SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D. C. 20549
FORM 10-QSB
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1997
___ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____________ to ____________________
Commission file number 0 - 24608
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FOTOBALL USA, INC.
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(Exact name of registrant as specified in its charter)
Delaware 33 - 0614889
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(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) Number)
3738 Ruffin Road, San Diego, California 92123
--------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(619) 467-9900
---------------------------
(Issuer's telephone number)
Check whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Exchange Act during the past 12 months
(or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past
90 days. Yes (X) No ___
As of October 31, 1997, the Company had 2,676,742 shares of its common
stock issued and outstanding.
Transitional Small Business Disclosure Format Yes ___ No (X)
Page 1 of 20<PAGE>
FOTOBALL USA, INC.
INDEX
Sequential
PART I. FINANCIAL INFORMATION Page No.
----------
Item 1. Financial Statements
Condensed Balance Sheets as of
December 31, 1996 and September 30, 1997 3
Condensed Statements of Operations for the
three months and nine months ended
September 30, 1996 and 1997 4
Condensed Statements of Cash Flows for the
nine months ended September 30, 1996 and 1997 5
Notes to Condensed Financial Statements 6-10
Item 2. Management's Discussion and Analysis or Plan of Operation 11-18
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Securities Holders 19
Item 6. Exhibits and Reports on Form 8-K 19
SIGNATURES 20
Page 2 of 20<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FOTOBALL USA, INC.
CONDENSED BALANCE SHEETS
(Unaudited)
December 31, 1996 September 30, 1997
ASSETS ----------------- ------------------
CURRENT ASSETS
Cash and equivalents $ 981,554 $ 1,453,422
Accounts receivable-net 7,369,617 1,413,071
Inventories (Note 4) 2,081,206 3,488,597
Prepaid expenses and other 176,285 205,559
Deferred income taxes 187,000 -
------------ ------------
TOTAL CURRENT ASSETS 10,795,662 6,560,649
------------ ------------
PROPERTY AND EQUIPMENT, net 1,039,225 1,344,364
------------ ------------
OTHER ASSETS
Deferred income taxes 264,000 483,200
Deposits and other 55,449 101,457
------------ ------------
TOTAL OTHER ASSETS 319,449 584,657
------------ ------------
$ 12,154,336 $ 8,489,670
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Note payable to bank $ 1,825,000 $ -
Current portion of capital leases 58,516 92,938
Accounts payable and accrued expenses 1,954,106 945,538
Income taxes payable 119,200 -
------------ ------------
TOTAL CURRENT LIABILITIES 3,956,822 1,038,476
------------ ------------
CAPITAL LEASES, net of current portion 138,976 249,570
------------ ------------
TOTAL LIABILITIES 4,095,798 1,288,046
------------ ------------
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value;
Authorized-1,000,000 shares; issued
and outstanding-none
Common stock, $.01 par value; authorized;
15,000,000 shares; issued and
outstanding - 2,676,742 shares 26,767 26,767
Additional paid-in capital 8,562,194 8,562,194
Accumulated deficit (530,423) (1,387,337)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 8,058,538 7,201,624
------------ ------------
$ 12,154,336 $ 8,489,670
============ ============
See accompanying notes to condensed financial statements.
Page 3 of 20<PAGE>
FOTOBALL USA, INC.
CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ ----------------------
1996 1997 1996 1997
----------- ---------- ----------- ---------
SALES $ 3,025,753 $2,625,750 $18,179,613 $9,430,585
COST OF SALES 1,840,805 1,763,866 12,221,116 6,075,789
----------- ---------- ----------- ----------
GROSS PROFIT 1,184,948 861,884 5,958,497 3,354,796
OPERATING EXPENSES
Royalties 161,340 237,352 773,564 563,718
Marketing 467,408 591,372 1,513,122 1,613,646
General and administrative 525,198 642,131 1,506,840 1,695,315
Depreciation and amortization 50,047 67,437 156,897 179,855
Settlement cost (Note 3) - 210,000 - 210,000
----------- ---------- ----------- ----------
TOTAL OPERATING EXPENSES 1,203,993 1,748,292 3,950,423 4,262,534
INCOME (LOSS) BEFORE
OTHER (INCOME) EXPENSE
AND INCOME TAXES (19,045) (886,408) 2,008,074 (907,738)
----------- ---------- ----------- ----------
OTHER (INCOME) EXPENSE
Interest expense 3,821 8,993 20,397 29,347
Interest income (31,321) (25,209) (123,650) (80,171)
---------- ---------- ----------- ----------
TOTAL OTHER INCOME (27,500) (16,216) (103,253) (50,824)
---------- ---------- ----------- ----------
INCOME (LOSS) BEFORE
INCOME TAX 8,455 (870,192) 2,111,327 (856,914)
INCOME TAX EXPENSE
(BENEFIT) 3,400 (5,300) 847,500 -
---------- ---------- ----------- ----------
NET INCOME (LOSS) $ 5,055 $ (864,892) $ 1,263,827 $ (856,914)
========== ========== =========== ==========
WEIGHTED AVERAGE NUMBER OF
COMMON SHARES OUTSTANDING 3,830,817 2,676,742 3,830,817 2,676,742
========== ========== =========== ==========
NET INCOME (LOSS) PER
COMMON SHARE $ NIL $ (.32) $ .37 $ (.32)
========== ========== =========== ==========
See accompanying notes to condensed financial statements.
Page 4 of 20<PAGE>
FOTOBALL USA, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended
September 30,
------------------------
1996 1997
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 1,263,827 $ (856,914)
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating activities:
Depreciation and amortization 156,897 206,658
Amortization of stock compensation expense 19,125 -
Changes in operating assets and liabilities:
Restricted cash (87,790) -
Accounts receivable (1,726,743) 5,956,546
Inventories (515,372) (1,407,391)
Production-in-process 93,657 -
Prepaid expenses and other (153,322) (29,274)
Deferred income taxes 553,100 (32,200)
Accounts payable and accrued expenses 276,227 (1,054,576)
Income taxes payable - (119,200)
----------- -----------
NET CASH PROVIDED BY (USED IN) OPERATING
ACTIVITIES (120,394) 2,663,649
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property and equipment (89,209) (314,139)
----------- -----------
NET CASH USED IN INVESTING ACTIVITIES (89,209) (314,139)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Net reductions in short-term credit facilities - (1,825,000)
Proceeds from exercise of options and warrants 150 -
Principal reductions of related party loans (58,010) -
Repayment of capital lease obligations (39,207) (52,642)
----------- -----------
NET CASH USED IN FINANCING ACTIVITIES (97,067) (1,877,642)
----------- -----------
NET INCREASE (DECREASE) IN CASH AND EQUIVALENTS (306,670) 471,868
CASH AND EQUIVALENTS, Beginning of period 2,162,268 981,554
----------- -----------
CASH AND EQUIVALENTS, End of period $ 1,855,598 $ 1,453,422
=========== ===========
See accompanying notes to condensed financial statements.
Page 5 of 20<PAGE>
FOTOBALL USA, INC.
NOTES TO CONSENSED FINANCIAL STATEMENTS (Unaudited)
THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1997
1. CONDENSED FINANCIAL STATEMENTS
------------------------------
The condensed balance sheet as of September 30, 1997, the condensed
statements of operations for the three months and nine months ended
September 30, 1996 and 1997, and the condensed statements of cash flows for
the nine months ended September 30, 1996 and 1997 have been prepared by the
Company without audit. In the opinion of management, all adjustments (which
include only normal recurring adjustments) necessary to present fairly the
financial position, results of operations and cash flows for all periods
presented have been made.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting
principles have been omitted, pursuant to the rules and regulations of the
Securities and Exchange Commission. It is suggested that these condensed
financial statements be read in conjunction with the financial statements
and notes thereto included in the Company's Annual Report on Form 10-KSB for
the fiscal year ended December 31, 1996.
The results of operations for the three months and nine months ended
September 30, 1997 are not necessarily indicative of the results of
operations to be expected for the full year ending December 31, 1997.
2. DISCLOSURE OF CERTAIN SIGNIFICANT RISKS AND UNCERTAINTIES
---------------------------------------------------------
Dependence Upon Licensing Arrangements - The Company's business is based
primarily upon its use of the insignia, logos, names, colors, likenesses
and other identifying marks and images borne by many of its products
pursuant to license arrangements with Professional Baseball, NFL and, to a
lesser extent, Colleges. The Company's licensing arrangements expire at
various times through December 31, 1999. The following table summarizes,
in descending order of 1996 revenue contribution, the Company's significant
license agreements and their terms:
Licensor Product Term Expiration Date
-------- ------- ---- ---------------
MLBP Baseball 3 years December 31, 1999
MLBPA Baseball 1 year (2 year option) December 31, 1999
NFL Team Logo Football 2 years March 31, 1998
The Company believes that its relationships with these licensors are
satisfactory and anticipates that each of the license agreements will be
renewed on acceptable terms and conditions. The non-renewal or termination
of one or more of the Company's licenses, particularly with Professional
Baseball or the NFL, could have a material adverse effect On the Company's
business.
Dependence on Promotions Business - The Company's promotions business
depends primarily upon a series of one-time projects with its customers.
Although the Company has had repeat business from certain promotions
customers, there can be no assurance that the Company will be able to
continue its relationships with its promotions customers or attract new
promotions customers to generate sufficient revenues to operate profitably.
Page 6 of 20<PAGE>
FOTOBALL USA, INC.
NOTES TO CONSENSED FINANCIAL STATEMENTS (Unaudited)
THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1997
(continued)
During the year ended December 31, 1996, 76% of the Company's sales was
derived from sales of the Company's promotional products, of which one
customer accounted for aggregate sales of $14,122,000 or 54% of sales, and
another customer accounted for aggregate sales of $4,400,000 or 17% of
sales. During the nine months ended September 30, 1997, 37% of the
Company's sales was derived from sales of the Company's promotional
products, of which one customer accounted for aggregate sales of
$2,400,000, or 26% of sales.
Variability of Gross Margins - Historically, the Company has realized
higher gross margins on its retail sales as compared to promotional sales.
In 1996, the Company realized gross margins of 29% as a result
of $14,000,000 of low margin toy car promotion sales. As the Company
does not anticipate any toy car sales during 1997, the Company
expects that its higher margin sports-related promotions and retail
business should contribute to higher margins in 1997, comparable with
gross margins realized during the nine months ended September 30, 1997.
The Company's current gross margins are lower than the historical averages
primarily due to the change in its sales mix. The Company is realizing a
greater percentage of its current sales from somewhat lower margin
entertainment, concessionaire and distributor related sales. The Company's
gross margins fluctuate, particularly between quarters, based in part on
the concentration of promotions and retail sales during the reporting
period. The type of product sold, the type of customer, the size of the
promotion and extent of competition also create variability in realized
gross margins.
Variability of Operating Results; Seasonality; Dependence Upon Baseball-
Related Sales - The Company has experienced, and expects to continue to
experience, significant quarter-to-quarter variability in its sales and net
income. This is due in part to the seasonality of its licensed sports
product business combined with a significant concentration of its business
from baseball. Historically, the Company has derived a significant amount
of sales from baseball-related products, representing 74% and 35% of the
Company's sales during the years ended December 31, 1995 and 1996,
respectively. As such, its sales tend to be concentrated during the second
and third quarters which coincide with the baseball season. Baseball-
related sales as a percentage of total sales decreased significantly in 1996
due to the $14,000,000 of toy car sales realized in 1996. Despite these toy
car sales, which are not anticipated to occur in the future, the
Company believes that the continuing decrease in the dependence upon
baseball-related sales during the past several years will continue in
the future, with the introduction of new product lines and non
baseball-related promotions. For the nine months ended September 30, 1997,
baseball-related sales represented 48% of the Company's total sales. The
second factor which significantly contributes to the variability of the
Company's operations is its dependence on promotions business as more fully
explained above.
Page 7 of 20<PAGE>
FOTOBALL USA, INC.
NOTES TO CONSENSED FINANCIAL STATEMENTS (Unaudited)
THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1997
(continued)
Dependence Upon Key Personnel - The success of the Company is largely
dependent on the personal efforts of Michael Favish, its President and
Chief Executive Officer. Mr. Favish has entered into a five-year
employment agreement with the Company, commencing on August 11, 1994,
which, among other things, precludes Mr. Favish from competing with the
Company for a period of two years following termination of his employment
with the Company. The loss of the services of Mr. Favish would have
a material adverse effect on the Company's business and prospects. The
Company maintains "key man" life insurance on the life of Michael Favish
in the amount of $1,000,000. The success of the Company was also dependent
on the personal efforts of Fred Ostern, its former Vice President of
Marketing. See Note 3 - "Legal Proceeding."
Dependence on Suppliers - In 1996, the Company purchased approximately 89%
of its raw material, consisting primarily of synthetic baseballs,
footballs and basketballs, from four companies located in China, with one
manufacturer accounting for 57% of total raw material purchased. China
currently holds most favored nation ("MFN") trading status with the United
States. Any conditions imposed by the President of the United States and
any legislation in the United States revoking or placing further conditions
on China's MFN trading status could have a material adverse effect on the
cost of all of the Company's products because products originating from
China could be subjected to substantially higher rates of duty.
Furthermore any political unrest could impact the Company's ability to
source products from China.
3. LEGAL PROCEEDINGS
-----------------
The Company was a defendant in an action brought in San Diego County,
California Superior Court on March 14, 1997 by Fred S. Ostern, the
Company's former Vice President-Marketing. The complaint alleged that the
Company breached the employment agreement between the Company and Mr.
Ostern by failing to pay Mr. Ostern the entire amount of the annual cash
bonus for 1996 in accordance with the provisions of his employment
agreement. On October 1, 1997, the Company entered into a settlement
agreement with Mr. Ostern whereby the Company agreed to pay a corporation
wholly owned by Mr. Ostern the aggregate sum of $350,000, consisting of
three monthly payments of $50,000 beginning October 1, 1997, and
the remaining $200,000 being due and payable in twelve monthly payments of
$16,667 during 1998. In consideration of the settlement amount, the
parties mutually agreed that Mr. Ostern's employment with the Company be
terminated. Mr. Ostern also agreed to certain non-solicitation and
non-competition provisions through December 31, 1998.
Mr. Ostern was instrumental in bringing in approximately $19,000,000 and
$2,000,000 in sales in 1996 and 1995, respectively. Such amounts
represented 73% and 26% of total sales in 1996 and 1995, respectively.
For the nine month period ended September 30, 1997, Mr. Ostern's sales were
approximately $2,500,000 or 27% of total sales. The Company recently
employed two senior promotional salespersons in order to increase its
promotional sales opportunities. There can be no assurance, however, that
these new sales professionals, combined with other marketing initiatives,
Page 8 of 20<PAGE>
FOTOBALL USA, INC.
NOTES TO CONSENSED FINANCIAL STATEMENTS (Unaudited)
THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1997
(continued)
will replace future sales which may have been otherwise contributed by Mr.
Ostern if he had continued to be employed by the Company.
4. INVENTORIES
-----------
Inventories are valued at the lower of cost or market. Cost is determined
on the first-in first-out (FIFO) method. Inventories consist of the
following:
December 31, 1996 September 30, 1997
----------------- ------------------
Finished goods $ 439,332 $ 813,078
Raw material 1,641,874 2,675,519
------------- ------------
Total inventory $ 2,081,206 $ 3,488,597
============= ============
5. BACKLOG
-------
Generally, substantially all of the Company's retail orders are processed
within one to four weeks after receipt of an order and are therefore
generally not deemed to be part of the Company's backlog. The Company
considers its backlog as those promotional orders and certain retail
orders in which an agreement has been signed defining the terms and
quantity of the promotion or order, and delivery extends beyond the normal
processing time of up to four weeks. Historically, the Company's backlog
of orders, which have consisted mainly of baseball-related products, are
highest between January and April of each year and are significantly lower
during the remainder of the year. The Company's backlog of orders was
$600,000 and $6,000,000 as of October 31, 1997 and 1996, respectively,
representing primarily entertainment-related orders in 1997, as compared
with the previously discussed toy car promotional sales for the
corresponding prior year period.
6. NET INCOME (LOSS) PER SHARE
---------------------------
Net income per share for the three and nine month periods ended
September 30, 1996 was computed by dividing net income by the weighted
average number of common shares and common share equivalents outstanding
during each period. Common share equivalents represent stock options
and warrants and are included in the weighted average shares pursuant
to the treasury stock method as prescribed by APB Opinion No. 25
"Earning Per Share." Net loss per share was determined by dividing net
loss by the weighted average number of common shares outstanding. The
computation of fully diluted net loss per share was anti-dilutive;
therefore, only primary loss per share is reported.
In February 1997, the Financial Accounting Standards Board issued
statement of Financial Accounting Standards No. 128 "Earnings per
Share" which is effective for financial statements for periods ending
after December 15, 1997. If the new pronouncement had been in effect for
Page 9 of 20<PAGE>
FOTOBALL USA, INC.
NOTES TO CONSENSED FINANCIAL STATEMENTS (Unaudited)
THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1997
(continued)
the three and nine-month periods ended September 30, 1996 and 1997,
earnings (loss) per share would have been as follows:
Three Months Nine Months
Ended September 30, Ended September 30,
---------------------- ----------------------
1996 1997 1996 1997
---------- ---------- ---------- ----------
As reported (fully diluted) $ NIL $ (.32) $ .37 $ (.32)
Basic EPS $ NIL $ (.32) $ .47 $ (.32)
Diluted EPS $ NIL $ (.32) $ .43 $ (.32)
Basic weighted average
shares outstanding 2,661,742 2,676,742 2,676,742 2,676,742
Diluted weighted average
shares outstanding 2,920,876 2,676,742 2,920,876 2,676,742
Page 10 of 20<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OR PLAN OF OPERATION
Recent Developments
During the three months ended September 30, 1997, the Company took several
significant steps in establishing a foundation for future growth. In August,
the Company named Mr. Salvatore DiMascio as a new member of the Board of
Directors. Mr. DiMascio is President of DiMascio Venture Management Inc.,
an investment and management firm. His experience includes over twenty years
in various executive positions with several public companies, including Anchor
Gaming, Conair Corporation and Revlon Inc.
In September 1997, the Company announced the appointment of Mr. Richard F.
Craven as Executive Vice President-Chief Operating Officer, a new position.
Mr. Craven will oversee marketing, operations and business development for
the Company. Mr. Craven, who is a graduate of Stanford University and
received his MBA from Harvard Business School, brings an extensive
background, including management experience with two high-growth business
units of Walt Disney Company, and with Taco Bell Corporation.
Finally, in October 1997, the Company reached an agreement with Mr. Fred
Ostern,the Company's former Vice President-Marketing regarding the action
filed on March 14, 1997 by Mr. Ostern against the Company. In reaching this
agreement, Mr. Ostern and the Company mutually agreed to terminate Mr.
Ostern's employment with the Company effective October 1, 1997. Mr. Ostern
dismissed the action with prejudice, and under the terms of the
settlement agreement the Company has agreed to pay a corporation wholly
owned by Mr. Ostern the aggregate sum of $350,000, payable in various amounts
during 1997 and 1998. See Note 3 - "Legal Proceedings." The Company
recognized the settlement amount as a pre-tax charge to operations in the
amount of $210,000 for the three months ended September 30, 1997, reflecting
the entire settlement amount, less a reserve amount of $140,000 which had
been accrued for by the Company in 1996.
Results of Operations
The following table sets forth certain (unaudited) operating data (in dollars
and as a percentage of the Company's sales) for the periods presented:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------- --------------------------
1996 1997 1996 1997
----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
<C> <C>
Sales $3,025,753 100% $2,625,750 100% $18,179,613 100%
$9,430,585 100%
Cost of Sales 1,840,805 61 1,763,866 67 12,221,116 67
6,075,789 64
Operating Expenses 1,203,993 40 1,748,292 67 3,950,423 22
4,262,534 45
Operating Income
(Loss) (19,045) (1) (886,408) (34) 2,008,074 11
(907,738) (10)
Interest Expense 3,821 1 8,993 1 20,397 1
29,347 1
Interest Income 31,321 1 25,209 1 123,650 1
80,171 1
Income (Loss)
Before Income Tax 8,455 1 (870,192) (33) 2,111,327 12
(856,914) (9)
Income Tax
Expense (Benefit) 3,400 1 (5,300) (1) 847,500 5
Net Income (Loss) $ 5,055 1% $(864,892) (33)% $ 1,263,827 7%
$ (856,914) (9)%
</TABLE>
Page 11 of 20<PAGE>
Three Months Ended September 30, 1996 and 1997:
Sales:
Sales were $2,626,000 for the three months ended September 30, 1997, a
decrease of 13% from sales of $3,026,000 for the three months ended
September 30, 1996. For the three months ended September 30, 1997,
promotional sales were $702,000, or 27% of sales, as compared to promotional
sales of $1,365,000, or 45% of sales, for the three months ended September 30,
1996. The 1997 promotional sales included $380,000 of a $740,000 baseball
promotion with Burger King, $360,000 of which was shipped and sales
recognized in the second quarter of 1997. The remaining promotional sales
represented various football, basketball, hockey and lapel pin related
promotions. Promotional sales in the 1996 period were primarily derived from
two customers: $667,000 in toy car sales to Chevron and a $472,000 baseball
promotion with McDonald's Corporation. Retail sales were $1,924,000 for the
three months ended September 30, 1997, an increase of 16% from retail sales
of $1,660,000 for the three months ended September 30, 1996. Sales increases
were realized primarily from the Company's basketball, hockey and soccer
product lines, through expanding entertainment related sales. However, sales
of the Fototire have not met expectations. The Company is actively pursuing
certain promotional and retail sales opportunities for this
product. The Fototire product has been selected to be sold in the
southeastern region of a national mass merchant for 1998. Finally, the
Company is currently engaged in discussions with certain Fortune 500 companies
regarding the possibility of corporate promotions. Based on these
opportunities, the Company believes that the Fototire product should, with
continued marketing efforts, generate improving sales in 1998. There can be
no assurance, however, that the Company will be successful in establishing a
market for the Fototire product. If unsuccessful in establishing a market
for this product in the next few months, the Company may be required to
record a charge to operations to establish a reserve against inventory for the
Fototire product. See "Liquidity and Capital Resources".
Gross Profit:
Gross profit was $862,000 for the three months ended September 30, 1997, a
decrease of 27% from gross profit of $1,185,000 for the three months ended
September 30, 1996. Gross profit decreased on an absolute basis as a result
of the decrease in sales. Gross margins, as a percentage of sales, decreased
from 39% to 33% for the three months ended September 30, 1996 and 1997,
respectively. This decrease was due to an inventory write down of
approximately $100,000. This charge to cost of sales, reflected the
write-down of certain non-sellable merchandise, primarily toy cars held in
inventory from a 1996 toy car promotion based on the current likelihood that
no further toy cars will be sold. The gross margins realized during the
three months ended September 30, 1997 are somewhat lower than the margins
that the Company has historically realized on its sports product sales
primarily as a result of an increase in somewhat lower margin entertainment
and team business sales. As previously noted, the Company's gross margins
fluctuate, particularly between quarters, based on several factors including
sales, and product mix (see Note 2 of the "Notes to Condensed Financial
Statements"). The Company anticipates that its gross margins for the fiscal
year ending December 31, 1997 should be consistent with the gross margins
realized for the nine months ended September 30, 1997.
Page 12 of 20<PAGE>
Operating Expense:
Operating expenses were $1,748,000, or 67% of sales, for the three months
ended September 30, 1997, as compared to operating expenses of $1,204,000,
or 40% of sales, for the three months ended September 30, 1996. Operating
expenses increased both in absolute terms and as a percentage of sales due
primarily to two factors: a non-recurring charge of $210,000 incurred in
connection with the settlement of a lawsuit with a former officer, (see
"Note 3 "Legal Proceedings") and an increase in operating costs of
$334,000, a substantial portion of which were the result of the Company's
expanded sales and marketing efforts.
Royalties expense was $237,000 for the three months ended September 30,
1997, an increase of 47% from royalties expense of $161,000 for the three
months ended September 30, 1996. Royalties expense as a percentage of sales
increased to 9% of sales for the three months ended September 30, 1997 from
5% of sales for the three months ended September 30, 1996, due to the
significantly higher percentage of retail sales to total aggregate sales in
1997 (73%) as compared to 1996 (55%). Retail sales typically require a royalty
of 10-18% as compared to 10% for promotional sales. Additionally, the
Company is amortizing the minimum royalty guarantees due in 1997, on the
Fototire product through December 31, 1997, of which $33,000 was expensed
for the three months ended September 30, 1997, and the remaining $40,000
will be expensed during the three months ending December 31, 1997.
Marketing expenses were $591,000 for the three months ended September 30,
1997, an increase of 27% from marketing expenses of $467,000 for the three
months ended September 30, 1996. Marketing expenses as a percentage of
sales increased to 23% of sales for the three months ended September 30, 1997
from 15% of sales for the three months ended September 30, 1996, due to
substantially higher expenses combined with lower sales volume. Marketing
expenses increased by $124,000 from 1996 to 1997 due to substantially higher
sales wages, advertising and travel costs reflecting the Company's expanded
sales and marketing efforts.
General and administrative expenses were $642,000 for the three months ended
September 30, 1997, an increase of 22% from general and administrative
expenses of $525,000 for the three months ended September 30, 1996. This
increase is primarily the result of three factors: increased personnel costs
resulting in part from the appointment of new senior management, substantially
higher professional service costs, including computer services and training
in connection with the installation of a new computer system; and higher
occupancy costs reflecting the Company's expanded inventory warehousing
requirements.
Other Income (Expense):
Interest expense was $9,000 for the three months ended September 30, 1997,
an increase of 135% from interest expense of $4,000 for the three months
ended September 30, 1996. The Company expects interest expense to
increase moderately in the future reflecting the continued financing of
machinery and equipment purchases through capital leases. Total capitalized
equipment and machinery leases were $343,000 at September 30, 1997, an
increase of $184,000 from total capitalized equipment and machinery leases
of $159,000 at September 30, 1996.
Page 13 of 20<PAGE>
Interest income was $25,000 for the three months ended September 30, 1997,
as compared to $31,000 for the three months ended September 30, 1996. This
decrease reflects the lower cash balances during the three months ended
September 30, 1997 as compared to the corresponding prior year period.
Nine Months Ended September 30, 1996 and 1997:
Sales:
Sales were $9,431,000 for the nine months ended September 30, 1997, a
decrease of 48% from sales of $18,180,000 for the nine months ended
September 30, 1996. The $8,750,000 decrease in sales was due to a
$10,062,000 decrease in promotional sales (including $7,900,000 in toy car
promotional sales) offset in part by a $1,313,000 or 28% increase in retail
sales. For the nine months ended September 30, 1997, promotional sales
were $3,500,000, as compared to promotional sales of $13,400,000 in 1996,
of which Chevron and Burger King accounted for 59% and 34% of promotional
sales, respectively, for the corresponding period in 1996. For the nine
months ended September 30, 1997, Burger King accounted for 69% of promotional
sales. Additionally, retail sales increased significantly for the nine
months ended September 30, 1997 as a result of increasing sales with Major
League Baseball teams and concessionaires, entertainment related customers,
as well as, to a lesser extent, college sales. Overall, retail sales were
$5,981,000 for the nine months ended September 30, 1997, a 25% increase over
retail sales of $ 4,780,000 for the corresponding prior year period.
Gross Profit:
Gross profit was $3,355,000 for the nine months ended September 30, 1997,
a decrease of 44% from gross profit of $5,958,000 for the nine months ended
September 30, 1996. As previously noted, gross profit decreased on an
absolute basis due to decreased sales. Gross margins as a percentage of sales
increased from 33% to 36% for the nine months ended September 30, 1996
and 1997, respectively, reflecting the higher margins on its sports-related
promotions and retail sales. As previously noted, the gross margins realized
on sales in future periods is expected to be comparable to the gross margins
realized during the nine months ended September 30, 1997, notwithstanding the
potential negative effect upon gross margins from a write down of Fototire
inventory, if necessary, as previously noted.
Operating Expenses:
Operating expenses were $4,263,000 for the nine months ended September
30, 1997, an increase of 8% from operating expenses of $3,950,000 for the
nine months ended September 30, 1996. Operating expenses as a percentage of
sales increased to 45% of sales for the nine months ended September 30, 1997
from 22% of sales for the nine months ended September 30, 1996, as a result
of the Company's fixed operating costs being allocated over significantly
lower sales volumes. Additionally, the 1997 results included a non-recurring
settlement charge of $210,000. (see Note 3 - "Legal Proceeding".) Excluding
this charge, operating expenses increased 3% in 1997 as compared to 1996.
Royalties expense was $564,000 for the nine months ended September 30,
1997, a decrease of 27% from royalties expense of $774,000 for the nine
months ended September 30, 1996. The decrease in royalties expense during
this period was the result of significantly less royalty-bearing
sports-related promotional sales as compared to the corresponding period in
Page 14 of 20<PAGE>
1996. Royalties expense as a percentage of sales increased to 6% of sales for
the nine months ended September 30, 1997 from 4% of sales for the nine months
ended September 30, 1996, principally due to the non-reoccurrence of the toy
car sales which had no royalty obligation.
Marketing expenses were $1,614,000 for the nine months ended September
30, 1997, an increase of 7% from marketing expenses of $1,513,000 for the
nine months ended September 30, 1996. Marketing expenses as a percentage
of sales increased to 17% of sales for the nine months ended September 30,
1997 from 8% of sales for the nine months ended September 30 1996, as a
result of the non-variable component of marketing expenses, such as wages
and exhibiting costs, being allocated over substantially lower sales volumes.
Marketing expenses on an absolute basis increased by $100,000 between
periods due to the increase in sales personnel, commissions to independent
sales representatives and advertising costs, offset in part by a significant
decrease in employee bonuses.
General and administrative expenses were $1,695,000 for the nine months
ended September 30, 1997, an increase of 12% from general and
administrative expenses of $1,507,000 for the nine months ended September
30, 1996. This increase is a result of several factors, including increased
wages, offset by a decrease in bonus compensation, combined with an
increase in legal expenses and professional services. The Company
anticipates that general and administrative expenses should remain materially
unchanged in 1998 based on the Company's efforts to improve efficiencies,
combined with the expectation that certain anomalous legal, consulting and
recruitment costs will be non-recurring.
Other Income (Expense):
Interest expense was $29,000 for the nine months ended September 30,
1997, an increase of 44% from interest expense of $20,000 for the nine
months ended September 30, 1996. The increase of $9,000 in interest
expense reflects the increase in the amount of the Company's capitalized
leases in 1997 as compared to 1996.
Interest income was $80,000 for the nine months ended September 30, 1997,
as compared to $124,000 for the nine months ended September 30, 1996.
This decrease is due to the Company's average cash balances available for
investment being lower during the nine months ended September 30, 1997
as compared to the corresponding prior year period, as more fully explained
below.
Income Tax Expense (Benefit):
An income tax benefit was not recognized for the nine month period ended
September 30, 1997 due to the anticipated recurring operating losses for the
fourth quarter of 1997, and the limitation on the utilization of tax loss
carryforward as a result of an "ownership change" (as defined by Section 382
of the Internal Revenue Code of 1986, as amended) which occurred in fiscal
1994 in connection with the Company's initial public offering. These
limitations create uncertainty as to the ultimate realization of the future
tax benefits from current and future operating losses and, therefore, no
income tax benefit was accrued.
Page 15 of 20<PAGE>
Liquidity and Capital Resources
The Company's net working capital decreased by approximately $1,317,000
from December 31, 1996 to September 30, 1997, to a net working capital
surplus of $5,522,000 at September 30, 1997 from a net working capital
surplus of $6,839,000 at December 31, 1996. Cash flow provided by
operating activities increased by $2,784,000 from cash provided by operating
activities of $120,000 for the nine months ended September 30, 1996, to
cash provided by operating activities of $2,664,000 for the nine months
ended September 30, 1997. The increase in cash provided by operating
activities was principally due to the collection of accounts receivable
offset in part by increases in inventory and reductions in trade payables.
The Company's inventories have increased significantly during the nine
months ended September 30, 1997, increasing to $3,489,000 from $2,081,000
at December 31, 1996. This increase is due to two factors: (1) the
Company's increasing retail sales and expanding product lines have required
an increased investment in inventory, and (2) the Company purchased
approximately $830,000 in promotional and retail size Fototire products in
anticipation of both substantially higher sales and a significant Fototire
promotion which was originally anticipated to occur in 1997, which the
customer later determined to forego. As previously noted, the Company is
aggressively pursuing several promotional and retail sales opportunities for
the Fototire product. The Company believes, that based on these potential
retail and promotional sales opportunities, and a merchandising commitment
in 1998 from a national retailer, that the Fototire may realize improving
sales in 1998. The ability to increase sales of this product would have a
significant positive impact on the Company's future cash flow.
Notwithstanding the above, the success of this new product will be determined
based on the degree of consumer acceptance at the retail and promotional
level. There can be no assurance that the Company will be successful in
establishing a market for the Fototire product. If the Company is
unsuccessful in establishing a market within the next several months, the
Company may be required to record a charge to operations to establish an
inventory reserve against Fototire product.
Cash and equivalents aggregated $1,453,000 at September 30, 1997, an
increase of $471,000 from cash and equivalents of $982,000 at December 31,
1996. This increase was due in part to the collection of the $5,600,000
receivable from Chevron offset in part by investments in inventory and
repayment of trade payables and bank lines of credit. The Company's
average cash balances have decreased significantly during 1997 as compared
to 1996 due primarily to the significant increase in inventory and operating
losses for the three months ended September 30, 1997. The Company anticipates,
given its expectation of operating losses for the three months ending December
31, 1997, that its cash balances at December 31, 1997 will be substantially
lower than at September 30, 1997. The Company is taking definitive steps to
improve its cash position as discussed in "1997/1998 Outlook" below.
Accounts receivable were $1,413,000 at September 30, 1997, a decrease of
$5,957,000 from accounts receivable of $7,370,000 at December 31, 1996.
This decrease was due primarily to the balance of $5,600,000 due from the
toy car promotion contract with Chevron, shown as an account receivable at
December 31, 1996, which was subsequently paid in the three months ended
March 31, 1997.
Page 16 of 20<PAGE>
At September 30, 1997, the Company has commitments for minimum
guaranteed royalties under licensing agreements totaling $979,529 in the
aggregate through 1999, of which $91,779 is due at various times in 1997.
Given the Company's expectation that it will realize operating losses during
the fourth quarter of 1997, these guaranteed royalties are anticipated to be
funded from cash reserves.
In December 1994, the Company entered into a $1,000,000 line of credit (the
"line of credit") with Merrill Lynch International Bank Limited at an interest
rate of 1.75% above the London Interbank Offering Rate term that
the Company chooses to select. Any borrowing under the line of credit,
which is used solely to collateralize the issuance of stand-by letters of
credit to manufacturers, are secured by cash collateral deposited with
Merrill Lynch equal to the credit outstanding. In December 1995, the Company
increased its existing line of credit with Merrill Lynch International Bank
Limited, from $1,000,000 to $3,000,000. The line of credit, which expired on
December 19, 1996, was subsequently renewed on March 27, 1997 extending
its term until December 10, 2001. There was no borrowing under the line of
credit as of September 30, 1997.
In December 1995, the Company entered into a separate one year credit
agreement with Scripps Bank. This revolving line of credit facility (the
"credit line") in the amount of $1,000,000 is collateralized by the assets of
the Company and actual borrowings are limited to available collateral, as
defined in the agreement. Borrowings under the credit line bear interest at
the bank's prime rate plus .75%. The credit line contains financial covenants
requiring the Company to maintain minimum net worth levels, minimum
working capital and debt to equity ratios. In November 1996, the credit line
was increased to $2,000,000 and was extended to April 15, 1998, under the
same terms. There was no borrowing under the credit line as of September
30, 1997.
Management believes that the Company's existing cash position and credit
facilities will be adequate to support the Company's liquidity and capital
needs, at least through the expiration of the credit line on April 15, 1998.
The Company is currently seeking to renew the credit line with modified loan
covenants. However, such renewal will require less restrictive financial
covenants by the bank. There can be no assurance, however, that the Company
will be successful in renewing this facility under acceptable terms.
Cautionary Statement Pursuant to Safe Harbor Provisions of the Private
Securities Litigation Reform Act of 1995:
This report contains "forward-looking statements" within the meaning of the
federal securities laws. These forward-looking statements include, among
others, statements concerning the Company's outlook for 1997 and 1998,
overall sales trends, gross margin trends, cost and inventory reduction
strategies and their results, the Company's expectations as to funding its
capital expenditures and operations during 1997 and beyond, and other
statement of expectations, beliefs, future plans and strategies, anticipated
events or trends, and similar expressions concerning matters that are not
historical facts. The forward-looking statements in this report and those
included in the Annual Report on Form 10-KSB for the fiscal year ended
December 31, 1996 are subject to risks and uncertainties that could cause
actual results to differ materially from those expressed in or implied by the
statements.
Page 17 of 20<PAGE>
1997/1998 Outlook:
As previously discussed, based on current sales trends, the Company expects
to realize operating losses during the three months ending December 31, 1997,
although in a lesser amount than the operating losses realized in the three
months ended September 30, 1997, primarily as a result of a recent surge in
World Series related retail sales and an increase in entertainment related
retail sales. See Item 2."Management's Discussion and Analysis or Plan of
Operation." The Company's retail business is expected to continue to realize
in 1998 growth rates comparable to 1997 and prior years. Growth in retail
sales is being driven by the following factors: (1) the significant growth of
the Company's "team" business representing sales of product to Major League
Baseball teams, concessionaires and corporate sponsors; (2) the aggressive
pursuit of nationwide representation with its national mass merchants,
including a current test program in 100 Walmart stores using a free-standing
fixture. If this test program is successful, the Company's distributor will
pursue installation of the fixture in the remaining approximately 1,900 Walmart
stores that carry souvenir sports products during 1998; (3) the Company's
increasing line of products, including the new hockey puck and lapel pin
products; (4) the Company's expanding customer relationships with Walt Disney
and Planet Hollywood; and (5) the significant increase in its college business,
supported by an expanding product line, including vulcanized rubber sports
balls.
The Company's promotional business, with its inherent variability, is more
difficult to forecast. Promotions sales are significantly lower in 1997 than
in 1996, resulting to a large extent from the reliance upon a few significant
customers. The Company's primary emphasis is the growth of its
promotional business and the mitigation of its variability through a
broadening of its customer relationships and an expansion of its sales staff.
The Company recently employed two senior promotional salespersons who
are expected to contribute significantly to these initiatives. The recent
positive consumer response to the national Wheaties cereal box promotion with
General Mills demonstrates the Company's ability to deliver highly effective
corporate sponsored sports promotions. The Company's focus in 1998 will be
to leverage its relationships with sports leagues to increase regional and
national corporate promotional sales.
The Company's primary focus during the next few months is the
establishment of specific strategic initiatives which will return
the Company to profitability in 1998 and improve the Company's cash
position. These initiatives include:
(i) the improvement of the Company's inventory procurement processes in
part through the employment of an inventory and production planner;
(ii) the identification and elimination of excess operating expenses;
(iii) improved gross margins through increased efficiencies at the San
Diego production facility;
(iv) the refocus of the Company's sales staff on aggressively pursing the
Company's core souvenir sports product business; and
(v) the search and evaluation for potential acquisitions which could
add critical mass to support the Company's current infrastructure,
and add synergistic product lines.
Page 18 of 20<PAGE>
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Securities Holders
-----------------------------------------------------
On July 31, 1997, the Company held its Annual Meeting of Stockholders.
The matters considered at the meeting consisted of the following:
The election of one Class III director to serve for a term of three years and
until his successor is elected and qualified. The results of the voting were
as follows:
Nominee Votes For Votes Withheld
------- --------- --------------
Michael Favish 2,373,750 103,410
The ratification of the Board of Directors' appointment of Hollander,
Gilbert & Co. as the Company's independent auditors for the year ending
December 31, 1997. The results of the voting were as follows:
For Against Abstained
--- ------- ---------
2,333,760 91,300 52,100
Item 6. Exhibits and Reports on Form 8-K
---------------------------------
(a) Exhibits
27 Financial Data Schedule
(b) Reports on Form 8-K for the three months ended September 30,
1997 - None
Page 19 of 20<PAGE>
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
FOTOBALL USA, INC.
---------------------------
(Registrant)
Dated: November 14, 1997 BY: /s/ Michael Favish
----------------------------
Michael Favish
President and Chief Executive Officer
(Duly Authorized Officer)
Dated: November 14, 1997 BY: /s/ David G. Forster
----------------------------
David G. Forster
Vice President-Finance, Treasurer
and Chief Financial Officer
(Principal Accounting Officer)
Page 20 of 20<PAGE>
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<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMA-
TION EXTRACTED FROM THE FINANCIAL STATEMENTS
CONTAINED IN THE FOTOBALL USA, INC. FORM 10-QSB
FOR THE PERIOD ENDED SEPTEMBER 30, 1997, AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 1,453,422
<SECURITIES> 0
<RECEIVABLES> 1,413,071
<ALLOWANCES> 0
<INVENTORY> 3,488,597
<CURRENT-ASSETS> 6,560,649
<PP&E> 2,218,549
<DEPRECIATION> 874,185
<TOTAL-ASSETS> 8,489,670
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<COMMON> 26,767
<OTHER-SE> 7,201,624
<TOTAL-LIABILITY-AND-EQUITY> 8,489,670
<SALES> 9,430,585
<TOTAL-REVENUES> 9,430,585
<CGS> 6,075,789
<TOTAL-COSTS> 4,262,534
<OTHER-EXPENSES> 0
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<INTEREST-EXPENSE> 29,347
<INCOME-PRETAX> (856,914)
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