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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to _________
Commission file number: 0-22635
------------
Racing Champions Ertl Corporation
------------------------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
Delaware 36-4088307
-------- ----------
(State or other jurisdiction (IRS Employer Identification No.)
of incorporation or organization)
800 Roosevelt Road, Building C, Suite 320, Glen Ellyn, IL 60137
---------------------------------------------------------------
(Address of principal executive offices)
Registrant's telephone number, including area code: 630-790-3507
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by sections 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
---
On August 9, 2002, there were outstanding 16,459,551 shares of the Registrant's
$0.01 par value common stock.
RACING CHAMPIONS ERTL CORPORATION
FORM 10-Q
June 30, 2002
INDEX
PART I - FINANCIAL INFORMATION
Page
Item 1. Condensed Consolidated Balance Sheets as of June 30,
2002 and December 31, 2001 (Unaudited) . . . . . . . . . . 3
Condensed Consolidated Statements of Earnings for the
Three Months and Six Months Ended June 30, 2002
and 2001 (Unaudited) . . . . . . . . . . . . . . . . . . 4
Condensed Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 2002 and 2001 (Unaudited). . . . 5
Notes to Condensed Consolidated Financial
Statements (Unaudited) . . . . . . . . . . . . . . . . . . 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations . . . . . . . . . . 13
Item 3. Quantitative and Qualitative Disclosures
about Market Risk . . . . . . . . . . . . . . . . . . . . 17
PART II - OTHER INFORMATION
Item 1. Legal Proceedings . . . . . . . . . . . . . . . . . . . . 18
Item 2. Changes in Securities and Use of Proceeds . . . . . . 18
Item 3. Defaults Upon Senior Securities . . . . . . . . . . . . 18
Item 4. Submission of Matter to a Vote of Security Holders . . . . 19
Item 5. Other Information . . . . . . . . . . . . . . . . . . . . 19
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . 20
Signatures . . . . . . . . . . . . . . . . . . . . . . . . 21
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
RACING CHAMPIONS ERTL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
June 30, 2002 December 31, 2001
------------- -----------------
(Unaudited)
ASSETS:
Cash and cash equivalents. . . . . . . . . $ 14,852 $ 16,510
Accounts receivable, net . . . . . . . . . 26,567 37,168
Inventory, net . . . . . . . . . . . . . . 27,711 17,544
Other current assets . . . . . . . . . . . 10,081 9,986
Property and equipment, net . . . . . . . 34,005 32,925
Goodwill, net . . . . . . . . . . . . . . 120,278 120,278
Other non-current assets . . . . . . . . . 462 1,112
--------- --------
Total assets . . . . . . . . . . . . . $ 233,956 $235,523
========= ========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Accounts payable and accrued expenses . . $ 38,015 $ 36,298
Other current liabilities . . . . . . . . 2,501 2,518
Bank term loans . . . . . . . . . . . . . -- 62,000
Line of credit . . . . . . . . . . . . . . 23,000 --
Other long-term liabilities . . . . . . . 15,806 16,946
--------- --------
Total liabilities . . . . . . . . . . . 79,322 117,762
Stockholders' equity . . . . . . . . . . 154,634 117,761
--------- --------
Total liabilities and stockholders' equity $ 233,956 $235,523
========= ========
See accompanying notes to condensed consolidated financial statements.
3
RACING CHAMPIONS ERTL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
For the three months For the six months
ended June 30, ended June 30,
-------------------- ------------------
2002 2001 2002 2001
--------- --------- --------- ---------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
Net sales . . . . . . . . . . . . . . . . . . $ 47,746 $ 43,077 $ 88,522 $79,533
Cost of sales . . . . . . . . . . . . . . . . 22,080 20,042 42,560 39,242
------------ ------------ ------------ -------
Gross profit . . . . . . . . . . . . . . . . 25,666 23,035 45,962 40,291
Selling, general and administrative expenses 16,546 16,353 31,811 29,271
Amortization of goodwill . . . . . . . . . . --- 851 --- 1,702
------------ ------------ ------------ -------
Operating income . . . . . . . . . . . . . . 9,120 5,831 14,151 9,318
Interest expense, net . . . . . . . . . . . . 1,010 1,677 1,655 3,920
Other expense (income) . . . . . . . . . . . (148) 489 (509) 466
------------ ------------ ------------ -------
Income before income taxes . . . . . . . . . 8,258 3,665 13,005 4,932
Income tax expense . . . . . . . . . . . . . 3,303 1,539 5,202 2,072
------------ ------------ ------------ -------
Net income. . . . . . . . . . . . . . . . . . $ 4,955 $ 2,126 $ 7,803 $ 2,860
============ ============ ============ =======
Net income per share:
Basic . . . . . . . . . . . . . . . . . $ 0.30 $ 0.14 $ 0.50 $ 0.19
============ ============ ============ =======
Diluted . . . . . . . . . . . . . . . . . $ 0.29 $ 0.14 $ 0.47 $ 0.19
============ ============ ============ =======
Weighted average shares outstanding:
Basic . . . . . . . . . . . . . . . . . . 16,347 14,686 15,483 14,677
Diluted . . . . . . . . . . . . . . . . . 17,291 15,121 16,505 15,080
See accompanying notes to condensed consolidated financial statements.
4
RACING CHAMPIONS ERTL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
For the six months
ended June 30,
---------------------
2002 2001
----------- ---------
(Unaudited) (Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income . . . . . . . . . . . . . . . . . . . . $ 7,803 $ 2,860
Depreciation and amortization . . . . . . . . . . . 4,536 6,243
Amortization of deferred financing costs . . . . . 688 281
Gain on sale of assets . . . . . . . . . . . . . . (348) (45)
Changes in operating assets and liabilities . . . . 1,068 10,404
------------ ---------
Net cash provided by operating activities . . . 13,747 19,743
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment . . . . . . . . (5,758) (2,492)
Proceeds from disposal of property and equipment 491 105
Increase in other non-current assets . . . . . . . (38) --
------------ ---------
Net cash used in investing activities . . . . . (5,305) (2,387)
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments to/from bank, net . . . . . . . . . . . . . . (39,000) (13,575)
Issuance of common stock upon option exercise . . . . . 82 --
Issuance of common stock upon warrant exercise. . . . . 3,634 --
Issuance of treasury stock. . . . . . . . . . . . . . . 59 68
Net cash proceeds from public stock offering. . . . . . 24,741 --
Expense recognized under option grants . . . . . . . . -- 11
------------ ---------
Net cash used in financing activities . . . . . . . . (10,484) (13,496)
Effect of exchange rate on cash . . . . . . . . . . . 384 (303)
------------ ---------
Net increase (decrease) in cash and cash equivalents (1,658) 3,557
------------ ---------
Cash and cash equivalents, beginning of period . . . . . . 16,510 12,582
------------ ---------
Cash and cash equivalents, end of period . . . . . . . . . $ 14,852 $ 16,139
============ =========
Supplemental information:
Cash paid during the period for:
Interest . . . . . . . . . . . . . . . . . . . . . . . . $ 1,312 $ 3,969
Income taxes . . . . . . . . . . . . . . . . . . . . . . $ 5,934 $ 537
Income tax refunds received . . . . . . . . . . . . . . . $ 121 $ 5,942
See accompanying notes to condensed consolidated financial statements.
5
RACING CHAMPIONS ERTL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION
The condensed consolidated financial statements include the accounts of Racing
Champions Ertl Corporation and its wholly-owned subsidiaries ("the Company").
All intercompany transactions and balances have been eliminated.
The accompanying condensed consolidated financial statements have been prepared
by management and, in the opinion of management, contain all adjustments,
consisting of normal recurring adjustments, necessary to present fairly the
financial position of the Company as of June 30, 2002 and 2001, the results of
operations for the three-month and six-month periods ended June 30, 2002 and
2001 and the cash flows for the six-month periods ended June 30, 2002 and 2001.
Certain information and note disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States have been omitted. It is suggested that these condensed
consolidated financial statements be read in conjunction with the consolidated
financial statements and related notes included in the Company's Form 10-K, as
amended, for the year ended December 31, 2001.
The results of operations for the three-month and six-month periods ended June
30, 2002 are not necessarily indicative of the operating results expected for
the full year.
NOTE 2 - NEW ACCOUNTING PRONOUNCEMENTS
On June 30, 2001, the Financial Accounting Standards Board issued Statement
No. 142, "Goodwill and Other Intangible Assets" ("Statement No. 142"). Under
Statement No. 142, goodwill and intangible assets that have indefinite useful
lives will not be amortized but rather will be tested at least annually for
impairment. Intangible assets that have finite useful lives will continue to be
amortized over their useful lives. The Company adopted Statement No. 142 on
January 1, 2002. As of June 30, 2002, goodwill, net of accumulated amortization,
is approximately $120.3 million. The Company has completed the transitional
goodwill impairment test, which resulted in no goodwill impairment. The
following pro forma financial information reflects net income and basic and
diluted earnings per share as if goodwill was not subject to amortization for
the three months and six months ended June 30, 2001 (dollars in thousands,
except per share data).
6
Three months Six months
ended ended
June 30, 2001 June 30, 2001
-------------- --------------
Reported net income. . . . . . . . . . . . . . . . $ 2,126 $ 2,860
Add back: Goodwill amortization, net of income tax 625 1,251
-------------- --------------
Adjusted net income. . . . . . . . . . . . . . . . $ 2,751 $ 4,111
Basic earnings per share:
Reported net income per share. . . . . . . . . . . $ 0.14 $ 0.19
Goodwill amortization per share. . . . . . . . . . 0.04 0.09
-------------- --------------
Adjusted net income per share. . . . . . . . . . . $ 0.18 $ 0.28
Diluted earnings per share:
Reported net income per share. . . . . . . . . . . $ 0.14 $ 0.19
Goodwill amortization per share. . . . . . . . . . 0.04 0.08
-------------- --------------
Adjusted net income per share. . . . . . . . . . . $ 0.18 $ 0.27
In August 2001, the Financial Accounting Standards Board issued Statement No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets"
("Statement No. 144"), which supercedes Statement No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" and
the accounting and reporting provisions of APB Opinion No. 30, "Reporting
Results of Operations--Reporting the Effects of Disposal of a Segment of a
Business and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions," for the disposal of segments of a business. Statement No. 144
creates a single accounting model for long-lived assets to be disposed of by
sale, whether previously held and used or newly acquired. Statement No. 144
requires that those long-lived assets be measured at the lower of carrying
amount or fair value less cost to sell, whether reported in continuing
operations or in discontinued operations. The provisions of Statement No. 144
are effective for financial statements issued for fiscal years beginning after
December 15, 2001, and interim periods within those fiscal years. The Company
does not expect Statement No. 144 to have a material impact on its financial
condition or results of earnings and there was no impact for the six months
ended June 30, 2002.
In April 2002, the Financial Accounting Standards Board issued Statement No.
145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections." During the quarter ended June 30,
2002, the Company elected early adoption of this Statement and accordingly
included $544,727 of financing fees related to the Company's previous credit
facility in interest expense in the accompanying statement of earnings. In
addition, in connection with the refinancing of the Company's credit facility,
the Company incurred approximately $284,000 in financing fees on the new credit
facility which is also included in interest expense.
7
NOTE 3 - BUSINESS SEGMENTS
The Company has no separately reportable segments in accordance with Financial
Accounting Standards Board Statement No. 131, "Disclosure About Segments of an
Enterprise and Related Information." ("Statement No. 131") Under the enterprise
wide disclosure requirements of Statement No. 131, the Company reports net sales
by each group of product lines and by distribution channel. Amounts for the
quarters ended June 30, 2002 and 2001 are as shown in the table below.
(amounts in thousands) 2002 2001
------- -------
Agricultural, construction and outdoor
sports vehicle replicas. . . . . . . . . . . . . . . $ 9,533 $ 9,506
Automotive, high performance and
racing vehicle replicas. . . . . . . . . . . . . . . 18,990 17,296
Sports trading cards and racing apparel and souvenirs. 9,548 9,178
Pre-teen vehicles and role play activity toys. . . . . 8,157 5,797
Collectible figures. . . . . . . . . . . . . . . . . . 1,518 1,300
------- -------
Net sales. . . . . . . . . . . . . . . . . . . . . . . $47,746 $43,077
======= =======
Mass retailers . . . . . . . . . . . . . . . . . . . . $14,583 $14,422
OEM dealers. . . . . . . . . . . . . . . . . . . . . . 6,526 4,845
Specialty and hobby wholesalers and retailers. . . . . 16,924 14,833
Corporate promotional. . . . . . . . . . . . . . . . . 5,547 6,061
Direct to consumers. . . . . . . . . . . . . . . . . . 4,166 2,916
------- -------
Net sales. . . . . . . . . . . . . . . . . . . . . . . $47,746 $43,077
======= =======
Amounts for the six months ended June 30, 2002 and 2001 are as shown in the
table below.
(amounts in thousands) 2002 2001
------- -------
Agricultural, construction and outdoor
sports vehicle replicas . . . . . . . . . . . . . . . $18,177 $18,532
Automotive, high performance and
racing vehicle replicas . . . . . . . . . . . . . . . 37,849 33,341
Sports trading cards and racing apparel and souvenirs. 16,100 14,191
Pre-teen vehicles and role play activity toys. . . . . 13,706 11,438
Collectible figures. . . . . . . . . . . . . . . . . . 2,690 2,031
------- -------
Net sales. . . . . . . . . . . . . . . . . . . . . . . $88,522 $79,533
======= =======
Mass retailers . . . . . . . . . . . . . . . . . . . . $29,364 $29,148
OEM dealers. . . . . . . . . . . . . . . . . . . . . . 13,192 9,702
Specialty and hobby wholesalers and retailers. . . . . 29,784 24,817
Corporate promotional. . . . . . . . . . . . . . . . . 9,459 10,820
Direct to consumers. . . . . . . . . . . . . . . . . . 6,723 5,046
------- -------
Net sales. . . . . . . . . . . . . . . . . . . . . . . $88,522 $79,533
======= =======
8
Information for the quarters ended June 30, 2002 and 2001 by geographic area is
set forth in the table below.
(amounts in thousands) 2002 2001
-------- --------
Net sales:
United States . . . . . . . . . . . . . . . . . $43,793 $39,575
Non-United States . . . . . . . . . . . . . . . 4,240 3,801
Sales and transfers between geographic areas. . (287) (299)
-------- --------
Total. . . . . . . . . . . . . . . . . . . . . . . $47,746 $43,077
======== ========
Operating income:
United States . . . . . . . . . . . . . . . . . $ 8,198 $ 4,966
Non-United States . . . . . . . . . . . . . . . 922 865
-------- --------
Total. . . . . . . . . . . . . . . . . . . . . . . $ 9,120 $ 5,831
======== ========
Information for the six months ended June 30, 2002 and 2001 by geographic area
is set forth in the table below.
(amounts in thousands) 2002 2001
-------- --------
Net sales:
United States . . . . . . . . . . . . . . . . . . .. $81,455 $72,727
Non-United States . . . . . . . . . . . . . . . . . 7,571 7,492
Sales and transfers between geographic areas. . . . (504) (686)
-------- --------
Total. . . . . . . . . . . . . . . . . . . . . . . . . $88,522 $79,533
======== ========
Operating income:
United States . . . . . . . . . . . . . . . . . . . $12,543 $ 7,876
Non-United States . . . . . . . . . . . . . . . . . 1,608 1,442
-------- --------
Total. . . . . . . . . . . . . . . . . . . . . . . . . $14,151 $ 9,318
======== ========
9
NOTE 4 - COMPREHENSIVE INCOME
The Company reports comprehensive income in accordance with Financial Accounting
Standards Board Statement No. 130, "Reporting Comprehensive Income." ("Statement
No. 130") Statement No. 130 requires companies to report all changes in equity
during a period, except those resulting from investment by owners and
distributions to owners, in a financial statement for the period in which they
are recognized.
Comprehensive income for the six months ended June 30, 2002 and 2001 is
calculated as follows:
(amounts in thousands) 2002 2001
------ ------
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $7,803 $2,860
Other comprehensive income-foreign currency translation adjustments 554 97
------ ------
Comprehensive income . . . . . . . . . . . . . . . . . . . . . . . . $8,357 $2,957
====== ======
NOTE 5 - COMMON STOCK
Authorized and outstanding shares and par value of the Company's voting common
stock are as follows:
Authorized Shares outstanding Shares outstanding
Shares Par Value at June 30, 2002 at December 31, 2001
---------- --------- ------------------ --------------------
Voting
Common Stock 28,000,000 $0.01 16,454,451 14,617,408
In September 1999, the Company's board of directors authorized a stock
repurchase program for a term of one year and up to an aggregate amount of $10.0
million. Under this program, the Company purchased 1,783,100 shares of its
outstanding common stock for approximately $7.6 million. In July 2001, the
Company's board of directors authorized a stock repurchase program for a term of
one year and up to an aggregate amount of $5.0 million. As of June 30, 2002 the
Company had repurchased 75,000 shares for approximately $321,000 under this
authorization. In 2001, the Company sold 24,000 shares out of treasury to two of
the Company's executive officers for $67,500 and in April 2002 the Company sold
3,805 shares out of treasury to three of the Company's executive officers for
$59,073.
NOTE 6 - DEBT
In April 2002, the Company completed a public offering of 1,545,000 shares of
common stock and certain selling stockholders sold 3,975,000 shares of common
stock at a price of $17.25 per share. The Company received proceeds of $25.2
million from the offering, net of underwriting discount, and used $24.0 million
of the proceeds to repay outstanding debt.
10
Upon the closing of the public offering, the Company entered into a new credit
facility to replace its previous credit facility. The credit facility is a
three-year $50.0 million unsecured revolving loan that bears interest, at the
Company's option, at a base rate or at a LIBOR rate plus a margin that varies
between 0.75% and 1.40%. The applicable margin is based on the Company's ratio
of consolidated debt to consolidated EBITDA. At June 30, 2002, the margin in
effect was 0.90% for LIBOR loans. The Company is also required to pay a
commitment fee on the average unused revolver of 0.20% to 0.30%, determined by
the ratio of consolidated debt to consolidated EBITDA. At June 30, 2002, the
commitment fee was 0.225% per annum on the average daily unused portion of the
revolving loan. Under the terms of the new credit facility, the Company is
required to comply with certain financial and non-financial covenants. Among
other restrictions, the Company is restricted from paying dividends, incurring
additional debt, entering into an acquisition, sale or merger transaction above
certain levels and repurchasing stock in excess of certain levels. The key
financial covenants include leverage and interest coverage ratios. At June 30,
2002, the amount outstanding under this facility was $23.0 million and the
Company was in compliance with all covenants.
NOTE 7 - INTEREST RATE COLLAR
The Company's previous credit agreement required that the Company maintain an
interest rate protection agreement. Effective June 3, 1999, the Company entered
into an interest rate collar transaction covering $35.0 million of its debt,
with a cap based on 30-day LIBOR rates of 8.0% and a floor of 5.09%. The
agreement, which had quarterly settlement dates, was in effect through June 3,
2002. For the six-month periods ended June 30, 2002 and 2001, the Company paid
$548,417 and $111, respectively, on the agreement, which is included in interest
expense on the accompanying consolidated statements of earnings.
Effective January 1, 2001, the Company adopted Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities." As a result of the adoption of this statement, the Company
recorded a one-time transition adjustment of approximately $85,000, in the
consolidated statement of earnings for the period ended March 31, 2001.
Additionally, a benefit of approximately $542,000 and a charge of approximately
$268,000 were recorded in interest expense related to the change in fair value
of the interest rate collar during the six-month periods ended June 30, 2002 and
2001, respectively. The fair value of the interest rate collar at June 30, 2002
and 2001 of approximately $0 and $353,000, respectively, is included in other
long-term liabilities in the consolidated balance sheet.
NOTE 8 - NET INCOME PER SHARE
The Company computes net income per share in accordance with SFAS No. 128,
"Earnings Per Share." Under the provisions of SFAS No. 128, basic net income
per share is computed by dividing the net income for the period by the weighted
average number of common shares outstanding during the period. Diluted net
income per share is computed by dividing the net income for the period by the
weighted average number of common and common equivalent shares outstanding
during the period. Certain options and warrants were not included in the
weighted average share calculation as their effect was antidilutive.
11
NOTE 9 - LEGAL PROCEEDINGS
In August 1999, a purported class action lawsuit was filed against the Company
in the U.S. District Court for the Southern District of California, in a case
entitled Dumas, et al. v. Racing Champions Corporation. The complaint alleges
----------------------------------------------
that the defendants have violated RICO and the California Unfair Competition Law
by selling packs of sports trading cards containing random assortments of cards
of varying values. This lawsuit has been dismissed by the trial court and
currently is on appeal to the Ninth Circuit Court of Appeals. The appeal was
consolidated with appeals of seven virtually identical lawsuits filed by other
putative plaintiffs' classes. The Company disputes this claim and intends to
vigorously defend its position, although no assurances can be given as to the
outcome of this matter.
A purported class action lawsuit was filed on August 21, 2000, in California
state court against Racing Champions South, Inc. and several other defendants in
a case entitled Chaset v. The Upper Deck Company, et al. The lawsuit purports to
----------------------------------------
include a proposed class of all U.S. residents who purchased sports cards
manufactured, licensed, marketed, sold or distributed by any defendant within a
time period of up to four years. The complaint alleges that the defendants have
violated the California unfair trade practices and consumer protection laws by
selling packs of sports trading cards containing random assortments of varying
values. The plaintiffs seek actual damages, attorneys' fees, pre- and
post-judgment interest, exemplary damages, and injunctive relief. In May 2001,
the defendants' motion for summary judgment was denied. In September 2001, the
California Supreme Court denied permission to the defendants to appeal the
denial of their motion for summary judgment. On March 7, 2002, the court
certified a class on the plaintiff's claim for false advertising under
California's consumer protection laws but declined to certify a class for the
claims relating to unfair trade practices. The defendants have moved to dismiss
the false advertising claim. The Company disputes these claims and intends to
vigorously defend its position, although no assurance can be given as to the
outcome of this matter.
The Company has certain contingent liabilities resulting from litigation and
claims incident to the ordinary course of business. Management believes that
the probable resolution of such contingencies will not materially affect the
financial position or the results of the Company's operations.
NOTE 10 - USE OF ESTIMATES
The preparation of the financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following is a discussion and analysis of the Company's financial condition,
results of operations, liquidity and capital resources. The discussion and
analysis should be read in conjunction with the Company's unaudited condensed
consolidated financial statements and notes thereto included elsewhere herein.
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 2002 COMPARED TO THREE MONTHS ENDED JUNE 30, 2001
Net sales. Net sales increased $4.6 million, or 10.7%, to $47.7 million for the
three months ended June 30, 2002 from $43.1 million for the three months ended
June 30, 2001. Sales in the Company's automotive, high performance and racing
vehicle replicas category increased 9.8%, driven by custom and classic die-cast
vehicles. Sales in the pre-teen vehicles and role play activity toys category
were up 40.7%, primarily due to increased sales of John Deere ride-on's. Sales
in the collectible figures category increased 16.8%, with increases in both the
Outdoor Sportman figures and the W. Britains line of collectible pewter figures.
Sales in the sports trading cards and racing apparel and souvenirs category
increased 4.0%. Within this category, racing apparel and souvenirs were up 51.4%
due to continued strong trackside performance while trading cards were down
compared to prior year as there were fewer card sets released in the second
quarter of 2002 compared to the second quarter of 2001. Sales in the
agricultural, construction and outdoor sports vehicle replicas category were
flat.
Gross profit. Gross profit increased $2.7 million, or 11.4%, to $25.7 million
for the three months ended June 30, 2002 from $23.0 million for the three months
ended June 30, 2001. The gross profit margin (as a percentage of net sales)
increased to 53.9% in 2002 compared to 53.4% in 2001. The increase in the gross
profit margin was attributable to improved product margins on die-cast vehicles
and also product mix. There were no major changes in the components of cost of
sales.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased $0.1 million, or 0.6%, to $16.5 million for
the three months ended June 30, 2002 from $16.4 million for the three months
ended June 30, 2001. As a percentage of net sales, selling, general and
administrative expenses decreased to 34.6% for the three months ended June 30,
2002 from 38.1% for the three months ended June 30, 2001.
Operating income. Operating income increased $3.3 million, or 56.9%, to $9.1
million for the three months ended June 30, 2002 from $5.8 million for the three
months ended June 30, 2001. As a percentage of net sales, operating income
increased to 19.1% for the three months ended June 30, 2002 from 13.5% for the
three months ended June 30, 2001.
Net interest expense. Net interest expense of $1.0 million for the three months
ended June 30, 2002 and $1.7 million for the three months ended June 30, 2001
relates primarily to bank term loans and line of credit borrowings.
Additionally, a benefit of approximately $281,000 and a charge of approximately
$101,000 were recorded in net interest expense related to the change in fair
value of the Company's interest rate collar during the second quarter of 2002
and 2001, respectively. For the quarters ended June 30, 2002 and 2001, the
Company paid $282,226 and $111, respectively, on the agreement, which is
included in interest expense. In conjunction with the closing of the Company's
public offering in April 2002, the Company refinanced its debt by entering into
a new three-year $50.0 million revolving credit facility. In April 2002, the
Financial Accounting Standards Board issued Statement No. 145, "Rescission of
FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and
Technical Corrections." During the quarter ended June 30, 2002, the Company
elected early adoption of this Statement and accordingly included $544,727 in
financing fees related to the Company's previous credit facility in interest
expense. In addition, in connection with the refinancing of the Company's credit
facility, the Company incurred approximately $284,000 in financing fees on the
new credit facility which is also included in interest expense.
13
Income tax. Income tax expense for the three months ended June 30, 2002 and
2001 includes provisions for federal, state and foreign income taxes at an
effective rate of 40.0% and 42.0%, respectively. The reduction in the effective
income tax rate is a result of generating higher income before income taxes
combined with a reduction in non-deductible and foreign tax items.
SIX MONTHS ENDED JUNE 30, 2002 COMPARED TO SIX MONTHS ENDED JUNE 30, 2001
Net sales. Net sales increased $9.0 million, or 11.3%, to $88.5 million for the
six months ended June 30, 2002 from $79.5 million for the six months ended June
30, 2001. Sales in the pre-teen vehicles and role play activity toys category
increased 19.8%, driven by John Deere ride-on's. Sales in the automotive, high
performance and racing vehicle replicas category increased 13.5%, driven
primarily by collector type products such as model kits and custom and classic
die-cast vehicles. Sales in the sports trading cards and racing apparel and
souvenirs category also increased 13.5% driven by both strong trackside
performance and successful trading card releases primarily in the first quarter
of 2002. Sales in the collectible figures category increased 32.5%, driven by
the W. Britains line of collectible pewter figures. These increases were
slightly offset by the decrease in sales in the agricultural, construction and
outdoor sports vehicle replicas category, which was down approximately 1.9%.
Gross profit. Gross profit increased $5.7 million, or 14.1%, to $46.0 million
for the six months ended June 30, 2002 from $40.3 million for the six months
ended June 30, 2001. The gross profit margin (as a percentage of net sales)
increased to 52.0% in 2002 compared to 50.7% in 2001. The increase in the gross
profit margin was due to improved product margins on die-cast vehicles and a
more favorable mix of higher margin product sales. There were no major changes
in the components of cost of sales.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased $2.5 million, or 8.7%, to $31.8 million for
the six months ended June 30, 2002 from $29.3 million for the six months ended
June 30, 2001. Included in selling, general and administrative expenses in 2001
is an adjustment to reduce the Company's estimate of its pension funding
liability of approximately $613,000 based on an updated actuarial valuation. As
a percentage of net sales, selling, general and administrative expenses
decreased to 35.9% for the six months ended June 30, 2002 from 36.9% for the six
months ended June 30, 2001.
Operating income. Operating income increased $4.9 million, or 51.9%, to $14.2
million for the six months ended June 30, 2002 from $9.3 million for the six
months ended June 30, 2001. As a percentage of net sales, operating income
increased to 16.0% for the six months ended June 30, 2002 from 11.7% for the six
months ended June 30, 2001.
14
Net interest expense. Net interest expense of $1.7 million for the six months
ended June 30, 2002 and $3.9 million for the six months ended June 30, 2001
relates primarily to bank term loans and line of credit borrowings.
Additionally, a benefit of approximately $542,000 and a charge of approximately
$268,000 were recorded in interest expense related to the change in fair value
of the Company's interest rate collar during the six months ended June 30, 2002
and 2001, respectively. For the six-month periods ended June 30, 2002 and 2001,
the Company paid $548,417 and $111, respectively, on the agreement, which is
also included in interest expense. In conjunction with the closing of the
Company's public offering in April 2002, the Company refinanced its debt by
entering into a new three-year $50.0 million revolving credit facility. In April
2002 the Financial Accounting Standards Board issued Statement No. 145,
"Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement
No. 13, and Technical Corrections." During the quarter ended June 30, 2002, the
Company elected early adoption of this Statement and accordingly included
$544,727 in financing fees related to the Company's previous credit facility in
interest expense. In addition, in connection with the refinancing of the
Company's credit facility, the Company incurred approximately $284,000 in
financing fees on the new credit facility which is also included in interest
expense.
Income tax. Income tax expense for the six months ended June 30, 2002 and June
30, 2001 includes provisions for federal, state and foreign income taxes at an
effective rate of 40.0% and 42.0%, respectively. The reduction in the effective
income tax rate is a result of generating higher income before income taxes
combined with a reduction in non-deductible and foreign tax items.
LIQUIDITY AND CAPITAL RESOURCES
-------------------------------
The Company's operations provided net cash of $13.7 million during the six
months ended June 30, 2002. Capital expenditures for the six months ended June
30, 2002 were approximately $5.8 million, of which approximately $2.3 million
was for molds and tooling.
On April 3, 2002, the Company completed a public offering of 1,545,000 shares of
common stock and certain selling stockholders sold 3,975,000 shares of common
stock at a price of $17.25 per share. The Company received proceeds of $25.2
million from the offering, net of underwriting discount, and used $24.0 million
of the proceeds to repay outstanding debt.
Upon the closing of the public offering, the Company entered into a new credit
facility to replace its previous credit facility. The credit facility is a
three-year $50.0 million unsecured revolving loan that bears interest, at the
Company's option, at a base rate or at a LIBOR rate plus a margin that varies
between 0.75% and 1.40%. The applicable margin is based on the Company's ratio
of consolidated debt to consolidated EBITDA. At June 30, 2002, the margin in
effect was 0.90% for LIBOR loans. The Company is also required to pay a
commitment fee on the average unused revolver of 0.20% to 0.30%, determined by
the ratio of consolidated debt to consolidated EBITDA. At June 30, 2002, the
commitment fee was 0.225% per annum on the average daily unused portion of the
revolving loan. Under the terms of the new credit facility, the Company is
required to comply with certain financial and non-financial covenants. Among
other restrictions, the Company is restricted from paying dividends, incurring
additional debt, entering into an acquisition, sale or merger transaction above
certain levels and repurchasing stock in excess of certain levels. The key
financial covenants include leverage and interest coverage ratios. At June 30,
2002, the amount outstanding under this facility was $23.0 million and the
Company was in compliance with all covenants.
15
The Company has met its working capital needs through funds generated from
operations and available borrowings under the credit agreement. The Company's
working capital requirements fluctuate during the year based on the seasonality
related to sales. Due to seasonal increases in demand for the Company's
products, working capital financing requirements are usually highest during the
third and fourth quarters. The Company expects that capital expenditures during
2002, principally for molds and tooling, will be approximately $11.0 million.
The Company believes that its cash flow from operations, cash on hand and
borrowings under the credit agreement will be sufficient to meet its working
capital and capital expenditure requirements and provide the Company with
adequate liquidity to meet anticipated operating needs for 2002. However, if
the Company's capital requirements vary materially from those currently planned,
the Company may require additional debt or equity financing. There can be no
assurance that financing, if needed, would be available on terms acceptable to
the Company, if at all.
FORWARD-LOOKING STATEMENTS
Certain statements contained in this report contain "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995.
These statements may be identified by the use of forward-looking words or
phrases such as "anticipate," "believe," "could," "expect," "intend," "may,"
"planned," "potential," "should," "estimate," "predict," "continue," "future,"
"will," "would" or the negative of those terms or other words of similar
meaning. Such forward-looking statements are inherently subject to known and
unknown risks and uncertainties. The Company's actual results and future
developments could differ materially from the results or developments expressed
in, or implied by, these forward-looking statements. Factors that may cause
actual results to differ materially from those contemplated by such
forward-looking statements include, but are not limited to, the following: (1)
the Company may not be able to manufacture, source and ship new and continuing
products on a timely basis and customers and consumers may not accept those
products at prices sufficient for the Company to profitably recover development,
manufacturing, marketing, royalty and other costs; (2) the inventory policies of
retailers, together with increased reliance by retailers on quick response
inventory management techniques, may increase the risk of underproduction of
popular items, overproduction of less popular items and failure to achieve tight
shipping schedules; (3) competition in the markets for the Company's products
may increase significantly; (4) the Company is dependent upon continuing
licensing arrangements with vehicle manufacturers, agricultural equipment
manufacturers, major race sanctioning bodies, race team owners, drivers,
sponsors, agents and other licensors; (5) the Company may experience
unanticipated negative results of litigation; (6) the Company relies upon a
limited number of independently owned factories located in China to manufacture
a significant portion of its vehicle replicas and certain other products; (7)
the Company is dependent upon the continuing willingness of leading retailers to
purchase and provide shelf space for the Company's products; (8) the Company may
not be able to collect outstanding accounts receivable from its major retail
customers; (9) the Company is subject to risks related to doing business in
foreign markets, including currency exchange rate fluctuations, economic and
political instability, restrictive actions by foreign governments, and
complications in complying with trade and foreign tax laws; and (10) general
economic conditions in the Company's markets. The Company undertakes no
obligation to make any revisions to the forward-looking statements contained in
this report or to update them to reflect events or circumstances occurring after
the date of this report.
16
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's previous credit agreement required that the Company maintain an
interest rate protection agreement. Effective June 3, 1999, the Company entered
into an interest rate collar transaction covering $35.0 million of its debt,
with a cap based on 30-day LIBOR rates of 8.0% and floor of 5.09%. The
agreement, which had quarterly settlement dates, was in effect through June 3,
2002. For the six-month periods ended June 30, 2002 and 2001, the Company paid
$548,417 and $111, respectively, which is included in interest expense on the
accompanying consolidated statements of earnings. Additionally, a benefit of
approximately $542,000 and a charge of approximately $268,000 were recorded in
interest expense related to the change in fair value of the Company's interest
rate collar during the six months ended June 30, 2002 and 2001, respectively.
Based on the Company's interest rate exposure on variable rate borrowings at
June 30, 2002, a one-percentage-point increase in average interest rates on the
Company's borrowings would increase future interest expense by approximately
$20,000 per month.
17
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company has certain contingent liabilities resulting from litigation and
claims incident to the ordinary course of business. Management believes that
the probable resolution of such contingencies will not materially affect the
financial position or the results of the Company's operations.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
(a) Not applicable.
(b) Not applicable.
(c) Effective April 3, 2002, the Company sold 1,700 shares of common stock
to Peter J. Henseler, the Company's President, 1,700 shares of common
stock to Curtis W. Stoelting, the Company's Chief Operating Officer
and Executive Vice President, and 405 shares of common stock to Jody
L. Taylor, the Company's Chief Financial Officer and Secretary. The
shares were sold from the Company's treasury stock at a price of
$15.53 per share. The shares were sold in a private placement exempt
from the registration requirements of the Securities Act of 1933, as
amended (the "Securities Act"), pursuant to Section 4(2) of the
Securities Act.
(d) Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
Not applicable.
18
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The annual meeting of stockholders of the Company was held on May 10, 2002.
The matters voted upon, including the number or votes cast for, against or
withheld, as well as the number of abstentions and broker non-votes, as to each
such matter were as follows:
Proposal 1: Election of directors
For Withheld
--- --------
John S. Bakalar . . . . . . . 11,046,432 672,017
Peter K.K. Chung . . . . . . 11,038,437 680,012
Robert E. Dods . . . . . . . 9,611,720 2,087,879
Daniel M. Gill . . . . . . . 11,032,782 685,667
Boyd L. Meyer . . . . . . . . 9,715,140 1,984,459
Avy H. Stein . . . . . . . . 9,479,795 2,238,654
John J. Vosicky . . . . . . . 11,045,006 673,443
Proposal 2: Approval and adoption of the Racing Champions Ertl Corporation
Employee Stock Purchase Plan.
For Against Abstain Broker Non-Votes
--- ------- ------- -----------------
8,240,164 66,024 10,467 3,401,794
Proposal 3: Approval and adoption of the amendment to the Racing Champions
Ertl Corporation Stock Incentive Plan to increase the number of shares of common
stock that may be issued pursuant thereto from 1,500,000 to 2,300,000.
For Against Abstain Broker Non-Votes
--- ------- ------- -----------------
7,254,804 1,049,324 12,527 3,401,794
ITEM 5. OTHER INFORMATION.
Not applicable.
19
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
3.1 Amended and Restated Certificate of Incorporation of the Company
(incorporated by reference to Exhibit 3.1 of the Company's Quarterly
Report on Form 10-Q for the quarter ended March 31, 2002 (File No.
0-22635) filed by the Company with the Securities and Exchange
Commission on May 14, 2002).
3.2 First Amendment to the Amended and Restated Certificate of
Incorporation of the Company (incorporated by reference to Exhibit 3.2
of the Company's Quarterly Report on Form 10-Q for the quarter ended
March 31, 2002 (File No. 0-22635) filed by the Company with the
Securities and Exchange Commission on May 14, 2002).
3.3 Certificate of Ownership and Merger changing the Company's name to
Racing Champions Ertl Corporation (incorporated by reference to
Exhibit 3.3 of the Company's Quarterly Report on Form 10-Q for the
quarter ended March 31, 2002 (File No. 0-22635) filed by the Company
with the Securities and Exchange Commission on May 14, 2002).
3.4 Amended and Restated By-Laws of the Company (incorporated by reference
to Exhibit 3.3 of the Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1998 (File No. 0-22635) filed by the
Company with the Securities and Exchange Commission on August 14,
1998).
10.1 Letter Agreement dated April 26, 2002, amending Employment Agreement
dated October 20, 2000, between the Company and Peter Henseler.
10.2 Letter Agreement dated April 26, 2002, amending Employment Agreement
dated October 20, 2000, between the Company and Curt Stoelting.
(b) Reports on Form 8-K:
Form 8-K dated June 11, 2002, filed with the Securities and Exchange
Commission on June 17, 2002, to report pursuant to Item 4 the termination of
Arthur Andersen LLP as auditors for the Company.
Form 8-K dated June 20, 2002, filed with the Securities and Exchange
Commission on June 26, 2002, to report pursuant to Item 4 the appointment of
KPMG LLP as auditors for the Company for the year ending December 31, 2002 and
the termination of Ernst & Young LLP as auditors for Racing Champions
International Limited.
20
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated this 12th day of August 2002.
RACING CHAMPIONS ERTL CORPORATION
By /s/ Robert E. Dods
---------------------------------------
Robert E. Dods, Chief Executive Officer
By /s/ Jody L. Taylor
---------------------------------------
Jody L. Taylor, Chief
Financial Officer and Secretary
21