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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
(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, 1998.
[ ] Transition Report pursuant to section 13 or 15(d) of the Securities Exchange
Act of 1934 for the transition period from to .
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Commission file number 0-22635
Racing Champions Corporation
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(Exact name of Registrant as Specified in Its Charter)
Delaware 36-4088307
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(State or Other Jurisdiction of (IRS Employer Identification No.)
Incorporation or Organization)
800 Roosevelt Road, Building C, Suite 320, Glen Ellyn, IL 60137
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 630-790-3507
Securities registered pursuant to Section 12(b) of the Exchange Act:
Name of each exchange on
Title of each class which registered
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NA NA
Securities registered pursuant to Section 12(g) of the Exchange Act:
Common Stock, Par Value $.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
Check 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 ]
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Aggregate market value of the Registrant's common stock held by
nonaffiliates as of March 15, 1999: $105,387,090. 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
March 15, 1999: 16,085,998.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 1999 Annual Meeting of the
Stockholders of the Registrant are incorporated by reference into Part III of
this report.
PART I
ITEM 1. BUSINESS
GENERAL
Racing Champions Corporation ("Racing Champions" or the "Company") is
the leading producer and marketer of die-cast racing replicas sold at more than
20,000 North American retail outlets. Racing Champions has leveraged its retail
presence and its relationship with NASCAR to market an extensive line of NASCAR
products, which in addition to die-cast racing replicas consists of Press
Pass trading cards, apparel and souvenirs. Building on its proven retail
strategies, and its leading-edge design and manufacturing capabilities, Racing
Champions has also broadened its offering of die-cast collectibles to include
high-profile, licensed vehicle replicas on behalf of World Championship
Wrestling and Sony "Signature" performers.
Since its inception in 1989, Racing Champions has capitalized on the
growing popularity of motor sports by offering an expanding line of high
quality, affordable racing replicas targeted toward racing fans and adult
collectors. Beginning in 1996, Racing Champions successfully expanded into
classic and custom vehicle collectibles by introducing the Racing Champions
Mint(TM) line of high quality die-cast replicas of classic and late-model
vehicles. Racing Champions continued this expansion in 1997 by introducing
additional lines of classic and custom vehicle replicas and two new lines of
collectible pewter figures. In 1998, Racing Champions introduced a new line of
die-cast vehicle replicas sold exclusively at hobby and collector shops and a
new line of collectible pewter figures.
Racing Champions is a holding company which was formed as a Delaware
corporation in April 1996 by an investor group (the "Investor Group") led by
Willis Stein & Partners, L.P., a private investment fund, for the purpose of
consummating a
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recapitalization (the "Recapitalization") which involved the acquisition by
Racing Champions of both Racing Champions, Inc., a privately held Illinois
corporation formed in 1989 (together with an affiliated company, the "RCI
Group"), and Racing Champions Limited, a privately held Hong Kong corporation
formed simultaneously in 1989 (together with certain affiliated companies, the
"RCL Group"). The RCI Group and the RCL Group, while under different ownership,
effectively operated as one entity with the RCI Group managing the licensing,
product development and sales operations, and the RCL Group managing the
overseas manufacturing and shipping operations. The RCI Group was owned equally
by Robert E. Dods and Boyd L. Meyer. The RCL Group was owned by Peter K.K.
Chung. Messrs. Dods, Meyer and Chung continue to serve as senior executives of
Racing Champions and collectively own approximately 24.3% of the outstanding
shares of the Company's common stock, par value $0.01 per share (the "Common
Stock").
RECENT DEVELOPMENTS
ACQUISITION OF WHEELS SPORTS GROUP, INC. In June 1998, Racing Champions
completed its acquisition of Wheels Sports Group, Inc., which was subsequently
renamed Racing Champions South, Inc. ("Racing Champions South"). Racing
Champions South markets and distributes collectible sports trading cards,
primarily for the NASCAR market, and NASCAR souvenirs and apparel.
PENDING ACQUISITION OF THE ERTL COMPANY, INC. Racing Champions has
entered into a letter of intent to acquire (the "Ertl Acquisition") The Ertl
Company, Inc. and certain of its foreign affiliates (collectively, "Ertl"). Ertl
manufactures, markets and distributes agricultural, imprint die-cast
collectibles and hobby model kits. The Ertl Acquisition is subject to the
satisfaction of a number of conditions, including the completion of due
diligence, the execution of a definitive acquisition agreement, the receipt of
necessary regulatory approvals and other closing conditions. Because there are
significant conditions remaining to be satisfied with respect to the Ertl
Acquisition, no assurance can be given that the Ertl Acquisition will be
consummated or, if consummated, that the terms of the Ertl Acquisition will be
as presently contemplated.
PRODUCTS
DIE-CAST RACING REPLICAS. Racing Champions has produced die-cast racing
replicas since its inception in 1989. Racing Champions' racing replicas include
a comprehensive line of scaled stock cars, trucks and team transporters
representing most of the vehicles competing in the current year's NASCAR Winston
Cup Series, Busch Grand National Series and Truck Series by Craftsman. In 1998,
Racing Champions produced over 1,500 different styles of racing replicas,
including various sizes such as 1:24, 1:64, 1:87 and 1:144 scale. A 1:24 scale
stock car replica is approximately eight inches long whereas a 1:64 scale stock
car replica is approximately three inches long. Racing Champions' racing
replicas generally retail at prices ranging from $2 to $60.
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The NASCAR product line covers stock cars in the Winston Cup and Busch
Grand National Series and racing trucks in the NASCAR Truck Series by Craftsman.
NASCAR stock cars were Racing Champions' initial offering in the collectible
racing replica category. NASCAR products include race cars and trucks, and team
transporters which are produced in various sizes including 1:24, 1:64, 1:87 and
1:144 scale. The NASCAR product line is produced in an annual Regular Edition as
well as special editions. The special editions are differentiated by more
detailed painting, special packaging and limited edition, serial numbered
production runs. In connection with NASCAR's 50th Anniversary celebration in
1998, Racing Champions offered four limited edition 50th Anniversary product
lines in unique gold packaging. Racing Champions also introduced its Signature
Drivers Series and Racing Champions Authentics in 1998. The Signature Driver
Series consists of 1:64 and 1:24 scale stock cars and 1:64 scale transporters
which feature opening hoods, intricately designed interiors and engines,
and driver-specific packaging. Racing Champions Authentics features enhanced
tooling, precise design and decoration and special customized packaging. Racing
Champions has entered into licenses with various NASCAR stock car and truck
teams, drivers, agents and sponsors, which allow Racing Champions to replicate
race cars and race trucks and team transporters for over 100 teams.
CLASSIC, CUSTOM AND FANTASY DIE-CAST VEHICLE REPLICAS
Racing Champions Mint. In early 1996, Racing Champions introduced the
Racing Champions Mint product line. Racing Champions Mint builds on Racing
Champions' racing replica success but still focuses on the collectible die-cast
vehicle market. Each month Racing Champions issues an assortment of six serial
numbered, highly detailed 1:64 scale replicas of classic and late model cars and
trucks in color schemes matching those used on the actual vehicle. Each new
issue is sequentially numbered and includes releases of new models and new paint
schemes. The replicas are selected from actual vehicles manufactured over the
past five decades. The limited production of these replicas enhances their
collectibility.
Racing Champions Hot Rod. Due to the success of Racing Champions Mint
and consumer feedback, Racing Champions launched in early 1997 a new line of
collectible die-cast hot rod car replicas. Like Racing Champions Mint, new Hot
Rod Collection models and styles are released in monthly assortments. Each
vehicle in the Racing Champions Hot Rod Collection is produced in limited
quantity and includes a serial number to enhance collectibility.
Other Classic and Custom Die-Cast. Racing Champions introduced several
additional lines in 1997 and 1998 to continue the expansion of its classic and
custom die-cast vehicle replica category. Racing Champions introduced Stock Rods
in 1997, which features the graphics of current NASCAR stock cars on replicas of
modern and vintage
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cars. In 1997, Racing Champions also launched Police USA, which features police
vehicles from various U.S. cities and states from the 1930's to the 1990's.
Fantasy Die-Cast. In 1998, Racing Champions introduced a new line of
fantasy die-cast collectible. These die-cast collectibles link popular
entertainment properties with die-cast vehicle replicas. Initial fantasy
die-cast products included the WCW and Hot Country Steel lines. Hot Country
Steel depicts country music stars on "hot" cars, while WCW vehicles contain
graphics associated with popular wrestlers in versions from two popular
wrestling associations, WCW and NWO.
OTHER COLLECTIBLES
Collectible Pewter Figures. In 1997, Racing Champions introduced a new
product category, collectible pewter figures. High quality pewter figures had
not previously been widely available through mass merchants. Racing Champions
initially focused on two proven and highly recognizable licensed properties --
comic book characters and popular athletes. Products in this category are
released in continuing series. Replicas of individual comic book characters and
popular athletes are produced in limited production runs and will not be
repeated. In order to further collectibility, all products are hand numbered and
sold with a certificate of authenticity. In 1998, Racing Champions introduced a
new line of Star Trek collectible pewter figures and vehicles.
Press Pass Trading Cards. Racing Champions designs and markets premium
collectible sports trading cards under the Press Pass brand name. Press Pass
trading cards primarily feature NASCAR race drivers, team owners and crew
chiefs. Press Pass has been an innovator in the collectible sports trading card
industry, having introduced season-long interactive cards, prism cards, 24-carat
gold signature cards, holofoil cards and "game-used" cards. Game-used cards
contain materials used in actual NASCAR races, including pieces of rubber taken
from tires, fire-suits and metal car parts. Press Pass also markets National
Football League and National Basketball Association draft pick trading cards.
Draft pick cards feature leading college players who are expected to be selected
in the NFL and the NBA drafts each year. Racing Champions also continues to
market NASCAR trading cards under the Wheels brand name.
APPAREL AND SOUVENIRS
Racing Champions distributes NASCAR-related merchandise to convenience
stores, mass market retailers such as Wal-Mart and K-Mart, grocery stores, drug
stores and other retail outlets. During 1998, merchandise distributed by Racing
Champions included T-shirts, hats, jackets, die-cast vehicle replicas,
sunglasses, golf balls, key chains, can coolers, bumper stickers, license plates
and souvenirs, all of which are produced by outside manufacturers. Racing
Champions distributes NASCAR-related merchandise pursuant to licenses or
sub-licenses granted by NASCAR team owners, drivers or corporate sponsors.
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LICENSES
Racing Champions 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 for
a limited period of time. Racing Champions has over 450 licenses with various
race team owners, drivers, sponsors and agents, generally for terms of 1 to 3
years. Racing Champions' racing replicas, collectible sports trading cards,
apparel and souvenirs are also officially licensed by major race sanctioning
bodies including NASCAR. Racing Champions also has license agreements with the
major automobile and truck manufacturers, including Chevrolet, Ford, Oldsmobile,
Pontiac, Buick, Dodge, Chrysler and Kenworth.
Royalty rates for racing replicas vary by racing category but generally
range in aggregate for all licensors from 12% to 21% of Racing Champions' sales
price. Certain special or limited edition products may carry higher royalty
rates. Royalty rates for NASCAR apparel and souvenirs generally range from 10%
to 14% of Racing Champions' sale price. Royalty rates related to non-racing
vehicle replicas range in aggregate from 3% to 10% of Racing Champions' sales
price. For collectible pewter figures Racing Champions pays royalty rates
ranging from 10% to 23% of Racing Champions' sales price depending on the number
of parties involved and the market value of the property or athlete. Royalties
are generally paid on a quarterly basis.
PATENTS AND TRADEMARKS
Racing Champions has registered several trademarks with the U.S. Patent
and Trademark Office, including the marks Racing Champions(TM), Sports
Champions(TM), Racing Champions Mint(TM), Press Pass(TM) and Comic Book
Champions(TM). Other trademark registrations are currently pending, including
Racing Champions Authentics(TM), Hot Country Steel(TM) and Collectible
Champions(TM). Racing Champions holds U.S. patents for its trading card display
stand and model vehicle and for its unique packaging system which includes a
die-cast vehicle, emblem and display stand. Racing Champions also holds a U.S.
patent for its pewter packaging system which includes a figurine mounted on a
display stand in front of a graphic reproduction associated with the figurine.
Racing Champions believes that there is significant value in its Racing
Champions trade name and trademark and plans to build additional value through
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increased customer awareness of many of Racing Champions' other trade names and
trademarks.
SALES AND DISTRIBUTION
In 1998, approximately 70% of Racing Champions' net sales were
distributed through national and regional retail chains including K-Mart,
Target, Toys 'R' Us, Wal-Mart, Hills, Meijer and ShopKo. Racing Champions'
products are sold at more than 20,000 retail outlets throughout North America.
Racing Champions utilizes electronic data interchange with its major retail
customers to monitor retail inventories and point of sale information and
receive and process customer orders.
In addition, Racing Champions sells to a limited number of wholesale
customers and at trackside which as a group represented approximately 18% of net
sales for 1998. The wholesale channel distributes Racing Champions' products to
hobby and collector shops throughout North America.
Racing Champions also distributes products through the
premium/promotional distribution channel. In total, this channel represented
approximately 8% of net sales for 1998. Premium/promotional customers include
Texaco, John Deere, General Mills, Procter & Gamble and Matco Tools. Racing
Champions' premium/promotional customers offer Racing Champions' customized
products to their customers through their own distribution outlets (e.g., Texaco
and John Deere), through special promotions (e.g., Procter & Gamble) or with the
purchase of their product.
In 1998, Racing Champions began "direct to consumer" distribution,
using direct mail and the Internet. This channel represented approximately 4% of
net sales for 1998.
Racing Champions' internal sales force provides direct customer contact
with virtually all of Racing Champions' retail and wholesale accounts. This
sales force is supplemented by six external sales representative organizations
which are divided geographically. These external sales representative
organizations provide more frequent and wider customer service and solicitation
of the national and regional retailers and support approximately 56% of Racing
Champions' 1998 net sales. Racing Champions' internal sales force complements
the external sales force by providing a more limited direct relationship between
Racing Champions and the accounts assigned to the external sales force. Certain
large accounts are designated as "house accounts" and are handled exclusively by
Racing Champions' internal sales staff. Sales representatives generally earn
commissions of 3% to 10% of the net sales price from their accounts, and their
commissions are not affected by the involvement of Racing Champions' internal
sales force with a customer or sale.
MARKETING
Racing Champions' marketing program is directed toward collectors and
potential new customers that fit the demographic profile of Racing Champions'
target market. The focus of Racing Champions' marketing plan is to increase
awareness of Racing
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Champions' product offerings and brand name. Racing Champions utilizes the
following media in its marketing plan.
ADVERTISING. Racing Champions places advertisements in collector's
publications with high, specific market penetration such as die-cast collector
publications and figure collector publications. Racing Champions also advertises
in national publications read by its targeted collectors and enthusiasts, such
as NASCAR Magazine, Die Cast Digest, Hot Rod Magazine, Motor Trend, DC and
Marvel comic books, and Sports Illustrated. In early 1998, Racing Champions
began radio and television advertising.
PUBLIC RELATIONS. Racing Champions has developed a sustained public
relations effort to build relationships with editors at collector publications.
Ongoing product notices keep editors abreast of changing products, increase
Racing Champions' credibility and market acceptance, and encourage the editorial
staffs of these publications to give adequate coverage to Racing Champions'
products.
CO-OP ADVERTISING. Racing Champions works closely with retail chains to
plan and execute ongoing retailer driven promotions and advertising. The
programs usually involve promotion of Racing Champions' products in retail
customers' print circulars, mailings and catalogs.
DIRECT CONSUMER. The Internet is an increasingly important part of
Racing Champions' marketing plan as collectors have quickly adopted the Internet
as a preferred way to communicate with other enthusiasts about their hobby.
Racing Champions has established a proprietary World Wide Web site
(www.racingchamps.com) on the Internet which highlights its products, lists
product release dates and collects information directly from consumers. Racing
Champions also gathers customer information through customer letters, e-mail,
telephone calls and product surveys. Racing Champions uses this customer
information for market research and dissemination of new product information. In
1998, Racing Champions commenced direct marketing of products through newspaper
and magazine inserts. Press Pass trading cards and other NASCAR merchandise are
also marketed through the Company's Platinum Club.
COMPETITION
Racing Champions believes that it had the largest domestic share in
1998 of the collectible scaled die-cast racing replica category. Racing
Champions competes with several larger domestic and foreign companies, such as
Mattel, Inc., Hasbro, Inc. and Action Performance Companies, Inc., and with
other producers of racing and non-racing vehicle replicas. Racing Champions also
competes with the producers of miniature die-cast toy vehicles such as
Matchbox(R) and Hot Wheels(R) who, like Racing Champions, principally distribute
through the mass merchant channel. In this market, Racing Champions competes
with Mattel, Inc. (Matchbox and Hot Wheels), Lewis Galoob Toys, Inc. (Micro
Machines(R)), Playing Mantis (Johnny Lightning(R)) and Jakks Pacific Inc. (Road
Champs) as well as other domestic and foreign producers of miniature die-cast
toy vehicles.
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Racing Champions' Press Pass trading cards compete with full line
collectible sports trading card companies, primarily Upper Deck, and with
several smaller companies with more limited product lines. Competition in the
distribution of NASCAR-related merchandise to convenience stores, mass market
retailers and other retail outlets is intense and is primarily based on product
appeal, ability to capture shelf or rack space, timely distribution, price and
quality. Competition is also based on the ability to obtain license agreements
with NASCAR race drivers, team owners and sponsors authorizing the right to use
the name, photograph, likeness, autograph or image of the NASCAR personality on
specific product lines to be sold through specific distribution channels or
retail outlets.
Racing Champions believes that its competitive position is enhanced by
a number of factors, including product quality, features, pricing and diversity,
its ability to recognize trends in its product markets and anticipate shifts in
consumer preferences, its success in designing and marketing new products, the
availability of adequate sources of manufacturing capacity and the ability of
its third party manufacturers to meet delivery schedules, and its ability to
renew existing licenses and to enter into new licenses. In addition, Racing
Champions has sought to develop brand loyalty, to produce products with a proven
track record of collectibility, and to capture shelf space at leading mass
merchants and other retailers. Many of Racing Champions' competitors have
greater financial, technical, marketing and other resources than Racing
Champions.
MANUFACTURING
HONG KONG OFFICE. Racing Champions Limited, the Company's Hong Kong
subsidiary (the "Hong Kong Subsidiary"), has an office in Kowloon, Hong Kong and
in the Racing Industrial Zone ("RIZ") in China and employs 94 people who oversee
all aspects of the manufacturing of Racing Champions' racing replicas and
certain other products. The Hong Kong Subsidiary sources 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 Hong
Kong to the United States.
DIE-CAST VEHICLE MANUFACTURING. Virtually all of Racing Champions'
die-cast vehicle products are manufactured by five independently owned factories
located in China. All of these factories (the "Dedicated Manufacturers") are
exclusively dedicated to manufacturing Racing Champions' products and all are
privately owned by independent Chinese entrepreneurs. All products are
manufactured to Racing Champions' specifications using molds and tooling that
are owned by Racing Champions. The Dedicated Manufacturers own the manufacturing
equipment and machinery, and purchase raw materials, hire workers and plan
production which includes subassemblies, final assemblies and packaging. Racing
Champions purchases fully assembled and packaged finished goods in master
cartons for distribution to its customers. Most of the Dedicated Manufacturers
have been supplying Racing Champions for more than five years. Racing Champions'
purchases in 1998 from the Dedicated Manufacturers, Win
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Yield, Sharp Success, Sunrise, Shun Fung and Remax were 31%, 26%, 15%, 13% and
12%, respectively, of Racing Champions' total purchases of die-cast vehicle
replicas.
With oversight from Racing Champions, the Dedicated Manufacturers
located a site in Dongguan (approximately 50 miles from Hong Kong) for the RIZ
which serves as a complex in which each independent Dedicated Manufacturer
operates a free standing factory facility. The factory facilities at the RIZ
were developed by a third party who is leasing the factory facilities to the
Dedicated Manufacturers. Currently, four of the Dedicated Manufacturers have
moved into their factory facilities in the RIZ and are manufacturing there.
Racing Champions has also established an office in the RIZ. This office houses
many of the engineering and quality control functions and provides more direct
oversight and coordination of the production activities.
COLLECTIBLE SPORTS TRADING CARDS MANUFACTURING. The production of
collectible sports trading cards begins with the conceptualization and design of
a card series. Racing Champions must coordinate the activities of various third
party contractors in the design and production process, including photographers,
printers, foil stampers and inkjetters. Following printing, foil stamping,
inkjetting and the placement of any other special effects on the cards, the card
sheets are delivered to a packager for cutting, collating and packaging. Racing
Champions generally prefers to coordinate the production of its collectible
sports trading cards through a limited number of suppliers. Racing Champions
believes that a number of alternate suppliers are available for each of the
primary functions necessary for production of collectible sports trading cards.
The production process generally requires from 90 to 180 days from
conceptualization of a card set to shipment. During the production process,
production delays are sometimes experienced due to a variety of factors such as
irregularities in foil stamping, chipping of trading cards during the cutting
process, and printing errors. In the past, Racing Champions has also encountered
production errors by its suppliers which have caused excess returns by
customers.
Due to the lead time required for the production of collectible sports
trading cards, Racing Champions is required to develop production forecasts for
the sale of new products. These production forecasts are based on management's
best estimate of anticipated sales, which estimate in turn is based upon prior
demand for similar products, input received from distributors, market conditions
at the time a card is conceptualized and other factors. In the event Racing
Champions' production forecasts do not correctly estimate demand for collectible
sports trading cards, Racing Champions may be required to write down excess
inventory or may miss potential market opportunities.
PRODUCT DEVELOPMENT. New product development is constantly occurring as
Racing Champions seeks to improve quality, update styles and add product lines.
New product design and updates are generally initiated domestically. The
designing process can take several days or a number of months depending upon
whether the process involves an enhancement to an existing product or a new
product design. Racing Champions has been able to develop new products and make
design changes quickly due
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to its rapid approval process, integrated Hong Kong Subsidiary and dedicated
manufacturing.
TOOLING. Racing Champions is continuously developing new tooling and
molds to produce its die-cast and pewter products. Racing Champions' engineering
staff works closely with outside tool makers to design and create new tooling.
Depending on the size and complexity of the model, tools can cost from $20,000
to $120,000. Racing Champions often produces back-up tools for high volume
models. Racing Champions owns all of its tools and provides them to the
manufacturers during production. Tools are returned to Racing Champions when a
product is no longer in production and are stored for future use or destroyed.
GRAPHICS. Existing product enhancements typically include graphics
changes to the vehicles for new color schemes, sponsor changes and/or driver
changes and revisions to product packaging. Graphics changes are photographed
and forwarded to the Hong Kong Subsidiary for incorporation into Racing
Champions' product line. Racing Champions' graphic arts personnel will redesign
the car decorating process in order to reflect the graphics changes. All changes
are reviewed domestically by Racing Champions personnel and samples are sent to
racing teams and sponsors prior to production for their approval.
PRODUCT SAFETY. Racing Champions' products are designed, manufactured,
packaged and labeled to conform with the 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. Racing Champions carries product liability insurance coverage with
a limit of $16.0 million per occurrence. As of December 31, 1998, Racing
Champions has never received a product liability claim.
EMPLOYEES
As of December 31, 1998, Racing Champions had 235 employees, 233 of
whom were employed full-time. Racing Champions emphasizes the recruiting and
training of high quality personnel and, to the extent possible, promotes people
from within Racing Champions. Racing Champions' employees are not covered by
collective bargaining agreements, and Racing Champions considers its employee
relations to be good. Racing Champions' continued success will depend in part on
its ability to attract, train and retain qualified personnel at all of its
locations.
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ITEM 2. PROPERTIES
Racing Champions' facilities are as follows:
<TABLE>
<CAPTION>
DESCRIPTION SQUARE FEET LOCATION LEASE EXPIRATION
---------------------------------------- ----------- -------------------- ----------------
<S> <C> <C> <C>
Corporate Headquarters.................. 12,280 Glen Ellyn, IL October 2000
Foreign Headquarters.................... 7,100 Kowloon, Hong Kong July 2000
Racing Champions, Inc.
Warehouse............................... 31,583 Chicago, IL December 2000
Racing Champions South
Office/Warehouse........................ 40,000 Mooresville, NC February 2002
Racing Champions South
Warehouse............................... 23,640 Mooresville, NC November 1999
RIZ office and quarter.................. 31,200 Dongguan City, China March 2003
</TABLE>
ITEM 3. LEGAL PROCEEDINGS
In the normal course of business Racing Champions also may be involved
in various legal proceedings from time to time. Racing Champions does not
believe it is currently involved in any claim or action the ultimate disposition
of which would have a material adverse effect on Racing Champions.
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, 1998.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Common Stock is traded on the NASDAQ National Market under the
symbol "RACN". The following table sets forth the high and low closing sale
prices for the Common Stock as reported by the NASDAQ National Market for the
periods indicated.
YEAR ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
HIGH LOW
------ ------
QUARTER
-------
<S> <C> <C>
Second (from June 12, 1997)................. $16.13 $14.50
Third....................................... $17.38 $11.50
Fourth...................................... $13.50 $ 6.81
YEAR ENDED DECEMBER 31, 1998
HIGH LOW
------ ------
QUARTER
-------
First....................................... $11.06 $ 7.81
Second...................................... $12.63 $10.88
Third....................................... $13.50 $ 8.00
Fourth...................................... $14.50 $10.25
</TABLE>
At December 31, 1998, there were approximately 142 holders of record of
Common Stock.
The Company has not paid any cash dividends on its Common Stock. The
Company intends to retain any earnings for use in the operation and expansion of
its business and, therefore, does not anticipate paying any cash dividends in
the foreseeable future.
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ITEM 6. SELECTED FINANCIAL DATA (amounts in thousands, except per share amounts)
The following table sets forth selected financial data with respect to
the Company for each of the periods indicated. The data for the years ended
December 31, 1994 and 1995 and for the four months ended April 30, 1996 are
derived from audited combined financial statements of the Predecessor -- RCI
Group. The data for the fiscal years ended March 31, 1995 and 1996 and for the
one month ended April 30, 1996 are derived from audited combined financial
statements of the Predecessor -- RCL Group. The data for the years ended
December 31, 1996, 1997 and 1998 are derived from the Company's consolidated
financial statements which have been audited by Arthur Andersen LLP, as
indicated in their report included elsewhere herein.
The pro forma financial data for the year ended December 31, 1997 which
gives effect to the acquisitions of High Performance Sports Marketing, Inc. and
Press Pass Partners by Wheels Sports Group Inc. ("Wheels") as if the purchases
had occurred on January 1, 1997 and as if Racing Champions' initial public
offering and Wheels' initial public offering had occurred on January 1, 1997 are
presented for informational purposes only and are not necessarily indicative of
the results of future operations of the Company or the actual results that would
have been achieved had such events occurred on such dates.
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<TABLE>
<CAPTION>
Predecessor - RCI Group(1) The Company Pro Forma
-------------------------- -------------------------------- ----------
Four
Year Year Months
Ended Ended Ended Year ended Year ended Year ended Year ended
Dec. 31 Dec. 31 April 30 Dec. 31 Dec. 31 Dec. 31 Dec. 31
1994 1995 1996 1996 1997 1998 (2) 1997 (2)
------- ------- -------- ---------- ---------- --------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Statement of Income Data:
Net sales $43,268 $48,592 $ 16,614 $ 56,908 $ 83,745 $ 156,464 $ 105,605
Gross profit 18,056 23,036 7,210 30,974 45,103 85,614 52,332
Operating income 8,565 9,724 108 12,098 13,262 23,123 13,040
Net income from continuing
operations $ 8,224 $ 9,392 $ 72 $ 3,372 $ 4,536 $ 11,741 $ 5,418
Per Share Data:
Net income from continuing
operations before
extraordinary item
Basic $ 0.29 $ 0.33 $ 0.73 $ 0.34
Diluted 0.28 0.32 0.71 0.33
Cash dividends - - - -
Book value
Basic $ 0.35 7.46 $ 11.01
Diluted 0.34 7.26 10.64
Weighted average common
shares and common share equivalents
outstanding
Basic 9,318 12,279 15,982
Diluted 9,645 12,621 16,426
Predecessor - RCL Group(1)
----------------------------------
Fiscal Years One month
ended March 31 ended Apr. 30
----------------- -------------
1995 1996 1996
------- ------- -------------
Statement of Income Data:
Net sales $22,331 $37,322 $ 3,852
Gross profit 5,288 7,085 752
Operating income 2,066 2,725 507
Net income $ 2,079 $ 2,603 $ 488
Dec. 31,
1998
----------
Actual
----------
Balance Sheet Data:
Working capital $ 9,420
Total assets 160,504
Total debt 34,000
Total stockholders' equity 102,582
</TABLE>
(1) On April 30, 1996, Racing Champions Corporation acquired the RCI Group and
the RCL Group in a recapitalization transaction. Accordingly, the RCI
Group and RCL Group selected financial data is provided as predecessor
companies to Racing Champions Corporation (the Registrant).
(2) The following supplemental financial data for the Company for the years
ended December 31, 1998 and 1997 give effect to the acquisitions of High
Performance Sports Marketing, Inc. and Press Pass Partners by Wheels as if
the purchases had occurred on January 1, 1997, assume that the initial
public offerings of Racing Champions and Wheels occurred on January 1,
1997, and exclude certain nonrecurring charges as reflected in the
supplemental footnotes.
SUPPLEMENTAL FINANCIAL DATA
<TABLE>
<CAPTION>
Year-ended Percent Year-ended Percent
Dec 31, of Net Dec 31, of Net
(Amounts in thousands 1998(a) Sales 1997(b) Sales
except per share data) ---------- ------- ---------- -------
<S> <C> <C> <C> <C>
Net sales $156,464 100.0% $101,487 100.0%
Gross profit 85,614 54.7 52,790 52.0
Operating income 28,906 18.5 20,813 20.5
Net income $ 15,602 10.0 $ 10,081 9.9
Net income per share:
Basic $ 0.98 $ 0.63
Diluted $ 0.95 $ 0.61
</TABLE>
(a) Amounts exclude nonrecurring, merger-related and restructuring charges in
connection with the acquisition of Wheels of approximately $5.5 million, as
well as approximately $0.3 million in nonrecurring compensation and rent
expense, $0.4 million in interest on deferred financing charges and $1.8
million in extraordinary charges for the early extinguishment of debt.
Merger transaction costs consisted primarily of fees for investment bankers
of approximately $0.6 million, professional advisers including legal and
accounting of approximately $0.9 million and financial printing and other
related costs of approximately $0.6 million. Restructuring costs included
primarily severance for terminated employees of approximately $1.1 million,
agreement extension costs of approximately $1.5 million and facility and
other exit costs of approximately $0.8 million.
(b) Amounts exclude the following items: (1) charges for the discontinued
operations of World of Racing, Inc. of $1.5 million, (2) charges for the
discontinued home decor product lines, including the goodwill related to
the Emerald Sports Group, Inc. acquisition of $0.7 million, (3) expenses
related to the 1997 acquisitions which were treated as pooling-of-interests
of $0.3 million, (4) accounting and audit fees of $0.5 million related to
acquisition and year end accounting and auditing work, (5) one-time bonus
payments of $0.2 million, (6) a net loss from the Wheels' trading card
operations of $2.9 million which includes approximately $0.7 million
related to defective products, (7) liquidation of discontinued High
Performance product lines which generated $1.0 million in sales and $1.3
million in cost of sales in 1997, (8) one-time bonus payments of $1.6
million which primarily relate to a transfer of equity ownership to a key
employee immediately prior to the Wheels acquisition of High Performance,
(9) costs of $0.3 million incurred in connection with the integration of
the other Wheels acquisitions into the High Performance facility in
Mooresville, NC, (10) the impact of a discontinued Press Pass product line
which generated minimal net sales and $0.5 million in cost of sales in
1997, and (11) compensation and rent expense of $0.6 million.
15
<PAGE> 16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Unless indicated otherwise, references to "Racing Champions" or the
"Company" are to Racing Champions Corporation and its subsidiaries, including
the operations of the RCI Group and the RCL Group prior to April 30,1996,
references to "Wheels" are to Wheels Sports Group, Inc. prior to its acquisition
by the Company on June 12, 1998, and references to "Racing Champions South" are
to Wheels Sports Group, Inc., which was renamed Racing Champions South, Inc.,
after its acquisition by the Company on June 12, 1998.
OVERVIEW
CORPORATE AND PRODUCT HISTORY. Racing Champions is a leading producer
and marketer of die-cast racing replicas sold at more than 20,000 North American
retail outlets. Racing Champions has leveraged this leadership position and its
relationship with NASCAR to market an extensive line of NASCAR collectibles,
which includes Press Pass trading cards in addition to die-cast racing replicas,
as well as NASCAR apparel and souvenirs. Building on its proven retail
strategies, and its leading-edge design and manufacturing capabilities, Racing
Champions has also broadened its offering of die-cast collectibles to include
high-profile, licensed vehicle replicas on behalf of World Championship
Wrestling and Sony "Signature" performers. The majority of Racing Champions'
products are sold through mass retailers, such as Wal-Mart, K-Mart, Target and
Toys 'R' Us. Racing Champions has maintained strong profit margins while selling
through the mass retail channel by offering high quality, collectible products,
managing product availability, continuously updating its products, diligently
controlling costs and realizing economies of scale.
Racing Champions' predecessors, the RCI Group and the RCL Group, each
began operations in 1989 with an initial product line of die-cast vehicles,
including racing car replicas. The RCI Group, owned by Robert E. Dods and Boyd
L. Meyer, operated Racing Champions' domestic operations, while the RCL Group,
owned by Peter K.K. Chung, operated Racing Champions' foreign operations. In
1990, Racing Champions shifted its focus to collectible stock car replicas and
in 1991 obtained the license to use the NASCAR trademark and logo on its
products and packaging.
16
<PAGE> 17
Over the next five years, Racing Champions experienced considerable
growth in its NASCAR product line and through its introduction of collectible
racing replicas from other major professional racing series. Racing Champions
believes that the measures it undertook from 1991 through 1996 have
significantly enhanced the Racing Champions brand name, thereby increasing
demand for the Company's products. In turn, Racing Champions' mass merchant
customers have responded by providing increased shelf space for Racing
Champions' product lines. Racing Champions believes that its significantly
broader product lines, enhanced brand name recognition among collectors and
retailers and increased shelf space have positioned it to compete favorably in
its principal channel of distribution.
In 1996, Racing Champions successfully expanded into non-racing
collectibles by introducing the Racing Champions Mint line of high quality
classic and late-model die-cast vehicle replicas. Racing Champions continued
this expansion in 1997 by introducing the Racing Champions Hot Rod Collection,
and in 1998 launched Hot Country Steel and WCW collectible vehicles.
On April 30, 1996, the Investor Group led by Willis Stein & Partners,
L.P., a private investment fund, consummated the Recapitalization in which
Racing Champions was formed as a new holding company for the purpose of
acquiring the domestic operations of the RCI Group and the foreign operations of
the RCL Group. This acquisition was accounted for using the purchase method of
accounting.
In June 1997, Racing Champions sold 5,357,142 shares of its common stock
in an initial public offering. The net proceeds to the Company from the sale of
the stock were approximately $69 million, after deduction of commissions and
offering expenses. The net proceeds were used to redeem preferred stock issued
in the Recapitalization, repay stockholder notes issued in the Recapitalization
and repay bank borrowings incurred in connection with the Recapitalization.
In June 1998, Racing Champions acquired Wheels Sports Group, Inc.,
subsequently renamed Racing Champions South, Inc. Racing Champions South markets
and distributes collectible sports trading cards, primarily for the NASCAR
market, and NASCAR souvenirs and apparel. In connection with this acquisition,
Racing Champions issued 2.7 million shares of Common Stock and assumed
outstanding options and warrants of Racing Champions South exercisable to
purchase up to 0.8 million shares of Common Stock. The transaction was accounted
for as a pooling of interests. All consolidated financial information has been
restated as if the transaction had been effected as of the beginning of the
earliest reporting period. In connection with the merger, the Company recorded a
charge to operating expenses in the second quarter of 1998 of approximately $5.5
million, including $2.1 million for direct and other merger related costs and
$3.4 million relating to restructuring of the Companies' combined operations.
Merger transaction costs consisted primarily of fees for investment bankers of
approximately $0.6 million, professional advisors including legal and accounting
of approximately $0.9 million and financial printing and other related costs of
approximately $0.6 million. Restructuring costs included primarily severance for
terminated employees of approximately $1.1 million, agreement extension costs of
approximately $1.5 million and facility and other exit costs of approximately
$0.8 million. These costs were expended by the Company prior to December 31,
1998.
Racing Champions decided to restructure Racing Champions South
primarily to facilitate the integration of six acquisitions made by Wheels in
1997. The two largest acquisitions were made late in the fourth quarter of
1997, and had not yet been fully integrated into the operations of Wheels.
Management also wanted to realign the operations of Wheels to conform to Racing
Champions. This meant integrating and operating under Racing Champions'
internal operating policies and procedures, primarily in the areas of sales and
marketing, production and order processing, and finance and administration. All
restructuring charges were accrued and expensed in the financial statements
during the second quarter of 1998. The restructuring was substantially
completed by the end of the third quarter of 1998, with all restructuring
charges expended before December 31, 1998. During this period, there were no
changes in the original restructuring plan or in the estimates recorded. The
Company believes that the restructuring will lower operating expenses, primarily
in the area of selling, general and administrative costs, in future periods.
As noted above, Wheels consummated a number of acquisitions during 1997
and incurred significant expenses in connection with such acquisitions. A
summary of these acquisitions follows.
Diamond Sports Group, Inc. and Green's Racing Souvenirs, Inc. On June
30, 1997, Wheels acquired 100% of the common stock of Diamond Sports Group,
Inc. ("Diamond"), a privately-held corporation located in Charlotte, North
Carolina, in exchange for 485,000 shares of Wheels' common stock. Diamond is
engaged in merchandising NASCAR-oriented products and providing motorsports
related hospitality management and corporation promotions.
On October 4, 1997, Wheels acquired 100% of the common stock of Green's
Racing Souvenirs, Inc. ("GRS"), a privately-held company located in South
Boston, Virginia, in exchange for 175,000 shares of Wheels' common stock. GRS is
engaged in merchandising NASCAR oriented racing souvenirs at race tracks and by
mail.
Wheels accounted for each of the Diamond and GRS transactions using the
pooling-of-interests method of accounting for business combinations.
Accordingly, all prior period consolidated financial statements have been
restated to include the combined results of operations, financial position and
cash flows of Diamond and GRS.
World of Racing, Inc. Wheels acquired World of Racing, Inc. ("WOR")
through a wholly owned subsidiary on January 28, 1997, by exchanging 310,000
shares of Wheels' common stock valued at $620,000 for 100% of the common stock
of WOR. WOR was a privately-held South Carolina corporation incorporated in
August 1996 to operate a fantasy race game. The transaction resulted WOR
becoming a wholly-owned subsidiary of Wheels. Effective June 30, 1997, Wheels'
Board of Directors voted to discontinue the operations of WOR and dispose of its
assets. The acquisition of WOR was originally accounted for as a pooling of
interests, but the discontinuance of its operations required the use of purchase
accounting. The $561,914 unamortized goodwill, along with property plant and
equipment with a net book value of approximately $132,000, were written off as
of June 30, 1997. In addition, as of June 30, 1997, Racing Champions recorded
estimated operating losses from June 30, 1997, through the end of the phase-out
period of approximately $222,000. Net liabilities of WOR at December 31, 1997,
amounted to approximately $116,000 and are included in other current liabilities
on the Company's consolidated balance sheet. The loss from operations and the
loss on disposition are presented as discontinued operations on the Company's
consolidated statement of operations for the year ended December 31, 1997. Net
sales of WOR amounted to approximately $174,000 for the year ended December 31,
1997.
Emerald Sports Group, Inc. On August 5, 1997, Wheels acquired 100% of
the common stock of Emerald Sports Group, Inc. ("Emerald"), a privately-held
corporation located in Charlotte, North Carolina, in exchange for 65,000 shares
of Wheels' common stock valued at $364,000. The transaction was accounted for as
a purchase and resulted in excess purchase price over the fair value of net
assets acquired of approximately $408,000. In December 1997, Wheels decided to
merge the operations of Emerald into those of Diamond and to dispose of
substantially all of Emerald's assets, with the exception of inventory, as of
December 31, 1997. As a result of the disposition of substantially all of
Emerald's assets and the discontinuance of its operations, Wheels recorded a
provision to reflect the impairment of unamortized goodwill related to the
Emerald acquisition of approximately $364,000, which is included in other
expense on the Company's consolidated statement of operations for the year ended
December 31, 1997. In addition, costs totaling approximately $200,000 related to
the disposal were accrued at December 31, 1997, and subsequently paid in 1998.
High Performance Sports Marketing, Inc. Effective October 24, 1997,
Wheels consummated the acquisition of High Performance Sports Marketing, Inc.
("High Performance"). High Performance is engaged in the merchandising of NASCAR
apparel and souvenirs through mass market retailers and convenience stores.
Consideration paid by Wheels consisted of cash in the amount of $1,672,000,
promissory notes totaling $1,000,000 and 444,444 shares of Wheels' common stock
valued at $4,000,000. In addition, the terms of the merger agreement required an
additional cash payment to be made at closing of $3,250,000 (the "Additional
Cash Consideration"). Payment the Additional Cash Consideration was made from
escrowed funds established in connection with Wheels' credit facility. In April
1998, Wheels negotiated the release of $500,000 of escrowed funds as partial
satisfaction of the Additional Cash Consideration. In addition, Wheels agreed to
pay an extension fee of $450,000 to the former High Performance stockholders,
$250,000 of which was paid on April 22, 1998. The remaining $200,000 of the
extension fee and the remaining $2,750,000 of the Additional Cash Consideration
was paid in June 1998. The transaction was accounted for as a purchase and
resulted in excess purchase price over the fair value of net assets acquired of
approximately $9.4 million.
Press Pass Partners. Effective December 31, 1997, Wheels consummated
the acquisition of Press Pass Partners ("Press Pass") through a transaction in
which the two corporate partners of Press Pass were merged into two newly formed
subsidiaries of Wheels. Press Pass is a designer and marketer of collectible
trading cards featuring NASCAR and other sports personalities. Consideration
paid by the Wheels consisted of cash of $3,100,000, promissory notes totaling
$1,000,000 and 600,000 shares of Wheels' common stock valued at $4,200,000. The
promissory notes were subsequently repaid in 1998. The transaction was accounted
for as a purchase and resulted in excess purchase price over the fair value of
net assets acquired of approximately $7.8 million.
SALES AND EXPENSES. Racing Champions' sales are recognized as products
are shipped. Racing Champions does not sell its products on consignment and
ordinarily accepts returns only for defective merchandise. Returns have
historically not been significant. In certain instances, where retailers are
unable to resell the quantity of products which they have purchased from Racing
Champions, Racing Champions may, in accordance with industry practice, assist
retailers in selling such excess inventory by offering credits and other price
concessions. These credits and other price concessions are evaluated and issued
annually.
17
<PAGE> 18
Mass merchant retailers purchase Racing Champions' products either in
the United States with credit terms ranging from 30 to 120 days or directly in
Hong Kong with payment made by irrevocable letter of credit or wire transfer. By
acquiring the products in Hong Kong, many of Racing Champions' retail customers
are able to realize efficiencies with respect to cost and logistics in the
distribution of the products to their retail locations in the United States.
Because Racing Champions incurs significantly lower distribution and
administrative costs with respect to direct shipments to customers from Hong
Kong, a price discount of approximately 15% to 25% is granted. As a result, Hong
Kong shipments have lower gross profit margins than domestic shipments.
Therefore, the annual fluctuations in the mix of United States versus Hong Kong
shipments will affect year-to-year comparability of net sales and gross profit
margins. However, Racing Champions believes that the operating income margin is
comparable for Hong Kong shipments due to the saved distribution and
administrative costs. For the years ended December 31, 1998, 1997 and 1996, Hong
Kong shipments constituted 45%, 52% and 43% respectively, of net sales.
Racing Champions' three largest expense categories are cost of sales,
royalties and sales commissions. Cost of sales consists primarily of purchases
of finished products from Racing Champions' manufacturing suppliers. Royalties
vary by product category and are paid on a quarterly basis. Multiple royalties
may be paid on a product to various licensors. In 1998, aggregate royalties by
product ranged from approximately 3% to 21% of Racing Champions' selling price.
Sales commissions ranging from 3% to 10% of net sales are paid quarterly to
Racing Champions' external sales representative organizations. In 1998, sales
subject to commissions represented 56% of total net sales.
At December 31, 1997 and December 31, 1996, Wheels had established
reserves for doubtful accounts, returns and allowances of $2,386,000 and
$237,000, respectively. During 1997, it became apparent that a trading card set
issued in late 1996, Crown Jewels Elite, had been improperly packed by Wheels'
contract packer. As a result, substantial quantities of that product which had
been purchased by distributors were not fit for sale on a retail basis. Although
Wheels encouraged distributors to continue to sell the product, Wheels accepted
product returns and issued credits and price concessions. Wheels recognized that
a significant portion of the improperly packaged card sets would eventually be
returned. Also contributing to the need for an increased reserve for doubtful
accounts, returns and allowances at December 31, 1997 was an overall weakness in
the trading card industry which reduced the ability of Wheels' major
customers to sell through to retail, thereby increasing the likelihood of
returns or other credits. Several major customers experienced financial
difficulties during the later part of 1997, also causing Wheels to increase
its reserves accordingly.
The following is a discussion and analysis of the Company's financial condition,
results of operations, liquidity and capital resources. The discussion and
analysis should be read in conjunction with the Company's audited consolidated
financial statements and notes thereto included elsewhere herein.
18
<PAGE> 19
RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
- ----------------------------------------------------------------------------------------------------------------------
(Amounts in thousands, except per share data) 1998 1998 1997 1997 1996 1996
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Net sales $156,464 100.0% $83,745 100.0% $ 56,908 100.0%
Cost of sales 70,850 45.3 38,642 46.1 25,934 45.6
-------- ------ ------- ------- --------- ------
Gross profit 85,614 54.7 45,103 53.9 30,974 54.4
Selling, general and administrative expenses 54,302 34.7 29,625 35.4 17,337 30.4
Merger related costs 5,526 3.5 -- -- -- --
Amortization of intangible assets 2,663 1.7 2,216 2.7 1,539 2.7
-------- ------ ------- ------- --------- ------
Operating income 23,123 14.8 13,262 15.8 12,098 21.3
Interest expense 2,751 1.8 5,220 6.2 6,780 11.9
Other expense 400 0.2 200 0.2 153 0.3
-------- ------ ------- ------- --------- ------
Income before income taxes 19,972 12.8 7,842 9.4 5,165 9.1
Income tax expense 8,231 5.3 3,306 4.0 1,793 3.2
-------- ------ ------- ------- --------- ------
Net income from continuing operations
before extraordinary item 11,741 7.5 4,536 5.4 3,372 5.9
Discontinued operations, net of tax benefit of
$428 -- -- 1,032 1.2 -- --
Extraordinary charge for early
extinguishment of debt, net of tax benefit of
$1,188 1,782 1.1 -- -- -- --
-------- ------ ------- ------- --------- ------
Net income $ 9,959 6.4% $ 3,504 4.2% $ 3,372 5.9%
-------- ------ ------- ------- --------- ------
- ----------------------------------------------------------------------------------------------------------------------
Dividends accrued on preferred stock -- -- 478 0.6 656 1.1
Net income available to common stockholders $ 9,959 6.4% $ 3,026 3.6% $ 2,716 4.8%
- ----------------------------------------------------------------------------------------------------------------------
Net income per share
Basic $ 0.62 -- $ 0.25 -- $ 0.29 --
Diluted $ 0.61 -- $ 0.24 -- $ 0.28 --
Weighted average shares outstanding
Basic 15,982 -- 12,279 -- 9,318 --
Diluted 16,426 -- 12,621 -- 9,645 --
</TABLE>
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
NET SALES. Net sales increased $72.8 million, or 87.0%, to $156.5
million for the year ended December 31, 1998 from $83.7 million for the year
ended December 31, 1997. This increase is primarily due to 66.6% growth in
collectible die-cast replicas. Within the collectible die-cast replica category,
custom, classic and fantasy vehicles increased 92.6%, primarily due to the
introduction of WCW Nitro Street Rods and the effect of a full year of Hot Rod
custom replicas. The NASCAR category increased 89.1% primarily due to the
effect of a full year of Stock Rods and due to the special editions that were
available in 1998 to commemorate NASCAR's 50th Anniversary. Net sales of other
racing replicas and pewter figures each decreased by approximately 70%. This
decrease was due to a greater focus of resources and capacity on the NASCAR and
classic, custom and fantasy die-cast vehicle categories. Trading cards and
apparel and souvenirs increased by approximately 50% due to the full year impact
from the acquisitions made in 1997 and due to increased product distribution in
1998. Most of the increases in all categories in 1998 were due to volume
increases as prices increased only by approximately 3% in most product lines in
1998.
GROSS PROFIT. Gross profit increased $40.5 million, or 89.8%, to $85.6
million for the year ended December 31, 1998 from $45.1 million for the year
ended December 31, 1997. The gross profit margin (as a percentage of net sales)
increased to 54.7% in 1998 from 53.9% in 1997. The gross profit margin increase
is due to the increase in volume in 1998 and also due to the increase in
domestic shipments (to 55% of net sales in 1998 from 48% of net sales in 1997)
which have a higher gross profit margin than Hong Kong shipments. This increase
was partially offset by increased cost of sales on the other collectible and
apparel and souvenir lines. There were no major changes in the components of
cost of sales in 1998.
19
<PAGE> 20
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased $24.7 million, or 83.4%, to $54.3 million for
the year ended December 31, 1998 from $29.6 million for the year ended December
31, 1997. As a percentage of net sales, selling, general and administrative
expenses decreased to 34.7% for the year ended December 31, 1998 from 35.4% for
the year ended December 31, 1997. The decrease in selling, general and
administrative expenses as a percentage of net sales was a result of spreading
fixed selling and administrative expenses over higher sales volume. Merger
related costs of $5.5 million included: (a) transaction costs of $2.1 million
consisting of fees for investment bankers of approximately $0.6 million,
professional advisors including legal and accounting of approximately $0.9
million and financial printing and other related costs of approximately $0.6
million; and (b) restructuring costs of $3.4 million consisting of severance for
terminated employees of approximately $1.1 million, agreement extension costs of
approximately $1.5 million and facility and other exit costs of approximately
$0.8 million. Amortization expense of $2.6 million and $2.2 million for the
years ended December 31, 1998 and 1997, respectively, related primarily to
intangible assets created in the Recapitalization.
OPERATING INCOME. Operating income increased $9.8 million, or 73.7%, to
$23.1 million for the year ended December 31, 1998 from $13.3 million for the
year ended December 31, 1997. As a percentage of net sales, operating income
decreased to 14.8% for the year ended December 31, 1998 from 15.8% for the year
ended December 31, 1997. This decrease was due to $5.5 million in merger-related
costs incurred in connection with the acquisition of Wheels Sports Group, Inc.
INTEREST EXPENSE. Interest expense of $2.8 million and $5.2 million for
the years ended December 31, 1998 and 1997, respectively, related primarily to
bank term loans and subordinated debt incurred in connection with the
Recapitalization. The decrease in interest expense recognized in 1998 was a
result of the use of proceeds from the Company's initial public offering in 1997
for the repayment of certain indebtedness resulting from the recapitalization.
INCOME TAX. Income tax expense for the years ended December 31, 1998
and December 31, 1997 include provisions for federal, state and Hong Kong income
taxes at an effective rate of 41.2% and 42.2%, respectively.
EXTRAORDINARY CHARGE FOR EARLY EXTINGUISHMENT OF DEBT. The
extraordinary charge of $1.8 million net of tax benefit of $1.2 million
recognized in 1998 related to the early extinguishment of debt and the
unamortized debt discount of obligations assumed from Wheels as a result of the
merger.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
NET SALES. Net sales increased $26.8 million, or 47.1%, to $83.7
million for the year ended December 31, 1997 from $56.9 million for the year
ended December 31, 1996. This increase can be attributed to a slight increase in
prices in 1997, but is primarily due to 38.5% growth in collectible die-cast
replicas with the remainder of the growth attributable to the collectible pewter
figures category, a new product introduction in 1997, and increases in apparel
and souvenir sales.
GROSS PROFIT. Gross profit increased $14.1 million, or 45.5%, to $45.1
million for the year ended December 31, 1997 from $31.0 million for the year
ended December 31, 1996. The gross profit margin (as a percentage of net sales)
decreased to 53.9% in 1997 from 54.4% in 1996. This decrease is due to the
increase in Hong Kong shipments (to 52% of net sales in 1997 from 43% of net
sales in 1996) which have a lower gross profit margin than domestic shipments.
There were no major changes in the components of cost of sales in 1997.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased $12.3 million, or 71.1%, to $29.6 million for
the year ended December 31, 1997 from $17.3 million for the year ended December
31, 1996. As a percentage of net sales, selling, general and administrative
expenses increased to 35.4% for the year ended December 31, 1997 from 30.4% for
the year ended December 31, 1996. The increase in selling, general and
administrative expenses
20
<PAGE> 21
related primarily to the Racing Champions South operations, including certain
nonrecurring charges for (a) the discontinued home decor product lines of $0.3
million, (b) expense related to the 1997 acquisitions which were treated as
pooling-of-interests of $0.3 million, (c) accounting and audit fees of $0.5
million related to acquisition and year end accounting and auditing work, (d)
one-time bonus payments of $0.2 million, (e) approximately $0.7 million related
to defective products from the Wheels' trading card operations, (f) one-time
bonus payments of $1.6 million which primarily relate to a transfer of equity
ownership to a key employee immediately prior to the Wheels acquisition of High
Performance, (g) costs of $0.3 million incurred in connection with the
integration of the other Wheels acquisitions into the High Performance facility
in Mooresville, NC, and (h) compensation and rent expense of $0.6 million.
Amortization expense of $2.2 million and $1.5 million for the years ended
December 31, 1997 and 1996, respectively, primarily related to intangible assets
created in the Recapitalization.
OPERATING INCOME. Operating income increased $1.2 million, or 9.9%, to
$13.3 million for the year ended December 31, 1997 from $12.1 million for the
year ended December 31, 1996. As a percentage of net sales, operating income
decreased to 15.8% for the year ended December 31, 1997 from 21.3% for the year
ended December 31, 1996.
INTEREST EXPENSE. Interest expense of $5.2 million and $6.8 million for
the years ended December 31,1997 and 1996, respectively, related primarily to
bank term loans and subordinated debt incurred in connection with the
Recapitalization.
INCOME TAX. Income tax expense for the years ended December 31, 1997
and December 31, 1996 include provisions for federal, state and Hong Kong income
taxes at an effective rate of 42.2% and 34.7%, respectively. The 1996 effective
tax rate is lower than the 1997 effective tax rate due to the nontaxable income
of Wheels prior to becoming a C corporation.
21
<PAGE> 22
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22
<PAGE> 23
CHANGES IN FINANCIAL CONDITION
Cash and cash equivalents decreased by $0.7 million for the year ended
December 31, 1998 and increased $0.7 million and $6.0 million for the years
ended December 31, 1997 and 1996, respectively. Net cash provided by operating
activities was $2.6 million, $9.2 million and $11.0 million in 1998, 1997 and
1996, respectively. The change in net cash provided by operating activities from
1997 to 1998 and from 1996 to 1997 is primarily attributable to the increases in
accounts receivable, inventory and accounts payable and accrued expenses (due to
increased sales volume). The large increase in the allowance for doubtful
accounts in 1997 is due to a Wheels trading card set that had been improperly
packaged by a contract packer.
Net cash used in discontinued operations of $0.6 million was a result
of the Board of Directors of Wheels voting to discontinue the operation of WOR
and dispose of its assets.
The acquisition of WOR was originally accounted for using
the pooling-of-interests method of accounting, but the discontinuance of its
operations required the use of purchase accounting. The $0.6 million in
unamortized goodwill, along with property, plant and equipment with a net book
value of approximately $0.1 million were written off as of June 30, 1997. In
addition, on June 30, 1997, Wheels recorded estimated operating losses from
June 30, 1997, through the end of the phase-out period of approximately $0.2
million. Net liabilities of WOR at December 31, 1997 amounted to approximately
$0.1 million. Net sales of WOR amounted to approximately $0.2 million for the
year ended December 31, 1997.
Net cash used in investing activities was $7.2 million, $8.1 million
and $30.4 million in 1998, 1997 and 1996, respectively. The decrease from 1997
to 1998 and from 1996 to 1997 was primarily attributable to less excess purchase
price resulting from acquisitions made under the purchase method of accounting.
(Please refer to the notes to the financial statements for a complete discussion
of all acquisitions made over the last three year period.)
Net cash provided by financing activities was $3.9 million, $0.2
million and $25.3 million in 1998, 1997 and 1996, respectively. The increase
from 1997 to 1998 was due to less discretionary paydown on the bank debt. The
decrease from 1996 to 1997 was due to the paydown of all junior and senior
subordinated notes, the redemption of the preferred stock and payment of
accrued dividends in conjunction with the Company's initial public offering.
LIQUIDITY AND CAPITAL RESOURCES
The Company's continuing operations provided net cash of $2.6 million
during the year ended December 31, 1998. This was primarily due to earnings from
operations. Capital expenditures for the year ended December 31, 1998 were
approximately $6.5 million, of which approximately $4.3 million was for molds
and tooling.
During 1998, the Company made payments of approximately $5.3 million to
stockholders of the Company in settlement of notes payable outstanding from the
acquisitions of High Performance and Press Pass consummated in 1997. Included in
these payments was the release of $3.3 million of escrowed funds related to the
High Performance acquisition.
During 1997, the Company received net proceeds of approximately $73.8
million from its initial public offering. The Company used the net proceeds to
repay certain indebtedness and redeem outstanding preferred stock.
On June 11, 1998, in connection with the acquisition of Wheels, the
Company revised and amended its credit agreement with BankBoston, N.A. and
certain other lenders. The revised and amended credit agreement provides for a
revolving loan, a five year term loan and the issuance of letters of credit. The
revolving loan allows the Company to borrow up to $12.0 million at any time
prior to June 30, 2003, based upon levels of the Company's accounts receivable,
inventory and cash flows and the amount of letter of credit exposure. The
Company had $12.0 million outstanding under the revolving loan at December 31,
1998. The term loan in the principal amount of $22.0 million is due in scheduled
quarterly payments with final maturity on June 30, 2003. All borrowings under
the credit agreement are secured by substantially all of the assets of the
Company.
The term loan and the revolving term loan bear interest, at the
Company's option, at BankBoston's base rate plus a margin that varies between
0.00% and 0.75% or at a reserve adjusted Eurodollar rate plus a margin that
varies between 1.50% and 2.25%. The applicable margin is based on the Company's
financial performance and is currently 0.00% for base rate loans and 1.50% for
Eurodollar loans. The credit agreement requires the Company to pay a commitment
fee of 0.50% per annum on the average daily unused portion of the revolving
loan.
BankBoston's Hong Kong branch has made available to the Hong Kong
Subsidiary a line of credit of up to $5.0 million. Amounts borrowed under this
line of credit bear interest at the bank's cost of funds plus 2% and are
cross-guaranteed by Racing Champions, Inc. and the Hong Kong Subsidiary. At
December 31, 1998 the Hong Kong Subsidiary had no outstanding borrowings under
this line of credit.
23
<PAGE> 24
The Company's anticipated debt service obligations under the existing
credit facilities for 1999 for scheduled interest and principal payments are
approximately $5.9 million. Average annual debt service obligations under these
same facilities through June 2003 are approximately $5.8 million.
The Company has met its working capital needs through funds generated
from operations and available borrowings under the credit agreement. The
Company's working capital requirements fluctuate during the year based on the
timing of the racing season. Due to seasonal increases in demand for the
Company's racing replicas, working capital financing requirements are usually
highest during the third and fourth quarters. The Company expects that
capital expenditures during 1999, principally for molds and tooling, will be
approximately $7.5 million. The Company believes that its cash flow from
operations, cash on hand and borrowings under the credit agreement will be
sufficient to meet its working capital and capital expenditure requirements and
provide the Company with adequate liquidity to meet anticipated operating needs
for the foreseeable future. However, any significant future product or property
acquisitions (including up-front licensing payments) may require additional debt
or equity financing. In connection with the Company's proposed acquisition of
The Ertl Company, Inc., the Company will need to amend the credit agreement to
increase its borrowing capacity thereunder.
YEAR 2000 PREPARATIONS
The Year 2000 issue relates to computer hardware and software and other
systems designed to use two digits rather than four digits to define the
applicable year. As a result, the Year 2000 would be translated as two zeroes.
Because the Year 1900 could also be translated as two zeroes, systems which use
two digits could read the date incorrectly for a number of date-sensitive
applications, resulting in potential calculation errors or the shutdown of major
systems. The Company has undertaken various initiatives intended to ensure that
its computer hardware and software and other systems will function properly with
respect to dates in the Year 2000 and thereafter. The systems subject to
potential Year 2000 issues include not only information technology ("IT")
systems, such as accounting and data processing, order processing and
communications systems, but also non-IT systems, such as alarm systems, fax
machines or other miscellaneous systems.
The Company's State of Readiness. The Company's Year 2000 compliance
program has focused on two initiatives: (1) a review of significant internal IT
and non-IT systems to determine the extent of potential Year 2000 issues and to
effect necessary upgrades with respect to Year 2000 compliance, and (2) the
circulation of surveys to the Company's major vendors and customers to assess
their Year 2000 readiness. The Company's main internal systems, including IT
systems such as financial systems and core order processing systems, and non-IT
systems have been tested and are either currently Year 2000 compliant or are
expected to be Year 2000 compliant by the end of the second quarter of 1999. The
Company has circulated surveys to approximately 100 of its key third party
vendors and customers. Through December 31, 1998, approximately 50% of these
surveys have been returned to the Company, and none of the surveys which have
been returned indicate significant Year 2000 compliance issues.
Costs to Address the Company's Year 2000 Issues. The majority of the
Company's internal Year 2000 issues have been or will be corrected through
systems upgrades for other business purposes or normal maintenance contracts.
The costs of such upgrades through December 31, 1998 has been approximately
$100,000. The estimated costs to complete all planned upgrades for the remaining
systems still not compliant is not expected to exceed $100,000.
24
<PAGE> 25
Risks to the Company for Year 2000 Issues. The Company believes that
its reasonably likely worse case scenario would be to revert to manual order
processing for orders currently processed through EDI systems and the Company's
internal order processing systems. The Company will continue to monitor the Year
2000 compliance of its customers and vendors. A number of risks relating to the
Year 2000 issue may be out of the Company's control, including reliance on
outside links for essential services such as communications and power. There can
be no assurance that a failure of systems of third parties on which the
Company's systems and operations will rely to be Year 2000 compliant will not
have a material adverse effect on the Company's business, financial condition or
operating results.
The Company's Year 2000 Contingency Plans. By the end of the second
quarter of 1999, the Company expects to be fully Year 2000 compliant. To the
extent that any of the Company systems are not Year 2000 compliant by the end of
the second quarter of 1999, the Company believes that it will have time to
implement alternative IT systems or manual systems by the end of 1999 which
should reduce the risk of non-compliance to the Company.
FORWARD-LOOKING STATEMENTS
A number of the matters discussed in this report that are not
historical or current facts deal with potential future circumstances and
developments. The Company's actual results and future developments could differ
materially from the results or developments expressed in, or implied by, these
forward-looking statements. Factors that may cause actual results to differ
materially from those contemplated by such forward-looking statements include,
but are not limited to, the following: (1) the Company's growth is dependent
upon its ability to continue to conceive, design, source and market new products
and upon continuing market acceptance of its existing and future products; (2)
competition in the markets for the Company's products may increase
significantly; (3) the Company is dependent upon continuing licensing
arrangements with race team owners, drivers, sponsors, agents, vehicle
manufacturers, major race sanctioning bodies and other licensers; (4) the
Company's assessment of the Year 2000 issue, including its identification,
assessment, remediation and testing efforts, the dates on which the Company
believes it will complete such efforts and the costs associated with such
efforts, is based upon management's estimates, which were derived from numerous
assumptions regarding future events, available resources, third-party
remediation plans, the accuracy of testing of the affected systems and other
factors, and no assurance can be given that these estimates will prove correct
or that actual results will not differ materially from currently anticipated;
(5) the Company relies upon five independently owned factories located in China
to manufacture its vehicle replicas and certain other products; (6) the Company
is dependent upon the continuing willingness of leading retailers to purchase
and provide shelf space for the Company's products; and (7) the Company may be
adversely affected by general economic conditions in its markets.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
As a result of the terms of the credit agreement, the Company is sensitive
to an increase in interest rates. In order to reduce its sensitivity to interest
rate increases, in September 1997, the Company entered into a two-year interest
rate swap agreement with its primary lender. Under this agreement, the Company
hedges on a quarterly basis, a notional amount ranging between $7 million and
$10 million through September, 1999, at a reserve adjusted Euro-rate of 6.20%.
During 1998 and 1997, the impact of this agreement was insignificant.
25
<PAGE> 26
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
FINANCIAL STATEMENTS
The consolidated financial statements of the Company and notes thereto
are filed under this item beginning on page F-1 of this report.
QUARTERLY RESULTS OF OPERATIONS
The following tables set forth unaudited quarterly results of
operations for each of the quarters in the years ended December 31, 1998 and
1997. All quarterly information was obtained from unaudited consolidated
financial statements not otherwise contained herein. The Company believes that
all necessary adjustments have been made to present fairly the quarterly
information when read in conjunction with the Consolidated Financial Statements
and Notes thereto included elsewhere herein. The operating results for any
quarter are not necessarily indicative of the results for any future period.
<TABLE>
<CAPTION>
FISCAL YEAR 1998
(Amounts in thousands, except per share data) Q1 Q2 Q3 Q4
<S> <C> <C> <C> <C>
Net sales $28,639 $42,693 $50,604 $34,528
Cost of sales 12,083 19,168 23,351 16,248
------- ------- ------- -------
Gross profit 16,556 23,525 27,253 18,280
Selling, general and administrative expenses 11,768 18,751 16,260 13,049
Amortization of intangible assets 663 669 666 665
------- ------- ------- -------
Operating income(1) 4,125 4,105 10,327 4,566
Interest expense(2) 792 743 625 591
Other expense 114 39 71 176
------- ------- ------- -------
Income before income taxes 3,219 3,323 9,631 3,799
Income tax expense 1,543 1,372 3,856 1,460
------- ------- ------- -------
Net income before extraordinary item 1,676 1,951 5,775 2,339
Extraordinary item(3) --- 1,782 --- ---
------- ------- ------- -------
Net income available to common stockholders $ 1,676 $ 169 $ 5,775 $ 2,339
------- ------- ------- -------
Net income per share before extraordinary item:
Basic $ 0.11 $ 0.12 $ 0.36 $ 0.15
Diluted $ 0.10 $ 0.12 $ 0.35 $ 0.14
Net income per share:
Basic $ 0.11 $ 0.01 $ 0.36 $ 0.15
Diluted $ 0.10 $ 0.01 $ 0.35 $ 0.14
Weighted average shares outstanding:
Basic 15,961 15,961 15,971 16,003
Diluted 16,359 16,292 16,430 16,502
</TABLE>
(1) Due to the seasonal increases in demand for the Company's racing replicas,
the second and third quarters generally reflect the highest sales levels
and operating income. The decrease in operating income for the second
quarter compared to the third quarter was a result of the Company recording
a second quarter charge to operating expenses of approximately $5.5 million
in nonrecurring, merger-related and restructuring charges incurred in
connection with the acquisition of Wheels in June 1998.
(2) Interest expense for the first and second quarters also includes
approximately $0.4 million in interest expense on deferred financing costs
of Wheels prior to the acquisition.
(3) The extraordinary item relates to the early extinguishment of debt on
Wheels' books that was paid at the time of the acquisition of Wheels by the
Company.
26
<PAGE> 27
<TABLE>
<CAPTION>
FISCAL YEAR 1997
(Amounts in thousands, except per share data) Q1 Q2 Q3 Q4(1)
- --------------------------------------------- ------- ------- ------- -------
<S> <C> <C> <C> <C>
Net sales $17,195 $24,950 $24,291 $17,309
Cost of sales 8,267 10,628 10,761 8,986
------- ------- ------- -------
Gross profit 8,928 14,322 13,530 8,323
Selling, general and administrative expenses 5,718 7,274 7,497 9,136
Amortization of intangible assets 558 554 554 550
------- ------- ------- -------
Operating income (loss) 2,652 6,494 5,479 (1,363)
Interest expense 2,409 2,142 303 366
Other expense 43 42 65 50
------- ------- ------- -------
Income (loss) before income taxes 200 4,310 5,111 (1,779)
Income tax expense (benefit) 185 1,888 1,897 (664)
------- ------- ------- -------
Net income (loss) from continuing operations 15 2,422 3,214 (1,115)
Discontinued operations --- 1,032 --- ---
------- ------- ------- -------
Net income (loss) $ 15 $ 1,390 $ 3,214 $(1,115)
------- ------- ------- -------
Net income (loss) per share from continuing operations:
Basic $ (0.03) $ 0.20 $ 0.21 $ (0.07)
Diluted $ (0.02) $ 0.19 $ 0.20 $ (0.07)
Net income (loss) per share:
Basic $ (0.03) $ 0.11 $ 0.21 $ (0.07)
Diluted $ (0.02) $ 0.10 $ 0.20 $ (0.07)
Weighted average shares outstanding:
Basic 9,427 11,030 15,388 15,576
Diluted 9,756 11,394 15,811 15,956
</TABLE>
(1) Fourth quarter operating loss includes (a) nonrecurring selling, general
and administrative expenses for the discontinued home decor product lines of
$0.3 million, expenses of $0.3 million related to the 1997 acquisitions which
were accounted for as pooling-of-interests, accounting and audit expenses of
$0.5 million related to acquisitions and year end and accounting and auditing
work, one time bonus payments of $0.2 million, a provision for defective
products from Wheels' trading card operations of approximately $0.7 million,
one-time bonus payments of $1.6 million which primarily relate to a transfer of
equity ownership in a key employee immediately prior to the Wheels acquisition
of High Performance, costs of $0.3 million incurred in connection with the
integration of the other Wheels acquisitions into the High Performance facility
in Mooresville, NC, and compensation and rent expenses of $0.6 million; (b) the
impact from the liquidation of discontinued High Performance product lines,
which generated $1.0 million dollars of sales and $1.3 million dollars in costs
of sales; and (c) the impact of discontinued Press Pass product line, which
generated minimal sales and $0.5 million in cost of sales.
27
<PAGE> 28
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" and "Section 16(a) Beneficial Ownership Reporting Compliance" in
the Company's Proxy Statement for the 1999 Annual Meeting of Stockholders which
will be filed on or before April 30, 1999.
28
<PAGE> 29
ITEM 11. EXECUTIVE COMPENSATION
Incorporated herein by reference to the discussion under "Executive
Compensation" in the Company's Proxy Statement for the 1999 Annual Meeting of
Stockholders which will be filed on or before April 30, 1999.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated herein by reference to the discussion under "Security
Ownership" in the Company's Proxy Statement for the 1999 Annual Meeting of
Stockholders which will be filed on or before April 30, 1999.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
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 1999 Annual Meeting of
Stockholders which will be filed on or before April 30, 1999.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
a. Exhibits:
EXHIBIT
NUMBER DOCUMENT DESCRIPTION
------- --------------------
3.1** Amended and Restated Certificate of Incorporation of the
Company.
3.2** First Amendment to Amended and Restated Certificate of
Incorporation of the Company.
3.3 Amended and Restated By-Laws of the Company
(incorporated by reference to Exhibit 3.3 of the
Company's Quarterly Report on Form 10-Q for the quarter
ended June 30, 1998 (File No. 0-22635)).
10.1 Amended and Restated Credit Agreement, dated as of
June 17, 1997, by and among the Company, Racing
Champions, Inc., BankBoston, N.A., as lender and agent,
and the other lenders party thereto (incorporated by
reference to Exhibit 10.1 of the Company's Annual Report
on Form 10-K for the year ended December 31, 1997 (File
No. 0-22635)).
29
<PAGE> 30
10.2 Amendment No. 3 to Amended and Restated Credit
Agreement, dated as of June 11, 1998, by and among
the Company, Racing Champions, Inc., BankBoston, N.A.,
as lender and agent, and the other lenders party
thereto (incorporated by reference to Exhibit 99.1 of
the Company's Current Report on Form 8-K dated June 12,
1998 (File No. 0-22635) filed by the Company with the
Securities and Exchange Commission on June 29, 1998).
10.3 Amended and Restated Guarantee and Security Agreement,
dated as of June 17, 1997, by and among the Company,
Racing Champions, Inc. and BankBoston, N.A., as agent
(incorporated by reference to Exhibit 10.2 of the
Company's Annual Report on Form 10-K for the year ended
December 31, 1997 (File No. 0-22635)).
10.4 Warrant Agreement, dated as of August 5, 1998, between
the Company and BankBoston, N.A., as warrant agent
(incorporated by reference to Exhibit 10.2 of the
Company's Quarterly Report on Form 10-Q for the quarter
ended June 30, 1998 (File No. 0-22635)).
10.5 Warrant dated December 31, 1997 issued by Wheels Sports
Group, Inc. to Indosuez CM II, Inc. (incorporated by
reference to Exhibit 10.3 of the Company's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1998
(File No. 0-22635)).
10.6 Registration Rights Agreement, dated as of December 31,
1997, between Wheels Sports Group, Inc. and Indosuez CM
II, Inc. (incorporated by reference to Exhibit 10.4 of
the Company's Quarterly Report on Form 10-Q for the
quarter ended June 30, 1998 (File No. 0-22635)).
10.7 Warrant dated April 27, 1997 issued by Wheels Sports
Group, Inc. to Schneider Securities, Inc. (incorporated
by reference to Exhibit 10.5 of the Company's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1998
(File No. 0-22635)).
10.8* Employment Agreement, dated as of April 30, 1996, by and
between Racing Champions, Inc. and Robert Dods
(incorporated by reference to Exhibit 10.12 of the
Company's Registration Statement on Form S-1)
(Registration No. 333-22493) filed with the Securities
and Exchange Commission on February 27, 1997).
10.9* Employment Agreement, dated as of April 30, 1996, by and
between Racing Champions, Inc. and Boyd Meyer
(incorporated by reference to Exhibit 10.13 of the
Company's Registration Statement on Form S-1
(Registration No. 333-22493) filed with the Securities
and Exchange Commission on February 27, 1997).
30
<PAGE> 31
10.10* Employment Agreement, dated as of April 30, 1996, by and
between Banerjan Company Limited and Peter Chung
(incorporated by reference to Exhibit 10.14 of the
Company's Registration Statement on Form S-1
(Registration No. 333-22493) filed with the Securities
and Exchange Commission on February 27, 1997).
10.11* Employment Agreement, dated as of April 30, 1998, by and
between Racing Champions, Inc. and Curt Stoelting
(incorporated by reference to Exhibit 10.7 of the
Company's Quarterly Report on Form 10-Q for the quarter
ended June 30, 1998 (File No. 0-22635)).
10.12* Employment Agreement, dated as of April 30, 1998, by and
between Racing Champions, Inc. and Peter Henseler
(incorporated by reference to Exhibit 10.8 of the
Company's Quarterly Report on Form 10-Q for the quarter
ended June 30, 1998 (File No. 0-22635)).
10.13* Employment Agreement, dated as of April 30, 1998, by and
between Racing Champions, Inc. and John Olsen
(incorporated by reference to Exhibit 10.8 of the
Company's Quarterly Report on Form 10-Q for the quarter
ended June 30, 1998 (File No. 0-22635)).
10.14* Employment Agreement, dated as of April 30, 1998, by and
between Racing Champions, Inc. and Kevin Camp
(incorporated by reference to Exhibit 10.10 of the
Company's Quarterly Report on Form 10-Q for the quarter
ended June 30, 1998 (File No. 0-22635)).
10.15* 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 Securities and Exchange Commission on
February 27, 1997).
10.16* Amendment No. 1 to 1996 Key Employees Performance
Compensation Plan (incorporated by reference to Exhibit
10.21 of the Company's Pre-Effective Amendment No. 1 to
Registration Statement on Form S-1 (Registration
No. 333-22493) filed with the Securities and Exchange
Commission on April 11, 1997).
10.17* Racing Champions Corporation Stock Incentive Plan, as
amended (incorporated by reference to Exhibit 10.11 of
the Company's Quarterly Report on Form 10-Q for the
quarter ended June 30, 1998 (File No. 0-22635)).
10.18* Racing Champions Corporation Employee Stock Purchase
Plan (incorporated by reference to Exhibit 10.23 of the
Company's Pre-Effective Amendment No. 1 to
Registration Statement on Form S-1 (Registration No.
333-22493) filed with the Securities and Exchange
Commission on April 11, 1997).
31
<PAGE> 32
10.19* 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)).
21** Subsidiaries of the Company.
23 Consent of Arthur Andersen LLP.
24** Power of Attorney
27** Financial Data Schedule.
- ---------------
* Management contract or compensatory plan or arrangement.
** Previously filed.
(b) Reports on Form 8-K.
The Company did not file any reports on Form 8-K for the three months
ended December 31, 1998
(c) Financial statement schedules.
32
<PAGE> 33
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/A to be
signed on its behalf by the undersigned, thereunto duly authorized.
RACING CHAMPIONS CORPORATION
By /s/ Robert E. Dods
---------------------------------------
Robert E. Dods, Chief Executive Officer
Date: June 28, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Form 10-K/A has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
<S> <C> <C>
/s/ Robert E. Dods Chief Executive Officer and Director June 28, 1999
- ----------------------------- (Principal Executive Officer)
Robert E. Dods
* President and Director June 28, 1999
- -----------------------------
Boyd L. Meyer
/s/ Curtis W. Stoelting Executive Vice President and Secretary June 28, 1999
- ----------------------------- (Principal Financial Officer and
Curtis W. Stoelting Principal Accounting Officer)
* Director June 28, 1999
- -----------------------------
Peter K.K. Chung
</TABLE>
34
<PAGE> 34
<TABLE>
<CAPTION>
<S> <C> <C>
* Director June 28, 1999
- -----------------------------
Avy H. Stein
* Director June 28, 1999
- -----------------------------
Daniel M. Gill
* Director June 28, 1999
- -----------------------------
John S. Bakalar
* Director June 28, 1999
- -----------------------------
John J. Vosicky
* Director June 28, 1999
- -----------------------------
Victor H. Shaffer
/s/ Curtis W. Stoelting June 28, 1999
- ----------------------------
Curtis W. Stoelting
*Attorney-in-Fact
</TABLE>
35
<PAGE> 35
[ARTHUR ANDERSEN LLP LOGO]
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the 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 15, 1999. Our
audits were made for the purpose of forming an opinion on the basic financial
statements taken as a whole. The schedule of Valuation and Qualifying Accounts
is presented for purposes of complying with the Securities and Exchange
Commission's rules and is not a part of the basic financial statements. This
schedule has been subject to the auditing procedures applied in the audits of
the basic financial statements and, in our opinion, fairly states in all
material respects the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Chicago, Illinois
February 15, 1999
<PAGE> 36
<TABLE>
<CAPTION>
Description
Valuation and Qualifying Accounts
Balance at Charged to Costs Charged to Other Balance at end
Description Beginning of year and Expenses Accounts Deductions of year
----------- ----------------- ---------------- ---------------- ------------ -------------------
<S> <C> <C> <C> <C> <C>
Allowance for doubtful
accounts
Year ended December
31, 1996 $ 455,000 $ 39,000 -- -- $ 494,000
Year ended December
31, 1997 $ 494,000 $1,068,000 $1,124,000 -- $ 2,686,000
Year ended December
31, 1998 $2,686,000 $ 608,560 -- $(2,194,650) $ 1,100,000
</TABLE>
33
<PAGE> 37
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the 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, 1998
and 1997 and the related consolidated statements of income, stockholders' equity
and cash flows for each year in the three year period ended December 31, 1998.
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 generally accepted auditing
standards. 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
Corporation and subsidiaries as of December 31, 1998 and 1997 and the results of
their operations and their cash flows for each year in the three year period
ended December 31, 1998 in conformity with generally accepted accounting
principles.
ARTHUR ANDERSEN LLP
Chicago, Illinois
February 15, 1999
F-1
<PAGE> 38
RACING CHAMPIONS CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
as of December 31, 1998 and 1997
<TABLE>
<CAPTION>
December 31,
1998 1997
------------- -------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 6,242,149 $ 6,903,864
Restricted cash - 3,300,000
Accounts receivable, net of allowance for doubtful
accounts of $1,100,000 and $2,686,000 22,079,678 12,179,247
Other receivable 129,212 -
Inventory 14,227,795 4,411,580
Deferred and prepaid taxes 801,763 712,813
Prepaid expenses 3,573,556 1,732,836
-------------------------------
Total current assets 47,054,153 29,240,340
Property and equipment:
Tooling 14,233,994 9,962,090
Other equipment 5,369,794 3,116,510
-------------------------------
19,603,788 13,078,600
Less- Accumulated depreciation (6,369,639) (3,129,961)
-------------------------------
13,234,149 9,948,639
Property held for sale 152,564 575,001
Excess purchase price over net assets acquired, net 99,726,572 101,569,087
Deferred financing costs - 1,679,791
Other assets 337,050 254,625
-------------------------------
Total assets $ 160,504,488 $ 143,267,483
===============================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 9,627,308 $ 5,899,375
Accrued expenses 6,674,031 7,450,949
Accrued royalties 4,958,052 3,247,232
Due to stockholders - 5,250,000
Line of credit 12,000,000 7,229,776
Current maturities of term notes 4,375,000 4,215,783
-------------------------------
Total current liabilities 37,634,391 33,293,115
Term notes, less current maturities 17,625,000 17,740,397
Deferred income taxes 2,663,255 630,210
-------------------------------
Total liabilities 57,922,646 51,663,722
Stockholders' equity:
Common stock, voting, $.01 par value, 28,000,000 shares authorized, 16,060,998
issued and outstanding at December 31, 1998 and 20,000,000 shares authorized,
15,960,794 shares issued and outstanding at December 31, 1997
160,610 159,608
Stock warrants outstanding 2,376,040 2,376,040
Additional paid-in capital 85,252,973 84,235,074
Retained earnings 14,792,219 4,833,039
-------------------------------
Total stockholders' equity 102,581,842 91,603,761
Total liabilities and stockholders' equity $ 160,504,488 $ 143,267,483
===============================
</TABLE>
The accompanying notes are an integral part of these consolidated balance
sheets.
F-2
<PAGE> 39
RACING CHAMPIONS CORPORATION AND SUBSIDIARIES
Consolidated Statements of Income
For the Years ended December 31, 1998, 1997, and 1996
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Net sales $156,463,996 $83,744,964 $56,908,028
Cost of sales, related party 8,218,345 5,242,441 3,990,651
Cost of sales, other 62,631,886 33,399,973 21,943,100
------------------------------------------
Gross profit 85,613,765 45,102,550 30,974,277
Selling, general and administrative expenses 54,302,304 29,624,815 17,336,761
Merger-related costs 5,525,695 - -
Amortization of intangible assets 2,663,278 2,216,278 1,539,101
------------------------------------------
Operating income 23,122,488 13,261,457 12,098,415
Interest expense 2,750,781 5,219,853 6,780,129
Other expense 399,499 200,401 153,471
------------------------------------------
Income before income taxes 19,972,208 7,841,203 5,164,815
Income tax expense 8,231,028 3,305,892 1,793,495
------------------------------------------
Net income from continuing operations before extraordinary
item 11,741,180 4,535,311 3,371,320
Discontinued operations, net of tax benefit of $428,000 - 1,032,080 -
Extraordinary charge for early extinguishment of debt, net
of tax benefit of $1,188,000 1,782,000 - -
==========================================
Net income $ 9,959,180 $3,503,231 $ 3,371,320
==========================================
Dividends accrued on preferred stock - 478,422 656,040
------------------------------------------
Net income available to common stockholders $ 9,959,180 $3,024,809 $ 2,715,280
==========================================
Pro forma income tax expense (unaudited) 328,045
-----------
Pro forma net income $ 2,387,235
===========
Net income per share from continuing operations
Basic $0.73 $0.33 $0.29
Diluted $0.71 $0.32 $0.28
Net income per share from discontinued operations
Basic $ - $0.08 $ -
Diluted $ - $0.08 $ -
Net income per share from extraordinary item
Basic $0.11 $ - $ -
Diluted $0.11 $ - $ -
Net income per share
Basic $0.62 $0.25 $0.29
Diluted $0.61 $0.24 $0.28
Pro forma net income per share
Basic $ - $ - $0.26
Diluted $ - $ - $0.25
Weighted average shares outstanding:
Basic 15,981,952 12,279,111 9,318,340
Diluted 16,425,852 12,620,696 9,644,689
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-3
<PAGE> 40
RACING CHAMPIONS CORPORATION AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
for the Years Ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
Stockholder
Stock Additional loans &
Common Preferred Warrants Treasury Paid-in Retained notes Stockholders'
Stock Stock Outstanding Stock Capital Earnings receivable Equity
-------- --------- ----------- -------- ----------- ----------- ---------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1996 $ 14,585 $ - $ - $ - $ 388,994 $ (58,729)$ - $ 344,850
Net Income - - - - - 164,022 - 164,022
--------- --------- ----------- -------- ----------- ----------- --------- ------------
Balance, April 30, 1996,
Recapitalization 14,585 - - - 388,994 105,293 - 508,872
Net Income - - - - - 3,207,298 - 3,207,298
Issuance of stock 78,853 787 - - 8,782,383 - - 8,862,023
Treasury stock acquisition - - - (25,000) - - - (25,000)
Stockholder loan receivable - - - - - - (12,989) (12,989)
Note receivable - - - - - - (95,436) (95,436)
Treasury stock retirement - - - 25,000 (25,000) - - -
Dividends paid - - - - - (21,435) - (21,435)
Accrued dividends - 656,040 - - - (656,040) - -
--------- --------- ----------- -------- ----------- ----------- --------- ------------
Balance, December 31, 1996 93,438 656,827 - - 9,146,377 2,635,116 (108,425) 12,423,333
Distribution to Subchapter S
stockholder - - - - - (431,337) - (431,337)
Adjustment for converting from
Subchapter S to C - - - - 395,549 (395,549) - -
--------- --------- ----------- -------- ----------- ----------- --------- ------------
Balance, January 1, 1997 93,438 656,827 - - 9,541,926 1,808,230 (108,425) 11,991,996
Net income - - - - - 3,503,231 - 3,503,231
Issuance of stock in connection
with purchase of:
World of Racing, Inc. (158,100
shares) 1,581 - - - 618,419 - - 620,000
Emerald Sports Group, Inc.
(33,150 shares) 331 - - - 363,669 - - 364,000
High Performance Sports
Marketing (226,666 shares) 2,267 - - - 3,997,733 - - 4,000,000
Press Pass Partners
(306,000 shares) 3,060 - - - 4,196,940 - - 4,200,000
Initial public offering 58,850 - 739,126 - 72,734,273 - - 73,532,249
Redemption of preferred stock - (1,135,249) - - (7,861,237) - - (8,996,486)
Accrued dividends - 478,422 - - - (478,422) - -
Consolidation of World of Racing, Inc. - - - - - - 95,436 95,436
Stockholder loan repayments - - - - - - 12,989 12,989
Issuance of stock warrants to bank - - 1,647,300 - - - - 1,647,300
Stock warrants exercised 81 - (10,386) - 121,665 - - 111,360
Stock options issued - - - - 521,686 - - 521,686
--------- --------- ----------- -------- ----------- ----------- --------- ------------
Balance, December 31, 1997 159,608 - 2,376,040 - 84,235,074 4,833,039 - 91,603,761
Net income - - - - - 9,959,180 - 9,959,180
Stock issued upon option exercise 1,002 - - - 1,006,491 - - 1,007,493
Expense recognized under stock
option grant - - - - 11,408 - - 11,408
--------- --------- ----------- -------- ----------- ----------- --------- ------------
Balance, December 31, 1998 $ 160,610 $ - $ 2,376,040 $ - $85,252,973 $14,792,219 $ - $102,581,842
========= ========= =========== ========= =========== =========== ========= ============
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-4
<PAGE> 41
Racing Champions Corporation and Subsidiaries
Consolidated Statements of Cash Flows
For the years ended December 31, 1998, 1997, and 1996
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
OPERATING ACTIVITIES 1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Net income $ 9,959,180 $ 3,503,231 $ 3,371,320
Adjustments to reconcile net income to net cash
provided by operating activities-
Loss from discontinued operations - 1,032,080 -
Extraordinary item 1,782,000 - -
Depreciation 3,269,853 2,151,783 927,241
Stock option expense - 521,686 -
Provision for uncollectible accounts - 1,068,000 39,000
Interest on deferred financing costs 12,862 462,587 745,820
Write-off of unamortized goodwill related to Emerald - 364,000 -
Amortization of intangibles 2,663,278 2,216,280 1,539,099
Gain (loss) on disposition of assets - (9,530) 1,490
Deferred income taxes 1,944,095 (501,828) 884,190
Deferred interest on junior subordinated debt - 1,375,890 1,938,083
Changes in operating assets and liabilities:
Accounts receivable and other receivable (10,029,643) (5,076,821) (2,037,170)
Inventory (9,816,215) (721,594) 1,075,142
Prepaid expenses (1,840,720) (135,931) (171,963)
Accounts payable and accrued expenses 4,661,835 2,928,425 2,669,064
------------ ------------ ------------
Net cash provided by continuing operating activities 2,606,525 9,178,258 10,981,316
Net cash used in discontinued operations - (630,000) -
INVESTING ACTIVITIES
Purchase of property and equipment (6,554,852) (4,144,760) (2,474,106)
Purchase of property held for sale - (152,000) -
Proceeds from disposal of property & equipment 421,929 - -
Purchase price in excess of net assets acquired (802,421) (3,731,575) (27,781,355)
Increase in other non-current assets (215,841) - -
Payment on note receivable - - 20,000
Issuance of note receivable - (50,000) (115,436)
------------ ------------ ------------
Net cash used by investing activities (7,151,185) (8,078,335) (30,350,897)
FINANCING ACTIVITIES
Initial public offering - 73,781,027 (248,778)
Stock issued for cash - - 5,661,309
Issuance of stock upon option exercise 1,007,493 - -
Redemption of preferred stock - (7,862,000) -
Expense recognized for option grant 11,408 - -
Cash dividends paid on preferred stock - (1,134,486) -
Proceeds from bank term loans 12,002,111 8,000,000 40,000,000
Payment on bank term loans (11,948,184) (29,300,000) (3,100,000)
Net borrowings on line of credit 4,770,224 6,485,650 19,000
Proceeds from issuance of junior subordinated notes - - 21,570,570
Payment of junior subordinated notes - (39,441,054) -
Payment of deferred interest on junior subordinated notes - (3,403,651) -
Payment of senior subordinated notes - (8,020,000) -
Net (decrease)/increase in due to stockholders (5,250,000) (1,117,008) 129,011
Payment of three day notes - - (38,934,116)
Proceeds from long term debt, net of restricted cash - 6,470,783 340,047
Payments on long term debt and capital leases (10,107) (2,674,692) (48,346)
Proceeds from exercise of warrants - 111,360 -
Payment of deferred financing costs - (1,379,791) -
Distributions to Subchapter S stockholders - (431,337) (21,435)
Purchase of treasury stock - - (25,000)
Decrease in note receivable from officer - 133,747 -
Release of escrowed cash 3,300,000 - -
------------ ------------ ------------
Net cash provided by financing activities 3,882,945 218,548 25,342,262
Net (decrease)/increase in cash and cash equivalents (661,715) 688,471 5,972,681
Cash and cash equivalents, beginning of year 6,903,864 6,215,393 242,712
------------ ------------ ------------
Cash and cash equivalents, end of year $ 6,242,149 $ 6,903,864 $ 6,215,393
============ ============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest during the year $ 2,621,554 $ 7,180,416 $ 5,461,029
Cash paid for taxes during the year $ 6,820,559 $ 1,792,649 $ 4,339,689
SUPPLEMENTAL NON-CASH INVESTING AND FINANCING ACTIVITIES:
Proceeds from long term debt placed in escrow $ - $ 3,330,000 $ -
Debt incurred in conjunction with acquisitions $ - $ 5,250,000 $ -
Stock issued to affect acquisitions $ - $ 8,200,000 $ 3,200,713
Issuance of junior subordinated notes for acquisitions $ - $ - $ 17,870,484
Issuance of senior subordinated notes for acquisitions $ - $ - $ 8,020,000
Issuance of three day notes for acquisitions $ - $ - $ 38,934,116
Issuance of stock and junior subordinated note to officer for $ - $ - $ 120,758
note receivable
Capital lease obligations $ - $ - $ 314,834
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-5
<PAGE> 42
RACING CHAMPIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1. DESCRIPTION OF BUSINESS:
Founded in 1989, Racing Champions Corporation ("RCC") and its Subsidiaries,
Racing Champions, Inc. ("RCI") and Racing Champions South, Inc. ("RCS")
(collectively "the Company"), is a leading producer and marketer of racing
die-cast replicas sold at major North American retail outlets. The Company has
leveraged its retail presence and its relationship with NASCAR to become a
designer and marketer of an extensive line of NASCAR products, which in addition
to die-cast racing replicas consists of Press Pass trading cards, apparel and
souvenirs. The Company has also broadened its offering of die-cast collectibles
to include high profile, vehicle replicas including World Championship Wrestling
and Sony "Signature" licenses. The Company has license agreements with major
U.S. automotive manufacturers and most of the major motorsport 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. Racing Champions Limited ("RCL"),
a wholly owned subsidiary of RCI, oversees the production of the Company's
products.
2. RECAPITALIZATION
On April 30, 1996, an investor group consummated a recapitalization (the
"Recapitalization") which involved the following: (a) the Company's purchase of
all of the outstanding stock of RCI and substantially all of the assets of
Dods-Meyer, Ltd. ("DML") (collectively the "RCI Group"); (b) the acquisition by
Banerjan Company Limited (subsequently renamed Racing Champions Limited), of
substantially all of the assets of Racing Champions Limited, Garnett Services,
Inc. and Hosten Investment Limited (collectively the "RCL Group"); and (c) the
contribution by the Company of all the outstanding stock of the Hong Kong
subsidiary to RCI.
The Recapitalization was financed with $40,000,000 of bank borrowings and the
issuance to management and the investor group of $8,020,000 of Senior
Subordinated Notes, $38,245,820 of Series A Junior Subordinated Notes,
$1,195,233 of the Company's Series B Preferred Stock, $118,840 of the Company's
Nonvoting Common Stock and $881,160 of the Company's Common
F-6
<PAGE> 43
Stock. All subordinated notes were paid in full in conjunction with the
Company's initial public offering in June of 1997.
The acquisitions were accounted for using the purchase method of accounting. The
excess purchase price over the book value of the net assets acquired was
$93,547,442. Of this excess $88,663,805 has been recorded as an intangible asset
and is being amortized on a straight-line basis over forty years and $4,883,637
was recorded as inventory and property and equipment.
3. STATEMENT OF SIGNIFICANT ACCOUNTING POLICIES:
Principles of Consolidation and Foreign Currency Translation/Transactions
The financial statements consolidate the accounts of RCC and its wholly owned
subsidiaries. All intercompany items and transactions have been eliminated. The
consolidated statement of income for 1996 contains amounts for twelve months of
Wheels (see note 5) and eight months of RCC, as RCC did not commence business
until May 1, 1996.
Foreign subsidiary assets and liabilities are 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.
Accordingly, exchange gains and losses resulting from translations for the years
ended December 31, 1998, 1997 and 1996 were insignificant, however, if they were
significant, the Company would have recorded such gains and losses as other
comprehensive income and expense.
Transactions in foreign currencies are translated into the local currency at the
rates which prevailed at the time of the transactions. Gains and losses on
foreign currency transactions are included in income. For the years ended
December 31, 1998, 1997 and 1996, gains and losses of such transactions were
insignificant.
Revenue Recognition
The Company recognizes revenue based upon transfer of title of product to
customers. The Company provides for estimated credit and other price
concessions.
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 valued at market
prices.
F-7
<PAGE> 44
Use of Estimates
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
Inventory
Inventory consists of finished goods and is stated at the lower of cost or
market. Cost is determined by the first-in, first-out method, and market
represents the lower of replacement cost or estimated net realizable value.
Income Taxes
The Company accounts for income taxes under Statement of Financial Accounting
Standards (SFAS) No. 109, "Accounting for Income Taxes." Under 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.
For periods prior to 1997 Wheels did not include a provision for income taxes
because the taxable income or loss was included in the income tax returns of the
individual shareholders under the Subchapter S corporation election. Wheels
converted to Subchapter C corporation status effective January 1, 1997 and as a
result the retained earnings at January 1, 1997 were reclassified to additional
paid-in-capital. For informational purposes, the consolidated statement of
income for the year ended December 31, 1996 includes a pro forma income tax
provision on taxable income for financial reporting purposes using statutory
federal and state rates that would have resulted if Wheels had filed corporate
tax returns during 1996.
Property and Equipment
Property and equipment are recorded at cost. Depreciation is computed using the
straight-line method for financial statement purposes. Accelerated methods are
used for income tax purposes. The estimated useful lives used in computing
depreciation for financial statement purposes are as follows:
F-8
<PAGE> 45
<TABLE>
<CAPTION>
Asset Descriptions Estimated Useful Life
------------------ ---------------------
<S> <C>
Tooling 4-8 years
Furniture and office equipment 7 years
Leasehold improvements 3-10 years
Computer systems 5 years
Vehicles 7 years
==========
</TABLE>
Property Held for Sale
Property held for sale consists of land and related improvements at December 31,
1998 and also included a building at December 31, 1997. Property held for sale
is stated at the lower of cost or estimated net realizable value.
Excess Purchase Price Over Net Assets Acquired
Excess of purchase price over net assets acquired (goodwill) is amortized over
40 years on a straight-line basis and is tax deductible over 15 years. The
Company periodically evaluates the carrying value of goodwill for possible
impairment based upon expected future undiscounted operating cash flows.
Amortization expense relating to excess of purchase price over the net assets
for the years ended December 31, 1998, 1997, and 1996 was approximately,
$2,700,000, $2,200,000 and $1,500,000, respectively.
Other Assets
Other assets at December 31, 1998 and 1997 consist primarily of refundable
deposits for leased vehicles.
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 in which there
were two customers accounting for approximately 14% and 12% of net sales for the
year ended December 31, 1998 and three customers accounting for approximately
22%, 16%, and 11% of net sales for the year ended December 31, 1997, and 19%,
17%, and 15% of net sales for the year ended December 31, 1996. Additionally, at
December 31, 1998 three customers accounted for approximately 16%, 15%, and 10%
of accounts receivable and at December 31, 1997 four customers accounted for
approximately 16%, 16%, 12% and 11% of accounts receivable. The Company does not
require collateral or other security to support customers' receivables. The
Company conducts periodic reviews of its customers' financial
F-9
<PAGE> 46
conditions and vendor payment practices to minimize collection risks on trade
accounts receivable. The Company has purchased insurance which covers a portion
of its receivables from major customers.
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 amounts of the Company's lines of credit, notes and other payables
approximate their fair values either due to their short-term nature, the
variable rates associated with these debt instruments or based on current rates
offered to the Company for debt with similar characteristics.
Advertising
The Company expenses the production costs of advertising the first time the
advertising takes place except for direct-response advertising, which is
capitalized and amortized over its expected period of future benefits (12-24
months). At December 31, 1998, $1,140,642, of direct-response advertising was
included in prepaid expenses. Direct-response advertising expensed for the year
ended December 31, 1998 was $1,350,899.
Accounting for Stock-Based Compensation
With respect to stock options granted to employees, SFAS No. 123 permits
companies to continue using the accounting method promulgated by the Accounting
Principles Board Opinion No. 25 ("APB No. 25") "Accounting for Stock Issued to
Employees, " to measure compensation or to adopt the fair value based method
prescribed by SFAS No. 123. The Company has elected to continue to measure
compensation cost under APB No. 25. If the APB No. 25 method is continued, pro
forma disclosures are required as if SFAS No. 123 accounting provisions were
followed.
Net Income Per Share
In December, 1997, the Company adopted SFAS No. 128, "Earnings Per Share". The
following table discloses the provisions set forth in SFAS No. 128:
F-10
<PAGE> 47
<TABLE>
<CAPTION>
Net Weighted Per-Share
For the year ended December 31, 1998 Income Average Shares Amount
- ------------------------------------ ------ -------------- ---------------
<S> <C> <C> <C>
Basic net income per share:
Net income available to common stockholders $9,959,180 15,981,952 $ 0.62
Plus effect of dilutive securities
Stock options and warrants --- 443,900 -
- ------------------------------------------------------------------------------------------------------------------------
Diluted net income per share:
Net income available to common stockholders plus
assumed conversions $9,959,180 16,425,852 $ 0.61
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
Options and warrants to purchase 611,114 shares of common stock at prices
ranging from $11.27 to $16.18 were outstanding during 1998 but were not
included in the computation of diluted earnings per share because the
options' and warrants' exercise price was greater than the average market
price of the common shares.
<TABLE>
<CAPTION>
Net Weighted Per-Share
For the year ended December 31, 1997 Income Average Shares Amount
- ------------------------------------ ------ -------------- ---------------
<S> <C> <C> <C>
Basic net income per share:
Net income available to common stockholders $3,024,809 12,279,111 $ 0.25
Plus effect of dilutive securities
Stock options and warrants --- 341,585 -
- ------------------------------------------------------------------------------------------------------------------------
Diluted net income per share:
Net income available to common stockholders plus
assumed conversions $3,024,809 12,620,696 $ 0.24
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
Options and warrants to purchase 505,366 shares of common stock at prices
ranging from $13.48 to $16.18 per share were outstanding during 1997 but were
not included in the computation of diluted earnings per share because the
options' and warrants' exercise price was greater than the average market price
of the common shares.
F-11
<PAGE> 48
<TABLE>
<CAPTION>
Net Weighted Per-Share
For the year ended December 31, 1996 Income Average Shares Amount
- ------------------------------------ ------ -------------- ---------
<S> <C> <C> <C>
Basic net income per share:
Net income available to common stockholders $ 2,715,280 9,318,340 $ 0.29
Plus effect of dilutive securities
Stock options - 326,349 -
- ------------------------------------------------------------------------------------------------------------------------
Diluted net income per share:
Net income available to common stockholders plus
assumed conversions $ 2,715,280 9,644,689 $ 0.28
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
Reclassifications
Certain prior year amounts have been reclassified to conform with the current
year presentation.
4. BUSINESS SEGMENT
In January 1998, the Company adopted SFAS No. 131, "Disclosure About Segments of
an Enterprise and Related Information." The Company has no separately reportable
segments in accordance with this standard. Under the enterprise wide disclosure
requirements of SFAS 131, the Company reports net sales, in thousands, by each
group of product lines and by distribution channel. Amounts for the year ended
December 31, 1998 are as shown in the tables below. Information for the years
ended December 31, 1997 and 1996 is not available.
<TABLE>
<CAPTION>
<S> <C>
Collectible die-cast $118,658
Other collectibles 13,039
Apparel and souvenirs 24,767
- -------------------------------------------------------------------------
Net Sales $156,464
- -------------------------------------------------------------------------
Mass retail $107,301
Wholesale and trackside 28,392
Premium/promotional 12,320
Direct and other 8,451
- -------------------------------------------------------------------------
Net Sales $156,464
- -------------------------------------------------------------------------
</TABLE>
F-12
<PAGE> 49
5. BUSINESS COMBINATIONS
RACING CHAMPIONS CORPORATION AND WHEELS SPORTS GROUP, INC.
On June 12, 1998, a subsidiary of the Company merged with Wheels Sports Group,
Inc. ("Wheels"), subsequently renamed Racing Champions South, Inc. The merger
was effected by exchanging 2.7 million shares of the Company's common stock for
all of the common stock of Wheels. Each share of Wheels was exchanged for 0.51
shares of the Company's common stock. In addition, outstanding Wheels' warrants
and stock options were converted at the same exchange ratio into warrants and
options to purchase the Company's common stock.
The merger has been accounted for as a pooling-of-interests. Accordingly, all
prior period consolidated financial statements presented have been restated to
include the results of operations, financial position and cash flows of Wheels
as though it had always been a part of the Company. Certain reclassifications
were made to the Wheels financial statements to conform to the Company's
presentations.
The results of operations for the separate companies and the combined amounts
presented in the consolidated financial statements follow.
F-13
<PAGE> 50
<TABLE>
<CAPTION>
(amounts in thousands) Six months
ended Year ended Year ended
June 30, 1998 December 31, 1997 December 31, 1996
------------- ----------------- -----------------
<S> <C> <C> <C>
Net sales:
Racing Champions $ 48,855 $ 76,562 $ 49,385
Wheels 23,856 7,491 7,523
Intercompany sales (1,379) (308) ---
-------- -------- --------
$ 71,332 $ 83,745 $ 56,908
======== ======== ========
Net income:
Racing Champions $ 4,212 $ 7,875 $ 2,551
Wheels (includes $1.6 million of
merger costs and $1.8 million of
extraordinary charges, net of income
taxes) (2,286) (6,792) 820
Intercompany eliminations
and tax adjustments (81) 2,421 ---
-------- -------- --------
$ 1,845 $ 3,504 $ 3,371
======== ======== ========
</TABLE>
In connection with the merger, the Company recorded a second quarter charge to
operating expenses of $5.5 million ($3.3 million after taxes, or $0.20 per
diluted common share) for direct and other merger related costs of $2.1 million
and $3.4 million pertaining to restructuring of the Companies' combined
operations.
Merger transaction costs consisted primarily of fees for investment bankers of
approximately $0.6 million, professional advisers including legal and accounting
of approximately $0.9 million and financial printing and other related costs of
approximately $0.6 million. Restructuring costs included primarily severance for
terminated employees of approximately $1.1 million, agreement extension costs of
approximately $1.5 million and facility and other exit costs of approximately
$0.8 million. These costs were expended by the Company prior to December 31,
1998.
DIAMOND SPORTS GROUP, INC. AND GREEN'S RACING SOUVENIRS, INC.
On June 30, 1997, Wheels acquired 100% of the common stock of Diamond Sports
Group, Inc. ("Diamond") a privately-held corporation located in Charlotte, North
Carolina, in exchange for 485,000 shares of the Wheels' common stock. Diamond is
engaged in merchandising NASCAR-oriented products and providing motorsports
related hospitality management and corporation promotions.
On October 4, 1997, Wheels acquired 100% of the common stock of Green's Racing
Souvenirs, Inc. ("GRS"), a privately-held company located in South
F-14
<PAGE> 51
Boston, Virginia, in exchange for 175,000 shares of the Wheels' common stock.
Green's is engaged in merchandising NASCAR-oriented racing souvenirs at race
tracks and by mail.
The Diamond and GRS transactions constituted tax-free reorganizations and each
has been accounted for using the pooling-of-interests method of accounting for
business combinations. Accordingly, all prior period consolidated financial
statements have been restated to include the combined results of operations,
financial position and cash flows of Diamond and GRS. There were no material
transactions between or among Diamond, GRS and Wheels prior to the combination.
Certain reclassifications have been made to Diamond's and GRS' financial
statements to conform to the Company's basis of presentation.
WORLD OF RACING, INC.
Wheels acquired World of Racing, Inc. ("WOR") through a wholly owned subsidiary
on January 28, 1997, by exchanging 310,000 shares of the Wheels' common stock
valued at $620,000 for 100% of the common stock of WOR. WOR was a privately-held
South Carolina corporation incorporated in August 1996 to operate a fantasy race
game. The transaction resulted in WOR becoming a wholly-owned subsidiary of
Wheels.
Effective June 30, 1997, Wheels' Board of Directors voted to discontinue the
operations of WOR and dispose of its assets. The acquisition of WOR was
originally accounted for as a pooling-of-interests, but the discontinuance of
its operations required the use of purchase accounting. The $561,914 unamortized
goodwill, along with property plant and equipment with a net book value of
approximately $132,000, were written off as of June 30, 1997. In addition, on
June 30, 1997, Wheels recorded estimated operating losses from June 30, 1997,
through the end of the phase-out period of approximately $222,000. Net
liabilities of WOR at December 31, 1997, amounted to approximately $116,000 and
are included in accrued expenses on the accompanying consolidated balance sheet.
The loss from operations and the loss on disposition are presented as
discontinued operations on the accompanying consolidated statement of operations
for the year ended December 31, 1997. Net sales of WOR amounted to approximately
$174,000 for the year ended December 31, 1997.
EMERALD SPORTS GROUP, INC.
On August 5, 1997, Wheels acquired 100% of the common stock of Emerald Sports
Group, Inc. ("Emerald") a recently formed privately-held corporation located in
Charlotte, North Carolina, in exchange for 65,000 shares of Wheels' common stock
valued at $364,000. The transaction was accounted for as a
F-15
<PAGE> 52
purchase and resulted in excess purchase price over the fair value of net assets
acquired of approximately $408,000.
In December 1997, Wheels decided to merge the operations of Emerald into those
of Diamond and to dispose of substantially all of Emerald's assets, with the
exception of inventory, as of December 31, 1997. As a result of the disposition
of substantially all of Emerald's assets and the discontinuance of its
operations, Wheels recorded a provision to reflect the impairment of
unamortized goodwill related to the Emerald acquisition of approximately
$364,000, which is included in other expense on the accompanying consolidated
statement of operations for the year ended December 31, 1997. In addition, costs
totaling approximately $200,000 (including $150,000 for severance of a
terminated employee and $50,000 in facility and other exit costs) were accrued
at December 31, 1997, and subsequently paid in 1998.
HIGH PERFORMANCE SPORTS MARKETING, INC.
Effective October 24, 1997, Wheels consummated the acquisition of High
Performance Sports Marketing, Inc. ("High Performance"). High Performance is
engaged in the merchandising of NASCAR apparel and souvenirs through mass market
retailers and convenience stores. The transaction was accounted for as a
purchase and resulted in excess purchase price over the fair value of net assets
acquired (assets acquired were approximately $2,349,000 and liabilities assumed
were approximately $1,709,000) of approximately $9,432,000. Consideration paid
by Wheels consisted of cash in the amount of $1,672,000, promissory notes
totaling $1,000,000, and 444,444 shares of Wheels' common stock valued at
$4,000,000. In addition, the terms of the purchase agreement between High
Performance and Wheels required an additional cash payment to be made at closing
of $3,250,000 (the "Additional Cash Consideration"). Payment of the Additional
Cash Consideration was paid out of escrowed funds ("Escrowed Funds") established
in connection with Wheels' Credit Facility obtained December 31, 1997. Escrowed
funds are shown as restricted cash on the accompanying consolidated balance
sheet at December 31, 1997. In December 1997, certain officers and directors of
Wheels executed a pledge agreement under which an aggregate of approximately
1,000,000 shares of personally-owned stock of Wheels was pledged to secure
payment of the Additional Cash Consideration.
In April 1998, Wheels negotiated the release of $500,000 of Escrowed Funds as
partial satisfaction of the Additional Cash Consideration. In addition, Wheels
agreed to pay an extension fee of $450,000 to the former High Performance
stockholders, $250,000 of which was paid on April 22, 1998. The remaining
$200,000 was paid on June 12, 1998 along with the remainder of the Additional
Cash Consideration.
F-16
<PAGE> 53
PRESS PASS PARTNERS
Effective December 31, 1997, Wheels consummated the acquisition of Press Pass
Partners, ("Press Pass") through a transaction in which the two corporate
partners of Press Pass were merged into two newly formed subsidiaries of the
Company. Press Pass is a designer and marketer of collectible trading cards
featuring NASCAR and other sports personalities. The transaction was accounted
for as a purchase and resulted in excess purchase price over the fair value of
net assets acquired (assets acquired were approximately $2,074,000 and
liabilities assumed were $1,544,000) of approximately $7,812,000. Consideration
paid by Wheels consisted of cash of $3,100,000, promissory notes totaling
$1,000,000, and 600,000 shares of Wheels' common stock valued at $4,200,000.
6. INCOME TAXES:
For financial reporting purposes, income before income taxes includes the
following components:
<TABLE>
<CAPTION>
Year Year Year
Ended Ended Ended
December 31, December 31, December 31,
1998 1997 1996
----------------------------------------------
<S> <C> <C> <C>
Pretax income:
United States......................................... $ 19,773,490 $ 7,696,151 $ 5,067,955
Foreign............................................... 198,718 145,052 96,860
---------------------------------------------
$ 19,972,208 $ 7,841,203 $ 5,164,815
=============================================
<CAPTION>
The significant components of income tax expense are as follows:
Year Year Year
Ended Ended Ended
December 31, December 31, December 31,
1998 1997 1996
------------------------------------------------
<S> <C> <C> <C>
Current
Federal.......................................... $ 5,018,002 $ 2,733,091 $ 749,095
State............................................. 716,857 482,310 160,210
Foreign.......................................... 2,716 10,319 --
---------------------------------------------
5,737,575 3,225,720 909,305
Deferred
Federal.......................................... 2,179,619 44,681 759,177
State............................................. 311,374 6,383 108,454
Foreign.......................................... 2,460 29,108 16,559
---------------------------------------------
2,493,453 80,172 884,190
---------------------------------------------
Income tax expense $ 8,231,028 $ 3,305,892 $ 1,793,495
=============================================
</TABLE>
F-17
<PAGE> 54
A reconciliation of statutory Federal tax rate and actual effective income tax
rate is as follows:
<TABLE>
<CAPTION>
Year Year Year
Ended Ended Ended
December 31, December 31, December 31,
1998 1997 1996
---------------------------------------------
<S> <C> <C> <C>
Statutory rate....................................... 34.0% 34.0% 34.0%
State taxes, net of federal benefit................ 4.8 4.8 4.8
Non taxable income................................ -- -- (6.4)
Other................................................. 2.4 3.4 2.3
--------------------------------------------
Effective rate........................................ 41.2% 42.2% 34.7%
============================================
</TABLE>
The significant components of deferred tax assets and liabilities are as
follows:
<TABLE>
<CAPTION>
December 31, December 31,
1998 1997
------------------------------
<S> <C> <C>
Current deferred tax assets
Reserves and allowances........................ $ 380,573 $ 840,981
------------------------------
Total current 380,573 840,981
Noncurrent deferred tax liabilities
Intangible assets................................. (3,947,665) (2,452,634)
Property and equipment........................ (563,650) (581,906)
Operating loss carryforward..................... 1,668,493 1,576,293
Other................................................ 179,567 828,037
------------------------------
Total noncurrent (2,663,255) (630,210)
------------------------------
Net deferred tax (liabilities) assets $(2,282,682) $ 210,771
------------------------------
</TABLE>
7. DEBT
In conjunction with the Company's initial public offering, the Company revised
and amended its bank agreement on June 17, 1997. The amended credit agreement
provided for a revolving loan and a five-year term loan. The revolving loan
allowed the Company to borrow up to $5 million at any time prior to June 28,
2002, based upon levels of the Company's accounts receivable, inventory and cash
flows. At December 31, 1997 there were $5,000,000 of borrowings outstanding on
the revolving loan. The revolving loan was amended on June 11, 1998 in
conjunction with the business combination of RCC and Wheels. The amended
agreement provides for a revolving loan which allows the Company to borrow up to
$12 million at any time prior to June 30, 2003. At December 31, 1998 there was
$12,000,000 outstanding on the revolving loan.
F-18
<PAGE> 55
The term loan was amended on June 11, 1998 increasing the principal amount to
$25 million and extending the final maturity to June 30, 2003. The outstanding
balance on the term loan at December 31, 1998 was $22,000,000 of which
$4,375,000 was current, and at December 31, 1997 was $15,600,000, of which
$3,950,000 was current.
Under the terms of the Company's credit agreement, the Company is required to
comply with certain financial covenants which require the Company to achieve
certain financial ratios and place restrictions on capital expenditures. As of
December 31, 1998, the Company was in compliance of all but one covenant, for
which the Company had obtained a waiver.
Borrowings under the credit agreement bear interest, at the Company's option, at
the bank's base rate plus a margin that varies between 0.0% and 0.75% or at a
reserve adjusted Eurodollar rate plus a margin that varies between 1.5% and
2.25%. All amounts outstanding under the credit agreement are secured by
substantially all of the assets of the Company.
The Company's Hong Kong subsidiary entered into a credit agreement with a bank
that provides for a line of credit of up to $5 million. Amounts borrowed under
this line of credit bear interest at the bank's cost of funds plus 2% and are
cross-guaranteed by RCI and RCL. As of December 31, 1998 and 1997 there were no
outstanding borrowings under this line of credit.
In September 1997, the Company entered into a two-year interest rate swap
agreement with its primary lender. Under this agreement, the Company hedges on a
quarterly basis, a notional amount ranging between $7 million and $10 million
through September, 1999, at a reserve adjusted Euro-rate of 6.20%. During 1998
and 1997, the impact of this agreement was insignificant.
During 1997 Wheels had lines of credit with various banks of $1,050,000
available borrowings. The borrowings outstanding on these lines of credit as of
December 31, 1997 were $731,176. In 1998 the outstanding borrowings were paid in
full and the lines of credit were terminated.
As of December 31, 1997 Wheels had three separate notes payable to stockholders,
which were issued in connection with its previous business combinations,
discussed in Note 5. At December 31, 1997 there were $5,250,000 outstanding on
these notes payable. In 1998 these notes were paid in full.
On December 31, 1997, Wheels established a Credit Facility with Credit Agricole
Indosuez providing a $7.7 million term loan and up to $10 million in revolving
F-19
<PAGE> 56
loans. At December 31,1997, Wheels had outstanding $7,747,783 on term loan and
$1,498,600 in revolving loans. The revolving loan proceeds, together with the
existing funds of Wheels, were used to repay $2.1 million in outstanding secured
debt. Term loan proceeds of $4.4 million were used to fund the cash
consideration payable under terms of the Press Pass acquisition, and to pay
certain expenses incurred in connection with the Press Pass and High Performance
acquisitions, discussed in Note 5. Additional term loan proceeds of $3.3 million
were placed in an escrow account to fund the Additional Cash Consideration
incurred in the High Performance acquisition. Escrowed Funds, which are shown as
restricted cash in the accompanying consolidated balance sheet at December 31,
1997, were released to former stockholders upon the merger of Wheels with RCC.
In connection with establishing the Credit Facility, Wheels granted to Credit
Agricole Indosuez a warrant to purchase 509,358 shares of Wheels' common stock
at a price of $3.50 per share. The warrant is exercisable through December 31,
2007. The exercise price and number of shares to be purchased are subject, from
time to time, to certain antidilutive adjustments. Wheels recorded a discount on
long term debt obtained under the Credit Facility based on the estimated fair
value of the warrants at December 31, 1997. Wheels amortized the discount and
included it as a component of interest expense over the term of the term loans
using the effective interest rate method. Wheels also incurred financing costs,
which were deferred and amortized over the term of the Credit Facility.
All obligations outstanding under the Credit Agricole Indosuez Credit Facility
were paid in full in conjunction with the merger of Wheels and RCC, and the
related warrant was converted into a warrant to purchase the combined Company's
stock, discussed in Note 5. The unamortized discount on the debt at the time of
the merger has been recorded as an extraordinary item in the accompanying
consolidated statement of income for 1998, related to the early extinguishment
of this debt.
F-20
<PAGE> 57
Long term debt consists of the following:
<TABLE>
<CAPTION>
December 31,1998 December 31, 1997
---------------- -----------------
<S> <C> <C>
Various notes payable to banks and
financing institutions, net of unamortized
discount of $1,647,300, due in monthly $ --- $ 6,356,180
payments at interest rates ranging from
4.9% to 10.7% at December 31, 1997, paid
in full in 1998.
Term Loan payable to the bank, bearing
interest ranging from 6.6875% to 6.8125%
as of December 31, 1998, with principal
payments in amounts varying from
$1,000,000 to $1,500,000 with final 22,000,000 15,600,000
payment due June 30, 2003.
---------------- -----------------
22,000,000 21,956,180
Less --- current maturities 4,375,000 4,215,783
---------------- -----------------
$ 17,625,000 $ 17,740,397
================ =================
</TABLE>
Principal maturities of long-term debt are as follows:
<TABLE>
<CAPTION>
<S> <C> <C>
2000 $ 4,750,000
2001 5,250,000
2002 5,750,000
2003 1,875,000
----------------------------------------------------
Total long-term debt $ 17,625,000
=============
</TABLE>
8. COMMITMENTS AND CONTINGENCIES:
Rental expense under cancellable and noncancellable operating leases amounted to
approximately $1.4 million for the year ended December 31, 1998. Commitments for
future minimum lease payments with terms extending beyond one year at December
31, 1998, for noncancellable operating leases are as follows:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------
<S> <C>
1999.............................. $1,385,687
- ---------------------------------------------------------------------
2000.............................. 950,286
- ---------------------------------------------------------------------
2001.............................. 463,602
- ---------------------------------------------------------------------
2002.............................. 269,278
- ---------------------------------------------------------------------
2003.............................. 79,524
- ---------------------------------------------------------------------
Thereafter........................ $ 196,898
- ---------------------------------------------------------------------
</TABLE>
F-21
<PAGE> 58
9. 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.
In May 1997, a proposed class action lawsuit was filed against several trackside
vendors, including GRS. The complaint alleges that the defendants have engaged
in price fixing activities at certain NASCAR events in violation of federal
anti-trust laws. Plaintiffs seek an unspecified amount of compensatory and
punitive damages and also an order enjoining the alleged price fixing practices.
GRS has entered into a joint defense agreement with certain co-defendants
pursuant to which defense costs are being reimbursed by defendant Americrown
Service Corporation. The existing joint defense agreement is to remain in effect
through class certification proceedings. The Company expects that GRS will
vigorously defend against the action, although no assurances can be given as to
the outcome of this matter.
10. CAPITAL STOCK:
On April 9, 1997, the Company issued a 7.885261-for-one stock split of common
stock and increased in the number of authorized shares to 20,000,000 shares of
voting common stock and 1,000,000 shares of nonvoting common stock. The
accompanying financial statements have been retroactively adjusted to reflect
the stock split.
On June 11, 1998, in conjunction with the merger of Wheels and Racing Champions
Corporation, discussed in Note 5, the Company increased the total number of
authorized shares of common stock to 28,000,000 shares.
On June 17, 1997, the Company sold 5,357,142 shares of its common stock in an
initial public offering. The net proceeds to the Company from the sale of the
stock were approximately $69 million, after deduction of commissions and
offering expenses. Approximately $9 million of the net proceeds was used to
redeem preferred stock issued in the Recapitalization; $43 million was used to
repay stockholder notes issued in the Recapitalization; and $17 million was used
to repay bank borrowings incurred in connection with the Recapitalization. In
addition, the Company filed its Restated Certificate of Incorporation to
eliminate the preferred stock and the nonvoting common stock. All nonvoting
common stock was exchanged on a 1 for 1 basis for common stock of the Company.
F-22
<PAGE> 59
In April 1997, Wheels completed an initial public offering of 1,035,000 shares
of Wheels' common stock at a price of $6.00 per share, resulting in net proceeds
of $4,732,260. Included as part of the offering were warrants for the purchase
of an additional 517,500 shares of Wheels' common stock at an exercise price of
$7.08 per share. The warrants, which were immediately exercisable, expire in
April 2002 and may be redeemed by the Company beginning April 1998 under certain
terms and conditions at a price of $0.05 per warrant. Holders of outstanding
warrants have no voting or other rights as a stockholder of the Company. In
addition, Wheels agreed to issue and sell to the underwriter of its public
offering, for nominal consideration, warrants to purchase an aggregate of 90,000
shares of Wheels' common stock and an additional 90,000 Wheels warrants at a
price of $8.70 per Wheels common share, commencing April 1998 and expiring in
April 2003. Warrants subject to purchase under warrants issued to the
underwriter have terms identical to those sold as part of Wheels initial public
offering. Wheels assigned $739,126 of the total net proceeds of the offering to
the value of stock warrants issued.
Further, Wheels entered into an agreement with the underwriter which provided
that, if the underwriter arranged for the purchase or sale of substantially all
of the assets of Wheels, or for a merger, consolidation or acquisition accepted
by Wheels during the five-year period ending April 2002, Wheels would pay the
underwriter a fee ranging from 3% - 5% of the total consideration received. In
connection with this, Wheels agreed to pay the underwriter a consulting fee of
$70,000. This amount was accounted for as a cost of the initial public offering.
11. STOCK OPTION PLAN:
The Company has adopted a 1996 Employee Stock Option Plan for its key employees.
The Employee Stock Option Plan is administered by the Board of Directors. The
Company has reserved 415,041 shares of common stock for issuance under the plan.
On April 30, 1996 and June 1, 1996, the Company granted 311,281 and 20,752
options, respectively, to purchase shares of common stock at an exercise price
equal to fair market value as determined by the Board of Directors in connection
with the Recapitalization. These options vest equally 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.
In April, 1997 the Company adopted the Racing Champions Corporation Stock
Incentive Plan, under which the Board of Directors may grant options to purchase
up to 311,852 shares of common stock to executives or key employees of the
Company. In 1997, the Company granted 185,753 options to purchase shares of
common stock at an exercise price equal to fair market value. In 1998 this plan
F-23
<PAGE> 60
was amended to allow the granting of options to purchase up to 600,000 shares of
common stock. In 1998 the Company granted options to purchase 390,601 shares.
Part of these options 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.
As part of the merger with Wheels, the Company adopted the Wheels 1996 Omnibus
Stock Plan, under which the Company has 400,000 shares of its common stock
reserved for issuance under this plan. In 1997, 254,940 options to purchase
shares of the Company's common stock were granted.
Stock option activity for the Company's stock option plans for the years ended
December 31, 1996, 1997 and 1998, is as follows:
<TABLE>
<CAPTION>
Weighted Shares
Average Available for
Exercise Future
1996 Shares Price Price Grants
- ---- ------ ------ -------- -------------
<S> <C> <C> <C> <C>
Granted 332,033 $ 0.13 $ 0.13
Exercised -- -- --
Cancelled -- -- --
--------
Outstanding as of December 31,
1996 332,033 483,008
1997
Granted 440,693 $9.84 - $16.18 $12.91
Exercised -- -- --
Canceled 1,275 $ 11.57 $11.57
--------
Outstanding as of December 31,
1997 771,451 643,590
</TABLE>
F-24
<PAGE> 61
<TABLE>
<CAPTION>
Weighted Shares
Average Available for
Exercise Future
Shares Price Price Grants
------ ------ -------- -------------
<S> <C> <C> <C> <C> <C>
1998
- ----
Granted 390,601 $9.187 - $13.50 $ 11.35
Exercised 100,204 $ 0.13 - $14.00 $ 10.05
Cancelled 195,116 $ 9.84 - $16.18 $ 12.61
-------
Outstanding as of December 31,
1998 866,732 448,105
</TABLE>
The following table summarizes information about stock options outstanding at
December 31,1998:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
--------------------------------------------------------- ----------------------------
Range of Weighted-Average Weighted- Weighted-
Exercise Number Remaining Average Number Average
Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price
-------- ----------- ---------------- -------------- ----------- --------------
<S> <C> <C> <C> <C> <C>
$0.13 328,033 7.3 $ 0.13 128,813 $ 0.13
$9.19 to
$9.84 61,920 8.6 $ 9.68 46,920 $ 9.84
$11.00 to
$16.18 476,779 8.0 $12.67 212,993 $13.20
</TABLE>
F-25
<PAGE> 62
Had compensation costs for the stock options issued been determined based on the
fair value at their grant date consistent with SFAS No. 123, the Company's net
income and earnings per share would have been reduced to the following pro forma
amounts:
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Net Income available to
common stockholders
As reported $9,959,180 $3,024,809 $2,715,280
Pro forma $9,558,193 $2,532,114 $2,713,607
Basic net income per share
As reported $ 0.62 $ 0.25 $ 0.29
Pro forma $ 0.60 $ 0.21 $ 0.29
Diluted net income per share
As reported $ 0.61 $ 0.24 $ 0.28
Pro forma $ 0.58 $ 0.20 $ 0.28
</TABLE>
The fair value of each option is estimated on the date of grant based on the
Black-Scholes option pricing model assuming, among other things, no dividend
yield, risk free rates of return from 4.7% to 7.0%, volatility factors of 41% to
60%, and expected life of 7 to 10 years. The weighted average fair value of
options granted under the Company's stock plan for the years ended December 31,
1998, 1997 and 1996 was $6.98, $6.91 and $6.91 per share, respectively.
The pro forma disclosure is not likely to be indicative of pro forma results
which 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.
12. RELATED PARTY TRANSACTIONS
The Company purchased $8,218,345, $5,242,441, and $3,990,651 of product during
1998, 1997 and 1996, respectively from a company controlled by a relative of one
of the Company's stockholders.
During 1996, an officer of the Company held ownership interests in two of the
Company's suppliers. These interests were disposed of by December 31, 1996.
During 1996, the Company paid $5,553,383 and $5,666,247 to these suppliers,
respectively, for purchases of die cast vehicle replicas.
F-26
<PAGE> 63
The Company leases warehouse space from a party related to an officer/director
of the Company. Rent expense for the years ended December 31, 1998, 1997, and
1996 was $82,120, $68,814, and $41,440 respectively.
RCS leases certain buildings which are owned by stockholders and/or directors of
the Company. These leases are accounted for as operating leases and have terms
from 1 to 5 years. The Company incurred rental expense on these leases of
$51,598 and $15,400 during the years ended December 31, 1997 and 1996,
respectively. In 1998 the lessor is no longer a related party.
RCS entered into a lease for a building on October 1, 1996, with a company owned
by three of the former stockholders of Diamond. The lease term was for three
years with an option to purchase the building during the lease term and a
mandatory purchase requirement at the end of 1999. The lease was capitalized
using a rate of 9%. Minimum monthly lease payments were $2,400. Lease payments,
representing interest, made during the years ended December 31, 1997 and 1996,
were $19,200 and $9,200. In August 1997, the Company exercised its right to
purchase the building for approximately $308,000; accordingly, the capital lease
obligation has been removed from the books at December 31, 1997. In 1998, the
Company sold the building for approximately the net book value.
During the year ended December 31, 1996, the Company leased office space from a
party related to a director of the Company. Rent expense for the year ended
December 31, 1996 was $241,036.
The Company pays sales commissions to an external sales representative
organization, of which one of the principals of this organization is a relative
of an officer/director of the Company. For the years ended December 31, 1998,
1997, and 1996, commissions of $283,226, $168,239 and $85,393, respectively were
allocated to the related principal.
13. EMPLOYEE BENEFIT PLAN
The Company adopted a 401(k) savings plan as of December, 1996, which became
effective on January 1, 1997. Employees meeting certain eligibility
requirements, as defined, may contribute up to 15% of pre-tax gross wages,
subject to certain restrictions. The Company will make matching contributions of
50% of the employees contributions up to 5% of employee wages. In 1998 and 1997
the Company's contributions were approximately $94,000 and $46,000 respectively.
F-27
<PAGE> 64
14. SUBSEQUENT EVENT
On February 1,1999, the Company announced that they had signed a letter of
intent to acquire The Ertl Company, Inc., a wholly-owned subsidiary of U.S.
Industries, Inc. The acquisition, which is subject to due diligence, completion
of a definitive purchase agreement, regulatory approvals and other customary
closing conditions, is expected to close in April 1999. It is expected that the
transaction will be accounted for under the purchase method of accounting.
F-28
<PAGE> 1
EXHIBIT 23
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation by
reference of our report dated February 15, 1999 included in this Form 10-K/A
into the Company's previously filed Registration Statements on Form S-8 (File
Nos. 333-50957, 333-50959, 333-58037 and 333-58035 and the Registration
Statement on Form S-8 to be filed on June 28, 1999) and on Form S-3 (File No.
333-71629).
/s/ Arthur Andersen LLP
ARTHUR ANDERSEN LLP
Chicago, Illinois
June 25, 1999
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