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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 September 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 Identification No.)
incorporation or organization)
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 October 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 September 30, 2003 (unaudited) and December 31, 2002 3
Statements of Operations for the three and nine months
ended September 30, 2003 and 2002 (unaudited) 4
Statements of Cash Flows for the nine months ended September 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 17
Item 4. Disclosure Controls and Procedures 17
PART II. OTHER INFORMATION
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
September 30, December 31,
2003 2004
(unaudited)
-------------------- --------------------
ASSETS
Current assets
Cash and equivalents $ 3,462,617 $ 5,189,250
Accounts receivable, net 3,965,683 3,684,133
Income tax and other receivables 157,887 125,489
Inventories 3,777,659 3,946,922
Prepaid expenses and other 513,206 317,841
Deferred income taxes 908,560 908,560
-------------------- --------------------
Total current assets 12,785,612 14,172,195
Property and equipment, net 2,033,273 2,203,169
Deposits and other assets 79,498 79,498
-------------------- --------------------
$ 14,898,383 $ 16,454,862
==================== ====================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable and accrued expenses $ 2,287,282 $ 3,137,987
Customer deposits 155,576 163,102
Income taxes payable -- 99,200
Current portion of capital leases 64,582 73,796
-------------------- --------------------
Total current liabilities 2,507,440 3,474,085
-------------------- --------------------
Long-term liabilities
Line of credit 241,898 669,397
Capital leases, net of current portion 78,559 135,075
Deferred rent 330,475 293,969
Deferred income taxes 53,000 53,000
Long-term reserve for discontinued operations -- 1,480
-------------------- --------------------
Total long-term liabilities 703,932 1,152,921
-------------------- --------------------
Total liabilities 3,211,372 4,627,006
-------------------- --------------------
Stockholders' equity
Preferred stock, $.01 par value; Series A, authorized - 1,000,000
shares, 0 shares issued and outstanding at September 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 September 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) (182,952) 37,390
-------------------- --------------------
Total stockholders' equity 11,687,011 11,827,856
-------------------- --------------------
$ 14,898,383 $ 16,454,862
==================== ====================
See accompanying Notes to Unaudited Financial Statements
Page 3 of 19
FOTOBALL USA, INC.
STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------------- ------------------------------------
2003 2002 2003 2002
--------------- ------------------- ---------------- ----------------
Net sales $ 8,249,992 $ 11,113,641 $ 24,679,127 $ 36,092,233
Cost of sales 4,762,213 6,959,131 14,735,023 22,933,517
--------------- ------------------- ---------------- ----------------
Gross profit 3,487,779 4,154,510 9,944,104 13,158,716
--------------- ------------------- ---------------- ----------------
Operating expenses
Royalties 708,484 801,311 2,127,257 2,695,267
Marketing 1,120,037 1,218,448 3,329,052 3,897,291
General and administrative 1,609,920 1,565,124 4,487,436 4,699,145
Depreciation and amortization 124,911 128,087 375,500 386,222
--------------- ------------------- ---------------- ----------------
Total operating expense 3,563,352 3,712,970 10,319,245 11,677,925
--------------- ------------------- ---------------- ----------------
Income (loss) from operations (75,573) 441,540 (375,141) 1,480,791
--------------- ------------------- ---------------- ----------------
Other income (expense)
Interest expense (2,734) (7,043) (8,905) (33,123)
Interest income 3,584 16,900 16,809 63,252
--------------- ------------------- ---------------- ----------------
Total other income (expense) 850 9,857 7,904 30,129
--------------- ------------------- ---------------- ----------------
Income (loss) before income taxes (74,723) 451,397 (367,237) 1,510,920
Income tax expense (benefit) (29,889) 180,559 (146,895) 604,368
--------------- ------------------- ---------------- ----------------
Net income (loss) $ (44,834) $ 270,838 $ (220,342) $ 906,552
=============== =================== ================ ================
Weighted average number of common shares
outstanding:
Basic 3,651,501 3,606,536 3,648,094 3,594,316
=============== =================== ================ ================
Diluted 3,651,501 3,934,946 3,648,094 3,915,050
=============== =================== ================ ================
Net income (loss) per common share:
Basic $ (0.01) $ 0.08 $ (0.06) $ 0.25
=============== =================== ================ ================
Diluted $ (0.01) $ 0.07 $ (0.06) $ 0.23
=============== =================== ================ ================
See accompanying Notes to Unaudited Financial Statements
Page 4 of 19
FOTOBALL USA, INC.
STATEMENTS OF CASH FLOWS
(UNAUDITED)
Nine months ended September 30,
--------------------------------------
2003 2002
----------------- -----------------
Cash flows from operating activities:
Net income (loss) $ (220,342) $ 906,552
Adjustments to reconcile net income (loss) to net cash used in operating
activities:
Depreciation and amortization of property and equipment 500,127 414,889
Provision for accounts receivable reserves 306,318 311,725
Changes in operating assets and liabilities:
Accounts receivable (587,868) (1,971,149)
Income tax and other receivables (32,398) 336,580
Inventories 169,263 (1,063,324)
Prepaid expenses and other (195,365) 800,821
Accounts payable and accrued expenses (850,705) 1,475,525
Customer deposits (7,526) (1,825,105)
Income taxes payable (99,200) 73,568
Deferred rent 36,506 33,695
Long-term reserve for discontinued operations (1,480) (20,720)
----------------- -----------------
Net cash used in operating activities (982,670) (526,943)
----------------- -----------------
Cash flows from investing activities:
Purchase of property and equipment (330,231) (376,252)
Decrease in long-term deposits -- 79,497
----------------- -----------------
Net cash used in investing activities (330,231) (296,755)
----------------- -----------------
Cash flows from financing activities:
Net borrowings (payments) from line of credit (427,499) 811,898
Proceeds from long-term debt -- 410,006
Payments on capital leases (65,730) (71,732)
Payments on long-term debt -- (2,078,519)
Proceeds from exercise of stock options 79,497 71,817
----------------- -----------------
Net cash used in financing activities (413,732) (856,530)
----------------- -----------------
Net decrease in cash and equivalents (1,726,633) (1,680,228)
Cash and equivalents, beginning of period 5,189,250 5,779,203
----------------- -----------------
Cash and equivalents, end of period $ 3,462,617 $ 4,098,975
================= =================
Supplemental disclosure of cash flow information:
Interest paid $ 30,995 $ 68,273
Incomes taxes paid $ 99,200 $ 530,800
Equipment acquired under lease -- $ 25,806
See accompanying Notes to Unaudited Financial Statements
Page 5 of 19
FOTOBALL USA, INC.
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
1. BASIS OF PRESENTATION
The balance sheet as of September 30, 2003, the statements of operations
for the three and nine months ended September 30, 2003 and 2002 and the
statements of cash flows for the nine months ended September 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 nine months ended September 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 NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
the options granted during 2003 is estimated to range from $1.68 to $1.94
on the date of grant using the Black-Scholes option-pricing model with the
following assumptions: dividend yield 0%, volatility of 71% to 75%,
risk-free interest rate of 1.05% to 1.41%, actual forfeitures and an
expected option life of 4 years. The fair value of the options granted
during the first nine months of 2002 is estimated to range from $2.61 to
$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 Nine Months Ended
September 30, September 30,
2003 2002 2003 2002
--------------- --------------- --------------- ---------------
Net income (loss) as reported $ (44,834) $ 270,838 $ (220,342) $ 906,552
Deduct: stock based compensation
determined under the fair value
based method for all awards, net of
tax (11,469) (53,628) (40,878) (109,228)
--------------- --------------- --------------- ---------------
Pro forma net income (loss) $ (56,303) $ 217,210 $ (261,221) $ 797,324
=============== =============== =============== ===============
Net income (loss) per share:
Basic - as reported $ (0.01) $ 0.08 $ (0.06) $ 0.25
=============== =============== =============== ===============
Basic - pro forma $ (0.02) $ 0.06 $ (0.07) $ 0.22
=============== =============== =============== ===============
Diluted - as reported $ (0.01) $ 0.07 $ (0.06) $ 0.23
=============== =============== =============== ===============
Diluted - pro forma $ (0.02) $ 0.06 $ (0.07) $ 0.20
=============== =============== =============== ===============
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 September 30, 2003 and December 31, 2002:
September 30, December 31,
2003 2002
------------------ -------------------
Finished goods $ 3,136,364 $ 2,817,140
Raw material 1,138,334 1,560,081
Less allowance for discontinued and obsolete inventory (497,039) (430,299)
------------------ -------------------
Total $ 3,777,659 $ 3,946,922
================== ===================
Page 7 of 19
FOTOBALL USA, INC.
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
3. ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses consisted of the following at
September 30, 2003 and December 31, 2002:
September 30, December 31,
2003 2002
------------------ -------------------
Accounts payable $ 1,607,932 $ 1,867,852
Accrued payroll and benefit expenses 204,472 211,829
Accrued commissions and bonuses 198,566 756,703
Royalties payable 20,433 26,355
Current reserve for discontinued operations 2,300 25,206
Accrued joint advertising costs 247,876 247,644
Accrued other taxes 5,703 2,398
------------------ -------------------
$ 2,287,282 $ 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 September 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. On September 29, 2003 the Company amended the Loan and
Security Agreement to remove the net income and earnings before interest
and taxes to interest expense ratio covenants. The Company is in compliance
with the amended covenants as of September 30, 2003. At September 30, 2003,
$241,898 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 NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
Basic and Diluted EPS were computed as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------------ ---------------------------------
2003 2002 2003 2002
----------------- ------------------ --------------- ---------------
Net income (loss) $ (44,834) $ 270,838 $ (220,342) $ 906,552
================= ================== =============== ===============
Weighted average shares for basic EPS 3,651,501 3,606,536 3,648,094 3,594,316
================= ================== =============== ===============
Basic EPS $ (0.01) $ 0.08 $ (0.06) $ 0.25
================= ================== =============== ===============
Weighted average shares for basic EPS 3,651,501 3,606,536 3,648,094 3,594,316
Plus dilutive stock options -- 328,410 -- 320,734
----------------- ------------------ --------------- ---------------
Weighted average shares for diluted EPS 3,651,501 3,934,946 3,648,094 3,915,050
================= ================== =============== ===============
Diluted EPS $ (0.01) $ 0.07 $ (0.06) $ 0.23
================= ================== =============== ===============
For the three months ended September 30, 2003 and 2002 shares related to stock
options of 660,225 and 105,200, respectively, were excluded from the calculation
of diluted EPS, as the effect of their inclusion would be anti-dilutive. For the
nine months ending September 30, 2003 and 2002 shares related to stock options
of 660,225 and 123,867, 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 10-Q for the quarter ended March 31, 2003 and June 30, 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 SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
2003 2002 2003 2002
----------------------- ------------------------ ------------------------- ------------------------
Net sales $ 8,249,992 100% $ 11,113,641 100% $ 24,679,127 100% $ 36,092,233 100%
Cost of sales 4,762,213 58 6,959,131 63 14,735,023 60 22,933,517 64
Operating expenses 3,563,352 43 3,712,970 33 10,319,245 42 11,677,925 32
Operating income (loss) (75,573) (1) 441,540 4 (375,141) (2) 1,480,791 4
Interest expense (2,734) -- (7,043) -- (8,905) -- (33,123) --
Interest income 3,584 -- 16,900 -- 16,809 -- 63,252 --
Inc. (loss) from continuing
operations before inc. tax (74,723) (1) 451,397 4 (367,237) (2) 1,510,920 4
Income tax exp. (benefit) (29,889) -- 180,559 2 (146,895) (1) 604,368 2
-------------- ---------------- ---------------- ---------------
Net income (loss) $ (44,834) (1)% $ 270,838 2% $ (220,342) (1)% $ 906,552 3%
============== ================ ================ ===============
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002:
SALES:
DISTRIBUTION CHANNEL % OF SALES Three Months Ended
September 30,
2003 2002
---------------- ---------------
Retail 47% 31%
Entertainment 20% 30%
Team 21% 13%
Promotion 12% 26%
---------------- ---------------
Total 100% 100%
================ ===============
Page 10 of 19
Net sales decreased $2.9 million, or 26%, for the third quarter of 2003
from sales for the third quarter of 2002. The decrease in sales was due to a
decrease in promotion sales (down 65%) and entertainment sales (down 49%) with
an offsetting increase in team sales (up 13%) and retail sales (up 8%).
Promotion sales decreased due to quick-serve restaurant bobblehead doll
promotions in the third quarter of 2002 that the Company was not able to replace
in the third quarter of 2003. Entertainment sales decreased due to a decrease in
The Disney Store and Disney theme park sales.
PRODUCT LINE % OF SALES Three Months Ended
September 30,
2003 2002
------------- -------------
Footballs 42% 33%
Baseballs 15% 12%
Basketballs 9% 6%
Bobbleheads 6% 11%
Helmets 4% 2%
Collector pins 10% 19%
Playground balls 8% 10%
Soccer/volleyballs 2% 2%
Other 4% 5%
------------- -------------
Total 100% 100%
============= =============
The Company realized product sales decreases for the third quarter of
2003 versus the third quarter of 2002 from collector pins (down 61%),
bobbleheads (down 59%), soccer/volleyball (down 40%), playground balls (down
39%), football (down 5%) and baseball (down 5%) with an offsetting increase in
helmets (up 47%) and basketball (up 17%).
GROSS PROFIT:
Gross profit decreased $0.7 million, or 16%, for the third quarter of
2003 from gross profit for the third quarter of 2002. Gross profit as a
percentage of sales increased to 42% for the third quarter of 2003 from 37% for
the third 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 $0.1 million, or 4%, for the third
quarter of 2003 from total operating expenses for the third quarter of 2002. The
decrease in total operating expenses is primarily due to a decrease in
royalties, salary related expenses and outside sales commissions offset by
increases in legal and investment banking fees related to an unsolicited offer
to buy the common stock of the Company. Total operating expenses as a percentage
of sales increased to 43% for the third quarter of 2003 from 33% for the third
quarter of 2002.
Royalty expenses decreased $0.1 million, or 12%, for the third quarter
of 2003 from royalty expenses for the third quarter of 2002. Royalty expenses as
a percentage of sales increased to 9% for the third quarter 2003 from 7% for the
third quarter of 2002. Royalty expenses as a percentage of sales increased due
to a greater mix of licensed merchandise sales and the mix of entertainment
license sales carrying higher royalty rates.
Page 11 of 19
Marketing expenses decreased $0.1 million, or 8%, for the third quarter
of 2003 from marketing expenses for the third quarter of 2002. The decrease in
marketing expenses is attributable to lower commission expenses and marketing
and selling expenses. Marketing expenses as a percentage of sales increased to
14% for the third quarter of 2003 from 11% for the third quarter of 2002.
General and administrative expenses increased $45,000, or 3%, for the
third quarter of 2003 from general and administrative expenses for the third
quarter of 2002. The increase is primarily attributable to increased investment
bank and legal fees related to the unsolicted offer to purchase the common stock
of the Company offset by decreases in salary-related, and travel and
entertainment related expense. Investment bank and legal fees related to the
un-solicited offer were $171,000 in the third quarter of 2003. General and
administrative expenses as a percentage of sales increased to 20% for the third
quarter of 2003 from 14% for the third quarter of 2002.
OTHER INCOME (EXPENSE):
Interest expense decreased by 61% for the third quarter of 2003 from
interest expense for the third 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
September 30, 2003 there was $241,898 outstanding under the line of credit.
Interest income decreased by 79% for the third quarter of 2003, from
interest income for the third 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 third quarter of 2002 as compared
to the third quarter of 2003.
INCOME TAX EXPENSE (BENEFIT):
The Company recorded income tax benefit of $30,000 for the third
quarter of 2003 calculated at an effective tax rate of 40% compared to a
$181,000 tax expense for the third quarter of 2002 calculated at an effective
tax rate of 40%.
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002:
SALES:
DISTRIBUTION CHANNEL % OF SALES Nine Months Ended
September 30,
2003 2002
------------- -------------
Retail 42% 26%
Entertainment 26% 26%
Team 22% 12%
Promotion 10% 36%
------------- -------------
Total 100% 100%
============= =============
Sales decreased by $11.0 million, or 32%, for the nine months ending
September 30, 2003 as compared to the nine months ending September 30, 2002. The
decrease was due to a decrease in promotion sales (down 81%), entertainment
sales (down 29%) with an offsetting increase in retail sales (up 9%) and team
sales (up 19%). Promotional sales decreased due to the $7.1 million Post
promotion and other quick-serve restaurant bobblehead doll promotions in the
first three quarters of 2002 that the company did not replace. Entertainment
sales decreased for the first three quarters of 2003 versus the
Page 12 of 19
same period of 2002 due to a decrease of sales to The Disney Store. Retail sales
increases were due to increases in sales to catalog retailers, warehouse clubs
and sporting goods accounts offseting lower sales to mass merchants. Team sales
increased for the nine months ending September 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 batting helmets.
PRODUCT LINE % OF SALES Nine Months Ended
September 30,
2003 2002
------------- -------------
Footballs 30% 17%
Baseballs 19% 14%
Basketballs 11% 7%
Bobbleheads 5% 28%
Helmets 4% 1%
Collector pins 11% 14%
Playground balls 14% 12%
Soccer/volleyballs 2% 2%
Other 4% 5%
------------- -------------
Total 100% 100%
============= =============
The Company realized product sales increases in the first three
quarters of 2003 versus the first three quarters of 2002 from helmets (up 118%),
footballs (up 17%) and basketball (up 1%), offset by product sales decreases in
bobbleheads (down 87%), collector pins (down 47%), soccer/volleyball (down 44%),
playground balls (down 24%) and baseball (down 6%).
GROSS PROFIT:
Gross profit decreased $3.2 million, or 24%, for the first three
quarters of 2003 from the gross profit for the first three quarters of 2002.
Gross profit as a percentage of sales increased to 40% for the first three
quarters of 2003 from 36% for the first three quarters 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 $1.4 million, or 12%, for the first
three quarters of 2003 as compared to the first three quarters of 2002. The
decrease in total operating expenses is primarily due to decreased salary and
related expenses, marketing and selling expenses, royalty and commission
expenses related to lower revenue offset by increases in legal and investment
banking fees related to an attempted acquisition in the beginning of the year
and the un-solicited offer to buy the common stock of the Company. Total
operating expenses as a percentage of sales increased to 42% for the first three
quarters of 2003 from 32% from the first three quarters of 2002.
Royalty expenses decreased $0.6 million, or 21%, for the first three
quarters of 2003 versus the first three quarters of 2002. Royalty expense
decreased due to the decrease in revenue. Royalty expense as a percentage of
sales increased to 9% for the first three quarters of 2003 versus 7% for the
first three quarters 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
three quarters of 2003 compared to the first three quarters of 2002 as well as
the mix of entertainment license sales carrying higher royalty rates.
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Marketing expenses decreased $0.6 million, or 15%, for the first three
quarters of 2003 compared to the first three quarters of 2002. The decrease in
marketing expenses is attributable to lower sales and marketing expense and
commissions and bonuses from lower revenue offset by higher salary and related
expenses. Marketing expenses as a percentage of sales increased to 13% for the
first three quarters of 2003 from 11% for the first three quarters of 2002.
General and administrative expenses decreased $0.2 million, or 5%, for
the first three quarters of 2003 compared to the first three quarters of 2002.
The decrease is primarily related to salary and salary related items resulting
from lower bonus accruals offset by increases in legal and investment banking
fees related to an attempted acquisition in the beginning of the year and the
unsolicited offer to buy the common stock of the Company. Investment bank and
legal fees related to the acquisition and un-solicited offer were $333,000 for
the nine months ended September 30, 2003. General and administrative expenses as
a percentage of sales increased to 18% for the first three quarters of 2003 from
13% for the first three quarters of 2002.
With lower than anticipated sales and the unsolicted offer related
expenses, the Company anticipates that it will incur a net loss for the fourth
quarter and full year ended December 31, 2003.
OTHER INCOME (EXPENSES):
Interest expense decreased by 73% for the first three quarters of 2003
compared to the first three quarters 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 73% for the first three quarters of 2003
from the interest income for the first three quarters 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 three quarters of 2003 versus
the first three quarters of 2002.
INCOME TAX EXPENSE (BENEFIT):
The Company recorded an income tax benefit of $0.1 million for the
first three quarters of 2003 calculated at an effective tax rate of 40% compared
to an income tax expense of $0.6 million for the first three quarters of 2002
calculated at an effective tax rate of 40%.
LIQUIDITY AND CAPITAL RESOURCES:
The Company's net working capital decreased to $10.3 million at
September 30, 2003 from $10.7 million at December 31, 2002.
Cash flows used in operations increased $0.5 million for the first
three quarters of 2003 from cash used in operations for the first three quarters
of 2002. This increase was primarily the result of a reduction of net income and
a decrease in accounts payable offset by smaller decreases in accounts
receivable and customer deposits. Accounts receivable increased at September 30,
2003 compared to December 31, 2002 due to increased sales for the quarter and
higher days sales outstanding. Accounts payable and accrued expenses decreased
at September 30, 2003 as compared to December 31, 2002 due to a reduction in
accrued commissions and bonuses.
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Days sales outstanding, calculated on gross accounts receivable and
trailing twelve months sales, increased 39% at September 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 30% at September 30, 2003 compared to December
31, 2002 due to the higher level of promotional sales, which tend not to require
the Company to carry inventory, in 2002 thereby increasing the 2002 inventory
turn. Excluding promotional sales, inventory turn decreased 5%.
Cash and equivalents were $3.5 million at September 30, 2003, a
decrease of $1.7 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, the decrease in accounts payable and accrued expenses, the purchase
of fixed assets and repayment of debt in the first three quarters of 2003.
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 (4.00% as of September 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
$1.0 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. On September 29,
2003 the Company amended the Loan and Security Agreement to remove the net
income and earnings before interest and taxes to interest expense ratio
covenants. The Company is in compliance with the amended covenants as of
September 30, 2003. At September 30, 2003, $0.2 million under the special
sublimit was the only outstanding borrowing.
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 September 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. In connection with its receipt
of the offer, the Company also announced the formation of a special committee
comprised solely of independent directors to review the offer. The special
committee has hired the investment banking firm of Imperial Capital, LLC to
provide financial advisory services to it in
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connection with the review process, which is ongoing.
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 entities
in the first fiscal year or interim period beginning after December 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 adoption of this accounting pronouncement did not have a
material impact on the Company's financial statements and related disclosures.
Page 16 of 19
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 September 30, 2003,
the Company's only variable rate debt outstanding was the $0.2 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.
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 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.10(14) Second Modification to Loan and Security Agreement with
Comerica Bank- California, dated September 29, 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 September 30, 2003
Earnings Release for three months ended June 30, 2003; Filed July 22,
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: November 14, 2003 BY: /s/ Michael Favish
------------------
Michael Favish
Chairman and Chief Executive Officer
(Principal Executive Officer)
Dated: November 14, 2003 BY: /s/ Thomas R. Hillebrandt
-------------------------
Thomas R. Hillebrandt
Senior Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
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