RACING CHAMPIONS CORP, 10-Q, 1999-08-16

RACING CHAMPIONS CORP
10-Q, 1999-08-16
MISC DURABLE GOODS

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<PAGE>

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

FORM 10-Q

(Mark One)
/x/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 1999

/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _______ to _________

Commission file number: 0-22635
-------------

Racing Champions Corporation
-------------------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)

Delaware 36-4088307
-------- ----------
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)

800 Roosevelt Road, Building C, Suite 320, Glen Ellyn, IL 60137
---------------------------------------------------------------
(Address of principal executive offices)

Registrant's telephone number, including area code: 630-790-3507

Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by sections 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
---- ------

On June 30, 1999, there were outstanding 16,407,781 shares of the Registrant's
$.01 par value common stock.

<PAGE>

RACING CHAMPIONS CORPORATION

FORM 10-Q

JUNE 30, 1999

INDEX

PART I - FINANCIAL INFORMATION
Page
Item 1. Consolidated Balance Sheets as of June 30, 1999 and
December 31, 1998 3

Consolidated Statements of Operations for the Three Months Ended
June 30, 1999 and 1998 and for the Six Months Ended
June 30, 1999 and 1998 4

Consolidated Statements of Cash Flows for the Six Months
Ended June 30, 1999 and 1998 5

Notes to Unaudited Consolidated Financial Statements 6

Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 10

Item 3. Quantitative and Qualitative Disclosures about Market Risk 15

PART II - OTHER INFORMATION

Item 1. Legal Proceedings 16

Item 2. Changes in Securities and Use of Proceeds 16

Item 3. Defaults Upon Senior Securities 16

Item 4. Submission of Matters to a Vote of Security Holders 16

Item 5. Other Information 17

Item 6. Exhibits and Reports on Form 8-K 17

Signatures 19

<PAGE>

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

RACING CHAMPIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>

June 30, 1999 December 31, 1998
------------------ ------------------
(Unaudited) (Unaudited)
<S> <C> <C>
ASSETS:
- - ------------------------------------------
Cash and cash equivalents. . . . . . . . . $ 9,139 $ 6,242
Accounts receivable, net . . . . . . . . . 49,687 22,208
Inventory, net . . . . . . . . . . . . . . 47,433 14,228
Other current assets . . . . . . . . . . . 13,610 4,376
Property and equipment, net . . . . . . . 38,064 13,387
Excess purchase price over net assets
acquired, net . . . . . . . . . . . . . 137,067 99,726
Other non-current assets . . . . . . . . . 4,230 337
------------------ ------------------
Total assets . . . . . . . . . . . . . . . $ 299,230 $ 160,504
================= ==================
LIABILITIES AND STOCKHOLDERS' EQUITY:
- - ------------------------------------------
Accounts payable and accrued expenses . .. $ 48,934 21,259
Bank term loans . . . . . . . . . . . . . 115,000 22,000
Line of credit . . . . . . . . . . . . . . 21,300 12,000
Other liabilities . . . . . . . . . . . . 11,786 2,663
----------------- ------------------
Total liabilities. . . . . . . . . . . . . 197,020 57,922
Stockholders' equity . . . . . . . . . . . 102,210 102,582
------------------ ------------------
Total liabilities and stockholders' equity $ 299,230 $ 160,504
================= ==================
</TABLE>

See accompanying notes to consolidated financial statements.

<PAGE>

RACING CHAMPIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

For the three months ended June 30, For the six months ended June 30,
-------------------------------------- --------------------------------------
1999 1998 1999 1998
------------------ ------------------ ------------------ ------------------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Net sales . . . . . . . . . . . . . . . . . . $ 57,706 $ 42,693 $ 92,978 $ 71,332
Cost of sales . . . . . . . . . . . . . . . . 34,185 19,168 50,803 31,378
------------------- ------------------ ------------------ ------------------
Gross profit . . . . . . . . . . . . . . . . 23,521 23,525 42,175 39,954
Selling, general and administrative expenses 22,973 13,226 35,664 24,863
Amortization of intangible assets . . . . . . 917 669 1,630 1,333
Restructuring and other charges . . . . . . . 6,400 - 6,400 -
Merger related costs . . . . . . . . . . . . - 5,525 - 5,525
------------------- ------------------ ------------------ ------------------
Operating income (loss) . . . . . . . . . . . (6,769) 4,105 (1,519) 8,233
Interest expense . . . . . . . . . . . . . . 2,017 743 2,581 1,535
Other expense . . . . . . . . . . . . . . . . 9 39 69 156
------------------- ------------------ ------------------ ------------------
Income (loss) before income taxes . . . . . (8,795) 3,323 (4,169) 6,542
Income tax expense (benefit) . . . . . . . . (3,561) 1,372 (1,688) 2,703
------------------- ------------------ ------------------ ------------------
Income (loss) before extraordinary item . . . (5,234) 1,951 (2,481) 3,839
Extraordinary charge for early
extinguishment of debt, net of tax benefit
of $1,188 . . . . . . . . . . . . . . . . . - 1,782 - 1,782
------------------- ------------------ ------------------ ------------------
Net income (loss) . . . . . . . . . . . . . . $ (5,234) $ 169 $ (2,481) $ 2,057
=================== ================== ================== ==================
Net income (loss) per share before
extraordinary item:
Basic. . . . . . . . . . . . . . . . . . . $ (0.32) $ 0.12 $ (0.15) $ 0.24
=================== ================== ================== ==================
Diluted. . . . . . . . . . . . . . . . . . $ - $ 0.12 $ - $ 0.24
=================== ================== ================== ==================
Net income (loss) per share:
Basic. . . . . . . . . . . . . . . . . . . $ (0.32) $ 0.01 $ (0.15) $ 0.13
=================== ================== ================== ==================
Diluted. . . . . . . . . . . . . . . . . . $ - $ 0.01 $ - $ 0.13
=================== ================== ================== ==================
Weighted average shares outstanding:
Basic . . . . . . . . . . . . . . . . . . 16,234 15,961 16,158 15,961
Diluted . . . . . . . . . . . . . . . . . 16,279 16,292 16,636 16,289

</TABLE>

See accompanying notes to consolidated financial statements.

<PAGE>

RACING CHAMPIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)

For the six months ended June 30,
---------------------------------------
1999 1998
------------------ -------------------
(Unaudited) (Unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) . . . . . . . . . . . . . . . . . . . $ (2,481) $ 2,057
Depreciation and amortization . . . . . . . . . . . . . 4,738 2,928
Deferred taxes and interest . . . . . . . . . . . . . . 837 1,531
Gain/loss on sale of assets . . . . . . . . . . . . . . (15) -
Changes in operating assets and liabilities . . . . . . (5,497) (7,089)
------------------ -------------------
Net cash used by operating activities . . . . . . . . (2,418) (573)

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment . . . . . . . . . . (3,568) (2,984)
Proceeds from disposal of property and equipment . . . 453 -
Purchase price of Ertl, net of cash acquired . . . . . (92,997) -
Purchase price in excess of net assets acquired . . . - (554)
Increase in other non-current assets . . . . . . . . . (3,057) (195)
------------------ -------------------
Net cash used by investing activities . . . . . . . . (99,169) (3,733)

CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowing from bank, net . . . . . . . . . . . . . . . 102,300 2,632
Issuance of common stock . . . . . . . . . . . . . . . 2,319 -
Payments on acquisition loans . . . . . . . . . . . . . - (3,250)
Expense recognized under option grants . . . . . . . . 11 -
------------------ -------------------
Net cash provided (used) by financing activities . . 104,630 (618)
------------------ -------------------
Effect of exchange rate on cash . . . . . . . . . . . (146) -
Net increase (decrease) in cash and cash equivalents 2,897 (4,924)
------------------ -------------------
Cash and cash equivalents, beginning of period . . . . . 6,242 10,203
------------------ -------------------
Cash and cash equivalents, end of period . . . . . . . . $ 9,139 $ 5,279
================== ===================

Supplemental information:
Cash paid during the period for:
Interest. . . . . . . . . . . . . . . . . . . . . . . . $ 1,396 $ 960
Taxes . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,539 $ 1,450

</TABLE>

See accompanying notes to consolidated financial statements.

<PAGE>

RACING CHAMPIONS CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - BASIS OF PRESENTATION

The consolidated financial statements include the accounts of Racing Champions
Corporation ("the Company") and its wholly-owned subsidiaries. All intercompany
transactions and balances have been eliminated.

The accompanying consolidated financial statements have been prepared by
management and, in the opinion of management, contain all adjustments,
consisting of normal recurring adjustments, necessary to present fairly the
financial position of the Company as of June 30, 1999, the results of operations
for the three month and six month periods ended June 30, 1999 and the cash flows
for the six month period ended June 30, 1999.

Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been omitted. It is suggested that these consolidated financial statements
be read in conjunction with the consolidated financial statements and related
notes included in the Company's Form 10-K for the year ended December 31, 1998.

The results of operations for the three month and six month periods ended June
30, 1999 are not necessarily indicative of the operating results for the full
year.

NOTE 2 - BUSINESS COMBINATIONS

On April 13, 1999, certain subsidiaries of the Company purchased 100% of the
outstanding shares of The Ertl Company, Inc. and certain of its affiliates
("Ertl") for approximately $95 million. Ertl is one of the oldest and most
respected names in collectibles and is the market leader in both agricultural
and custom imprint die cast collectibles. This transaction has been accounted
for under the purchase method of accounting and, accordingly, the operating
results of Ertl have been included in the Company's consolidated financial
statements since the date of acquisition. The purchase was funded with a
draw-down on the Company's credit facility (Note 6). The excess of the
aggregate purchase price over the fair market value of net assets acquired of
approximately $39 million is being amortized over 40 years.

The following unaudited pro forma consolidated results of operations for the six
months ended June 30, 1999 and 1998 assume that the Ertl acquisition occurred as
of January 1 of each year (in thousands, except per share data):

<PAGE>

June 30, 1999 June 30, 1998
--------------- ---------------
<S> <C> <C>
Net sales. . . . . . . . . . . . . . . . $ 127,958 $ 140,120
Loss before extraordinary item . . . . . (4,800) (1,625)
Net loss . . . . . . . . . . . . . . . . (4,800) (3,407)
Earnings per share:
Basic. . . . . . . . . . . . . . . . . $ (0.30) $ (0.21)
Diluted. . . . . . . . . . . . . . . . -- --
</TABLE>

Pro forma data does not purport to be indicative of the results that would have
been obtained had this acquisition actually occurred at the beginning of the
periods presented and is not intended to be a projection of future results.

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.
<TABLE>
<CAPTION>

Six months ended
------------------
June 30, 1998
------------------
<S> <C>
Net Sales:
Racing Champions . . $ 48,855
Wheels . . . . . . . 23,856
Intercompany sales. (1,379)
------------------
Combined . . . . . . $ 71,332
==================

Net income:
Racing Champions . . $ 4,212
Wheels . . . . . . . (2,074)
Intercompany
eliminations and tax
adjustments. . . . . (81)
------------------
Combined . . . . . . $ 2,057
==================
</TABLE>

In connection with the merger, the Company recorded a charge to operating
expenses of $5.5 million ($3.3 million after taxes, or $0.20 per diluted
common share) in the second quarter of 1998 for direct and other merger-related

<PAGE>

costs of $2.1 million and $3.4 million pertaining to the merger and
restructuring of the Companies' combined operations.

Merger transaction costs consisted primarily of fees for investment bankers,
attorneys, accountants, financial printing and other related charges.
Restructuring costs included severance for terminated employees and exit and
agreement extension costs.

NOTE 3 - RESTRUCTURING AND OTHER CHARGES

In the second quarter of 1999, the Company recorded restructuring and other
charges of $6.4 million. These charges related to the Company's alignment of
operations, product lines and direct marketing efforts with the consolidation
plans for those same areas at Ertl. Approximately $2.2 million of the charges
relate to the re-focusing of direct mail programs, $3.8 million relates to the
reduction and consolidation of product lines and the remaining $0.4 million
relates to operational consolidation, including severance and relocation costs.

NOTE 4 - 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 Racing Champions, Inc. ("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 Racing Champions Limited to RCI.

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 40 years and
$4,883,637 was recorded as inventory and property and equipment.

<PAGE>

NOTE 5 - COMMON STOCK

Authorized and issued shares and par values of the Company's voting common stock
are as follows:
<TABLE>
<CAPTION>

AUTHORIZED PAR SHARES OUTSTANDING SHARES OUTSTANDING
---------- ------
SHARES VALUE AT JUNE 30, 1999 AT DECEMBER 31, 1998
---------- ------ ------------------ --------------------
<S> <C> <C> <C> <C>
Voting Common Stock 28,000,000 $ .01 16,407,781 16,060,998
</TABLE>

NOTE 6 - DEBT

In connection with the acquisition of Ertl, the Company entered into a new
credit agreement which provides for a five year revolving loan, five year term
loan, and the issuance of letters of credit. The revolving loan allows the
Company to borrow up to $60.0 million at any time prior to March 31, 2004. At
June 30, 1999, the Company had $21.3 million outstanding on the revolving loan.
The term loan in the principal amount of $115.0 million is due in scheduled
quarterly payments beginning June 30, 2000 with final maturity on March 31,
2004.

The term loan and the revolving term loan bear interest, at the Company's
option, at an alternate base rate plus a margin that varies between 0.00% and
0.50% or at a LIBOR rate plus margin that varies between 0.75% and 1.50%. The
applicable margin is based on the Company's ratio of consolidated debt to
consolidated EBITDA and is currently 0.50% for base rate loans and 1.50% for
LIBOR loans. The credit agreement also requires the Company to pay a commitment
fee determined by the ratio of consolidated debt to consolidated EBITDA. At
June 30, 1999, the commitment fee was 0.30% per annum on the average daily
unused portion of the revolving loan.

Under the terms of the Company's credit agreement, the Company is required to
comply with certain financial and non-financial covenants. As of June 30, 1999,
the Company was in compliance with all of these covenants.

NOTE 7 - PER SHARE INFORMATION

In December 1997, the Company adopted Statement of Financial Accounting
Standards No. 128, "Earnings per Share." Furthermore, the consolidated
financial statements have been retroactively adjusted to reflect a
7.885261-for-one stock split issued on April 9, 1997.

<PAGE>

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

The following is a discussion and analysis of the Company's financial condition,
results of operations, liquidity and capital resources. The discussion and
analysis should be read in conjunction with the Company's unaudited consolidated
financial statements and notes thereto included elsewhere herein.

The Company acquired The Ertl Company, Inc. and certain of its affiliates
("Ertl") on April 13, 1999, in a transaction accounted for under the purchase
method of accounting. Accordingly, the operations of Ertl are included in the
Company's operations from the date of acquisition.

RESULTS OF OPERATIONS

THREE MONTHS ENDED JUNE 30, 1999 COMPARED TO THREE MONTHS ENDED JUNE 30, 1998

Net sales. Net sales increased $15.0 million, or 35.1%, to $57.7 million for
the three months ended June 30, 1999 from $42.7 million for the three months
ended June 30, 1998. The increase in sales is primarily attributable to the
acquisition of Ertl, which contributed approximately $31 million. The Racing
Champions brand die cast collectibles category decreased approximately $12
million, quarter to quarter. Sales decreased in all areas within the die cast
category, with weak performance by the Precious Metals line in the second
quarter of 1999 as compared to strong sales in the second quarter of 1998 of
last year's NASCAR 50th Anniversary line. The overall decrease in die cast
sales was due to the significant commitment of the Company's customers to Star
Wars products, which altered retailers' purchasing patterns and tied up
promotional retail space. Also, sales in the Company's direct mail channel have
leveled off. Sales of other Racing Champions products decreased approximately
$4 million, quarter to quarter, mostly due to planned reductions based on
focusing product lines and reducing low volume SKU's in the apparel and
souvenirs category.

Gross profit. Gross profit remained constant at $23.5 million for the three
months ended June 30, 1999 and June 30, 1998. Gross profit margin (as a
percentage of net sales) decreased to 40.8% in the second quarter of 1999
compared to 55.1% in the second quarter of 1998. The Company earned higher
gross margins in the second quarter of 1998, mostly due to the special 50th
Anniversary NASCAR die-cast and souvenir products that carried higher gross
margins. In addition, gross margins in the second quarter of 1999 were
negatively affected by the lower volume in 1999 and the addition of the Ertl
operations with lower gross margins (in the range of 40% to 45%) than the
traditional Racing Champions gross margins. There were no major changes in the
components of cost of sales.

Selling, general and administrative expenses. Selling, general and
administrative expenses increased $9.8 million, or 74.2%, to $23.0 million for
the three months ended June 30, 1999 from $13.2 million for the three months
ended June 30, 1998. The increase in selling, general and administrative
expenses is due to the addition of the Ertl operations. As a percentage of net
sales, selling, general and administrative expenses increased to 39.8% for the
three months ended June 30, 1999 from 31.0% for the three months ended June 30,
1998. The

<PAGE>

increase as a percentage of net sales is due to both the addition of the Ertl
expenses and a result of spreading fixed costs over lower volume of Racing
Champions products.

Operating income. Operating income decreased $10.9 million, or 265.9%, to an
operating loss of $6.8 million for the three months ended June 30, 1999 from
operating income of $4.1 million for the three months ended June 30, 1998. As a
percentage of net sales, operating income decreased to (11.7)% for the three
months ended June 30, 1999 from 9.6% for the three months ended June 30, 1998.
The decrease in operating income is a primarily a result of the $6.4 million in
restructuring and other charges taken by the Company during the quarter. These
charges relate to the alignment of the Racing Champions' operations, product
lines and direct marketing efforts with the consolidated plans for those same
areas of Ertl. The operating margin was also negatively affected by the low
sales volume of Racing Champions products in the second quarter.

Interest expense. Interest expense of $2.0 million for the three months
ended June 30, 1999 and $0.7 million for the three months ended June 30, 1998
related primarily to the Company's bank term loans and line of credit. The
increase in interest expense, quarter to quarter, is due to increased borrowings
in 1999 in connection with the acquisition of Ertl.

Income tax. Income tax expense for the three months ended June 30, 1999, and
June 30, 1998 include provisions for federal, state and Hong Kong income taxes
at an effective rate of 40.5% and 41.3%, respectively.

SIX MONTHS ENDED JUNE 30, 1999 COMPARED TO SIX MONTHS ENDED JUNE 30, 1998

Net sales. Net sales increased $21.7 million, or 30.4%, to $93.0 million
for the six months ended June 30, 1999 from $71.3 million for the six months
ended June 30, 1998. The increase is primarily attributable to the acquisition
of Ertl, which contributed $31 million of the Company's net sales for the six
months ended June 30, 1999. The Racing Champions brand die cast collectibles
category decreased approximately $2 million as compared to the six months ended
June 30, 1998. Within the die cast category, sales decreased primarily in the
NASCAR category, with weak performance by the Precious Metals line for the six
months ended June 30, 1999 as compared to strong sales for the six months ended
June 30, 1998 of last year's NASCAR 50th Anniversary line. The overall decrease
in die cast sales is due to the significant commitment of the Company's
customers to Star Wars products, which altered retailers' purchasing patterns
and tied up promotional retail space. Also, sales in the Company's direct mail
channel have leveled off. Sales of other Racing Champions products decreased
approximately $8 million as compared to the six months ended June 30, 1998,
mostly due to planned reductions based on focusing product lines and reducing
low volume SKU's in the apparel and souvenirs category.

Gross profit. Gross profit increased $2.2 million, or 5.5%, to $42.2
million for the six months ended June 30, 1999 from $40.0 million for the six
months ended June 30, 1998. Gross profit margin (as a percentage of net
sales) decreased to 45.4% in the six months ended June 30, 1999 compared to
56.0% in the six months ended June 30, 1998. The Company earned higher gross
margins in the six months ended June 30, 1998, mostly due to the special 50th
Anniversary NASCAR die-cast and souvenir products that carried higher gross
margins. In addition, gross margins in the second quarter of 1999 were
negatively affected by the lower volume in 1999 and the addition of the Ertl
operations in the second quarter, with lower gross margins (in the range of 40%
to 45%) than the traditional Racing Champions gross margins. There were no
major changes in the components of cost of sales.

Selling, general and administrative expenses. Selling, general and
administrative expenses increased $10.8 million, or 43.4%, to $35.7 million for
the six months ended June 30, 1999 from $24.9 million for the six months ended
June 30, 1998. The increase in selling, general and administrative expenses is
due to the addition

<PAGE>

of the Ertl operations. As a percentage of net sales, selling, general and
administrative expenses increased to 38.4% for the six months ended June 30,
1999 from 34.9% for the six months ended June 30, 1998. The increase as a
percentage of net sales is due to both the addition of the Ertl expenses and a
result of spreading fixed costs over lower volume of Racing Champions products.

Operating income. Operating income decreased $9.7 million, or 118.3%, to a
loss of $1.5 million for the six months ended June 30, 1999 from operating
income of $8.2 million for the six months ended June 30, 1998. As a percentage
of net sales, operating income decreased to (1.6)% for the six months ended June
30, 1999 from 11.5% for the six months ended June 30, 1998. The decrease in
operating income is primarily a result of the $6.4 million in restructuring and
other charges taken by the Company during the second quarter of 1999. These
charges relate to the alignment of the Racing Champions' operations, product
lines and direct marketing efforts with the consolidated plans for those same
areas of Ertl. The operating margin was also negatively affected by the low
sales volume of Racing Champions products in the second quarter of 1999.

Interest expense. Interest expense of $2.6 million for the six months ended
June 30, 1999 and $1.5 million for the six months ended June 30, 1998 related
primarily to the Company's bank term loans and line of credit. The increase in
interest expense, period to period, is due to increased borrowings in 1999 in
connection with the acquisition of Ertl.

Income tax. Income tax expense for the six months ended June 30, 1999, and
June 30, 1998 include provisions for federal, state and Hong Kong income taxes
at an effective rate of 40.5% and 41.3%, respectively.

LIQUIDITY AND CAPITAL RESOURCES

The Company's operations used net cash of $2.4 million during the six months
ended June 30, 1999. Capital expenditures for the six months ended June 30,
1999 were approximately $3.6 million, of which approximately $2.7 million was
for molds and tooling.

On April 13, 1999, in conjunction with the Company's acquisition of Ertl, the
Company paid all outstanding amounts on its old credit facility and entered into
a new credit facility. The new 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 $60.0 million at any time prior to March 31,
2004. At June 30, 1999, the Company had $21.3 million outstanding on the
revolving loan. The term loan in the principal amount of $115.0 million is due
in scheduled quarterly payments beginning June 30, 2000 with final maturity on
March 31, 2004.

The term loan and the revolving term loan bear interest, at the Company's
option, at an alternate base rate plus a margin that varies between 0.00% and
0.50% or at a LIBOR rate plus a margin that varies between 0.75% and 1.50%. The
applicable margin is based on the Company's ratio of consolidated debt to
consolidated EBITDA and is currently 0.50% for base rate loans and 1.50% for
LIBOR loans. The credit agreement also requires the Company to pay a commitment
fee determined by the ratio of consolidated total debt to consolidated EBITDA.
Currently, the commitment fee is 0.30% per annum on the average daily unused
portion of the revolving loan.

<PAGE>

The Company's anticipated debt service obligations under the new credit facility
for 1999 for scheduled interest payments are approximately $5.0 million.
Average annual debt service obligations under these same facilities through
March, 2004 are approximately $34.5 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 seasonality
related to sales. Due to seasonal increases in demand for the Company's
products, working capital financing requirements are usually highest during the
third quarter and fourth quarters. The Company expects that capital
expenditures during 1999, principally for molds and tooling, will be
approximately $9.0 million. The Company believes that its cash flow from
operations, cash on hand and borrowings under the credit agreement will be
sufficient to meet its working capital and capital expenditure requirements and
provide the Company with adequate liquidity to meet anticipated operating needs
for the foreseeable future. However, any significant future product or property
acquisitions (including up-front licensing payments) may require additional debt
or equity financing.

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 third quarter of 1999. The
Company has circulated surveys to approximately 100 of its key third party
vendors and customers. Through June 30, 1999, approximately 55% 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 June 30, 1999 has been approximately
$175,000. The estimated costs to complete all planned upgrades for the
remaining systems still not compliant is not expected to exceed $75,000.

<PAGE>

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 third 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
third 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 racing 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; (7) the Company's ability to
integrate and assimilate the business of Ertl; and (8) general economic
conditions in the Company's markets.

<PAGE>

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company's credit agreement requires that the Company maintain an
interest rate protection agreement. Effective June 3, 1999, the Company entered
into an interest rate collar transaction covering $35 million of its debt, with
a cap based on 30 day LIBOR rates of 8% and floor of 5.09%. The agreement,
which has quarterly settlement dates, is in effect through June 3, 2002. During
the second quarter of 1999, the effect of this agreement was insignificant.

Based on the Company's interest rate exposure on variable rate borrowings
at June 30, 1999, a one-percentage-point increase in average interest rates on
the Company's borrowings would increase future interest expense by approximately
$125,000 per month.

<PAGE>

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

There were no material developments with respect to legal proceedings
involving the Company during the second quarter of 1999.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.

(a) Not applicable.

(b) Not applicable.

(d) Not applicable.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

Not applicable.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

The annual meeting of stockholders of the Company was held on May 13, 1999.

The matters voted upon, including the number of votes cast for, against or
withheld, as well as the number of abstentions and broker non-votes, as to each
such matter were as follows:

<PAGE>

Proposal 1: Election of directors
<TABLE>
<CAPTION>

For Withheld
---------- --------
<S> <C> <C>
John S. Bakalar . 14,499,206 85,547
Peter K.K. Chung. 14,254,570 330,183
Robert E. Dods. . 14,508,436 76,317
Daniel M. Gill. . 14,508,051 76,702
Samuel B. Guren . 14,509,206 75,547
Boyd L. Meyer . . 14,509,206 75,547
Victor H. Shaffer 14,509,106 75,647
Avy H. Stein. . . 14,508,821 75,932
John J. Vosicky . 14,509,206 75,547
</TABLE>

Proposal 2: Approval of amendment to the Company's Stock Incentive Plan

For Against Abstain Broker Non-Votes
--- ------- ------- -----------------
11,367,774 1,451,816 47,530 1,717,633

Proposal 3: Ratification of appointment of Arthur Andersen LLP as auditors of
the Company

For Against Abstain Broker Non-Votes
--- ------- ------- -----------------
14,574,528 1,962 8,263 0

ITEM 5. OTHER INFORMATION.

Not applicable.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.

(a) Exhibits:

3.1 Amended and Restated Certificate of Incorporation of the
Company (incorporated by reference to Exhibit 3.1 of the Company's Annual Report
on Form 10-K for the year ended December 31, 1998 (File No. 0-22635) filed by
the Company with the Securities and Exchange Commission on March 29, 1999).

3.2 First Amendment to Amended and Restated Certificate of
Incorporation of the Company (incorporated by reference to Exhibit 3.2 of the
Company's Annual Report on Form 10-K for the year ended December 31, 1998 (File
No. 0-22635) filed by the Company with the Securities and Exchange Commission on
March 29, 1999).

3.3 Amended and Restated By-Laws of the Company (incorporated by
reference to Exhibit 3.2 of the Company's Quarterly Report on Form 10-Q for the
quarter ended June 30, 1998 (File No. 0-22635) filed by the Company with the
Securities and Exchange Commission on August 14, 1998).

<PAGE>

10.1 Credit Agreement, dated as of April 13, 1999, by and among
the Company, Racing Champions, Inc., Racing Champions South, Inc., Racing
Champions Worldwide Limited, First Union National Bank, as lender and agent, and
the other lenders party thereto (incorporated by reference to Exhibit 99.2 of
the Company's Current Report on Form 8-K dated April 13, 1999 (File No. 0-22635)
filed by the Company with the Securities and Exchange Commission on April 28,
1999).

10.2 Stock and Asset Purchase Agreement, dated as of April 13,
1999, among U.S. Industries, Inc., JUSI Holdings, Inc., USI Overseas Limited,
USI Canada, Inc., Racing Champions Corporation, Racing Champions, Inc., RCNA
Holdings, Inc., Racing Champions Worldwide Limited and Racing Champions Limited
(incorporated by reference to Exhibit 2.1 of the Company's Current Report on
Form 8-K dated April 13, 1999 (File No. 0-22635) filed by the Company with the
Securities and Exchange Commission on April 28, 1999).

10.3 Employment Agreement, dated as of April 30, 1999, between
Racing Champions, Inc. and Robert E. Dods.

10.4 Employment Agreement, dated as of April 30, 1999, between
Racing Champions, Inc. and Boyd L. Meyer.

10.5 Employment Agreement, dated as of April 30, 1999, between
Racing Champions Limited and Peter K.K. Chung.

10.6 Racing Champions Corporation Stock Incentive Plan, as
amended.

27 Financial Data Schedule.

(b) Reports on Form 8-K:

The Company filed a Form 8-K on April 28, 1999, reporting the
following:

Item 2. Consummation of the acquisition of The Ertl Company, Inc.
and certain of its affiliates ("Ertl").

Execution of the Company's Credit Agreement with First Union
National Bank, as lender and agent, and the other lenders named therein.

The Company filed an amendment to its Form 8-K on June 28, 1999 to
include historical financial information for Ertl and pro forma financial
information required pursuant to Item 7.

<PAGE>

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

Dated this 16th day of August, 1999.

RACING CHAMPIONS CORPORATION

By /s/ Robert E. Dods
----------------------------------
Robert E. Dods, Chief Executive Officer

By /s/ Curtis W. Stoelting
----------------------------------------
Curtis W. Stoelting, Executive Vice President-
Finance and Operations and Secretary

EXHIBIT 10.3

EMPLOYMENT AGREEMENT

THIS EMPLOYMENT AGREEMENT (this "Agreement") is made as of April 30,
1999, by and between Racing Champions, Inc., an Illinois corporation (the
"Company"), and Robert E. Dods (the "Employee"). The Company is a wholly-owned
Subsidiary of Racing Champions Corporation, a Delaware corporation (the
"Parent").

RECITAL

The Company desires to employ the Employee and the Employee is willing
to make his services available to the Company on the terms and conditions set
forth below. Certain capitalized terms used herein are defined in section 10
below.

AGREEMENTS

In consideration of the premises and the mutual agreements which
follow, the parties agree as follows:

1. Employment. The Company hereby employs the Employee and the
Employee hereby accepts employment with the Company on the terms and subject to
the conditions set forth in this Agreement.

2. Term. The term of the Employee's employment hereunder shall
commence on the date hereof and shall continue until terminated as provided in
section 6 below.

3. Duties. The Employee shall serve as the Chief Executive
Officer of the Company and will, under the direction of the Company's board of
directors (the "Board of Directors"), faithfully and to the best of his ability,
perform the duties of such position. The Employee shall be one of the principal
executive officers of the Company and shall, subject to the control of the Board
of Directors, have the normal duties, responsibilities and authority associated
with such position. The Employee shall also perform such additional duties and
responsibilities which may from time to time be reasonably assigned or delegated
by the Board of Directors. The Employee agrees to devote his entire business
time, effort, skill and attention to the proper discharge of such duties while
employed by the Company.

4. Compensation. The Employee shall receive a base salary of
$500,000 per year, payable in regular and equal monthly installments (the "Base
Salary"). The Employee's Base Salary shall be reviewed annually by the Board of
Directors of the Company to determine appropriate increases, if any, in such
Base Salary.

<PAGE>

5. Fringe Benefits.

(a) Vacation. The Employee shall be entitled to five weeks
of paid vacation annually. The Employee and the Company shall mutually
determine the time and intervals of such vacation.

(b) Medical, Health, Dental, Disability and Life Coverage.
The Employee shall be eligible to participate in any medical, health, dental,
disability and life insurance policy in effect for the other two most senior
executives of the Parent and its Subsidiaries (collectively, the "Senior
Management").

(c) Incentive Bonus and Stock Ownership Plans. The Employee
shall be entitled to participate in any incentive bonus or other incentive
compensation plan developed generally for the Senior Management of the Parent
and its Subsidiaries on a basis consistent with his position and level of
compensation. The Employee shall also be entitled to participate in any
incentive stock option plan or other stock ownership plan developed generally
for the Senior Management of the Parent and its Subsidiaries, on a basis
consistent with his position and level of compensation (including the Racing
Champions Corporation Stock Incentive Plan).

(d) Automobile. The Company agrees to reimburse the Employee
up to $990.00 per month, as such amount may be increased from time to time
consistent with the Company's reimbursement policy for Senior Management of the
Company to cover Employee's expenses in connection with his leasing of an
automobile. Additionally, the Company will pay for the gas used for business
purposes. All maintenance and insurance expense for the automobile is the
responsibility of the Employee.

(e) Reimbursement for Reasonable Business Expenses. The
Company shall pay or reimburse the Employee for reasonable expenses incurred by
him in connection with the performance of his duties pursuant to this Agreement
including, but not limited to, travel expenses, expenses in connection with
seminars, professional conventions or similar professional functions and other
reasonable business expenses.

(f) Key Man Insurance. The parties agree that the Company
has the option to purchase one or more key man life insurance policies upon the
life of the Employee. The Parent and the Company shall own and shall have the
absolute right to name the beneficiary or beneficiaries of said policy. The
Employee agrees to cooperate fully with the Parent and the Company in securing
said policy, including, but not limited to submitting himself to any physical
examination which may be required at such reasonable times and places as the
Parent and the Company shall specify.

6. Termination.

(a) Termination of the Employment Period. The Employment
Period shall continue until (i) the second anniversary of the date hereof unless
the parties mutually agree to extend the term of this Agreement (such
anniversary of the date hereof or such extended date

<PAGE>

being referred to herein as the "Expected Completion Date"), (ii) the Employee's
death or Disability, (iii) the Employee resigns or (iv) the Board of Directors
determines that termination of Employee's employment is in the best interests of
the Company.

(b) Definitions.

(i) For purposes of this Agreement, "Disability" shall
mean a physical or mental sickness or any injury which renders the Employee
incapable of performing the services required of him as an employee of the
Company and which does or may be expected to continue for more than six (6)
months during any 12-month period. In the event Employee shall be able to
perform his usual and customary duties on behalf of the Company following a
period of disability, and does so perform such duties or such other duties as
are prescribed by the Board of Directors for a period of three continuous
months, any subsequent period of disability shall be regarded as a new period of
disability for purposes of this Agreement. The Company and the Employee shall
determine the existence of a Disability and the date upon which it occurred. In
the event of a dispute regarding whether or when a Disability occurred, the
matter shall be referred to a medical doctor selected by the Company and the
Employee. In the event of their failure to agree upon such a medical doctor,
the Company and the Employee shall each select a medical doctor who together
shall select a third medical doctor who shall make the determination. Such
determination shall be conclusive and binding upon the parties hereto.

(ii) For purposes of this Agreement, "Cause" shall be
deemed to exist if the Employee shall have (1) violated the terms of section 7
or 8 of this Agreement; (2) committed a felony or a crime involving moral
turpitude; (3) engaged in serious misconduct which is demonstrably injurious to
the Parent or any of its Subsidiaries; (4) engaged in fraud or dishonest with
respect to the Parent or any of its Subsidiaries or made a material
misrepresentation to the stockholders or directors of the Parent or the Company;
or (5) committed acts of negligence in the performance of his duties which are
substantially injurious to the Parent or any of its Subsidiaries.

(iii) For purposes of this Agreement, "Good Reason"
shall mean (1) the material diminution of the Employee's duties set forth in
section 3 above or (2) the relocation of the offices at which the Employee is
principally employed to a location which is more than 50 miles from the offices
at which the Employee is principally employed as of the date hereof; provided,
that travel necessary for the performance of the Employee's duties set forth in
section 3 above shall not determine the location where the Employee is
"principally employed."

(c) Termination for Disability or Death. In the event of
termination for Disability or death, payments of the Employee's Base Salary
shall be made to the Employee, his designated beneficiary or his estate for a
period of six (6) months after the Termination Date in accordance with the
normal payroll practices of the Company. During this period, the Company shall
also reimburse the Employee for amounts paid if any, to continue medical, dental
and health coverage pursuant to the provisions of the Consolidated Omnibus
Budget Reconciliation Act.

<PAGE>

During this period, the Company will also continue Employee's life insurance and
disability coverage, to the extent permitted under applicable policies, and will
pay to the Employee the fringe benefits pursuant to section 5 which have accrued
prior to the Termination Date.

(d) Termination by the Company without Cause or by the
Employee for Good Reason. If (i) the Employment Period is terminated by the
Company for any reason other than for Cause, Disability or death, (ii) if the
Employment Period is terminated by the Company for what the Company believes is
Cause or Disability, and it is ultimately determined that the Employment Period
was terminated without Cause or Disability or (iii) the Employee resigns for
Good Reason, the Employee shall be entitled to receive, as damages for such a
termination, his Base Salary from the Termination Date to the later to occur of
(i) the Expected Completion Date or (ii) the first anniversary of the
Termination Date. Such payment of Base Salary shall be made in accordance with
the normal payroll practices of the Company. During this period, the Company
shall also reimburse the Employee for amounts paid, if any, to continue medical,
dental and health coverage pursuant to the provisions of the Consolidated
Omnibus Budget Reconciliation Act. During this period, the Company will also
continue Employee's life insurance and disability coverage, to the extent
permitted under applicable policies, and will pay to the Employee the fringe
benefits pursuant to section 5 which have accrued prior to the date of
termination.

(e) Termination by the Company for Cause or by the Employee
Without Good Reason. If the Employment Period is terminated by the Company with
Cause or as a result of the Employee's resignation without Good Reason, the
Employee shall not be entitled to receive his Base Salary or any fringe benefits
or bonuses for periods after the Termination Date.

(f) Effect of Termination. The termination of the Employment
Period pursuant to section 6(a) shall not affect the Employee's obligations as
described in sections 7 and 8.

7. Noncompetition and Nonsolicitation. The Employee acknowledges
and agrees that the contacts and relationships of the Parent and its
Subsidiaries with its customers, suppliers, licensors and other business
relations are, and have been, established and maintained at great expense and
provide the Parent and its Subsidiaries with a substantial competitive advantage
in conducting their business. The Employee acknowledges and agrees that by
virtue of the Employee's employment with the Company, the Employee will have
unique and extensive exposure to and personal contact with the Parent's and its
Subsidiaries' customers and licensors, and that he will be able to establish a
unique relationship with those Persons that will enable him, both during and
after employment, to unfairly compete with the Parent and its Subsidiaries.
Furthermore, the parties agree that the terms and conditions of the following
restrictive covenants are reasonable and necessary for the protection of the
business, trade secrets and Confidential Information (as defined in section 8
below) of the Parent and its Subsidiaries and to prevent great damage or loss to
the Parent and its Subsidiaries as a result of action taken by the Employee.
The Employee acknowledges and agrees that the noncompete restrictions and
nondisclosure of Confidential Information restrictions contained in this
Agreement are reasonable and the consideration provided for herein is sufficient
to fully and adequately compensate the Employee

<PAGE>

for agreeing to such restrictions. The Employee acknowledges that he could
continue to actively pursue his career and earn sufficient compensation in the
same or similar business without breaching any of the restrictions contained in
this Agreement. The Employee acknowledges that one business of the Parent and
its Subsidiaries is the design, production (including, without limitation, the
obtaining of the licenses necessary therefor), marketing and sale of die cast
metal replicas of vehicles.

(a) Noncompetition. The Employee hereby covenants and agrees
that during the Employment Period and for two (2) years thereafter (the
"Noncompete Period"), he shall not, directly or indirectly, either individually
or as an employee, principal, agent, partner shareholder, owner, trustee,
beneficiary, co-venturer, distributor, consultant, representative or in any
other capacity, participate in, become associated with, provide assistance to,
engage in or have a financial or other interest in any business, activity or
enterprise which is competitive with the Parent or any of its Subsidiaries or
any successor or assign of the Parent or any of its Subsidiaries. The ownership
of less than a one percent interest in a corporation whose shares are traded in
a recognized stock exchange or traded in the over-the-counter market, even
though that corporation may be a competitor of the Parent, shall not be deemed
financial participation in a competitor. If the final judgment of a court of
competent jurisdiction declares that any term or provision of this section is
invalid or unenforceable, the parties agree that the court making the
determination of invalidity or unenforceability shall have the power to reduce
the scope, duration, or area of the term or provision, to delete specific words
or phrases, or to replace any invalid or unenforceable term or provision with a
term or provision that is valid and enforceable and that comes closest to
expressing the intention of the invalid or unenforceable term or provision, and
this Agreement shall be enforceable as so modified. The term "indirectly" as
used in this section and section 8 below is intended to include any acts
authorized or directed by or on behalf of the Employee or any Affiliate of the
Employee.

(b) Nonsolicitation. The Employee hereby covenants and
agrees that during the Noncompete Period, he shall not, directly or indirectly,
either individually or as an employee, agent, partner, shareholder, owner,
trustee, beneficiary, co-venturer, distributor, consultant or in any other
capacity:

(i) canvass, solicit or accept from any Person who is a
customer or licensor of the Parent or any of its Subsidiaries (any such Person
is hereinafter referred to individually as a "Customer," and collectively as the
"Customers") any business which in competition with the business of the Parent
or any of its Subsidiaries or the successors or assigns of the Parent or any of
its Subsidiaries, including, without limitation, the canvassing, soliciting or
accepting of business from any Person which is or was a Customer of the Parent
or any of its Subsidiaries within two years preceding the date hereof or with
the Parent or any of its Subsidiaries during the Noncompete Period;

(ii) advise, request, induce or attempt to induce any of
the Customers, suppliers, or other business contacts of the Parent or any of its
Subsidiaries who currently have or have had business relationships with the
Parent within two years preceding the date hereof or with the Parent or any of
its Subsidiaries during the

<PAGE>

Noncompete Period, to withdraw, curtail or cancel any of its business or
relations with the Parent or any of its Subsidiaries;

(iii) induce or attempt to induce any employee, sales
representative, consultant or other agent of the Parent or any of its
Subsidiaries to terminate his relationship or breach any agreement with the
Parent or any of its Subsidiaries; or

(iv) hire any person who was an employee, sales
representative, consultant or other agent of the Parent or any of its
Subsidiaries at any time during the Noncompete Period.

8. Confidential Information. The Employee acknowledges and agrees
that the customers, business connections, customer lists, procedures,
operations, techniques, and other aspects of and information about the business
of the Parent and its Subsidiaries (the "Confidential Information") are
established at great expense and protected as confidential information and
provide the Parent and its Subsidiaries with a substantial competitive advantage
in conducting their business. The Employee further acknowledges and agrees that
by virtue of his past employment with the Company, and by virtue of his
employment with the Company, he has had access to and will have access to, and
has been entrusted with and will be entrusted with, Confidential Information,
and that the Company would suffer great loss and injury if the Employee would
disclose this information or use in a manner not specifically authorized by the
Company. Therefore, the Employee agrees that during the Employment Period and
for five (5) years thereafter, he will not, directly or indirectly, either
individually or as an employee, agent, partner, shareholder, owner trustee,
beneficiary, co-venturer distributor, consultant or in any other capacity, use
or disclose or cause to be used or disclosed any Confidential Information,
unless and to the extent that any such information become generally known to and
available for use by the public other than as a result of the Employee's acts or
omissions. The Employee shall deliver to the Company at the termination of the
Employment Period, or at any other time the Company may request, all memoranda,
notes, plans, records, reports, computer tapes, printouts and software and other
documents and data (and copies thereof) relating to the Confidential
Information, Work Product (as defined below) or the business of the Parent or
any of its Subsidiaries which he may then possess or have under his control.
The Employee acknowledges and agrees that all inventions, innovations,
improvements, developments, methods, designs, analyses, drawings, reports and
all similar or related information (whether or not patentable) which relate to
the Parent's or any of its Subsidiaries' actual or anticipated business research
and development or existing or future products or services and which are
conceived, developed or made by the Employee while employed by the Parent and
its Subsidiaries ("Work Product") belong to the Parent or such Subsidiary, as
the case may be.

9. Common Law of Torts and Trade Secrets. The parties agree that
nothing in this Agreement shall be construed to limit or negate the common law
of torts or trade secrets where it provides the Parent and its Subsidiaries with
broader protection than that provided herein.

<PAGE>

10. Definition.

"Affiliate" means, with respect to any Person, any other Person
controlling, controlled by or under common control with such Person and any
partner of a Person which is a partnership.

"Person" means any individual, partnership, corporation, limited
liability company, association, joint stock company, trust, joint venture,
unincorporated organization and any governmental entity or any department,
agency or political subdivision thereof.

"Subsidiary" means, with respect to any Person, any corporation,
partnership, association or other business entity of which (i) if a corporation,
a majority of the total voting power of shares of stock entitled (without regard
to the occurrence of any contingency) to vote in the election of directors,
managers or trustees thereof is at the time owned or controlled, directly or
indirectly, by that Person or one or more of the other Subsidiaries of that
Person or a combination thereof, or (ii) if a partnership, association or other
business entity, a majority of the partnership or other similar ownership
interest thereof is at the time owned or controlled, directly or indirectly, by
any Person or one or more Subsidiaries of that Person or a combination thereof.
For purposes hereof, a Person or Persons shall be deemed to have a majority
ownership interest in a partnership, association or other business entity if
such Person or Persons shall be allocated a majority of partnership, association
or other business entity gains or losses or shall be or control any managing
director or general partner of such partnership, association or other business
entity.

11. Specific Performance. The Employee acknowledges and agrees
that irreparable injury to the Company may result in the event the Employee
breaches any covenant or agreement contained in sections 7 and 8 and that the
remedy at law for the breach of any such covenant will be inadequate.
Therefore, if the Employee engages in any act in violation of the provisions of
sections 7 and 8, the Employee agrees that the Company shall be entitled, in
addition to such other remedies and damages as may be available to it by law or
under this Agreement, to injunctive relief to enforce the provisions of sections
7 and 8.

12. Waiver. The failure of either party to insist in any one or
more instances, upon performance of the terms or conditions of this Agreement
shall not be construed as a waiver or a relinquishment of any right granted
hereunder or of the future performance of any such term, covenant or condition.

13. Notices. Any notice to be given hereunder shall be deemed
sufficient if addressed in writing and delivered by registered or certified mail
or delivered personally, in the case of the Company, to its principal business
office, and in the case of the Employee, to his address appearing on the records
of the Company, or to such other address as he may designate in writing to the
Company.

14. Severability. In the event that any provision shall be held
to be invalid or unenforceable for any reason whatsoever, it is agreed such
invalidity or unenforceability shall not affect any other provision of this
Agreement and the remaining covenants, restrictions and

<PAGE>

provisions hereof shall remain in full force and effect and any court of
competent jurisdiction may so modify the objectionable provision as to make it
valid, reasonable and enforceable. Furthermore, the parties specifically
acknowledge the above covenant not to compete and covenant not to disclose
confidential information are separate and independent agreements.

15. Complete Agreement. Except as otherwise expressly set forth
herein, this document embodies the complete agreement and understanding among
the parties hereto with respect to the subject matter hereof and supersedes and
preempts any prior understandings, agreements or representations by or among the
parties, written or oral, which may have related to the subject matter hereof in
any way.

16. Amendment. This Agreement may only be amended by an agreement
in writing signed by each of the parties hereto.

17. Governing Law. This Agreement shall be governed by and
construed exclusively in accordance with the laws of the State of Illinois,
regardless of choice of law requirements. The parties hereby consent to the
jurisdiction of the state courts of the State of Illinois and of any federal
court in the venue of Illinois for the purpose of any suit, action or proceeding
arising out of or related to this Agreement, and expressly waive any and all
objections they may have as to venue in any of such courts.

18. Benefit. This Agreement shall be binding upon and inure to
the benefit of and shall be enforceable by and against the Company, its
successors and assigns and the Employee, his heirs, beneficiaries and legal
representatives. It is agreed that the rights and obligations of the Employee
may not be delegated or assigned.

IN WITNESS WHEREOF, the parties have executed or caused this
Employment Agreement to be executed as of the date first above written.

RACING CHAMPIONS, INC.

By: /s/ Boyd L. Meyer
---------------------
Its: President
---------------------

/s/ Robert E. Dods
---------------------
Robert E. Dods

EXHIBIT 10.4

EMPLOYMENT AGREEMENT

THIS EMPLOYMENT AGREEMENT (this "Agreement") is made as of April 30,
1999, by and between Racing Champions, Inc., an Illinois corporation (the
"Company"), and Boyd L. Meyer (the "Employee"). The Company is a wholly-owned
Subsidiary of Racing Champions Corporation, a Delaware corporation (the
"Parent").

RECITAL

AGREEMENTS

In consideration of the premises and the mutual agreements which
follow, the parties agree as follows:

1. Employment. The Company hereby employs the Employee and the
Employee hereby accepts employment with the Company on the terms and subject to
the conditions set forth in this Agreement.

2. Term. The term of the Employee's employment hereunder shall
commence on the date hereof and shall continue until terminated as provided in
section 6 below.

3. Duties. The Employee shall serve as the President of the
Company and will, under the direction of the Company's board of directors (the
"Board of Directors"), faithfully and to the best of his ability, perform the
duties of such position. The Employee shall be one of the principal executive
officers of the Company and shall, subject to the control of the Board of
Directors, have the normal duties, responsibilities and authority associated
with such position. The Employee shall also perform such additional duties and
responsibilities which may from time to time be reasonably assigned or delegated
by the Board of Directors. The Employee agrees to devote his entire business
time, effort, skill and attention to the proper discharge of such duties while
employed by the Company.

<PAGE>

5. Fringe Benefits.

(a) Vacation. The Employee shall be entitled to five weeks
of paid vacation annually. The Employee and the Company shall mutually
determine the time and intervals of such vacation.

6. Termination.

<PAGE>

(b) Definitions.

<PAGE>

During this period, the Company will also continue Employee's life insurance and
disability coverage, to the extent permitted under applicable policies, and
will pay to the Employee the fringe benefits pursuant to section 5 which have
accrued prior to the Termination Date.

(f) Effect of Termination. The termination of the Employment
Period pursuant to section 6(a) shall not affect the Employee's obligations as
described in sections 7 and 8.

<PAGE>

Noncompete Period, to withdraw, curtail or cancel any of its business or
relations with the Parent or any of its Subsidiaries;

(iv) hire any person who was an employee, sales
representative, consultant or other agent of the Parent or any of its
Subsidiaries at any time during the Noncompete Period.

<PAGE>

10. Definition.

"Affiliate" means, with respect to any Person, any other Person
controlling, controlled by or under common control with such Person and any
partner of a Person which is a partnership.

<PAGE>

16. Amendment. This Agreement may only be amended by an agreement
in writing signed by each of the parties hereto.

IN WITNESS WHEREOF, the parties have executed or caused this
Employment Agreement to be executed as of the date first above written.

RACING CHAMPIONS, INC.

By: /s/ Robert E. Dods
---------------------
Its: Chief Executive Officer
---------------------

/s/ Boyd L. Meyer
---------------------
Boyd L. Meyer

EXHIBIT 10.5

EMPLOYMENT AGREEMENT

THIS EMPLOYMENT AGREEMENT (this "Agreement") is made as of April 30,
1999, by and between Racing Champions Limited, a Hong Kong corporation (the
"Company"), and Peter K.K. Chung (the "Employee"). The Company is a
wholly-owned Subsidiary of Racing Champions, Inc., an Illinois corporation,
which is a wholly-owned Subsidiary of Racing Champions Corporation, a Delaware
corporation (the "Parent").

RECITAL

AGREEMENTS

In consideration of the premises and the mutual agreements which
follow, the parties agree as follows:

1. Employment. The Company hereby employs the Employee and the
Employee hereby accepts employment with the Company on the terms and subject to
the conditions set forth in this Agreement.

2. Term. The term of the Employee's employment hereunder shall
commence on the date hereof and shall continue until terminated as provided in
section 6 below.

<PAGE>

5. Fringe Benefits.

(a) Vacation. The Employee shall be entitled to five weeks
of paid vacation annually. The Employee and the Company shall mutually
determine the time and intervals of such vacation.

(c) Incentive Bonus and Stock Ownership Plans. The Employee
shall be entitled to participate in any incentive bonus or other incentive
compensation plan developed generally for the Senior Management of the Parent
and its Subsidiaries, on a basis consistent with his position and level of
compensation. The Employee shall also be entitled to participate in any
incentive stock option plan or other stock ownership plan developed generally
for the Senior Management of the Parent and its Subsidiaries, on a basis
consistent with his position and level of compensation (including the Racing
Champions Corporation Stock Incentive Plan).

(d) Automobile. The Company agrees to reimburse the Employee
up to $2,000 per month, as such amount may be increased from time to time
consistent with the Company's reimbursement policy for Senior Management of the
Company to cover Employee's expenses in connection with his leasing of an
automobile. Additionally, the Company will pay for the gas used for business
purposes. All maintenance and insurance expense for the automobile is the
responsibility of the Employee.

6. Termination.

<PAGE>

being referred to herein as the "Expected Completion Date"), (ii) the
Employee's death or Disability, (iii) the Employee resigns or (iv) the Board
of Directors determines that termination of Employee's employment is in the
best interests of the Company.

(b) Definitions.

<PAGE>

During this period, the Company will also continue Employee's life insurance and
disability coverage, to the extent permitted under applicable policies, and
will pay to the Employee the fringe benefits pursuant to section 5 which have
accrued prior to the Termination Date.

(f) Effect of Termination. The termination of the Employment
Period pursuant to section 6(a) shall not affect the Employee's obligations as
described in sections 7 and 8.

<PAGE>

(ii) advise, request, induce or attempt to induce any of
the Customers, suppliers, or other business contacts of the Parent or any of its
Subsidiaries who currently have or have had business relationships with the
Parent or any of its Subsidiaries within two years preceding the date hereof or
with the Parent or any of its

<PAGE>

Subsidiaries during the Noncompete Period, to withdraw, curtail or cancel any of
its business or relations with the Parent or any of its Subsidiaries;

(iv) hire any person who was an employee, sales
representative, consultant or other agent of the Parent or any of its
Subsidiaries at any time during the Noncompete Period.

8. Confidential Information. The Employee acknowledges and agrees
that the customers, business connections, customer lists, procedures,
operations, techniques, and other aspects of and information about the business
of the Parent and its Subsidiaries (the "Confidential Information") are
established at great expense and protected as confidential information and
provide the Parent and its Subsidiaries with a substantial competitive advantage
in conducting their business. The Employee further acknowledges and agrees that
by virtue of his past employment with the Company, and by virtue of his
employment with the Company, he has had access to and will have access to, and
has been entrusted with and will be entrusted with, Confidential Information,
and that the Company would suffer great loss and injury if the Employee would
disclose this information or use in a manner not specifically authorized by the
Company. Therefore, the Employee agrees that during the Employment Period and
for five (5) years thereafter, he will not, directly or indirectly, either
individually or as an employee, agent, partner, shareholder, owner trustee,
beneficiary, co-venturer distributor, consultant or in any other capacity, use
or disclose or cause to be used or disclosed any Confidential Information,
unless and to the extent that any such information become generally known to and
available for use by the public other than as a result of the Employee's acts or
omissions. The Employee shall deliver to the Company at the termination of the
Employment Period, or at any other time the Company may request, all memoranda,
notes, plans, records, reports, computer tapes, printouts and software and other
documents and data (and copies thereof) relating to the Confidential
Information, Work Product (as defined below) or the business of the Parent or
any of its Subsidiary which he may then possess or have under his control. The
Employee acknowledges and agrees that all inventions, innovations, improvements,
developments, methods, designs, analyses, drawings, reports and all similar or
related information (whether or not patentable) which relate to the Parent's or
any of its Subsidiaries' actual or anticipated business research and development
or existing or future products or services and which are conceived, developed or
made by the Employee while employed by the Parent and its Subsidiaries ("Work
Product") belong to the Parent or such Subsidiary, as the case may be.

<PAGE>

10. Definition.

"Affiliate" means, with respect to any Person, any other Person
controlling, controlled by or under common control with such Person and any
partner of a Person which is a partnership.

<PAGE>

16. Amendment. This Agreement may only be amended by an agreement
in writing signed by each of the parties hereto.

IN WITNESS WHEREOF, the parties have executed or caused this
Employment Agreement to be executed as of the date first above written.

RACING CHAMPIONS LIMITED

By:/s/ Daniel M. Gill
---------------------

Its: Director
--------

/s/ Peter K.K. Chung
-----------------------
Peter K.K. Chung

Exhibit 10.6

RACING CHAMPIONS CORPORATION

STOCK INCENTIVE PLAN

Article 1. Establishment and Purpose

1.1 Establishment. Racing Champions Corporation, a Delaware
corporation (the "Company"), hereby establishes a stock option plan for
employees and others providing services to the Company, as described herein,
which shall be known as the Racing Champions Corporation Stock Incentive Plan
(the "Plan"). It is intended that certain of the options issued pursuant to the
Plan to employees of the Company may constitute incentive stock options within
the meaning of section 422 of the Internal Revenue Code, and that other options
issued pursuant to the Plan shall constitute nonstatutory options. The Board
shall determine which options are to be incentive stock options and which are to
be nonstatutory options and shall enter into option agreements with recipients
accordingly.

1.2 Purpose. The purpose of the Plan is to provide a means for the
Company to attract and retain competent personnel and to provide to
participating directors, officers and other key employees long term incentives
for high levels of performance by providing them with a means to acquire a
proprietary interest in the Company's success.

Article II. Definitions

2.1 Definitions. For purposes of this Plan, the following terms shall
be defined as follows:

(a) "Board" means the Board of Directors of the Company.

(b) "Cause" means the definition of Cause in Optionee's employment
agreement, if any, with the Company. If no such employment agreement or
definition in such agreement exists, Cause means (i) breach by Optionee of any
covenant not to compete or confidentiality agreement with the Company, (ii)
failure by Optionee to substantially perform his duties to the reasonable
satisfaction of the Board, (iii) serious misconduct by Optionee which is
demonstrably and substantially injurious to the Company, (iv) fraud or
dishonesty by Optionee with respect to the Company, (v) material

<PAGE>

misrepresentation by Optionee to a stockholder or director of the Company or
(vi) acts of negligence by Optionee in performance of Optionee's duties that are
substantially injurious to the Company. The Board, by majority vote, shall make
the determination of whether Cause exists.

(d) "Commission" means the Securities and Exchange Commission or any
successor agency.

(e) "Committee" means the Committee provided for by Article IV hereof, which
may be created at the discretion of the Board.

(f) "Company" means Racing Champions Corporation, a Delaware corporation.

(g) "Consultant" means any person or entity, including an officer or
director of the Company who provides services (other than as an Employee) to the
Company and includes a Qualified Director, as defined below.

(h) "Date of Exercise" means the date the Company receives notice, by an
Optionee, of the exercise of an Option pursuant to section 9.1 of this Plan.
Such notice shall indicate the number of shares of Stock the Optionee intends to
purchase upon exercise of an Option.

(i) "Employee" means any person, including an officer or director of the
Company, who is employed by the Company.

(j) "Exchange Act" means the Securities Exchange Act of 1934, as amended
from time to time, and any successor thereto.

(k) "Fair Market Value" means the fair market value of Stock upon which an
Option is granted under this Plan, as determined by the Board. If the Stock is
traded on an over-the-counter securities market or national securities exchange,
"Fair Market Value" shall mean an amount equal to the average of the highest and
lowest reported sales prices of the Stock reported on such over-the-counter
market or such national securities exchange on the applicable date

<PAGE>

or, if no sales of Stock have been reported for that date, on the next preceding
date for which sales where reported.

(l) "Incentive Stock Option" means an Option granted under this Plan which
is intended to qualify as an "incentive stock option" within the meaning of
section 422 of the Code.

(m) "IRS" means the Internal Revenue Service, or any successor agency.

(n) "Nonstatutory Option" means an Option granted under this Plan which is
not intended to qualify as an incentive stock option within the meaning of
section 422 of the Code. Nonstatutory Options may be granted at such times and
subject to such restrictions as the Board shall determine without conforming to
the statutory rules of section 422 of the Code applicable to incentive stock
options.

(o) "Option" means the right, granted under this Plan, to purchase Stock of
the Company at the option price for a specified period of time. For purposes of
this Plan, an Option may be an Incentive Stock Option, a Nonstatutory Option or
a Reload Option.

(p) "Optionee" means an Employee or Consultant holding an Option under the
Plan.

(q) "Parent Corporation" shall have the meaning set forth in section 424(e)
of the Code with the Company being treated as the employer corporation for
purposes of this definition.

(r) "Qualified Director" means a director who is both (a) a "Non-Employee
Director" as defined in Rule 16b-3(b)(3)(i), as promulgated by the Commission
under the Exchange Act, or any successor definition adopted by the Commission,
and (b) an "Outside Director" as defined by section 162(m) of the Code and the
regulations promulgated thereunder, or any successor definition adopted by the
IRS.

(s) "Reload Option" means an Option granted pursuant to section 8.1 of this
Plan.

(t) "Rule 16b-3" means Rule 16b-3, as promulgated by the Commission under
Section 16(b) of the Exchange Act, as amended from time to time.

<PAGE>

(u) "Significant Stockholder" means an individual who, within the meaning of
section 422(b)(6) of the Code, owns stock possessing more than ten percent of
the total combined voting power of all classes of stock of the Company. In
determining whether an individual is a Significant Stockholder, an individual
shall be treated as owning stock owned by certain relatives of the individual
and certain stock owned by corporations in which the individual is a partner,
and estates or trusts of which the individual is a beneficiary, all as provided
in section 424(d) of the Code.

(v) "Stock" means the Common Stock, par value $.01 per share, of the
Company.

2.2 Gender and Number. Except when otherwise indicated by the context,
any masculine terminology when used in this Plan also shall include the feminine
gender and the definition of any term herein in the singular shall also include
the plural.

Article III. Eligibility and Participation.

3.1 Eligibility and Participation. All Employees are eligible to
participate in this Plan and receive Incentive Stock Options and/or Nonstatutory
Options. All Consultants are eligible to participate in this Plan and receive
Nonstatutory Options hereunder. Optionees in the Plan shall be selected by the
Board from among those Employees and Consultants who, in the opinion of the
Board, are in a position to contribute materially to the Company's continued
growth and development and to its long-term financial success.

Article IV. Administration.

4.1 Administration. The Board shall be responsible for administering
the Plan.

The Board is authorized to interpret the Plan, to prescribe, amend, and
rescind rules and regulations relating to the Plan, to provide for conditions
and assurances deemed necessary or advisable to protect the interests of the
Company, and to make all other determinations necessary or advisable for the
administration of the Plan, but only to the extent not contrary to the express
provisions of the Plan. Determinations, interpretations or other actions made
or taken by the Board pursuant to the provisions of this Plan shall be final
and binding and conclusive for all purposes and upon all persons.

<PAGE>

At the discretion of the Board, this Plan may be administered by a
Committee which shall be a compensation committee of the Board, consisting
solely of two or more Qualified Directors. The members of such Committee may be
directors who are eligible to receive Options under this Plan, but Options may
be granted to such persons only by action of the full Board and not by action of
the Committee. Such Committee shall have full power and authority, subject to
the limitations of the Plan and any limitations imposed by the Board, to
construe, interpret and administer this Plan and to make determinations which
shall be final, conclusive and binding upon all persons, including, without
limitation, the Company, the stockholders, the directors and any persons having
any interests in any Options which may be granted under this Plan and, by
resolution providing for the creation and issuance of any such Option, to fix
the terms upon which, the time or times at or within which, and the price or
prices at which any such shares may be purchased from the Company upon the
exercise of such Option, which terms, time or times and price or prices shall,
in every case, be set forth or incorporated by reference in the instrument or
instruments evidencing such Option, and shall be consistent with the provisions
of the Plan.

The Board may from time to time remove members from, or add members to, the
Committee. The Board may terminate the Committee at any time. Vacancies on the
Committee, howsoever caused, shall be filled by the Board. The Committee shall
select one of its members as Chairman, and shall hold meetings at such times and
places as the Chairman may determine. A majority of the Committee at which a
quorum is present, or acts reduced to or approved in writing by all of the
members of the Committee, shall be the valid acts of the Committee. A quorum
shall consist of two-thirds of the members of the Committee.

Where the Committee has been created by the Board, references herein to
actions to be taken by the Board shall be deemed to refer to the Committee as
well, except where limited by this Plan or by the Board.

The Board shall have all of the enumerated powers of the Committee but
shall not be limited to such powers. No member of the Board or the Committee
shall be liable for any action or determination made in good faith with respect
to the Plan or any Option granted under it.

4.2 Special Provisions for Grants to Officers or Directors. Rule 16b-3
provides that the grant of a stock option to a director or officer of a company
subject to the Exchange Act will be exempt from the provisions of Section 16(b)
of the Exchange Act if the conditions set forth in Rule 16b-3 are satisfied.
Unless otherwise specified by the Board, grants of Options hereunder to
individuals who

<PAGE>

are officers or directors of the Company for purposes of Section 16(b) of the
Exchange Act shall be made in a manner that satisfies the conditions of
Rule 16b-3.

Article V. Stock Subject to the Plan.

5.1 Number. The total number of shares of Stock hereby made available
and reserved for issuance under the Plan shall be 2,000,000. The aggregate
number of shares of Stock available under this Plan shall be subject to
adjustment as provided in section 5.3. The total number of shares of Stock may
be authorized but unissued shares of Stock, or shares acquired by purchase as
directed by the Board from time to time in its discretion, to be used for
issuance upon exercise of Options granted hereunder.

5.2 Unused Stock; Payment with Stock. If an Option shall expire or
terminate for any reason without having been exercised in full, the unpurchased
shares of Stock subject thereto shall (unless the Plan shall have terminated)
become available for other Options under the Plan. In addition, upon the full
or partial payment of any option price by the transfer to the Company of shares
of Stock pursuant to section 7.7, upon satisfaction of tax withholding
obligations with shares of Stock pursuant to section 15.1 or any other payment
made or benefit realized under this Plan by the transfer or relinquishment of
shares of Stock, only the net number of shares of Stock actually issued or
transferred by the Company, after subtracting the number of shares of Stock so
transferred or relinquished, will be charged against the maximum share
limitation set forth in section 5.1 above.

5.3 Adjustment in Capitalization. In the event of any change in the
outstanding shares of Stock by reason of a stock dividend or split,
recapitalization, reclassification or other similar corporate change, the
aggregate number of shares of Stock set forth in section 5.1 shall be
appropriately adjusted by the Board, whose determination shall be conclusive;
provided, however, that fractional shares shall be rounded to the nearest whole
share. In any such case, the number and kind of shares that are subject to any
Option (including any Option outstanding after termination of employment) and
the Option price per share shall be proportionately and appropriately adjusted
without any change in the aggregate Option price to be paid therefor upon
exercise of the Option.

Article VI. Duration of the Plan.

6.1 Duration of the Plan. The Plan shall be in effect for ten years
from the date of its approval by the Company's stockholders. Any Options
outstanding at the end of such period shall remain in effect in accordance with
their terms.

<PAGE>

The Plan shall terminate before the end of such period if all Stock subject
to the Plan has been purchased pursuant to the exercise of Options granted under
the Plan.

Article VII. Terms of Stock Options.

7.1 Grant of Options. Subject to section 5.1, Options may be granted
to Employees or Consultants at any time and from time to time as determined by
the Board; provided, however, that Consultants may receive only Nonstatutory
Options and may not receive Incentive Stock Options. The Board shall have
complete discretion in determining the number of Options granted to each
Optionee. In making such determinations, the Board may take into account the
nature of services rendered by such Employee or Consultant, their present and
potential contributions to the Company, and such other factors as the Board in
its discretion shall deem relevant. The Board shall also determine whether an
Option is to be an Incentive Stock Option or a Nonstatutory Option.

In the cases of Incentive Stock Options, the total Fair Market Value
(determined at the date of grant) of shares of Stock with respect to which
Incentive Stock Options are exercisable for the first time by the Optionee
during any calendar year under all plans of the Company under which incentive
stock options may be granted (and all such plans of any Parent Corporation and
any subsidiary corporations of the Company) shall not exceed $100,000.
(Hereinafter, this requirement is sometimes referred to as the "$100,000
Limitation.")

Nothing in this Article VII of the Plan shall be deemed to prevent the
grant of Options permitting exercise in excess of the maximums established by
the preceding paragraph where such excess amount is treated as a Nonstatutory
Option.

7.2 No Tandem Options. Where an Option granted under this Plan is
intended to be an Incentive Stock Option, the Option shall not contain terms
pursuant to which the exercise of the Option would affect the Optionee's right
to exercise another Option, or vice versa, such that the Option intended to be
an Incentive Stock Option would be deemed a tandem stock option within the
meaning of the regulations under section 422 of the Code.

7.3 Option Agreement; Terms and Conditions to Apply Unless Otherwise
Specified. As determined by the Board on the date of grant, each Option shall
be evidenced by an Option agreement (the "Option Agreement") that includes the
nontransferability provisions required by section 11.2 hereof and specifies:
whether the Option is an Incentive Stock Option or a Nonstatutory

<PAGE>

Option; the Option price; the duration of the Option; the number of shares of
Stock to which the Option applies; any vesting or exercisability restrictions
which the Board may impose; in the case of an Incentive Stock Option, a
provision implementing the $100,000 Limitation; and any other terms and
conditions as shall be determined by the Board at the time of grant of the
Option.

All Option Agreements shall incorporate the provisions of this Plan by
reference, with certain provisions to apply depending upon whether the Option
Agreement applies to an Incentive Stock Option or to a Nonstatutory Option.

7.4 Option Price. No Incentive Stock Option granted pursuant to this
Plan shall have an Option price that is less than the Fair Market Value of Stock
on the date the Option is granted. Incentive Stock Options granted to
Significant Stockholders shall have an Option price of not less than 110 percent
of the Fair Market Value of Stock on the date of grant. The Option price for
Nonstatutory Options shall be established by the Board.

7.5 Term of Options. Each Option shall expire at such time as the
Board shall determine when it is granted, provided, however, that no Option
shall be exerciseable later than the tenth anniversary date of its grant.

7.6 Exercise of Options. Options granted under this Plan shall be
exercisable at such times and be subject to such restrictions and conditions as
the Board shall in each instance approve, which need not be the same for all
Optionees.

7.7 Payment. Payment for all shares of Stock shall be made at the time
that an Option, or any part thereof, is exercised, and no shares shall be issued
until full payment therefor has been made. Such payment may be made in cash,
outstanding shares of Stock, in combinations thereof, or any other method of
payment approved by the Board; provided, however, that (i) the deposit of any
withholding tax shall be made in accordance with applicable law and (ii) that
such shares of Stock used to pay the exercise price have been held by the
Participant for at least six months prior to the exercise date. If shares of
Stock are being used in part or full payment for the shares to be acquired upon
exercise of the Option, such shares shall be valued for the purpose of such
exchange as of the date of exercise of the Option at the Fair Market Value of
the shares. Any certificates evidencing shares of Stock used to pay the purchase
price shall be accompanied by stock powers duly endorsed in blank by the
registered holder of the certificate (with signatures thereon guaranteed). In
the event the certificates tendered by the holder in such payment cover more
shares than are required for such payment, the certificate shall also be
accompanied by instructions from the holder to the

<PAGE>

Company's transfer agent with regard to the disposition of the balance of the
shares covered thereby.

Article VIII. Reload Options.

8.1 Grants of Reload Options. Concurrently with any award of Options,
the Board may grant Reload Options to purchase a number of shares of Stock equal
to the sum of (i) the number of outstanding shares of Stock used to exercise the
underlying Option pursuant to section 7.7, and (ii) the number of shares of
Stock used to satisfy any tax withholding requirement incident to the exercise
of the underlying Options pursuant to section 15.1. If the Board grants Reload
Options in connection with a grant of Options, the Option Agreement with respect
to such underlying Options shall state that Reload Options have been granted
with respect to the underlying Options. Upon exercise of an underlying Option,
the Reload Option will be evidenced by an amendment to the underlying Option
Agreement. No additional Reload Options will be granted to the Optionee when
Options are exercised pursuant to the terms of this Plan following termination
of the Optionee's employment.

8.2 Terms of Reload Options. A Reload Option will be subject to all of
the terms and conditions of the underlying Option, except that (i) the option
price per share of Stock purchasable under a Reload Option shall be equal to the
Fair Market Value of the Stock at time of grant upon exercise of the underlying
Option, and (ii) the term of the Reload Option will equal the remaining option
term of the underlying Option.

Article IX. Written Notice, Issuance of Stock Certificates, Stockholder
Privilege.

9.1 Written Notice. An Optionee wishing to exercise an Option shall
give written notice to the Company, in the form and manner prescribed by the
Board. Full payment for the Options exercised, as provided in section 7.7
above, must accompany the written notice.

9.2 Issuance of Stock Certificate. As soon as practicable after the
receipt of written notice and payment, the Company shall deliver to the Optionee
or to a nominee of the Optionee a certificate or certificates for the requisite
number of shares of Stock.

9.3 Privileges of a Stockholder. An Optionee or any other person
entitled to exercise an Option under this Plan shall not have stockholder
privileges with respect to any Stock covered by the Option until the date of
issuance of a stock certificate for such Stock.

<PAGE>

Article X. Termination of Employment or Services.

Except as otherwise expressly specified by the Board, all Options granted
under this Plan shall be subject to the following termination provisions.

10.1 Death. If an Optionee's employment in the case of an Employee, or
provision of services as a Consultant in the case of a Consultant, terminates by
reason of death, the Option may thereafter be exercised at any time prior to the
expiration date of the Option or within 12 months after the date of such death,
whichever period is the shorter, by the person or persons entitled to do so
under the Optionee's will or, if the Optionee shall fail to make a testamentary
disposition of an Option or shall die intestate, the Optionee's legal
representative or representatives. The Option shall be exercisable only to the
extent that such Option was exercisable as of the date of death.

10.2 Termination Other Than for Cause or Due to Death. In the event of
an Optionee's termination of employment in the case of an Employee, or
termination of the provision of services as a Consultant in the case of a
Consultant, other than for Cause or by reason of death, the Optionee may
exercise such portion of his Option as was exercisable by him at the date of
such termination (the "Termination Date") at any time within three months of the
Termination Date; provided, however, that where the Optionee is an Employee, and
is terminated due to disability within the meaning of Code section 422, he may
exercise such portion of his Option as was exercisable by him on his Termination
Date within one year of his Termination Date. In any event, the Option cannot
be exercised after the expiration of the original term of the Option. Options
not exercised within the applicable period specified above shall terminate.

In the case of an Employee, a change of duties or position within the
Company, if any, shall not be considered a termination of employment for
purposes of this Plan. The Option Agreements may contain such provisions as the
Board shall approve with respect to the effect of approved leaves of absence
upon termination of employment.

10.3 Termination for Cause. In the event of an Optionee's termination
of employment in the case of an Employee, or termination of the provision of
services as a Consultant in the case of a Consultant, which termination is by
the Company for Cause, any Option or Options held by him under the Plan, to the
extent not exercised before such termination, shall forthwith terminate.

<PAGE>

Article XI. Rights of Optionees

11.1 Service. Nothing in this Plan shall interfere with or limit in
any way the right of the Company to terminate any Employee's employment, or any
Consultant's services, at any time, nor confer upon any Employee any right to
continue in the employ of the Company, or upon any Consultant any right to
continue to provide services to the Company.

11.2 Nontransferability. Options granted under this Plan shall be
nontransferable by the Optionee, other than by will or the laws of descent and
distribution, and shall be exercisable during the Optionee's lifetime only by
the Optionee.

Article XII. Amendment, Modification
and Termination of the Plan

12.1 Amendment, Modification, and Termination of the Plan.
The Board may at any time terminate and from time to time may amend or modify
the Plan provided, however, that no such action of the Board, without approval
of the stockholders, may:

(a) increase the total amount of Stock which may be purchased through
Options granted under the Plan, except as provided in Article V;

(b) change the class of Employees or Consultants eligible to receive
Options; or

No amendment, modification or termination of the Plan shall in any manner
adversely affect any outstanding Option under the Plan without the consent of
the Optionee holding the Option.

Article XIII. Acquisition, Merger and Liquidation

13.1 Acquisition. Notwithstanding anything herein to contrary, in the
event that an Acquisition (as defined below) occurs with respect to the Company,
the Company shall have the option, but not the obligation, to cancel Options
outstanding as of the effective date of Acquisition, whether or not such Options
are then exercisable, in return for payment to the Optionees for each Option of
an amount equal to a reasonable, good faith estimate of an amount (hereinafter
the

<PAGE>

"Spread") equal to the difference between the net amount per share payable in
the Acquisition, or as a result of the Acquisition, less the exercise price per
share of the Option. In estimating the Spread, appropriate adjustments to give
effect to the existence of the options shall be made, such as deeming the
Options to have been exercised, with the Company receiving the exercise price
payable thereunder, and treating the shares receivable upon exercise of the
Options as being outstanding in determining the net amount per share. For
purposes of this section, an "Acquisition" shall mean any transaction in which
substantially all of the Company's assets are acquired or in which a controlling
amount of the Company's outstanding shares are acquired, in each case by a
single person or entity or an affiliated group of persons and/or entities. For
purposes of this section a controlling amount shall mean more than 50% of the
issued and outstanding shares of stock of the Company. The Company shall have
such an option regardless of how the Acquisition is effectuated, whether by
direct purchase, through a merger or similar corporate transaction, or
otherwise. In cases where the acquisition consists of the acquisition of assets
of the Company, the net amount per share shall be calculated on the basis of the
net amount receivable with respect to shares upon a distribution and liquidation
by the Company after giving effect to expenses and charges, including but not
limited to taxes, payable by the Company before the liquidation can be
completed.

Where the Company does not exercise its option under this section 13.1, the
remaining provisions of this Article XIII shall apply, to the extent applicable.

13.2 Merger or Consolidation. Subject to section 13.1 and to any
required action by the stockholders, if the Company shall be the surviving
corporation in any merger or consolidation, any Option granted hereunder shall
pertain to and apply to the securities to which a holder of the number of shares
of Stock subject to the Option would have been entitled in such merger or
consolidation.

13.3 Other Transactions. Subject to section 13.1, dissolution or a
liquidation of the Company or a merger and consolidation in which the Company is
not the surviving corporation shall cause every Option outstanding hereunder to
terminate as of the effective date of the dissolution, liquidation, merger or
consolidation. However, the Optionee either (i) shall be offered a firm
commitment whereby the resulting or surviving corporation in a merger or
consolidation will tender to the Optionee an option (the "Substitute Option") to
purchase its shares on terms and conditions both as to number of shares and
otherwise, which will substantially preserve to the Optionee the rights and
benefits of the Option outstanding hereunder granted by the Company, or (ii)
shall have the right immediately prior to such dissolution, liquidation, merger,
or consolidation to

<PAGE>

exercise any unexercised Options whether or not then exercisable, subject to the
provisions of this Plan. The Board shall have absolute and uncontrolled
discretion to determine whether the Optionee has been offered a firm commitment
and whether the tendered Substitute Option will substantially preserve to the
Optionee the rights and benefits of the Option outstanding hereunder. In any
event, any Substitute Option for an Incentive Stock Option shall comply with the
requirements of the Code.

Article XIV. Securities Registration

14.1 Securities Registration. In the event that the Company shall deem
it necessary or desirable to register under the Securities Act of 1933, as
amended, or any other applicable statute, any Options or any Stock with respect
to which an Option may be or shall have been granted or exercised, or to qualify
any such Options or Stock under the Securities Act of 1933, as amended, or any
other statute, then the Optionee shall cooperate with the Company and take such
action as is necessary to permit registration or qualification of such Options
or Stock.

Unless the Company has determined that the following representation is
unnecessary, each person exercising an Option under the Plan may be required by
the Company, as a condition to the issuance of the shares pursuant to exercise
of the Option, to make a representation in writing (a) that he is acquiring such
shares for his own account for investment and not with a view to, or for sale in
connection with, the distribution of any part thereof, and (b) that before any
transfer in connection with the resale of such shares, he will obtain the
written opinion of counsel to the Company, or other counsel acceptable to the
Company, that such shares may be transferred. The Company may also require that
the certificates representing such shares contain legends reflecting the
foregoing.

Article XV. Tax Withholding

15.1 Tax Withholding. Whenever shares of Stock are to be issued in
satisfaction of Options exercised under this Plan, the Company shall have the
power to require the recipient of the Stock to remit to the Company an amount
sufficient to satisfy federal, state and local withholding tax requirements.
Unless otherwise determined by the Board, withholding obligations may be settled
with Stock, including Stock that is part of the award that gives rise to the
withholding requirement. The obligations of the Company under the Plan shall be
conditional on such payment or arrangements, and the Company, its subsidiaries
and affiliates shall, to the extent permitted by law, have the right to deduct
any such taxes from any payment otherwise due to the participant.

<PAGE>

Article XVI. Indemnification

16.1 Indemnification. To the extent permitted by law, each person who
is or shall have been a member of the Board shall be indemnified and held
harmless by the Company against and from any loss, cost, liability, or expense
that may be imposed upon or reasonably incurred by him in connection with or
resulting from any claim, action, suit, or proceeding to which he may be a party
or in which he may be involved by reason of any action taken or failure to act
under the Plan and against and from any and all amounts paid by him in
settlement thereof, with the Company's approval, or paid by him in satisfaction
of judgment in any such action, suit or proceeding against him, provided he
shall give the Company an opportunity, at its own expense, to handle and defend
it on his own behalf. The foregoing right of indemnification shall not be
exclusive of any other rights of indemnification to which such persons may be
entitled under the Company's articles of incorporation or bylaws, as a matter of
law, or otherwise, or any power that the Company may have to indemnify them or
hold them harmless.

Article XVII. Requirements of Law

17.1 Requirements of Law. The granting of Options and the issuance of
shares of Stock upon the exercise of an Option shall be subject to all
applicable laws, rules, and regulations, and to such approvals by any
governmental agencies or national securities exchanges as may be required.

17.2 Governing Law. The Plan and all agreements hereunder shall be
construed in accordance with and governed by the laws of the state of Delaware.

Article XVIII. Compliance with Code

18.1 Compliance with Code. Incentive Stock Options granted hereunder
are intended to qualify as "incentive stock options" under Code section 422. If
any provision of this Plan is susceptible to more than one interpretation, such
interpretation shall be given thereto as is consistent with Incentive Stock
Options granted under this Plan being treated as incentive stock options under
the Code. Options granted hereunder to any person who is a "covered employee"
under Code section 162(m) at any time when the Company is subject to Code
section 162(m) are intended to qualify as performance-based compensation within
the meaning of Code section 162(m)(4)(C). If any provision of this Plan is
susceptible to more than one interpretation, such interpretation shall be given
thereto as is consistent with Options granted under this Plan to such "covered
employees" being treated as performance-based compensation under Code section
162(m).

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