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Form 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[x] Annual Report pursuant to section 13 or 15(d) of the Securities Exchange
Act of 1934 for the fiscal year ended December 31, 2002.
[ ] 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
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(Exact name of Registrant as Specified in Its Charter)
Delaware 36-4088307
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(State or Other Jurisdiction of (IRS Employer Identification No.)
Incorporation or Organization)
800 Roosevelt Road, Building C, Suite 320, Glen Ellyn, Illinois 60137
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 630-790-3507
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Securities registered pursuant to Section 12(b) of the Exchange Act:
Title of each class Name of each exchange on which registered
NA NA
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Securities registered pursuant to Section 12(g) of the Exchange Act:
Common Stock, Par Value $0.01 Per Share
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(Title of class)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ X ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes X No
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Aggregate market value of the Registrant's common stock held by nonaffiliates as
of June 28, 2002, (the last business day of the Registrant's most recently
completed second quarter): $242,458,558. Shares of common stock held by any
executive officer or director of the Registrant and any person who beneficially
owns 10% or more of the outstanding common stock have been excluded from this
computation because such persons may be deemed to be affiliates. This
determination of affiliate status is not a conclusive determination for other
purposes.
Number of shares of the Registrant's common stock outstanding as of February 15,
2003: 16,466,194
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 2003 Annual Meeting of the Stockholders
of the Registrant are incorporated by reference into Part III of this report.
2
As used in this report, the terms "we," "us," "our," "Racing Champions Ertl" and
the "Company" means Racing Champions Ertl Corporation and its subsidiaries,
unless the context indicates another meaning, and the term "common stock" means
our common stock, par value $0.01 per share.
Special Note Regarding Forward-Looking Statements
Certain statements contained in this report are considered "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. These statements may be identified by the use of forward-looking words
or phrases such as "anticipate," "believe," "could," "expect," "intend," "may,"
"hope," "plan," "potential," "should," "estimate," "predict," "continue,"
"future," "will," "would" or the negative of these terms or other words of
similar meaning. Such forward-looking statements are inherently subject to known
and unknown risks and uncertainties. Our actual results and future developments
could differ materially from the results or developments expressed in, or
implied by, these forward-looking statements. Factors that may cause actual
results to differ materially from those contemplated by such forward-looking
statements include, but are not limited to, those described under the caption
"Risk Factors" in Item 1 of this report. We undertake no obligation to make any
revisions to the forward-looking statements contained in this filing or to
update them to reflect events or circumstances occurring after the date of this
filing.
Part I
Item 1. Business
For information as to net sales, operating income and identifiable assets by
geographic area, see the information set forth in Note 4 to our consolidated
financial statements included elsewhere herein.
Overview
We are a leading producer and marketer of innovative collectibles and toys
targeted at adult collectors and children. Our diverse product offering includes
scaled die-cast replicas of John Deere agricultural equipment and NASCAR stock
cars, other licensed vehicle replicas, pre-teen toys, sports trading cards,
racing apparel and souvenirs, and collectible figures. These products are sold
under our market-focused brand names, including Racing Champions(R), Ertl
Collectibles(R), Britains(R), American Muscle(TM), AMT(R), Outdoor
Sportsman(TM), W. Britain(R), Press Pass(R) and JoyRide Studios(R) . We
reinforce our brands and enhance the authenticity of our products by linking
them with highly recognized licensed properties. Our products are marketed
through multiple channels of distribution, including mass retailers, specialty
and hobby wholesalers and retailers, OEM dealers such as the John Deere dealer
network, corporate accounts for promotional purposes and direct to consumers. We
sell through more than 20,000 retail outlets located in North America, Europe
and Asia Pacific.
3
Products
We provide a diverse offering of highly detailed, authentic replicas and
stylized toys known for their quality workmanship. Our products have received
numerous "best of" awards from collector, family and toy magazines and currently
retail from $0.50 to $299.99. We have successfully expanded our product
offering, which currently consists of five product categories. By offering a
wide range of products at varying price points, we believe our products appeal
to a broad range of consumers. The following chart summarizes our current
product categories:
Category Our Key Licenses Our Key Brands Price Range
Automotive, High Performance Ford Racing Champions $ 1.29 - $59.99
and Racing Vehicle Replicas General Motors Ertl Collectibles
DaimlerChrysler American Muscle
NASCAR AMT
NHRA
Harley-Davidson
Universal Studios
Agricultural, Construction and John Deere Ertl $1.99 - $174.99
Outdoor Sports Vehicle Replicas Case IH Ertl Precision
New Holland Ertl Collectibles
Agco Outdoor Sportsman
Polaris Britains
Pre-Teen Vehicles and Role Play John Deere Ertl $1.29 - $299.99
Activity Toys Thomas & Friends Ertl Preschool
Bob the Builder Ertl Toys
Warner Brothers Bumble Ball
Ford Hometown Roadway
General Motors Harley-Davidson Little Dreams
DaimlerChrysler John Deere Kids
Harley-Davidson
Dr. Seuss
Sports Trading Cards and Racing NASCAR Racing Champions $0.50 - $295.00
Apparel and Souvenirs NHRA Press Pass
Wheels
Collectible Figures Realtree W. Britain $9.95 - $279.00
Mossy Oak Outdoor Sportsman
Sega JoyRide Studios
Electronic Arts
Nintendo
Microsoft Corporation
MechWarrior
Dale Earnhardt, Inc.
4
Automotive, High Performance and Racing Vehicle Replicas. We were a pioneer of
the licensed die-cast racing replica market and have produced die-cast racing
replicas since our inception in 1989, which gives us the longest continuously
produced line of racing replicas in the United States and a well-established
collector base for our products. Through acquisitions and product development,
we have expanded this category to include other automotive and high performance
vehicle replicas. We produce a broad line of replicas in this category
including:
- - American Muscle collectible die-cast classic, high performance,
entertainment-related and late model automobiles and trucks;
- - Ertl Collectibles die-cast custom imprint cars and trucks and various
scales of delivery trucks and tractor trailers;
- - Racing Champions die-cast high performance and late model non-racing cars
and trucks;
- - AMT plastic model kits and American Muscle BodyShop die-cast activity kits
principally of vintage and high performance automobiles, race cars and
trucks;
- - Racing Champions die-cast stock cars, trucks and team transporters
representing a large number of the vehicles competing in the NASCAR Winston
Cup Series, NASCAR Busch Grand National Series and the National Hot Rod
Association (NHRA) Drag Racing Series; and
- - The Fast and the Furious by Racing Champions, a full line of die-cast tuner
car collectibles, figures and playsets.
We market our 1:64th scale die-cast vehicle replicas to consumers for purchase
as either toys or collectibles. Our larger scaled, highly detailed die-cast
vehicle replicas are primarily targeted to adult collectors. Collectors, by
their nature, make multiple purchases of die-cast vehicles because of their
affinity for classic, high performance and late model cars, trucks, hot rods and
tuners. These collectors value the authenticity of the replicas and the
enjoyment of building their own unique collections. Our model kits are primarily
1:25th scale and are purchased by adult hobbyists who enjoy building and
collecting a range of models.
In 2002, we produced more than 200 different styles of racing vehicle replicas.
Racing vehicle replicas are primarily marketed to racing fans and adult
collectors. These fans and collectors are attracted to racing replicas due to
the highly detailed, precise nature of the replicas, distinctive paint schemes
and the popularity of racing teams, drivers and sponsors represented by the
replicas.
Throughout 2002, we introduced new releases in the American Muscle product line,
began shipping special 50th Anniversary Corvette products, launched both 1:18th
scale and 1:10th scale highly detailed collectible Harley-Davidson die-cast
replicas, expanded our line of 1:18th scale entertainment-related automotive
replicas, shipped a new series of 1:64th scale entertainment-related
automobiles, released a line of concept cars based on the latest designs from
the 2002 auto shows and relaunched our extensive line of 1:64th scale high
performance automotive die-cast replicas. We also reissued approximately 60
model kits, leveraging our tooling library of over 2,000 models. We produced
racing vehicle replicas for more than 60 NASCAR and NHRA race teams. At the
beginning of 2002, we signed new licenses with the Lowe's Home Improvement
NASCAR race team driven by Jimmie Johnson and the Tide NASCAR race team driven
by Ricky Craven. We also introduced the new 1:9th scale Racing Champions
Authentics replica of the Harley-Davidson NHRA Pro Stock drag racing bike.
Throughout 2003, we plan to issue multiple new releases in our American Muscle
line. We will continue to focus on 1:18th and 1:64th scale entertainment-related
automotive replicas, adding many new product introductions. We plan to
re-release more than 60 model kits and introduce six newly tooled plastic kits.
We also expect to produce racing replicas for over 30 NASCAR teams. Racing
Champions Ertl is also the master toy and collectible licensee for the popular
movie The Fast and the Furious, as well as its sequel, 2 Fast 2 Furious,
scheduled for release in June 2003. A full line of die-cast tuner car
collectibles, figures and playsets will be introduced throughout the year in
conjunction with this popular property and lifestyle trend.
5
Agricultural, Construction and Outdoor Sports Vehicle Replicas. This category
includes replicas of vintage and modern tractors, farm implements and
construction vehicles of major OEMs such as John Deere, Case IH and New Holland.
We also market all-terrain vehicle (ATV) replicas of major manufacturers such as
Polaris, Kawasaki, Yamaha, Bombardier and Suzuki. These replicas are sold at a
wide range of retail prices and are positioned from classic sandbox toys to
high-end collector display units. Collectors of these vehicle replicas identify
with the form and function of the full-sized units, value the authenticity of
the replicas and purchase multiple products in order to build their own unique
collections.
In 2002, we had numerous new releases in this category including more than 100
new John Deere agricultural and construction vehicle replicas and new Kawasaki,
Suzuki and Bombardier die-cast ATV replicas. Other new releases included the
1:18th scale 2002 Chevrolet Suburban and 1:6th scale Polaris ATV.
For 2003, we plan to introduce over 75 new John Deere, Case IH and New Holland
agricultural and construction vehicle replicas along with new releases of
Polaris, Kawasaki, Yamaha and Suzuki ATV die-cast replicas.
Pre-Teen Vehicles and Role Play Activity Toys. This category is marketed to
parents and grandparents of preschool children and to children ages 5 to 12.
Products in this category include:
- - John Deere stylized plastic and metal vehicle replicas, ride-on vehicles
and role play activity toys;
- - Thomas & Friends metal train locomotives, rail cars and plastic railway
accessories;
- - Bob the Builder plastic and metal construction vehicles, figures and
accessories;
- - Scooby-Doo, John Deere, Thomas & Friends and NASCAR push and rolls, toy
books, radio control vehicles, playsets and puzzles based on various
characters from these licensed properties;
- - Harley-Davidson preschool toys, including personalized motorcycles,
motorcycle rider figures, accessories and playsets;
- - Hometown Roadway(TM), interlocking wooden track vehicle and building
systems based on hometown real-life themes from licensing partners such as
John Deere, Harley-Davidson, Texaco, Ford, General Motors and
DaimlerChrysler; and
- - Figures and vehicles based on the world famous books from Dr. Seuss with
our initial products including well-known scenes from The Cat in the Hat
and Green Eggs and Ham.
In 2001, we introduced to John Deere dealers the battery-powered, John Deere
Gator ride-on, which retailed for $299.99 domestically. We have the right to
sell this product through the John Deere dealer network, and our manufacturing
partner has the right to sell this product in other distribution channels. Other
new John Deere ride-ons in 2001 included a metal tricycle, a plastic pedal
tractor and two sizes of steel wagons. In 2002, we introduced additional John
Deere ride-ons and a Polaris battery-powered ATV ride-on.
In 2003, we expect new product introductions in the John Deere preschool and
ride-on areas to increase interest in our product lines in this category. We
plan to introduce classic products with unique features in both the John Deere
and Harley-Davidson product lines, directed to parents of young children,
expanding our presence in homes.
Sports Trading Cards and Racing Apparel and Souvenirs. We market our premium
collectible sports trading cards under the Press Pass brand name, which
primarily feature NASCAR race drivers, team owners and crew chiefs. Press Pass
also markets draft pick trading cards, which feature top college players who are
expected to be selected in the professional football and basketball drafts. Our
trading cards are targeted to sports fans and trading card collectors. The
collector base for sports trading cards primarily consists of children and adult
males.
Racing apparel and souvenirs sold by us include shirts, hats, jackets,
sunglasses, key chains, can coolers, bumper stickers, license plates and other
souvenirs featuring racing related licenses. Licensed properties on these
products include NASCAR, Lowes Home Improvement Racing, Tide Racing, Ford
Racing, Chevrolet Racing, Dodge Racing, Caterpillar Racing and Cartoon Network
Racing. We primarily sell apparel and souvenir products at trackside trailer
concessions at NASCAR racing events. We also distribute these products to mass
retailers and specialty wholesalers and retailers.
6
Collectible Figures. Under the brand name of W. Britain, we sell hand painted
metal military and ceremonial figures fashioned after European and American
historical events and themes. The W. Britain metal figures and sets are sold
primarily at collector, hobby, gift and specialty stores. In 2001, we launched
our Outdoor Sportsman product line of 12-inch and 5-inch plastic figure replicas
dressed in authentic outdoor sports attire, licensed from Realtree and Mossy
Oak, and outdoor sports accessory replicas.
In 2002, we introduced JoyRide Studios, a new brand of collectible figures and
vehicles based on popular video game titles. Introductions of the articulated
figures and highly detailed vehicles are based on well-known video games and
include special "codes, strategies and cheats" from the experts at GamePro
Magazine, a multi-platform gaming magazine that is a popular publication for
gamers, and Nintendo Power, a popular gaming magazine focused on Nintendo
platform games. GamePro Magazine and Nintendo Power are also providing
development and marketing support for most of these product lines.
In 2003, the JoyRide Studios collection will expand in three areas. We will
offer new characters in existing product lines associated with the best selling
video games under the GamePro and Nintendo Power sub-brand. Early in 2003, we
added a new collectible product line of larger scale MechWarrior die-cast
figures based upon the popular science fiction world. In mid-2003, we plan to
introduce collectible figures based upon Halo, one of Microsoft's top selling
gaming properties, which is available in video game format for X-Box and online.
Licenses
We market virtually all of our products under licenses from other parties. We
have license agreements with automotive and truck manufacturers; agricultural,
construction and outdoor sports vehicle and equipment manufacturers; major race
sanctioning bodies; race team owners, sponsors and drivers; and entertainment,
publishing and media companies. A significant element of our strategy depends on
our ability to identify and obtain licenses for recognizable and respected
brands and properties. Our licenses reinforce our brands and establish our
products' authenticity, credibility and quality with consumers, and in some
cases, provide for new product development opportunities and expanded
distribution channels. Our licenses are generally limited in scope and duration
and authorize the sale of specific licensed products on a nonexclusive basis.
Our licenses often require us to make minimum guaranteed royalty payments
whether or not we meet specific sales targets. We have approximately 600 license
agreements, generally for terms of one to three years.
Channels of Distribution
Our products are available through more than 20,000 retail outlets located in
North America, Europe and Asia Pacific. We market our products through multiple
channels of distribution in order to maximize our sales opportunities for our
broad product offering. Products with lower price points are generally sold in
mass retailer channels while products with higher detailed features and prices
are typically sold in hobby, collector and independent toy stores and through
wholesalers and OEM dealers. Our leading position in multiple distribution
channels enhances our ability to secure additional licenses, extends the reach
of our products to consumers and mitigates the risk of concentration by channel
or customer.
Mass Retailers. We marketed 37.5% of our products through the mass retailer
channel in 2002. Our products marketed through this channel are targeted
predominantly at price conscious end-users. As a result, the majority of our
products marketed through this channel are designed to span lower price points
and retail for less than $30.00. Key customers in our mass retailer channel
include Wal-Mart, Kmart, Target, Toys R Us, Midstates Distribution and Tractor
Supply Company.
Specialty and Hobby Wholesalers and Retailers. We sell many of the products
available at mass retailers as well as higher priced products with special
features to specialty and hobby wholesalers and retailers. We reach these
customers directly through our internal telesales group and business-to-business
website and through specialty toy representatives and collectible and toy trade
shows. Key customers in our specialty and hobby wholesaler and retailer channel
include Great Planes, Excell Marketing, Beckett & Associates and Master Toys &
Novelties, Inc.
OEM Dealers. We often sell licensed products to the licensing OEM's dealer
network. OEM licensing partners benefit from our OEM dealer sales by receiving
additional royalties. We often give OEM dealers the first opportunity to
purchase new products and provide them with a short-term exclusivity period. Key
customers in our OEM dealer channel include John Deere, Case IH, Polaris and
Harley-Davidson.
7
Corporate Promotional Accounts. We have the top position in North America in the
die-cast vehicle corporate promotional channel. Corporate promotional products
allow a company to promote its products, reinforce its brands and reward
employees and customers. In this channel, we can cost-effectively accommodate
both large-unit orders and lower-unit orders, which gives us a competitive
advantage. Key customers in our corporate promotional channel include Texaco,
Matco Tools, M&M Mars and Caterpillar.
Direct to Consumers. We make certain products available for direct sales to
consumers through trackside event sales concessions, company stores, a
business-to-consumer website located at www.diecastexpress.com and a strategic
alliance with the Bradford Exchange Group, a top direct marketing company.
Individual products sold directly to consumers sell at prices similar to those
found at retailers, hobby stores and dealers.
Patents and Trademarks
We have registered several trademarks with the U.S. Patent and Trademark Office,
including the marks Racing Champions(R), Ertl(R) and Press Pass(R). A number of
Ertl trademarks are also registered in foreign countries. We hold U.S. patents
for our trading card display stand and model vehicle and for our unique
packaging system that includes a die-cast vehicle, emblem and display stand. We
believe our Racing Champions and Ertl trademarks hold significant value, and we
plan to build additional value through increased customer awareness of our many
other trade names and trademarks.
Sales and Marketing
Our sales organization consists of an internal sales force and external sales
representative organizations. Our internal sales force provides direct customer
contact with nearly all of our retail chains and key wholesale accounts. A
number of accounts are designated as "house accounts" and are handled
exclusively by our internal sales staff. Our inside sales and customer service
groups use telephone calls, mailings, faxes and e-mails to directly contact OEM
dealers and smaller volume customers such as collector, hobby, specialty and
independent toy stores.
Our internal sales force is supplemented by external sales representative
organizations that are geographically divided. These external sales
representative organizations provide more frequent customer contact and
solicitation of the national, regional and specialty retailers and supported
35.4% of our net sales in 2002. External sales representatives generally earn
commissions of 3% to 10% of the net sales price from their accounts. Their
commissions are unaffected by the involvement of our internal sales force with a
customer or sale.
In 2001, we launched a business-to-business website called RCE Online
Advantage(TM) located at www.rceb2b.com. This website, targeted to smaller
volume accounts, allows qualified customers to view new product offerings, place
orders, check open order shipping status and review past orders. We believe that
RCE Online Advantage leverages our internal sales force, inside sales group and
customer service group by providing customers with greater information access
and more convenient ordering capability.
Our marketing programs are directed toward collectors, current customers and
potential new customers that fit the demographic profile of our target market.
Our objectives include increasing awareness of our product offerings and brand
names. We utilize the following media in our marketing plans.
- - Advertising. We place print advertisements in publications with high
circulation and targeted penetration in key vertical categories such as
outdoor sports, die-cast, trading cards, action figures and NASCAR. We run
commercials on cable television programs that target key consumers. For
example, in 2002, we promoted our new JoyRide Studios product line by
running commercials on MTV, Nickelodeon and Cartoon Network.
- - Public Relations. We have developed a sustained public relations effort to
build relationships with editors at publications targeted across all of our
product lines. Ongoing press releases keep editors abreast of new product
introductions, increase our credibility and market acceptance, and
encourage the editorial staffs of these publications to give more coverage
to our products.
- - Co-op Advertising. We work closely with retail chains to plan and execute
ongoing retailer driven promotions and advertising. The programs usually
involve promotion of our products in retail customers' print circulars,
mailings and catalogs.
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- - Internet. The Internet is an increasingly important part of our marketing
plan because collectors have quickly adopted the Internet as a preferred
way to communicate with other enthusiasts about their hobby. Our website,
www.rcertl.com, highlights our products, lists product release dates and
collects market data directly from consumers. We also gather consumer
information through consumer letters, e-mail, telephone calls and product
surveys.
Competition
We compete with several large international toy and collectible companies, such
as Mattel, Inc., Hasbro, Inc., Action Performance Companies, Inc., Jakks
Pacific, Inc., Little Tikes Company and Maisto Ltd. and with other producers of
vehicle replicas, toys and model kits such as Playing Mantis, Yat Ming, Bburago,
FUNline, Revell-Monogram and Zindart/Corgi. Our Press Pass sports trading cards
compete primarily with Topps, Upper Deck and Fleer, and with several smaller
companies with more limited product lines. Competition in the distribution of
our products is intense and primarily based on product appeal, ability to
capture shelf or rack space, timely distribution, price and quality. Competition
is also based on the ability to obtain license agreements for existing and new
products to be sold through specific distribution channels or retail outlets.
Many of our competitors have greater financial, technical, marketing and other
resources than we have.
Production
We are an industry leader in bringing new products to market rapidly and
efficiently. Our integrated design and engineering expertise, extensive library
of die-cast molds and dedicated suppliers enable us to be first to market with
many innovative products.
Far East Product Sourcing. We have operations in Kowloon, Hong Kong and in the
Racing Industrial Zone in Dongguan City, China and employ 136 people in Hong
Kong and China who oversee the sourcing of the majority of our products. This
group assists our suppliers in sourcing raw materials and packaging, performs
engineering and graphic art functions, executes the production schedule,
provides on-site quality control, facilitates third-party safety testing and
coordinates the delivery of shipments for export from China.
Far East Production. All of our products are manufactured in China, except for
plastic ride-ons, sports trading cards and certain racing apparel and souvenirs.
Our China-based product sourcing accounted for approximately 90.5% of our total
product purchases in 2002. We primarily use four independent, dedicated
suppliers who manufacture only our products in six factories, four of which are
located in the Racing Industrial Zone. These independent, dedicated suppliers
produced approximately 69.5% of our China-based product purchases in 2002. In
order to supplement our independent, dedicated suppliers, we use approximately
ten other suppliers in China. All products are manufactured to our
specifications using molds and tooling that we own. These suppliers own the
manufacturing equipment and machinery, purchase raw materials, hire workers and
plan production. We purchase fully assembled and packaged finished goods in
master cartons for distribution to our customers. Most of our suppliers have
been supplying us for more than five years. Our purchases in 2002 from our
independent, dedicated suppliers, Sharp Success, Win Yield, Sunrise and Shun
Fung, were 27.5%, 19.9%, 12.9% and 9.3%, respectively, of our China-based
product purchases. We use only purchase orders and not long-term contracts with
our foreign suppliers.
Domestic Production. The production of plastic ride-ons, sports trading cards
and certain racing apparel and souvenirs is completed primarily by U.S.-based
suppliers. We create the product design and specifications and coordinate the
manufacturing activities. We generally prefer to coordinate the production of
these products through a limited number of suppliers and believe that a number
of alternate suppliers are available.
Tooling. To create new products, we continuously invest in new tooling. These
tooling expenditures represent the majority of our capital expenditures.
Depending on the size and complexity of the product, the cost of tooling a
product ranges from $3,000 to $160,000. For many of our products, we eliminate
significant tooling time by utilizing our extensive tooling library of more than
13,000 tools. We own all of our tools and provide them to our suppliers during
production. Tools are returned to us when a product is no longer in production
and are stored for future use.
Product Safety. Our products are designed, manufactured, packaged and labeled to
conform with the U.S. safety requirements of the American Society for Testing
and Materials and the Consumer Product Safety Commission and are periodically
reviewed and approved by independent safety testing laboratories. Products sold
in Europe also conform to European Commission standards. We carry product
liability insurance coverage with a limit of over $25.0 million per occurrence.
We have never been the subject of a product liability claim.
Logistics. Our customers purchase our products either in the United States or
the United Kingdom, or directly from China. We own a distribution facility in
Dyersville, Iowa and use an independent warehouse in the United Kingdom.
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Seasonality
We have experienced, and expect to continue to experience, substantial
fluctuations in our quarterly net sales and operating results, which is typical
of many companies in our industry. Our business is highly seasonal due to high
consumer demand for our products during the year-end holiday season.
Approximately 58.3% of our net sales over the three years ended December 31,
2002 were generated in the second half of the year, with August and September
being the largest shipping months. As a result, our investment in working
capital, mainly inventory and accounts receivable, is highest during the fourth
quarter and lowest during the first quarter.
Customers
We derive a significant portion of our sales from some of the world's largest
retailers and OEM dealers. Our top five customers accounted for 37.4%, 39.0% and
35.5% of total net sales in 2000, 2001 and 2002, respectively. The John Deere
dealer network and Wal-Mart, our largest customers, accounted for 15.0% and
11.8% of total net sales in 2002, respectively. Other than the John Deere dealer
network and Wal-Mart, no other customer accounted for more than 10% of our total
net sales in 2000, 2001 or 2002. Many of our retail customers generally purchase
large quantities of our products on credit, which may cause a concentration of
accounts receivable among some of our largest customers.
Employees
As of December 31, 2002, we had 398 employees, 11 of whom were employed
part-time. We emphasize the recruiting and training of high-quality personnel,
and to the extent possible, promote people from within Racing Champions Ertl. A
collective bargaining agreement covers 57 of our employees, all of whom work in
the distribution facility in Dyersville, Iowa. We consider our employee
relations to be good. Our continued success will depend, in part, on our ability
to attract, train and retain qualified personnel at all of our locations.
Available Information
We maintain our corporate website at www.rcertl.com and we make available, free
of charge, through this website our annual report on Form 10-K, quarterly
reports on Form 10-Q, current reports on Form 8-K, and amendments to those
reports that we file with or furnish to the Securities and Exchange Commission
(the "Commission"), as soon as reasonably practicable after we electronically
file such material with, or furnish it to, the Commission. Information on our
website is not part of this report.
Acquisition of Learning Curve International, Inc.
On March 4, 2003, the Company acquired Learning Curve International, Inc.
("Learning Curve"), with an effective date of February 28, 2003, for 666,667
shares of our common stock and approximately $106.7 million of cash, less debt
and capital lease obligations, including $12.0 million in escrow to secure
Learning Curve's indemnification obligations under the merger agreement. The
purchase price is subject to a post-closing working capital adjustment and to
the payment by the Company of additional consideration of up to $6.5 million
based on sales and margin targets for the Learning Curve product lines in 2003.
Learning Curve develops and markets a variety of high-quality, award-winning
traditional children's toys for every stage of childhood from birth through age
eight. Its product lines include Thomas & Friends Wooden Railway, the top
selling brand of expandable wooden toy railway systems in the United States, and
the recently introduced Take Along Thomas die-cast train series and playsets.
Other products include Lamaze infant toys, Madeline dolls and accessories,
Eden(R) plush, Feltkids(R) activity boards and Lionel battery-powered train
systems. Unless otherwise indicated, the information in this report does not
give effect to the Learning Curve acquisition. The Company financed the
acquisition by drawing down $110.0 million from a new $140.0 million credit
facility. (See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Liquidity and Capital Resources" for additional
information regarding this new credit facility.)
10
Risk Factors
The risks described below are not the only risks we face. Additional risks that
we do not yet know of or that we currently think are immaterial may also impair
our business operations. If any of the events or circumstances described in the
following risks actually occur, our business, financial condition or results of
operations could be materially adversely affected. In such cases, the trading
price of our common stock could decline.
Our net sales and profitability depend on our ability to continue to conceive,
design and market collectibles and toys that appeal to consumers.
The introduction of new products is critical in our industry and to our growth
strategy. Our business depends on our ability to continue to conceive, design
and market new products and upon continuing market acceptance of our product
offering. Rapidly changing consumer preferences and trends make it difficult to
predict how long consumer demand for our existing products will continue or what
new products will be successful. Our current products may not continue to be
popular or new products that we introduce may not achieve adequate consumer
acceptance for us to recover development, manufacturing, marketing and other
costs. A decline in consumer demand for our products, our failure to develop new
products on a timely basis in anticipation of changing consumer preferences, or
the failure of our new products to achieve and sustain consumer acceptance could
reduce our net sales and profitability.
Competition for licenses could increase our licensing costs or limit our ability
to market products.
We market virtually all of our products under licenses from other parties. These
licenses are generally limited in scope and duration and generally authorize the
sale of specific licensed products on a nonexclusive basis. Our license
agreements often require us to make minimum guaranteed royalty payments that may
exceed the amount we are able to generate from actual sales of the licensed
products. Any termination of our significant licenses or inability to develop
and enter into new licenses could limit our ability to market our products or
develop new products. Competition for licenses could require us to pay licensors
higher royalties and higher minimum guaranteed payments in order to obtain or
retain attractive licenses. In addition, licenses granted to other parties,
whether or not exclusive, could limit our ability to market products, including
products we currently market. If we cannot retain and obtain the necessary
licenses for our existing and future products, our business will suffer.
Competition in our markets could cause our business to suffer.
We operate in highly competitive markets. We compete with several larger
domestic and foreign companies such as Mattel, Inc., Hasbro, Inc., Jakks
Pacific, Inc., Maisto Ltd. and Action Performance Companies, Inc., with private
label products sold by many of our retail customers and with other producers of
collectibles and toys. Many of our competitors have longer operating histories,
greater brand recognition and greater financial, marketing and other resources
than we do. In addition, we may face competition from new participants in our
markets because the collectible and toy industries have limited barriers to
entry. We experience price competition for our products, competition for shelf
space at retailers and competition for licenses, all of which may increase in
the future. If we cannot compete successfully in the future, our business will
suffer.
We may experience difficulties in integrating our recent acquisition of Learning
Curve.
We completed our acquisition of Learning Curve on March 4, 2003, with an
effective date of February 28, 2003. The integration of Learning Curve's
operations into our existing operations involves a number of risks including:
- possible adverse effects on our reported operating results;
- unanticipated costs relating to the integration of Learning Curve;
- difficulties in achieving planned cost-savings and synergies;
- diversion of management's attention; and
- unanticipated management or operational problems or liabilities.
Any or all of these risks could have a material adverse effect on our business,
financial condition or results of operations.
11
We depend on the continuing willingness of mass retailers to purchase and
provide shelf space for our products.
In 2002, we sold 37.5% of our products to mass retailers. Our success depends
upon the continuing willingness of these retailers to purchase and provide shelf
space for our products. We do not have long-term contracts with our customers.
In addition, our access to shelf space at retailers may be reduced by store
closings, consolidation among these retailers and competition from other
products. An adverse change in our relationship with, or the financial viability
of, one or more of our customers could reduce our net sales and profitability.
We may not be able to collect outstanding accounts receivable from our major
retail customers.
Many of our retail customers generally purchase large quantities of our products
on credit, which may cause a concentration of accounts receivable among some of
our largest customers. Our profitability may be harmed if one or more of our
largest customers were unable or unwilling to pay these accounts receivable when
due or demand credits or other concessions for products they are unable to sell.
We only maintain credit insurance for some of our major customers and the amount
of this insurance generally does not cover the total amount of the accounts
receivable. Insurance coverage for future sales is subject to reduction or
cancellation.
We rely on a limited number of foreign suppliers in China to manufacture a
majority of our products.
We rely on four independent suppliers in China to manufacture a majority of our
products in six factories, five of which are located in close proximity to each
other in the Racing Industrial Zone manufacturing complex in China. We use only
purchase orders and not long-term contracts with our foreign suppliers. Any
difficulties encountered by these suppliers, such as a fire, accident, natural
disaster or other disruption, could result in product defects, production
delays, cost overruns or the inability to fulfill orders on a timely basis. The
occurrence of any of these events could increase our costs, delay the completion
of orders, cause the cancellation of orders, delay the introduction of new
products or cause us to miss a selling season applicable to some of our
products. In addition, if these suppliers do not continue to manufacture our
products exclusively, our product sourcing would be adversely affected. Any of
these events would harm our business.
Currency exchange rate fluctuations could adversely affect our results of
operations.
We are subject to a variety of risks associated with changes among the relative
values of the U.S. dollar, Euro, U.K. pound, Hong Kong dollar and Chinese
Renminbi. Any material increase in the value of the Hong Kong dollar or Chinese
Renminbi relative to the U.S. dollar or U.K. pound would increase our expenses,
and therefore, could adversely affect our profitability. We are also subject to
exchange rate risk relating to transfers of funds denominated in U.K. pounds or
Euros from our U.K. subsidiary to the United States. We do not hedge foreign
currency risk.
Because we rely on foreign suppliers and we sell products in foreign markets, we
are susceptible to numerous international business risks that could harm our
business.
Our international operations subject us to numerous risks, including the
following:
- - economic and political instability;
- - restrictive actions by foreign governments;
- - greater difficulty enforcing intellectual property rights and weaker laws
protecting intellectual property rights;
- - changes in import duties or import or export restrictions;
- - timely shipping of product and unloading of product through West Coast
ports, as well as timely rail/truck delivery to the Company's warehouse
and/or a customer's warehouse;
- - complications in complying with the laws and policies of the United States
affecting the importation of goods including duties, quotas and taxes; and
- - complications in complying with trade and foreign tax laws.
Any of these risks could harm our business.
12
Product liability, product recalls and other claims relating to the use of our
products could harm our business.
Because we sell collectibles and toys to consumers, we face product liability
risks relating to the use of our products. We also must comply with a variety of
product safety and product testing regulations. If we fail to comply with these
regulations or if we face product liability claims, we may be subject to damage
awards or settlement costs that exceed our insurance coverage, and we may incur
significant costs in complying with recall requirements. In addition, a number
of our licenses may be terminated by the licensor if any products marketed under
the license are subject to a product liability claim or recall. Even if a
product liability claim is without merit, the claim could harm our business.
Trademark infringement or other intellectual property claims relating to our
products could harm our business.
Our industry is characterized by frequent litigation regarding trademark
infringement and other intellectual property rights. We have been a defendant in
trademark infringement claims and claims of breach of license from time to time,
and we may continue to be subject to such claims in the future. The defense of
intellectual property litigation is both costly and disruptive to the time and
resources of our management even if the claim is without merit. We also may be
required to pay substantial damages or settlement costs to resolve intellectual
property litigation.
Our debt covenants may limit our ability to complete acquisitions, incur debt,
make investments, sell assets, merge or complete other significant transactions.
Our credit agreement includes provisions that place limitations on a number of
our activities including our ability to:
- incur additional debt;
- create liens on our assets or make guarantees;
- make certain investments or loans;
- pay dividends; or
- dispose of or sell assets or enter into a merger or similar transaction.
These debt covenants could restrict our business operations.
Sales of our products are seasonal, which causes our operating results to vary
from quarter to quarter.
Sales of our products are seasonal. Historically, our net sales and
profitability have peaked in the third quarter due to the holiday season buying
patterns. Seasonal variations in operating results may put a strain on our
business, impact our debt levels and cause fluctuations in our stock price.
The trading price of our common stock has been volatile, and investors in our
common stock may experience substantial losses.
The trading price of our common stock has been volatile and may continue to be
volatile in the future. The trading price of our common stock could decline or
fluctuate in response to a variety of factors including:
- - our failure to meet the performance estimates of securities analysts;
- - changes in financial estimates of our net sales and operating results or
buy/sell recommendations by securities analysts;
- - the timing of announcements by us or our competitors concerning significant
product developments, acquisitions or financial performance;
- - fluctuation in our quarterly operating results;
- - substantial sales of our common stock;
- - general stock market conditions; or
- - other economic or external factors.
13
We may face future securities class action lawsuits that could require us to pay
damages or settlement costs and otherwise harm our business.
A securities class action lawsuit was filed against us in 2000 following a
decline in the trading price of our common stock from $17.00 per share on June
21, 1999 to $6.50 per share on June 28, 1999. We settled this lawsuit in 2002
with a $1.8 million payment, covered by insurance, after incurring legal costs
of $1.0 million that were not covered by insurance. Future volatility in the
price of our common stock may result in additional securities class action
lawsuits against us, which may require that we pay substantial damages or
settlement costs in excess of our insurance coverage and incur substantial legal
costs, and which may divert management's attention and resources from our
business.
Item 2. Properties
As of December 31, 2002, our facilities were as follows:
Description Square Feet Location Lease Expiration
----------- ----------- -------- ----------------
Corporate headquarters. . . . . . . . . . . . . . . . . . . . . 10,257 Glen Ellyn, IL October 2003
Hong Kong office. . . . . . . . . . . . . . . . . . . . . . . . 10,296 Kowloon, Hong Kong July 2004
Racing Champions South, Inc. office . . . . . . . . . . . . . . 6,864 Charlotte, NC April 2007
RC Ertl, Inc. office and warehouse. . . . . . . . . . . . . . . 328,000 Dyersville, IA Owned
RC Ertl, Inc. warehouse . . . . . . . . . . . . . . . . . . . . 166,000 Dyersville, IA Owned
Racing Champions International Limited office . . . . . . . . . 5,419 Exeter, United Kingdom October 2013
Racing Champions International Limited warehouse(1) . . . . . . 71,026 Nottingham, United Kingdom September 2004
Racing Industrial Zone office, warehouse, quarters and storage. 78,840 Dongguan City, China March 2004
Green's Racing Souvenirs, Inc. office and warehouse . . . . . . 20,000 South Boston, VA December 2004
____________________
(1) The Nottingham warehouse has been sublet and is no longer used in our
operations. U.K. distribution activities have been contracted to an
independent warehouse.
Item 3. Legal Proceedings
In March 2003, we participated in an industry settlement of a number of class
action lawsuits including the class action lawsuit originally 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. Our portion of the settlement amount was approximately $204,000 and was
- --
provided for in the accompanying consolidated balance sheet as of December 31,
2002.
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 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended December 31, 2002.
14
Part II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters
Our common stock has traded on the Nasdaq National Market under the symbol
"RACN" since March 4, 2002. From May 8, 2000 to March 3, 2002, our common stock
traded on the Nasdaq SmallCap Market. Prior to May 8, 2000, the common stock
traded on the Nasdaq National Market. The following table sets forth the high
and low closing sale prices for the common stock as reported by the Nasdaq for
the periods indicated.
2001: High Low
---- ---
First Quarter . . . $ 3.31 $ 1.00
Second Quarter. . . 5.20 2.40
Third Quarter . . . 7.50 4.15
Fourth Quarter. . . 12.95 4.53
2002: High Low
---- ---
First Quarter . . . $20.31 $12.00
Second Quarter. . . 22.44 16.75
Third Quarter . . . 21.50 14.96
Fourth Quarter. . . 16.81 12.41
As of December 31, 2002, there were approximately 139 holders of record of our
common stock. We believe the number of beneficial owners of our common stock on
that date was substantially greater.
We have not paid any cash dividends on our common stock. We intend to retain any
earnings for use in the operation and expansion of our business, and therefore,
do not anticipate paying any cash dividends in the foreseeable future. Our
credit agreement contains a provision restricting our ability to pay dividends.
Item 6. Selected Financial Data
The following table presents selected consolidated financial data, which should
be read along with our consolidated financial statements and the notes to those
statements and with "Management's Discussion and Analysis of Financial Condition
and Results of Operations." The consolidated statements of earnings data for the
years ended December 31, 2000, 2001 and 2002 and the consolidated balance sheet
data as of December 31, 2001 and 2002 are derived from our audited financial
statements included elsewhere herein. The consolidated statement of earnings
data for the years ended December 31, 1998 and 1999 and the consolidated balance
sheet data as of December 31, 1998, 1999 and 2000 are derived from our audited
financial statements which are not included herein.
15
(In thousands, except per share data)
Year Ended December 31,
---------------------------------------------
1998 1999 2000 2001 2002
---- ---- ---- ---- ----
Consolidated Statements of Earnings:
Net sales. . . . . . . . . . . . . . . . . . . . . $156,464 $231,360 $214,806 $203,248 $213,456
Cost of sales(1) . . . . . . . . . . . . . . . . . 70,850 132,683 116,328 99,481 102,763
-------- -------- -------- -------- ---------
Gross profit . . . . . . . . . . . . . . . . . . 85,614 98,677 98,478 103,767 110,693
Selling, general and administrative expenses(1)(2) 54,302 79,762 71,636 67,853 68,769
Other charges(3) . . . . . . . . . . . . . . . . . 5,526 6,400 - - -
Amortization of goodwill . . . . . . . . . . . . . 2,663 3,543 3,795 3,376 -
-------- -------- -------- -------- ---------
Operating income . . . . . . . . . . . . . . . . 23,123 8,972 23,047 32,538 41,924
Interest expense, net. . . . . . . . . . . . . . . 2,751 7,650 11,375 6,470 1,835
Other expense (income) . . . . . . . . . . . . . . 400 (105) 662 277 (603)
-------- -------- -------- -------- ---------
Income before income taxes . . . . . . . . . . . 19,972 1,427 11,010 25,791 40,692
Income tax expense . . . . . . . . . . . . . . . . 8,231 892 5,120 10,668 15,947
-------- -------- -------- -------- ---------
Net income from continuing operations
before extraordinary item. . . . . . . . . . . $ 11,741 $ 535 $ 5,890 $ 15,123 $ 24,745
Net income from continuing operations
before extraordinary item per share:
Basic. . . . . . . . . . . . . . . . . . . . . . $ 0.73 $ 0.03 $ 0.40 $ 1.03 $ 1.55
Diluted. . . . . . . . . . . . . . . . . . . . . 0.71 0.03 0.39 1.00 1.47
Weighted average shares outstanding:
Basic. . . . . . . . . . . . . . . . . . . . . . 15,982 16,249 14,827 14,663 15,981
Diluted. . . . . . . . . . . . . . . . . . . . . 16,426 16,588 15,085 15,159 16,829
(In thousands)
As of December 31,
--------------------------------------------
1998 1999 2000 2001 2002
---- ---- ---- ---- ----
Consolidated Balance Sheet Data:
Working capital. . . . . . . . $ 9,420 $ 39,028 $ 38,955 $ 26,392 $ 49,540
Total assets . . . . . . . . . 160,504 276,282 251,907 235,523 236,287
Total debt . . . . . . . . . . 34,000 123,000 97,000 62,000 8,000
Total stockholders' equity . . 102,582 101,848 104,196 118,099 170,881
(1) Depreciation expense was approximately $3.3 million, $7.5 million, $9.6
million, $9.2 million and $9.1 million for the years ended December 31,
1998, 1999, 2000, 2001 and 2002, respectively.
(2) Selling, general and administrative expenses for 2000 include a charge of
$2.5 million related to minimum guaranteed royalty payments on
NASCAR-related licensing agreements, which exceeded royalties earned on
product sales.
(3) Other charges include $5.5 million in merger-related costs for the year
ended December 31, 1998 in connection with the acquisition of Wheels Sports
Group, Inc. and $6.4 million in restructuring and other charges for the
year ended December 31, 1999 in connection with the integration of The Ertl
Company, Inc.
16
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
We are a leading producer and marketer of collectibles and toys targeted at
adult collectors and children. Our products are marketed through multiple
channels of distribution and are available at more than 20,000 retail outlets
located in North America, Europe and Asia Pacific. Our product categories
include (i) automotive, high performance and racing vehicle replicas; (ii)
agricultural, construction and outdoor sports vehicle replicas; (iii) pre-teen
vehicles and role play activity toys; (iv) sports trading cards and racing
apparel and souvenirs; and (v) collectible figures. We market virtually all of
our products under licenses from other parties, and we are currently party to
approximately 600 license agreements.
Corporate History. Since our inception in 1989, we have capitalized on the
popularity of themed collectibles and toys. We became well-known in the early
1990s for our officially licensed collectible die-cast replicas of popular race
cars. We capitalized on our status as a pioneer of this market to become a
leading producer of other automotive die-cast replicas. These products were
primarily sold in the mass retailer channel under our Racing Champions brand.
On April 30, 1996, an investor group led by Willis Stein & Partners, L.P. and
some members of our management consummated a recapitalization transaction in
which our foreign and domestic operations were combined. This transaction was
accounted for using the purchase method and provided us with a stronger platform
to manage our business more effectively.
Following several years of strong growth, we completed an initial public
offering in June 1997. In the offering, we sold approximately 5.4 million shares
of common stock and received net proceeds of $68.7 million. This offering
provided us with additional capital to grow our business through internal
initiatives and acquisitions.
In June 1998, we acquired Wheels Sports Group, Inc. (subsequently renamed Racing
Champions South, Inc.) for 2.7 million shares of our common stock. This
transaction was accounted for as a pooling of interests. All financial
information is presented as if this transaction had been effected as of the
beginning of the earliest reporting period. The purchase of Wheel Sports Group
built upon our strength in the racing segment by expanding our product lines to
include collectible sports trading cards, souvenirs and apparel.
In April 1999, we acquired The Ertl Company, Inc. for approximately $94.6
million in cash. This transaction was accounted for using the purchase method,
and accordingly, the operating results of Ertl have been included in our
consolidated financial statements since the date of the acquisition. Ertl is a
premier producer and marketer of collectibles and toys focused on agricultural
and heavy equipment die-cast vehicle replicas, classic and high performance
die-cast vehicle replicas, custom imprint die-cast vehicle replicas, preschool
toys, collectible figures and hobby model kits. The combination dynamically
transformed us into the company now known as Racing Champions Ertl.
Integration Initiatives. During 1999 and 2000, we focused on integrating our
acquisitions, particularly Ertl. We implemented numerous initiatives to achieve
synergies and cost savings from these acquisitions. For example, we:
- - relocated certain tooling and production to China from Mexico;
- - combined offices and warehouses in the United States, Hong Kong and China,
and eliminated excess facilities;
- - consolidated back-office and support functions and systems;
- - simplified the organizational structure, eliminated redundant functions and
right-sized facilities across the combined entity; and
- - eliminated unprofitable products and product lines.
In 2001, we realized significant benefits from the integration, which reduced
Ertl's inventory and resulted in increased profitability and cash flow. Our
gross margins increased from 42.7% in 1999 to 51.9% in 2002, and our selling,
general and administrative expenses declined 13.8%, from $79.8 million in 1999
to $68.8 million in 2002. From our highest debt level after the Ertl acquisition
closed, we have reduced our bank debt by $138.3 million to $8.0 million as of
December 31, 2002 through our integration initiatives and active working capital
management.
17
On March 4, 2003, we acquired Learning Curve, with an effective date of February
28, 2003, for 666,667 shares of our common stock and approximately $106.7
million of cash, less debt and capital lease obligations, including $12.0
million in escrow to secure Learning Curve's indemnification obligations under
the merger agreement. The purchase price is subject to a post-closing working
capital adjustment and to the payment by the Company of additional consideration
of up to $6.5 million based on sales and margin targets for the Learning Curve
product lines in 2003. This transaction was accounted for under the purchase
method, and accordingly, the operating results of Learning Curve will be
included in our consolidated financial statements from the effective date of the
acquisition beginning in the quarter ending March 31, 2003. Learning Curve
develops and markets a variety of high-quality, award-winning traditional
children's toys for every stage of childhood from birth through age eight. Its
product lines include Thomas & Friends Wooden Railway, the top selling brand of
expandable wooden toy railway systems in the United States, and the recently
introduced Take Along Thomas die-cast train series and playsets. Other products
include Lamaze infant toys, Madeline dolls and accessories, Eden(R) plush,
Feltkids(R) activity boards and Lionel battery-powered train systems. The
Company financed its acquisition of Learning Curve by drawing down $110.0
million from a new $140.0 million credit facility. (See "Liquidity and Capital
Resources.")
Sales. Our sales are primarily derived from the sale of collectibles and toys
and are recognized upon transfer of title of product to our customers. We market
our products through a variety of distribution channels including mass
retailers, specialty and hobby wholesalers and retailers, OEM dealers, corporate
promotional accounts and direct to consumers. For the years ended December 31,
2000, 2001 and 2002, sales to mass retailers comprised 41.2%, 40.8% and 37.5%,
respectively, of our net sales.
Our products are marketed and distributed in North America, Europe and Asia
Pacific. International sales constituted less than 10% of our net sales for each
of the last three years. We expect international sales to increase over the next
several years as we expand our geographic reach. Our net sales have not been
materially impacted by foreign currency fluctuations.
We derive a significant portion of our sales from some of the world's largest
retailers and OEM dealers. Our top five customers accounted for 37.4%, 39.0% and
35.5% of our net sales in 2000, 2001 and 2002, respectively. The John Deere
dealer network and Wal-Mart, our largest customers, accounted for 15.0% and
11.8% of our net sales in 2002, respectively. Other than the John Deere dealer
network and Wal-Mart, no other customer accounted for more than 10% of our net
sales in 2000, 2001 or 2002.
We provide certain customers the option to take delivery of our products either
in the United States or United Kingdom with credit terms ranging from 30 to 120
days or directly in China with payment made by irrevocable letter of credit or
wire transfer. Since direct sales from China reduce our distribution and
administrative costs, we generally grant price discounts of 15.0% to 25.0% on
these sales, which results in lower gross profit margins for these sales
compared to sales related to shipments from the United States or United Kingdom.
Therefore, annual fluctuations in the mix of products shipped in the United
States or United Kingdom vs. products delivered in China will affect
year-to-year comparability of net sales and gross profit margins. However, we
believe that our operating income margin is comparable for products delivered in
China vs. products shipped in the United States or United Kingdom due to the
elimination of distribution and certain administrative costs. For the years
ended December 31, 2000, 2001 and 2002, direct sales from China constituted
13.2%, 9.8% and 11.1%, respectively, of our net sales.
We do not sell our products on consignment and ordinarily accept returns only
for defective merchandise. In certain instances, where retailers are unable to
resell the quantity of products that they have purchased from us, we may, in
accordance with industry practice, assist retailers in selling such excess
inventory by offering credits and other price concessions, which are typically
evaluated and issued annually. Returns and allowances on an annual basis have
ranged from 3.0% to 8.5% of net sales over the last three years.
Expenses. Cost of sales primarily consists of purchases of finished products,
which accounted for 81.4%, 80.1 % and 80.1% of our cost of sales in 2000, 2001
and 2002, respectively. The remainder of our cost of sales includes tooling
depreciation, freight-in from suppliers and concept and design expenses.
Substantially all of our purchases of finished products are denominated in Hong
Kong dollars, and therefore, subject to currency fluctuations. Historically, we
have not incurred substantial expense due to currency fluctuations because the
Hong Kong government has maintained a policy of linking the Hong Kong dollar and
U.S. dollar since 1983.
18
Selling, general and administrative expenses primarily consist of royalties,
employee compensation, advertising and marketing expenses, freight-out to
customers and sales commissions. Royalties vary by product category and are
generally paid on a quarterly basis. Multiple royalties may be paid to various
licensors on a single product. In 2002, aggregate royalties by product ranged
from approximately 2% to 20% of our selling price. Royalty expense for 2002 was
approximately 8.8% of our net sales. Sales commissions ranged from approximately
3% to 10% of the net sales price and are paid quarterly to our external sales
representative organizations. In 2002, sales subject to commissions represented
35.4% of our net sales, and sales commission expense was 1.6% of our net sales.
Seasonality. We have experienced, and expect to continue to experience,
substantial fluctuations in our quarterly net sales and operating results, which
is typical of many companies in our industry. Our business is highly seasonal
due to high consumer demand for our products during the year-end holiday season.
Approximately 58.3% of our net sales over the three years ended December 31,
2002 were generated in the second half of the year. As a result, our investment
in working capital, mainly inventory and accounts receivable, is generally
highest during the fourth quarter and lowest during the first quarter.
Results of Operations
(In thousands, except per share data)
Year Ended December 31,
---------------------------------------------
2000 2001 2002
----------- --------- -------------
Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ -------
Net sales . . . . . . . . . . . . . . . . . . $214,806 100.0% $203,248 100.0% $213,456 100.0%
Cost of sales . . . . . . . . . . . . . . . . 116,328 54.2 99,481 48.9 102,763 48.1
-------- ------ -------- ------ -------- ------
Gross profit. . . . . . . . . . . . . . . . 98,478 45.8 103,767 51.1 110,693 51.9
Selling, general and administrative expenses. 71,636 33.3 67,853 33.4 68,769 32.2
Amortization of goodwill. . . . . . . . . . . 3,795 1.8 3,376 1.7 - -
-------- ------ -------- ------ -------- ------
Operating income. . . . . . . . . . . . . . 23,047 10.7 32,538 16.0 41,924 19.7
Interest expense, net . . . . . . . . . . . . 11,375 5.3 6,470 3.2 1,835 0.9
Other expense (income). . . . . . . . . . . . 662 0.3 277 0.1 (603) (0.3)
-------- ------ -------- ------ -------- ------
Income before income taxes. . . . . . . . . 11,010 5.1 25,791 12.7 40,692 19.1
Income tax expense. . . . . . . . . . . . . . 5,120 2.4 10,668 5.2 15,947 7.5
-------- ------ -------- ------ -------- ------
Net income. . . . . . . . . . . . . . . . . $ 5,890 2.7 $ 15,123 7.5 $ 24,745 11.6
Net income per share:
Basic . . . . . . . . . . . . . . . . . . . $ 0.40 $ 1.03 $ 1.55
Diluted . . . . . . . . . . . . . . . . . . 0.39 1.00 1.47
Weighted average shares outstanding:
Basic . . . . . . . . . . . . . . . . . . . 14,827 14,663 15,981
Diluted . . . . . . . . . . . . . . . . . . 15,085 15,159 16,829
19
Year Ended December 31, 2002 Compared to Year Ended December 31, 2001
Net Sales. Net sales increased $10.3 million, or 5.1%, to $213.5 million for
2002 from $203.2 million for 2001. Approximately $7.9 million of this $10.3
million increase was due to net sales in our six new product lines. All five of
our product categories experienced sales growth year over year. Net sales in our
sports trading cards and racing apparel and souvenirs category increased
approximately 19.0%, primarily driven by our racing apparel programs. Net sales
in our collectible figures category were up approximately 31.1%, primarily
driven by the introduction of our JoyRide Studios collectible figures and
vehicles. Net sales in our agricultural, construction and outdoor sports vehicle
replicas category were up approximately 2.9%, primarily driven by our precision
and collector-type product lines sold primarily through OEM dealers. Net sales
in our pre-teen vehicles and role play activity toys category increased
approximately 3.4% year over year, driven by our new product introductions as
well as our ride-ons and classic licensed products like Scooby Doo. Net sales in
our automotive, high performance and racing vehicle replicas category increased
approximately 1.1%.
Gross Profit. Gross profit increased $6.9 million, or 6.6%, to $110.7 million
for 2002 from $103.8 million for 2001. The gross profit margin increased to
51.9% in 2002 from 51.1% in 2001. The increase in the gross profit margin was
due to higher sales volume 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 $0.9 million, or 1.3%, to $68.8 million for
2002 from $67.9 million for 2001. However, as a percentage of net sales,
selling, general and administrative expenses decreased to 32.2% for 2002 from
33.4% for 2001, as a result of continuous expenditure control and leveraging our
fixed costs over higher volume. Also 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.
Operating Income. Operating income increased $9.4 million, or 28.9%, to $41.9
million for 2002 from $32.5 million for 2001. As a percentage of net sales,
operating income increased to 19.6% for 2002 from 16.0% for 2001.
Net Interest Expense. Net interest expense of $1.8 million for 2002 and $6.5
million for 2001 related primarily to bank term loans and a line of credit. The
decrease in net interest expense was due to the reduction in average outstanding
debt balances and the decrease in interest rates. Additionally, a benefit of
approximately $542,000 and a charge of approximately $457,000 were recorded in
interest expense related to the change in fair value of the Company's interest
rate collar during 2002 and 2001, respectively. In 2002 and 2001, the Company
paid approximately, $548,000 and $241,000, respectively, on the interest rate
collar 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 three-year $50.0 million unsecured
revolving credit facility. In April 2002, the Financial Accounting Standards
Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 145,
"Rescission of the FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections." During the second quarter of 2002,
the Company elected early adoption of this Statement and accordingly included
approximately $545,000 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 for 2002.
Income Tax. Income tax expense for 2002 and 2001 included provisions for
federal, state and foreign income taxes at an effective rate of 39.2% and 41.4%,
respectively. The reduction in the effective income tax rate is a result of a
lower effective state income tax rate coupled with the cessation of amortization
of non-deductible goodwill resulting from the adoption of SFAS No. 142.
Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
Net Sales. Net sales decreased $11.6 million, or 5.4%, to $203.2 million for
2001 from $214.8 million for 2000. Approximately $7.4 million of this $11.6
million decrease was due to fewer net sales of low margin liquidation items. Net
sales in our automotive, high performance and racing vehicle replica category
decreased 18.4%. Net sales in our agricultural, construction and outdoor sports
vehicle replica category decreased 15.4%. The decreased net sales in these
categories were primarily due to fewer inventory liquidations, a focused effort
on SKU reduction and the timing of new releases in 2001. These decreases were
partially offset by increased net sales of sports trading cards and racing
apparel and souvenirs, which increased 48.8%, due to additional trading card
releases in 2001 vs. 2000, as well as increased net sales of our apparel and
souvenirs at trackside events. Net sales in the pre-teen vehicles and role play
activity toys category also increased by 23.9%, primarily due to the
introduction of new John Deere ride-ons and the Little Muscle product line. Net
sales in the collectible figures category increased 22.3%, due to the
introduction of Outdoor Sportsman collectible figures and increased net sales of
our W. Britain collectible metal figures.
20
Gross Profit. Gross profit increased $5.3 million, or 5.4%, to $103.8 million
for 2001 from $98.5 million for 2000. The gross profit margin increased to 51.1%
in 2001 from 45.8% in 2000. The increase in the gross profit margin was
attributable to realization of a full year's benefit from the integration of
Ertl, including better product sourcing, consolidated manufacturing in China and
streamlined product development efforts, as well as a reduction in sales of
products with lower margins. There were no major changes in the components of
cost of sales.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses decreased $3.7 million, or 5.2%, to $67.9 million for
2001 from $71.6 million for 2000. The decrease was due, in part, to the
realization of a full year's benefit from the integration of Ertl and improved
control of discretionary expenditures, but it was also impacted by the lower
sales volume in 2001. In addition, selling, general and administrative expenses
for 2000 included a $2.5 million charge related to minimum guaranteed royalty
payments on NASCAR-related license agreements, which exceeded royalties earned
on product sales. As a percentage of net sales, selling, general and
administrative expenses remained relatively constant at 33.4% for 2001 and 33.3%
for 2000.
Operating Income. Operating income increased $9.5 million, or 41.3%, to $32.5
million for 2001 from $23.0 million for 2000. As a percentage of net sales,
operating income increased to 16.0% for 2001 from 10.7% for 2000.
Net Interest Expense. Net interest expense of $6.5 million for 2001 and $11.4
million for 2000 related primarily to bank term loans and a line of credit. The
decrease in net interest expense was due to the reduction in average outstanding
debt balances and the decrease in interest rates.
Income Tax. Income tax expense for 2001 and 2000 included provisions for
federal, state and foreign income taxes at an effective rate of 41.4% and 46.5%,
respectively. The reduction in the effective income tax rate is a result of a
lower effective foreign tax rate coupled with generating higher income before
income taxes while nondeductible items remained comparable.
Liquidity and Capital Resources
We generally fund our operations and working capital needs through cash
generated from operations and borrowings under our credit facility. Our
operating activities generated cash of approximately $34.0 million in 2002,
$45.0 million in 2001 and $38.6 million in 2000. Net cash provided by operating
activities for 2002 decreased primarily due to increased investments in
inventory and higher levels of prepaid taxes.
Net cash used in investing activities was $8.9 million in 2002 compared to $6.5
million in 2001. The increase in 2002 was primarily attributable to capital
expenditures of $9.5 million in 2002 as compared to $6.5 million in 2001.
Capital expenditures for molds and tooling for 2002 and 2001 were $5.7 million
and $5.2 million, respectively.
Net cash used in financing activities was $25.3 million in 2002 as compared to
$35.2 million in 2001. In 2002, we made net payments of $54.0 million on our
bank borrowings, utilizing $24.0 million in cash proceeds from our public
offering in April 2002 and cash from operations.
We believe that our cash flow from operations, cash on hand and available
borrowings will be sufficient to meet our working capital and capital
expenditure requirements and provide us with adequate liquidity to meet
anticipated operating needs for 2003. Working capital financing requirements are
usually highest during the third and fourth quarters due to seasonal increases
in demand for our collectibles and toys. In addition, we expect that capital
expenditures during 2003, principally for molds and tooling, will be
approximately $12.0 million. Although operating activities are expected to
provide sufficient cash, any significant future product or property
acquisitions, including up-front licensing payments, may require additional debt
or equity financing.
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.
21
Upon the closing of the public offering, the Company entered into a new credit
facility in April 2002 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 (defined as
earnings before interest, taxes, depreciation and amortization). At December 31,
2002, the margin in effect was 0.75% for LIBOR loans and the rate was 2.17%. 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 December 31, 2002, the commitment fee was 0.20% per annum on the
average daily unused portion of the revolving loan. Under the terms of this
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 December 31, 2002, the amount outstanding under this
facility was $8.0 million, and the Company was in compliance with all covenants.
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. During 2001 and 2002, the Company paid $0.2 million and $0.5 million,
respectively, on the agreement, which is included in interest expense on the
accompanying consolidated statements of earnings.
Our Hong Kong subsidiary has a credit agreement with a bank that provides for a
line of credit of up to $2.0 million. Amounts borrowed under this line of credit
bear interest at the bank's prime rate or prevailing funding cost, whichever is
greater, and are cross-guaranteed by the Company. As of December 31, 2002 and
2001 there were no outstanding borrowings under this line of credit.
The Company's United Kingdom subsidiary has a line of credit with a bank for
$1.0 million. Amounts borrowed under this line of credit bear interest at 1.00%
over the bank's base rate, and the line of credit is subject to a letter of
guarantee given by the Company for $0.8 million. At December 31, 2002 and 2001,
there were no amounts outstanding on the line of credit.
Upon the closing of the acquisition of Learning Curve on March 4, 2003, with an
effective date of February 28, 2003, the Company entered into a new credit
facility to replace its April 2002 credit facility. The credit facility is
comprised of a $60.0 million term loan and a $80 million revolving loan. Thirty
million dollars of the term loan has a fixed interest rate of 2.61% plus
applicable margin through the maturity of the agreement. The remaining term loan
and revolving loan bear interest, at the Company's option, at a base rate or at
a LIBOR rate plus a margin that varies between 0.75% and 1.75%. The applicable
margin is based on the Company's ratio of consolidated debt to EBITDA. Upon
closing, the margin in effect was 1.75% for LIBOR loans. The Company is also
required to pay a commitment fee of 0.25% to 0.40% per annum on the average
daily unused portion of the revolving loan. Under the terms of the credit
facility, the Company is required to comply with certain financial and
non-financial covenants. Among other restrictions, the Company is restricted in
its ability to pay dividends, incur additional debt and make acquisitions above
certain amounts. The key financial covenants include minimum EBITDA and interest
coverage and leverage ratios. The credit facility is secured by working capital
assets and certain intangible assets. On March 4, 2003, the Company had $110.0
million outstanding on this credit facility.
Critical Accounting Policies and Estimates
The Company makes certain estimates and assumptions that affect the reported
amounts of assets and liabilities and the reported amounts of revenues and
expenses. The accounting policies described below are those the Company
considers critical in preparing its consolidated financial statements. These
policies include significant estimates made by management using information
available at the time the estimates are made. However, as described below, these
estimates could change materially if different information or assumptions were
used.
Allowance for Doubtful Accounts. The allowance for doubtful accounts represents
adjustments to customer trade accounts receivable for amounts deemed
uncollectible. The allowance for doubtful accounts reduces gross trade
receivables to their net realizable value and is disclosed on the face of the
accompanying balance sheets. The Company's allowance is based on management's
assessment of the business environment, customers' financial condition,
historical trends, customer payment practices, receivable aging and customer
disputes. The Company has purchased credit insurance that covers a portion of
its receivables from major customers. The Company will continue to proactively
review its credit risks and adjust its customer terms to reflect the current
environment.
22
Inventory. Inventory, which consists of finished goods, has been written down
for excess quantities and obsolescence and is stated at lower of cost or market.
Cost is determined by the first-in, first-out method, and market represents the
lower of replacement cost or estimated net realizable value. Inventory
write-downs are recorded for damaged, obsolete, excess and slow-moving
inventory. The Company's management uses estimates to record these write-downs
based on its review of inventory by product category, length of time on hand and
order bookings. Changes in public and consumer preferences and demand for
product or changes in the customer's buying patterns and inventory management
could impact the inventory valuation.
Impairment of Long-lived Assets and Goodwill. Long-lived assets have been
reviewed for impairment based on SFAS No. 144, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of." This statement
requires that an impairment loss be recognized whenever the sum of the expected
future cash flows (undiscounted and without interest charges) resulting from the
use and ultimate disposal of an asset is less than the carrying amount of the
asset. Goodwill has been reviewed for impairment based on SFAS No. 142,
"Goodwill and Other Intangible Assets." Under SFAS 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. The Company's management
reviews for indicators that might suggest an impairment loss could exist.
Testing for impairment requires estimates of expected cash flows to be generated
from the use of the assets. Various uncertainties, including changes in consumer
preferences, deterioration in the political environment or changes in general
economic conditions, could impact the expected cash flows to be generated by an
asset or group of assets. (See discussion under "Recently Issued Accounting
Pronouncements" regarding SFAS No. 144, which supercedes SFAS No. 121.)
Income Taxes. The Company records current and deferred income tax liabilities.
In determining the required liability, management considers certain tax
exposures and all available evidence. However, if the available evidence were to
change in the future, an adjustment to the tax-related balances may be required.
Accrued Allowances. The Company ordinarily accepts returns only for defective
merchandise. In certain instances, where retailers are unable to resell the
quantity of products that they have purchased from the Company, the Company may,
in accordance with industry practice, assist retailers in selling excess
inventory by offering credits and other price concessions, which are typically
evaluated and issued annually. Other allowances can also be issued for defective
merchandise, volume programs and co-op advertising. All allowances are accrued
throughout the year, as sales are recorded. The allowances are based on the
terms of the various programs in effect; however, management also takes into
consideration historical trends and specific customer and product information
when making its estimates.
Accrued Royalties. Royalties are accrued based on the provisions in licensing
agreements for amounts due on net sales during the period as well as management
estimates for additional royalty exposures. Royalties vary by product category
and are generally paid on a quarterly basis. Multiple royalties may be paid to
various licensors on a single product. Royalty expense is included in selling,
general and administrative expenses on the consolidated statements of earnings.
Recently Issued Accounting Pronouncements
On June 30, 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets." Under SFAS 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 SFAS No. 142 on
January 1, 2002. Goodwill had been amortized over 40 years on a straight-line
basis through December 31, 2001. Approximately $88.7 million of our goodwill is
tax deductible over 15 years. Amortization expense relating to goodwill for the
years ended December 31, 2000 and 2001 was approximately $3.8 million and $3.4
million, respectively. Accumulated amortization was $16.6 million at December
31, 2001 and 2002. As of December 31, 2002, goodwill, net of accumulated
amortization, is approximately $119.2 million. The Company has completed its
transitional impairment test as of January 1, 2002 and its annual goodwill
impairment test as of October 1, 2002, both of 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 years ended December 31, 2000 and 2001.
23
(In thousands, except per share data)
Year ended Year ended
December 31, 2000 December 31, 2001
----------------- -----------------
Reported net income. . . . . . . . . . . . . . . . $ 5,891 $15,123
Add back: Goodwill amortization, net of income tax 2,800 2,487
------- -------
Adjusted net income. . . . . . . . . . . . . . . . $ 8,691 $17,610
Basic net income per share:
Reported net income per share. . . . . . . . . . . $ 0.40 $ 1.03
Goodwill amortization per share. . . . . . . . . . 0.19 0.17
------- -------
Adjusted net income per share. . . . . . . . . . . $ 0.59 $ 1.20
Diluted net income per share:
Reported net income per share. . . . . . . . . . . $ 0.39 $ 1.00
Goodwill amortization per share. . . . . . . . . . 0.19 0.16
------- -------
Adjusted net income per share. . . . . . . . . . . $ 0.58 $ 1.16
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," which supercedes SFAS 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 Accounting Principles Board (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.
SFAS 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. SFAS
No. 144 requires that those long-lived assets be measured at the lower of
carrying amount or fair value less cost to sell, whether included in continuing
operations or in discontinued operations. The provisions of SFAS No. 144 are
effective for financial statements issued for fiscal years beginning after
December 15, 2001, and interim periods within those fiscal years. There was no
impact on the Company upon adoption.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections."
During the second quarter, the Company elected early adoption of this Statement
and accordingly included approximately $545,000 of deferred financing fees
related to the Company's previous credit facility in interest expense in the
accompanying statements of earnings. In addition, in connection with the
refinancing of the Company's credit facility in April 2002, the Company incurred
approximately $284,000 in financing fees on the new credit facility, which was
also included in interest expense for the second quarter of 2002.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." Commitment to a plan to exit an activity or
dispose of long-lived assets will no longer be enough to record a one-time
charge for most anticipated costs. Instead, companies will record exit or
disposal costs when they are incurred and can be measured at fair value, and
they will subsequently adjust the recorded liability for changes in estimated
cash flows. The statement is effective for restructuring activities that are
initiated after December 31, 2002. There was no impact on the Company upon
adoption.
24
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure-an Amendment of FASB Statement No. 123."
This statement provides alternative methods of transition for an entity that
voluntarily changes to the fair value based method of accounting for stock-based
employee compensation. It also amends the disclosure provisions of SFAS No. 123
to require prominent disclosure about the effects on reported net income of an
entity's accounting policy decisions with respect to stock-based employee
compensation. This statement is effective for financial statements for fiscal
years ending after December 15, 2002. The Company has complied with the new
disclosure requirements by moving its disclosure of the effects on reported net
income with respect to stock-based employee compensation to the accounting
policy note (Note 3 to the accompanying consolidated financial statements) and
will comply with quarterly disclosure requirements beginning with the first
quarter of 2003.
Item 7A. 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 a floor of 5.09%. The
agreement, which had quarterly settlement dates, expired on June 3, 2002. For
the years ended December 31, 2001 and 2002, the Company paid approximately
$241,000 and $548,000, respectively, which is included in interest expense on
the accompanying consolidated statements of income. Additionally, a charge of
approximately $457,000 and a benefit of approximately $542,000 were recorded in
interest expense related to the change in fair value of the Company's interest
rate collar during the years ended December 31, 2001 and 2002, respectively.
Based on the Company's interest rate exposure on variable rate borrowings at
March 4, 2003, a one-percentage-point increase in average interest rates on
the Company's borrowings would increase future interest expense by approximately
$67,000 per month.
Item 8. Financial Statements and Supplementary Data
Financial Statements
Our consolidated financial statements and notes thereto are filed under this
item beginning on page F-1 of this report.
25
Quarterly Results of Operations
The following tables set forth our unaudited quarterly results of operations for
2001 and 2002. We have prepared this unaudited information on a basis consistent
with the audited consolidated financial statements contained in this report and
this unaudited information includes all adjustments, consisting only of normal
recurring adjustments, that we consider necessary for a fair presentation of our
results of operations for the quarters presented. You should read this quarterly
financial data along with the Condensed Consolidated Financial Statements and
the related notes to those statements included in our Quarterly Reports on Form
10-Q filed with the Commission. The operating results for any quarter are not
necessarily indicative of the results for any future period.
(In thousands, except per share data)
Fiscal Year 2002
------------------------------------
Q1 Q2 Q3 Q4
------ ------ ------ ------
Net sales . . . . . . . . . . . . . . . . . . $40,776 $47,746 $70,944 $53,990
Cost of sales . . . . . . . . . . . . . . . . 20,479 22,080 33,450 26,754
-------- -------- -------- --------
Gross profit. . . . . . . . . . . . . . . . 20,297 25,666 37,494 27,236
Selling, general and administrative expenses. 15,265 16,546 20,831 16,127
-------- -------- -------- --------
Operating income. . . . . . . . . . . . . . 5,032 9,120 16,663 11,109
Interest expense, net . . . . . . . . . . . . 645 1,010 194 (14)
Other expense (income). . . . . . . . . . . . (360) (148) (53) (42)
-------- -------- -------- --------
Income before income taxes. . . . . . . . . 4,747 8,258 16,522 11,165
Income tax expense. . . . . . . . . . . . . . 1,899 3,303 6,609 4,136
-------- -------- -------- --------
Net income. . . . . . . . . . . . . . . . . $ 2,848 $ 4,955 $ 9,913 $ 7,029
Net income per share:
Basic . . . . . . . . . . . . . . . . . . . $ 0.19 $ 0.30 $ 0.60 $ 0.43
Diluted . . . . . . . . . . . . . . . . . . 0.18 0.29 0.58 0.41
Weighted average shares outstanding:
Basic . . . . . . . . . . . . . . . . . . . 14,625 16,347 16,460 16,463
Diluted . . . . . . . . . . . . . . . . . . 15,700 17,291 17,234 17,103
(In thousands, except per share data)
Fiscal Year 2001
-----------------------------------
Q1 Q2 Q3 Q4
------ ----- ------ ------
Net sales . . . . . . . . . . . . . . . . . . . $36,456 $43,077 $65,819 $57,896
Cost of sales . . . . . . . . . . . . . . . . . 19,201 20,042 30,837 29,401
-------- ------- -------- -------
Gross profit. . . . . . . . . . . . . . . . . 17,255 23,035 34,982 28,495
Selling, general and administrative expenses(1) 12,917 16,353 20,434 18,149
Amortization of goodwill. . . . . . . . . . . . 851 851 830 844
-------- ------- -------- -------
Operating income. . . . . . . . . . . . . . . 3,487 5,831 13,718 9,502
Interest expense, net . . . . . . . . . . . . . 2,243 1,677 1,571 979
Other expense (income). . . . . . . . . . . . . (23) 489 (486) 297
-------- ------- -------- -------
Income before income taxes. . . . . . . . . . 1,267 3,665 12,633 8,226
Income tax expense. . . . . . . . . . . . . . . 532 1,539 5,306 3,291
-------- ------- -------- -------
Net income. . . . . . . . . . . . . . . . . . $ 735 $ 2,126 $ 7,327 $ 4,935
Net income per share:
Basic . . . . . . . . . . . . . . . . . . . . $ 0.05 $ 0.14 $ 0.50 $ 0.34
Diluted . . . . . . . . . . . . . . . . . . . 0.05 0.14 0.48 0.32
Weighted average shares outstanding:
Basic . . . . . . . . . . . . . . . . . . . . 14,669 14,686 14,682 14,615
Diluted . . . . . . . . . . . . . . . . . . . 15,023 15,121 15,216 15,265
(1) Selling, general and administrative expenses for the first quarter of 2001
include an adjustment of approximately $613,000 to reduce our estimate of our pension
funding liability based on a recent actuarial valuation. This adjustment resulted in
income after taxes of approximately $356,000
26
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Not applicable.
Part III
Item 10. Directors and Executive Officers of the Registrant
Information regarding the executive officers and directors of the Company is
incorporated herein by reference to the discussions under "Election of
Directors," "Executive Officers" and "Section 16(a) Beneficial Ownership
Reporting Compliance" in the Company's Proxy Statement for the 2003 Annual
Meeting of Stockholders, which will be filed with the Commission on or before
April 30, 2003.
Item 11. Executive Compensation
Information regarding executive compensation is incorporated herein by reference
to the discussion under "Executive Compensation" and "Compensation of Directors"
in the Company's Proxy Statement for the 2003 Annual Meeting of Stockholders,
which will be filed with the Commission on or before April 30, 2003.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Information regarding security ownership of certain beneficial owners and
management is incorporated herein by reference to the discussion under "Security
Ownership" in the Company's Proxy Statement for the 2003 Annual Meeting of
Stockholders, which will be filed with the Commission on or before April 30,
2003.
Equity Compensation Plan Information
The following table summarizes share information, as of December 31, 2002, for
the Company's equity compensation plans, including the Racing Champions Ertl
Corporation Stock Incentive Plan, the Racing Champions Ertl Corporation Employee
Stock Purchase Plan, the Racing Champions, Inc. 1996 Key Employees Stock Option
Plan and the Wheels Sports Group, Inc. 1996 Omnibus Stock Plan. All of these
plans have been approved by the Company's stockholders, other than the Wheels
Sports Group, Inc. 1996 Omnibus Stock Plan, which was approved by Wheels Sports
Group's stockholders and assumed by the Company following its acquisition of
Wheels Sports Group in 1998.
Number of Number of
common shares to be common shares
issued upon exercise Weighted-average available for future
of outstanding exercise price of issuance under
options, outstanding options, equity
Plan Category warrants and rights warrants and rights compensation plans
- ------------- ------------------- -------------------- --------------------
Equity compensation plans approved
by stockholders. . . . . . . . . 1,593,255 $ 6.17 956,847
Equity compensation plans not
approved by stockholders . . . . - - -
--------- -------- -------
Total. . . . . . . . . . . . . . . 1,593,255 $ 6.17 956,847
27
Item 13. Certain Relationships and Related Transactions
Information regarding certain relationships and related transactions is
incorporated herein by reference to the discussions under "Executive
Compensation-Employment Agreements" and "Certain Relationships and Related
Transactions" in the Company's Proxy Statement for the 2003 Annual Meeting of
Stockholders, which will be filed with the Commission on or before April 30,
2003.
Item 14. Controls and Procedures
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 the Company's Chief Executive Officer and the Company's
Chief Financial Officer, of the effectiveness of the design and operation of the
Company's disclosure controls and procedures. Based on this evaluation, the
Company's Chief Executive Officer and Chief Financial Officer concluded that the
Company's disclosure controls and procedures were effective in timely alerting
them to material information relating to the Company required to be included in
the Company's periodic filings with the Commission. It should be noted that in
designing and evaluating the disclosure controls and procedures, management
recognized that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the desired control
objectives, and management necessarily was required to apply its judgment in
evaluating the cost-benefit relationship of possible controls and procedures.
There have been no significant changes in the Company's internal controls or in
other factors that could significantly affect the internal controls subsequent
to the date the Company completed its evaluation.
Part IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) The following documents are filed as part of this report:
1. Financial Statements
The following consolidated financial statements of the Company are included
in Item 8 of this report:
Reports of Independent Auditors
Consolidated Balance Sheets as of December 31, 2001 and 2002
Consolidated Statements of Earnings for the years ended December 31, 2000,
2001 and 2002
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 2000, 2001 and 2002
Consolidated Statements of Cash Flows for the years ended December 31,
2000, 2001 and 2002
Notes to Consolidated Financial Statements
28
2. Financial Statement Schedules
Reports of Independent Auditors
Financial Statement Schedule for the years ended December 31, 2000, 2001
and 2002:
Schedule
Number Description Page
II Valuation and Qualifying 34
Accounts
All other schedules for which provision is made in the applicable
accounting regulations of the Commission are not required under the related
instructions, are inapplicable or the required information is shown in the
financial statements or notes thereto, and therefore, have been omitted.
3. Exhibits
2.1 Agreement and Plan of Merger, dated as of February 3, 2003, among the
Company, RBVD Sub I Inc., Racing Champions Worldwide Limited, Racing
Champions Limited and Learning Curve International, Inc. [incorporated by
reference to Exhibit 2.1 of the Company's Current Report on Form 8-K filed
with the Commission on March 18, 2003 (File No. 0-22635)].
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)].
3.2 First Amendment to Amended and Restated Certificate of Incorporation of the
Company [incorporated by reference to Exhibit 3.2 of the Company's
Quarterly Report on Form 10-Q for the quarter ended March 31, 2002 (File
No. 0-22635)].
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)].
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 June 30, 1998 (File No. 0-22635)].
10.1 Credit Agreement, dated as of April 3, 2002, among Racing Champions, Inc.,
Racing Champions South, Inc., Racing Champions Worldwide Limited, the
guarantors from time to time parties thereto, the lenders from time to time
parties thereto, and Harris Trust and Savings Bank, as administrative agent
[incorporated by reference to Exhibit 10.1 of the Company's Quarterly
Report on Form 10-Q for the quarter ended March 31, 2002 (File No.
0-22635)].
10.2* Employment Agreement, dated as of April 30, 2001, between Racing Champions
Corporation and Robert E. Dods [incorporated by reference to Exhibit 10.10
of the Company's Annual Report on Form 10-K for the year ended December 31,
2001 (File No. 0-22635)].
10.3* Employment Agreement, dated as of April 30, 2001, between Racing Champions
Corporation and Boyd L. Meyer [incorporated by reference to Exhibit 10.11
of the Company's Annual Report on Form 10-K for the year ended December 31,
2001 (File No. 0-22635)].
10.4* Employment Agreement, dated as of April 30, 2001, between Racing Champions
Limited and Peter K.K. Chung [incorporated by reference to Exhibit 10.12 of
the Company's Annual Report on Form 10-K for the year ended December 31,
2001 (File No. 0-22635)].
10.5* Employment Agreement, dated as of July 29, 2002, between the Company and
Curtis W. Stoelting [incorporated by reference to Exhibit 10.2 of the
Company's Quarterly Report on Form 10-Q for the quarter ended September 30,
2002 (File No. 0-22635)].
10.6* Employment Agreement, dated as of July 29, 2002, between the Company and
Peter J. Henseler [incorporated by reference to Exhibit 10.1 of the
Company's Quarterly Report on Form 10-Q for the quarter ended September 30,
2002 (File No. 0-22635)].
10.7* Employment Agreement, dated as of July 29, 2002, between the Company and
Jody L. Taylor [incorporated by reference to Exhibit 10.3 of the Company's
Quarterly Report on Form 10-Q for the quarter ended September 30, 2002
(File No. 0-22635)].
29
10.8* Racing Champions Corporation 1996 Key Employees Stock Option Plan
[incorporated by reference to Exhibit 10.19 of the Company's Registration
Statement on Form S-1 (Registration No. 333-22493) filed with the
Commission on February 27, 1997].
10.9* Racing Champions Corporation Stock Incentive Plan, as amended
[incorporated by reference to Exhibit 10.5 of the Company's Quarterly
Report on Form 10-Q for the quarter ended September 30, 2002 (File No.
0-22635)].
10.10* Wheels Sports Group, Inc. 1996 Omnibus Stock Plan [incorporated by
reference to Exhibit 10.6 of the Company's Quarterly Report on Form 10-Q
for the quarter ended June 30, 1998 (File No. 0-22635)].
10.11* Racing Champions Ertl Corporation Employee Stock Purchase Plan, as
amended [incorporated by reference to Exhibit 10.4 of the Company's
Quarterly Report on Form 10-Q for the quarter ended September 30, 2002
(File No. 0-22635)].
21 Subsidiaries of the Company
23.1 Consent of KPMG LLP
23.2 Consent of Ernst & Young LLP
23.3 Information regarding Arthur Andersen LLP
24 Power of Attorney (included as part of the signature page hereof)
- -----------------
* Management contract or compensatory plan or arrangement.
(b) Reports on Form 8-K
The Company did not file any reports on Form 8-K for the three months
ended December 31, 2002.
(c) Exhibits
The response to this portion of Item 14 is submitted as a separate section
of this report.
(d) Financial statement schedules
The response to this portion of Item 14 is submitted as a separate section
of this report.
30
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this Form 10-K to be signed on its
behalf by the undersigned, thereunto duly authorized.
Date: March 27, 2003 RACING CHAMPIONS ERTL CORPORATION
By /s/ Curtis W. Stoelting
---------------------------------
Curtis W. Stoelting,
Chief Executive Officer
POWER OF ATTORNEY
Each person whose signature appears below hereby appoints Curtis W. Stoelting
and Jody L. Taylor, and each of them individually, his true and lawful
attorney-in-fact, with power to act with or without the other and with full
power of substitution and resubstitution, in any and all capacities, to sign any
or all amendments to the Form 10-K and file the same with all exhibits thereto,
and other documents in connection therewith, with the Securities and Exchange
Commission, granting unto said attorneys-in-fact and agents full power and
authority to do and perform each and every act and thing requisite and necessary
to be done in and about the premises, as fully to all intents and purposes as he
might or could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents, or their substitutes, may lawfully cause to be
done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this Form
10-K has been signed below by the following persons on behalf of the Registrant
and in the capacities and on the dates indicated
/s/ Robert E. Dods Chairman of the Board and March 27, 2003
Robert E. Dods Director
/s/ Boyd L. Meyer Vice Chairman and Director March 27, 2003
Boyd L. Meyer
/s/ Curtis W. Stoelting Chief Executive Officer and March 27, 2003
Curtis W. Stoelting Director (Principal Executive Officer)
/s/ Peter J. Henseler President and Director March 27, 2003
Peter J. Henseler
/s/ Jody L. Taylor Chief Financial Officer and March 27, 2003
Jody L. Taylor Secretary (Principal Financial and
Accounting Officer)
/s/ Peter K.K. Chung Director March 27, 2003
Peter K.K. Chung
/s/ Paul E. Purcell Director March 27, 2003
Paul E. Purcell
/s/ John S. Bakalar Director March 27, 2003
John S. Bakalar
/s/ John J. Vosicky Director March 27, 2003
John J. Vosicky
/s/ Daniel M. Wright Director March 27, 2003
Daniel M. Wright
31
CERTIFICATIONS
I, Curtis W. Stoelting, Chief Executive Officer of Racing Champions Ertl
Corporation, certify that:
1. I have reviewed this annual report on Form 10-K of Racing Champions Ertl
Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this annual report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
the registrant's board of directors (or persons performing the equivalent
function):
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 27, 2003
/s/ Curtis W. Stoelting
------------------------------
Curtis W. Stoelting
Chief Executive Officer
32
I, Jody L. Taylor, Chief Financial Officer of Racing Champions Ertl Corporation,
certify that:
1. I have reviewed this annual report on Form 10-K of Racing Champions Ertl
Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this annual report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
the registrant's board of directors (or persons performing the equivalent
function):
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 27, 2003
/s/ Jody L. Taylor
------------------------------
Jody L. Taylor
Chief Financial Officer
33
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Racing Champions Ertl Corporation and subsidiaries:
Under date of February 19, 2003, we reported on the consolidated balance sheets
of Racing Champions Ertl Corporation and subsidiaries as of December 31, 2002,
and the related consolidated statements of earnings, stockholders' equity, and
cash flows for the year then ended. In connection with our audit of the
aforementioned consolidated financial statements, we also audited the related
consolidated financial statement schedule of Valuation and Qualifying Accounts
as of December 31, 2002. This financial statement schedule is the responsibility
of the Company's management. Our responsibility is to express an opinion on the
financial statement schedule based on our audit.
In our opinion, this financial statement schedule, when considered in relation
to the basic consolidated financial statements taken as a whole, presents
fairly, in all material respects, the information set forth therein.
Our report on the consolidated financial statements refers to our audit of the
disclosures that were added to revise the 2001 and 2000 consolidated financial
statements, as more fully described in note 3 to the consolidated financial
statements. However, we were not engaged to audit, review, or apply any
procedures to the 2001 and 2000 consolidated financial statements other than
with respect to such disclosures.
/s/ KPMG LLP
KPMG LLP
Chicago, Illinois
February 19, 2003
Schedule II
Description
Valuation and Qualifying Accounts
Balance at Charged to Charged to
Beginning of Costs and Other Balance at
Description Year Expenses Accounts Deductions End of Year
- ----------- ------------ ---------- ---------- ---------- -----------
Allowance for doubtful accounts:
Year ended December 31, 2000 . . $ 5,454,949 $2,053,230 - $(4,176,915) $ 3,331,264
Year ended December 31, 2001 . . $ 3,331,264 $2,499,763 - $(2,821,907) $ 3,009,120
Year ended December 31, 2002 . . $ 3,009,120 $ 753,849 - $(1,162,393) $ 2,600,576
34
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
This is a copy of a previously issued report by Arthur Andersen LLP related to
their audits of the Company as of and for the fiscal years ended December 31,
2000 and 2001. This report has not been reissued by Arthur Andersen LLP.
To the Board of Directors and Stockholders of Racing Champions Corporation and
Subsidiaries:
We have audited in accordance with generally accepted auditing standards, the
consolidated financial statements of Racing Champions Corporation included in
this annual report and issued our report thereon dated February 22, 2002. Our
audits were made for the purpose of forming an opinion on the basic financial
statements taken as a whole. The schedule of Valuation and Qualifying Accounts
is presented for purposes of complying with the Securities and Exchange
Commission's rules and is not a part of the basic financial statements. This
schedule has been subject to the auditing procedures applied in the audits of
the basic financial statements and, in our opinion, fairly states in all
material respects the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.
/s/ ARTHUR ANDERSEN LLP
ARTHUR ANDERSEN LLP
Chicago, Illinois
February 22, 2002
35
INDEX TO FINANCIAL STATEMENTS
RACING CHAMPIONS ERTL CORPORATION AND SUBSIDIARIES
Reports of Independent Auditors . . . . . . . . . . . . . . . . . . . . F-2
Consolidated Balance Sheets as of December 31, 2001 and 2002. . . F-5
Consolidated Statements of Earnings for the years ended
December 31, 2000, 2001 and 2002 . . . . . . . . . . . . . . . . . . . F-6
Consolidated Statements of Stockholders' Equity for the years
ended December 31, 2000, 2001 and 2002 . . . . . . . . . . . . . . . F-7
Consolidated Statements of Cash Flows for the years ended
December 31, 2000, 2001 and 2002 . . . . . . . . . . . . . . . . . . F-8
Notes to Consolidated Financial Statements . . . . . . . . . . . . . . F-9
F-1
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Stockholders of
Racing Champions Ertl Corporation:
We have audited the 2002 consolidated financial statements of Racing Champions
Ertl Corporation and subsidiaries (the Company) listed in the accompanying
index. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audit. The 2001 and 2000
consolidated financial statements of the Company as listed in the accompanying
index were audited by other auditors, certain of whom have ceased operations.
The auditors who ceased operations expressed an unqualified opinion on the 2001
and 2000 consolidated financial statements based on their audits and the reports
of other auditors (who have not ceased operations) who audited the financial
statements of Racing Champions Worldwide Limited, which statements reflected
total assets and total net sales of 11.7% and 8.4%, respectively, in 2001, and
10.4% and 9.9%, respectively, in 2000, of the related consolidated totals before
the revision described in Note 3 to the consolidated financial statements, in
their report dated February 22, 2002.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the consolidated
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
In our opinion, the 2002 consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Racing
Champions Ertl Corporation and subsidiaries as of December 31, 2002, and the
results of their operations and their cash flows for the year then ended in
conformity with accounting principles generally accepted in the United States of
America.
As discussed above, the 2001 and 2000 consolidated financial statements of
Racing Champions Ertl Corporation and subsidiaries as listed in the accompanying
index were audited by other auditors, certain of whom have ceased operations. As
described in Note 3, these consolidated financial statements have been revised
to include the transitional disclosures required by Statement of Financial
Accounting Standards No. 142, Goodwill and Other Intangible Assets, which was
adopted by the Company as of January 1, 2002. In our opinion, the disclosures
for 2001 and 2000 in Note 3 are appropriate. However, we were not engaged to
audit, review, or apply any procedures to the 2001 or 2000 consolidated
financial statements of the Company other than with respect to such disclosures
and, accordingly, we do not express an opinion or any other form of assurance on
the 2001 or 2000 consolidated financial statements taken as a whole.
/s/ KPMG LLP
KPMG LLP
Chicago, Illinois
February 19, 2003
F-2
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
This is a copy of a previously issued report by Arthur Andersen LLP related to
their audits of the Company as of and for the fiscal years ended December 31,
2000 and 2001. This report has not been reissued by Arthur Andersen LLP.
To the Board of Directors and Stockholders of
Racing Champions Corporation and subsidiaries:
We have audited the accompanying consolidated balance sheets of RACING CHAMPIONS
CORPORATION (a Delaware corporation) and subsidiaries as of December 31, 2000
and 2001 and the related consolidated statements of income, stockholders' equity
and cash flows for each year in the three-year period ended December 31, 2001.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits. We did not audit the financial statements of Racing Champions
Worldwide Limited, which statements reflect total assets and total net sales of
10.4% and 9.9%, respectively, in 2000, and 11.7% and 8.4%, respectively, in
2001, of the related consolidated totals. Those statements were audited by other
auditors whose report has been furnished to us, and our opinion, insofar as it
relates to the amounts included for those entities, is based solely on the
report of the other auditors.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits and the report of other auditors
provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of other auditors, the
financial statements referred to above present fairly, in all material respects,
the consolidated financial position of Racing Champions Corporation and
subsidiaries as of December 31, 2000 and 2001 and the results of their
operations and their cash flows for each year in the three-year period ended
December 31, 2001 in conformity with accounting principles generally accepted in
the United States.
/s/ ARTHUR ANDERSEN LLP
ARTHUR ANDERSEN LLP
Chicago, Illinois,
February 22, 2002
F-3
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors
Racing Champions Worldwide Limited
We have audited the consolidated balance sheet of Racing Champions Worldwide
Limited as of December 31, 2001 and the related consolidated statements of
income, shareholders' equity and cash flows for each of the two years in the
period ended December 31, 2001 (not presented separately herein). These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Racing Champions
Worldwide Limited at December 31, 2001 and the consolidated results of its
operations and its consolidated cash flows for each of the two years in the
period ended December 31, 2001, in conformity with accounting principles
generally accepted in the United States.
/s/ Ernst & Young LLP
Ernst & Young LLP
Exeter, England
February 22, 2002
F-4
CONSOLIDATED BALANCE SHEETS
December 31,
-------------------
2001 2002
---- ----
Assets
Current assets:
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . $ 16,509,550 $ 17,104,158
Accounts receivable, net of allowance for doubtful accounts
of $3,009,120 and $2,600,576. . . . . . . . . . . . . . . . . . . . 36,971,520 30,911,448
Other receivables . . . . . . . . . . . . . . . . . . . . . . . . . . 196,842 154,480
Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17,544,506 23,563,030
Deferred income taxes and prepaid taxes, net. . . . . . . . . . . . . 6,589,080 7,739,712
Prepaid expenses. . . . . . . . . . . . . . . . . . . . . . . . . . . 3,396,727 3,940,151
------------ -----------
Total current assets. . . . . . . . . . . . . . . . . . . . . . . . . 81,208,225 83,412,979
Property and equipment:
Land. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 716,675 699,498
Buildings and improvements. . . . . . . . . . . . . . . . . . . . . . 4,944,808 5,014,251
Tooling . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48,805,727 52,277,344
Other equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,447,621 13,479,010
------------ -----------
64,914,831 71,470,103
Less accumulated depreciation . . . . . . . . . . . . . . . . . . . . . (31,989,611) (38,099,276)
------------ -----------
32,925,220 33,370,827
Goodwill, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120,277,657 119,221,962
Other assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,112,022 281,590
------------ -----------
Total assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . $235,523,124 $236,287,358
Liabilities and stockholders' equity
Current liabilities:
Accounts payable. . . . . . . . . . . . . . . . . . . . . . . . . . . $ 7,132,961 $ 8,614,626
Taxes payable, net. . . . . . . . . . . . . . . . . . . . . . . . . . 2,789,348 -
Accrued expenses. . . . . . . . . . . . . . . . . . . . . . . . . . . 8,628,019 9,528,835
Accrued allowances. . . . . . . . . . . . . . . . . . . . . . . . . . 11,479,174 9,764,216
Accrued royalties . . . . . . . . . . . . . . . . . . . . . . . . . . 6,268,342 5,224,231
Current maturities of term notes. . . . . . . . . . . . . . . . . . . 16,000,000 -
Other current liabilities . . . . . . . . . . . . . . . . . . . . . . 2,517,970 740,844
------------ -----------
Total current liabilities . . . . . . . . . . . . . . . . . . . . . . 54,815,814 33,872,752
Line of credit. . . . . . . . . . . . . . . . . . . . . . . . . . . . - 8,000,000
Term notes, less current maturities . . . . . . . . . . . . . . . . . 46,000,000 -
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . 10,040,251 14,076,672
Other long-term liabilities . . . . . . . . . . . . . . . . . . . . . 6,567,637 9,457,387
------------ -----------
Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . 117,423,702 65,406,811
Commitments and contingencies
Stockholders' equity
Common stock, voting, $0.01 par value, 28,000,000 shares authorized,
16,451,508 shares issued and 14,617,408 shares outstanding
at December 31, 2001 and 18,293,666 shares issued and
16,463,371 shares outstanding at December 31, 2002. . . . . . . . . . 164,515 182,936
Stock warrants outstanding. . . . . . . . . . . . . . . . . . . . . . 728,740 -
Additional paid-in capital. . . . . . . . . . . . . . . . . . . . . . 89,288,930 118,705,647
Accumulated other comprehensive loss. . . . . . . . . . . . . . . . .. (593,837) (1,284,509)
Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . 36,341,329 61,086,038
------------ -----------
125,929,677 178,690,112
Treasury stock, at cost, 1,834,100 shares at December 31, 2001
and 1,830,295 shares at December 31, 2002 . . . . . . . . . . . . . (7,830,255) (7,809,565)
------------ -----------
Total stockholders' equity. . . . . . . . . . . . . . . . . . . . . . 118,099,422 170,880,547
------------ -----------
Total liabilities and stockholders' equity. . . . . . . . . . . . . . $235,523,124 $236,287,358
The accompanying notes are an integral part of these consolidated financial statements.
F-5
CONSOLIDATED STATEMENTS OF EARNINGS
Year Ended December 31,
----------------------------------
2000 2001 2002
---- ---- ----
Net sales. . . . . . . . . . . . . . . . . . . . . . . . . . $214,805,880 $203,248,030 $213,455,890
Cost of sales, related party . . . . . . . . . . . . . . . . 7,743,639 9,003,651 9,589,712
Cost of sales, other . . . . . . . . . . . . . . . . . . . . 108,584,057 90,476,908 93,172,883
------------ ------------ ------------
Gross profit . . . . . . . . . . . . . . . . . . . . . . . 98,478,184 103,767,471 110,693,295
Selling, general and administrative expenses . . . . . . . . 71,636,219 67,853,149 68,769,010
Amortization of goodwill . . . . . . . . . . . . . . . . . . 3,794,757 3,376,354 -
------------ ------------ ------------
Operating income . . . . . . . . . . . . . . . . . . . . . 23,047,208 32,537,968 41,924,285
Interest expense, net. . . . . . . . . . . . . . . . . . . . 11,374,822 6,470,160 1,835,667
Other expense (income) . . . . . . . . . . . . . . . . . . . 662,036 276,803 (602,931)
------------ ------------ ------------
Income before income taxes . . . . . . . . . . . . . . . . 11,010,350 25,791,005 40,691,549
Income tax expense . . . . . . . . . . . . . . . . . . . . . 5,119,753 10,667,996 15,946,840
------------ ------------ ------------
Net income . . . . . . . . . . . . . . . . . . . . . . . . $ 5,890,597 $ 15,123,009 $ 24,744,709
Net income per share:
Basic. . . . . . . . . . . . . . . . . . . . . . . . . . . $ 0.40 $ 1.03 $ 1.55
Diluted. . . . . . . . . . . . . . . . . . . . . . . . . . $ 0.39 $ 1.00 $ 1.47
Weighted average shares outstanding:
Basic. . . . . . . . . . . . . . . . . . . . . . . . . . . 14,826,506 14,662,620 15,980,958
Diluted. . . . . . . . . . . . . . . . . . . . . . . . . . 15,085,045 15,159,089 16,828,924
The accompanying notes are an integral part of these consolidated financial statements.
F-6
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Stock
Common Warrants Treasury
Stock Outstanding Stock
------ ----------- --------
BALANCE, DECEMBER 31, 1999. . . . . . . . . . . $ 164,327 $ 728,740 $(3,596,727)
Net income. . . . . . . . . . . . . . . . . . . - - -
Stock issued upon option exercise . . . . . . . 120 - -
Expense recognized under stock
option grant. . . . . . . . . . . . . . . . .. - - -
Treasury stock acquisition. . . . . . . . . . . - - (3,991,338)
Other comprehensive income-foreign
currency translation adjustments,
net of tax. . . . . . . . . . . . . . . . . . - - -
----------- ------------ ------------
Comprehensive income. . . . . . . . . . . . . .
----------- ------------ ------------
BALANCE, DECEMBER 31, 2000 . . . . . . . . . . 164,447 728,740 (7,588,065)
Net income. . . . . . . . . . . . . . . . . . . - - -
Stock issued upon option exercise . . . . . . . 68 - -
Expense recognized under stock
option grant. . . . . . . . . . . . . . . . . - - -
Treasury stock acquisition. . . . . . . . . . . - - (321,400)
Reissue treasury stock. . . . . . . . . . . . . - - 79,210
Other comprehensive income-foreign
currency translation adjustments,
net of tax. . . . . . . . . . . . . . . . . . - - -
Other comprehensive loss-minimum
pension liability adjustments,
net of tax. . . . . . . . . . . . . . . . . . - - -
----------- ------------ -----------
Comprehensive income. . . . . . . . . . . . . .
----------- ------------ -----------
BALANCE, DECEMBER 31, 2001. . . . . . . . . . . 164,515 728,740 (7,830,255)
Net income. . . . . . . . . . . . . . . . . . . - - -
Public stock offering . . . . . . . . . . . . . 15,450 - -
Stock issued upon option exercise . . . . . . . 312 - -
Stock warrants exercised. . . . . . . . . . . . 2,659 (651,316) -
Stock warrants expired. . . . . . . . . . . . . - (77,424) -
Reissue treasury stock. . . . . . . . . . . . . - - 20,690
Other comprehensive income-foreign
currency translation adjustments,
net of tax. . . . . . . . . . . . . . . . . . - - -
Other comprehensive loss-minimum
pension liability adjustments,
net of tax. . . . . . . . . . . . . . . . . . - - -
----------- ------------ ------------
Comprehensive income. . . . . . . . . . . . . .
----------- ------------ ------------
BALANCE, DECEMBER 31, 2002. . . . . . . . . . . $ 182,936 $ - $(7,809,565)
The accompanying notes are an integral part of these consolidated financial statements.
Accumulated
Other Additional Total
Comprehensive Paid-in Retained Stockholders' Comprehensive
Income (Loss) Capital Earnings Equity Income
------------- ---------- -------- ------------- -------------
BALANCE, DECEMBER 31, 1999 . . . . . . . . . . $ (16,991) $ 89,241,161 $15,327,723 $101,848,233
Net income. . . . . . . . . . . . . . . . . . . - - 5,890,597 5,890,597 $ 5,890,597
Stock issued upon option exercise . . . . . . . - 1,440 - 1,560 -
Expense recognized under stock
option grant. . . . . . . . . . . . . . . . . - 22,823 - 22,823 -
Treasury stock acquisition. . . . . . . . . . . - - - (3,991,338) -
Other comprehensive income-foreign
currency translation adjustments,
net of tax. . . . . . . . . . . . . . . . . . 424,171 - - 424,171 424,171
------------ ------------ ----------- ------------- ------------
Comprehensive income . . . . . . . . . . . . . $ 6,314,768
------------ ------------ ----------- ------------- ------------
BALANCE, DECEMBER 31, 2000 . . . . . . . . . . 407,180 89,265,424 21,218,320 104,196,046
Net income. . . . . . . . . . . . . . . . . . . - - 15,123,009 15,123,009 15,123,009
Stock issued upon option exercise . . . . . . . - 12,392 - 12,460 -
Expense recognized under stock
option grant. . . . . . . . . . . . . . . . . - 22,824 - 22,824 -
Treasury stock acquisition. . . . . . . . . . . - - - (321,400) -
Reissue treasury stock. . . . . . . . . . . . . - (11,710) - 67,500 -
Other comprehensive income-foreign
currency translation adjustments,
net of tax. . . . . . . . . . . . . . . . . . 87,514 - - 87,514 87,514
Other comprehensive loss-minimum
pension liability adjustments,
net of tax. . . . . . . . . . . . . . . . . . (1,088,531) - - (1,088,531) (1,088,531)
------------ ------------ ----------- ------------- ------------
Comprehensive income . . . . . . . . . . . . . $14,121,992
------------ ------------ ----------- ------------- ------------
BALANCE, DECEMBER 31, 2001. . . . . . . . . . . (593,837) 89,288,930 36,341,329 118,099,422
Net income. . . . . . . . . . . . . . . . . . . - - 24,744,709 24,744,709 24,744,709
Public stock offering . . . . . . . . . . . . . - 24,721,460 - 24,736,910 -
Stock issued upon option exercise . . . . . . . - 296,678 - 296,990 -
Stock warrants exercised. . . . . . . . . . . . - 4,282,772 - 3,634,115 -
Stock warrants expired. . . . . . . . . . . . . - 77,424 - - -
Reissue treasury stock. . . . . . . . . . . . . - 38,383 - 59,073 -
Other comprehensive income-foreign
currency translation adjustments,
net of tax. . . . . . . . . . . . . . . . . . 662,168 - - 662,168 662,168
Other comprehensive loss-minimum
pension liability adjustments,
net of tax. . . . . . . . . . . . . . . . . . (1,352,840) - - (1,352,840) (1,352,840)
------------ ------------ ----------- ------------- ------------
Comprehensive income . . . . . . . . . . . . . $24,054,037
------------ ------------ ----------- ------------- ------------
BALANCE, DECEMBER 31, 2002. . . . . . . . . . . $(1,284,509) $118,705,647 $61,086,038 $170,880,547
The accompanying notes are an integral part of these consolidated financial statements.
F-7
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31,
---------------------------------
2000 2001 2002
---- ---- ----
Operating activities
Net income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 5,890,597 $ 15,123,009 $ 24,744,709
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation. . . . . . . . . . . . . . . . . . . . . . . . . . . 9,603,872 9,188,293 9,064,997
Stock option expense. . . . . . . . . . . . . . . . . . . . . . . 22,824 22,824 -
Provision for uncollectible accounts. . . . . . . . . . . . . . . 2,053,229 2,715,193 808,064
Interest on deferred financing costs. . . . . . . . . . . . . . . 423,092 561,408 687,849
Amortization of goodwill. . . . . . . . . . . . . . . . . . . . . 3,794,757 3,376,354 -
(Gain) loss on disposition of assets. . . . . . . . . . . . . . . (19,968) 309,844 (314,241)
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . 7,189,431 5,533,739 3,157,440
Changes in operating assets and liabilities:
Accounts and other receivables. . . . . . . . . . . . . . . . . (4,685,001) 7,661,122 5,706,990
Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,887,297 1,209,141 (5,547,482)
Prepaid expenses. . . . . . . . . . . . . . . . . . . . . . . . 4,163,384 (426,623) (1,011,260)
Accounts payable and accrued expenses . . . . . . . . . . . . . 1,772,489 869,845 (3,833,820)
Other liabilities . . . . . . . . . . . . . . . . . . . . . . . (472,835) (1,108,217) 537,001
------------- ------------ -------------
Net cash provided by operating activities . . . . . . . . . . . 38,623,168 45,035,932 34,000,247
Investing activities
Purchase of property and equipment. . . . . . . . . . . . . . . . (8,217,973) (6,476,957) (9,515,679)
Proceeds from disposal of property and equipment. . . . . . . . . 276,641 123,811 457,003
Decrease (increase) in other non-current assets . . . . . . . . . (279,657) (118,973) 123,615
------------- ------------ -------------
Net cash used in investing activities . . . . . . . . . . . . . (8,220,989) (6,472,119) (8,935,061)
Financing activities
Net cash proceeds from public stock offering. . . . . . . . . . . - - 24,736,910
Issuance of stock upon option exercises . . . . . . . . . . . . . 1,560 12,460 296,990
Payment on bank term loans. . . . . . . . . . . . . . . . . . . . (18,000,000) (35,000,000) (62,000,000)
Net borrowings (payments) on line of credit . . . . . . . . . . . (8,000,000) - 8,000,000
Proceeds from stock warrants exercised. . . . . . . . . . . . . . - - 3,634,115
Purchase of stock to be held in treasury. . . . . . . . . . . . . (3,991,338) (321,400) -
Proceeds from reissuance of treasury stock. . . . . . . . . . . . - 67,500 59,073
------------- ------------ -------------
Net cash used in financing activities . . . . . . . . . . . . . (29,989,778) (35,241,440) (25,272,912)
Effect of exchange rate changes on cash . . . . . . . . . . . . . . (96,148) 605,635 802,334
------------- ------------ -------------
Net increase in cash and cash equivalents . . . . . . . . . . . 316,253 3,928,008 594,608
Cash and cash equivalents, beginning of year. . . . . . . . . . . 12,265,289 12,581,542 16,509,550
------------- ------------ -------------
Cash and cash equivalents, end of year. . . . . . . . . . . . . . $ 12,581,542 $ 16,509,550 $ 17,104,158
Supplemental disclosure of cash flow information:
Cash paid for interest during the period. . . . . . . . . . . . . $ 12,602,079 $ 6,311,736 $ 1,712,592
Cash paid for income taxes during the period. . . . . . . . . . . $ 1,877,427 $ 4,205,191 $ 14,845,702
Cash refund received for income taxes . . . . . . . . . . . . . . $ 5,421,869 $ 6,979,767 $ 335,935
Non-cash write-off of pension liability against goodwill,
net of income taxes . . . . . . . . . . . . . . . . . . . . . . - - $ 1,055,695
The accompanying notes are an integral part of these consolidated statements.
F-8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2000, 2001 AND 2002
1. DESCRIPTION OF BUSINESS
Founded in 1989, Racing Champions Ertl Corporation ("RCEC") and Subsidiaries,
Racing Champions Inc. ("RCI"), RC Ertl, Inc. ("RCE"), Racing Champions Limited
("RCL"), Racing Champions International Limited ("RCIL"), Racing Champions
Worldwide Limited ("RCWL") and Racing Champions South, Inc. ("RCS")
(collectively "the Company") is a leading producer and marketer of collectibles
and toys. The Company sells American Muscle die-cast vehicle replicas, NASCAR
and NHRA die-cast racing replicas, officially licensed die-cast replicas of
automobiles, trucks, agricultural and construction equipment and
powered-recreational and sport vehicles, plastic preschool products, AMT model
kits, Press Pass sports trading cards and NASCAR souvenirs and apparel. The
Company has license agreements with major U.S. automotive and equipment
manufacturers and many of the major motorsports sanctioning bodies, sponsors,
team owners and their drivers, as well as entertainment and media companies for
their well-known characters and properties. The Company sells its products
primarily in North America, Europe and Asia Pacific. RCL, based in Hong Kong and
China, oversees the production of the Company's products. RCIL, based in the
United Kingdom, sells the Company's products in Europe and Asia Pacific. Sales
of the Company's products are seasonal with net sales and profitability peaking
in the third quarter due to holiday season buying patterns.
2. RECAPITALIZATION AND ACQUISITIONS
Recapitalization
Purchase price in excess of the book value of the net assets acquired in
connection with the Company's recapitalization ("Recapitalization") in 1996 of
$88.7 million, which is deductible for tax purposes, has been recorded as
goodwill and through December 31, 2001, was being amortized on a straight-line
basis over a 40-year period.
Racing Champions Corporation and The Ertl Company, Inc.
On April 13, 1999, the Company purchased all of the outstanding shares of The
Ertl Company, Inc. (subsequently renamed RC Ertl, Inc.) and certain of its
affiliates ("Ertl") for approximately $94.6 million. This transaction was
accounted for under the purchase method of accounting, and accordingly, the
operating results of Ertl have been included in the Company's consolidated
financial statements since the date of acquisition. The purchase was funded with
a drawdown on the Company's credit facility (Note 6). The excess of the
aggregate purchase price over the fair market value of net assets acquired of
approximately $31.1 million was being amortized on a straight-line basis over 40
years through December 31, 2001.
3. SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The financial statements consolidate the accounts of RCC and its wholly owned
subsidiaries. All intercompany items and transactions have been eliminated.
Foreign Currency Translation/Transactions
Foreign subsidiary assets and liabilities are reported in the local currency and
translated at the rates of exchange at the balance sheet date while income
statement accounts are translated at the average exchange rates in effect during
the period. Exchange gains and losses resulting from translation for the years
ended December 31, 2000, 2001 and 2002 have been recorded net of income tax as a
component of accumulated other comprehensive (loss) income in stockholders'
equity. The net exchange losses resulting from transactions in foreign
currencies for the years ended December 31, 2000, 2001 and 2002 were $0.5
million, $0.2 million and $0.3 million, respectively, and are included in the
accompanying consolidated statements of earnings.
Revenue Recognition
The Company recognizes revenue based upon transfer of title of product to
customers. The Company provides for estimated credit and other concessions at
the time the sale is recorded.
F-9
Shipping and Handling Costs
Shipping and handling costs are included, net of recoveries, in selling, general
and administrative expenses in the accompanying consolidated statements of
earnings. For the years ended December 31, 2000, 2001 and 2002 net shipping and
handling costs were $4.4 million, $4.8 million and $5.9 million, respectively.
Cash and Cash Equivalents
The Company considers all highly liquid investments with original maturities of
90 days or less to be cash equivalents. Such investments are stated at cost,
which approximates fair value.
Use of Estimates
The preparation of the financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes. Actual results could differ
from those estimates.
During the first quarter of 2001, the Company recorded an adjustment of
approximately $613,000 to reduce the Company's estimate of its pension funding
liability based on a recent actuarial valuation. This adjustment is included in
selling, general and administrative expenses in the consolidated statement of
income for the year ended December 31, 2001. This adjustment resulted in income
after taxes of approximately $356,000.
Inventory
Inventory, which consists of finished goods, has been written down for excess
quantities and obsolescence and is stated at lower of cost or market. Cost is
determined by the first-in, first-out method, and market represents the lower of
replacement cost or estimated net realizable value. Inventory write-downs are
recorded for damaged, obsolete, excess and slow-moving inventory. The Company's
management uses estimates to record these write-downs based on its review of
inventory by product category, length of time on hand and order bookings.
Changes in public and consumer preferences and demand for product or changes in
the customer's buying patterns and inventory management could impact the
inventory valuation.
Property and Equipment
Property and equipment are recorded at cost. Depreciation is computed using the
straight-line method for financial statement purposes at rates adequate to
depreciate the cost of applicable assets over their expected useful lives.
Accelerated methods are used for income tax purposes. Repairs and maintenance
are charged to expense as incurred. Gains or losses resulting from sales or
retirements are recorded as incurred, at which time related costs and
accumulated depreciation are removed from the accounts. The estimated useful
lives used in computing depreciation for financial statement purposes are as
follows:
Asset Descriptions Estimated Useful Life
Buildings and improvements 3-15 years
Tooling 3-7 years
Other equipment 1-10 years
F-10
Other Assets
Other assets at December 31, 2001, consisted of an intangible pension asset,
refundable deposits for leased equipment and deferred financing fees. These
deferred financing fees were being amortized on a straight-line basis over the
term of the debt agreement, and the related debt was repaid in April 2002 with
the proceeds from the public offering. Interest expense related to the
amortization of the deferred financing fees for the years ended December 31,
2000, 2001 and 2002 was approximately, $0.4 million, $0.6 million and $0.1
million respectively. The remainder of the deferred financing fees of
approximately $0.5 million were written off upon repayment of the loan and
recorded as interest expense in the accompanying statement of income in
accordance with SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64,
Amendment of FASB Statement No. 13, and Technical Corrections." Other assets at
December 31, 2002, consist of an intangible pension asset and refundable
deposits for leased equipment.
Allowance for Doubtful Accounts
The allowance for doubtful accounts represents adjustments to customer trade
accounts receivable for amounts deemed uncollectible. The allowance for doubtful
accounts reduces gross trade receivables to their net realizable value and is
disclosed on the face of the accompanying balance sheets. The Company's
allowance is based on management's assessment of the business environment,
customers' financial condition, historical trends, customer payment practices,
receivable aging and customer disputes. The Company will continue to proactively
review its credit risks and adjust its customer terms to reflect the current
environment.
Accrued Allowances
The Company ordinarily accepts returns only for defective merchandise. In
certain instances, where retailers are unable to resell the quantity of products
that they have purchased from the Company, the Company may, in accordance with
industry practice, assist retailers in selling excess inventory by offering
credits and other price concessions, which are typically evaluated and issued
annually. Other allowances can also be issued for defective merchandise, volume
programs and co-op advertising. All allowances are accrued throughout the year,
as sales are recorded. The allowances are based on the terms of the various
programs in effect; however, management also takes into consideration historical
trends and specific customer and product information when making its estimates.
Accrued Royalties
Royalties are accrued based on the provisions in licensing agreements for
amounts due on net sales during the period as well as management estimates for
additional royalty exposures. Royalties vary by product category and are
generally paid on a quarterly basis. Multiple royalties may be paid to various
licensors on a single product. Royalty expense is included in selling, general
and administrative expenses on the consolidated statements of earnings.
Concentration of Credit Risk
Concentration of credit risk is limited to trade accounts receivable and is
subject to the financial conditions of certain major customers. There were two
customers accounting for approximately 11.8% and 13.8% of net sales for the year
ended December 31, 2000, two customers accounting for approximately 15.6% and
14.6% of net sales for the year ended December 31, 2001 and two customers
accounting for approximately 11.8% and 15.0% of net sales for the year ended
December 31, 2002. Additionally, one customer accounted for approximately 35.1%
and 21.7% of accounts receivable, and a second customer accounted for
approximately 8.2% and 10.3% of accounts receivable at December 31, 2001, and
December 31, 2002, respectively. The Company does not require collateral or
other security to support customers' receivables. The Company conducts periodic
reviews of its customers' financial conditions and vendor payment practices to
minimize collection risks on trade accounts receivable. The Company has
purchased credit insurance, which covers a portion of its receivables from major
customers.
F-11
Supplier Concentration
The Company's purchases in 2000 from two of its dedicated suppliers, Sharp
Success and Win Yield, were 21.1% and 15.4%, respectively, of its total product
purchases. The Company's purchases in 2001 from three of its dedicated
suppliers, Sharp Success, Win Yield and Sunrise, were 22.5%, 15.0% and 11.3%,
respectively, of its total product purchases. The Company's purchases in 2002
from three of its dedicated suppliers, Sharp Success, Win Yield and Sunrise,
were 24.9%, 18.0% and 11.6%, respectively, of its total product purchases. There
were no other suppliers accounting for more than 10.0% of total product
purchases during the years ended December 31, 2000, 2001 or 2002.
Fair Value of Financial Instruments
The carrying amounts of cash, receivables, accounts payable and accrued expenses
approximate fair value because of the short-term nature of the items. The
carrying amount of the revolving credit facility approximates its fair value, as
the interest rate is variable.
Derivative Instruments
The Company accounted for its interest rate collar under Statement of Financial
Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and
Hedging Activities." Under SFAS No. 133, the Company had recorded the interest
rate collar on the consolidated balance sheet at its fair value. Changes in fair
value were recorded in interest expense in the consolidated statements of
earnings. The interest rate collar expired in June 2002 and the related fair
value was written off to interest expense at expiration.
Advertising
The Company expenses the production costs of advertising the first time the
advertising takes place. Advertising expenses for the years ended December 31,
2000, 2001 and 2002, were approximately $1.0 million, $0.7 million and $2.6
million, respectively.
Income Taxes
The Company accounts for income taxes under SFAS No. 109, "Accounting for Income
Taxes." Under the asset and liability method of SFAS No. 109, deferred income
taxes are recognized for the expected future tax consequences of temporary
differences between financial statement carrying amounts and the tax bases of
existing assets and liabilities using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected to
be recovered or settled. In determining the required liability, management
considers certain tax exposures and all available evidence.
Accounting for Stock-Based Compensation
The Company accounts for stock-based compensation arrangements with employees in
accordance with the provisions of Accounting Principles Board (APB) Opinion No.
25, "Accounting for Stock Issued to Employees," and complies with the disclosure
provisions of SFAS No. 123, "Accounting for Stock-Based Compensation." Under APB
No. 25, compensation expense is based on the difference, if any, on the
measurement date, between the estimated fair value of the Company's stock and
the exercise price of options to purchase that stock. The compensation expense
is amortized on a straight-line basis over the vesting period of the options. To
date, no compensation expense has been recorded related to stock-based
compensation agreements with employees.
Had compensation costs for stock options issued, including options issued for
shares under the employee stock purchase plan, been determined based on the fair
value at their grant date consistent with SFAS No. 123, the Company's net income
and earnings per share would have been reduced to the following pro forma
amounts:
F-12
(In thousands, except per share data)
Year Ended December 31,
--------------------------
2000 2001 2002
---- ---- ----
Net income as reported. . . . . . . . . . . . . . . $5,890 $15,123 $24,745
Deduct: total stock-based employee compensation
expense determined under fair value based
method for all awards, net of related tax effects (12) (499) (797)
------- -------- --------
Pro forma net income. . . . . . . . . . . . . . . . $5,878 $14,624 $23,948
Basic net income per share
As reported . . . . . . . . . . . . . . . . . . . $ 0.40 $ 1.03 $ 1.55
Pro forma . . . . . . . . . . . . . . . . . . . . $ 0.40 $ 1.00 $ 1.50
Diluted net income per share
As reported . . . . . . . . . . . . . . . . . . . $ 0.39 $ 1.00 $ 1.47
Pro forma . . . . . . . . . . . . . . . . . . . . $ 0.39 $ 0.96 $ 1.42
The fair value of each stock option is estimated on the date of grant based on
the Black-Scholes option pricing model assuming, among other things, no dividend
yield, risk-free rates of return from 4.69% to 5.74%, volatility factors of
79.08% to 87.76% and expected life of 5 to 10 years. The weighted average fair
value of options granted under the Company's stock option plan for the years
ended December 31, 2000, 2001 and 2002, was $1.26, $6.91 and $15.61 per share,
respectively.
The pro forma disclosure is not likely to be indicative of pro forma results
that may be expected in future years because of the fact that options vest over
several years. Compensation expense is recognized as the options vest and
additional awards may be granted.
The Company accounts for stock-based compensation arrangements with
non-employees in accordance with SFAS No. 123, which establishes a fair value
based method of accounting for stock-based compensation plans. Under the fair
value based method, compensation cost is measured at the grant date based on the
value of the award, which is calculated using an option pricing model, and is
recognized over the service period, which is usually the vesting period.
Approximately $23,000 was recorded as compensation expense for stock-based
compensation agreements with non-employees for the years ended December 31, 2000
and 2001. There was no recorded compensation expense for the year ended December
31, 2002.
Net Income Per Share
The Company computes net income per share in accordance with SFAS No. 128,
"Earnings Per Share." Under the provisions of SFAS No. 128, basic net income per
share is computed by dividing net income for the period by the weighted average
number of common shares outstanding during the period. Diluted net income per
share is computed by dividing net income for the period by the weighted average
number of common and common equivalent shares outstanding during the period. The
following table discloses the components of earnings per share as required by
SFAS No. 128:
(In thousands, except per share data)
For the Year
Ended December 31, 2000
--------------------------
Weighted Per
Net Average Share
Income Shares Amount
------ -------- ------
Basic net income per share:
Net income. . . . . . . . . . . . . $ 5,890 14,827 $ 0.40
Plus effect of dilutive securities:
Stock options and warrants. . . . . - 258 -
------- ----- -------
Diluted net income per share:
Net income plus assumed conversions $ 5,890 15,085 $ 0.39
F-13
Options and warrants to purchase 877,374 shares of common stock at prices
ranging from $5.00 to $15.00 per share were outstanding during 2000 but were not
included in the computation of diluted earnings per share because the options'
and warrants' exercise prices were greater than the average market price of the
common shares.
(In thousands, except per share data)
For the Year
Ended December 31, 2001
--------------------------
Weighted Per
Net Average Share
Income Shares Amount
------ -------- ------
Basic net income per share:
Net income . . . . . . . . . . . . . $15,123 14,663 $1.03
Plus effect of dilutive securities:
Stock options and warrants . . . . - 496 -
------- ------ ------
Diluted net income per share:
Net income plus assumed conversions $15,123 15,159 $1.00
Options and warrants to purchase 1,259,504 shares of common stock at prices
ranging from $7.94 to $16.77 per share were outstanding during 2001 but were not
included in the computation of diluted earnings per share because the options'
and warrants' exercise prices were greater than the average market price of the
common shares.
(In thousands, except per share data)
For the Year
Ended December 31, 2002
--------------------------
Weighted Per
Net Average Share
Income Shares Amount
------ -------- ------
Basic net income per share:
Net income. . . . . . . . . . . . . $24,745 15,981 $ 1.55
Plus effect of dilutive securities:
Stock options . . . . . . . . . . . - 848 -
------- ------ ------
Diluted net income per share:
Net income plus assumed conversions $24,745 16,829 $ 1.47
Options to purchase 5,000 shares of common stock at $18.72 per share were
outstanding during 2002 but were not included in the computation of diluted
earnings per share because the options' exercise price was greater than the
average market price of the common shares.
Comprehensive Income
The Company reports comprehensive income in accordance with SFAS No. 130,
"Reporting Comprehensive Income." SFAS 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. The Company has chosen to disclose comprehensive
income, which encompasses net income, foreign currency translation adjustments
and pension liability, as part of the consolidated statements of stockholders'
equity. The income tax (benefit) expense related to the components of
comprehensive (loss) income in 2000, 2001 and 2002 were $368,672, $(707,202) and
$(417,106), respectively.
F-14
Recently Issued Accounting Pronouncements
On June 30, 2001, the Financial Accounting Standards Board (FASB) issued
Statement No. 142, "Goodwill and Other Intangible Assets" (SFAS No. 142). Under
SFAS 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 SFAS No. 142 on January
1, 2002. Goodwill had been amortized over 40 years on a straight-line basis
through December 31, 2001. Approximately $88.7 million of this goodwill is tax
deductible over 15 years. Amortization expense relating to goodwill for the
years ended December 31, 2000 and 2001 was approximately $3.8 million and $3.4
million, respectively. Accumulated amortization was $16.6 million at December
31, 2001 and 2002. As of December 31, 2001, goodwill, net of accumulated
amortization, was approximately $120.3 million. During 2002, the Company wrote
off approximately $1.1 million of pension obligations (net of income tax of $0.7
million) and adjusted goodwill. As of December 31, 2002, goodwill, net of
accumulated amortization, was approximately $119.2 million. The Company has
completed its transitional impairment test as of January 1, 2002 and its annual
goodwill impairment test as of October 1, 2002, both of 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 years ended December 31, 2000 and 2001.
(In thousands, except per share data)
Year ended Year ended
December 31, 2000 December 31, 2001
----------------- -----------------
Reported net income. . . . . . . . . $ 5,891 $ 15,123
Add back: Goodwill amortization, net
of income tax . . . . . . . . . . . 2,800 2,487
-------- ---------
Adjusted net income. . . . . . . . . $ 8,691 $ 17,610
Basic net income per share:
Reported net income per share. . . . $ 0.40 $ 1.03
Goodwill amortization per share. . . 0.19 0.17
-------- ---------
Adjusted net income per share. . . . $ 0.59 $ 1.20
Diluted net income per share:
Reported net income per share. . . . $ 0.39 $ 1.00
Goodwill amortization per share. . . 0.19 0.16
-------- ---------
Adjusted net income per share. . . . $ 0.58 $ 1.16
In August 2001, the FASB issued Statement No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" (SFAS No. 144), which supercedes
SFAS 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.
SFAS 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. SFAS
No. 144 requires that those long-lived assets be measured at the lower of
carrying amount or fair value less cost to sell, whether included in continuing
operations or in discontinued operations. The provisions of SFAS No. 144 are
effective for financial statements issued for fiscal years beginning after
December 15, 2001, and interim periods within those fiscal years. There was no
impact on the Company upon adoption.
F-15
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections."
During the second quarter, the Company elected early adoption of this Statement,
and accordingly, included approximately $545,000 of deferred financing fees
related to the Company's previous credit facility in interest expense in the
accompanying statement of income. 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 was also included
in interest expense for the second quarter of 2002.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." Commitment to a plan to exit an activity or
dispose of long-lived assets will no longer be enough to record a one-time
charge for most anticipated costs. Instead, companies will record exit or
disposal costs when they are incurred and can be measured at fair value, and
they will subsequently adjust the recorded liability for changes in estimated
cash flows. The statement is effective for restructuring activities that are
initiated after December 31, 2002. There was no impact on the Company upon
adoption.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure-an Amendment of FASB Statement No. 123."
This statement provides alternative methods of transition for an entity that
voluntarily changes to the fair value based method of accounting for stock-based
employee compensation. It also amends the disclosure provisions of SFAS No. 123
to require prominent disclosure about the effects on reported net income of an
entity's accounting policy decisions with respect to stock-based employee
compensation. This statement is effective for financial statements for fiscal
years ending after December 15, 2002. The Company has complied with the new
disclosure requirements by moving its disclosure of the effects on reported net
income with respect to stock-based employee compensation to this note and will
comply with quarterly disclosure requirements beginning with the first quarter
of 2003.
Reclassifications
Certain prior year amounts have been reclassified to conform to the current year
presentation.
4. BUSINESS SEGMENT
The Company has no separately reportable segments in accordance with SFAS No.
131, "Disclosure About Segments of an Enterprise and Related Information." Under
the enterprise wide disclosure requirements of SFAS No. 131, the Company reports
net sales by each group of product lines and by distribution channel. Amounts
for the years ended December 31, 2000, 2001 and 2002 are as shown in the tables
below.
Year Ended December 31,
--------------------------
(In thousands) 2000 2001 2002
---- ---- ----
Automotive, high performance and
racing vehicle replicas. . . . . . . . $ 95,040 $ 77,530 $ 78,348
Agricultural, construction and outdoor
sports vehicle replicas. . . . . . . . 68,189 57,703 59,392
Sports trading cards and racing apparel
and souvenirs. . . . . . . . . . . . . 16,816 25,018 29,772
Pre-teen vehicles and role play
activity toys. . . . . . . . . . . . . 30,320 37,564 38,823
Collectible figures. . . . . . . . . . . 4,441 5,433 7,121
-------- -------- --------
Net sales. . . . . . . . . . . . . . . . $214,806 $203,248 $213,456
Mass retailers . . . . . . . . . . . . . $ 88,441 $ 82,882 $ 80,056
Specialty and hobby wholesalers
and retailers. . . . . . . . . . . . . 52,559 49,171 59,950
OEM dealers. . . . . . . . . . . . . . . 36,699 35,676 40,763
Corporate promotional. . . . . . . . . . 28,961 25,004 19,733
Direct to consumers. . . . . . . . . . . 8,146 10,515 12,954
-------- -------- --------
Net sales. . . . . . . . . . . . . . . . $214,806 $203,248 $213,456
F-16
Information by geographic area for the years ended December 31, 2000, 2001 and
2002 is set forth in the table below.
December 31,
--------------------------
(In thousands) 2000 2001 2002
---- ---- ----
Net sales:
United States. . . . . . . . . . . . . . . . $194,831 $187,317 $196,753
Foreign . . . . . . . . . . . . . . . . . . . 21,238 17,133 17,496
Sales and transfers between geographic areas. (1,263) (1,202) (793)
--------- --------- ---------
Combined total . . . . . . . . . . . . . . . . $214,806 $203,248 $213,456
Operating income:
United States. . . . . . . . . . . . . . . . $ 19,758 $ 28,306 $ 38,760
Foreign. . . . . . . . . . . . . . . . . . . 3,289 4,232 3,164
--------- --------- ---------
Combined total . . . . . . . . . . . . . . . . $ 23,047 $ 32,538 $ 41,924
Identifiable assets:
United States. . . . . . . . . . . . . . . . $223,838 $204,514 $202,292
Foreign. . . . . . . . . . . . . . . . . . . 28,069 31,009 33,995
--------- --------- ---------
Combined total . . . . . . . . . . . . . . . . $251,907 $235,523 $236,287
5. INCOME TAXES
For financial reporting purposes, income before income taxes includes the
following components:
Year Ended December 31,
--------------------------
(In thousands) 2000 2001 2002
---- ---- ----
Income before income taxes:
United States. . . . . . . $ 8,745 $21,743 $37,517
Foreign. . . . . . . . . . 2,265 4,048 3,175
------- ------- -------
$11,010 $25,791 $40,692
The significant components of income tax expense are as follows:
Year Ended December 31,
--------------------------
(In thousands) 2000 2001 2002
---- ---- ----
Current
Federal . . . . . $ - $ 3,290 $10,592
State . . . . . . - 590 568
Foreign . . . . . 610 1,254 926
------ ------- -------
610 5,134 12,086
Deferred
Federal . . . . . 3,946 4,852 3,378
State . . . . . . 564 682 483
Foreign . . . . . - - -
------ ------- -------
4,510 5,534 3,861
------ ------- -------
Income tax expense. $5,120 $10,668 $15,947
F-17
A reconciliation of the statutory federal tax rate and actual effective income
tax rate is as follows:
Year Ended December 31,
--------------------------
2000 2001 2002
---- ---- ----
Statutory rate . . . . . . . . . . . 35.0% 35.0% 35.0%
State taxes, net of federal benefit. 3.3 3.2 1.7
Foreign. . . . . . . . . . . . . . . 3.4 (0.9) (1.0)
Other. . . . . . . . . . . . . . . . 4.8 4.1 3.5
----- ----- -----
Effective rate . . . . . . . . . . . 46.5% 41.4% 39.2%
The significant components of deferred tax assets and liabilities are as
follows:
December 31,
---------------
(In thousands) 2001 2002
---- ----
Deferred tax assets
Bad debt allowance. . . . . . . . $ 1,000 $ 1,325
Inventory allowance . . . . . . . 3,081 1,597
Sales allowance . . . . . . . . . 2,360 3,226
Accrued pension . . . . . . . . . 769 1,628
Accrued legal . . . . . . . . . . 52 300
Accrued royalties . . . . . . . . - 252
Purchase accounting . . . . . . . 973 262
Other . . . . . . . . . . . . . . 716 481
--------- ---------
Total deferred tax assets . . . 8,951 9,071
Deferred tax liabilities
Intangible assets . . . . . . . . (6,558) (9,562)
Property and equipment. . . . . . (4,718) (5,457)
Foreign exchange. . . . . . . . . (431) (872)
Other . . . . . . . . . . . . . . (695) (75)
--------- ---------
Total deferred tax liabilities. (12,402) (15,966)
--------- ---------
Net deferred tax liability. . . . . $ (3,451) $ (6,895)
Current deferred income taxes are presented with net prepaid taxes in the
accompanying consolidated balance sheets. Net prepaid taxes at December 31, 2001
and 2002 were $0 and $558,341, respectively.
F-18
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.
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 (defined as earnings before
interest, taxes, depreciation and amortization). At December 31, 2002, the
margin in effect was 0.75% 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 December 31, 2002, the
commitment fee was 0.20% 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 December
31, 2002, the amount outstanding under this facility was $8.0 million, and the
Company was in compliance with all covenants.
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. During 2001 and 2002, the Company paid $0.2 million and $0.5 million,
respectively, on the agreement, which is included in interest expense on the
accompanying consolidated statements of income. During 2000, the effect of this
agreement was insignificant.
Effective January 1, 2001, the Company adopted SFAS 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 income. Additionally,
charges of approximately $457,000 and income of approximately $542,000 were
recorded in interest expense related to the change in fair value of the interest
rate collar during the years ended December 31, 2001 and 2002, respectively. The
fair value of the interest rate collar at December 31, 2001 of approximately
$542,000 was included in other long-term liabilities in the consolidated balance
sheet.
The Company's Hong Kong subsidiary has a credit agreement with a bank that
provides for a line of credit of up to $2.0 million. Amounts borrowed under this
line of credit bear interest at the bank's prime rate or prevailing funding
cost, whichever is higher, and are cross-guaranteed by the Company. As of
December 31, 2001 and 2002, there were no outstanding borrowings under this line
of credit.
The Company's United Kingdom subsidiary has a line of credit with a bank for
$1.0 million. The line of credit bears interest at 1.00% over the bank's base
rate, and is subject to a letter of guarantee given by the Company for $0.8
million. At December 31, 2001 and 2002, there were no amounts outstanding on the
line of credit.
Long-term debt consists of the following:
December 31,
-------------
(In thousands) 2001 2002
---- ----
Term loan payable to banks, bearing interest at
3.83% as of December 31, 2001, with quarterly
principal payments of $4,000 and final balloon
payment due April 1, 2003 . . . . . . . . . . . . . . . . $62,000 $ --
Revolving line of credit, bearing interest at
2.17% as of December 31, 2002; matures on April 30, 2005. - 8,000
Less - current maturities . . . . . . . . . . . . . . . . . 16,000 -
------- ------
$46,000 $8,000
F-19
7. COMMITMENTS AND CONTINGENCIES
Rental expense for office and warehouse space and equipment under cancelable and
non-cancelable operating leases amounted to approximately $2.7 million, $2.5
million and $2.3 million for the years ended December 31, 2000, 2001 and 2002,
respectively. Commitments for future minimum lease payments with terms extending
beyond one year at December 31, 2002, for non-cancelable operating leases are as
follows:
Year Ending December 31,
(In thousands)
- ---------------------------
2003 . . . . . . . . . . . . . . $1,987
2004 . . . . . . . . . . . . . . 1,203
2005 . . . . . . . . . . . . . . 456
2006 . . . . . . . . . . . . . . 382
2007 . . . . . . . . . . . . . . 241
Thereafter . . . . . . . . . . . 527
------
Total. . . . . . . . . . . . . . $4,796
The Company markets virtually all of its products under licenses from other
parties. These licenses are generally limited in scope and duration and
authorize the sale of specific licensed products on a nonexclusive basis. The
Company has approximately 600 licenses with various vehicle and equipment
manufacturers, race team owners, drivers, sponsors, agents and entertainment and
media companies, generally for terms of one to three years. Many of the licenses
include minimum guaranteed royalty payments that the Company must pay whether or
not they meet specified sales targets. The Company believes it either achieved
its minimum guarantees or has accrued for the costs related to these guarantees
for the years ended December 31, 2000, 2001 and 2002. During 2000, the Company
recorded a $2.5 million charge related to minimum guaranteed royalty payments
from NASCAR-related license agreements that exceeded royalties earned on product
sales. Royalty costs are included in selling, general and administrative
expenses in the accompanying consolidated statements of earnings.
8. 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.
9. CAPITAL STOCK
At December 31, 2001, there were outstanding public warrants to purchase 255,838
shares of the Company's common stock at an exercise price of $13.88 per share.
The public warrants could be redeemed by the Company under certain terms and
conditions at a price of $0.05 per warrant. In addition, there were outstanding
underwriter warrants to purchase an aggregate of 45,900 shares of the Company's
common stock at an exercise price of $16.77 per share and underwriter warrants
to purchase an aggregate of 11,705 shares of the Company's common stock at
$13.88 per share. No holder of any of the outstanding warrants had voting or
other rights as a stockholder of the Company. The Company assigned $739,126 to
the value of all stock warrants issued. All of the warrants had an expiration
date of April 16, 2002 and were either exercised as of the expiration date (with
aggregate proceeds to the Company of $3.6 million) or expired unexercised.
F-20
10. STOCK REPURCHASE PROGRAM
On September 1, 1999, the Company announced that its board of directors had
authorized stock repurchases by the Company for a term of one year and up to an
aggregate amount of $10.0 million. At December 31, 1999, the Company had
repurchased 775,500 shares of its outstanding common stock for approximately
$3.6 million. During 2000, the Company repurchased 1,007,600 shares of its
outstanding common stock for approximately $4.0 million.
On July 24, 2001, the Company announced that its board of directors had
authorized stock repurchases by the Company for a term of one year and up to an
aggregate amount of $5.0 million. The Company's bank lenders consented to the
stock repurchases through May 10, 2002. As of December 31, 2001, the Company had
repurchased 75,000 shares for approximately $321,000 under this authorization.
There were no stock repurchases during 2002.
11. STOCK OPTION PLAN
The Company has an employee stock option plan for its key employees. The
employee stock option plan is administered by the Board of Directors. The
Company has reserved 415,041 shares of common stock for issuance under the plan.
On April 30, 1996 and June 1, 1996, the Company granted 311,281 and 20,752
options, respectively, to purchase shares of common stock at an exercise price
equal to fair market value as determined by the Board of Directors in connection
with the Recapitalization. These options vested in equal installments over a
five-year period. The options will expire on the earlier of the tenth
anniversary of the date of grant or 30 days after the date of termination of the
employees' employment with the Company.
The Company maintains a stock incentive plan, under which the Board of Directors
may grant options to purchase up to 2,300,000 shares of common stock to
executives or key employees of the Company at an exercise price equal to fair
value. Part of the options, which have been granted vested immediately, and the
rest vest over a five-year period. These options expire on the tenth anniversary
of the date of grant or 90 days after the date of termination of the employees'
employment with the Company.
The Company also maintains an omnibus stock plan, under which the Company has
400,000 shares of its common stock reserved for issuance. In 1997, 254,940
options to purchase shares of the Company's common stock were granted under this
plan.
Stock option activity for the Company's stock option plans for the years ended
December 31, 2000, 2001 and 2002, is as follows:
Weighted Shares
Average Available
Exercise for Future
Shares Price Price Grants
------ ----- -------- -----------
Outstanding as of December 31, 1999 962,770 $ 7.44 1,140,155
--------- -------------- ---------- -------
2000
- ----
Granted . . . . . . . . . . . . . . 390,000 $ 1.41 - $1.56 $ 1.49
Exercised . . . . . . . . . . . . . 12,000 $ 0.13 $ 0.13
Canceled. . . . . . . . . . . . . . 94,650 $5.00 - $14.00 $ 10.03
--------- -------------- ---------- -------
Outstanding as of December 31, 2000 1,246,120 $ 5.45 844,805
--------- -------------- ---------- -------
2001
- ----
Granted . . . . . . . . . . . . . . 450,000 $ 7.94 $ 7.94
Exercised . . . . . . . . . . . . . 6,800 $ 1.41 - $5.00 $ 1.83
Canceled. . . . . . . . . . . . . . 22,500 $1.41 - $14.00 $ 3.60
--------- -------------- ---------- -------
Outstanding as of December 31, 2001 1,666,820 $ 6.17 417,305
--------- -------------- ---------- -------
2002
- ----
Granted . . . . . . . . . . . . . . 5,000 $ 18.72 $ 18.72
Exercised . . . . . . . . . . . . . 31,200 $0.13 - $11.57 $ 4.26
Canceled. . . . . . . . . . . . . . 47,365 $1.41 - $14.00 $ 8.54
--------- -------------- ---------- -------
Outstanding as of December 31, 2002 1,593,255 $ 6.17 459,670
--------- -------------- ---------- -------
Exercisable as of December 31, 2002 888,884 $ 6.27
--------- -------------- ---------- -------
F-21
The following table summarizes information about stock options outstanding at
December 31, 2002:
Options Outstanding Options Exercisable
----------------------------- ----------------------------
Weighted Average Weighted Weighted
Range of Exercise Number Remaining Average Number Average
Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price
- ------------------- ----------- ---------------- -------------- ----------- --------------
$0.13 to $1.56 . . . 586,529 6.0 $ 0.96 371,128 $ 0.66
$5.00 to $12.00. . . 842,106 7.6 $ 8.22 358,136 $ 8.59
$12.73 to $18.72 . . 164,620 4.8 $ 14.26 159,620 $14.12
12. EMPLOYEE STOCK PURCHASE PLAN
On October 1, 2002, the Company implemented the Racing Champions Ertl
Corporation Employee Stock Purchase Plan to provide employees of the Company
with an opportunity to purchase common stock of the Company through accumulated
payroll deductions. The plan allows eligible employees to purchase shares of the
Company's common stock through quarterly offering periods commencing on each
January 1, April 1, July 1 and October 1 with the first offering period
commencing on October 1, 2002. The option price for each share of common stock
purchased will equal 90% of the last quoted sales price of a share of the
Company's common stock as reported by the Nasdaq National Market on the first
day of the quarterly offering period or the last day of the quarterly offering
period, whichever is lower. The Company has reserved 500,000 shares of common
stock held in treasury for issuance under the plan. The plan will terminate on
July 1, 2007, unless sooner terminated by the board.
Under the plan, purchase rights for 2,229 shares of Company stock were granted
on October 1, 2002. The plan is considered non-compensatory under APB No. 25,
and as such, resulted in no compensation expense being recorded. Had the plan
been accounted for in accordance with SFAS No. 123, compensation cost of $6,490,
net of income tax, would have been recognized for the fair value of the
employees' purchase rights, which was estimated using the Black-Scholes model
with the following assumptions: an expected life of three months, expected
volatility of 79.08% and risk-free interest rate of 1.59%. The weighted-average
fair value of those purchase rights granted in 2002 was $4.70. In January 2003,
2,823 shares were issued out of treasury stock relating to the purchase rights
granted on October 1, 2002.
13. RELATED PARTY TRANSACTIONS
The Company purchased approximately $7.7 million, $9.0 million and $9.6 million
of product during 2000, 2001 and 2002, respectively, from a company controlled
by a relative of one of the Company's stockholders/directors.
The Company leased warehouse space from a party related to an officer/director
of the Company. Rent expense for the year ended December 31, 2000 was $7,970.
This lease was terminated in February 2000.
The Company pays sales commissions to an external sales representative
organization, of which one of the principals of this organization was a relative
of a stockholder/director of the Company. For the years ended December 31, 2000
and 2001, commissions of $144,662 and $26,113, respectively, were allocated to
the related principal. In April 2001, the principal left the external sales
representative organization.
F-22
14. EMPLOYEE BENEFIT PLANS
The Company has a 401(k) savings plan. Employees meeting certain eligibility
requirements, as defined, may contribute up to 15% of pre-tax gross wages,
subject to certain restrictions. The Company makes matching contributions of 50%
of the employees' contributions up to 5% of employee wages. For the years ended
December 31, 2000, 2001 and 2002, the Company's contributions were approximately
$0.3 million, $0.2 million and $0.3 million, respectively.
The Company also maintains a pension plan for hourly union employees. Benefits
under this plan are based on a stated amount or specified years of service as
negotiated in the respective collective bargaining agreements. The Company's
funding policy is to make contributions in amounts actuarially determined by an
independent consulting actuary to fund the benefits to be provided.
Net periodic cost of the defined benefit plan included the following components:
Year Ended December 31,
--------------------------
(In thousands) 1999 2000 2001
---- ---- ----
Benefits earned during the period (service cost) $ 99 $ 121 $ 131
Interest cost on projected benefit obligation. . 555 612 637
Expected return on plan assets . . . . . . . . . (706) (801) (772)
Amortization of prior service cost . . . . . . . - 19 19
Amortization of unrecognized gain. . . . . . . . (6) - -
------ ------ ------
Net periodic pension cost (benefit). . . . . . . $ (58) $ (49) $ 15
The change in benefit obligation and plan assets and reconciliation of funded
status are as follows:
(In thousands) 2000 2001 2002
---- ---- ----
Change in projected benefit obligation during the period:
Projected benefit obligation, beginning of period. . . . . . . $ 7,274 $ 8,111 $ 9,150
Service cost . . . . . . . . . . . . . . . . . . . . . . . . . 99 121 131
Interest cost. . . . . . . . . . . . . . . . . . . . . . . . . 555 612 637
Actuarial loss . . . . . . . . . . . . . . . . . . . . . . . . 525 682 759
Benefits and non-investment trust expenses paid. . . . . . . . (342) (376) (348)
-------- -------- --------
Projected benefit obligation, end of period. . . . . . . . . . $ 8,111 $ 9,150 $10,329
Change in plan assets during the period:
Plan assets at fair value, beginning of period . . . . . . . . $ 6,821 $ 8,118 $ 7,601
Actual return on plan assets . . . . . . . . . . . . . . . . . 672 (617) (680)
Employer contributions . . . . . . . . . . . . . . . . . . . . 967 476 575
Benefits and non-investment expenses paid. . . . . . . . . . . (342) (376) (348)
-------- -------- --------
Plan assets at fair value, end of period . . . . . . . . . . . $ 8,118 $ 7,601 $ 7,148
Reconciliation of accrued and total amount recognized:
Funded status of the plan. . . . . . . . . . . . . . . . . . . $ 7 $(1,549) $(3,181)
Unrecognized prior service costs . . . . . . . . . . . . . . . - 228 208
Unrecognized net loss. . . . . . . . . . . . . . . . . . . . . 4 1,858 4,069
-------- -------- --------
Net amount recognized. . . . . . . . . . . . . . . . . . . . . $ 11 $ 537 $ 1,096
Amounts recognized in the consolidated balance sheets:
Prepaid benefit cost . . . . . . . . . . . . . . . . . . . . . $ 11 $ - $ -
Accrued benefit liability. . . . . . . . . . . . . . . . . . . - (1,549) (3,181)
Intangible asset . . . . . . . . . . . . . . . . . . . . . . . - 228 208
Accumulated other comprehensive loss . . . . . . . . . . . . . - 1,858 4,069
-------- -------- --------
Net amount recognized. . . . . . . . . . . . . . . . . . . . . $ 11 $ 537 $ 1,096
Assumptions used for the year-end disclosure were as follows:
2000 2001 2002
---- ---- ----
Discount rate. . . . . . . . . . . . . . . . . . . . . . . . . 7.25% 7.00% 6.50%
Mortality table. . . . . . . . . . . . . . . . . . . . . . . . 83 GAM 83 GAM 83 GAM
Assumptions used for the period expense were as follows:
2000 2001 2002
---- ---- ----
Discount rate. . . . . . . . . . . . . . . . . . . . . . . . . 7.75% 7.25% 7.00%
Expected return on plan assets . . . . . . . . . . . . . . . . 9.50% 9.50% 8.50%
Mortality table. . . . . . . . . . . . . . . . . . . . . . . . 83 GAM 83 GAM 83 GAM
The assets of the defined benefit plan are primarily invested in listed stocks
and bonds.
F-23
15. SUBSEQUENT EVENTS (unaudited)
On March 4, 2003, the Company acquired Learning Curve, with an effective date of
February 28, 2003, for 666,667 shares of the Company's common stock and
approximately $106.7 million of cash, less debt and capital lease obligations,
including $12.0 million in escrow to secure Learning Curve's indemnification
obligations under the merger agreement. The purchase price is subject to a
post-closing working capital adjustment and to the payment by the Company of
additional consideration of up to $6.5 million based on sales and margin targets
for the Learning Curve product lines in 2003. This transaction was accounted for
under the purchase method and accordingly, the operating results of Learning
Curve will be included in our consolidated financial statements from the
effective date of the acquisition beginning in the quarter ending March 31,
2003. Learning Curve develops and markets a variety of high-quality,
award-winning traditional children's toys for every stage of childhood from
birth through age eight. Its product lines include Thomas & Friends Wooden
Railway, the top selling brand of expandable wooden toy railway systems in the
United States, and the recently introduced Take Along Thomas die-cast train
series and playsets. Other products include Lamaze infant toys, Madeline dolls
and accessories, Eden(R) plush, Feltkids(R) activity boards and Lionel
battery-powered train systems.
Upon the closing of the acquisition of Learning Curve on March 4, 2003, the
Company entered into a new credit facility to replace its previous credit
facility. The credit facility is comprised of a $60.0 million term loan and a
$80 million revolving loan. Thirty million dollars of the term loan has a fixed
interest rate of 2.61% plus applicable margin through the maturity of the
agreement. The remaining term loan and revolving loan, bear interest, at the
Company's option, at a base rate or at a LIBOR rate plus a margin that varies
between 0.75% and 1.75%. The applicable margin is based on the Company's ratio
of consolidated debt to EBITDA. Upon closing, the margin in effect was 1.75% for
LIBOR loans. The Company is also required to pay a commitment fee of 0.25% to
0.40% per annum on the average daily unused portion of the revolving loan. Under
the terms of the credit facility, the Company is required to comply with certain
financial and non-financial covenants. Among other restrictions, the Company is
restricted in its ability to pay dividends, incur additional debt and make
acquisitions above certain amounts. The key financial covenants include minimum
EBITDA and interest coverage and leverage ratios. The credit facility is secured
by working capital assets and certain intangible assets. On March 4, 2003, the
Company had $110.0 million outstanding on this credit facility.
In March 2003, we participated in an industry settlement of a number of class
action lawsuits including the class action lawsuit originally 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. Our portion of the settlement amount was approximately $204,000 and was
provided for in the accompanying consolidated balance sheet as of December 31,
2002.
F-24