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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
- ------- SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
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 - 24608
FOTOBALL USA, INC.
- --------------------------------------------------------------------------------
(Exact name of small business issuer as specified in its charter)
Delaware 33 - 0614889
- -------------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6740 Cobra Way, San Diego, California 92121
-----------------------------------------------------
(Address of principal executive offices) (Zip Code)
(858) 909 - 9900
---------------------------
(Issuer's telephone number)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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 whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes No X
----- -----
As of July 31, 2003, the Company had 3,651,501 shares of its common
stock issued and outstanding.
FOTOBALL USA, INC.
INDEX
Page No.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Balance Sheets as of June 30, 2003 (unaudited) and December 31, 2002 3
Statements of Operations for the three and six months
ended June 30, 2003 and 2002 (unaudited) 4
Statements of Cash Flows for the six months ended June 30, 2003 and 2002 (unaudited) 5
Notes to Financial Statements (unaudited) 6 - 9
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations 10 -16
Item 3. Quantitative and Qualitative Disclosure about Market Risk 16
Item 4. Disclosure Controls and Procedures 16-17
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders 18
Item 6. Exhibits and Reports on Form 8-K 18
SIGNATURES 19
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FOTOBALL USA, INC.
BALANCE SHEETS
June 30, 2003 December 31,
(unaudited) 2002
-------------------- --------------------
ASSETS
Current assets
Cash and equivalents $ 3,808,097 $ 5,189,250
Accounts receivable, net 4,352,868 3,684,133
Income tax and other receivables 205,880 125,489
Inventories 4,181,839 3,946,922
Prepaid expenses and other 496,013 317,841
Deferred income taxes 908,560 908,560
-------------------- --------------------
Total current assets 13,953,257 14,172,195
Property and equipment, net 2,093,654 2,203,169
Deposits and other assets 79,498 79,498
-------------------- --------------------
$ 16,126,409 $ 16,454,862
==================== ====================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable and accrued expenses $ 3,199,862 $ 3,137,987
Customer deposits 266,045 163,102
Income taxes payable -- 99,200
Current portion of capital leases 84,416 73,796
-------------------- --------------------
Total current liabilities 3,550,323 3,474,085
-------------------- --------------------
Long-term liabilities
Line of credit 384,398 669,397
Capital leases, net of current portion 88,538 135,075
Deferred rent 318,306 293,969
Deferred income taxes 53,000 53,000
Long-term reserve for discontinued operations -- 1,480
-------------------- --------------------
Total long-term liabilities 844,242 1,152,921
-------------------- --------------------
Total liabilities 4,394,565 4,627,006
-------------------- --------------------
Stockholders' equity
Preferred stock, $.01 par value; Series A, authorized - 1,000,000 shares, 0
shares issued and outstanding at June 30, 2003 and
December 31, 2002, respectively -- --
Common stock, $.01 par value; authorized - 15,000,000 shares;
Issued and outstanding - 3,651,501 shares at June 30, 2003
and 3,609,834 shares at December 31, 2002 36,515 36,098
Additional paid-in capital 11,833,448 11,754,368
Retained earnings (accumulated deficit) (138,119) 37,390
-------------------- --------------------
Total stockholders' equity 11,731,844 11,827,856
-------------------- --------------------
$ 16,126,409 $ 16,454,862
==================== ====================
See accompanying Notes to Unaudited Financial Statements
Page 3 of 19
FOTOBALL USA, INC.
STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended June 30, Six Months Ended June 30,
----------------------------------- ------------------------------------
2003 2002 2003 2002
--------------- ---------------- ---------------- ----------------
Net sales $ 7,548,506 $ 14,274,321 $ 16,429,135 $ 24,978,592
Cost of sales 4,679,330 9,135,471 9,972,810 15,974,386
--------------- ---------------- ---------------- ----------------
Gross profit 2,869,176 5,138,850 6,456,325 9,004,206
--------------- ---------------- ---------------- ----------------
Operating expenses
Royalties 592,794 1,082,203 1,418,773 1,893,956
Marketing 994,597 1,372,337 2,209,015 2,678,844
General and administrative 1,279,807 1,807,655 2,877,515 3,134,020
Depreciation and amortization 125,227 127,718 250,589 258,135
--------------- ---------------- ---------------- ----------------
Total operating expense 2,992,425 4,389,913 6,755,892 7,964,955
--------------- ---------------- ---------------- ----------------
Income (loss) from operations (123,249) 748,937 (299,567) 1,039,251
--------------- ---------------- ---------------- ----------------
Other income (expense)
Interest expense (3,112) (11,161) (6,172) (26,080)
Interest income 5,410 22,573 13,224 46,352
--------------- ---------------- ---------------- ----------------
Total other income (expense) 2,298 11,412 7,052 20,272
--------------- ---------------- ---------------- ----------------
Income (loss) before income taxes (120,951) 760,349 (292,515) 1,059,523
Income tax expense (benefit) (48,380) 304,140 (117,006) 423,809
--------------- ---------------- ---------------- ----------------
Net income (loss) $ (72,571) $ 456,209 $ (175,509) $ 635,714
=============== ================ ================ ================
Weighted average number of common shares
outstanding:
Basic 3,651,501 3,594,460 3,646,363 3,588,104
=============== ================ ================ ================
Diluted 3,651,501 3,946,857 3,646,363 3,905,549
=============== ================ ================ ================
Net income (loss) per common share:
Basic $ (0.02) $ 0.13 $ (0.05) $ 0.18
=============== ================ ================ ================
Diluted $ (0.02) $ 0.12 $ (0.05) $ 0.16
=============== ================ ================ ================
See accompanying Notes to Unaudited Financial Statements
Page 4 of 19
FOTOBALL USA, INC.
STATEMENTS OF CASH FLOWS
(UNAUDITED)
Six months ended June 30,
--------------------------------------
2003 2002
----------------- -----------------
Cash flows from operating activities:
Net income (loss) $ (175,509) $ 635,714
Adjustments to reconcile net income (loss) to net cash used in operating
activities:
Depreciation and amortization of property and equipment 333,529 275,510
Provision for accounts receivable reserves 176,899 167,973
Changes in operating assets and liabilities:
Accounts receivable (845,634) (1,052,395)
Income tax and other receivables (80,391) 338,277
Inventories (234,917) (2,368,590)
Prepaid expenses and other (178,172) 834,857
Accounts payable and accrued expenses 61,874 1,283,855
Customer deposits 102,943 (1,644,590)
Income taxes payable (99,200) 173,009
Deferred rent 24,337 21,928
Long-term reserve for discontinued operations (1,480) (16,299)
----------------- -----------------
Net cash used in operating activities (915,721) (1,350,751)
----------------- -----------------
Cash flows from investing activities:
Purchase of property and equipment (224,013) (231,864)
----------------- -----------------
Net cash used in investing activities (224,013) (231,864)
----------------- -----------------
Cash flows from financing activities:
Net borrowings from line of credit (284,999) 954,398
Proceeds from long-term debt -- 410,006
Payments on capital leases (35,917) (51,968)
Payments on long-term debt -- (2,078,519)
Proceeds from exercise of stock options 79,497 40,638
----------------- -----------------
Net cash used in financing activities (241,419) (725,445)
----------------- -----------------
Net decrease in cash and equivalents (1,381,153) (2,308,060)
Cash and equivalents, beginning of period 5,189,250 5,779,203
----------------- -----------------
Cash and equivalents, end of period $ 3,808,097 $ 3,471,143
================= =================
Supplemental disclosure of cash flow information:
Interest paid $ 21,129 $ 67,840
Incomes taxes paid $ 99,200 $ 250,000
See accompanying Notes to Unaudited Financial Statements
Page 5 of 19
FOTOBALL USA, INC.
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
THREE AND SIX MONTHS ENDED JUNE 30, 2003 AND 2002
1. BASIS OF PRESENTATION
The balance sheet as of June 30, 2003, the statements of operations for the
three and six months ended June 30, 2003 and 2002 and the statements of cash
flows for the six months ended June 30, 2003 and 2002 have been prepared by the
Company without audit. In the opinion of management, all entries (which include
only normal recurring items) necessary to present fairly the financial position,
results of operations and cash flows for all periods presented have been made.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been omitted, pursuant to the rules and
regulations of the Securities and Exchange Commission. It is suggested that
these financial statements are read in conjunction with the financial statements
and notes thereto included in the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 2002.
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities as of the
date of the financial statements, as well as the reported amounts of revenue and
expenses during the period. Significant estimates have been made by management
with respect to the realizability of the Company's deferred tax assets,
allowance for bad debt and uncollectible receivables, allowance for sales
returns and the provision for discontinued and obsolete inventories. Actual
results could differ from these estimates.
The results of operations for the three and six months ended June 30, 2003 are
not necessarily indicative of the results of operations to be expected for any
other interim period or for the year ending December 31, 2003.
RECLASSIFICATIONS - Certain amounts in the 2002 financial statements have been
reclassified to conform to the 2003 presentation.
STOCK-BASED COMPENSATION - In December 2002, the Financial Accounting Standards
Board issued Statement of Financial Accounting Standards No. 148, Accounting for
Stock-Based Compensation--Transition and Disclosure--an amendment of FASB
Statement No. 123 (SFAS 148). SFAS 148 amends FASB Statement No. 123, Accounting
for Stock-Based Compensation, to provide alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
employee compensation. In addition, this Statement amends the disclosure
requirements of Statement 123 to require prominent disclosures in both annual
and interim financial statements about the method of accounting for stock-based
employee compensation and the effect of the method used on reported results. The
Company adopted the disclosure provisions of SFAS 148 beginning with its annual
financial statements for the year ended December 31, 2002.
The Company applies Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees and related interpretations in accounting for its
stock options. No compensation expense has been recognized for the options
granted under the Company's 1998 Stock Option Plan. Compensation cost is based
upon the fair value at the grant date consistent with the methodology prescribed
under SFAS No. 123, "Accounting for Stock-Based Compensation". The following
table represents the effect on net income (loss) and earnings (loss) per share
if the Company had applied the fair value recognition provisions of FASB
Statement No. 123 "Accounting for Stock-Based Compensation" as amended by SFAS
No. 148 "Accounting for Stock-Based Compensation Transition and Disclosure". The
fair value of
Page 6 of 19
FOTOBALL USA, INC.
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
THREE AND SIX MONTHS ENDED JUNE 30, 2003 AND 2002
the options granted during 2003 is estimated to range from $1.72 to $1.94 on the
date of grant using the Black-Scholes option-pricing model with the following
assumptions: dividend yield 0%, volatility of 73% to 75%, risk-free interest
rate of 1.21% to 1.41%, actual forfeitures and an expected option life of 4
years. The fair value of the options granted during the first six months of 2002
is estimated to be $2.87 on the date of grant using the Black-Scholes
option-pricing model with the following assumptions: dividend yield 0%,
volatility of 77%, risk-free interest rate of 1.57%, actual forfeitures and an
expected option life of 4 years.
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
--------------- --------------- --------------- ---------------
Net income (loss) as reported $ (72,571) $ 456,209 $ (175,509) $ 635,714
Deduct: stock based compensation
determined under the fair value
based method for all awards, net of
tax (12,984) (25,894) (29,409) (55,600)
--------------- --------------- --------------- ---------------
Pro forma net income (loss) $ (85,555) $ 430,315 $ (204,918) $ 580,114
=============== =============== =============== ===============
Earnings (loss) per share:
Basic - as reported $ (0.02) $ 0.13 $ (0.05) $ 0.18
=============== =============== =============== ===============
Basic - pro forma $ (0.02) $ 0.12 $ (0.06) $ 0.16
=============== =============== =============== ===============
Diluted - as reported $ (0.02) $ 0.12 $ (0.05) $ 0.16
=============== =============== =============== ===============
Diluted - pro forma $ (0.02) $ 0.11 $ (0.06) $ 0.15
=============== =============== =============== ===============
2. INVENTORIES
Inventories are valued at the lower of cost or market. Cost is determined on the
first-in first-out (FIFO) method. Inventories consisted of the following at June
30, 2003 and December 31, 2002:
June 30, December 31,
2003 2002
------------------ -------------------
Finished goods $ 3,463,554 $ 2,817,140
Raw material 1,198,094 1,560,081
Less allowance for discontinued and obsolete inventory (479,809) (430,299)
------------------ -------------------
Total $ 4,181,839 $ 3,946,922
================== ===================
Page 7 of 19
FOTOBALL USA, INC.
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
THREE AND SIX MONTHS ENDED JUNE 30, 2003 AND 2002
3. ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses consisted of the following at June 30,
2003 and December 31, 2002:
June 30, December 31,
2003 2002
------------------ -------------------
Accounts payable $ 2,621,684 $ 1,867,852
Accrued payroll and benefit expenses 208,714 211,829
Accrued commissions and bonuses 110,990 756,703
Royalties payable 5,000 26,355
Current reserve for discontinued operations 8,411 25,206
Accrued joint advertising costs 241,734 247,644
Accrued other taxes 3,329 2,398
------------------ -------------------
$ 3,199,862 $ 3,137,987
================== ===================
4. LINE OF CREDIT
The Company's credit line with U.S. Bank National Association ("US Bank")
expired on May 15, 2002. There were no outstanding borrowings under the US Bank
credit line when it expired. The Company obtained a new credit line from
Comerica Bank-California ("Comerica") on June 24, 2002. The Comerica credit line
is limited to the lesser of $5 million or 80% of eligible accounts receivable,
as defined in the loan agreement, and carries interest at the rate of the
Comerica prime rate (4.0% as of June 30, 2003) plus 0.5%. The credit line
contains a special sublimit of $1.2 million that is reduced by $0.3 million on
each anniversary of the loan agreement. On June 26, 2002, the Company borrowed
$1 million under the special sublimit to refinance the outstanding balance on
its $1.5 million term loan with US Bank. The Company's assets collateralize the
Comerica credit line. The loan agreement contains financial covenants applicable
to the credit line requiring the Company to maintain a minimum current ratio of
2 to 1, a minimum quick ratio of 1.25 to 1, a maximum debt to worth ratio of 1
to 1, net income of more than $100,000 on a rolling twelve month basis and a
minimum earnings before interest and taxes to interest expense ratio of 2 to 1.
For purposes of calculating the financial covenant ratios, "current liabilities"
include amounts outstanding under the credit line except for the special
sublimit. The credit line matures on December 24, 2004. On April 16, 2003 the
Company retroactively amended the net income covenant from $100,000 on a rolling
six month basis to $100,000 on a rolling twelve month basis. The Company is in
compliance with the amended covenants as of June 30, 2003. At June 30, 2003,
$384,000 under the special sublimit was the only outstanding borrowing.
5. EARNINGS PER SHARE
Basic earnings per share ("EPS") excludes dilution and is computed by dividing
net income or loss attributable to common stockholders by the weighted-average
of common shares outstanding for the period. Diluted EPS reflects the potential
dilution that could occur if common stock options using the treasury stock
method were exercised or converted into common stock. Potential common shares in
the diluted EPS are excluded in loss periods, as their effect would be
anti-dilutive.
Page 8 of 19
FOTOBALL USA, INC.
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
THREE AND SIX MONTHS ENDED JUNE 30, 2003 AND 2002
Basic and Diluted EPS was computed as follows:
Three Months Ended June 30, Six Months Ended June 30,
------------------------------------ ---------------------------------
2003 2002 2003 2002
----------------- ------------------ --------------- ---------------
Net income (loss) $ (72,571) $ 456,209 $ (175,509) $ 635,714
================= ================== =============== ===============
Weighted average shares for basic EPS 3,651,501 3,594,460 3,646,363 3,588,104
================= ================== =============== ===============
Basic EPS $ (0.02) $ 0.13 $ (0.05) $ 0.18
================= ================== =============== ===============
Weighted average shares for basic EPS 3,651,501 3,594,460 3,646,363 3,588,104
Plus dilutive stock options -- 352,397 -- 317,445
----------------- ------------------ --------------- ---------------
Weighted average shares for diluted EPS 3,651,501 3,946,857 3,646,363 3,905,549
================= ================== =============== ===============
Diluted EPS $ (0.02) $ 0.12 $ (0.05) $ 0.16
================= ================== =============== ===============
For the three months ended June 30, 2003 and 2002 shares related to stock
options of 662,225 and 93,200, respectively, were excluded from the calculation
of diluted EPS, as the effect of their inclusion would be anti-dilutive. For the
six months ending June 30, 2003 and 2002 shares related to stock options of
662,225 and 110,200, respectively, were excluded from the calculation of diluted
EPS, as the effect of their inclusion would be anti-dilutive.
Page 9 of 19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
CAUTIONARY STATEMENTS PURSUANT TO SAFE HARBOR PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995:
This report contains forward-looking statements within the meaning of the
federal securities laws. These forward-looking statements involve risks,
uncertainties and assumptions that, if they never materialize or prove
incorrect, could cause the results of the Company to differ materially from
those expressed or implied by such forward-looking statements. All statements,
other than statements of historical fact, are forward-looking statements,
including statements regarding profitability in 2003, liquidity and other
statements of expectations, beliefs, future plans and strategies, anticipated
events or trends, and similar expressions concerning matters that are not
historical facts. The risks, uncertainties and assumptions referred to above
include the inability to obtain material cost of sales reductions, sufficient
operational efficiencies from its use of technology and to secure new promotions
and the risk factors listed from time to time in the Company's filings with the
Securities and Exchange Commission including but not limited to, the Annual
Report on Form 10-K for the year ended December 31, 2002 and the Quarterly
Report on Form 10Q for the quarter ended March 31, 2003.
RESULTS OF OPERATIONS:
The following table sets forth certain operating data (in dollars and
as a percentage of the Company's net sales) for the periods presented:
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
2003 2002 2003 2002
------------------------- ------------------------ ------------------------- ------------------------
Net sales $ 7,548,506 100% $ 14,274,321 100% $ 16,429,135 100% $ 24,978,592 100%
Cost of sales 4,679,330 62 9,135,471 64 9,972,810 61 15,974,386 64
Operating expenses 2,992,425 40 4,389,913 31 6,755,892 41 7,964,955 32
Operating income (loss) (123,249) (2) 748,937 5 (299,567) (2) 1,039,251 4
Interest expense (3,112) -- (11,161) -- (6,172) -- (26,080) --
Interest income 5,410 -- 22,573 -- 13,224 -- 46,352 --
Inc. (loss) from continuing
operations before inc. tax (120,951) (2) 760,349 5 (292,515) (2) 1,059,523 4
Income tax exp. (benefit) (48,380) (1) 304,140 2 (117,006) (1) 423,809 2
---------------- ---------------- ---------------- ---------------
Net income (loss) $ (72,571) (1)% $ 456,209 3% $ (175,509) (1)% $ 635,714 3%
================ ================ ================ ===============
FOR THE THREE MONTHS ENDED JUNE 30, 2003 AND 2002:
SALES:
DISTRIBUTION CHANNEL % OF SALES Three Months Ended June 30,
2003 2002
---------------- ---------------
Retail 34% 24%
Entertainment 33% 25%
Team 28% 14%
Promotion 5% 37%
---------------- ---------------
Total 100% 100%
================ ===============
Page 10 of 19
Net sales decreased $6.7 million, or 47%, for the second quarter of
2003 from sales for the second quarter of 2002. The decrease in sales was due to
a decrease in promotion sales (down 93%), entertainment sales (down 29%), retail
sales (down 25%) with an offsetting increase in team sales (up 9%). Promotion
sales decreased due to a $3.3 million Post promotion and other quick-serve
restaurant bobblehead doll promotions in the second quarter of 2002 that the
Company was not able to replace in the second quarter of 2003. Entertainment
sales decreased due to a decrease in The Disney Store sales, which represented
over $0.7 million in sales in the second quarter of 2002. Retail sales were down
due a a $1.0 million "Scooby Doo" and "Spider-Man" promotion at Wal-Mart
included in the second quarter of 2002 that was not replaced in 2003 and
declines in sporting goods stores sales offset by increases in sales to Target
and Toys R Us.
PRODUCT LINE % OF SALES Three Months Ended June 30,
2003 2002
------------- -------------
Footballs 12% 9%
Baseballs 27% 16%
Basketballs 14% 9%
Bobbleheads 3% 33%
Helmets 7% 2%
Collector pins 13% 10%
Playground balls 16% 14%
Soccer/volleyballs 2% 3%
Other 6% 4%
------------- -------------
Total 100% 100%
============= =============
The Company realized product sales decreases for the second quarter of
2003 versus the second quarter of 2002 from bobbleheads (down 95%), hockey (down
64%), soccer/volleyball (down 57%), playground balls (down 40%) collector pins
(down 34%), football (down 29%), basketball (down 20%), baseball (down 10%) with
an offsetting increase in helmets (up 83%).
GROSS PROFIT:
Gross profit decreased $2.3 million, or 44%, for the second quarter of
2003 from gross profit for the second quarter of 2002. Gross profit as a
percentage of sales increased to 38% for the second quarter of 2003 from 36% for
the second quarter of 2002. The increase in gross margin was primarily due to
higher percentage of non-promotional sales and higher gross margins on promotion
and retail sales.
OPERATING EXPENSES:
Total operating expenses decreased $1.4 million, or 32%, for the second
quarter of 2003 from total operating expenses for the second quarter of 2002.
The decrease in total operating expenses is primarily due to a decrease in
royalties, salary related expenses and outside sales commissions. Total
operating expenses as a percentage of sales increased to 40% for the second
quarter of 2003 from 31% for the second quarter of 2002.
Royalty expenses decreased $0.5 million, or 45%, for the second quarter
of 2003 from royalty expenses for the second quarter of 2002. Royalty expenses
as a percentage of sales remained at 8% for both second quarters ending 2003 and
2002.
Marketing expenses decreased $0.4 million, or 28%, for the second
quarter of 2003 from marketing expenses for the second quarter of 2002. The
decrease in marketing expenses is attributable to
Page 11 of 19
lower commission expenses and salary related items. Marketing expenses as a
percentage of sales increased to 13% for the second quarter of 2003 from 10% for
the second quarter of 2002.
General and administrative expenses decreased $0.5 million, or 29%, for
the second quarter of 2003 from general and administrative expenses for the
second quarter of 2002. The decrease is primarily attributable to decreased
salary-related, travel and entertainment, and telecommunications expenses
resulting from the credit received on the re-billing of past charges under a new
telecommunications contract. General and administrative expenses as a percentage
of sales increased to 17% for the second quarter of 2003 from 13% for the second
quarter of 2002 mostly due to the decrease in sales.
OTHER INCOME (EXPENSE):
Interest expense decreased by 72% for the second quarter of 2003 from
interest expense for the second quarter of 2002. This decrease reflects a
decrease in the amount outstanding on the Company's debt and capital lease
obligations as further discussed under "Liquidity and Capital Resources". As of
June 30, 2003 there was $384,398 outstanding under the credit line.
Interest income decreased by 76% for the second quarter of 2003, from
interest income for the second quarter of 2002. Excess cash is deposited into an
interest-bearing depository account. The decrease was due to higher average cash
balances, and higher interest rates during the second quarter of 2002 as
compared to the second quarter of 2003.
INCOME TAX EXPENSE (BENEFIT):
The Company recorded income tax benefit of approximately $48,000 for
the second quarter of 2003 calculated at an effective tax rate of 40% compared
to a $304,000 tax expense for the second quarter of 2002 calculated at an
effective tax rate of 40%.
FOR THE SIX MONTHS ENDED JUNE 30, 2003 AND 2002:
SALES:
DISTRIBUTION CHANNEL % OF SALES Six Months Ended June 30,
2003 2002
------------- -------------
Retail 40% 24%
Entertainment 29% 24%
Team 23% 12%
Promotion 8% 40%
------------- -------------
Total 100% 100%
============= =============
Sales decreased by $8.5 million, or 34%, for the six months ending June
30, 2003 as compared to the six months ending June 30, 2002. The decrease was
due to a decrease in promotion sales (down 86%), entertainment sales (down 18%)
with an offsetting increase in retail sales (up 9%) and team sales (up 22%).
Promotional sales decreased due to the $7.1 million Post promotion and other
quick-serve restaurant bobblehead doll promotions in the first half of 2002 that
the company did not replace. Entertainment sales decreased for the first half of
2003 versus the same period of 2002 due to a decrease of sales to The Disney
Store at the beginning of 2003. Retail sales increases were due to increases in
sales to Target, Toys R Us and Sam's Club offseting lower sales to The Sports
Authority and Wal-Mart. Team sales increased for the six months ending June 30,
2003 from the same period in 2002 due to higher sales to concessionaires and
Major League baseball teams from growth in the sales of souvenir
Page 12 of 19
batting helmets. As a consequence of the loss of The Disney Store business and
the Post promotion, the Company does not expect to attain the level of
profitability it had previously planned to achieve in 2003. While the Company
expects the third quarter, traditionally its strongest period, to assist in
closing the shortfall of the first half of 2003, its expectations for the fourth
quarter are not sufficient to achieve any real level of profitability for the
full year 2003.
PRODUCT LINE % OF SALES Six Months Ended June 30,
2003 2002
------------- -------------
Footballs 24% 11%
Baseballs 20% 14%
Basketballs 11% 8%
Bobbleheads 5% 35%
Helmets 5% 1%
Collector pins 11% 11%
Playground balls 17% 13%
Soccer/volleyballs 2% 2%
Other 5% 5%
------------- -------------
Total 100% 100%
============= =============
The Company realized product sales increases in the first half of 2003
versus the first half of 2002 from helmets (up 167%), footballs (up 48%), offset
by product sales decreases in bobbleheads (down 91%), soccer/volleyball (down
45%), collector pins (down 36%), playground balls (down 19%), baseball (down 6%)
and basketballs (down 4%).
GROSS PROFIT:
Gross profit decreased $2.5 million, or 28%, for the first half of 2003
from the gross profit for the first half of 2002. Gross profit as a percentage
of sales increased to 39% for the first half of 2003 from 36% for the first half
of 2002. The increase in gross margin was primarily due to higher percentage of
non-promotional sales and higher gross margins on promotion and retail sales.
OPERATING EXPENSE:
Total operating expenses decreased $1.2 million, or 15%, for the first
half of 2003 as compared to the first half of 2002. The decrease in total
operating expenses is primarily due to decreased royalty and commission expenses
related to lower revenue. Total operating expenses as a percentage of sales
increased to 41% for the first half of 2003 from 32% from the first half of
2002.
Royalty expenses decreased $0.5 million, or 25%, for the first half of
2003 versus the first half of 2002. Royalty expense decreased due to the
decrease in revenue. Royalty expense as a percentage of sales increased to 9%
for the first half of 2003 versus 8% for the first half of 2002. The increase in
royalty expense as a percentage of sales was due to a higher percentage of
licensed merchandise sales in the first quarter of 2003 compared to the first
quarter of 2002 as well as the mix of entertainment license sales carrying
higher royalty rates.
Marketing expenses decreased $0.5 million, or 18%, for the first half
of 2003 compared to the first half of 2002. The decrease in marketing expenses
is attributable to lower commissions and bonuses from lower revenue offset by
higher show expenses. Marketing expenses as a percentage of sales increased to
13% for the first half of 2003 from 11% for the first half of 2002.
Page 13 of 19
General and administrative expenses decreased $0.3 million, or 8%, for
the first half of 2003 compared to the first half of 2002. The decrease is
primarily related to salary and salary related items resulting from lower bonus
accruals offset by acquisition costs. General and administrative expenses as a
percentage of sales increased to 18% for the first half of 2003 from 13% for the
first half of 2002.
OTHER INCOME (EXPENSES):
Interest expense decreased by 76% for the first half of 2003 compared
to the first half of 2002. This decrease reflects a decrease in the amount of
the Company's debt and capital lease obligations as discussed under "Liquidity
and Capital Resources".
Interest income decreased by 71% for the first half of 2003 from the
interest income for the first half of 2002. Excess cash is deposited in an
interest-bearing account. The decrease reflects lower interest rates and lower
average cash balances in the first half of 2003 versus the first half of 2002.
INCOME TAX EXPENSE (BENEFIT):
The Company recorded income tax benefit of $0.1 million for the first
half of 2003 calculated at an effective tax rate of 40% compared to an income
tax expense of $0.4 million for the first half of 2002 calculated at an
effective tax rate of 40%.
LIQUIDITY AND CAPITAL RESOURCES:
The Company's net working capital decreased to $10.4 million at June
30, 2002 from $10.7 million at December 31, 2002.
Cash flows used in operations decreased $0.4 million for the first half
of 2003 from cash used in operations for the first half of 2002. This decrease
was primarily the result of decreases in accounts receivable and inventories,
changes in customer deposits offset by a decrease in net income. Accounts
receivable increased at June 30, 2003 compared to December 31, 2002 due to
decreased promotion sales in the first half of 2003, for which customers usually
include a down payment on projects. Inventory increased at June 30, 2003
compared to December 31, 2002 due to the Company purchasing inventory in
preparation for third quarter 2003 promotion sales. Accounts payable and accrued
expenses remained constant at June 30, 2003 compared to December 31, 2002.
Days sales outstanding, calculated on gross accounts receivable and
trailing twelve months sales, increased 44% at June 30, 2003 compared to
December 31, 2002 due to the higher proportion of promotional sales in the first
half of 2002 carrying more favorable payment terms than retail customer sales.
Inventory turns, calculated on gross inventory and trailing twelve months
average cost of sales, decreased 26% at June 30, 2003 compared to December 31,
2002 due to increased inventory levels to prepare for third quarter 2003 sales.
Cash and equivalents were $3.8 million at June 30, 2003, a decrease of
$1.4 million from $5.2 million of cash and equivalents at December 31, 2002.
This decrease in cash was primarily due to an increase in accounts receivable
and inventories, the purchase of fixed assets and repayment of debt in the first
half of 2003.
The Company's credit line with U.S. Bank National Association ("US
Bank") expired on May
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15, 2002. There were no outstanding borrowings under the US Bank credit line
when it expired. The Company obtained a new credit line from Comerica
Bank-California ("Comerica") on June 24, 2002. The Comerica credit line is
limited to the lesser of $5 million or 80% of eligible accounts receivable, as
defined in the loan agreement, and carries interest at the rate of the Comerica
prime rate (4.00% as of June 30, 2003) plus 0.5%. The credit line contains a
special sublimit of $1.2 million that is reduced by $0.3 million on each
anniversary of the loan agreement. On June 26, 2002, the Company borrowed $1
million under the special sublimit to refinance the outstanding balance on its
$1.5 million term loan with US Bank. The Company's assets collateralize the
Comerica credit line. The loan agreement contains financial covenants applicable
to the credit line requiring the Company to maintain a minimum current ratio of
2 to 1, a minimum quick ratio of 1.25 to 1, a maximum debt to worth ratio of 1
to 1, net income of more than $100,000 on a rolling twelve month basis and a
minimum earnings before interest and taxes to interest expense ratio of 2 to 1.
For purposes of calculating the financial covenant ratios, "current liabilities"
include amounts outstanding under the credit line except for the special
sublimit. The credit line matures on December 24, 2004. On April 16, 2003 the
Company retroactively amended the net income covenant from $100,000 on a rolling
six month basis to $100,000 on a rolling twelve month basis. The Company is in
compliance with the amended covenants as of June 30, 2003. At June 30, 2003,
$0.4 million under the special sublimit was the only outstanding borrowings. The
Company must achieve net income of at least $250,000 in the third quarter of
2003 to stay in compliance with its net income covenant. If the Company fails to
stay in compliance with his covenant, it may not be able to negotiate a waiver
from Comerica thereby requiring repayment of the total amount outstanding on its
line of credit and potentially impacting its ability to fund its future working
capital requirements or it may be able to negotiate a waiver but experience an
increase in the cost of its debt financing.
Management believes that the Company's existing cash position, combined
with internally generated cash flows, will be adequate to support the Company's
liquidity and capital needs through at least June 30, 2004.
On July 1, 2003, the Company announced a stock buyback plan to purchase
up to $500,000 worth of the company's common stock over the next 12 months which
represents approximately 170,000 shares or 5% of the current issued and
outstanding shares at current market prices. The share purchases may be made
from time to time on the open market or in privately negotiated transactions
depending on market conditions and other factors all in accordance with the
requirements of the Securities and Exchange Commission. The plan does not
obligate the Company to acquire any specific number of shares and may be
discontinued at any time. On July 28, 2003, the Company announced the suspension
of the stock buyback plan, in light of an unsolicited offer from a third party
for the acquisition of the outstanding shares of common stock of the Company at
a price in excess of their current market price.
NEW ACCOUNTING STANDARDS:
On January 17, 2003, the FASB issued FASB Interpretation No. 46,
"Consolidation of Variable Interest Entities." Variable interest entities
include such entities often referred to as structured finance or special purpose
entities. FIN 46 expands upon and strengthens existing accounting guidance that
addresses when a company should include in its financial statements the assets,
liabilities and activities of another entity. A variable interest entity is a
corporation, partnership, trust, or any other legal structure used for business
purposes that either does not have equity investors with voting rights or has
equity investors that do not provide sufficient financial resources for the
entity to support its activities. FIN 46 requires a variable interest entity to
be consolidated by a company if that company is subject to a majority of the
risk of loss from the variable interest entity's activities or is entitled to
receive a majority of the entity's residual returns or both. The consolidation
requirements of FIN 46 apply immediately to variable interest entities created
after January 31, 2003. The consolidation requirements apply to older
Page 15 of 19
entities in the first fiscal year or interim period beginning after June 15,
2003. FIN 46 will also affect leasing transactions where the lessor is a
variable interest entity. Disclosure requirements apply to any financial
statements issued after January 31, 2003. The Company does not believe that the
adoption of this accounting pronouncement will have a material impact on the
Company's financial statements and related disclosures.
In April 2003, the FASB issued Statement of Financial Accounting
Standards No. 149 (SFAS No. 149), "Amendment of Statement 133 on Derivative
Instruments and Hedging Activities." SFAS No. 149 amends and clarifies financial
accounting and reporting for derivative instruments, including certain
derivative instruments embedded in other contracts (collectively referred to as
derivatives) and for hedging activities under SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities." SFAS No. 149 is effective for
contracts entered into or modified after June 30, 2003, except for provisions of
this Statement that relate to SFAS No. 133 Implementation Issues that have been
effective for fiscal quarters that began prior to June 15, 2003 and for hedging
relationships designated after June 30, 2003. The Company does not believe that
the adoption of this accounting pronouncement will have a material impact on the
Company's financial statements and related disclosures.
In May 2003, the FASB issued Statement of Financial Accounting
Standards No. 150 (SFAS No. 150), "Accounting for Certain Financial Instruments
with Characteristics of both Liabilities and Equity." SFAS No. 150 establishes
standards for how an issuer classifies and measures certain financial
instruments with characteristics of both liabilities and equity. It requires
that an issuer classify a financial instrument that is within its scope as a
liability (or an asset in some circumstances). Many of those instruments were
previously classified as equity. SFAS No. 150 is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after June 15,
2003, except for mandatorily redeemable financial instruments of nonpublic
entities. It is to be implemented by reporting the cumulative effect of a change
in an accounting principle for financial instruments created before the issuance
date of the Statement and still existing at the beginning of the interim period
of adoption. The Company does not believe that the adoption of this accounting
pronouncement will have a material impact on the Company's financial statements
and related disclosures.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company's exposure to market risk relates to interest rate risk
with its variable rate credit line. The Company does not use derivative
financial instruments to manage or reduce market risk. As of June 30, 2003, the
Company's only variable rate debt outstanding was the $0.4 million outstanding
balance on its credit line. A 10% change in future interest rates on the
variable rate credit line would not lead to a material decrease in future
earnings assuming all other factors remained constant.
ITEM 4. DISCLOSURE CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES:
The Company maintains disclosure controls and procedures that are
designed to ensure that information required to be disclosed in the Company's
reports filed pursuant to the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), is recorded, processed, summarized and reported within the time
periods specified in the Securities and Exchange Commission's rules and forms,
and that such information is accumulated and communicated to the Company's
management, including its chief executive officer and chief financial officer,
as appropriate, to allow timely decisions regarding required disclosure.
Page 16 of 19
Within 90 days prior to the date of this report, the Company carried
out an evaluation, under the supervision and with the participation of the
Company's management, including its Chairman and Chief Executive Officer,
Michael Favish, and its Senior Vice President and Chief Financial Officer,
Thomas R. Hillebrandt, of the effectiveness of the design and operation of the
Company's disclosure controls and procedures pursuant to Exchange Act Rule
13a-14(c) and 15d-14(c). Based upon the foregoing, the Company concluded that
its disclosure controls and procedures are effective in timely alerting the
Company's management to material information relating to the Company required to
be included in the Company's Exchange Act reports.
CHANGES IN INTERNAL CONTROLS:
Since the most recent review of the Company's disclosure controls and
procedures by Messrs. Favish and Hillebrandt, there have been no significant
changes in internal controls or in other factors that could significantly affect
these controls.
Page 17 of 19
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Stockholders of the Company was held on June 18,
2003 at the Wyndham Garden Hotel located at 5975 Lusk Boulevard, San Diego,
California and the following matters were voted on at that meeting:
The election of the following directors of the Company to hold office
until the 2006 Annual Meeting of Stockholders and until the election and
qualification of their successors was approved:
Broker
Nominee For Against Withhold Abstain Non-Votes Total Votes
Michael Favish 3,233,308 -- 121,485 -- -- 3,354,793
John J. Shea 3,295,333 -- 59,460 -- -- 3,354,793
The increase in the number of the Company's shares of common stock
reserved for issuance under the Company's 1998 Stock Option Plan from 800,000 to
1,100,000 was not approved.
Broker
For Against Withhold Abstain Non-Votes Total Votes
1,449,450 428,971 -- 8,897 1,467,475 3,354,793
The ratification of the selection of KPMG LLP as the Company's
independent public accountants for the fiscal year ending December 31, 2003 was
approved.
Broker
For Against Withhold Abstain Non-Votes Total Votes
3,345,596 8,417 -- 780 -- 3,354,793
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.4(5) Form of Employment Agreement with Kevin Donovan dated
June 16, 2003
31.1 Certifications Pursuant To Rule 13a-14, as Adopted
Pursuant to Section 302 of the Sarbanes-Oxley Act Of
2002
32.1 Certifications Pursuant To 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act Of 2002
(b) Reports on Form 8-K for the three months ended June 30, 2003
Earnings Release for three months ended March 30, 2003; Filed
April 23, 2003
Page 18 of 19
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
FOTOBALL USA, INC
----------------------------------------
(Registrant)
Dated: August 14, 2003 BY: /s/ Michael Favish
------------------
Michael Favish
Chairman and Chief Executive Officer
(Principal Executive Officer)
Dated: August 14, 2003 BY: /s/ Thomas R. Hillebrandt
-------------------------
Thomas R. Hillebrandt
Senior Vice President and
Chief Financial Officer
(Principal Financial and
Accounting Officer)
Page 19 of 19