required to complete such repair after notice from Lessor. In the event Lessee does not elect to contribute the amount of the shortfall in damages necessary for the repair, as provided in Paragraph 14, Lessor may elect either to (a) fund the shortfall itself, in which event Lessor shall proceed with the repair and restoration or (b) terminate this Lease. 15. Broker's Commissions. Lessee and Lessor each represent and warrant to the other that neither has had any dealings with any person, firm, broker or finder (other than those persons, if any, whose names are set forth in this Paragraph 15) in connection with the negotiation of this Lease and/or the consummation of the transaction contemplated hereby, and no other broker or other person, firm or entity is entitled to any commission or finder's fee in connection with said transaction and Lessee and Lessor do each hereby indemnify and hold the other harmless from and against any costs, expenses, attorneys' fees or liability for compensation, commission or charges which may be claimed by any such unnamed broker, finder or other similar party by reason of any dealings or actions of the indemnifying party. Named brokers: Lessor's Broker: Cushman & Wakefield of California, Inc. Lessee's Broker: Los Angeles Real Estate Management, Inc. -33- 39 The commission payable to Lessor's Broker with respect to this Lease shall be pursuant to the terms of the separate commission agreement in effect between Lessor and Lessor's Broker. Lessor's Broker shall pay a portion of its commission to Lessee's Broker, if so provided in any agreement between Lessor's Broker and Lessee's Broker. Nothing in this Lease shall impose any obligation on Lessor to pay a commission or fee (a) to any party other than Lessor's Broker or (b) to any party with respect to (i) the exercise by Lessee of any option or right of first refusal pursuant to this Lease, or (ii) any extension or renewal of this Lease. 16. Estoppel Certificate. (a) Lessee shall at any time upon not less than twenty (20) days' prior written notice from Lessor execute, acknowledge and deliver to Lessor a statement in writing (i) certifying that this Lease is unmodified and in full force and effect (or, if modified, stating the nature of such modification and certifying that this Lease, as so modified, is in full force and effect) and the date to which the rent and other charges are paid in advance, if any, and (ii) acknowledging that there are not, to Lessee's knowledge, any uncured defaults on the part of Lessor hereunder, or specifying such defaults if any are claimed. Any such statement may be conclusively relied upon by any prospective purchaser or encumbrancer of the Premises. (b) At Lessor's option, Lessee's failure to deliver such statement within such time shall be a material breach of this Lease or shall be conclusive upon Lessee (i) that this Lease is in full force and effect, without modification except as may be represented by Lessor, (ii) that there are no uncured defaults in Lessor's performance, and (iii) that not more than one month's rent has been paid in advance or such failure may be considered by Lessor as a default by Lessee under this Lease. Anything to the contrary notwithstanding in this Paragraph 16(b) of the Lease, Lessee's failure to deliver an estoppel certificate will not be deemed a default or breach by Lessee of the Lease unless Lessee's failure continues uncured for five days after an additional written notice to Lessee of such default. (c) If Lessor desires to finance, refinance, or sell the Premises, or any part thereof, Lessee hereby agrees to deliver to any lender or purchaser designated by Lessor such financial statements of Lessee as may be reasonably required by such lender or purchaser to evaluate the ability of Lessee to perform its obligations under this Lease. Such statements shall include the past two years' financial statements of Lessee. All such financial statements shall be received by Lessor and such lender or purchaser in confidence and shall be used only for the purposes herein set forth. -34- 40 (d) Lessor shall at any time upon no less than 20 days' prior written notice from Lessee referring to this Paragraph of the Lease execute, acknowledge and deliver to Lessee a statement in writing (a) certifying that the Lease is unmodified and to Lessor's actual knowledge in full force and effect (or, if modified, stating the nature of such modification and certifying that to Lessor's actual knowledge of this Lease, as so modified, it is in full force and effect) and the date to which rent and other charges are paid in advance, if any, and (b) acknowledging that it has not given Lessee any written notices of default, or providing copies of such notices if any have been given. 17. Lessor's Liability. The term "Lessor" as used herein shall mean only the owner or owners at the time in question of the fee title or a lessee's interest in a ground lease of the Premises, and in the event of any transfer of such title or interest, Lessor herein named (and in case of any subsequent transfers then the grantor) shall be relieved from and after the date of such transfer of all liability for Lessor's obligations to be performed after the date of such transfer, but shall remain fully liable for all obligations of Lessor arising under the Lease prior to the date of such transfer. Lessor agrees that any funds in the hands of Lessor or the then grantor at the time of such transfer, in which Lessee has an interest, shall be delivered to the grantee. The obligations contained in this Lease to be performed by Lessor shall, subject as aforesaid, be binding on Lessor's successors and assigns, only during their respective periods of ownership. 18. Severability. The invalidity of any provision of this Lease as determined by a court of competent jurisdiction, shall in no way affect the validity of any other provision hereof, provided that Lessee shall have no obligation to perform its monetary obligations under this Lease if Lessor has no obligation to deliver the Premises to Lessee and perform the obligations of Lessor as set forth in this Lease. 19. Interest on Past-due Obligations. Except as expressly herein provided, any amount due to Lessor not paid when due shall bear interest at the Interest Rate from the date due. Payment of such interest shall not excuse or cure any default by Lessee under this Lease, provided, however, that interest shall not be payable on late charges incurred by Lessee nor on any amounts upon which late charges are paid by Lessee. Likewise, except as specifically set forth in this Lease any payments or credits to be made to Lessee hereunder shall bear interest at the Interest Rate from the date due. As used herein, the term "Interest Rate" means the lesser of (a) a floating annual interest rate equal to three percent (3%) over the prime rate (for corporate loans at large United States money center commercial banks) published in the Wall Street Journal on the first business day of each month, or (b) the maximum rate permitted by applicable law. In the -35- 41 event that the Wall Street Journal fails to publish such a prime rate, the "prime rate" shall be the prime rate or reference rate quoted by a national bank having offices in California selected by Lessor in its sole discretion. 20. Time of Essence. Time is of the essence. 21. Additional Rent. Any monetary obligations of Lessee to Lessor under the terms of this Lease shall be deemed to be rent. 22. Incorporation of Prior Agreements; Amendments. This Lease contains all agreements of the parties with respect to any matter mentioned herein. No prior agreement or understanding pertaining to any such matter shall be effective. This Lease may be modified in writing only, signed by the parties in interest at the time of the modification. Except as otherwise stated in this Lease, Lessee hereby acknowledges that neither the real estate broker listed in Paragraph 15 hereof nor any cooperating broker on this transaction nor the Lessor or any employees or agents of any of said persons has made any oral or written warranties or representations to Lessee relative to the condition or use by Lessee of said Premises and Lessee acknowledges that Lessee assumes all responsibility regarding the Occupational Safety Health Act, the legal use and adaptability of the Premises and the compliance thereof with all applicable laws and regulations in effect during the term of this Lease except as otherwise specifically stated in this Lease. 23. Notices. Any notice given pursuant to this Lease shall be in writing, shall be personally delivered, delivered by Federal Express or comparable overnight courier, providing written evidence of delivery, or delivered by U.S. registered or certified mail, return receipt requested, postage prepaid and sent to Lessor and Lessee at the following addresses: LESSOR: Prudential Real Estate Investors 2029 Century Park East Suite 2050 Los Angeles, California 90067 Attn: Regional Counsel With a copy by the same method to: Prudential Real Estate Investors c/o Cushman & Wakefield of California, Inc. 555 South Flower Street, Suite 4200 Los Angeles, CA 90071 Attn: Mark Harryman -36- 42 LESSEE: Galoob Toys, Inc. 500 Forbes Boulevard South San Francisco, CA 94080 Attn: Vice President, Operations With a copy by the same method to: Galoob Toys, Inc. 500 Forbes Boulevard South San Francisco, CA 94080 Attn: William G. Catron, Esq. General Counsel or such other address as either party may from time to time designate as its notice address by notifying the other party thereof. Notice so sent shall be deemed given (a) when personally delivered, or (b) on the first business day following deposit with Federal Express or a comparable overnight courier service providing written evidence of delivery, or (c) five business days following deposit in the United States mail, if notice is sent by registered or certified mail, return receipt requested, postage prepaid. A copy of all notices required or permitted to be given to Lessor hereunder shall be concurrently transmitted to such party or parties at such addresses as Lessor may from time to time hereafter designate by notice to Lessee. 24. Waivers. No waiver by Lessor of any provision hereof shall be deemed a waiver of any other provision hereof or of any subsequent breach by Lessee of the same or any other provision. Lessor's consent to, or approval of, any act shall not be deemed to render unnecessary the obtaining of Lessor's consent to or approval of any subsequent act by Lessee. The acceptance of rent hereunder by Lessor shall not be a waiver of any preceding breach by Lessee of any provision hereof, other than the failure of Lessee to pay the particular rent so accepted, regardless of Lessor's knowledge of such preceding breach at the time of acceptance of such rent. 25. No Recording. Lessee shall not record this Lease. 26. Holding Over. If Lessee, with Lessor's consent, remains in possession of the Premises or any part thereof after the expiration of the term hereof, such occupancy shall be a tenancy from month to month upon all the provisions of this Lease pertaining to the obligations of Lessee, except that the monthly rent shall be 125% of the rent payable in the last month of the Lease Term, but all options and rights of first refusal, if any, granted under the terms of this Lease shall be deemed terminated and be of no further effect during said month to month tenancy. -37- 43 27. Cumulative Remedies. No remedy or election hereunder shall be deemed exclusive but shall, wherever possible, be cumulative with all other remedies at law or in equity. 28. [Intentionally Omitted] 29. Binding Effect; Choice of Law. Subject to any provisions hereof restricting assignment or subletting by Lessee and subject to the provisions of Paragraph 17, this Lease shall bind the parties, their personal representatives, successors and assigns. This Lease shall be governed by the laws of the State of California. 30. Subordination. (a) Subject to the terms of this Paragraph 30, this Lease, at Lessor's option, shall be subordinate to any ground lease, mortgage, deed of trust, or any other hypothecation or security now or hereafter placed upon the real property of which the Premises are a part and to any and all advances made on the security thereof and to all renewals, modifications, consolidations, replacements and extensions thereof. Notwithstanding anything to the contrary herein, Lessee's right to quiet possession of the Premises shall not be disturbed if Lessee is not in default and so long as Lessee shall pay the rent and observe and perform all of the provisions of this Lease, unless this Lease is otherwise terminated pursuant to its terms. If any mortgagee, trustee or ground lessor shall elect to have this Lease prior to the lien of its mortgage, deed of trust or ground lease, and shall give written notice thereof to Lessee prior to the effective date of any transfer of ownership of the Premises through foreclosure of that mortgage or deed of trust or termination of that ground lease, this Lease shall be deemed prior to such mortgage, deed of trust or ground lease, whether this Lease is dated prior or subsequent to the date of said mortgage, deed of trust or ground lease or the date of recording thereof. (b) Provided that such documents confirm the non-disturbance protection of Lessee as set forth in Paragraph 30(a) above, Lessee agrees to execute any documents required to effectuate an attornment, a subordination or to make this Lease prior to the lien of any mortgage, deed of trust or ground lease, as the case may be. Lessee's failure to execute such documents within 20 days after written demand shall constitute a material default by Lessee hereunder. (c) Lessor represents and warrants that there are currently no monetary encumbrances affecting the Premises. Lessor acknowledges and agrees that as a condition to any subordination of this Lease to any mortgage, deed of trust or ground lease affecting the Premises (whether now existing or put in place in the future), Lessee shall receive a written assurance -38- 44 in recordable form from the holder of such lien or mortgage (or the lessor under the ground lease) that upon any foreclosure (or deed in lieu thereof) or termination of such ground lease, this Lease and Lessee's right to quiet possession and occupancy of the Premises shall not be disturbed so long as no Event of Default by Lessee exists under this Lease. 31. Attorney's Fees. (a) If either party brings an action or proceeding to enforce the terms hereof or declare rights hereunder, the prevailing party in any such proceeding, action, or appeal thereon, shall be entitled to his reasonable attorney's fees and such fees as may be awarded in the same suit or recovered in a separate suit, whether or not such action or proceeding is pursued to decision or judgment. The term, "prevailing party" shall include, without limitation, a party who obtains legal counsel or brings an action against the other by reason of the other's breach or default, or who defends such action, and substantially obtains or defeats the relief sought, whether by compromise, settlement, judgment, or abandonment of the claim or defense by the other party. (b) The attorney's fee award shall not be computed in accordance with any court fee schedule, but shall be such as to fully reimburse all attorney's fees reasonably incurred in good faith. 32. Lessor's Access. Lessor and Lessor's agents shall have the right to enter the Premises at reasonable times for the purpose of inspecting the same, showing the same to prospective purchasers, lenders, or lessees, and making such alterations, repairs, improvements or additions to the Premises or to the building of which they are a part as Lessor may deem necessary or desirable. Lessor may at any time place on or about the Premises any ordinary "For Sale" signs and Lessor may at any time during the last 120 days of the term hereof place on or about the Premises any ordinary "For Lease" signs, all without rebate of rent or liability to Lessee. Notwithstanding anything to the contrary in Paragraph 32, except in the case of emergency or during periods in which an Event of Default exists under this Lease, Lessor shall give Lessee notice in advance (not to exceed 2 business days) of Lessor's intent to enter the Premises. 33. Auctions. Lessee shall not conduct, nor permit to be conducted, either voluntarily or involuntarily, any auction upon the Premises without first having obtained Lessor's prior written consent. Notwithstanding anything to the contrary in this Lease, Lessor shall not be obligated to exercise any standard of reasonableness in determining whether to grant such consent. 34. Signs. Lessee shall not place any sign upon the Premises without Lessor's prior written consent; provided, however, that -39- 45 Lessee shall have the right, at its sole cost and expense, to install a sign on the exterior of the Building identifying its name and logo and the name and logo of Skyway Distribution. The graphics, materials, color, design, lettering, size, location and specifications of Lessee's signage shall be subject to the prior written approval of Lessor, which approval shall not be unreasonably withheld or delayed, and the approval of the City of Ontario. The sign shall be installed and maintained, at Lessee's sole cost and expense, pursuant to an installation and maintenance program approved by Lessor. At the expiration or earlier termination of this Lease, Lessor shall, at Lessee's sole cost and expense, cause the sign to be removed and the exterior of the Building affected by the sign to be restored to the condition existing prior to the installation of the sign. Lessor may disapprove any signage that contains a name which relates to an entity or individual which is of a character or reputation, or is associated with a political orientation or faction, which would reasonably offend the landlord of a comparable building. This signage right is personal to Galoob Toys, Inc. 35. Merger. The voluntary or other surrender of this Lease by Lessee, or a mutual cancellation thereof, or a termination by Lessor, shall not work a merger, and shall, at the option of Lessor, terminate all or any existing subtenancies or may, at the option of Lessor, operate as an assignment to Lessor of any or all of such subtenancies. 36. Consents. Except for Paragraphs 33, 34 and 47 hereof, wherever in this Lease the consent of one party is required to an act of the other party, such consent shall not be unreasonably withheld. 37. [Intentionally Omitted] 38. Quiet Possession. Upon Lessee paying the rent for the Premises and observing and performing all of the covenants, conditions and provisions on Lessee's part to be observed and performed hereunder, Lessee shall have quiet possession of the Premises for the entire term hereof subject to all of the provisions of this Lease, and all easements, covenants, conditions and restrictions of record. The individuals executing this Lease on behalf of Lessor represent and warrant to Lessee that they are fully authorized and legally capable of executing this Lease on behalf of Lessor and that such execution is binding upon all parties holding an ownership interest in the Premises. 39. Options. 39.1 Definition. As used in this paragraph the word "Options" has the following meaning: (a) the right or option to extend the term of this Lease or to renew this Lease or to extend or renew any lease that Lessee has on other property of Lessor; (b) the option or right of first refusal to lease the Premises or -40- 46 the right of first offer to lease the Premises or the right of first refusal to lease other property of Lessor or the right of first offer to lease other property of Lessor; (c) the right or option to purchase the Premises, or the right of first refusal to purchase the Premises, or the right of first offer to purchase the Premises or the right or option to purchase other property of Lessor, or the right of first refusal to purchase other property of Lessor or the right of first offer to purchase other property of Lessor. 39.2 Options Personal. Each Option granted to Lessee in this Lease is personal to Lessee and may not be exercised or be assigned, voluntarily or involuntarily, by or to any person or entity other than Lessee, provided, however, the Option may be exercised by or assigned to any Lessee Affiliate as defined in Paragraph 12.4 of this Lease. The Options herein granted to Lessee are not assignable separate and apart from this Lease. 39.3 Option. Lessor hereby grants to Lessee the option to extend the term of this Lease for a five (5) year period commencing on the date following the date of expiration of the initial Lease Term (the "Option Period") upon each and all of the following terms and conditions: (a) Lessee shall deliver to Lessor (in the manner set forth in Paragraph 23 of this Lease) at least 180 and not more than 270 days prior to the expiration of the initial Lease Term a written notice of exercise of the option to extend this Lease for said additional term, time being of the essence. If said notification of the exercise of said option is not so given and received, this option shall automatically expire. (b) The provisions of Paragraph 39, including the provision relating to default of Lessee set forth in Para graph 39.5, of this Lease are conditions of this option; (c) All of the terms and conditions of this Lease as modified by this option shall apply; and (d) The monthly Base Rent for each month of the Option Period shall be the C.P.I. Adjusted Option Rent (as defined below) of the Premises as of the commencement of the Option Period, but in no event less than $112,400.00. 39.4 C.P.I. Adjusted Option Rent. With respect to any Option Period the "C.P.I. Adjusted Option Rent" shall mean a Base Rent calculated as follows: (a) As used herein, the term "C.P.I." shall mean the Consumer Price Index of the Bureau of Labor Statistics of the U.S. Department of Labor for Urban Wage Earners and Clerical Workers, Los Angeles-Anaheim-Riverside, California (1982-84=100). With respect to the Option Period the Base Rent of $112,400.00 -41- 47 payable as set forth in Paragraph 4 of the Lease, shall be multiplied by a fraction the numerator of which shall be the C.P.I. of the calendar month during which the Option Period commences, and the denominator of which shall be the C.P.I. for the calendar month in which the original Lease term commenced. The sum so calculated shall constitute the "C.P.I. Adjusted Option Rent" hereunder. (b) Pending determination of the C.P.I. Adjusted Option Rent, Lessee shall pay an estimated adjusted Base Rent equal to an estimated C.P.I. Adjusted Option Rent, as reasonably determined by Lessor by reference to the then available C.P.I. information. Upon notification of the actual adjustment after publication of the required C.P.I., any overpayment shall be credited against the next installment of rent due, and any underpayment shall be immediately due and payable by Lessee. Lessor's failure to request payment of an estimated or actual rent adjustment shall not constitute a waiver of the right to any adjustment provided for in the Lease or this Paragraph 39.4. (c) In the event the compilation and/or publication of the C.P.I. shall be transferred to any other governmental department or bureau or agency or shall be discontinued, then the index most nearly the same as the C.P.I. (as selected by Lessor) shall be used to make such calculation. 39.5 Effect of Default on Options. (a) Lessee shall have no right to exercise an Option, notwithstanding any provision in the grant of Option to the contrary, (i) if an Event of Default has occurred under this Lease and is continuing as of the date the Option is exercised, or (ii) in the event that Lessor has given to Lessee three or more notices of default under Paragraph 13.1(b), where a late charge has become payable under Paragraph 13.4 for each of such defaults, whether or not the defaults are cured, during the 12 month period prior to the time that Lessee intends to exercise the subject Option, or (iii) in the event that Lessor has given to Lessee three or more notices of default under Paragraph 13.1(c), whether or not the defaults are cured, during the 12 month period prior to the time Lessee intends to exercise the subject option. (b) The period of time within which an Option may be exercised shall not be extended or enlarged by reason of Lessee's inability to exercise an Option because of the provisions of Paragraph 39.5. (c) All rights of Lessee under the provisions of an Option shall terminate and be of no further force or effect, notwithstanding Lessee's due and timely exercise of the Option, if, after such exercise and during the term of this Lease, (i) Lessee fails to pay to Lessor a monetary obligation of Lessee -42- 48 for a period of 30 days after notice that such obligation is due, or (ii) Lessee fails to commence to cure a default specified in Paragraph 13.1(c) within 30 days after the date that Lessor gives notice to Lessee of such default and/or Lessee fails thereafter to diligently prosecute said cure to completion. 40. [Intentionally Omitted] 41. Security Measures. Lessee hereby acknowledges that the rental payable to Lessor hereunder does not include the cost of guard service or other security measures, and that Lessor shall have no obligation whatsoever to provide same. Lessee assumes all responsibility for the protection of Lessee, its agents and invitees from acts of third parties. 42. Easements. Lessor reserves to itself the right, from time to time, to grant such easements, rights and dedications that Lessor deems necessary or desirable, and to cause the recordation of Parcel Maps and restrictions, so long as such easements, rights, dedications, Maps and restrictions do not interfere with or otherwise affect the use of the Premises by Lessee or any rights or obligations of Lessee under this Lease. Lessee shall sign any of the aforementioned documents upon request of Lessor and failure to do so shall constitute a material breach of this Lease by Lessee without the need for further notice to Lessee. 43. Performance Under Protest. If at any time a dispute shall arise as to any amount or sum of money to be paid by one party to the other under the provisions hereof, the party against whom the obligation to pay the money is asserted shall have the right to make payment "under protest" and such payment shall not be regarded as a voluntary payment, and there shall survive the right on the part of said party to institute suit for recovery of such sum. If it shall be adjudged that there was no legal obligation on the part of said party to pay such sum or any part thereof, said party shall be entitled to recover such sum or so much thereof as it was not legally required to pay under the provisions of this Lease. 44. Authority. Each individual executing this Lease on behalf of Lessor or Lessee, respectively, represents and warrants that he or she is duly authorized to execute and deliver this Lease on behalf of said entity and to bind such entity to the terms hereof. 45. Cashier's Checks. (a) In the event that any check given to Lessor by Lessee shall not be honored by the bank upon which it is drawn on two or more occasions, then Lessor, at its option may require all future payments to be made by Lessee under this Lease to be made by cashier's checks. -43- 49 (b) Any payment made by Lessee pursuant to a written notice to pay or be deemed in default under this Lease shall be made by cashier's check. 46. Amendments to Lease. (a) At such times as a rental adjustment is made to this Lease by virtue of any provision of this Lease, the parties shall execute a written amendment to this Lease to reflect said change. (b) Lessee agrees to make any non-monetary modifications to this Lease that may be required by an institutional mortgagee of Lessor, so long as such modifications do not materially affect the rights or obligations of Lessee under this Lease. 47. Storage Tanks. (a) Notwithstanding anything to the contrary in Paragraph 7.5 hereof, Lessee shall not install storage tanks of any size or shape in the Premises, above or below ground, without the consent of the Lessor which can be withheld in Lessor's sole discretion. If Lessor elects to grant its consent, Lessor shall have the right to condition its consent upon Lessee agreeing to give to Lessor such assurances that Lessor, in its sole discretion, deems necessary to protect itself against potential problems concerning the installation, use, removal and contamination of the Premises as a result of the installation and/or use of such tank, including but not limited to the installation of a concrete encasement for said tank. Lessee shall comply at its expense with all applicable permit and/or registration requirements and repair any damage caused by the installation, maintenance or removal of such tank. Upon termination of the Lease, Lessee shall, at its sole cost and expense, remove any tank from the Premises, remove and replace any contaminated soil or materials (and compact or treat the same as then required by law) and repair any damage or change to the Premises caused by said installation and/or removal. Nothing contained herein shall be construed to diminish or reduce Lessee's obligations under Paragraph 48. (b) Lessor shall have the right to employ experts and/or consultants, at Lessee's expense, to advise Lessor with respect to the installation, operation, monitoring, maintenance and removal and restoration of any such tank. 48. Lessee's Covenants Regarding Hazardous Materials. 48.1 Lessor's Prior Consent. Notwithstanding anything contained in this Lease to the contrary, Lessee has not caused or permitted, and shall not cause or permit any "Hazardous Materials" (as defined in Paragraph 48.2, below) to be brought -44- 50 upon, kept, stored, discharged, released or used in, under or about the Premises by Lessee, its agents, employees, contractors, subcontractors, licensees or invitees, unless (a) such Hazardous Materials are reasonably necessary to Lessee's business and will be handled, used, kept, stored and disposed of in a manner which complies with all "Hazardous Materials Laws" (as defined in Paragraph 48.2, below); (b) Lessee will comply with such other rules or requirements as Lessor may from time to time impose, including without limitation that (i) such materials are in small quantities, properly labeled and contained, (ii) such materials are handled and disposed of in accordance with the highest accepted industry standards for safety, storage, use and disposal, (iii) such materials are for use in the ordinary course of business (i.e., as with office or cleaning supplies), (c) notice of and a copy of the current material safety data sheet is provided to Lessor for each such Hazardous Material, and (d) Lessor shall have granted its prior written consent to the use of such Hazardous Materials. 48.2 Compliance with Hazardous Materials Laws. As used herein, the term "Hazardous Materials" means any (a) oil, petroleum, petroleum products, flammable substances, explosives, radioactive materials, hazardous wastes or substances, toxic wastes or substances or any other wastes, materials or pollutants which (i) pose a hazard to the Premises or to persons on or about the Premises or (ii) cause the Premises to be in violation of any Hazardous Materials Laws (as hereinafter defined); (b) asbestos in any form, urea formaldehyde foam insulation, transformers or other equipment which contain dielectric fluid containing levels of polychlorinated biphenyls, or radon gas; (c) chemical, material or substance defined as or included in the definition of "hazardous substances," "hazardous wastes," "hazardous materials," "extremely hazardous waste," "restricted hazardous waste," or "toxic substances" or words of similar import under any applicable local, state or federal law or under the regulations adopted or publications promulgated pursuant thereto, including, but not limited to, the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, 42 U.S.C. ss. 9601, et seq.; the Resources Conservation Recovery Act, 42 U.S.C. ss. 6901, et seq.; the Hazardous Materials Transportation Act, as amended, 49 U.S.C. ss. 1801, et seq.; the Federal Water Pollution Control Act, as amended, 33 U.S.C. ss. 1251, et seq.; Sections 25115, 25117, 25122.7, 25140, 25249.8, 25281, 25316 and 25501 of the California Health and Safety Code; and Article 9 or Article 11 of Title 22 of the California Code of Regulations, Division 4, Chapter 20; (d) other chemical, material or substance, exposure to which is prohibited, limited or regulated by any governmental authority or may or could pose a hazard to the health and safety of the occupants of the Premises or the owners and/or occupants of property adjacent to or surrounding the Premises, or any other Person coming upon the Premises or adjacent property; and (e) other chemical, materials or substance which may or could pose a hazard to the environment. As used -45- 51 herein the term "Hazardous Materials Laws" means any federal, state or local laws, ordinances, regulations or policies relating to the environment, health and safety, and Hazardous Materials (including, without limitation, the use, handling, transportation, production, disposal, discharge or storage thereof) or to industrial hygiene or the environmental conditions on, under or about the Premises, including, without limitation, soil, ground water and indoor and ambient air conditions. Lessee shall at all times and in all respects comply with all Hazardous Materials Laws with respect to Hazardous Materials brought onto or used on the Premises by Lessee or any Lessee Party. 48.3 Hazardous Materials Removal. Upon expiration or earlier termination of this Lease, Lessee shall, at Lessee's sole cost and expense, cause all Hazardous Materials brought on the Premises with Lessor's consent to be removed from the Premises in compliance with all applicable Hazardous Materials Laws. If Lessee or its employees, agents, or contractors violates the provisions of the foregoing two paragraphs, or if Lessee's acts, negligence, or business operations contaminate, or expand the scope of contamination of, the Premises from such Hazardous Materials, then Lessee shall promptly, at Lessee's expense, take all investigatory and/or remedial action (collectively, the "Remediation") that is necessary in order to clean up, remove and dispose of such Hazardous Materials causing the violation on the Premises or the underlying groundwater or the properties adjacent to the Premises to the extent such contamination was caused by Lessee, in compliance with all applicable Hazardous Materials Laws. Lessee shall further repair any damage to the Premises caused by the Hazardous Materials contamination caused by Lessee or any Lessee Party. Lessee shall provide prior written notice to Lessor of such Remediation, and Lessee shall commence such Remediation no later than thirty (30) days after such notice to Lessor and diligently and continuously complete such Remediation. Such written notice shall also include Lessee's method, time and procedure for such Remediation and Lessor shall have the right to require reasonable changes in such method, time or procedure of the Remediation. Lessee shall not take any Remediation in response to the presence of any Hazardous Materials in or about the Premises or enter into any settlement agreement, consent decree or other compromise in respect to any claims relating to any Hazardous Materials in any way connected with the Premises, without first notifying Lessor of Lessee's intention to do so and affording Lessor ample opportunity to appear, intervene or otherwise appropriately assert and protect Lessor's interests with respect thereto. 48.4 Notices. Lessee shall immediately notify Lessor in writing of: (a) any enforcement, cleanup, removal or other governmental or regulatory action threatened, instituted, or completed pursuant to any Hazardous Materials Laws with respect to the Premises; (b) any claim, demand, or complaint made or threatened by any person against Lessee or the Premises relating -46- 52 to damage, contribution, cost recovery compensation, loss or injury resulting from any Hazardous Materials; and (c) any reports made to any governmental authority arising out of any Hazardous Materials on or removed from the Premises. Lessor shall have the right (but not the obligation) to join and participate, as a party, in any legal proceedings or actions affecting the Premises initiated in connection with any Hazardous Materials Laws. 48.5 Indemnification of Lessor. Lessee shall indemnify, protect, defend and forever hold Lessor harmless from any and all damages, losses, expenses, liabilities, obligations and costs arising out of any failure of Lessee to observe the foregoing covenants in Paragraphs 47 and 48. 48.6 Preexisting Conditions. Notwithstanding anything to the contrary in this Lease, Lessee shall not be liable to Lessor under this Lease for any cost associated with Hazardous Materials, if any, to the extent that the Hazardous Materials existed on the Premises prior to the date of this Lease and were not brought on to the Premises by Lessee, its agents, employees, contractors, subcontractors, licensees or invitees (the "Preexisting Conditions"). Lessor hereby reserves the right to enter upon the Premises at reasonable times to perform any work necessary or, in Lessor's judgment, advisable in connection with any such Preexisting Conditions, and no such entry or performance of work shall constitute a constructive eviction or otherwise entitle Lessee to any damages or reduction in rent, or to terminate this Lease. The foregoing right of entry may be exercised by Lessor, its agents, employees, and contractors and by any person Lessor may identify as being connected with the Preexisting Conditions, and such person's agents, employees and contractors. Without limiting any other provision of this Lease, Lessee shall provide Lessor with the original of any notices or other documents received by Lessee in connection with the Preexisting Conditions. 49. Rail Spur. Lessor makes no representation or warranty to Lessee with respect to the condition, fitness or suitability for Lessee's use of the rail spur adjacent to the Premises. Lessee shall be solely responsible for all costs and expenses incurred in connection with the use, maintenance, repair and operation of the rail spur. 50. Early Entry By Lessee and Lessee's Work. 50.1 Without limiting Paragraph 3.3 of the Lease, Lessee shall be permitted to enter the Premises prior to the Lease commencement, but not earlier than December 1, 1996, without the obligation for payment of Base Rent for the purpose of installing racking, transfer of stock and other specific improvements needed for Lessee's use; provided that (a) Lessee first provides Lessor with all insurance required by the terms of this Lease to be -47- 53 carried by Lessee, and (b) all construction by Lessee shall be performed in accordance with the terms of this Lease, including without limitation Paragraph 7.5. 50.2 Without limiting any other provision of this Lease, Lessor shall not be responsible for damages or loss to any work performed by Lessee or to Lessee's personal property or the personal property of Lessee's contractors, employees or agents which occurs during such period of early access, except to the extent resulting from any act or negligence of Lessor, its agents, employees or contractors. 51. Lessor's Work. Lessor shall, at Lessor's sole cost and expense prior to the Lessor Completion Date, Substantially Complete the following improvements ("Lessor's Work"): (a) Recarpet, and/or replace with tile as necessary the floor coverings in the office areas and repaint the primary office area. (b) Clean and paint office and shop restrooms. Replace floors as necessary. (c) Construct a security guard station improved with electrical and communication conduits connected to the building at the entry to the truck court. Secure the entry to the truck court with an electrical rolling gate that can be controlled from the security guard station and the building. (d) Restripe the truck court and number the parking spaces per a Lessee approved container parking plan. Provide heavy duty truck bumpers along the westerly fence line in the truck court. (e) Thoroughly clean and seal the slab floor in the battery charging area with a Silikal Floor Sealer. (f) Install dock light/fan units and related power at each truck-high loading position. (g) Replace the existing westerly chain-link fence with a new 8" high chain-link fence. The top of the new fence line will be improved with three strands of barbed wire and the chain-link mesh with slats for screening yard area operations. (h) Ensure that building fire alarm is in good operating condition and actively monitored. Lessee shall be responsible for monitoring the fire alarm system beginning the first day Lessee takes possession of the Premises. (i) Ensure that pit levelers and edge of dock equipment are in good operating condition. -48- 54 (j) Erect an 8-foot high chain-link demising fence separating the northern portion of the warehouse from the southerly portion. The chain-link demising fence should be improved with three strands of barbed wire. Lessor will consider modifications to the existing curtains per fire department high pile storage requirements (if necessary). 52. Delay in Completion of Lessor's Work. As used in this Lease, the term "Lessor's Completion Date" means the date that is the later of (a) 60 days after the date upon which Lessor and Lessee agree upon the final specifications for Lessor's Work, or (b) 60 days after Lessor receives a building permit for Lessor's Work, if a building permit is required for Lessor's Work. As used in this Lease, "Substantial Completion" means that the work in question is completed except for (a) minor so-called "punch-list" items, (b) items that do not materially affect Lessee's ability to use the Premises, or (c) the proposed security guard station. Lessor's Completion Date shall be postponed by one day for each day Substantial Completion is delayed by reason of Lessee Delays (as defined below) or Force Majeure Delays (as defined below). As used herein, the term "Force Majeure Delay" shall mean delays in the construction and completion of Lessor's Work caused by strikes, lockouts, labor disputes, acts of God, fire, floods, earthquake, epidemics, freight embargoes, unavailability of materials and supplies, development moratoria imposed by any governmental authority, or other causes beyond the reasonable control of Lessor or its contractors, subcontractors or suppliers. As used herein, the term "Lessee Delay" shall mean any delay in Substantial Completion of Lessor's Work which is caused by any act or failure to act by Lessee, its agents, or contractors. No Lessee Delay shall be deemed to occur unless and until Lessor provides written notice to Lessee, in compliance with the notice provisions of the Lease, claiming that such delay(s) occurred and specifying in detail the action or inaction on the part of Lessee which is the basis for such claim. If such action or inaction is not cured by Lessee by the date which is one (1) business day after Lessee's receipt of such notice (the "Cure Date"), then unless Lessee proves that such action or inaction did not actually cause a delay in Substantial Completion of Lessor's Work, the Lessee Delay as set forth in such notice shall be deemed to have occurred commencing as of the date after the Cure Day and continuing for the number of days the inaction or action claimed by Lessor in such notice remains uncured and actually and directly causes a delay in Substantial Completion of the Lessor Work beyond such date. If Lessor's Work is not Substantially Complete by the Lessor Completion Date, the Rent Commencement Date under this Lease shall be postponed by one day -49- 55 for each day of delay in Substantial Completion of Lessor's Work until Substantial Completion occurs. "LESSOR": THE PRUDENTIAL INSURANCE COMPANY OF AMERICA, a New Jersey corporation By: Cushman & Wakefield of California, Inc. Its Managing Agent By: /s/ Mark F. Hardyman ------------------------------------ Mark F. Hardyman, Portfolio Mgr. ------------------------------------ [Printed Name and Title] By: /s/ William Durecae ------------------------------------ William Durecae, Director ------------------------------------ [Printed Name and Title] "LESSEE": GALOOB TOYS, INC., a Delaware corporation By: /s/ Lou Novak ------------------------------------ Lou Novak, C.O.O. ------------------------------------ [Printed Name and Title] By: ------------------------------------ ------------------------------------ [Printed Name and Title] -50- 56 EXHIBIT A Premises Description The westerly 595 feet of Lot 15 of Tract No. 13645 in the City of Ontario, County of San Bernardino, State of California, as per map filed in Book 215, Pages 27 through 30 of Maps, records of said county. EXHIBIT A Page 1 of 1 57 EXHIBIT B Schedule of Reports 1. Fire Sprinkler System Report dated October 30, 1995, including 5-Year Certification dated October 18, 1995. 2. Report of Inspection of Fire Sprinkler System Pump prepared September 11, 1996 by Grinnel Fire Protection Company. 3. Roofing Report prepared by Stout Roofing, Inc. 4. 1996 statement from South Coast Air Quality Management District regarding operation of diesel fuel fire pump. EXHIBIT B Page 1 of 1 EX-11 5 COMPUTATION OF PER SHARE EARNINGS 1 EXHIBIT 11 GALOOB TOYS, INC. AND SUBSIDIARIES COMPUTATION OF EARNINGS PER SHARE
Years ended December 31 ----------------------- 1996 1995 1994 ---- ---- ---- Primary Earnings: - ----------------- Net earnings (loss) applicable to common shares ($000) $ (5,849) $ 6,272 $ 15,297 =========== =========== =========== Average shares of common stock outstanding during the period 14,289,364 10,071,304 9,852,673 Add: Incremental shares from assumed exercise of stock options and warrants -- 380,146 258,439 ---------- ---------- ---------- 14,289,364 10,451,450 10,111,112 ========== ========== ========== Net earnings (loss) per common share - primary $(.41) $ 0.60 $ 1.51 Fully Diluted Earnings: - ----------------------- Net earnings (loss) applicable to common shares ($000) $(5,849) $ 6,272 $ 15,297 Add: Preferred stock dividends: Paid ($000) 6 -- -- In arrears ($000) 15 3,127 3,127 Add: Interest on Debentures ($000) 205 1,030 1,072 ---------- ---------- ---------- $(5,623) $ 10,429 $ 19,496 ========== ========== ========== Average shares of common stock outstanding during the period 14,289,364 10,071,304 9,852,673 Add: Incremental shares from assumed exercise of stock options and warrants 1,113,296 444,409 261,458 Add: Shares issuable upon assumed conversion of Preferred Stock 534,309 2,180,148 2,180,148 Add: Shares issuable upon assumed conversion of 8% Convertible Subordinated Debentures, weighted 310,660 1,511,879 1,511,879 ---------- ---------- ---------- 16,247,629 14,207,740 13,806,158 ========== ========== ========== Net earnings (loss) per common share - Fully diluted $ (A) $ (A) $ 1.41 ========== ========== ==========
(A) Anti dilutive, therefore fully diluted earnings per share is same as primary earnings per share, $(0.41) and $(0.60) for 1996 and 1995, respectively. EX-21 6 SUBSIDIARIES 1 EXHIBIT 21 GALOOB TOYS, INC. AND SUBSIDIARIES SUBSIDIARIES OF THE REGISTRANT Galco International Toys, N.V., an Aruba corporation Galoob Direct, Inc., a California corporation EX-23.1 7 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS 1 EXHIBIT 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Prospectus constituting part of the Registration Statement on Form S-3 (No.33-33640) and Registration Statements on Form S-8 (No. 33-9393 and No. 33-56004) of Galoob Toys, Inc. and subsidiaries of our report dated January 31, 1997, appearing on page F-1 of this Form 10-K. Price Waterhouse LLP San Francisco, California March 31, 1997 EX-27 8 FINANCIAL DATA SCHEDULE
5 YEAR DEC-31-1996 JAN-01-1996 DEC-31-1996 27,920 0 112,219 9,897 19,974 180,417 16,589 6,117 196,905 46,023 0 0 0 179 149,612 196,905 284,905 284,905 144,282 144,282 116,959 0 3,183 20,936 2,485 20,936 0 0 0 18,451 (.41) (.41)
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