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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE AT OF 1934
(Mark One)
[X] Annual Report pursuant to section 13 or 15(d) of the Securities Exchange
Act of 1934 for the fiscal year ended December 31, 2001.
[ ] Transition Report pursuant to section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from ___ to ____.
Commission file number 0-22635
Racing Champions Corporation
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(Exact name of Registrant as Specified in Its Charter)
Delaware 36-4088307
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(State or Other Jurisdiction of (IRS Employer Identification No.)
Incorporation or Organization)
800 Roosevelt Road, Building C, Suite 320, Glen Ellyn, IL 60137
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 630-790-3507
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Securities registered pursuant to Section 12(b) of the Exchange Act:
Name of each exchange on
Title of each class which registered
NA NA
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Securities registered pursuant to Section 12(g) of the Exchange Act:
Common Stock, Par Value $.01 Per Share
----------------------------------------------------
(Title of class)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
Aggregate market value of the Registrant's common stock held by
nonaffiliates as of February 15, 2002: $133,752,243. Shares of common stock held
by any executive officer or director of the Registrant and any person who
beneficially owns 10% or more of the outstanding common stock have been excluded
from this computation because such persons may be deemed to be affiliates. This
determination of affiliate status is not a conclusive determination for other
purposes.
Number of shares of the Registrant's common stock outstanding as of
February 15, 2002: 14,617,408.
DOCUMENTS INCORPORATED BY REFERENCE
None.
2
As used in this report, the terms "we," "us," "our," "Racing Champions"
and the "Company" means Racing Champions Corporation and its subsidiaries,
unless the context indicates another meaning, and the term "common stock" means
our common stock, par value $0.01 per share.
PART I
ITEM 1. BUSINESS
For information as to net sales, operating income and identifiable
assets by geographic area, see the information set forth under in Note 5 to our
consolidated financial statements included elsewhere herein.
OVERVIEW
We are a leading producer and marketer of innovative collectibles and
toys targeted at males of all ages. Our diverse product offering includes scaled
die-cast replicas of John Deere agricultural equipment and NASCAR stock cars,
other licensed vehicle replicas, pre-teen toys, sports trading cards, racing
apparel and souvenirs, and collectible figures. These products are sold under
our market-focused brand names, including Racing Champions(R), Ertl(R), American
Muscle(TM), AMT(R), W. Britain(R) and Press Pass(R). We reinforce our brands and
enhance the authenticity of our products by linking them with highly recognized
licensed properties. Our products are marketed through multiple channels of
distribution, including mass retailers and specialty and hobby wholesalers and
retailers, as well as OEM dealers such as the John Deere dealer network, and to
corporate accounts for promotional purposes. We sell through more than 20,000
retail outlets located in North America, Europe and Asia Pacific.
PRODUCTS
We provide a diverse offering of highly detailed, authentic replicas and
stylized toys known for their quality workmanship. Our products have received
numerous "best of" awards from collector, family and toy magazines and currently
retail from $0.99 to $324.99. We have successfully expanded our product
offering, which currently consists of five product categories. By offering a
wide range of products at varying price points, we believe our products appeal
to a broad rage of consumers. The following chart summarizes our current product
categories:
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OUR KEY OUR KEY
CATEGORY LICENSES BRANDS PRICE RANGE
-------- -------- ------ -----------
Automotive, High Ford Racing Champions $1.29 - $39.99
Performance and Racing General Motors Racing Champions Authentics
Vehicle Replicas DaimlerChrysler Ertl Collectibles
NASCAR American Muscle
NHRA AMT
BodyShop
Agricultural, John Deere Ertl $1.99 - $174.99
Construction and Outdoor Case IH Ertl Precision
Sports Vehicle Replicas New Holland Ertl Collectibles
Agco Outdoor Sportsman
Polaris Britains
Honda
Pre-Teen Vehicles and John Deere Ertl $1.29 - $299.99
Role Play Activity Toys Thomas the Tank Engine Ertl Preschool
Bob the Builder Ertl Toys
Warner Brothers Little Muscle
Ford Bumble Ball
General Motors
DaimlerChrysler
Sports Trading Cards and NASCAR Racing Champions $0.99 - $324.99
Racing Apparel and NHRA Press Pass
Souvenirs NFL Wheels
Collectible Figures Realtree W. Britain $9.95 - $229.00
Mossy Oak Outdoor Sportsman
AUTOMOTIVE, HIGH PERFORMANCE AND RACING VEHICLE REPLICAS. We were a
pioneer of the licensed die-cast racing replica market and have produced
die-cast racing replicas since our inception in 1989, which gives us the longest
continuously produced line of racing replicas in the United States and a
well-established collector base for our products. Through acquisitions and
product development, we have expanded this category to include other automotive
and high performance vehicle replicas. We produce a broad line of replicas in
this category, including:
- American Muscle collectible die-cast classic, high performance,
entertainment-related and late model automobiles and trucks;
- Ertl Collectibles die-cast custom imprint cars and trucks and various
scales of delivery trucks and tractor trailers;
- Racing Champions die-cast high performance and late model non-racing
cars and trucks;
- AMT plastic model kits and BodyShop die-cast activity kits
principally of vintage and high performance automobiles, race cars,
trucks, aircraft and spacecraft; and
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- Racing Champions die-cast stock cars, trucks and team transporters
representing a large number of the vehicles competing in the NASCAR
Winston Cup Series, NASCAR Busch Grand National Series and the
National Hot Rod Association (NHRA) Drag Racing Series.
We market our 1:64th scale die-cast vehicle replicas to consumers for
purchase as either toys or collectibles. Our larger scaled, highly detailed
die-cast vehicle replicas are primarily targeted to adult collectors.
Collectors, by their nature, make multiple purchases of die-cast vehicles
because of their affinity for classic, high performance and late model cars,
trucks and hot rods. These collectors value the authenticity of the replicas and
the enjoyment of building their own unique collections. Our model kits are
primarily 1:25th scale and are purchased primarily by adult hobbyists who enjoy
building and collecting a range of models.
In 2001, we produced over 200 different styles of racing vehicle
replicas. Racing vehicle replicas are primarily marketed to racing fans and
adult collectors. These fans and collectors are attracted to racing replicas due
to the highly detailed, precise nature of the replicas, distinctive paint
schemes and the popularity of racing teams, drivers and sponsors represented by
the replicas.
Throughout 2002, we plan to introduce new releases in the American
Muscle product line, expand our line of 1:18th scale entertainment-related
automotive replicas, ship a new series of 1:64th scale entertainment-related
automobiles, release a line of concept cars based on the latest designs from the
2002 auto shows and relaunch our extensive line of 1:64th scale high performance
automotive die-cast replicas. In 2002, we plan to reissue over 50 model kits,
leveraging our tooling library of over 2,500 models. We also expect to produce
racing vehicle replicas for over 60 NASCAR and NHRA race teams. We recently
signed new licenses with the Lowe's Home Improvement NASCAR race team driven by
Jimmie Johnson and the Tide NASCAR race team driven by Ricky Craven.
AGRICULTURAL, CONSTRUCTION AND OUTDOOR SPORTS VEHICLE REPLICAS. This
category includes replicas of vintage and modern tractors, farm implements and
construction vehicles of major OEMs such as John Deere, Case IH and New Holland.
We also market replicas of all-terrain vehicles, snowmobiles, power boats and
personal watercraft of major manufacturers such as Polaris, Honda, Kawasaki,
Mastercraft, Correct Craft and Triton. These replicas are sold at a wide range
of retail prices and are positioned from classic sandbox toys to high-end
collector display units. Collectors of these vehicle replicas identify with the
form and function of the full-sized units, value the authenticity of the
replicas and purchase multiple products in order to build their own unique
collections.
In 2002, we plan numerous new releases in this category including over
45 new John Deere agricultural and construction replicas and new Polaris,
Kawasaki, Suzuki and Bombardier die-cast all-terrain vehicle replicas. Other new
releases include the 1:18th scale 2002 Chevrolet Suburban, 1:18th scale highly
detailed Triton bass boat and 1:6th scale Polaris all-terrain vehicle, which
will be sold individually and in a set with a 12-inch figure from our Outdoor
Sportsman line.
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PRE-TEEN VEHICLES AND ROLE PLAY ACTIVITY TOYS. This category is marketed
to parents and grandparents of preschool children and to children ages 5 to 12.
Products in this category include:
- John Deere stylized plastic and metal vehicle replicas, ride-on
vehicles and role play activity toys;
- Thomas the Tank Engine metal train locomotives, rail cars and plastic
railway accessories;
- Bob the Builder plastic and metal construction vehicles, figures and
accessories;
- Scooby Doo, John Deere, Thomas the Tank Engine and NASCAR push and
rolls, toy books, radio control vehicles, playsets and puzzles based
on various characters from these licensed properties; and
- Little Muscles plastic and metal personalized vehicles based on
licenses from Ford, General Motors and Daimler Chrysler, which we
introduced in 2001.
In 2001, we introduced to John Deere dealers the battery powered, John
Deere Gator ride-on, which retailed for $299. This product won numerous "toy of
the year" awards and was our top dollar selling item in 2001. We have the right
to sell this product through the John Deere dealer network and our manufacturing
partner has the right to sell this product in other distribution channels. Other
new John Deere ride-ons in 2001 included a metal tricycle, a plastic pedal
tractor and two sizes of steel wagons. In 2002, we plan to introduce additional
John Deere ride-ons and a Polaris battery powered all-terrain vehicle ride-on.
SPORTS TRADING CARDS AND RACING APPAREL AND SOUVENIRS. We market our
premium collectible sports trading cards under the Press Pass brand name, which
primarily feature NASCAR race drivers, team owners and crew chiefs. Press Pass
also markets NFL draft pick trading cards, which feature top college players who
are expected to be selected in the NFL draft. Our trading cards are targeted to
sports fans and trading card collectors. The collector base for sports trading
cards primarily consists of children and adult males.
Racing apparel and souvenirs sold by us include shirts, hats, jackets,
sunglasses, key chains, can coolers, bumper stickers, license plates and other
souvenirs featuring racing related licenses. Licensed properties on these
products include NASCAR, Ford Racing, Chevrolet Racing, Dodge Racing,
Caterpillar Racing and Cartoon Network Racing. In 2002, we added licensed
properties from the Lowe's Home Improvement and Tide racing teams. We primarily
sell apparel and souvenir products at trackside trailer concessions at NASCAR
racing events. We also distribute these products to wholesalers and retailers.
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COLLECTIBLE FIGURES. Under the brand name of W. Britain, we sell hand
painted metal military and ceremonial figures fashioned after European and
American historical events and themes. The W. Britain metal figures and sets are
sold primarily at collector, hobby, gift and specialty stores. In 2001, we
launched our Outdoor Sportsman product line of 12-inch and 5-inch plastic figure
replicas dressed in authentic outdoor sports attire, licensed from Realtree and
Mossy Oak, and outdoor sports accessory replicas. In 2002, we plan to introduce
a new line of highly detailed historic military leaders, sculpted as 12-inch
plastic figures and dressed in authentic replica clothing. In some cases, these
figures will be packaged and sold as a set with a miniature metal figure of the
same military leader.
NEW PRODUCTS
A key component of our strategy is to be first to market with innovative
collectibles and toys. We focus on identifying new product or licensing
opportunities in market segments where significant consumer enthusiasm exists.
We have an intimate understanding of the markets we serve due to the insight of
our integrated development teams, each of which focuses exclusively on a
specific end user group. This focus allows us to better understand the unique
preferences of our target markets and develop innovative, branded products that
appeal to our consumers' passions. Some of our new products are extensions to
our existing product lines and others are entirely new product lines. The
following is a summary of the six new product lines we plan to introduce in
2002.
50TH ANNIVERSARY CORVETTE. In the second half of 2002, we will begin
shipping special 50th Anniversary Corvette products based on a license agreement
with General Motors, which is exclusive for model kits and 1:18th scale die-cast
replicas and non-exclusive for 1:64th scale die-cast replicas. This product line
will include the release of a special American Muscle die-cast replica series of
milestone Corvettes. We will also launch a special series of AMT and BodyShop
Corvette model kits commemorating the 50th anniversary. With some of our
retailers, we expect to receive incremental shelf space for these product lines,
which are a natural extension of our die-cast vehicle replicas and model kits.
HARLEY-DAVIDSON. We recently signed a multi-year license agreement with
this legendary motorcycle manufacturer, which will allow us to produce and
market the following products to selected distribution channels beginning in the
second half of 2002.
- Harley-Davidson Collectibles. Under the American Muscle brand, we
plan to produce both 1:18th scale and 1:10th scale highly detailed
collectible Harley-Davidson die-cast replicas. We plan to market
these products at Harley-Davidson dealers, at specialty, collector
and hobby stores and at non-discount chain retailers. We believe that
the collectible Harley-Davidson product line will expand our reach to
include an entirely new audience and collector base.
- Harley-Davidson Preschool Toys. We plan to introduce a new line of
Harley-Davidson preschool toys, including personalized motorcycles,
motorcycle rider figures,
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accessories and play sets. We plan to market these products at
Harley-Davidson dealers, at specialty and independent toy stores and
at non-discount chain retailers.
- Harley-Davidson NHRA Pro Stock Drag Racing Bike. For the first time,
Harley-Davidson is producing a drag racing bike for competition on
the NHRA circuit. In 2002, we plan to produce a new 1:6th scale
Racing Champions Authentics replica of the Harley-Davidson NHRA Pro
Stock drag racing bike that we will market through Harley-Davidson
dealers and hobby stores.
HOMETOWN ROADWAY. We plan to introduce Hometown Roadway(TM),
interlocking wooden track vehicle and building systems based on hometown
real-life themes from licensing partners such as John Deere, Texaco, Ford,
General Motors and DaimlerChrysler. The basic units will include wooden vehicles
and connecting wooden roadway sections and will be compatible with existing
wooden vehicle systems. We also plan to produce wooden police, fire and rescue
vehicle systems. In addition to selling basic units, we plan to sell larger
sets, which would include wooden vehicles, a wooden roadway and wooden replica
buildings.
JOYRIDE STUDIOS. We recently introduced JoyRide Studios, a new brand of
collectible figures and vehicles based on popular video game titles.
Introductions of the articulated figures and highly detailed vehicles will be
based on new video game releases and will include special "codes, strategies and
cheats" from the experts at GamePro Magazine, a multi-platform gaming magazine
that is a popular publication for gamers, and Nintendo Power, a popular gaming
magazine focused on Nintendo platform games. GamePro Magazine and Nintendo Power
are also providing development and marketing support for most of these product
lines.
The new JoyRide Studios' branded products will be released beginning in
July 2002 under license agreements with well-known video game publishers, such
as Nintendo, Sega and Electronic Arts. These products will feature famous
characters from video game software available on personal computers and on
top-selling next-generation video game systems including Nintendo's GameCube and
Game Boy Advance, Sony's PlayStation 2 and Microsoft's Xbox. Initial collectible
video game figures and vehicles will be based on properties such as SSX Tricky,
Cel Damage, Command & Conquer, Sonic the Hedgehog, Virtua Fighter 4, Super
Monkey Ball, Crazy Taxi, Luigi's Mansion, Legend of Zelda and Metroid. We plan
to market these products through many of our existing customers as well as
through electronic and video game retailers.
STACKERS. In 2002, we will introduce Stackers(TM), an interactive
building block and track system that also serves as a play environment and
display cases for 1:64th scale die-cast vehicle replicas. This product line will
include display blocks, connecting tracks and other accessories and will be sold
in sets, most of which will include our 1:64th scale die-cast vehicle replicas.
The Stackers display blocks are buildable into extensive designs and are
compatible with existing block building systems. Stackers will be sold primarily
at mass retailers and specialty toy stores.
DR. SEUSS. We recently signed a license agreement with Dr. Seuss
Enterprises, L.P., which allows us to develop and market a line of highly
featured figures and vehicles based on the world famous books from Dr. Seuss.
Initial products will include well-known scenes from the
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The Cat in the Hat and Green Eggs and Ham. We plan to release these products
beginning in July 2002 in specialty and independent toy stores and in
non-discount chains.
LICENSES
We market virtually all of our products under licenses from other
parties. We have license agreements with automotive and truck manufacturers;
agricultural, construction and outdoor sports vehicle and equipment
manufacturers, major race sanctioning bodies; race team owners, sponsors and
drivers; and entertainment, publishing and media companies. A significant
element of our strategy depends on our ability to identify and obtain licenses
for recognizable and respected brands and properties. Our licenses reinforce our
brands and establish our products' authenticity, credibility and quality with
consumers and, in some cases, provide for new product development opportunities
and expanded distribution channels. Our licenses are generally limited in scope
and duration and authorize the sale of specific licensed products on a
nonexclusive basis. Our licenses often require us to make minimum guaranteed
royalty payments whether or not we meet specific sales targets. We have
approximately 600 license agreements generally for terms of 1 to 3 years.
CHANNELS OF DISTRIBUTION
Our products are available through more than 20,000 retail outlets
located in North America, Europe and Asia Pacific. We market our products
through multiple channels of distribution in order to maximize our sales
opportunities for our broad product offering. Products with lower price points
are generally sold in mass retail channels while products with higher detailed
features and prices are typically sold in hobby, collector and independent toy
stores and through wholesalers and OEM dealers. Our leading position in multiple
distribution channels enhances our ability to secure additional licenses,
extends the reach of our products to consumers and mitigates the risk of
concentration by channel or customer.
MASS RETAILERS. We marketed 40.8% of our products through the mass
retail channel in 2001. Our products marketed through this channel are targeted
predominantly at price conscious end-users. As a result, the majority of our
products marketed through this channel are designed to span lower price points
and retail for less than $30. Key customers in our mass retail channel include
Wal-Mart, Kmart, Target, Toys R Us, Zany Brainy and Tractor Supply Corporation.
SPECIALTY AND HOBBY WHOLESALERS AND RETAILERS. We sell many of the
products available at mass retailers as well as special higher feature and
higher priced products to specialty and hobby wholesalers and retailers. We
reach these customers directly through our internal telesales group and
business-to-business web site and through specialty toy outside representatives
and collectible and toy trade shows. Key customers in our specialty and hobby
wholesaler and retailer channel include Great Planes, Master Toys, Excell
Marketing, Toymaster and Horizon Hobby.
OEM DEALERS. We often sell licensed products to the licensing OEM's
dealer network. OEM licensing partners benefit from our OEM dealer sales by
receiving additional royalties. We often give OEM dealers the first opportunity
to purchase new products and provide them with a
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short-term exclusive period. Key customers in our OEM dealer channel include
John Deere, Case IH and Polaris. In 2002, we expect our new Harley-Davidson
product line to expand our OEM dealers channel.
CORPORATE PROMOTIONAL ACCOUNTS. We have the top position in North
America in the die-cast vehicle corporate promotional channel. Corporate
promotional products allow a company to promote its products, reinforce its
brands and reward employees and customers. In this channel we can
cost-effectively accommodate both large unit orders and lower unit orders, which
gives us a competitive advantage. Key customers in our corporate promotional
account channel include Texaco, Matco Tools, Mac Tool, BP Amoco and
Bristol-Myers Squibb.
DIRECT TO CONSUMER. We make certain of our products available for direct
sales to consumers through our trackside event sales concessions, our company
stores, our business-to-consumer website located at www.diecastexpress.com and
our strategic alliance with the Bradford Group, a top direct marketing company.
Individual products sold direct to consumer are sold at prices similar to retail
prices found at retailers, hobby stores and dealers.
PATENTS AND TRADEMARKS
We have registered several trademarks with the U.S. Patent and Trademark
Office, including the marks Racing Champion(R), Ertl(R) and Press Pass(R). A
number of Ertl trademarks are also registered in foreign countries. We hold U.S.
patents for our trading card display stand and model vehicle and for our unique
packaging system which includes a die-cast vehicle, emblem and display stand. We
believe that there is a significant value in our Racing Champions and Ertl
trademarks and plan to build additional value through increased customer
awareness of many of our other trade names and trademarks.
SALES AND MARKETING
Our sales organization consists of an internal sales force and external
sales representative organizations. Our internal sales force provides direct
customer contact with nearly all of our retail chains and key wholesale
accounts. A number of accounts are designated as "house accounts" and are
handled exclusively by our internal sales staff. Our inside sales and customer
service groups use telephone, mailings, faxes and e-mails to directly contact
OEM dealers and smaller volume customers such as collector, hobby, specialty and
independent toy stores.
Our internal sales force is supplemented by external sales
representative organizations that are divided geographically. These external
sales representative organizations provide more frequent customer contact and
solicitation of the national, regional and specialty retailers and supported
32.2% of our net sales in 2001. External sales representatives generally earn
commissions of 1% to 10% of the net sales price from their accounts, and their
commissions are not affected by the involvement of our internal sales force with
a customer or sale.
In 2001, we launched a business-to-business website called RCE
Advantage(TM) located at www.rceb2b.com. This website, targeted to smaller
volume accounts, allows qualified
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customers to view new product offerings, place orders, check order and shipping
status and review account history information. We believe that RCE Advantage
leverages our internal sales force, inside sales group and customer service
group by providing customers with information access and ordering capability.
We direct our marketing program toward collectors, current users and
potential new users that fit the demographic profile of our target market. The
focus of our marketing plan is to increase awareness of our product offerings
and brand names. We use the following media in our marketing plan.
- Advertising. We place advertisements in publications with high,
specific market penetration such as outdoor sports enthusiast,
die-cast, trading card collector and figure collector publications.
We also advertise in national publications read by our targeted
enthusiasts, demographic profile and collector base, such as NASCAR
Magazine, Parenting Magazine and Toy Cars & Models. We also use
advertisements on cable television programs that target our
consumers. For example, in 2001, we promoted our new Outdoor
Sportsman product line by advertising on cable television hunting and
fishing shows and by placing advertisements in outdoor sports related
publications.
- Public Relations. We have developed a sustained public relations
effort to build relationships with editors at collector publications.
Ongoing product notices keep editors abreast of changing products,
increase our credibility and market acceptance, and encourage the
editorial staffs of these publications to give more coverage to our
products. We also use press releases to increase awareness of new
product introductions.
- Co-op Advertising. We work closely with retail chains to plan and
execute ongoing retailer driven promotions and advertising. The
programs usually involve promotion of our products in retail
customers' print circulars, mailings and catalogs.
- Direct Consumer. The Internet is an increasingly important part of
our marketing plan because collectors have quickly adopted the
Internet as a preferred way to communicate with other enthusiasts
about their hobby. We have established a website located at
www.rcertl.com that highlights our products, lists product release
dates and collects market data directly from consumers. We also
gather consumer information through consumer letters, e-mail,
telephone calls and product surveys.
COMPETITION
We compete with several large international toy and collectible
companies, such as Mattel, Inc., Hasbro, Inc., Action Performance Companies,
Inc., Jakks Pacific Inc., Little Tikes Company and Maisto Ltd., and with other
producers of vehicle replicas, toys and model kits such as Playing Mantis, Yat
Ming, Burago, FUNline, Revell-Monogram and Zindart/Corgi. Our Press Pass sports
trading cards compete primarily with Topps, Upper Deck and Fleer, and with
several
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smaller companies with more limited product lines. Competition in the
distribution of our products is intense and is primarily based on product
appeal, ability to capture shelf or rack space, timely distribution, price and
quality. Competition is also based on the ability to obtain license agreements
for existing and new products to be sold through specific distribution channels
or retail outlets. Many of our competitors have greater financial, technical,
marketing and other resources than we have.
PRODUCTION
We are an industry leader in bringing new products to market rapidly and
efficiently. Our integrated design and engineering expertise, extensive library
of die-cast molds and dedicated suppliers enable us to be first to market with
many innovative products.
FAR EAST PRODUCT SOURCING. We have operations in Kowloon, Hong Kong and
in the Racing Industrial Zone in Dongguan City, China and employ 154 people in
Hong Kong and China who oversee the sourcing of the majority of our products.
This group assists our suppliers in sourcing raw materials and packaging,
performs engineering and graphic art functions, executes the production
schedule, provides on-site quality control, facilitates third-party safety
testing and coordinates the delivery of shipments for export from China.
FAR EAST PRODUCTION. All of our products are manufactured in China,
except for plastic ride-ons, sports trading cards and racing apparel and
souvenirs. Our China-based product sourcing accounted for approximately 83.6% of
our total product purchases in 2001. We primarily use four independent,
dedicated suppliers who manufacture only our products in six factories, five of
which are located in the Racing Industrial Zone. These independent, dedicated
suppliers produced approximately 67.0% of our China-based product purchases in
2001. In order to supplement our independent, dedicated suppliers, we use
approximately 10 other suppliers in China. All products are manufactured to our
specifications using molds and tooling that we own. These suppliers own the
manufacturing equipment and machinery, purchase raw materials, hire workers and
plan production. We purchase fully assembled and packaged finished goods in
master cartons for distribution to our customers. Most of our suppliers have
been supplying us for more than five years. Our purchases in 2001 from our
independent, dedicated suppliers, Sharp Success, Win Yield, Sunrise and Shun
Fung were 26.9%, 18.0%, 13.5%, and 8.5%, respectively, of our China-based
product purchases. We have only purchase orders and not long-term contracts with
our suppliers.
DOMESTIC PRODUCTION. The production of plastic ride-ons, sports trading
cards and NASCAR apparel and souvenirs is completed primarily by U.S.-based
suppliers. We create the product design and specifications and coordinate the
manufacturing activities. We generally prefer to coordinate the production of
these products through a limited number of suppliers and believe that a number
of alternate suppliers are available.
TOOLING. To create new products, we continuously invest in new tooling.
These tooling expenditures represent the majority of our capital expenditures.
Depending on the size and complexity of the product, the cost of tooling a
product generally ranges from $15,000 to $150,000. For
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many of our products, we eliminate significant tooling time by utilizing our
extensive tooling library of over 13,000 tools. We own all of our tools and
provide them to our suppliers during production. Tools are returned to us when a
product is no longer in production and are stored for future use.
PRODUCT SAFETY. Our products are designed, manufactured, packaged and
labeled to conform with the U.S. safety requirements of the American Society for
Testing and Materials and the Consumer Product Safety Commission and are
periodically reviewed and approved by independent safety testing laboratories.
Products sold in Europe also conform to European Commission standards. We carry
product liability insurance coverage with a limit of over $20.0 million per
occurrence. We have never been the subject of a product liability claim.
LOGISTICS. Our customers purchase our products either in the United
States or the United Kingdom, or directly from China. We own a distribution
facility in Dyersville, Iowa and use an independent warehouse in the United
Kingdom.
SEASONALITY
We have experienced, and expect to continue to experience, substantial
fluctuations in our quarterly net sales and operating results, which is typical
of many companies in our industry. Our business is highly seasonal due to high
consumer demand for our products during the year-end holiday season.
Approximately 58.2% of our net sales over the two years ended December 31, 2001
were generated in the second half of the year, with September and October being
the largest shipping months. As a result, our investment in working capital,
mainly inventory and accounts receivable is highest during the fourth quarter
and lowest during the first quarter.
CUSTOMERS
We derive a significant portion of our sales from some of the world's
largest retailers and OEM dealers. Our top five customers accounted for 34.1%,
37.4% and 39.0% of total net sales in 1999, 2000 and 2001, respectively.
Wal-Mart and the John Deere dealer network, our largest customers, accounted for
15.6% and 14.6% of total net sales in 2001, respectively. Other than Wal-Mart
and the John Deere dealer network, no other customer accounted for more than 10%
of our total net sales in 1999, 2000 or 2001. Many of our retail customers
generally purchase large quantities of our products on credit, which may cause a
concentration of accounts receivable among some of our largest customers.
EMPLOYEES
As of December 31, 2001, we had 418 employees, 16 of whom were employed
part-time. We emphasize the recruiting and training of high quality personnel
and, to the extent possible, promote people from within Racing Champions. A
collective bargaining agreement covers 57 of our employees, all of whom work in
the distribution facility in Dyersville, Iowa. We consider our employee
relations to be good. Our continued success will depend in part on our ability
to attract, train and retain qualified personnel at all of our locations.
13
ITEM 2. PROPERTIES
As of December 31, 2001, our facilities were as follows:
DESCRIPTION SQUARE FEET LOCATION LEASE EXPIRATION
- ----------------------------------- ----------- ----------- ----------------
Corporate Headquarters............ 10,257 Glen Ellyn, IL October 2003
Hong Kong office................. 19,828 Kowloon, Hong Kong June 2002
Racing Champions South, Inc. office 6,864 Charlotte, NC April 2007
Racing Champions South, Inc. office
and warehouse............... 40,000 Mooresville, NC February 2002
Racing Champions Ertl, Inc. office
and warehouse.................... 328,000 Dyersville, IA Owned
Racing Champions Ertl, Inc.
warehouse........................ 171,500 Dyersville, IA Owned
Racing Champions International
Limited office................... 5,419 Exeter, United Kingdom October 2013
Racing Champions International 71,026 Nottingham, United September
Limited warehouse(1)....... Kingdom 2004
Racing Industrial Zone office, June 2002 through
quarters and storage............. 53,700 Dongguan City, China March 2003
Green's Racing Souvenirs, Inc.
office and warehouse............. 20,000 South Boston, VA December 2004
- --------------------
(1) The Nottingham warehouse has been sublet and is no longer used in the
our operations. U.K. distribution activities have been contracted to an
independent warehouse.
ITEM 3. LEGAL PROCEEDINGS
We have settled the securities class action lawsuit originally filed in
2000 in the U.S. District Court for the Northern District of Illinois, Eastern
Division under the caption Market Street Securities, Inc., et al. v. Racing
Champions Corporation, et al. Pursuant to the settlement, we made a $1.8 million
payment, which was covered by insurance. We incurred legal expenses of
approximately $1.0 million in connection with this lawsuit that were not covered
by insurance.
In August 1999, a purported class action lawsuit was filed against us in
the U.S. District Court for the Southern District of California, in a case
entitled Dumas, et al. v. Racing Champions Corporation. The complaint alleges
that the defendants have violated RICO and the California Unfair Competition Law
by selling packs of sports trading cards containing random assortments of cards
of varying values. This lawsuit has been dismissed by the trial court and
currently is on appeal to the Ninth Circuit Court of Appeals. The appeal was
consolidated with appeals of seven virtually identical lawsuits filed by other
putative plaintiffs' classes. We dispute
14
this claim and intends to vigorously defend our position, although no assurances
can be given as to the outcome of this matter.
A purported class action lawsuit was filed on August 21, 2000, in
California state court against Racing Champions South, Inc. and several other
defendants in a case entitled Chaset v. The Upper Deck Company, et al. The
lawsuit purports to include a proposed class of all U.S. residents who purchased
sports cards manufactured, licensed, marketed, sold or distributed by any
defendant within a time period of up to four years. The complaint alleges that
the defendants have violated the California unfair trade practices and consumer
protection laws by selling packs of sports trading cards containing random
assortments of varying values. The plaintiffs seek actual damages, attorneys'
fees, pre- and post-judgment interest, exemplary damages, and injunctive relief.
In May 2001, the defendant's motion for summary judgment was denied. In
September 2001, the California Supreme Court denied permission to the defendants
to appeal the denial of their motion for summary judgment. The plaintiffs'
motion for class certification is currently pending with the trial court. We
dispute these claims and intend to vigorously defend our position, although no
assurance can be given as to the outcome of this matter.
We have certain contingent liabilities resulting from litigation and
claims incident to the ordinary course of business. Management believes that the
probable resolution of such contingencies will not materially affect the
financial position or the results of our operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the
fourth quarter of the fiscal year ended December 31, 2001.
15
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock has traded on the Nasdaq SmallCap Market under the
symbol "RACN" since May 8, 2000. Prior to May 8, 2000, the common stock traded
on the Nasdaq National Market. We have applied to have our common stock listed
on the Nasdaq Stock Market under the symbol "RACN." The following table sets
forth the high and low closing sale prices for the common stock as reported by
the Nasdaq for the periods indicated.
HIGH LOW
---- ---
2000:
First Quarter.............................. $ 5.00 $ 3.13
Second Quarter............................. 3.53 1.13
Third Quarter.............................. 1.78 0.84
Fourth Quarter............................. 1.69 0.84
2001:
First Quarter.............................. $ 3.31 $ 1.00
Second Quarter............................. 5.20 2.40
Third Quarter.............................. 7.50 4.15
Fourth Quarter............................. 12.95 4.53
As of December 31, 2001, there were approximately 176 holders of record
of our common stock and over 1,800 beneficial owners of our common stock.
We have not paid any cash dividends on our common stock. We intend to
retain any earnings for use in the operation and expansion of our business and,
therefore, do not anticipate paying any cash dividends in the foreseeable
future. Our amended credit agreement contains a provision restricting our
ability to pay dividends.
16
ITEM 6. SELECTED FINANCIAL DATA
The following table presents selected consolidated financial data, which
should be read along with our consolidated financial statements and the notes to
those statements and with "Management's Discussion and Analysis of Financial
Condition and Results of Operations." The consolidated statement of income data
for the years ended December 31, 1999, 2000 and 2001 and the consolidated
balance sheet data as of December 31, 2000 and 2001 are derived from our audited
consolidated financial statements included elsewhere herein. The consolidated
statement of income data for the years ended December 31, 1997 and 1998 and the
consolidated balance sheet data as of December 31, 1997, 1998 and 1999 are
derived from our audited consolidated financial statements which are not
included herein.
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------
1997 1998 1999 2000 2001
------- ------- ------ ------ ------
CONSOLIDATED STATEMENTS OF INCOME: (IN THOUSANDS, EXCEPT PER SHARE DATA)
Net sales....................... $83,745 $156,464 $231,360 $214,806 $203,248
Cost of sales (1)............... 38,642 70,850 132,683 116,328 99,481
------ -------- --------- --------- ---------
Gross profit.................. 45,103 85,614 98,677 98,478 103,767
Selling, general and
administrative expenses (1)(2). 29,625 54,302 79,762 71,636 67,853
Other charges (3)............... - 5,526 6,400 - -
Amortization of goodwill and
other assets................... 2,216 2,663 3,543 3,795 3,376
------- -------- --------- --------- ---------
Operating income.............. 13,262 23,123 8,972 23,047 32,538
Interest expense................ 5,220 2,751 7,650 11,375 6,470
Other expense (income).......... 200 399 (105) 662 277
------- -------- --------- --------- ---------
Income before income taxes.... 7,842 19,972 1,427 11,010 25,791
Income tax expense.............. 3,306 8,231 892 5,120 10,668
------- -------- --------- --------- ---------
Net income from continuing
operations before
extraordinary item........... $ 4,536 $ 11,741 $ 535 $ 5,890 $ 15,123
======= ======== ========= ========= =========
Net income from continuing
operations before extraordinary
item per share:
Basic......................... $0.33 $0.73 $0.03 $0.40 $1.03
Diluted....................... 0.32 0.71 0.03 0.39 1.00
Weighted average shares
outstanding:
Basic......................... 12,279 15,982 16,249 14,827 14,663
Diluted....................... 12,621 16,426 16,588 15,085 15,159
AS OF DECEMBER 31,
------------------------------------------------------------
1997 1998 1999 2000 2001
--------- --------- --------- -------- --------
BALANCE SHEET DATA: (IN THOUSANDS)
Working capital............... $(4,053) $ 9,420 $ 39,028 $ 38,955 $ 26,392
Total assets.................. 29,240 160,504 276,282 251,907 235,523
Total debt.................... 29,186 34,000 123,000 97,000 62,000
Total stockholders' equity.... 91,604 102,582 101,848 104,565 117,761
- ---------------------
(1) Depreciation expense was approximately $2.2 million, $3.3 million, $7.5
million, $9.6 million and $9.2 million for the years ended December 31,
1997, 1998, 1999, 2000 and 2001, respectively.
(2) Selling, general and administrative expenses for 2000 include a charge of
$2.5 million related to minimum guaranteed royalty payments on
NASCAR-related licensing agreements, which exceeded royalties earned on
product sales.
(3) Other charges include $5.5 million in merger related costs for the year
ended December 31, 1998 in connection with the acquisition of Wheels Sports
Group, Inc. and $6.4 million in restructuring and other charges for the year
ended December 31, 1999 in connection with the integration of The Ertl
Company, Inc.
17
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
We are a leading producer and marketer of collectibles and toys targeted
at males of all ages. Our products are marketed through multiple channels of
distribution and are available at more than 20,000 retail outlets located in
North America, Europe and Asia Pacific. Our product categories include (i)
automotive, high performance and racing vehicle replicas; (ii) agricultural,
construction and outdoor sports vehicle replicas; (iii) pre-teen vehicles and
role play activity toys; (iv) sports trading cards and racing apparel and
souvenirs; and (v) collectible figures. We market virtually all of our products
under licenses from other parties, and we are currently party to approximately
600 license agreements.
Corporate History. Since our inception in 1989, we have capitalized on
the popularity of themed collectibles and toys. We became well known in the
early 1990's for our officially licensed collectible die-cast replicas of
popular race cars. We capitalized on our status as a pioneer of this market to
become a leading producer of other automotive die-cast replicas. These products
were primarily sold in the mass retail channel under our Racing Champions brand.
On April 30, 1996, an investor group led by Willis Stein & Partners,
L.P. and some members of our management consummated a recapitalization
transaction in which our foreign and domestic operations were combined. This
transaction was accounted for using the purchase method and provided us with a
stronger platform to manage our business more effectively.
Following several years of strong growth, we completed an initial public
offering in June 1997. In the offering, we sold approximately 5.4 million shares
of common stock and received net proceeds of $68.7 million. This offering
provided us with additional capital to grow our business through internal
initiatives and acquisitions.
In June 1998, we acquired Wheel Sports Group, Inc. (subsequently renamed
Racing Champions South, Inc.) for 2.7 million shares of our common stock. This
transaction was accounted for as a pooling of interests. All financial
information is presented as if this transaction had been effected as of the
beginning of the earliest reporting period. The purchase of Wheel Sports Group
built upon our strength in the racing segment by expanding our product lines to
include collectible sports trading cards, souvenirs and apparel.
In April 1999, we acquired The Ertl Company, Inc. for approximately
$94.6 million in cash. This transaction was accounted for using the purchase
method and accordingly, the operating results of Ertl have been included in our
consolidated financial statements since the date of the acquisition. Ertl is a
premier producer and marketer of collectibles and toys focused on agricultural
and heavy equipment die-cast vehicle replicas, classic and high performance
die-cast vehicle replicas, custom imprint die-cast vehicle replicas, preschool
toys, collectible figures and hobby model kits. The combination dynamically
transformed us into the company now known as Racing Champions Ertl.
18
Integration Initiatives. During 1999 and 2000, we focused on integrating
our acquisitions, particularly Ertl. We implemented numerous initiatives to
achieve synergies and cost savings from these acquisitions. For example, we:
- relocated certain tooling and production to China from Mexico;
- combined offices and warehouses in the United States, Hong Kong and
China, and eliminated excess facilities;
- consolidated back-office and support functions and systems;
- simplified the organizational structure, eliminated redundant
functions and right-sized facilities across the combined entity; and
- eliminated unprofitable products and product lines.
In 2001, we realized significant benefits from the integration, which
reduced Ertl's inventory and resulted in increased profitability and cash flow.
Our gross margins increased from 42.7% in 1999 to 51.1% in 2001 and our selling,
general and administrative expenses declined 14.9%, from $79.8 million in 1999
to $67.9 million in 2001. From our highest debt level after the Ertl acquisition
closed, we have reduced our bank debt by $84.3 million to $62.0 million as of
December 31, 2001 through our integration initiatives and active working capital
management.
Sales. Our sales are primarily derived from the sale of collectibles and
toys and are recognized upon transfer of title of product to our customers. We
market our products through a variety of distribution channels, including mass
retailers; specialty and hobby wholesalers and retailers; OEM dealers; corporate
promotional accounts; and direct to consumer. For the years ended December 31,
1999, 2000, and 2001, sales to mass retailers comprised 43.5%, 41.2% and 40.8%,
respectively, of our net sales.
Our products are marketed and distributed in North America, Europe and
Asia Pacific. International sales constituted less than 10% of our net sales for
each of the last three years. We expect international sales to increase over the
next several years as we expand our geographic reach. Our net sales have not
been materially impacted by foreign currency fluctuations.
We derive a significant portion of our sales from some of the world's
largest retailers and OEM dealers. Our top five customers accounted for 34.1%,
37.4% and 39.0% of our net sales in 1999, 2000 and 2001, respectively. Wal-Mart
and the John Deere dealer network, our largest customers, accounted for 15.6%
and 14.6% of our net sales in 2001, respectively. Other than Wal-Mart and the
John Deere dealer network, no other customer accounted for more than 10% of our
net sales in 1999, 2000 or 2001.
We provide customers the option to take delivery of our products either
in the United States or the United Kingdom with credit terms ranging from 30 to
120 days or directly in China with payment made by irrevocable letter of credit
or wire transfer. Since direct sales from China reduce our distribution and
administrative costs, we generally grant price discounts of 15.0% to 25.0% on
these sales, which results in lower gross profit margins for these sales
compared to
19
sales completed in the United States or the United Kingdom. Therefore, annual
fluctuations in the mix of products delivered in the United States or the United
Kingdom versus products delivered in China will affect year-to-year
comparability of net sales and gross profit margins. However, we believe that
our operating income margin is comparable for products delivered in China versus
products delivered in the United States or the United Kingdom due to the
elimination of distribution and certain administrative costs. For the years
ended December 31, 1999, 2000, and 2001, direct sales from China constituted
21.5%, 13.2% and 9.8%, respectively, of our net sales.
We do not sell our products on consignment and ordinarily accept returns
only for defective merchandise. In certain instances, where retailers are unable
to resell the quantity of products that they have purchased from us, we may, in
accordance with industry practice, assist retailers in selling such excess
inventory by offering credits and other price concessions, which are typically
evaluated and issued annually. Returns and allowances have ranged from 5.0% to
9.0% of net sales over the last three fiscal years.
Expenses. Cost of sales primarily consists of purchases of finished
products, which accounted for 85.6%, 81.4 % and 80.1% of our cost of sales in
1999, 2000 and 2001, respectively. The remainder of our cost of sales includes
tooling depreciation, freight-in from the supplier and concept and design
expenses. Substantially all of our purchases of finished products are
denominated in Hong Kong dollars and, therefore, subject to currency
fluctuations. Historically, we have not incurred substantial expense due to
currency fluctuations because the Hong Kong government has maintained a policy
of linking the U.S. dollar and the Hong Kong dollar since 1983.
Selling, general and administrative expenses primarily consist of
royalties, employee compensation, advertising and marketing expenses,
freight-out to customers and sales commissions. Royalties vary by product
category and are generally paid on a quarterly basis. Multiple royalties may be
paid on a product to various licensors. In 2001, aggregate royalties by product
ranged from approximately 2.0% to 20.0% of our selling price. Royalty expense
for 2001 was approximately 9.4% of our net sales. Sales commissions range from
1.0% to 10.0% of the net sales price and are paid quarterly to our external
sales representative organizations. In 2001, sales subject to commissions
represented 32.2% of our net sales and sales commission expense was 1.8% of our
net sales.
Seasonality. We have experienced, and expect to continue to experience,
substantial fluctuations in our quarterly net sales and operating results, which
is typical of many companies in our industry. Our business is highly seasonal
due to high consumer demand for our products during the year-end holiday season.
Approximately 58.1% of our net sales over the two years ended December 31, 2001
were generated in the second half of the year. As a result, our investment in
working capital, mainly inventory and accounts receivable is generally highest
during the fourth quarter and lowest during the first quarter.
20
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------------
1999 2000 2001
-------------------- ------------------------ -------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
-------- --------- -------- --------- -------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net sales....................... $231,360 100.0% $214,806 100.0% $203,248 100.0%
Cost of sales................... 132,683 57.3 116,328 54.2 99,481 48.9
------- ----- ------- ----- ------- -----
Gross profit................... 98,677 42.7 98,478 45.8 103,767 51.1
Selling, general and
administrative expenses........ 79,762 34.5 71,636 33.3 67,853 33.4
Amortization of goodwill and
other assets................... 3,543 1.5 3,795 1.8 3,376 1.7
Restructuring and other charges. 6,400 2.8 - 0.0 - 0.0
------- ----- ------- ----- ------- -----
Operating income............... 8,972 3.9 23,047 10.7 32,538 16.0
Interest expense, net........... 7,650 3.3 11,375 5.3 6,470 3.2
Other expense (income).......... (105) 0.0 662 0.3 277 0.1
-------- ----- ------- ----- ------- -----
Income before income taxes..... 1,427 0.6 11,010 5.1 25,791 12.7
Income tax expense.............. 892 0.4 5,120 2.4 10,668 5.2
------- ----- ------- ----- ------- -----
Net income..................... $ 535 0.2 $ 5,890 2.7 $ 15,123 7.5
======= ===== ======= ===== ======= =====
Net income per share:
Basic.......................... $ 0.03 $ 0.40 $ 1.03
Diluted........................ 0.03 0.39 1.00
Weighted average shares
outstanding:
Basic.......................... 16,249 14,827 14,663
Diluted........................ 16,588 15,085 15,159
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
Net Sales. Net sales decreased $11.6 million, or 5.4%, to $203.2 million
for 2001 from $214.8 million for 2000. Approximately $7.4 million of the sales
decrease was due to fewer sales of low margin liquidation items. Sales
in our automotive, high performance and racing vehicle replica category
decreased 16.7%. Sales in our agricultural, construction and outdoor sports
vehicle replica category decreased 8.6%. The decreased sales in these categories
were primarily due to fewer inventory liquidations, a focused effort of SKU
reduction and the timing of new releases in 2001. These decreases were partially
offset by increased sales of sports trading cards and racing apparel and
souvenirs, which increased 48.4%, due to additional trading card releases in
2001 versus 2000, as well as increased sales of our apparel and souvenirs at
trackside events. Sales in the pre-teen and role play activity toys category
also increased by 6.2%, primarily due to the introduction of new John Deere
ride-ons and the Little Muscle product line. Sales in the collectible figures
category increased 3.8%, due to the introduction of Outdoor Sportsman
collectible figures and increased sales of our W. Britain collectible metal
figures.
Gross Profit. Gross profit increased $5.3 million, or 5.4%, to $103.8
million for 2001 from $98.5 million for 2000. The gross profit margin increased
to 51.1% in 2001 from 45.8% in 2000. The increase in the gross profit margin was
attributable to realization of a full year's benefit from the integration of
Ertl, including better product sourcing, consolidated manufacturing in China and
streamlined product development efforts, as well as a reduction in
21
sales of products with lower margins. There were no major changes in the
components of cost of sales.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses decreased $3.7 million, or 5.2%, to $67.9 million for
2001 from $71.6 million for 2000. The decrease was due in part to the
realization of a full year's benefit from the integration of Ertl and improved
control of discretionary expenditures, but was also impacted by the lower sales
volume in 2001. In addition, selling, general and administrative expenses for
2000 included a $2.5 million charge related to minimum guaranteed royalty
payments on NASCAR-related license agreements, which exceeded royalties earned
on product sales. As a percentage of net sales, selling, general and
administrative expenses remained relatively constant at 33.4% for 2001 and 33.3%
for 2000.
Operating Income. Operating income increased $9.5 million, or 41.3%, to
$32.5 million for 2001 from $23.0 million for 2000. As a percentage of net
sales, operating income increased to 16.0% for 2001 from 10.7% for 2000.
Net Interest Expense. Net interest expense of $6.5 million for 2001 and
$11.4 million for 2000 related primarily to bank term loans and a line of
credit. The decrease in net interest expense was due to the reduction in average
outstanding debt balances and the decrease in interest rates.
Income Tax. Income tax expense for 2001 and 2000 included provisions for
federal, state and foreign income taxes at an effective rate of 41.4% and 46.5%,
respectively. The reduction in the effective income tax rate is a result of
generating higher income before income taxes while nondeductible items remained
comparable.
YEAR ENDED DECEMBER 31, 2000 COMPARED TO YEAR ENDED DECEMBER 31, 1999
Net Sales. Net sales decreased $16.6 million, or 7.2%, to $214.8 million
for 2000 from $231.4 million for 1999. This decrease was primarily attributable
to the decrease in sales of our automotive, high performance and racing vehicle
replica category, which decreased 27.4%. Most of this decrease was concentrated
in our racing vehicle replica product lines, which decreased 73.8%. Sales in our
sports trading cards and racing apparel and souvenirs category also decreased by
34.3%. The decreased sales in these categories were primarily due to reduced
purchases of NASCAR-related product by mass retailers and wholesalers. These
decreases were partially offset by increases of sales in our pre-teen vehicles
and role play activity toys category, which increased by 78.8%, our
agricultural, construction and outdoor sports vehicle replicas category, which
increased by 26.2%, and our collectible figures category, which increased by
17.5%. Each of these categories benefited from new product extensions and
releases in several lines.
Gross Profit. Gross profit decreased $0.2 million, or 0.2%, to $98.5
million for 2000 from $98.7 million for 1999 due primarily to lower sales
volume. The gross profit margin increased to 45.8% in 2000 from 42.7% in 1999.
The increase in the gross profit margin was
22
attributable to the integration of operations with Ertl, better sourcing of
products, lower product costs and a reduction in sales of products with lower
margins. There were no major changes in the components of cost of sales.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses decreased $8.2 million, or 10.3%, to $71.6 million for
2000 from $79.8 million for 1999. The decrease was due primarily to the
integration of operations and control of discretionary expenditures, but was
also impacted by the lower sales volume in 2000. As a percentage of net sales,
selling, general and administrative expenses decreased to 33.3% for 2000 from
34.5% for 1999. Selling, general and administrative expenses for 2000 included a
$2.5 million charge related to minimum guaranteed royalty payments on
NASCAR-related license agreements, which exceeded royalties earned on product
sales.
Operating Income. Operating income increased $14.0 million, or 155.6%,
to $23.0 million for 2000 from $9.0 million for 1999. As a percentage of net
sales, operating income increased to 10.7% for 2000 from 3.9% for 1999.
Net Interest Expense. Net interest expense of $11.4 million for 2000 and
$7.7 million for 1999 related primarily to bank term loans and a line of credit.
The increase in net interest expense was due primarily to the increases in
average outstanding debt balances and interest rates.
Income Tax. Income tax expense for 2000 and 1999 included provisions for
federal, state and foreign income taxes at an effective rate of 46.5% and 62.5%,
respectively. The reduction in the effective income tax rate is a result of
generating higher income before income taxes while nondeductible items remained
comparable.
LIQUIDITY AND CAPITAL RESOURCES
We generally fund our operations and working capital needs through cash
generated from operations and borrowings under our credit facility. Our
operating activities generated cash of approximately $45.0 million in 2001,
$38.6 million in 2000 and $22.1 million in 1999. Net cash provided by operating
activities for 2001 increased primarily due to improved net income and reduced
investment in working capital, principally inventory and accounts receivable.
The decrease in working capital was a result of lower sales volume and improved
management of capital resources.
Net cash used in investing activities was $6.5 million in 2001 compared
to $8.2 million in 2000. The decrease from 2001 to 2000 was primarily
attributable to the lower levels of capital expenditures of $6.5 million in 2001
as compared to $8.2 million in 2000. Capital expenditures for molds and tooling
for 2001 and 2000 were $5.2 million and $7.0 million, respectively.
Net cash used in financing activities was $35.2 million in 2001 as
compared to $30.0 million in 2000. In 2001, we made payments of $35.0 million on
our bank borrowings and repurchased 75,000 shares of our outstanding common
stock for approximately $0.3 million in
23
accordance with our share repurchase program. Since we implemented this program
in 1999, we have repurchased approximately 1.9 million shares of our outstanding
common stock for approximately $7.9 million, equating to an average stock price
of $4.26 per share.
We believe that our cash flow from operations, cash on hand and
available borrowings will be sufficient to meet our working capital and capital
expenditure requirements and provide us with adequate liquidity to meet
anticipated operating needs for 2002. Working capital financing requirements are
usually highest during the third and fourth quarters due to seasonal increases
in demand for our collectibles and toys. In addition, we expect that capital
expenditures during 2002, principally for molds and tooling, will be
approximately $11.0 million. Although operating activities are expected to
provide sufficient cash, any significant future product or property
acquisitions, including up-front licensing payments, may require additional debt
or equity financing.
We entered into a credit agreement on April 13, 1999, amended on August
31, 2000, which provides for a revolving loan, term loan, and the issuance of
letters of credit. The revolving loan allows us to borrow up to $15.0 million
based upon our levels of inventory and accounts receivable. At December 31,
2001, based on our borrowing base calculation, we had the ability to borrow
$15.0 million. At December 31, 2000, we had no amounts outstanding on the
revolving loan. The term loan, in the principal amount of $62.0 million at
December 31, 2001, is due in scheduled quarterly payments of $4.0 million with a
final balloon payment on April 1, 2003. All borrowings under the credit facility
are secured by substantially all of our assets.
The term loan and the revolving loan bear interest, at our option, at an
alternate base rate plus a margin that varies between 0.15% and 1.75% or at a
LIBOR rate plus a margin that varies between 0.90% and 3.50%. The applicable
margin is based on our ratio of consolidated debt to consolidated EBITDA. At
December 31, 2001 the margin in effect was 0.50% for base rate loans and 1.75%
for LIBOR loans. The credit agreement also requires us to pay a commitment fee
determined by the ratio of consolidated debt to consolidated EBITDA. At December
31, 2001, the commitment fee was 0.25% per annum on the average daily unused
portion of the revolving loan. During 2001, we paid $59,888 in commitment fees.
Under the terms of our credit agreement, we are required to comply with
certain financial and non-financial covenants. Among other restrictions, the
Company is restricted from paying dividends, incurring additional debt and
entering into an acquisition, sale or merger transaction. The key financial
covenants include leverage ratio, minimum EBITDA and maximum capital
expenditures. As of December 31, 2001, we were in compliance with all of these
covenants.
Our credit agreement requires that we maintain an interest rate
protection agreement. Effective June 3, 1999, we entered into an interest rate
collar transaction covering $35.0 million of our debt, with a cap based on 30
day LIBOR rates of 8.00% and a floor of 5.09%. The agreement, which has
quarterly settlement dates, is in effect through June 3, 2002. During 2001, we
made payments of $0.2 million under this contract, which is recorded as interest
expense in
24
the accompanying consolidated statements of income. During 1999 and 2000, the
effect of this agreement was insignificant.
Our Hong Kong subsidiary entered into a credit agreement with a bank
that provides for a line of credit of up to $2.0 million. Amounts borrowed under
this line of credit bear interest at the bank's prime rate or cost of funds,
whichever is greater. As of December 31, 2001 and 2000 there were no outstanding
borrowings under this line of credit.
The Company's U.K. subsidiary has a line of credit with its bankers for
$0.6 million. The line of credit bears interest at 1.00% over the bank's base
rate, and is subject to a letter of guarantee given by Racing Champions
Corporation for $0.8 million. At December 31, 2001 and 2000 respectively the
Company had no amounts outstanding on the line of credit.
Our anticipated debt service obligations under the existing credit
facilities for 2002 for scheduled interest and principal payments are
approximately $19.0 million. Average annual debt service obligations under these
same facilities through April 2003 are approximately $49.0 million.
In February 2002, we plan to file a Registration Statement with the
Securities and Exchange Commission (the "Commission") with regard to a public
offering of our common stock. Under the proposed public offering, we intend to
sell to the public 1,500,000 shares of common stock and certain selling
stockholders propose to sell to the public 3,000,000 shares of common stock.
Upon the closing of the proposed public offering, we plan to enter into
a new credit facility that will replace our existing credit facility. We have
received from four of our existing lenders commitment letters for this new
credit facility, subject to customary closing conditions, final due diligence
and the completion of an equity offering with at least $18.0 million of gross
proceeds. We expect that the new credit facility will be a three-year $50.0
million unsecured revolving loan that will bear interest at a LIBOR rate plus a
margin that varies between 0.75% and 1.40%. The applicable margin will be based
on our ratio of consolidated debt to consolidated EBITDA. We will also be
required to pay a commitment fee on the average unused revolver of 0.20% to
0.30%, determined by the ratio of consolidated debt to consolidated EBITDA. We
estimate that we will be required to pay arrangement, administrative and
up-front fees of approximately $0.2 million and to maintain certain financial
coverage ratios.
Concurrent with the completion of the proposed offering, we also plan to
change our name to Racing Champions Ertl Corporation by merging a wholly owned
subsidiary with that name into us.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards (SFAS) No. 141, "Business Connections" and
SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 requires that
all business combinations initiated after June 30, 2001, be accounted for using
the purchase method of accounting. With the adoption of SFAS No. 142 on January
1, 2002, goodwill will no longer be subject to amortization over its estimated
useful life. Goodwill will be subject to at least an annual assessment of
impairment by applying a fair-value based test, beginning on the date of
adoption
25
of the new standard. The Company has not yet determined the impact that SFAS No.
142 will have on the Company's financial condition or results of operations.
FORWARD-LOOKING STATEMENTS
Certain statements contained in this report contain "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. These statements may be identified by the use of forward-looking words
or phrases such as "anticipate," "believe," "could," "expect," "intend," "may,"
"hope," "plan," "potential," "should," "estimate," "predict," "continue,"
"future," "will," "would or the negative or those terms or other words of
similar meaning." Such forward-looking statements are inherently subject to
known and unknown risks and uncertainties. Our actual results and future
developments could differ materially from the results or developments expressed
in, or implied by, these forward-looking statements. Factors that may cause
actual results to differ materially from those contemplated by such
forward-looking statements include, but are not limited to, the following: we
may not be able to manufacture, source and ship new and continuing products on a
timely basis and customers and consumers may not accept those products at prices
sufficient for us to profitably recover development, manufacturing, marketing,
royalty and other costs; the inventory policies of retailers, together with
increased reliance by retailers on quick response inventory management
techniques, may increase the risk of underproduction of popular items,
overproduction of less popular items and failure to achieve tight shipping
schedules; competition in the markets for our products may increase
significantly; we are dependent upon continuing licensing arrangements with
vehicle manufacturers, agricultural equipment manufacturers, major race
sanctioning bodies, race team owners, drivers, sponsors, agents and other
licensors; we may experience unanticipated negative results of litigation; we
rely upon a limited number of independently owned factories located in China to
manufacture a significant portion of our vehicle replicas and certain other
products; we are dependent upon the continuing willingness of leading retailers
to purchase and provide shelf space for our products; we may not be able to
collect outstanding accounts receivable from our major retail customers; we are
subject to risks related to doing business in foreign markets, including
currency exchange rate fluctuations, economic and political instability,
restrictive actions by foreign governments, and complications in complying with
trade and foreign tax laws; and general economic conditions in our markets. We
undertake no obligation to make any revisions to the forward-looking statements
contained in this filing or to update them to reflect events or circumstances
occurring after the date of this filing.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Our credit agreement requires that we maintain an interest rate
protection agreement. Effective June 3, 1999, we entered into an interest rate
collar transaction covering $35.0 million of our debt, with a cap based on 30
day LIBOR rates of 8.00% and a floor of 5.09%. The agreement, which has
quarterly settlement dates, is in effect through June 3, 2002. During 2001, we
made payments of $0.2 million under this contract, which is recorded as interest
expense in the accompanying consolidated statements of income. During 1999 and
2000, the effect of this agreement was insignificant. Based on our interest rate
exposure on variable rate borrowings at December
26
31, 2001, a one-percentage-point increase in average interest rates on our
borrowings would increase future interest expense by approximately $52,000 per
month.
27
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
FINANCIAL STATEMENTS
Our consolidated financial statements and notes thereto are filed under
this item beginning on page F-1 of this report.
QUARTERLY RESULTS OF OPERATIONS
The following tables set forth our unaudited quarterly results of
operations for 2000 and 2001. We have prepared this unaudited information on a
basis consistent with the audited consolidated financial statements contained in
this report and this unaudited information includes all adjustments, consisting
only of normal recurring adjustments, that we consider necessary for a fair
presentation of our results of operations for the quarters presented. You should
read this quarterly financial data along with the Condensed Consolidated
Financial Statements and the related notes to those statements included in our
Quarterly Reports on Form 10-Q filed with the Commission. The operating results
for any quarter are not necessarily indicative of the results for any future
period.
FISCAL YEAR 2001
--------------------------------------------------------
(Amounts in thousands, except per share Q1 Q2 Q3 Q4
data) -- -- -- --
Net sales................................. $36,456 $43,077 $ 65,819 $57,896
Cost of sales............................. 19,201 20,042 30,837 29,401
------ ------ ------ ------
Gross profit........................ 17,255 23,035 34,982 28,495
Selling, general and administrative
expenses(1).............................. 12,917 16,353 20,434 18,149
Amortization of goodwill and other assets. 851 851 830 844
------ ------ ------ ------
Operating income.................... 3,487 5,831 13,718 9,502
Interest expense, net..................... 2,243 1,677 1,571 979
Other expense (income).................... (23) 489 (486) 297
------ ------ ------ ------
Income before income taxes ......... 1,267 3,665 12,633 8,226
Income tax expense ....................... 532 1,539 5,306 3,291
------ ------ ------ ------
Net income ......................... $ 735 $ 2,126 $ 7,327 $4,935
======= ======== ======== ======
Net income per share:
Basic............................... $ 0.05 $ 0.14 $ 0.50 $ 0.34
Diluted............................. 0.05 0.14 0.48 0.32
Weighted average shares outstanding:
Basic .............................. 14,669 14,686 14,682 14,615
Diluted............................. 15,023 15,121 15,216 15,265
- ------------------
(1) Selling, general and administrative expenses for the first quarter of
2001 include an adjustment of approximately $613,000 to reduce our
estimate of our pension funding liability based on a recent actuarial
valuation. This adjustment resulted in income after taxes of
approximately $356,000.
28
FISCAL YEAR 2000
--------------------------------------------------
(Amounts in thousands, except per share data) Q1 Q2 Q3 Q4
-- -- -- --
Net sales......................................... $ 45,427 $ 50,078 $ 65,831 $ 53,470
Cost of sales..................................... 26,611 27,234 34,219 28,264
-------- -------- -------- --------
Gross profit...................................... 18,816 22,844 31,612 25,206
Selling, general and administrative expenses (1).. 16,635 17,920 17,673 19,408
Amortization of goodwill and other assets......... 947 953 947 948
-------- -------- -------- --------
Operating income.................................. 1,234 3,971 12,992 4,850
Interest expense, net............................. 2,390 2,923 3,271 2,791
Other expense (income)............................ (55) (284) 526 475
-------- -------- -------- --------
Income (loss) before income taxes................. (1,101) 1,332 9,195 1,584
Income tax expense (benefit)...................... (290) 407 4,266 737
-------- -------- -------- --------
Net income (loss)................................. $ (811) $ 925 $ 4,929 $ 847
======== ======== ======== ========
Net income (loss) per share:
Basic............................................ $ (0.05) $ 0.06 $ 0.34 $ 0.06
Diluted.......................................... (0.05) 0.06 0.33 0.06
Weighted average shares outstanding:
Basic ........................................... 15,322 14,663 14,662 14,662
Diluted.......................................... 15,564 14,889 14,879 14,875
- ------------------
(1) Selling, general and administrative expenses for the fourth quarter of
2000 include a charge of $2.5 million related to minimum guaranteed
royalty payments on NASCAR related licensing agreements, which exceed
royalties earned on product sales.
29
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS AND EXECUTIVE OFFICERS
Our directors and executive officers are as follows:
NAME AGE POSITION
-------------------------- --- ----------------------------------------------------
Robert E. Dods............ 53 Chairman of the Board, Chief Executive Officer and
Director
Boyd L. Meyer............. 59 Vice Chairman of the Board and Director
Peter K.K. Chung.......... 48 President of Racing Champions Limited and Director
Peter J. Henseler......... 43 President
Curtis W. Stoelting....... 42 Chief Operating Officer and Executive Vice President
Jody L. Taylor............ 33 Chief Financial Officer and Secretary
Avy H. Stein.............. 47 Director
Daniel M. Gill............ 38 Director
John J. Vosicky........... 53 Director
John S. Bakalar........... 53 Director
Robert E. Dods has served as our Chairman of the Board and Chief
Executive Officer since July 1998 and as a director since April 1996. Mr. Dods
served as our President from April 1996 to July 1998. Mr. Dods co-founded Racing
Champions, Inc., our predecessor, in 1989.
Boyd L. Meyer has served as our Vice Chairman of the Board since October
2000 and as a director since April 1996. From July 1998 to October 2000, Mr.
Meyer served as our President. From April 1996 to July 1998, Mr. Meyer served as
our Executive Vice President. Mr. Meyer co-founded Racing Champions, Inc. in
1989.
Peter K.K. Chung has served as a director and as President of Racing
Champions Limited since April 1996. Mr. Chung formed the predecessors to Racing
Champions Limited in 1989 to handle the overseas operating activities of Racing
Champions, Inc.
Peter J. Henseler has served as our President since October 2000. From
March 1999 to October 2000, Mr. Henseler served as our Executive Vice
President-Sales and Marketing. From July 1998 to March 1999, Mr. Henseler served
as our Senior Vice President-Sales and Marketing. From April 1996 to July 1998,
Mr. Henseler served as our Vice President-Marketing.
30
Curtis W. Stoelting has served as our Chief Operating Officer since
October 2000 and as our Executive Vice President since July 1998. Mr. Stoelting
also served as our Secretary from April 1996 to October 2001. From April 1996 to
July 1998, Mr. Stoelting served as our Vice President-Finance and Operations.
Jody L. Taylor has served as our Chief Financial Officer and Secretary
since October 2001. Ms. Taylor served as our Senior Vice President-Finance from
October 2000 to October 2001 and as our Vice President-Finance from June 1998 to
October 2000. From July 1998 to October 2001, Ms. Taylor served as our Assistant
Secretary. From June 1996 to June 1998, Ms. Taylor served as our Controller. Ms.
Taylor is a Certified Public Accountant.
Avy H. Stein has served as a director since April 1996. Mr. Stein is a
founder and has served as Managing Director of Willis Stein & Partners, L.L.C.,
since 1994. Prior to founding Willis Stein & Partners, L.L.C., Mr. Stein served
as a managing director of Continental Illinois Venture Corporation from 1989
through 1994. Mr. Stein is a director of Tremont Corporation and CTN Media
Group, Inc.
Daniel M. Gill has served as a director since April 1996. Mr. Gill is a
founder and has served as a managing director of Willis Stein & Partners,
L.L.C., since 1994. Prior to founding Willis Stein & Partners, L.L.C., Mr. Gill
served as a Managing Director of Continental Illinois Venture Corporation from
1990 through 1994. Mr. Gill is a director of CTN Media Group, Inc.
John J. Vosicky has served as a director since October 1997. Mr. Vosicky
is currently a private investor. From July 1994 to July 2001, Mr. Vosicky served
as Executive Vice President and Chief Financial Officer of Comdisco, Inc., a
technology services company.
John S. Bakalar has served as a director since October 1997. Mr. Bakalar
is currently a private investor. From May 1993 to November 1997, Mr. Bakalar was
President and Chief Operating Officer of Rand-McNally, Inc., a printing and
publishing company.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), requires our directors and executive officers, and persons who
own more than 10% of a registered class of our equity securities, to file with
the Commission initial reports of beneficial ownership on Form 3 and reports of
changes in beneficial ownership of our equity securities on Form 4 or 5. The
rules promulgated by the Commission under Section 16(a) of the Exchange Act
require those persons to furnish us with copies of all reports filed with the
Commission pursuant to Section 16(a). Based solely upon a review of such forms
actually furnished to us, and written representations of certain of our
directors and executive officers that no forms were required to be filed, all
directors, executive officers and 10% stockholders have filed with the
Commission on a timely basis all reports required to be filed under Section
16(a) of the Exchange Act, except that Mr. Vosicky filed a late Form 5 to report
the grant of an option during 2001 and Mr. Dods filed a late Form 5 to report a
gift during 2001.
31
ITEM 11. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION INFORMATION. The following table sets forth
information for the years indicated below concerning the compensation of our
Chief Executive Officer and our four other most highly compensated executive
officers in 2001. We refer to these people in this report as our "named
executive officers."
SUMMARY COMPENSATION TABLE
LONG-TERM
ANNUAL COMPENSATION COMPENSATION
---------------------------- --------------
SECURITIES
UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION SALARY BONUS(1) OPTIONS (#) COMPENSATION
- ------------------------------------- -------- --------- --------------------------------
Robert E. Dods, Chief Executive
Officer and Chairman of the
Board of Directors............... 2001 $350,000 $ -- -- $ --
2000 446,555 -- -- --
1999 500,000 275,000 -- --
Boyd L. Meyer, Vice Chairman of the
Board of Directors.................. 2001 150,000 -- -- --
2000 396,555 -- -- --
1999 500,000 275,000 -- --
Peter K.K. Chung, President of Racing
Champions Limited................... 2001 283,332 -- -- --
2000 462,500 -- -- --
1999 500,000 275,000 -- --
Peter J. Henseler, President........ 2001 250,000 365,000 75,000 8,902 (2)
2000 221,608 275,000 100,000 7,048 (2)
1999 159,018 20,188 33,000 6,242 (2)
Curtis W. Stoelting, Chief Operating
Officer and Executive Vice
President......................... 2001 250,000 365,000 75,000 9,402 (3)
2000 221,608 275,000 100,000 6,818 (3)
1999 205,044 20,188 33,000 6,049 (3)
- ----------
(1) Consists of special bonuses paid to Messrs. Dods, Meyer and Chung in
1999 for their efforts relating to our acquisition and subsequent
integration of The Ertl Company, Inc. into Racing Champions and amounts
paid to Messrs. Stoelting and Henseler pursuant to our bonus program.
32
(2) For 1999, consists of $1,242 of premiums paid by us for term life
insurance under which Mr. Henseler is the beneficiary and $5,000 of
matching contributions under the Racing Champions Savings Plan. For
2000, consists of $1,798 of premiums paid by us for term life insurance
under which Mr. Henseler is the beneficiary and $5,250 of matching
contributions under the Racing Champions Savings Plan. For 2001,
consists of $3,652 of premiums paid by us for term life insurance under
which Mr. Henseler is the beneficiary and $5,250 of matching
contributions under the Racing Champions Savings Plan.
(3) For 1999, consists of premiums of $1,049 paid by us for term life
insurance under which Mr. Stoelting is the beneficiary and $5,000 of
matching contributions under the Racing Champions Savings Plan. For
2000, consists of premiums of $1,568 paid by us for term life insurance
under which Mr. Stoelting is the beneficiary and $5,250 of matching
contributions under the Racing Champions Savings Plan. For 2001,
consists of premiums of $4,152 paid by us for term life insurance under
which Mr. Stoelting is the beneficiary and $5,250 of matching
contributions under the Racing Champions Savings Plan.
OPTION GRANTS DURING 2001. The following table provides information
regarding stock options granted to our named executive officers during the year
ended December 31, 2001.
OPTION/SAR GRANTS IN LAST FISCAL YEAR
POTENTIAL
REALIZABLE VALUE
NUMBER OF AT ASSUMED ANNUAL
SECURITIES % OF TOTAL RATES OF STOCK
UNDERLYING OPTIONS/SARS PRICE APPRECIATION
OPTIONS/SARS GRANTED TO EXERCISE OR OPTION TERM ($)(2)
GRANTED (#) EMPLOYEES IN PRICE EXPIRATION ------------------------
NAME (1) FISCAL YEAR ($/ SH) DATE 5% 10%
---- ----------- ----------- --------- ---------- -- ---
Peter J. Henseler.. 75,000 17.9 7.94 10/30/2011 374,507 949,074
Curtis W. Stoelting 75,000 17.9 7.94 10/30/2011 374,507 949,074
- ----------
(1) Options with respect to 20% of the underlying shares become exercisable
on October 30 of each year from 2002 to 2006.
(2) The dollar amounts under these columns are the result of theoretical
calculations at 5% and 10% rates set by the Commission, and therefore
are not intended to forecast possible future appreciation, if any, in
our common stock.
FISCAL YEAR-END OPTION VALUES. The following table provides information
regarding the value of unexercised options held by our named executive officers
at December 31, 2001. No named executive officer exercised any options during
the year ended December 31, 2001.
33
AGGREGATED FISCAL YEAR-END OPTION VALUES
NUMBER OF SECURITIES UNDERLYING
UNEXERCISED OPTIONS AT FISCAL VALUES OF UNEXERCISED IN-THE-MONEY
YEAR-END (#) OPTIONS AT FISCAL YEAR-END ($)
NAME EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE(1)
- --------------- ------------------------- ----------------------------
Peter J. Henseler.. 103,513/179,909 791,914/1,288,767
Curtis W. Stoelting 154,489/181,612 1,299,196/1,290,220
- ------------------
(1) Calculated based on closing sale price of $12.30 per share on December
31, 2001.
EMPLOYMENT AGREEMENTS. On April 30, 2001, we entered into employment
agreements with Robert E. Dods and Boyd L. Meyer and Racing Champions Limited
entered into an employment agreement with Peter K.K. Chung, all of which
terminate on December 31, 2002. Pursuant to the employment agreements, Mr. Dods
will receive a base salary of $350,000 per year in 2001, and $150,000 per year
in 2002; Mr. Meyer will receive a base salary of $150,000 per year in 2001 and
$100,000 per year in 2002; and Mr. Chung will receive a base salary of $250,000
per year beginning in May 2001 and $150,000 per year beginning in May 2002. The
employment agreements with Messrs. Dods, Meyer and Chung also provide that the
executive officer is eligible to participate in medical, health, dental,
disability and life insurance policies. Pursuant to the employment agreements,
each executive officer has agreed not to compete with us during employment and
for a period of two years following termination of employment and has agreed to
maintain the confidentiality of our proprietary information and trade secrets.
The employment agreements provide that if the executive officer's employment is
terminated by us without "cause" or by the executive officer for "good reason,"
the executive officer will be entitled to continuation of his then effective
base salary for a period equal to the greater of one year or the remaining term
of the employment agreement.
On October 20, 2000, we entered into employment agreements with Curtis
W. Stoelting and Peter J. Henseler, which terminate on April 30, 2002. Pursuant
to the employment agreements, Messrs. Stoelting and Henseler will each receive
base salaries of $250,000, and are entitled to participate in our bonus program
and the 1997 Stock Incentive Plan. The employment agreements with Messrs.
Stoelting and Henseler provide that the executive officer is eligible to
participate in any medical, health, dental, disability and life insurance policy
that are in effect for our other senior management excluding Messrs. Dods, Meyer
and Chung. Pursuant to the employment agreements, each executive officer has
agreed not to compete with us during employment and for a period of two years
following termination of employment and has agreed to maintain the
confidentiality of our proprietary information and trade secrets. The employment
agreements provide that if the executive officer's employment is terminated by
us without "cause" or by the executive for "good reason," the executive officer
will be entitled to continuation of his then effective base salary for two years
following the date of termination, except that if such termination occurs at any
time after a "change in control" with respect to us, the executive officer will
be entitled to continuation of his then effective base salary for three years
following the date of termination.
34
COMPENSATION OF DIRECTORS
Directors who are our employees or are affiliates of Willis Stein &
Partners, L.P. receive no compensation for services as members of the Board of
Directors or committees of the Board of Directors. Other directors receive an
annual retainer of $7,500, payable in cash, and receive a fee of $1,000 for each
Board of Directors meeting attended and $1,000 for each committee meeting
attended. Fees for attendance at Board of Directors meetings and committee
meetings may not exceed $1,000 per day. In October 2001, consistent with past
practice, we issued stock options to Mr. Bakalar and Mr. Vosicky, our outside
directors, in lieu of their retainer and meeting fees. Each outside director
received 15,000 stock options at an exercise price of $7.94 per share.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
During 2001, the members of the Compensation Committee of our Board of
Directors were Avy H. Stein, Robert E. Dods and John J. Vosicky. Mr. Dods is our
Chairman of the Board and Chief Executive Officer.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table provides information regarding the beneficial
ownership of our common stock as of January 15, 2002 by:
- each person known by us to be the beneficial owner of more than 5%
of our common stock;
- each director;
- each named executive officer; and
- all directors and executive officers as a group.
The following table is based on information supplied to us by the
stockholders, officers and directors described above. We have determined
beneficial ownership in accordance with the rules of the Commission. Unless
otherwise indicated, the persons and entities included in the table have sole
voting and investment power with respect to all shares beneficially owned,
except to the extent authority is shared by spouses under applicable law. Shares
of common stock subject to options that are either currently exercisable or
exercisable within 60 days of January 15, 2002, are treated as outstanding and
beneficially owned by the holder for the purpose of computing the percentage
ownership of the holder. However, these shares are not treated as outstanding
for the purpose of computing the percentage ownership of any other person. The
table lists applicable percentage ownership based on 14,617,408 shares
outstanding.
35
Unless otherwise indicated, the address for each person listed below is
800 Roosevelt Road, Building C, Suite 320, Glen Ellyn, Illinois, 60137.
SHARES OF PERCENT OF
COMMON COMMON
STOCK STOCK
BENEFICIALLY BENEFICIALLY
NAME OWNED OWNED
------------------------- ------------ -------------
Robert E. Dods(1)................................. 1,368,701 9.4%
Boyd L. Meyer(2).................................. 1,368,700 9.4
Peter K.K. Chung(3)............................... 1,388,701 9.5
Peter J. Henseler(4).............................. 136,942 *
Curtis W. Stoelting(5)............................ 337,342 2.2
Avy H. Stein(6)................................... 2,381,249 16.3
Daniel M. Gill(7)................................. 2,381,249 16.3
John S. Bakalar(8)................................ 35,200 *
John J. Vosicky(9)................................ 34,000 *
Willis Stein & Partners, L.P.(10)................. 2,381,249 16.3
All directors and executive officers as a group
(10 persons)(11)............................... 7,083,303 47.4
----------
*Less than 1%.
(1) Represents 1,368,701 shares of common stock held by a revocable trust
for which Mr. Dods serves as trustee.
(2) Represents 403,798 shares of common stock held by the Meyer Family
Limited Partnership, for which Mr. Meyer serves as a general partner and
shares voting and investment power with members of his immediate family
who are the other general partners, and 964,902 shares of common stock
held by a revocable trust for which Mr. Meyer serves as trustee.
(3) Represents shares of common stock held by corporations controlled by
Mr. Chung.
(4) Includes 105,229 shares of common stock subject to stock options.
(5) Includes 156,777 shares of common stock subject to stock options.
(6) Represents shares of common stock held by Willis Stein & Partners, L.P.
Mr. Stein may be deemed to beneficially own the shares of common stock
owned by Willis Stein by virtue of his status as a managing director of
Willis Stein & Partners, L.L.C., the general partner of Willis Stein &
Partners, L.P. Mr. Stein disclaims any beneficial ownership in these
shares except to the extent of any pecuniary interest arising from being
a managing director of Willis Stein & Partners, L.L.C.
(7) Represents shares of common stock held by Willis Stein & Partners, L.P.
Mr. Gill may be deemed to beneficially own the shares of common stock
owned by Willis Stein by
36
virtue of his status as a managing director of Willis Stein & Partners,
L.L.C., the general partner of Willis Stein & Partners, L.P. Mr. Gill
disclaims any beneficial ownership in these shares except to the extent
of any pecuniary interest arising from being a managing director of
Willis Stein & Partners, L.L.C.
(8) Includes 15,200 shares of common stock subject to stock options.
(9) Includes 14,000 shares of common stock subject to stock options.
(10) The general partner of Willis Stein & Partners, L.P. is Willis Stein &
Partners, L.L.C., a Delaware limited liability company, of which John R.
Willis, Avy H. Stein, Daniel M. Gill and Daniel H. Blumenthal are
managing directors. Each such person may, through Willis Stein &
Partners, L.L.C., be deemed to share the power to direct the voting and
disposition of all of the common stock held by Willis Stein & Partners,
L.P. The address of Willis Stein & Partners, L.P. is 227 West Monroe
Street, Suite 4300, Chicago, Illinois 60606.
(11) Includes (i) 1,368,701 shares of common stock held by a revocable trust
for which Mr. Dods serves as trustee; (ii) 403,798 shares of common
stock held by the Meyer Family Limited Partnership, for which Mr. Meyer
serves as a general partner and shares voting and investment power with
members of his immediate family who are the other general partners,
964,902 shares of common stock held by a revocable trust for which Mr.
Meyer serves as trustee, (iii) 1,388,701 shares of common stock held by
corporations controlled by Mr. Chung, (iv) 2,381,249 shares of common
stock for which Messrs. Gill and Stein share voting and investment power
(Messrs. Gill and Stein disclaim any beneficial ownership in such shares
of common stock except to the extent of any pecuniary interest arising
from being a managing director of Willis Stein & Partners, L.P.) and (v)
333,674 shares of common stock subject to stock options.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
James Chung, brother of Peter K.K. Chung, President of Racing Champions
Limited and a member of our Board of Directors, owns 70% of one of our dedicated
suppliers. For the year ended December 31, 2001, we paid $9.0 million to this
supplier for the purchase of die-cast vehicle replicas. We expect to continue to
make purchases from this supplier during 2002. We believe that the terms for the
purchase of products from this supplier are no less favorable to us then we
could have obtained from an unaffiliated party.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report:
1. Financial Statements. The following consolidated financial
statements of the Company are included in Item 8 of this report:
37
Report of Independent Public Accountants
Consolidated Balance Sheets - as of December 31, 2000 and 2001.
Consolidated Statements of Income - for the years ended December
31, 1999, 2000 and 2001.
Consolidated Statements of Stockholders' Equity - for the years
ended December 31, 1999, 2000 and 2001.
Consolidated Statements of Cash Flows - for the years ended
December 31, 1999, 2000 and 2001.
Notes to consolidated financial statements.
2. Financial Statement Schedules:
Report of Independent Public Accountants.
Financial Statement Schedule for the years ending December 31,
1999, 2000 and 2001:
Schedule
Number Description Page
------ ----------- ----
II Valuation and Qualifying 47
Accounts
All other schedules for which provision is made in the applicable
accounting regulations of the Commission are not required under the related
instructions, are inapplicable or the required information is shown in the
financial statements or notes thereto, and therefore have been omitted.
3. Exhibits:
3.1 Amended and Restated Certificate of Incorporation of the
Company (incorporated by reference to Exhibit 3.1 of the
Company's Annual Report on Form 10-K for the year ended
December 31, 1998 (File No. 0-22635)).
38
3.2 First Amendment to Amended and Restated Certificate of
Incorporation of the Company (incorporated by reference to
Exhibit 3.2 of the Company's Annual Report on Form 10-K for
the year ended December 31, 1998 (File No. 0-22635)).
3.3 Amended and Restated By-Laws of the Company (incorporated by
reference to Exhibit 3.3 of the Company's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1998 (File No.
0-22635)).
10.1 Credit Agreement, dated as of April 13, 1999, among the Company,
Racing Champions, Inc., Racing Champions South, Inc., Racing
Champions Worldwide Limited, First Union National Bank, as
lender and agent, and the other lenders party thereto
(incorporated by reference to Exhibit 99.2 of the Company's
Current Report on Form 8-K dated April 13, 1999 (File No.
0-22635)).
10.2 First Amendment to Credit Agreement, dated as of August 30,
1999, among the Company, Racing Champions, Inc., Racing
Champions South, Inc., Racing Champions Worldwide Limited,
Green's Racing Souvenirs, Inc., RCNA Holdings, Inc., The Ertl
Company, Inc., Ertl Direct, Inc., First Union National Bank, as
agent and lender, and the other lenders party thereto
(incorporated by reference to Exhibit 10.1 of the Company's
Quarterly Report on Form 10-Q for the quarter ended September
30, 1999 (File No. 0-22635)).
39
10.3 Second Amendment to Credit Agreement, dated as of May 15, 2000,
among the Company, Racing Champions, Inc., Racing Champions
South, Inc., Racing Champions Worldwide Limited, First Union
National Bank, as agent and lender, and the other lenders party
thereto (incorporated by reference to Exhibit 10.1 of the
Company's Quarterly Report on Form 10-Q for the quarter
ended June 30, 2000 (File No. 0-22635)).
10.4 Waiver Letter dated July 14, 2000, relating to Second Amendment
to Credit Agreement, dated as of May 15, 2000, among the
Company, Racing Champions, Inc., Racing Champions South, Inc.,
Racing Champions Worldwide Limited, First Union National Bank,
as agent and lender, and the other lenders party thereto
(incorporated by reference to Exhibit 10.2 of the Company's
Quarterly Report on Form 10-Q for the quarter ended June
30, 2000 (File No. 0-22635)).
10.5 Third Amendment to Credit Agreement, dated as of August 31,
2000, among the Company, Racing Champions, Inc., Racing
Champions South, Inc., Racing Champions Worldwide Limited, First
Union National Bank, as agent and lender, and the other lenders
party thereto (incorporated by reference to Exhibit 10.1 of the
Company's Quarterly Report on Form 10-Q for the quarter ended
September 30, 2000 (File No. 0-22635)).
10.6 Security Agreement, dated as of August 30, 1999, among the
Company, Racing Champions, Inc., Racing Champions South, Inc.,
Racing Champions Worldwide Limited, Green's Racing Souvenirs,
Inc., RCNA Holdings, Inc., The Ertl Company, Inc., Ertl Direct,
Inc., and First Union National Bank, as agent and lender
(incorporated by reference to Exhibit 10.2 of the Company's
Quarterly Report on Form 10-Q for the quarter ended September
30, 1999 (File No. 0-22635)).
40
10.7 Stock and Asset Purchase Agreement, dated as of April 13, 1999,
among U.S. Industries, Inc., JUSI Holdings, Inc., USI Overseas
Limited, USI Canada, Inc., Racing Champions Corporation, Racing
Champions, Inc., RCNA Holdings, Inc., Racing Champions Worldwide
Limited and Racing Champions Limited (incorporated by reference
to Exhibit 2.1 of the Company's Current Report on Form 8-K dated
April 13, 1999 (File No. 0-22635)).
10.8 Warrant Agreement, dated as of August 5, 1998, between the
Company and BankBoston, N.A., as warrant agent (incorporated by
reference to Exhibit 10.2 of the Company's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1998 (File No.
0-22635)).
10.9 Warrant dated April 27, 1997 issued by Wheels Sports Group, Inc.
to Schneider Securities, Inc. (incorporated by reference to
Exhibit 10.5 of the Company's Quarterly Report on Form 10-Q for
the quarter ended June 30, 1998 (File No. 0-22635)).
10.10* Employment Agreement, dated as of April 30, 2001, between Racing
Champions Corporation and Robert E. Dods.
10.11* Employment Agreement, dated as of April 30, 2001, between Racing
Champions Corporation and Boyd L. Meyer.
10.12* Employment Agreement, dated as of April 30, 2001, between Racing
Champions Limited and Peter K.K. Chung.
10.13* Employment Agreement, dated as of October 20, 2000, by and
between Racing Champions Corporation and Curtis W. Stoelting
(incorporated by reference to Exhibit 10.15 of the Company's
Annual Report on Form 10-K for the year ended December 31, 2000
(File No. 0-22635)).
41
10.14* Employment Agreement, dated as of October 20, 2000, by and
between Racing Champions Corporation and Peter J. Henseler
(incorporated by reference to Exhibit 10.16 of the Company's
Annual Report on Form 10-K for the year ended December 31, 2000
(File No. 0-22635)).
10.15* Employment Agreement, dated as of April 30, 2001, by and between
Racing Champions Ertl, Inc. and Jody L. Taylor.
10.16* Racing Champions Corporation 1996 Key Employees Stock Option
Plan (incorporated by reference to Exhibit 10.19 of the
Company's Registration Statement on Form S-1 (Registration No.
333-22493) filed with the Commission on February 27, 1997).
10.17* Racing Champions Corporation Stock Incentive Plan, as amended
(incorporated by reference to Exhibit 10.19 of the Company's
Annual Report on Form 10-K for the year ended December 31, 1999
(File No. 0-22635)).
10.18* Wheels Sports Group, Inc. 1996 Omnibus Stock Plan (incorporated
by reference to Exhibit 10.6 of the Company's Quarterly Report
on Form 10-Q for the quarter ended June 30, 1998 (File No.
0-22635)).
10.19 Registration Agreement, dated as of April 30, 1996, by and among
the Company, Willis Stein & Partners, L.P., Baird Capital
Partners II Limited Partnership, BCP II Affiliates Fund Limited
Partnership, Nassau Capital Partners L.P., NAS Partners I
L.L.C., Robert Dods, Boyd Meyer, Peter Chung, Dods-Meyer, Ltd.,
Racing Champions Limited, Garnett Services, Inc., Hosten
Investment Limited, Curt Stoelting, John Olsen, Peter Henseler
and Kevin Camp (filed as an exhibit to the Company's
Registration Statement on Form S-1 (File No. 333-22493) and
incorporated herein by reference.)
21 Subsidiaries of the Company.
42
23.1 Consent of Arthur Andersen LLP.
23.2 Consent of Ernst & Young LLP.
24 Power of Attorney (included as part of the signature page
hereof).
- ---------------
* Management contract or compensatory plan or arrangement.
(b) Reports on Form 8-K.
The Company did not file any reports on Form 8-K for the three months
ended December 31, 2001.
(c) Exhibits.
The response to this portion of Item 14 is submitted as a separate
section of this report.
(d) Financial statement schedules.
The response to this portion of Item 14 is submitted as a separate
section of this report.
43
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
RACING CHAMPIONS CORPORATION
By /s/ Robert E. Dods
--------------------------------------
Robert E. Dods, Chief Executive
Officer
Date: February 22, 2002
POWER OF ATTORNEY
Each person whose signature appears below hereby appoints Curtis W.
Stoelting and Jody L. Taylor, and each of them individually, his true and lawful
attorney-in-fact, with power to act with or without the other and with full
power of substitution and resubstitution, in any and all capacities, to sign any
or all amendments to the Form 10-K and file the same with all exhibits thereto,
and other documents in connection therewith, with the Securities and Exchange
Commission, granting unto said attorneys-in-fact and agents full power and
authority to do and perform each and every act and thing requisite and necessary
to be done in and about the premises, as fully to all intents and purposes as he
might or could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents, or their substitutes, may lawfully cause to be
done by virtue hereof.
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
/s/ Robert E. Dods Chairman of the Board, Chief February 22, 2002
- ----------------------------- Executive Officer and Director
Robert E. Dods (Principal Executive Officer)
/s/ Boyd L. Meyer Vice Chairman and Director February 22, 2002
- -----------------------------
Boyd L. Meyer
/s/ Curtis W. Stoelting Chief Operating Officer and February 22, 2002
- ----------------------------- Executive Vice President
Curtis W. Stoelting (Principal Financial Officer)
44
/s/ Jody L. Taylor Chief Financial Officer and February 22, 2002
- ----------------------------- Secretary (Principal Accounting
Jody L. Taylor Officer)
/s/ Peter K.K. Chung February 22, 2002
- -----------------------------
Peter K.K. Chung Director
/s/ Avy H. Stein February 22, 2002
- -----------------------------
Avy H. Stein Director
/s/ Daniel M. Gill February 22, 2002
- -----------------------------
Daniel M. Gill Director
/s/ John S. Bakalar February 22, 2002
- -----------------------------
John S. Bakalar Director
/s/ John J. Vosicky February 22, 2002
- -----------------------------
John J. Vosicky Director
45
[ARTHUR ANDERSEN LLP LOGO]
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of Racing Champions
Corporation and Subsidiaries:
We have audited in accordance with generally accepted auditing standards, the
consolidated financial statements of Racing Champions Corporation included in
this annual report and issued our report thereon dated February 22, 2002. Our
audits were made for the purpose of forming an opinion on the basic financial
statements taken as a whole. The schedule of Valuation and Qualifying Accounts
is presented for purposes of complying with the Securities and Exchange
Commission's rules and is not a part of the basic financial statements. This
schedule has been subject to the auditing procedures applied in the audits of
the basic financial statements and, in our opinion, fairly states in all
material respects the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Chicago, Illinois
February 22, 2002
46
Schedule II
Description
Valuation and Qualifying Accounts
Balance at Charged to Charged to
Beginning Costs and Other Balance at
Description of Year Expenses Accounts Deductions End of Year
----------- ------- -------- -------- ---------- -----------
Allowance for doubtful accounts:
Year ended December 31, 1999 $1,100,000 $3,535,094 $2,338,383 $(1,518,528) $5,454,949
Year ended December 31, 2000 $5,454,949 $2,053,230 -- $(4,176,915) $3,331,264
Year ended December 31, 2001 $3,331,264 $2,499,763 -- $(2,821,907) $3,009,120
47
RACING CHAMPIONS CORPORATION AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Reports of Independent Auditors ..........................................................F-2
Consolidated Balance Sheets as of December 31, 2000 and 2001..............................F-4
Consolidated Statements of Income for the years ended December 31, 1999, 2000 and 2001....F-5
Consolidated Statements of Stockholders' Equity for the years ended December 31, 1999
2000 and 2001...........................................................................F-6
Consolidated Statements of Cash Flows for the years ended December 31, 1999,
2000 and 2001 F-7
Notes to Consolidated Financial Statements ...............................................F-8
F-1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
Racing Champions Corporation and subsidiaries:
We have audited the accompanying consolidated balance sheets of RACING CHAMPIONS
CORPORATION (a Delaware corporation) and subsidiaries as of December 31, 2000
and 2001 and the related consolidated statements of income, stockholders' equity
and cash flows for each year in the three-year period ended December 31, 2001.
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 did not audit the financial statements of Racing Champions
Worldwide Limited, which statements reflect total assets and total net sales of
10.4% and 9.9%, respectively, in 2000, and 11.7% and 8.4%, respectively, in
2001, of the related consolidated totals. Those statements were audited by other
auditors whose report has been furnished to us, and our opinion, insofar as it
relates to the amounts included for those entities, is based solely on the
report of the other auditors.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards 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. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits and the report of other auditors
provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of other auditors, the
financial statements referred to above present fairly, in all material respects,
the consolidated financial position of Racing Champions Corporation and
subsidiaries as of December 31, 2000 and 2001 and the results of their
operations and their cash flows for each year in the three-year period ended
December 31, 2001 in conformity with accounting principles generally accepted in
the United States.
ARTHUR ANDERSEN LLP
Chicago, Illinois,
February 22, 2002
F-2
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors
Racing Champions Worldwide Limited
We have audited the consolidated balance sheets of Racing Champions Worldwide
Limited as of December 31, 2001 and 2000 and the related consolidated statements
of income, shareholders' equity and cash flows for each of the two years in the
period ended December 31, 2001 (not presented separately herein). 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 in accordance with auditing standards generally accepted
in the United States. Those standards 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. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Racing Champions
Worldwide Limited at December 31, 2001 and 2000, and the consolidated results of
their operations and their consolidated cash flows for each of the two years in
the period ended December 31, 2001, in conformity with accounting principles
generally accepted in the United States.
ERNST & YOUNG LLP
Exeter, England
February 22, 2002
F-3
RACING CHAMPIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
-----------------------------------
2000 2001
---------------- ----------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents........................ $ 12,581,542 $ 16,509,550
Accounts receivable, net of allowance for
doubtful accounts
of $3,009,120 and $3,331,264................... 41,488,415 36,971,520
Income tax and other receivable.................. 6,516,872 196,842
Inventory........................................ 18,650,953 17,544,506
Deferred taxes................................... 7,988,049 6,589,080
Prepaid expenses................................. 3,481,743 3,396,727
---------------- ----------------
Total current assets........................... 90,707,574 81,208,225
PROPERTY AND EQUIPMENT:
Land............................................. 725,514 716,675
Buildings and improvements....................... 4,935,668 4,944,808
Tooling.......................................... 44,079,366 37,178,627
Other equipment.................................. 10,335,771 10,447,621
---------------- ----------------
60,076,319 53,287,731
LESS ACCUMULATED DEPRECIATION...................... (23,840,694) (20,362,511)
---------------- ----------------
36,235,625 32,925,220
Goodwill, net.................................... 123,534,772 120,277,657
Other assets..................................... 1,428,712 1,112,022
---------------- ----------------
TOTAL ASSETS....................................... $251,906,683 $235,523,124
================ ================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable................................. $ 6,790,940 $ 7,132,961
Taxes payable.................................... 852,357 2,789,348
Accrued expenses................................. 9,381,662 8,628,019
Accrued allowances............................... 11,377,943 11,479,174
Accrued royalties................................ 6,902,619 6,268,342
Current maturities of term notes................. 14,000,000 16,000,000
Other current liabilities........................ 2,447,012 2,517,970
---------------- ----------------
Total current liabilities...................... 51,752,533 54,815,814
Term notes, less current maturities.............. 83,000,000 46,000,000
Deferred income taxes............................ 6,244,794 10,303,011
Other long-term liabilities...................... 6,344,638 6,643,407
---------------- ----------------
TOTAL LIABILITIES.................................. 147,341,965 117,762,232
Commitments and Contingencies
STOCKHOLDERS' EQUITY:
Common stock, voting, $0.01 par value, 28,000,000
shares authorized, 16,444,708 shares issued and
14,661,608 shares outstanding at December 31,
2000 and 16,451,508 shares issued and
14,617,408 shares outstanding at December 31,
2001........................................... 164,447 164,515
Stock warrants outstanding....................... 728,740 728,740
Additional paid-in capital....................... 89,265,424 89,288,930
Accumulated other comprehensive (loss) income.... 775,852 (932,367)
Retained earnings................................ 21,218,320 36,341,329
---------------- ----------------
112,152,783 125,591,147
Treasury stock, at cost, 1,783,100 shares at
December 31, 2000 and 1,834,100 shares at
December 31, 2001.............................. (7,588,065) (7,830,255)
---------------- ----------------
Total stockholders' equity....................... 104,564,718 117,760,892
Total liabilities and stockholders' equity....... $ 251,906,683 $ 235,523,124
================ ================
The accompanying notes are an integral part of these consolidated balance
sheets.
F-4
RACING CHAMPIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEAR ENDED DECEMBER 31,
-------------------------------------------------
1999 2000 2001
-------------- --------------- --------------
Net sales................................. $ 231,360,417 $214,805,880 $203,248,030
Cost of sales, related party.............. 5,957,866 7,743,639 9,003,651
Cost of sales, other...................... 126,725,490 108,584,057 90,476,908
-------------- --------------- -------------
GROSS PROFIT.......................... 98,677,061 98,478,184 103,767,471
Selling, general and administrative expenses 79,762,220 71,636,219 67,853,149
Restructuring and other charges........... 6,400,000 - -
Amortization of goodwill and other assets. 3,542,579 3,794,757 3,376,354
-------------- --------------- -------------
OPERATING INCOME...................... 8,972,262 23,047,208 32,537,968
Interest expense, net..................... 7,650,127 11,374,822 6,470,160
Other expense (income).................... (104,943) 662,036 276,803
-------------- --------------- -------------
INCOME BEFORE INCOME TAXES............ 1,427,078 11,010,350 25,791,005
Income tax expense........................ 891,574 5,119,753 10,667,996
-------------- --------------- -------------
NET INCOME............................ $ 535,504 $ 5,890,597 $ 15,123,009
============== =============== =============
Net income per share:
Basic................................... $ 0.03 $ 0.40 $ 1.03
Diluted................................. $ 0.03 $ 0.39 $ 1.00
Weighted average shares outstanding:
Basic................................... 16,249,380 14,826,506 14,662,620
Diluted................................. 16,587,947 15,085,045 15,159,089
The accompanying notes are an integral part of these consolidated
statements.
F-5
RACING CHAMPIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATION STATEMENTS OF STOCKHOLDERS' EQUITY
ACCUMULATED OTHER
STOCK WARRANTS COMPREHENSIVE
COMMON STOCK OUTSTANDING TREASURY STOCK INCOME (LOSS)
-------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1998.................. $160,610 $2,376,040 $ - $ -
Net income.................................. - - - -
Stock issued upon option exercise........... 1,119 - - -
Expense recognized under stock option grant. - - - -
Stock warrants exercised.................... 2,598 (1,647,300) - -
Treasury stock acquisition.................. - - (3,596,727) -
Other comprehensive loss--foreign currency
translation adjustments.................. - - - (16,991)
-------- ---------- ------------- -----------
Comprehensive income........................
BALANCE, DECEMBER 31, 1999.................. 164,327 728,740 (3,596,727) (16,991)
Net income.................................. - - - -
Stock issued upon option exercise........... 120 - - -
Expense recognized under stock option grant. - - - -
Treasury stock acquisition.................. - - (3,991,338) -
Other comprehensive income--foreign currency
translation adjustments.................. - - - 792,843
-------- ---------- ------------- -----------
Comprehensive income........................
BALANCE, DECEMBER 31, 2000.................. 164,447 728,740 (7,588,065) 775,852
Net income.................................. - - - -
Stock issued upon option exercise........... 68 - - -
Expense recognized under stock option grant. - - - -
Treasury stock acquisition.................. - - (321,400) -
Reissue treasury stock...................... - - 79,210 -
Other comprehensive income--foreign currency
translation adjustments.................. - - - 149,342
Other comprehensive loss--minimum pension
liability adjustments.................... - - - (1,857,561)
-------- ---------- ------------- -----------
Comprehensive income........................
BALANCE, DECEMBER 31, 2001.................. $164,515 $ 728,740 $ (7,830,255) $ (932,367)
======== ========== ============= ===========
ADDITIONAL TOTAL
PAID-IN RETAINED STOCKHOLDERS' COMPREHENSIVE
CAPITAL EARNINGS EQUITY INCOME (LOSS)
---------------------------------------------------------------------
BALANCE, DECEMBER 31, 1998.................. $85,252,973 $14,792,219 $102,581,842
Net income.................................. - 535,504 535,504 $ 535,504
Stock issued upon option exercise........... 538,619 - 539,738 -
Expense recognized under stock option grant. 22,824 - 22,824 -
Stock warrants exercised.................... 3,426,745 - 1,782,043 -
Treasury stock acquisition.................. - - (3,596,727) -
Other comprehensive loss--foreign currency
translation adjustments.................. - - (16,991) (16,991)
----------- ----------- ------------ ----------------
Comprehensive income........................ $ 518,513
================
BALANCE, DECEMBER 31, 1999.................. 89,241,161 15,327,723 101,848,233
Net income.................................. - 5,890,597 5,890,597 5,890,597
Stock issued upon option exercise........... 1,440 - 1,560 -
Expense recognized under stock option grant. 22,823 - 22,823 -
Treasury stock acquisition.................. - - (3,991,338) -
Other comprehensive income--foreign currency
translation adjustments.................. - 792,843 792,843
----------- ----------- ------------ ----------------
Comprehensive income........................ $ 6,683,440
================
BALANCE, DECEMBER 31, 2000.................. 89,265,424 21,218,320 104,564,718
Net income.................................. - 15,123,009 15,123,009 15,123,009
Stock issued upon option exercise........... 12,392 - 12,460 -
Expense recognized under stock option grant. 22,824 - 22,824 -
Treasury stock acquisition.................. - - (321,400) -
Reissue treasury stock...................... (11,710) - 67,500 -
Other comprehensive income--foreign currency
translation adjustments.................. - - 149,342 149,342
Other comprehensive loss--minimum pension
liability adjustments.................... - - (1,857,561) (1,857,561)
----------- ----------- ------------ ----------------
Comprehensive income........................ $ 13,414,790
================
BALANCE, DECEMBER 31, 2001.................. $89,288,930 $36,341,329 $117,760,892
=========== =========== ============
The accompanying notes are an integral part of these consolidated
statements.
F-6
RACING CHAMPIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
--------------------------------------------------
1999 2000 2001
-------------- ------------- ---------------
OPERATING ACTIVITIES
Net income.................................... $ 535,504 $ 5,890,597 $15,123,009
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation.............................. 7,491,888 9,603,872 9,188,293
Stock option expense...................... 22,824 22,824 22,824
Provision for uncollectible accounts...... 2,378,702 2,053,229 2,715,193
Interest on deferred financing costs...... 228,936 423,092 561,408
Amortization of goodwill and other assets. 3,542,579 3,794,757 3,376,354
(Gain) loss on disposition of assets...... 25,043 (19,968) 309,844
Deferred income taxes..................... 599 7,189,431 5,457,969
Changes in operating assets and
liabilities, net of acquisition activity:
Accounts and income tax receivable...... 2,240,257 (4,685,001) 7,661,122
Inventory............................... 18,870,223 8,887,297 1,209,141
Prepaid expenses........................ 2,027,666 4,163,384 (426,623)
Accounts payable and accrued expenses... (14,222,269) 1,772,489 869,845
Other liabilities....................... (1,032,590) (472,835) (1,032,447)
-------------- ------------ ------------
Net cash provided by operating activities..... 22,109,362 38,623,168 45,035,932
INVESTING ACTIVITIES
Purchase of property and equipment............ (9,885,390) (8,217,973) (6,476,957)
Proceeds from disposal of property and equipment 2,136,899 276,641 123,811
Purchase price of Ertl, net of cash........... (92,996,967) - -
Increase in other non-current assets.......... (1,507,729) (279,657) (118,973)
-------------- ------------ ------------
Net cash used in investing activities......... (102,253,187) (8,220,989) (6,472,119)
FINANCING ACTIVITIES
Issuance of stock............................. 539,738 1,560 12,460
Proceeds from bank term loans................. 115,000,000 - -
Payment on bank term loans.................... (22,000,000) (18,000,000) (35,000,000)
Net borrowings (payments) on line of credit... (4,000,000) (8,000,000) -
Proceeds from exercise of warrants............ 1,782,043 - -
Payment of deferred financing costs........... (1,558,089) - -
Purchase of stock to be held in treasury...... (3,596,727) (3,991,338) (321,400)
Proceeds from reissuance of treasury stock.... - - 67,500
------------- ----------- -----------
Net cash (used in) provided by financing
activities.................................... 86,166,965 (29,989,778) (35,241,440)
EFFECT OF EXCHANGE RATE CHANGES ON CASH - (96,148) 605,635
------------- ------------ -----------
Net increase in cash and cash equivalents. 6,023,140 316,253 3,928,008
Cash and cash equivalents, beginning of year 6,242,149 12,265,289 12,581,542
------------- ----------- -----------
Cash and cash equivalents, end of year...... $ 12,265,289 $12,581,542 $16,509,550
============= ============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest during the period.... $ 7,150,393 $12,602,079 $6,311,736
Cash paid for taxes during the period....... $ 3,707,704 $1,877,427 $4,205,191
Cash refund received for taxes.............. $ 56,925 $5,421,869 $6,979,767
The accompanying notes are an integral part of these consolidated
statements.
F-7
RACING CHAMPIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1999, 2000 AND 2001
1. DESCRIPTION OF BUSINESS
Founded in 1989, Racing Champions Corporation ("RCC") and Subsidiaries, Racing
Champions Inc. ("RCI"), Racing Champions Ertl, Inc. ("RCE"), Racing Champions
Limited ("RCL"), Racing Champions International Limited ("RCIL"), Racing
Champions Worldwide Limited ("RCWL") and Racing Champions South, Inc. ("RCS")
(collectively "the Company") is a leading producer and marketer of collectibles
and toys. The Company sells American Muscle die-cast vehicle replicas, NASCAR
and NHRA die-cast racing replicas, officially licensed die-cast replicas of
automobiles, trucks, agricultural and construction equipment and
powered-recreational and sport vehicles, plastic preschool products, AMT model
kits, Press Pass sports trading cards and NASCAR souvenirs and apparel. The
Company has license agreements with major U.S. automotive and equipment
manufacturers and many of the major motorsports sanctioning bodies, sponsors,
team owners and their drivers, as well as entertainment and media companies for
their well-known characters and properties. The Company sells its products
primarily in North America, Europe and Asia Pacific. RCL, based in Hong Kong and
China, oversees the production of the Company's products. RCIL, based in the
United Kingdom, sells the Company's products in Europe and Asia Pacific. Sales
of the Company's products are seasonal with net sales and profitability peaking
in the third quarter due to holiday season buying patterns.
2. RECAPITALIZATION AND ACQUISITIONS
RECAPITALIZATION
Purchase price in excess of the book value of the net assets acquired in
connection with the Company's recapitalization ("Recapitalization") in 1996 of
$88.7 million, which is deductible for tax purposes, has been recorded as
goodwill and through December 31, 2001, was being amortized on a straight-line
basis over a 40 year period.
RACING CHAMPIONS CORPORATION AND WHEELS SPORTS GROUP, INC.
On June 12, 1998, a subsidiary of the Company merged with Wheels Sports Group,
Inc. ("Wheels"), subsequently renamed Racing Champions South, Inc. The merger
was effected by exchanging 2.7 million shares of the Company's common stock for
all of the common stock of Wheels. Each share of Wheels was exchanged for 0.51
shares of the Company's common stock. In addition, outstanding Wheels' warrants
and stock options were converted at the same exchange ratio into warrants and
options to purchase the Company's common stock. The merger has been accounted
for as a pooling-of-interests.
RACING CHAMPIONS CORPORATION AND THE ERTL COMPANY, INC.
On April 13, 1999, the Company purchased all of the outstanding shares of The
Ertl Company, Inc. (subsequently renamed Racing Champions Ertl, Inc.) and
certain of its affiliates ("Ertl") for approximately $94.6 million. This
transaction has been accounted for under the purchase method of accounting and
accordingly, the operating results of Ertl have been included in the Company's
consolidated financial statements since the date of acquisition. The purchase
was funded with a draw-down on the Company's credit facility (Note 7). The
excess of the aggregate purchase price over the fair market value of net assets
acquired of approximately $31.1 million was being amortized on a straight-line
basis over 40 years through December 31, 2001.
The following unaudited pro forma consolidated results of operations for the
year ended December 31, 1998 and 1999 assumes that the Ertl acquisition occurred
as of January 1, 1998 and 1999 (amounts in thousands, except per share data):
F-8
DECEMBER 31, 1998 DECEMBER 31, 1999
------------------ -----------------
Net sales........................... $ 329,175 $ 266,340
Income (loss) before extraordinary item 8,872 (3,471)
Net income (loss)................... 7,090 (3,471)
Earnings (loss) per share:
Basic............................. $ 0.44 $ (0.21)
Diluted........................... $ 0.43 -
Pro forma data does not purport to be indicative of the results that would have
been obtained had this acquisition actually occurred at the beginning of the
periods presented and is not intended to be a projection of future results.
3. SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The financial statements consolidate the accounts of RCC and its wholly owned
subsidiaries. All intercompany items and transactions have been eliminated.
Foreign Currency Translation/Transactions
Foreign subsidiary assets and liabilities are reported in the local currency and
translated at the rates of exchange at the balance sheet date while income
statement accounts are translated at the average exchange rates in effect during
the period. Exchange gains and losses resulting from translations for the years
ended December 31, 1999, 2000 and 2001 have been recorded as a component of
accumulated other comprehensive (loss) income in stockholders' equity. The net
exchange losses resulting from transactions in foreign currencies for the years
ended December 31, 2000 and 2001 were $0.5 and $0.2 million, respectively, and
are included in the accompanying consolidated statements of income. Exchange
gains and losses resulting from transactions in foreign currencies for 1999 were
insignificant.
Revenue Recognition
The Company recognizes revenue based upon transfer of title of product to
customers. The Company provides for estimated credit and other concessions at
the time the sale is recorded.
Shipping and Handling Costs
Shipping and handling costs are included in selling, general and administrative
expenses in the accompanying consolidated statements of income. For the years
ended December 31, 1999, 2000 and 2001, shipping and handling costs were $3.4
million, $4.4 million and $4.8 million, respectively.
Cash and Cash Equivalents
The Company considers all highly liquid investments with original maturities of
90 days or less to be cash equivalents. Such investments are stated at cost,
which approximates fair value.
Use of Estimates
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
During the first quarter of 2001, the Company recorded an adjustment of
approximately $613,000 to reduce the Company's estimate of its pension funding
liability based on a recent actuarial valuation. This adjustment
F-9
is included in selling, general and administrative expenses in the consolidated
statement of operations. This adjustment resulted in income after taxes of
approximately $356,000.
Inventory
Inventory consists of finished goods and is stated at the lower of cost or
market. Cost is determined by the first-in, first-out method, and market
represents the lower of replacement cost or estimated net realizable value.
Property and Equipment
Property and equipment are recorded at cost. Depreciation is computed using the
straight-line method for financial statement purposes at rates adequate to
depreciate the cost of applicable assets over their expected useful lives.
Accelerated methods are used for income tax purposes. Repairs and maintenance
are charged to expense as incurred. Gains or losses resulting from sales or
retirements are recorded as incurred, at which time related costs and
accumulated depreciation are removed from the accounts. The estimated useful
lives used in computing depreciation for financial statement purposes are as
follows:
Asset Descriptions Estimated Useful Life
- ------------------ ---------------------
Buildings and improvements 2-40 years
Tooling 3-8 years
Other equipment 2-13 years
==========
Goodwill
Purchase price in excess of identifiable net assets acquired (goodwill) was
being amortized over 40 years on a straight-line basis through December 31,
2001. Approximately $88.7 million of this goodwill is tax deductible over 15
years. Amortization expense relating to goodwill for the years ended December
31, 1999, 2000 and 2001 was approximately $3.4 million, $3.7 million and $3.4
million, respectively. Accumulated amortization was $13.2 million and $16.6
million at December 31, 2000 and 2001, respectively. The Company reviews
goodwill for impairment whenever events or changes in circumstances indicate
that its carrying amount may not be recoverable. To date, no such events or
changes in circumstances have occurred.
Other Assets
Other assets at December 31, 2000 consist primarily of refundable deposits for
leased equipment and deferred financing fees. Other assets at December 31, 2001
consist of intangible pension asset, refundable deposits for leased equipment
and deferred financing fees. These deferred financing fees are being amortized
over the term of the debt agreement on a straight-line basis. Interest expense
related to the deferred financing fees for the years ended December 31, 1999,
2000 and 2001 was approximately, $0.2 million, $0.4 million and $0.6 million,
respectively. Accumulated amortization was $0.6 million and $1.2 million at
December 31, 2000 and 2001, respectively.
Concentration of Credit Risk
Concentration of credit risk is limited to trade accounts receivable and is
subject to the financial conditions of certain major customers. There were two
customers accounting for approximately 11.5% and 11.1% of net sales for the year
ended December 31, 1999, two customers accounting for approximately 11.8% and
13.8% of net sales for the year ended December 31, 2000 and two customers
accounting for approximately 15.6% and 14.6% of net sales for the year ended
December 31, 2001. Additionally, one customer accounted for approximately 25.2%
and 35.1% of accounts receivable at December 31, 2000 and December 31, 2001,
respectively. The Company does not require collateral or other security to
support customers' receivables. The Company conducts periodic reviews of its
customers' financial conditions and vendor payment practices
F-10
to minimize collection risks on trade accounts receivable. The Company has
purchased credit insurance which covers a portion of its receivables from major
customers.
Supplier Concentration
The Company's purchases in 1999 from two of its dedicated suppliers, Sharp
Success and Win Yield, were 11.7% and 10.4%, respectively, of its total product
purchases. The Company's purchases in 2000 from two of its dedicated suppliers,
Sharp Success and Win Yield, were 21.1% and 15.4%, respectively, of its total
product purchases. The Company's purchases in 2001 from three of its dedicated
suppliers, Sharp Success, Win Yield, and Sunrise, were 22.5%, 15.0%, and 11.3%,
respectively, of its total product purchases. There were no other suppliers
accounting for more than 10.0% of total product purchases during the years ended
December 31, 1999, 2000 or 2001.
Fair Value of Financial Instruments
The carrying amounts of cash, receivables, accounts payable and accrued expenses
approximate fair value because of the short-term nature of the items.
Derivative Instruments
The Company accounts for its interest rate collar under Statement of Financial
Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and
Hedging Activities." Under SFAS No. 133, the Company has recorded its interest
rate collar on the consolidated balance sheet at its fair value. Changes in fair
value are recorded in interest expense in the consolidated statement of
operations.
Advertising
The Company expenses the production costs of advertising the first time the
advertising takes place except for certain direct-response advertising, which is
capitalized and amortized over its expected period of future benefits. At
December 31, 2000 and 2001, no direct-response advertising was included in
prepaid expenses. Direct-response advertising relating to prior prepaid expenses
that were expensed for the years ended December 31, 1999, 2000 and 2001 was
approximately $1.8 million, $0 and $0, respectively.
Income Taxes
The Company accounts for income taxes under SFAS No. 109, "Accounting for Income
Taxes." Under the asset and liability method of SFAS No. 109, deferred income
taxes are recognized for the expected future tax consequences of temporary
differences between financial statement carrying amounts and the tax bases of
existing assets and liabilities using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected to
be recovered or settled.
Accounting for Stock-Based Compensation
The Company accounts for stock-based compensation arrangements with employees in
accordance with the provisions of Accounting Principles Board ("APB") Opinion
No. 25, "Accounting for Stock Issued to Employees," and complies with the
disclosure provisions of SFAS No. 123, "Accounting for Stock-Based
Compensation." Under APB No. 25, compensation expense is based on the
difference, if any, on the measurement date, between the estimated fair value of
the Company's stock and the exercise price of options to purchase that stock.
The compensation expense is amortized on a straight-line basis over the vesting
period of the options. To date, no compensation expense has been recorded
related to stock-based compensation agreements with employees.
The Company accounts for stock-based compensation arrangements with
non-employees in accordance with SFAS No. 123, which establishes a fair value
based method of accounting for stock-based compensation plans. Under the fair
value based method, compensation cost is measured at the grant date based on the
value of the award, which is calculated using an option pricing model, and is
recognized over the service
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period, which is usually the vesting period. Approximately $23,000 has been
recorded as compensation expense for stock-based compensation agreements with
non-employees for each year ended December 31, 1999, 2000 and 2001.
Net Income Per Share
The Company computes net income per share in accordance with SFAS No. 128,
"Earnings Per Share." Under the provisions of SFAS No. 128, basic net income per
share is computed by dividing net income for the period by the weighted average
number of common shares outstanding during the period. Diluted net income per
share is computed by dividing net income for the period by the weighted average
number of common and common equivalent shares outstanding during the period. The
following table discloses the components of earnings per share as set forth in
SFAS No. 128: (amounts in thousands, except per share data):
FOR THE YEAR ENDED DECEMBER 31, 1999
------------------------------------
WEIGHTED PER
NET AVERAGE SHARE
INCOME SHARES AMOUNT
-------------- -------------- --------------
Basic net income per share:
Net income.................................. $535 16,249 $0.03
Plus effect of dilutive securities:
Stock options and warrants............... - 339 -
-------------- -------------- --------------
Diluted net income per share:
Net income plus assumed conversions........... $535 16,588 $0.03
============== ============== ==============
Options and warrants to purchase 749,104 shares of common stock at prices
ranging from $9.84 to $16.18 per share were outstanding during 1999 but were not
included in the computation of diluted earnings per share because the options'
and warrants' exercise prices were greater than the average market price of the
common shares.
FOR THE YEAR ENDED DECEMBER 31, 2000
------------------------------------
WEIGHTED PER
NET AVERAGE SHARE
INCOME SHARES AMOUNT
-------------- -------------- --------------
Basic net income per share:
Net income.................................. $5,890 14,827 $0.40
Plus effect of dilutive securities:
Stock options and warrants............... - 258 -
-------------- -------------- --------------
Diluted net income per share:
Net income plus assumed conversions........... $5,890 15,085 $0.39
============== ============== ==============
Options and warrants to purchase 877,374 shares of common stock at prices
ranging from $5.00 to $15.00 per share were outstanding during 2000 but were not
included in the computation of diluted earnings per share because the options'
and warrants' exercise prices were greater than the average market price of the
common shares.
F-12
FOR THE YEAR ENDED DECEMBER 31, 2001
------------------------------------
WEIGHTED PER
NET AVERAGE SHARE
INCOME SHARES AMOUNT
-------------- -------------- --------------
Basic net income per share:
Net income.................................. $15,123 14,663 $1.03
Plus effect of dilutive securities:
Stock options and warrants............... - 496 -
-------------- -------------- --------------
Diluted net income per share:
Net income plus assumed conversions........... $15,123 15,159 $1.00
============== ============== ==============
Options and warrants to purchase 1,259,504 shares of common stock at prices
ranging from $7.94 to $16.77 per share were outstanding during 2001 but were not
included in the computation of diluted earnings per share because the options'
and warrants' exercise prices were greater than the average market price of the
common shares.
Recent Accounting Pronouncements
On June 30, 2001, the Financial Accounting Standards Board issued Statement No.
141, "Business Combinations" ("Statement No. 141"). Under Statement No. 141, all
business combinations initiated after June 30, 2001 must be accounted for using
the purchase method of accounting. Use of the pooling-of-interests method will
be prohibited. Additionally, Statement No. 141 requires that certain intangible
assets be recognized as assets apart from goodwill if they meet one of two
criteria: (1) the contractual-legal criterion or (2) the separability criterion.
Statement No. 141 is effective for all business combinations initiated after
June 30, 2001.
On June 30, 2001, the Financial Accounting Standards Board issued Statement No.
142, "Goodwill and Other Intangible Assets" ("Statement No. 142"). Under
Statement No. 142, goodwill and intangible assets that have indefinite useful
lives will not be amortized but rather will be tested at least annually for
impairment. Intangible assets that have finite useful lives will continue to be
amortized over their useful lives. The Company will adopt Statement No. 142 as
of January 1, 2002. As of December 31, 2001, goodwill, net of accumulated
amortization, is approximately $120.3 million and related amortization expense
for the years ended December 31, 1999, 2000 and 2001 was approximately $3.4
million, $3.7 million and $3.4 million, respectively. The Company has not yet
determined the impact that Statement No. 142 will have on the Company's
financial condition or results of operations.
In August 2001, the Financial Accounting Standards Board issued Statement
No.144, "Accounting for the Impairment or Disposal of Long-Lived Assets"
("Statement No. 144"), which supercedes Statement No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" and
the accounting and reporting provisions of APB Opinion No. 30, "Reporting
Results of Operations--Reporting the Effects of Disposal of a Segment of a
Business and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions," for the disposal of segments of a business. Statement No. 144
creates a single accounting model for long-lived assets to be disposed of by
sale, whether previously held and used or newly acquired. Statement No. 144
requires that those long-lived assets be measured at the lower of carrying
amount or fair value less cost to sell, whether reporting in continuing
operations or in discontinued operations. The provisions of Statement No. 144
are effective for financial statements issued for fiscal years beginning after
December 15, 2001, and interim periods within those fiscal years. The Company
has not yet determined the impact that Statement No. 144 will have on the
Company's financial condition or results of operations.
Reclassifications
Certain prior year amounts have been reclassified to conform to the current year
presentation.
F-13
4. RESTRUCTURING AND OTHER CHARGES
In the second quarter of 1999, the Company recorded restructuring and other
charges of $6.4 million. These charges relate to the Company's alignment of
operations, product lines and direct marketing efforts with the consolidation
plans for those same areas at RCE. Approximately $2.2 million of the charges
relate to the re-focusing of the direct mail programs, $4.0 million relate to
the reduction and consolidation of product lines and the remaining $0.2 million
relate to operational consolidation, including severance and relocation costs.
For the year ended December 31, 1999, all of the charges related to direct mail
were expended, approximately $3.7 million of the reduction and consolidation of
product lines were expended and approximately $0.1 million of the charges
related to severance and relocation were expended. The remainder of these
charges was expended in the first quarter of 2000.
5. BUSINESS SEGMENT
The Company has no separately reportable segments in accordance with SFAS No.
131, "Disclosure About Segments of an Enterprise and Related Information." Under
the enterprise wide disclosure requirements of SFAS 131, the Company reports net
sales by each group of product lines and by distribution channel. Amounts for
the years ended December 31, 1999, 2000 and 2001 are as shown in the tables
below.
YEAR ENDED DECEMBER 31,
-----------------------
(amounts in thousands) 1999 2000 2001
-------------- -------------- --------------
Automotive, High Performance and
Racing Vehicle Replicas................. 130,987 95,040 79,189
Agricultural, Construction and Outdoor
Sports Vehicle Replicas................. $ 54,029 $ 68,189 $ 62,295
Pre-Teen Vehicles and Role Play
Activity Toys........................... 16,961 30,320 32,195
Sports Trading Cards and Racing Apparel and
Souvenirs............................... 25,603 16,816 24,960
Collectible Figures....................... 3,780 4,441 4,609
-------------- -------------- --------------
Net sales................................. $ 231,360 $ 214,806 $ 203,248
Mass retail............................... $ 100,549 $ 88,441 $ 82,925
OEM Dealers............................... 29,753 36,699 35,674
Specialty and Hobby Wholesalers
and Retailers........................... 62,364 52,559 49,125
Corporate Promotional..................... 25,135 28,961 25,012
Direct to Consumer........................ 13,559 8,146 10,512
-------------- -------------- --------------
Net sales................................. $231,360 $214,806 $203,248
F-14
Information by geographic area for the years ended December 31, 1999, 2000 and
2001 is set forth in the table below.
DECEMBER 31,
--------------------------------------------------
(amounts in thousands) 1999 2000 2001
-------------- -------------- --------------
Net sales:
United States............................. $ 213,417 $ 194,831 $ 187,317
Foreign................................... 21,986 21,238 17,133
Sales and transfers between geographic
areas..................................... (4,043) (1,263) (1,202)
-------------- -------------- --------------
Combined total................................ $ 231,360 $ 214,806 $ 203,248
Operating income:
United States............................ $ 6,284 $ 19,758 $ 28,306
Foreign.................................. 2,688 3,289 4,232
-------------- -------------- --------------
Combined total................................ $ 8,972 $ 23,047 $ 32,538
Identifiable assets:
United States............................ $ 248,049 $ 223,838 $ 204,514
Foreign.................................. 28,233 28,069 31,009
-------------- -------------- --------------
Combined total................................ $ 276,282 $ 251,907 $ 235,523
6. INCOME TAXES
For financial reporting purposes, income before income taxes includes the
following components:
YEAR ENDED DECEMBER 31,
--------------------------------------------------
(amounts in thousands) 1999 2000 2001
-------------- -------------- --------------
Pretax income:
United States...................... $ 263 $ 8,745 $ 21,743
Foreign............................ 1,164 2,265 4,048
-------------- -------------- --------------
$ 1,427 $ 11,010 $ 25,791
============== ============== ==============
The significant components of income tax expense are as follows:
YEAR ENDED DECEMBER 31,
--------------------------------------------------
(amounts in thousands) 1999 2000 2001
-------------- -------------- --------------
Current
Federal............................ $ - $ - $ 3,366
State.............................. - - 590
Foreign............................ 293 610 1,254
-------------- --------------
293 610 5,210
Deferred
Federal............................ 493 3,946 4,776
State.............................. 106 564 682
Foreign............................ - - -
-------------- -------------- --------------
599 4,510 5,458
-------------- -------------- --------------
Income tax expense...... $ 892 $ 5,120 $ 10,668
============== ============== ==============
F-15
A reconciliation of the statutory Federal tax rate and actual effective income
tax rate is as follows:
YEAR ENDED DECEMBER 31,
-------------------------------------------------
1999 2000 2001
------------- ------------- -------------
Statutory rate............................ 34.0% 35.0% 35.0%
State taxes, net of federal benefit....... 4.8 5.1 4.9
Foreign................................... (7.1) 3.4 (0.9)
Other--primarily non-deductible goodwill.. 30.8 3.0 2.4
------------- ------------- -------------
Effective rate............................ 62.5% 46.5% 41.4%
============= ============= =============
The significant components of deferred tax assets and liabilities are as
follows:
DECEMBER 31,
--------------------------------
(amounts in thousands) 2000 2001
-------------- --------------
Deferred tax assets
Bad debt reserve.................................. $ 1,039 $ 1,000
Inventory reserve................................. 1,343 3,081
Sales allowance reserve........................... 3,545 2,360
Net operating loss................................ 3,444 -
Other............................................. 2,634 1,741
-------------- --------------
Total deferred tax assets...................... 12,005 8,182
Deferred tax liabilities
Intangible assets................................. (5,710) (6,558)
Property and equipment............................ (3,978) (4,718)
Other............................................. (574) (620)
-------------- --------------
Total deferred tax liabilities................ (10,262) (11,896)
-------------- --------------
Net deferred tax (liability) asset................... $ 1,743 $ (3,714)
============== ==============
7. DEBT
The Company entered into a credit agreement on April 13, 1999, amended on August
31, 2000, which provides for a revolving loan, term loan, and the issuance of
letters of credit. The revolving loan allows the Company to borrow up to $15.0
million prior to April 1, 2003, based upon the Company's levels of inventory and
accounts receivables. At December 31, 2001, based on the Company's borrowing
base calculation, the Company had the ability to borrow $15.0 million. At
December 31, 2001, the Company had no amounts outstanding on the revolving loan.
The term loan, in the principal amount of $62.0 million at December 31, 2001, is
due in scheduled quarterly payments of $4.0 million with a final balloon payment
on April 1, 2003. All borrowings under the credit facility are secured by
substantially all of the assets of the Company.
The term loan and the revolving loan bear interest, at the Company's option, at
an alternate base rate plus a margin that varies between 0.15% and 1.75% or at a
LIBOR rate plus a margin that varies between 0.90% and 3.50%. The applicable
margin is based on the Company's ratio of consolidated debt to consolidated
EBITDA. At December 31, 2001 the margin in effect was 0.50% for base rate loans
and 1.75% for LIBOR loans. The credit agreement also requires the Company to pay
a commitment fee determined by the ratio of consolidated debt to consolidated
EBITDA. At December 31, 2001, the commitment fee was 0.25% per annum on the
average daily unused portion of the revolving loan. During 2001, the Company
paid $59,888 in commitment fees.
Under the terms of the Company's credit agreement, the Company is required to
comply with certain financial and non-financial covenants. Among other
restrictions, the Company is restricted from paying dividends, repurchasing
stock, incurring additional debt and entering into an acquisition, sale or
merger transaction. The key financial covenants include leverage ratio, minimum
EBITDA and maximum capital
F-16
expenditures. As of December 31, 2001, the Company was in compliance with the
covenants in the credit agreement.
The Company's credit agreement also requires that the Company maintain an
interest rate protection agreement. Effective June 3, 1999, the Company entered
into an interest rate collar transaction covering $35.0 million of its debt,
with a cap based on 30 day LIBOR rates of 8.0% and floor of 5.09%. The
agreement, which has quarterly settlement dates, is in effect through June 3,
2002. During 2001, the Company paid $0.2 million on the agreement, which is
included in interest expense on the accompanying consolidated statements of
income. During 1999 and 2000, the effect of this agreement was insignificant.
Effective January 1, 2001, the Company adopted Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities." As a result of the adoption of this statement, the Company recorded
a one-time transition adjustment of approximately $85,000, in the consolidated
statement of operations. Additionally, charges of approximately $457,000 were
recorded in interest expense related to the decline in fair value of the
interest rate collar during the year ended December 31, 2001. The fair value of
the interest rate collar at December 31, 2001 of approximately $542,000 is
included in the liability section of the consolidated balance sheet.
The Company's Hong Kong subsidiary entered into a credit agreement with a bank
that provides for a line of credit of up to $2.0 million. Amounts borrowed under
this line of credit bear interest at the bank's prime rate or prevailing funding
cost, whichever is higher, and are cross-guaranteed by RCI, RCE and RCL. As of
December 31, 2000 and 2001 there were no outstanding borrowings under this line
of credit.
The Company's U.K. subsidiary has a line of credit with its bankers for $0.6
million. The line of credit bears interest at 1.00% over the bank's base rate,
and is subject to a letter of guarantee given by Racing Champions Corporation
for $0.8 million. At December 31, 2001 and 2000 respectively the Company had no
amounts outstanding on the line of credit.
During 1999, warrants valued at $1.6 million issued in conjunction with a
subsidiary's 1997 debt agreement were exercised.
Long-term debt consists of the following: (amounts in thousands)
DECEMBER 31,
--------------------------------
2000 2001
-------------- --------------
Term loan payable to banks, bearing interest at
3.83% as of December 31, 2001, with quarterly
principal payments of $4,000 and final balloon
payment due April 1, 2003.......................... $ 97,000 $ 62,000
Less -- current maturities......................... 14,000 16,000
-------------- --------------
$ 83,000 $ 46,000
============== ==============
8. COMMITMENTS AND CONTINGENCIES
Rental expense for office and warehouse space and equipment under cancelable and
noncancelable operating leases amounted to approximately $3.2 million, $2.7
million and $2.5 million for the years ended December 31, 1999, 2000 and 2001
respectively. Commitments for future minimum lease payments with terms extending
beyond one year at December 31, 2001, for noncancelable operating leases are as
follows: (amounts in thousands)
2002............................ $2,049
2003............................ 1,517
2004............................ 929
2005............................ 397
2006............................ 239
Thereafter...................... 603
------
Total................... $5,734
======
The Company markets virtually all of its products under licenses from other
parties. These licenses are generally limited in scope and duration and
authorize the sale of specific licensed products on a nonexclusive
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basis. The Company has approximately 600 licenses with various vehicle and
equipment manufacturers, race team owners, drivers, sponsors, agents and
entertainment and media companies, generally for terms of 1 to 3 years. Many of
the licenses include minimum guaranteed royalty payments that the Company must
pay whether or not they meet specified sales targets. The Company believes it
either achieved its minimum guarantees or has accrued for the costs related to
these guarantees for the year 2001. During 2000, the Company recorded a $2.5
million charge related to minimum guaranteed royalty payments from
NASCAR-related license agreements that exceeded royalties earned on product
sales. Royalty costs are included in selling, general and administrative
expenses in the accompanying consolidated statements of income.
9. LEGAL PROCEEDINGS
The Company has settled the securities class action lawsuit originally filed in
2000 in the U.S. District Court for the Northern District of Illinois, Eastern
Division under the caption Market Street Securities, Inc., et al. v. Racing
Champions Corporation, et al. Pursuant to the settlement, the Company made a
$1.8 million payment, which was covered by insurance. The Company incurred legal
expenses of approximately $1.0 million in connection with this lawsuit that were
not covered by insurance.
In August 1999, a purported class action lawsuit was filed against the Company
in the U.S. District Court for the Southern District of California, in a case
entitled Dumas, et al. v. Racing Champions Corporation. The complaint alleges
that the defendants have violated RICO and the California Unfair Competition Law
by selling packs of sports trading cards containing random assortments of cards
of varying values. This lawsuit has been dismissed by the trial court and
currently is on appeal to the Ninth Circuit Court of Appeals. The appeal was
consolidated with appeals of seven virtually identical lawsuits filed by other
putative plaintiffs' classes. The Company disputes this claim and intends to
vigorously defend its position, although no assurances can be given as to the
outcome of this matter.
A purported class action lawsuit was filed on August 21, 2000, in California
state court against Racing Champions South, Inc. and several other defendants in
a case entitled Chaset v. The Upper Deck Company, et al. The lawsuit purports to
include a proposed class of all U.S. residents who purchased sports cards
manufactured, licensed, marketed, sold or distributed by any defendant within a
time period of up to four years. The complaint alleges that the defendants have
violated the California unfair trade practices and consumer protection laws by
selling packs of sports trading cards containing random assortments of varying
values. The plaintiffs seek actual damages, attorneys' fees, pre- and
post-judgment interest, exemplary damages, and injunctive relief. In May 2001,
the defendants' motion for summary judgment was denied. In September 2001, the
California Supreme Court denied permission to the defendants to appeal the
denial of their motion for summary judgment. The plaintiffs' motion for class
certification is currently pending with the trial court. The Company disputes
these claims and intends to vigorously defend its position, although no
assurance can be given as to the outcome of this matter.
The Company has certain contingent liabilities resulting from litigation and
claims incident to the ordinary course of business. Management believes that the
probable resolution of such contingencies will not materially affect the
financial position or the results of the Company's operations.
10. CAPITAL STOCK
There are currently outstanding public warrants to purchase 255,838 shares of
the Company's common stock at an exercise price of $13.88 per share. The public
warrants may be redeemed by the Company under certain terms and conditions at a
price of $0.05 per warrant. In addition, there are outstanding underwriter
warrants to purchase an aggregate of 45,900 shares of the Company's common stock
at an exercise price of $16.77 per share and underwriter warrants to purchase
warrants to purchase an aggregate of 11,705 shares of the Company's common stock
at $13.88 per share. No holder of any of the outstanding warrants has voting or
other rights as a stockholder of the Company. All of the warrants expire in
April 2002. The Company assigned $739,126 to the value of all stock warrants
issued.
F-18
11. STOCK REPURCHASE PROGRAM
On September 1, 1999, the Company announced that its board of directors had
authorized stock repurchases by the Company for a term of one year and up to an
aggregate amount of $10.0 million. At December 31, 1999, the Company had
repurchased 775,500 shares of its outstanding common stock for approximately
$3.6 million. During 2000, the Company repurchased 1,007,600 shares of its
outstanding common stock for approximately $4.0 million.
On July 24, 2001, the Company announced that its board of directors had
authorized stock repurchases by the Company for a term of one year and up to an
aggregate amount of $5.0 million. The Company's bank lenders have consented to
the stock repurchases through May 10, 2002. As of December 31, 2001 the Company
had repurchased 75,000 shares for approximately $321,000 under this
authorization.
12. STOCK OPTION PLAN
The Company has an employee stock option plan for its key employees. The
employee stock option plan is administered by the Board of Directors. The
Company has reserved 415,041 shares of common stock for issuance under the plan.
On April 30, 1996 and June 1, 1996, the Company granted 311,281 and 20,752
options, respectively, to purchase shares of common stock at an exercise price
equal to fair market value as determined by the Board of Directors in connection
with the Recapitalization. These options vest in equal installments over a
five-year period. The options will expire on the earlier of the tenth
anniversary of the date of grant or 30 days after the date of termination of the
employees' employment with the Company.
The Company maintains a stock incentive plan, under which the Board of Directors
may grant options to purchase up to 1,500,000 shares of common stock to
executives or key employees of the Company at an exercise price equal to fair
value. Part of the options which have been granted vested immediately and the
rest vest over a five-year period. These options expire on the tenth anniversary
of the date of grant or 90 days after the date of termination of the employees'
employment with the Company.
The Company also maintains an omnibus stock plan, under which the Company has
400,000 shares of its common stock reserved for issuance. In 1997, 254,940
options to purchase shares of the Company's common stock were granted under this
plan.
Stock option activity for the Company's stock option plans for the years ended
December 31, 1999, 2000 and 2001, is as follows:
F-19
WEIGHTED- SHARES
AVERAGE AVAILABLE
EXERCISE FOR FUTURE
SHARES PRICE PRICE GRANTS
-------------- ----------------- -------------- --------------
Outstanding as of December 31, 1998..................... 866,732 $ 7.71 448,105
- ---------------------------------------------------------------------------------------------------------------------------------
1999
Granted................................................. 354,250 $5.00 - $10.94 $ 7.47
Exercised............................................... 111,912 $0.13 - $11.57 $ 4.82
Cancelled............................................... 146,300 $0.13 - $14.00 $ 11.04
- ---------------------------------------------------------------------------------------------------------------------------------
Outstanding as of December 31, 1999..................... 962,770 $ 7.44 1,140,155
- ---------------------------------------------------------------------------------------------------------------------------------
2000
Granted................................................. 390,000 $ 1.41 - $1.56 $ 1.49
Exercised............................................... 12,000 $0.13 $ 0.13
Cancelled............................................... 94,650 $5.00 - $14.00 $ 10.03
- ---------------------------------------------------------------------------------------------------------------------------------
Outstanding as of December 31, 2000..................... 1,246,120 $ 5.45 844,805
- ---------------------------------------------------------------------------------------------------------------------------------
2001
Granted................................................. 450,000 $7.94 $ 7.94
Exercised............................................... 6,800 $ 1.41 - $5.00 $ 1.83
Cancelled............................................... 22,500 $1.41 - $14.00 $ 3.60
Outstanding as of December 31, 2001..................... 1,666,820 $ 6.17 417,305
- ---------------------------------------------------------------------------------------------------------------------------------
Exercisable as of December 31, 1999..................... 359,559 $ 8.09
- ---------------------------------------------------------------------------------------------------------------------------------
Exercisable as of December 31, 2000..................... 474,195 $ 7.30
- ---------------------------------------------------------------------------------------------------------------------------------
Exercisable as of December 31, 2001..................... 694,906 $ 6.42
The following table summarizes information about stock options outstanding at
December 31, 2001:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------- --------------------------------
WEIGHTED AVERAGE WEIGHTED WEIGHTED
RANGE OF EXERCISE NUMBER REMAINING AVERAGE NUMBER AVERAGE
PRICES OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE
---------------------- --------------- ----------------- -------------- --------------------------------
$0.13 to $1.56 612,529 7.0 $ 0.96 308,529 $ 0.44
$5.00 to $12.00 868,506 8.5 $ 8.17 210,536 $ 8.89
$12.73 to $16.18 185,785 5.0 $13.97 175,841 $13.97
Had compensation costs for the stock options issued been determined based on the
fair value at their grant date consistent with SFAS No. 123, the Company's net
income and earnings per share would have been reduced to the following pro forma
amounts:
YEAR ENDED DECEMBER 31,
--------------------------------------------------
(amounts in thousands, except per share data) 1999 2000 2001
-------------- -------------- --------------
Net Income
As reported........................ $ 535 $5,890 $15,123
Pro forma.......................... $ 407 $5,878 $14,624
Basic net income per share
As reported........................ $ 0.03 $ 0.40 $ 1.03
Pro forma.......................... $ 0.03 $ 0.40 $ 1.00
Diluted net income per share
As reported........................ $ 0.03 $ 0.39 $ 1.00
Pro forma.......................... $ 0.02 $ 0.39 $ 0.96
The fair value of each option is estimated on the date of grant based on the
Black-Scholes option pricing model assuming, among other things, no dividend
yield, risk free rates of return from 4.69% to 5.74%, volatility factors of
79.93% to 87.76%, and expected life of 5 to 10 years. The weighted average fair
value of
F-20
options granted under the Company's stock option plan for the years ended
December 31, 1999, 2000 and 2001 was $5.76, $1.26 and $6.91 per share,
respectively.
The pro forma disclosure is not likely to be indicative of pro forma results
that may be expected in future years because of the fact that options vest over
several years, compensation expense is recognized as the options vest and
additional awards may be granted.
13. RELATED PARTY TRANSACTIONS
The Company purchased approximately $6.0 million, $7.7 million, and $9.0 million
of product during 1999, 2000 and 2001, respectively from a company controlled by
a relative of one of the Company's stockholders/directors.
The Company leased warehouse space from a party related to an officer/director
of the Company. Rent expense for the years ended December 31, 1999 and 2000 was
$95,640 and $7,970, respectively. This lease was terminated in February 2000.
The Company pays sales commissions to an external sales representative
organization, of which one of the principals of this organization is a relative
of an officer/director of the Company. For the years ended December 31, 1999,
2000 and 2001, commissions of $166,882, $144,662 and $26,113, respectively, were
allocated to the related principal. In April 2001, the principal left the
external sales representative organization.
14. EMPLOYEE BENEFIT PLANS
The Company has a 401(k) savings plan. Employees meeting certain eligibility
requirements, as defined, may contribute up to 15% of pre-tax gross wages,
subject to certain restrictions. The Company makes matching contributions of 50%
of the employees' contributions up to 5% of employee wages. For the years ended
December 31, 1999, 2000 and 2001 the Company's contributions were approximately
$0.2 million, $0.3 million and $0.2 million, respectively.
The Company also maintains a pension plan for hourly union employees. Benefits
under this plan, are based on a stated amount for specified years of service as
negotiated in the respective collective bargaining agreements. The Company's
funding policy is to make contributions in amounts actuarially determined by an
independent consulting actuary to fund the benefits to be provided.
Net periodic cost of the defined benefit plan included the following components:
YEAR ENDED DECEMBER 31,
--------------------------------
(amounts in thousands) NINE MONTHS ENDED
DECEMBER 31, 1999 2000 2001
--------------------- -------------- --------------
Benefits earned during the period
(service cost)............... $ 85 $ 99 $ 121
Interest cost on projected
benefit obligation........... 413 555 612
Expected return on plan assets. (488) (706) (801)
Amortization of prior service cost 19
Amortization of unrecognized gain - (6) -
--------------------- -------------- --------------
Net periodic pension costs..... $ 10 $(58) $ (49)
F-21
The change in benefit obligation and plan assets and reconciliation of funded
status are as follows: (amounts in thousands)
1999 2000 2001
-------------- ------------- --------------
Change in projected benefit obligation
during the period:
Projected benefit obligation, beginning
of period........................... $ 7,959 $ 7,274 $ 8,111
Service cost.......................... 85 99 121
Interest cost......................... 413 555 612
Actuarial loss (gain)................. (927) 525 682
Benefits and noninvestment trust
expenses paid....................... (256) (342) (376)
-------------- ------------- --------------
Projected benefit obligation, end $ 7,274 $ 8,111 $ 9,150
of period...........................
Change in plan assets during the period:
Plan assets at fair value, beginning
of period........................... $ 6,919 $ 6,821 $ 8,118
Actual return on plan assets.......... 122 672 (617)
Employer contributions................ 37 967 476
Benefits and noninvestment expenses
paid................................ (256) (342) (376)
-------------- ------------- --------------
Plan assets at fair value, end of period $ 6,822 $ 8,118 $ 7,601
Reconciliation of accrued and total amount
recognized:
Funded status of the plan............. $ (453) $ 7 $ (1,549)
Unrecognized prior service costs...... - - 228
Unrecognized net gain................. (561) 4 1,858
-------------- ------------- --------------
Net amount recognized................. $(1,014) $ 11 $ 537
Amounts recognized in the consolidated
balance sheets:
Prepaid benefit cost.................. $ - $ 11 $ -
Accrued benefit liability............. (1,014) - (1,549)
Intangible asset...................... - - 228
Accumulated other comprehensive
loss................................ - - 1,858
-------------- ------------- --------------
Net amount recognized................. $(1,014) $ 11 $ 537
Supplemental Noncash Financing
Activities:
Unfunded pension obligation........... - - $ 2,085
Assumptions used for the year-end disclosure were as follows:
1999 2000 2001
---- ---- ----
Discount rate........................ 7.75% 7.25% 7.00%
Expected return on plan assets....... 9.50% 9.50% 9.50%
Mortality table...................... 71 GAT 83 GAM 83 GAM
F-22
Assumptions used for the period expense were as follows:
1999 2000 2001
---- ---- ----
Discount rate........................ 7.00% 7.75% 7.00%
Expected return on plan assets....... 9.00% 9.50% 9.50%
Mortality table...................... 83 GAM 83 GAM 83 GAM
The assets of the defined benefit plan are primarily invested in listed stocks
and bonds.
15. SUBSEQUENT EVENTS
The Board of Directors of the Company has approved the filing of a Registration
Statement with the Securities and Exchange Commission with regard to a public
offering of the Company's common stock. Under the proposed public offering, the
Company intends to sell to the public 1,500,000 shares of common stock and
certain selling stockholders propose to sell to the public 3,000,000 shares of
common stock. The Company intends to use the proceeds from the proposed public
offering to repay outstanding debt and for general corporate purposes, including
working capital.
Upon the closing of the proposed public offering, the Company plans to enter
into a new credit facility to replace its existing credit facility. The Company
expects that the new credit facility will be a three-year $50.0 million
unsecured revolving loan that will bear interest at a LIBOR rate plus a margin
that varies between 0.75% and 1.40%.
Upon the closing of the proposed public offering, the Company plans to change
its name to Racing Champions Ertl Corporation by merging a wholly owned
subsidiary with that name into the Company.
F-24