SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For fiscal year ended September 30, 1997
Commission file number 0-21630
-------------------------
ACTION PERFORMANCE COMPANIES, INC.
(Exact Name of Registrant as Specified in Its Charter)
ARIZONA 86-0704792
(State of Incorporation) (I.R.S. Employer Identification No.)
2401 West First Street
Tempe, Arizona 85281
(602) 894-0100
(Address, including zip code, and telephone number, including area code,
of principal executive offices)
Securities registered pursuant to Section 12(b) of the Exchange Act: None
Securities registered pursuant to Section 12(g) of the Exchange Act:
Common Stock, par value $.01 per share
Indicate by check mark whether the registrant (1) filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
Check if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K
is not contained herein, and will not be contained, to the best of registrant's
knowledge, in definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ]
Issuer's revenues for its most recent fiscal year: $130,380,000.
The aggregate market value of Common Stock held by nonaffiliates of the
registrant (13,868,740 shares) based on the closing price of the registrant's
Common Stock as reported on the Nasdaq National Market on December 15, 1997, was
$458,535,216. For purposes of this computation, all officers, directors and 10%
beneficial owners of the registrant are deemed to be affiliates. Such
determination should not be deemed an admission that such officers, directors or
10% beneficial owners are, in fact, affiliates of the registrant.
As of December 15, 1997, there were outstanding 16,012,471 shares of
registrant's Common Stock, par value $.01 per share.
Documents incorporated by reference: Portions of the registrant's definitive
Proxy Statement for the 1998 Annual Meeting of Shareholders are incorporated by
reference into Part III of this Report.
ACTION PERFORMANCE COMPANIES, INC.
ANNUAL REPORT ON FORM 10-K
FISCAL YEAR ENDED SEPTEMBER 30, 1997
TABLE OF CONTENTS
Page
PART I
ITEM 1. BUSINESS.................................................... 1
ITEM 2. PROPERTIES..................................................18
ITEM 3. LEGAL PROCEEDINGS...........................................19
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.........20
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS.............................21
ITEM 6. SELECTED FINANCIAL DATA.....................................22
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS...............23
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK...........................................29
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.................30
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE.........................30
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT..........30
ITEM 11. EXECUTIVE COMPENSATION......................................30
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT..............................................30
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS..............30
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND
REPORTS ON FORM 8-K.........................................31
SIGNATURES ............................................................34
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS...................................F-1
i
PART I
ITEM 1. BUSINESS
Overview
The Company is the leader in the design and sale of licensed
motorsports collectible and consumer products in the United States. The
Company's products include die-cast scaled replicas of motorsports vehicles,
apparel (including t-shirts, hats, and jackets), and souvenirs. The Company
markets its products pursuant to license arrangements with popular race car
drivers (including exclusive license arrangements with seven-time Winston Cup
champion Dale Earnhardt, 1995 and 1997 Winston Cup champion Jeff Gordon, and
seven-time National Hot Rod Association ("NHRA") Funny Car champion John Force),
car owners, car sponsors, automobile manufacturers, and the National Association
for Stock Car Auto Racing ("NASCAR"). The Company's motorsports collectibles and
most of the Company's apparel and souvenirs are manufactured by third parties,
generally utilizing the Company's designs, tools, and dies. The Company screen
prints and embroiders a portion of the licensed motorsports apparel that it
sells.
The Company markets its products to approximately 5,000 specialty
retailers either directly or through its wholesale distributor network; to
motorsports enthusiasts directly through its Racing Collectibles Club of America
(the "Collectors' Club"), which currently has approximately 107,000 members; and
through mobile trackside souvenir stores, promotional programs for corporate
sponsors, and fan clubs. In December 1996, the Company entered into a license
agreement with Hasbro, Inc. ("Hasbro"), a multi-billion dollar toy and game
manufacturer, covering the exclusive sale by Hasbro of a new line of
motorsports-related products in the mass-merchandise market.
The Company's products and other programs capitalize on the rapidly
growing popularity of motorsports. USA Today reports that motorsports racing is
the fastest growing spectator sport in the United States with attendance at
NASCAR Winston Cup events more than doubling in the past decade from 75,643 per
event in 1985 to approximately 180,000 in 1996. Approximately 5.6 million fans
attended the 31 races of the Winston Cup series in 1996. USA Today also reports
that TV ratings are growing even faster than attendance, with more than 100
million people tuning in to NASCAR's televised events each year. According to
NASCAR, more than 70 of the Fortune 500 companies utilize motorsports
sponsorship or advertising as part of their marketing strategies.
Historically, the Company has designed and marketed die-cast
collectibles featuring NASCAR drivers and vehicles. In 1995, the Company began
expanding its lines of die-cast collectibles to include other types of
motorsports vehicles, including NHRA drag racing, NASCAR's new "Super Truck"
racing series, United States Auto Club ("USAC") racing, and "World of Outlaws"
sprint car racing. During fiscal 1997, the Company expanded its product
offerings by acquiring Sports Image, Inc. ("Sports Image"), Motorsport
Traditions Limited Partnership and Creative Marketing and Promotions, Inc.
(together, "Motorsport Traditions"), and Robert Yates Promotions, Inc. ("RYP"),
which market and distribute licensed motorsports products including apparel and
souvenirs; Image Works, Inc., which manufactures and markets licensed
motorsports apparel through the mass-merchandise markets ("Image Works"); and
the motorsports collectibles-related assets of Simpson Products, Inc.
("Simpson"). As a result of these acquisitions, the Company now markets and
distributes licensed motorsports apparel and other souvenir items featuring the
likeness of Dale Earnhardt, Jeff Gordon, Darrell Waltrip, Bobby Labonte, and
other popular drivers. During fiscal 1997, the Company also expanded its
development of promotional programs for corporate sponsors of motorsports, which
feature the Company's products and which are intended to increase the brand
awareness of the products and services of the corporate sponsors. The Company
also has begun to represent a number of popular race car drivers in a broad
range of licensing and other revenue-producing opportunities, including product
licenses, corporate sponsorships, endorsement contracts, and speaking
engagements.
The Company has continued to take significant steps that are intended
to add new product lines and distribution channels to capitalize on the growing
demand for licensed motorsports products but will not compete with sales of the
Company's existing products. As part of these ongoing efforts, in October 1997
the Company announced that it has agreed to acquire the assets related to the
motorsports die-cast collectible product lines of
Revell-Monogram, Inc. ("Revell") and to enter into a strategic alliance with
Revell involving extensive product licensing and distribution arrangements. In
October 1997, the Company also entered into a ten-year license agreement with
Richard Childress Racing Enterprises, Inc. ("RCR") with respect to various
rights used in connection with Dale Earnhardt licensed products. On December 9,
1997, the Company acquired certain assets and assumed certain liabilities
related to sales of motorsports merchandise licensed by NASCAR Winston Cup
driver Rusty Wallace and entered into a seven-year license agreement for the
name and likeness of Mr. Wallace (the "Rusty Wallace Acquisition").
The Company focuses on developing long-term relationships with the
most popular drivers, car owners, car sponsors, car manufacturers, and others in
the various top racing categories. The Company continually strives to strengthen
its relationships with licensors and to develop opportunities to market
innovative licensed collectible and consumer products that appeal to motorsports
enthusiasts. The Company believes that its license agreements with popular
NASCAR and other motorsports personalities and sponsors significantly enhance
the collectible value and marketability of its products. The Company believes
that it will be able to leverage its relationships to attract additional drivers
in order to generate increased revenue for the Company as well as increased
earnings for the drivers.
The Company pursues a strategy designed to enhance its leadership
position in the motorsports collectible and consumer products industry. Key
aspects of this strategy include (i) continuing to enhance its existing products
and introduce new products that appeal to racing enthusiasts, (ii) expanding and
strengthening its licensing arrangements, (iii) pursuing strategic acquisitions
and alliances, (iv) expanding existing and identifying new distribution
channels, and (v) developing promotional programs for corporate sponsors.
The Company was incorporated in Arizona in 1992. The Company's
principal executive offices are located at 4707 East Baseline Road, Phoenix,
Arizona 85040, and its telephone number is (602) 337-3700. As used herein, the
term "Company" refers to Action Performance Companies, Inc. and its subsidiaries
and operating divisions. See Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Overview."
Industry Overview
Motorsports racing in the United States consists of several distinct
segments, each with its own organizing bodies and events. The largest segment,
in terms of attendance and media exposure, is stock car racing, which is
dominated by NASCAR. The other principal segments are drag racing, with NHRA the
most important organizing body, and Indy car racing, controlled by the Indy
Racing League and Championship Auto Racing Teams.
According to USA Today, motorsports racing is the fastest growing
spectator sport in the United States. Approximately 15.4 million people attended
motorsports' premier events in 1996, almost three times the 1981 attendance.
Approximately 5.6 million fans attended the 31 races in the NASCAR Winston Cup
series in 1996, representing attendance of approximately 180,000 per event, more
than double the 75,643 attendance per Winston Cup event in 1985. Published
reports estimate that attendance at NASCAR Winston Cup events in 1997 exceeded
6.0 million fans. NHRA attendance also has grown significantly in recent years,
reaching total attendance of almost 1.9 million in 1996. Motorsports events also
have achieved significant success on television, with coverage of NASCAR and
NHRA races provided by broadcast and cable television networks, such as ABC,
CBS, ESPN, TBS, and TNN, in addition to regional sports networks. Several
leading cable companies have joined forces recently to launch Speedvision, a
motorsports cable network. USA Today reports that TV ratings are growing even
faster than attendance, with more than 100 million people tuning into NASCAR's
televised events in 1996. The Company believes that the recent construction of
new superspeedways in Los Angeles, California, Ft. Worth, Texas, Las Vegas,
Nevada, and other major cities will stimulate continued growth in the
motorsports industry through increased exposure to new racing enthusiasts and
markets.
The growing popularity of motorsports has been recognized by corporate
America. According to NASCAR, more than 70 of the Fortune 500 companies utilize
motorsports sponsorship or other activities as part of their marketing
strategies.
2
Products and Services
Die-Cast Scaled Replica Vehicles
The Company designs and markets scaled replicas of motorsports-related
vehicles that are constructed using die-cast bodies and chassis with free
wheeling deluxe wheels and tires. The Company markets its die-cast racing
collectibles pursuant to approximately 300 active licenses with race car
drivers, owners, and sponsors as well as under license agreements with NASCAR,
Ford Motor Company, and several divisions of General Motors Corp. The die-cast
collectibles offered by the Company relate to stock car, NHRA drag racing,
"Super Truck" racing, USAC racing, and "World of Outlaws" sprint car racing. The
Company's die-cast collectibles consist of (i) 1:64th and 1:24th scale replicas
of actual racing vehicles, which are approximately three inches and eight inches
long, respectively; (ii) 1:96th and 1:64th scale racing vehicle transporters;
(iii) a 1:16th scale pit wagon; and (iv) 1:24th scale dually trucks with
trailers. The Company's die-cast replicas typically range in price at retail
from approximately $9.00 to $75.00 per item, depending on size, type of vehicle,
and level of detail. A 1:24th scale replica of an actual racing vehicle
typically retails for $35.00. The Company offers its die-cast collectibles
primarily through its wholesale distributor network to specialty retailers,
through its Collectors' Club, through mobile trackside stores, and through
corporate promotional programs. See Item 1, "Business - Sales and Distribution."
Historically, the Company has designed and marketed die-cast
collectibles featuring drivers and vehicles from the NASCAR Winston Cup series.
During fiscal 1995, the Company began the development of several new lines of
die-cast collectibles featuring replicas of vehicles from other popular
motorsports. The Company successfully introduced its line of Winston NHRA Top
Fuel Dragsters and a line of die-cast collectible replicas from the popular new
NASCAR "Super Truck" series in fiscal 1995 and introduced its line of Top Fuel
Funny Car replicas in fiscal 1996. In addition, during the second half of fiscal
1997 the Company introduced the "Elite" series of die-cast replicas of NASCAR
racing vehicles, which feature highly detailed equipment such as spark plug
wires, braided hoses, and realistic suspension systems. The Company sells the
Elite series of collectibles exclusively through the Collectors' Club for
approximately $75.00 per replica.
The Company enhances the collectible value and appeal of its products
through various measures. These measures include (i) designing die-cast
collectibles that include features that are not offered by the Company's
competitors; (ii) limiting the quantities of each item that it produces and
sells; (iii) specifying on the packaging material of certain die-cast
collectibles the quantity of that limited-edition item actually produced; (iv)
offering certain items only through its Collectors' Club; and (v) designing and
developing new packaging concepts to improve the display of each collectible
item.
Motorsports Consumer Products
The Company markets various licensed motorsports apparel, souvenir,
and other consumer products, including t-shirts, jackets, hats, license plate
brackets, mugs, pins, and key chains. Each of the motorsports consumer products
generally features the name, likeness, and car number of a popular race car
driver. The Company intends to acquire licenses with additional drivers and to
develop new motorsports consumer products, including items bearing the "NASCAR"
name and logo in connection with the Company's license agreement with NASCAR.
The Company's licensed motorsports apparel items utilize unique and creative
designs that are printed or applied to high-quality shirts, hats, jackets, and
other products. The Company designs and sells its motorsports apparel products
in sizes ranging from infant to youth to men's and women's adult sizes. The
Company designs its motorsports consumer products primarily for high-volume
distribution through retail outlets, mobile trackside stores, and promotional
programs with corporate sponsors of racing teams and racing events. See Item 1,
"Business - Sales and Distribution."
3
Mass-Merchandise License
The Company licenses Hasbro to produce a new line of
motorsports-related products specifically designed for the mass-merchandise
market. Under this license, Hasbro currently markets a line of die-cast replicas
of racing vehicles, which was jointly developed by the Company and Hasbro, under
the "Winner's Circle" brand name. The mass-market die-cast products manufactured
and marketed by Hasbro are completely distinct from the Company's current
products and do not compete directly with the Company's limited-edition
motorsports die-cast collectible products. Under the agreement, Hasbro also will
market other licensed motorsports products, including radio-controlled cars,
slot car sets, games (such as electronic and CD-ROM interactive games), plush
toys, figurines, play sets, walkie talkies, and other items similar to products
that Hasbro currently markets under the "Kenner," "Tonka," and "Milton Bradley"
brand names.
The Company believes that the license agreement with Hasbro allows the
Company to capitalize on opportunities in the mass-merchandise market. The
agreement will enable the Company to remain focused on its core business of
designing and marketing motorsports collectibles, apparel, and souvenir products
while enabling the Company to benefit from Hasbro's retail mass-merchandise
marketing expertise and resources. The agreement also provides a means of
expanding the Company's product offerings without committing substantial
resources to manufacturing and marketing activities or subjecting it to the
risks inherent in the mass-merchandise market.
Corporate Promotional Programs
The Company provides comprehensive marketing services designed to
create corporate promotional programs for large corporate sponsors that
advertise in motorsports. Many corporations sponsor racing vehicles or events
and advertise at motorsports events and in motorsports-related media in order to
increase awareness of their brands among consumers and to encourage consumers to
purchase their products. The Company provides design services, graphic artists,
and the capacity to deliver a wide array of promotional products, such as
die-cast replicas, t-shirts, and hats. The corporate sponsors use these products
either as free or low-cost awards with the purchase of their own products or in
sweepstakes or other promotions. The Company also provides in-house marketing
and distribution support for its promotional programs, including in-bound order
processing, order fulfillment, sweepstakes processing, and redemption programs.
Die-cast replica vehicles sold as promotional items are not sold through the
Company's wholesale distribution network or through its Collectors' Club.
Action Sports Management
The Company represents a number of top race car drivers in a broad
range of licensing and other revenue-producing opportunities, including product
licenses, corporate sponsorships, endorsement contracts, and speaking
engagements. The Company provides a number of services designed to enable
drivers to maximize revenue opportunities throughout their careers. Since the
commencement of its sports management business in fiscal 1996, the Company has
entered into exclusive agreements to represent six-time Winston NHRA Funny Car
champion John Force and other popular drag racing drivers, including Darrell
Alderman, Mike Dunn, Scott Geoffrion, and Darrell Gwynn. As a result of the
Company's ability to represent drivers effectively in obtaining favorable
licensing arrangements and other revenue opportunities, the Company believes
that it is well-positioned to attract and retain top race car drivers.
Sales and Distribution
The Company markets its die-cast collectibles to approximately 5,000
specialty retailers through its wholesale distributor network, through its
Collectors' Club, through mobile trackside stores, and through corporate
promotional programs. The Company markets its motorsports consumer products
primarily through direct trackside sales to race fans; through an in-house sales
force and independent representatives to approximately 5,000 specialty retailers
and to major discount and department stores, retail automotive product outlets,
and convenience stores; and through promotional programs with corporate
sponsors.
4
Wholesale Distribution
The Company markets its die-cast collectibles on a wholesale basis
through approximately 40 distributors operating in the United States. The
distributors solicit orders for the Company's die-cast products from
approximately 5,000 specialty retailers throughout the United States. The
retailers include stores specializing in motorsports collectibles and apparel
and stores specializing in other sports collectible items. Employees of the
Company attend trade shows in an effort to attract new distributors and
retailers to its network. The Company advertises its die-cast collectibles in
newspapers and magazines covering motorsports and the collectibles markets.
These advertisements encourage consumers to contact the nearest retailers to
purchase the Company's die-cast collectibles. The Company also takes measures to
increase consumer awareness of its products through radio and television
advertising, including promotion of its collectibles on "home shopping"
television programs and advertising during popular television programs of
interest to motorsports enthusiasts.
The Company utilizes its distributor network as well as an in-house
sales force and independent representatives to market its motorsports apparel,
souvenirs, and other consumer products on a wholesale basis to the same
specialty retailers that sell its die-cast collectibles. The Company's in-house
sales force and independent representatives also market certain motorsports
consumer products on a wholesale basis to automobile sections in major discount
and department stores such as Wal-Mart and K-Mart, to automotive retail stores,
and to convenience stores.
Collectors' Club
The Company markets certain of its die-cast collectibles exclusively
through its Collectors' Club. Members of the Company's Collectors' Club pay a
lifetime membership fee that entitles them to receive membership premiums, a
quarterly magazine, catalogs, and other special sales materials highlighting the
Company's collectibles and other products. Membership in the Collectors' Club
increased from approximately 22,000 members in September 1994 to approximately
100,000 members as of September 30, 1997. The Company strives to increase
collector interest in its products and to enhance its products' value as
collectibles by (i) offering certain items exclusively through its Collectors'
Club; (ii) producing a limited number of each collectible; and (iii) limiting
the number of a particular item that each member may purchase. Following the
acquisitions of Sports Image and Motorsport Traditions, the Company began
developing a line of licensed motorsports apparel and souvenirs to offer
exclusively through its Collectors' Club. The Company advertises its Collectors'
Club in publications that focus on motorsports or the collectibles industry and
through limited radio and television advertisements. During 1996, the Company
increased its advertising on cable television during televised motorsports
events and related programming in order to enhance its exposure to motorsports
enthusiasts.
The Company employs customer service representatives and an automated
call distribution telephone system to take membership applications, take
customer orders, and handle customer inquiries. The Company utilizes an advanced
telephone and computer system that combines telemarketing functions,
computerized order processing, and automated warehouse operations to answer and
process telephone orders to its Collectors' Club more effectively and
efficiently and to accommodate the significant growth in club membership in
recent years. The system also enables the Company to track the effectiveness of
each advertisement and to target its marketing and advertising programs
accurately for enhanced impact.
Trackside Sales
Average attendance at NASCAR Winston Cup racing events grew to
approximately 180,000 fans per race during 1996. Following the Rusty Wallace
Acquisition, the Company owns and operates 25 fully equipped mobile trackside
stores to capitalize on this large base of potential customers. Some or all of
the Company's mobile trackside stores travel to each NASCAR Winston Cup race (34
events in 1997) as well as to other selected racing events. Each mobile
trackside store is decorated with the logos and color scheme of a particular
racing team and driver and sells a complete assortment of licensed motorsports
apparel, souvenirs, and die-cast collectibles dedicated
5
to that team and driver. These mobile stores represent the only trackside
opportunities for racing enthusiasts to purchase motorsports products using the
name and likeness of the driver and racing team featured in each store.
Corporate Promotional Programs
The Company creates promotional programs for large corporate sponsors
of motorsports. The Company plans to pursue future promotional programs and
currently is in discussions with major race car drivers and corporate sponsors
in its effort to develop such programs. See Item 1, "Business - Products and
Services - Corporate Promotional Programs."
Design and Production
Die-cast Scaled Replica Vehicles
The Company designs each die-cast collectible that it markets. The
Company's design artists take numerous photographs of the actual racing cars,
trucks, and other vehicles to be produced as die-cast replicas. Working from
these photographs, the Company's artists and engineers use computer software to
create detailed scale renderings of the vehicles. After approval of the
rendering by the vehicle owner, driver, or racing team sponsor, the Company
supplies computerized renderings to its manufacturer in the Peoples' Republic of
China ("China"). The manufacturer produces a sample or model, which the Company
then inspects for quality and detail. After final approval, the manufacturer
produces the die-cast replicas, packages them, and ships the finished products
to the Company or, in certain instances, directly to the Company's customers.
The Company's die-cast collectibles are manufactured under an
exclusive agreement with a third-party manufacturer in China. The term of the
agreement currently extends through December 31, 1997 and automatically renews
for successive one-year terms unless terminated by either party by giving
written notice to the other party at least 90 days prior to the end of the
then-current term. The Company owns a significant portion of the tooling that
the third-party manufacturer uses to produce die-cast collectibles for the
Company and has partial control over the production of its die-cast collectibles
under the manufacturing agreement. The Company invested approximately $2.6
million and $7.0 million in tooling for its proprietary line of die-cast
collectibles in fiscal 1996 and fiscal 1997, respectively. The Company believes
the breadth and quality of the tooling program provides the Company with a
competitive advantage in the motorsports collectible market. The Company intends
to make additional investments in tooling in order to support the growth of its
business. The Company also devotes a significant amount of time and effort to
the production of its die-cast collectibles to ensure that the resulting
products display a level of quality and detail that is superior to competing
products, including opening hoods and trunks, detailed engines, working
suspensions, and pad printing instead of stickers or decals. The Company
believes that its overseas manufacturer of die-cast collectibles is dedicated to
high quality and productivity as well as support for new product development. An
affiliate of the Company's China-based die-cast manufacturer currently owns
450,000 shares of the Company's Common Stock. The Company believes that this
ownership interest further aligns the interests of the manufacturer with those
of the Company.
Motorsports Consumer Products
The Company currently designs substantially all of its licensed
motorsports apparel, souvenirs, and other consumer products and arranges for the
manufacture of most of such products on a purchase order basis with third-party
manufacturers located primarily in the United States. As a result of its recent
acquisition of Image Works, the Company now screen prints and embroiders a
portion of the licensed motorsports apparel that it sells. The Company's graphic
artists and product designers seek to develop unique products and artistic
designs that will appeal to motorsports enthusiasts and distinguish the
Company's apparel and souvenir products from those of its competitors. The
Company's artists and designers also work closely with the third-party
manufacturers in order to ensure that the products conform to design
specifications and meet or exceed quality requirements. The Company believes
that a number of alternative manufacturers for each of these products is readily
available in the event that
6
the Company is unable to obtain products from any particular manufacturer. The
Company owns the tooling and dies used to manufacture certain of its motorsports
consumer products. As the Company develops new motorsports consumer products
that require specialized tooling, the Company intends to build or purchase the
new tooling that will be required to permit the third-party manufacturers to
produce those items.
Licenses
Product Licenses
The Company focuses on developing long-term relationships with and
engages in comprehensive efforts to license the most popular drivers and car
owners in each top racing category, their sponsors, and others in the
motorsports industry. The Company currently has licenses with approximately 300
race car drivers, car owners, and car sponsors as well as with NASCAR, Ford
Motor Company, several divisions of General Motors Corp., and PACCAR, Inc. (the
manufacturer of Kenworth and Peterbilt trucks). The Company continually strives
to strengthen its relationships with licensors and to develop opportunities to
market innovative collectible and consumer products that appeal to motorsports
enthusiasts. The Company believes that its license agreements with top race car
drivers, such as seven-time Winston Cup champion Dale Earnhardt, 1995 and 1997
Winston Cup champion Jeff Gordon, six-time NHRA Funny Car champion John Force,
Kenny Bernstein, Rusty Wallace, Dale Jarrett, Mark Martin, Bill Elliot, and
Bobby Labonte, significantly enhance the collectible value and marketability of
its products. By aligning itself with top racing personalities and providing a
broad range of revenue opportunities, the Company believes that it will be able
to leverage those relationships to attract additional drivers in order to
generate increased revenue for the Company as well as increased earnings for the
drivers.
Except for its licenses with Dale Earnhardt, Jeff Gordon, Rusty
Wallace, and certain race car team owners, as described below, the licenses with
race car drivers generally provide for a term of one year and permit the Company
to use the driver's name, photograph or likeness, and autograph; the licenses
with race car owners generally provide for a term of one year and permit the
Company to use the car number and colors; the licenses with manufacturers
provide for terms of two or more years and permit the Company to reproduce the
cars or trucks themselves; and the license agreements with various sponsors
generally provide for terms of one to three years and permit the Company to
reproduce the sponsors' decals and logos as they appear on the cars or trucks.
Depending upon the particular agreement, the individual licenses either renew
automatically, may be renewed or extended upon written request by the Company,
or expire at the end of the specified term. The agreements with the drivers, car
owners, car and truck manufacturers, and car sponsors provide for payments by
the Company to the licensors of either (i) a fixed dollar amount, which may
include a substantial advance to the licensor; (ii) a fixed amount per item sold
by the Company pursuant to the license; (iii) a percentage of the net sales for
a program or a percentage of the Company's wholesale price per item sold by the
Company pursuant to the license; or (iv) a combination of the above. License
agreements with certain sponsors do not require payments by the Company to the
licensors because of the advertising value provided to the licensor as a result
of having its decals and logos displayed on the Company's products. The Company
continually strives to renew existing agreements or to enter into new license
agreements with existing or new drivers, car owners, and car sponsors and to
develop new product programs pursuant to its license agreements in its effort to
maintain its leadership position in the motorsports licensed products industry.
Dale Earnhardt License Agreement
In connection with the acquisition of Sports Image, the Company
entered into a license agreement with Dale Earnhardt (the "Earnhardt License")
under which the Company has the right to market licensed motorsports products
utilizing the likeness of Mr. Earnhardt. Under the Earnhardt License, Mr.
Earnhardt also granted the Company the right of first refusal to make, have
made, use, sell, or otherwise distribute any new licensable products that Mr.
Earnhardt becomes aware of and approves for marketing. The Earnhardt License
also provides that Mr. Earnhardt will not personally market and will not permit
others to market, through the same channels of distribution used by the Company,
any products bearing his likeness that are the same as or similar to products
marketed by the Company
7
under the Earnhardt License. The term of the Earnhardt License extends to
November 2011 and from year to year thereafter unless terminated by either
party.
Jeff Gordon License and Endorsement Agreements
In connection with the acquisition of Motorsport Traditions, the
Company acquired the exclusive rights to manufacture and market various apparel
and souvenir products bearing the name, likeness, and signature of Jeff Gordon
and the likeness of his race car under a license agreement with an affiliate of
Mr. Gordon (the "Gordon Apparel and Souvenir License"). The Gordon Apparel and
Souvenir License expires on December 31, 2000, subject to renewal by agreement
between the parties. The Gordon Apparel and Souvenir License requires the
Company to pay the licensor royalties based on a percentage of the wholesale
price of licensed products sold by the Company, with minimum royalty payments
each year during the term of the agreement.
In connection with the acquisition of Motorsport Traditions, the
Company also entered into a license agreement (the "Gordon Die-Cast License")
with an affiliate of Jeff Gordon. Pursuant to the Gordon Die-Cast License, the
Company has the exclusive right to manufacture and market die-cast replicas of
Mr. Gordon's race car and related vehicles. The Gordon Die-Cast License expires
on December 31, 2000. The Gordon Die-Cast License requires the Company to pay
the licensor royalties based on a percentage of the wholesale price of licensed
products sold by the Company, with minimum royalty payments each year during the
term of the agreement.
In connection with the Gordon Die-Cast License, the Company entered
into a personal service and endorsement agreement with Jeff Gordon and an
affiliate of Mr. Gordon (the "Endorsement Agreement"). During the term of the
Endorsement Agreement, which expires on December 31, 2000, the Company will have
the right to use Mr. Gordon's name, likeness, signature, and endorsement in
connection with the advertisement, promotion, and sale of the die-cast
collectibles to be produced under the Gordon Die-Cast License.
Rusty Wallace License Agreement
In connection with the Rusty Wallace Acquisition in December 1997, the
Company entered into a license agreement (the "Wallace License") with an
affiliate of Rusty Wallace. Pursuant to the Wallace License, the Company has a
right of first refusal to make, have made, use, sell, or otherwise distribute
any new licensable products that bear the name or likeness of Mr. Wallace. The
Wallace License also provides that Mr. Wallace will not personally market and
will not permit others to market, through the same channels of distribution used
by the Company, any products bearing his likeness that are the same as or
similar to products marketed by the Company under the Wallace License. The
Wallace License requires the Company to pay the licensor royalties based on a
percentage of the wholesale price of licensed products sold by the Company, with
minimum royalty payments each year during the term of the agreement if certain
minimum sales requirements are met. The Wallace License expires on December 31,
2004, subject to two five-year renewal options by agreement between the parties.
Significant Team Owner Licenses
During fiscal 1997, the Company entered into license agreements with
several of the most popular NASCAR race car team owners, including Robert Yates
Racing, Inc. ("Yates"), Richard Childress Racing Enterprises, Inc.
("Childress"), Joe Gibbs Racing, Inc. ("Gibbs"), and Dale Earnhardt, Inc.
("DEI"). These licenses provide the Company with a right of first refusal to
market products bearing the likeness of Yates' "#28" and "#88" Winston Cup cars;
Childress' "#3" and "#31" Winston Cup and other racing vehicles; Gibbs' "#18"
Winston Cup car and a second car beginning in 1998; and DEI's "#14" Winston Cup
car and other racing vehicles. To the extent that the Company exercises its
right of first refusal, the license agreements also provide that the licensor
will not directly market and will not permit others to market, through the same
distribution channels used by the Company, any of the licensed products. The
license agreements with Yates, Childress, Gibbs, and DEI provide for terms of
15, 10, 5, and 3 years, respectively. Each of the license agreements with the
team owners requires the Company to pay the licensor royalties
8
based on a percentage of the wholesale price of licensed products sold by the
Company. Certain of the license agreements also provide for minimum royalty
payments to the licensors.
Hasbro License Agreement
The license agreement between the Company and Hasbro (the "Hasbro
License") covers the exclusive sale by Hasbro in the mass-merchandise market of
specific motorsports-related products for which the Company has or will secure
exclusive or non-exclusive licenses from race car drivers, owners,
manufacturers, and sponsors. The Company believes that the Hasbro License
provides the Company with a source of revenue from the mass-merchandise market
without committing substantial resources to manufacturing and marketing
activities or subjecting the Company to the risks inherent in the
mass-merchandise market. Under the Hasbro License, the Company is responsible
for acquiring and maintaining the license rights with the licensors, and Hasbro
is responsible for all costs and other arrangements relating to tooling,
manufacturing, transportation, marketing, distribution, and sales of licensed
products. Hasbro will be responsible for and will pay or reimburse the Company
for all license fees and royalties, including advances and guarantees, paid to
licensors for licensed products. The licensed products consist of (i) die-cast
replicas of motorsports vehicles and a 1:18th-scale plastic toy car, for which
Hasbro pays a specified royalty, and (ii) all other products that Hasbro may
market as licensed motorsports products, including, for example,
radio-controlled cars, slot car sets, games (including electronic and CD-ROM
interactive games), plush toys, figurines, play sets, walkie talkies, and other
products, for which Hasbro pays a specified royalty. Hasbro currently markets
similar products under the "Kenner," "Tonka," "Milton Bradley," and other brand
names. Hasbro will pay the Company guaranteed minimum annual royalty payments of
$500,000 to $1.0 million, depending on certain circumstances.
Hasbro's initial focus under the Hasbro License has been to develop,
with the Company's assistance, a line of motorsports die-cast products for the
retail mass-merchandise market. Hasbro will fund all capital requirements for
this product line and will manufacture, distribute, and market the products
under the "Winner's Circle" brand name. This product line has been recently
introduced to mass-market retailers. The mass-market die-cast products
manufactured and marketed under the Hasbro License are completely distinct from
the Company's current products and do not compete directly with the Company's
limited-edition motorsports die-cast collectible products.
The Hasbro License provides for a term ending on December 31, 2001.
Hasbro may extend the Hasbro License for an additional three-year term, provided
that total wholesale revenue of licensed products exceeds a specified amount
during the initial term.
NASCAR License Agreement
In April 1997, the Company entered into a licensing agreement and
marketing alliance with NASCAR that gives the Company the non-exclusive right to
use the "NASCAR" name and logo on all of its products and product packaging as
well as on related sales, marketing, and promotional materials. The licensing
arrangement became effective immediately for all of the Company's products other
than die-cast products. Beginning on January 1, 1998, the Company also will have
the right to include the NASCAR name and logo on its die-cast products,
packaging, and related materials. Under the NASCAR license, the Company will be
an official licensee of the "NASCAR 50th Anniversary" program and intends to
develop several product lines in connection with that promotion. In addition,
the Company and NASCAR currently are working together to develop other
promotional programs targeted at many of NASCAR's corporate sponsors.
Competition
The motorsports collectible and consumer product industry is extremely
competitive. The Company competes with major domestic and international
companies, some of which have greater market recognition and substantially
greater financial, technical, marketing, distribution, and other resources than
the Company possesses. The Company believes that Racing Champions, Inc.,
Revell-Monogram, Inc., and The ERTL Company, Inc.
9
currently constitute its principal competitors in the die-cast collectible
industry. The Company's motorsports apparel and souvenirs compete with similar
products sold or licensed by drivers, owners, sponsors, and other licensors with
which the Company currently does not have licenses as well as with sports
apparel licensors and manufacturers in general. Emerging companies also may
increase their participation in these markets. The Company's promotional
products compete for advertising dollars against other specialty advertising
programs and media, such as television, radio, newspapers, magazines, and
billboards.
The Company believes that its relationships and licenses with top race
car drivers, car owners, and other popular licensors represent a significant
advantage over its competitors in the motorsports collectible and consumer
products industry. The Company strives to expand and strengthen these
relationships and to develop opportunities to market innovative licensed
collectible and consumer products that appeal to motorsports enthusiasts. The
ability of the Company to compete successfully depends on a number of factors
both within and outside its control, including the quality, features, pricing,
and diversity of its products; the quality of its customer services; its ability
to recognize industry trends and anticipate shifts in consumer demands; its
success in designing and marketing new products; the availability of adequate
sources of manufacturing capacity and the ability of its third-party
manufacturers to meet delivery schedules; its efficiency in filling customer
orders; the continued popularity of the motorsports personalities with whom the
Company has licensing arrangements; its ability to renew existing licensing
arrangements and enter into new licensing arrangements; its ability to develop
and maintain effective marketing programs that enable it to sell its products to
motorsports enthusiasts; product introductions by the Company's competitors; the
number, nature, and success of its competitors in a given market; and general
market and economic conditions.
Backlog
The Company accepts orders from members of its Collectors' Club in
advance of the arrival of certain collectible products from the manufacturers.
The Company had outstanding orders for approximately $5.0 million of such
products as of September 30, 1997.
Trademarks and Patent Rights
Although the Company's business historically has not depended on
trademark or patent protection, the Company recognizes the increasing value of
its various trade names and marks. The Company is taking steps designed to
protect, maintain, and increase the value of its trade names and marks. The
Company does, however, license valuable trademarks and other rights from third
parties. See Item 1, "Business - Licenses."
Insurance
The Company maintains a $2.0 million product liability insurance
policy to cover the sale of its die-cast and other products. The Company
maintains an additional $5.0 million in commercial umbrella liability coverage.
The Company also maintains a $6.0 million insurance policy to cover its molds
and dies located at its third-party manufacturer in China and a $5.0 million
insurance policy to cover lost revenue in the event of certain interruptions of
business with its overseas manufacturer of die-cast collectibles. The Company
believes its insurance coverage is adequate.
Employees
As of December 15, 1997, the Company had 418 full-time employees. The
Company has experienced no work stoppages and is not a party to a collective
bargaining agreement. The Company believes that it maintains good relations with
its employees.
10
Executive Officers
The following table sets forth certain information regarding each of
the executive officers of the Company.
Name Age Position Held
---- --- -------------
Fred W. Wagenhals...................... 56 Chairman of the Board, President, and
Chief Executive Officer
Tod J. Wagenhals....................... 33 Executive Vice President, Secretary, and Director
Charles C. Blossom, Jr................. 47 Vice President Chief Operating Officer, and Director
Christopher S. Besing.................. 37 Vice President, Chief Financial Officer,
Treasurer, and Director
Fred W. Wagenhals has served as Chairman of the Board, President, and
Chief Executive Officer of the Company since November 1993 and served as
Chairman of the Board and Chief Executive Officer from May 1992 until September
1993 and as President from July 1993 until September 1993. Mr. Wagenhals
co-founded Racing Champions, Inc. in April 1989 and served as a director of that
company until April 1993. From October 1990 until May 1992, Mr. Wagenhals served
as Chairman of the Board and Chief Executive Officer of Race Z, Inc. and Action
Performance Sales, Inc. ("APS"), which were engaged in sales of promotional
products and collectible items related to the racing industry.
Tod J. Wagenhals has served as Executive Vice President of the Company
since July 1995, as a director of the Company since December 1993, and as
Secretary of the Company since November 1993. Mr. Wagenhals served as a Vice
President of the Company from September 1993 to July 1995. Mr. Wagenhals served
in various marketing capacities with the Company from May 1992 until September
1993 and with APS from October 1991 until May 1992. Mr. Wagenhals was National
Accounts Manager of Action Products, Inc. from January 1989 to October 1991. Mr.
Wagenhals is the son of Fred W. Wagenhals.
Charles C. Blossom, Jr. has served as Vice President, Chief Operating
Officer, and as a director of the Company since November 1997. Mr. Blossom
served as Senior Vice President -- Sales and Marketing of the Company from July
1997 to November 1997. From January 1996 to July 1997, Mr. Blossom was engaged
in providing professional business consulting services. From October 1992 to
January 1996, Mr. Blossom served as President of Mac Tools, a $300 million
subsidiary of The Stanley Works, which manufactures and distributes tools and
equipment to the automotive aftermarket. Mr. Blossom served as Vice President --
Sales and Marketing of Mac Tools from May 1992 to October 1992, and as Vice
President -- Air Tool Operations from September 1989 to May 1992. From December
1983 to September 1989, Mr. Blossom owned and operated American Pneumatic
Technologies, Inc. before selling that business to Mac Tools.
Christopher S. Besing has served as a Vice President and the Chief
Financial Officer of the Company since joining the Company in January 1994, as a
director of the Company since May 1995, and as Treasurer of the Company since
February 1996. Prior to joining the Company, Mr. Besing held several financial
and accounting positions with Orbital Sciences Corporation ("OSC") from
September 1986 to December 1993, most recently as Director of Accounting and
Controller of OSC's Launch Systems Group in Chandler, Arizona. Prior to joining
OSC, Mr. Besing was employed as an accountant with Arthur Andersen & Co. from
January 1985 to August 1986. Mr. Besing is a Certified Public Accountant.
11
SPECIAL CONSIDERATIONS
The following factors, in addition to those discussed elsewhere in
this Report, should be carefully considered in evaluating the Company and its
business.
Certain Factors That Could Adversely Affect Operating Results
The Company's operating results are affected by a wide variety of
factors that could adversely impact its net sales and operating results. These
factors, many of which are beyond the control of the Company, include the
Company's ability to identify trends in the motorsports collectibles and
consumer markets and to create and introduce products on a timely basis that
take advantage of those trends and that compete effectively on the basis of
price and consumer tastes and preferences; its ability to identify popular
motorsports personalities and to enter into and maintain mutually satisfactory
licensing arrangements with them; the racing success of the key motorsports
personalities with whom the Company has license arrangements; the Company's
ability to design and arrange for the timely production and delivery of its
products, the market acceptance of the Company's products; the level and timing
of orders placed by customers; seasonality; the popularity and life cycles of
and customer satisfaction with products designed and marketed by the Company;
and competition and competitive pressures on prices.
New motorsports collectible and consumer products frequently can be
successfully marketed for only a limited time. The Company's ability to increase
its sales and marketing efforts to stimulate customer demand and its ability to
monitor third-party manufacturing arrangements in order to maintain satisfactory
delivery schedules and product quality are important factors in its long-term
prospects. A slowdown in demand for the Company's products as a result of
ineffective marketing efforts, manufacturing difficulties, changing cultural and
demographic trends or consumer tastes and spending patterns, economic
conditions, or other broad-based factors could adversely affect the Company's
operating results.
Dependence on License Arrangements
The Company markets its products pursuant to licensing arrangements
with race car drivers, race car owners, race car sponsors, automobile
manufacturers, and NASCAR. The licensing arrangements vary in scope and duration
and generally authorize the sale of specified licensed products for short
periods of time. In some cases, the license agreements provide for the payment
of minimum royalties or other fixed amounts, so that the Company may have
significant payment obligations with respect to a particular agreement
regardless of the level of sales of products licensed under that agreement or
the profitability of those sales. The success of licensing arrangements depends
on many factors, including the reasonableness of license fees in relationship to
revenue generated by sales of licensed products, the continued popularity of
licensors, and the absence of their sickness, incapacity, or death. The
termination, cancellation, or inability to renew material licensing
arrangements, or the inability to develop and enter into new licensing
arrangements, would have a material adverse effect on the Company. See Item 1,
"Business Licenses."
Dependence on Third Parties for Manufacturing
The Company depends upon third parties to manufacture all of its
motorsports collectibles and most of its consumer products. Although the Company
owns most of the tools, dies, and molds utilized in the manufacturing processes
of its collectible products and owns the tooling and dies used to manufacture
certain of its consumer products, the Company has limited control over the
manufacturing processes themselves. As a result, any difficulties encountered by
the third-party manufacturers that result in product defects, production delays,
cost overruns, or the inability to fulfill orders on a timely basis could have a
material adverse effect on the Company.
The Company does not have long-term contracts with its third-party
manufacturers. Although the Company believes it would be able to secure other
third-party manufacturers to produce its products as a result of its ownership
of the molds and tools used in the manufacturing process, the Company's
operations would be adversely affected
12
if it lost its relationship with any of its current suppliers (including
particularly its manufacturer of die-cast products, which currently utilizes one
facility in China to produce all of the Company's die-cast products) or if its
current suppliers' operations or sea or air transportation with its China-based
die-cast manufacturer were disrupted or terminated even for a relatively short
period of time. The Company's tools, dies, and molds are located at the
facilities of its third-party manufacturers, and, accordingly, significant
damage to such facilities (particularly the facility used by its die-cast
product manufacturer in China) could result in the loss of or damage to a
material portion of its key tools, dies, and molds in addition to production
delays while new facilities were being arranged and replacement tools, dies, and
molds were being produced. The Company does not maintain an inventory of
sufficient size to provide protection for any significant period against an
interruption of supply, particularly if it were required to obtain alternative
sources of supply.
Although the Company does not itself purchase the raw materials used
to manufacture its products, it is potentially subject to variations in the
prices it pays its third-party manufacturers for products depending on what they
pay for the raw materials. In this regard, the Company understands that the
price of zinc, a principal raw material in its die-cast replicas, has increased
substantially over the last several years, although to date these price
increases have not been reflected in increases in the prices the Company pays
for its die-cast replicas.
Integration of Business Operations
The Company has completed a number of acquisitions during and
subsequent to fiscal 1997. Following these acquisitions, the Company has
substantially consolidated the operations of the various acquired entities,
several of which were based in the same city and marketed substantially
identical types of products through substantially identical channels of
distribution, into Company's existing operations in Phoenix, Arizona or the
operations of Sports Image in Concord, North Carolina. There can be no assurance
that the Company will be able to complete effectively the integration of the
operations of the acquired companies with the Company's operations, to manage
effectively the combined operations of the acquired businesses, to achieve the
Company's operating and growth strategies with respect to these businesses, to
obtain increased revenue opportunities as a result of the anticipated synergies
created by expanded product offerings and additional distribution channels, or
to reduce the overall selling, general, and administrative expenses associated
with the acquired operations. The integration of the management, operations, and
facilities of the acquired companies and any other businesses the Company may
acquire in the future could involve unforeseen difficulties, which could have a
material adverse effect on the Company's business, financial condition, and
operating results.
The Company has conducted due diligence reviews of each of the
acquired businesses and has received representations and warranties regarding
each of the acquired businesses. There can be no assurance, however, that
unforeseen liabilities will not arise in connection with the operation of the
acquired businesses or future acquired businesses or that any contractual or
other remedies available to the Company will be sufficient to compensate the
Company in the event unforeseen liabilities arise. For example, the Company
recently was named as a defendant in a lawsuit based upon actions alleged to
have been taken by several of the newly acquired businesses prior to the
Company's acquisitions of those entities. The Company currently is unable to
quantify the amount of liability, if any, that it may incur as a result of the
lawsuit. See Item 3, "Legal Proceedings."
The Company anticipates using the opportunities created by the
combination of its acquired operations to effect what the Company believes will
be substantial cost savings, including a reduction in operating expenses as a
result of the elimination of duplicative sales, marketing, administrative,
warehouse, and distribution facilities, functions, and personnel. Significant
uncertainties, however, accompany any business combination, and there can be no
assurance that the Company will be able to achieve its anticipated integration
of facilities, functions, and personnel in order to achieve operating
efficiencies or otherwise realize cost savings as a result of the recent
acquisitions or future acquisitions. The inability to achieve the anticipated
cost savings could have a material adverse effect on the Company's business,
financial condition, and operating results.
13
Management of Growth
Since 1993, the Company's business operations have undergone
significant changes and growth, including its emphasis on and the expansion of
its collectible product lines, acquisition of its motorsports consumer products
lines, and significant investments in tooling and licensing arrangements. The
Company's ability to manage effectively any significant future growth, however,
will require it to integrate successfully the operations of any acquired
businesses with the Company's operations and to enhance further its operational,
financial, and management systems; to expand its facilities and equipment; to
receive products from third-party manufacturers on a timely basis; and to
successfully hire, train, retain, and motivate additional employees. The failure
of the Company to manage its growth on an effective basis could have a material
adverse effect on the Company's business, financial condition, and operating
results. In August 1997, the Company relocated its corporate headquarters to a
new, 140,000 square foot facility in Phoenix, Arizona. The Company also recently
entered into a lease for a new 121,000 square foot facility in Concord, North
Carolina, for its operations based in that area. The Company may be required to
increase staffing and other expenses as well as make expenditures on capital
equipment and manufacturing sources in order to meet the anticipated demand of
its customers. Sales of the Company's collectible and consumer products are
subject to changing consumer tastes, and customers for the Company's promotional
items generally do not commit to firm orders for more than a short time in
advance. The Company's profitability would be adversely affected if the Company
increases its expenditures in anticipation of future orders that do not
materialize. Certain customers may increase orders for the Company's products on
short notice, which would place an excessive short-term burden on the Company's
resources.
Rapid Market Changes
The markets for the Company's products are subject to rapidly changing
customer tastes, a high level of competition, seasonality, and a constant need
to create and market new products. Demand for motorsports collectible and
consumer products depends upon the popularity of certain drivers and other
personalities, themes, cultural and demographic trends, marketing and
advertising expenditures, and general economic conditions. Because these factors
can change rapidly, customer demand also can shift quickly. New motorsports
collectible and consumer products frequently can be successfully marketed for
only a limited time. The Company may not always be able to respond to changes in
customer tastes and demands because of the amount of time and financial
resources that may be required to bring new products to market. The inability to
respond quickly to market changes could have a material adverse effect on the
Company's business, financial condition, and operating results. See Item 1,
"Business Products and Services."
Dependence on New Products
The Company's operating results depend to a significant extent on its
ability to continue to develop and introduce new products on a timely basis that
compete effectively on the basis of price and that address customer tastes,
preferences, and requirements. The success of new product introductions depends
on various factors, including proper new product selection, successful sales and
marketing efforts, timely production and delivery of new products, and consumer
acceptance of new products. There can be no assurance that any new products will
receive or maintain substantial market acceptance. The failure of the Company to
design, develop, and introduce popular products on a timely basis would
adversely affect its future operating results. See Item 1, "Business - Products
and Services."
Competition
The motorsports collectible and consumer products markets are
extremely competitive. The Company competes with major domestic and
international companies, some of which have greater market recognition and
substantially greater financial, technical, marketing, distribution, and other
resources than the Company possesses. The Company believes that Racing
Champions, Inc., Revell-Monogram, Inc., and The ERTL Company, Inc. currently
constitute its principal competitors in the motorsports die-cast replica
industry. The Company's motorsports apparel and souvenirs compete with similar
products sold or licensed by drivers, owners, sponsors, and other licensors with
14
which the Company currently does not have licenses as well as with sports
apparel licensors and manufacturers in general. Emerging companies also may
increase their participation in these motorsports markets. The Company's
promotional programs must compete for advertising dollars against other
specialty advertising programs and media, such as television, radio, newspapers,
magazines, and billboards. The Company competes primarily on the basis of the
current popularity of the race car drivers and others with whom it has licenses
and its ability to obtain favorable licensing arrangements with other popular
licensors; the appeal of its products; and the cost, design, and delivery
schedules of its products. There can be no assurance that the Company will
continue to be able to compete successfully in the future. See Item 1, "Business
- - Competition."
Potential Regulation of Corporate Sponsorship
Tobacco and alcohol companies provide a significant amount of
advertising and promotional support of racing events, drivers, and car owners.
In August 1996, the U.S. Food and Drug Administration (the "FDA") published
final regulations that will substantially restrict tobacco industry sponsorship
of sporting events, including motorsports, beginning in 1998. In April 1997, a
federal district judge ruled that the FDA did not have the authority to regulate
tobacco marketing. That ruling, if upheld on appeal, would have the effect of
overturning the FDA regulations. In addition to the FDA regulations, however,
certain major manufacturers of tobacco products have reached a proposed
settlement with attorneys general of a number of states that have filed lawsuits
against such tobacco product manufacturers. The terms of those settlements
include potential voluntary restrictions on advertising by the tobacco industry.
The final terms of some or all of those settlements will be subject to approval
by the United States Congress and the President of the United States. The FDA
regulations, if ultimately approved, and any other legislation, regulations, or
other initiatives, including the pending settlement negotiations, that limit or
prohibit advertisements of tobacco and alcohol products at sporting events,
including racing events, could ultimately affect the popularity of motorsports,
which could have a material adverse effect on the Company. The Company believes,
however, that other major consumer products companies would quickly replace
tobacco and alcohol companies as sponsors of motorsports in the event that
advertisement of those products declines.
Seasonal Fluctuations in Sales
Because the auto racing season is concentrated between the months of
February and November, the second and third calendar quarters of each year (the
Company's third and fourth fiscal quarters) generally are characterized by
higher sales of motorsports products. Seasonal fluctuations in quarterly sales
may require the Company to take temporary measures, including changes in its
personnel levels, borrowing amounts, and production and marketing activities,
and could result in unfavorable quarterly earnings comparisons. The Company
believes, however, that holiday sales of its products are increasing, which has
the effect of reducing seasonal fluctuations in its sales.
International Trade, Exchange, and Financing
The Company obtains its die-cast collectibles and other replicas under
a manufacturing arrangement with a third-party manufacturer in China. The
Company believes that production of its die-cast products overseas enables the
Company to obtain these items on a cost basis that enables the Company to market
them profitably. The Company's reliance on its third-party manufacturer to
provide personnel and facilities in China, and the Company's maintenance of
equipment and inventories abroad, expose it to certain economic and political
risks, including the business and financial condition of the third-party
manufacturer, political and economic conditions abroad, and the possibility of
expropriation, supply disruption, currency controls, and exchange fluctuations
as well as changes in tax laws, tariffs, and freight rates. Protectionist trade
legislation in either the United States or foreign countries, such as a change
in the current tariff structures, export compliance laws, or other trade
policies, could adversely affect the Company's ability to purchase its products
from foreign suppliers or the price at which the Company can obtain those
products.
15
All of the Company's purchases from its foreign manufacturers are
denominated in United States dollars. As a result, the foreign manufacturers
bear any risks associated with exchange rate fluctuations subsequent to the date
the Company places its orders with those manufacturers. Although the October
1997 financial crisis in Asia did not result in any short-term changes in the
prices that the Company pays for its die-cast products, an extended period of
financial pressure on overseas markets or a devaluation of the Chinese currency
that results in a financial setback to the Company's overseas manufacturer could
have an adverse impact on the Company's operations. Purchases of die-cast
products from the China-based manufacturer of those products generally require
the Company to provide an international letter of credit in an amount equal to
the purchase order. Although the Company currently has in place financing
arrangements in an amount that it considers adequate for anticipated purchase
levels, the inability to fund any letter of credit required by a supplier would
have an adverse impact on the Company's operations.
Under the terms of its license agreement with Hasbro, Hasbros royalty
payments to the Company for sales by Hasbro in foreign countries are based on
the exchange rates in effect on the last day of the calendar quarter for which
such royalties are owed. As a result, the Company bears any risks that may be
associated with exchange rate fluctuations between the date on which Hasbro
records overseas sales of products subject to the license agreement and the last
day of the calendar quarter in which the sales are made. The Company does not
currently believe that royalties from overseas sales of products by Hasbro will
represent a material percentage of the Company's total revenue. As a result, the
Company does not currently anticipate that it will engage in hedging
transactions intended to offset potential adverse consequences of exchange rate
fluctuations with respect to royalty payments due from Hasbro for sales in
foreign countries.
Possible Need for Additional Capital to Support Growth
The Company's business operations have grown considerably in recent
years as a result of an increase in the number of licensing arrangements with
race car drivers, car owners, sponsors, automobile manufacturers, and others;
expansion of the Company's product offerings, including additional lines of
die-cast replicas that have required substantial investments in new tooling; and
significant acquisitions of complementary businesses. The Company has financed
this growth through cash generated by operations, by debt and equity financings,
and by issuing additional shares of Common Stock for acquisitions. Continued
rapid growth, whether externally through additional acquisitions or internally
through new licensing arrangements or new product offerings, could require
substantial additional capital in excess of funds available to the Company
through its existing credit facility, cash generated by operations, and the
proceeds of the public offering completed in July 1997. The timing and amount of
any such capital requirements cannot be predicted at this time. Although the
Company has been able to obtain adequate financing on acceptable terms in the
past, there can be no assurance that such financing will continue to be
available on acceptable terms. If such financing is not available on
satisfactory terms, the Company may be unable to expand its business at the rate
desired and its operating results may be adversely affected. Debt financing
increases expenses and must be repaid regardless of operating results. Equity
financing could result in additional dilution to existing shareholders.
Dependence on Key Personnel
The Company's development and operations to date have been, and its
proposed operations will be, substantially dependent upon the efforts and
abilities of its senior management, including Fred W. Wagenhals, the Company's
Chairman of the Board, President, and Chief Executive Officer. The loss of
services of one or more of its key employees, particularly Mr. Wagenhals, could
have a material adverse effect on the Company. The Company maintains key person
insurance on the life of Mr. Wagenhals in the amount of $3.0 million. The
Company does not maintain such insurance on any of its other officers.
Possible Volatility of Stock Price
The market price of the Company's Common Stock has increased
dramatically during the last three years. See Item 5, "Market for the
Registrants' Common Equity and Related Stockholder Matters." The period was
marked
16
by generally rising stock prices, extremely favorable industry conditions, and
substantially improved operating results by the Company. There can be no
assurance that these favorable conditions will continue. The trading price of
the Company's Common Stock in the future could be subject to wide fluctuations
in response to quarterly variations in operating results of the Company, actual
or anticipated announcements of new products by the Company or its competitors,
changes in analysts' estimates of the Company's financial performance, general
conditions in the markets in which the Company competes, worldwide economic and
financial conditions, and other events or factors. The stock market also has
experienced extreme price and volume fluctuations that have particularly
affected the market prices for many rapidly expanding companies and that often
have been unrelated to the operating performance of such companies. These broad
market fluctuations and other factors may adversely affect the market price of
the Company's Common Stock.
Litigation
The Company is one of approximately 30 defendants in a lawsuit in
which the state of Arizona seeks recovery of certain clean-up costs under
federal and state environmental laws. The Company was recently named as a
defendant in a class action lawsuit alleging that the defendants engaged in
certain price fixing and other anti-competitive activities in violation of
federal antitrust laws. The Company also is a defendant in a lawsuit alleging
breach of contract, fraud, trademark infringement, and other claims with respect
to licenses for certain of its die-cast products. The Company is actively
defending these lawsuits. In the event a decision adverse to the Company is
rendered in any of these lawsuits, the resolution of such matter could have a
material adverse effect on the Company's business, financial condition, and
operation results. The Company's financial statements currently reflect no
provision for any of these lawsuits. See Item 3, "Legal Proceedings" and Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Rights to Acquire Shares; Potential Issuance of Additional Shares
As of December 15, 1997, options to acquire a total of 1,137,710
shares were outstanding under the Company's 1993 Stock Option Plan (the "1993
Plan"). During the terms of such options, the holders thereof will have the
opportunity to profit from an increase in the market price of Common Stock, with
resulting dilution in the interests of holders of Common Stock. The existence of
such stock options could adversely affect the terms on which the Company can
obtain additional financing, and the holders of such options can be expected to
exercise such options at a time when the Company, in all likelihood, would be
able to obtain additional capital by offering shares of its Common Stock on
terms more favorable to the Company than those provided by the exercise of such
options.
Shares Eligible for Future Sale; Potential Depressive Effect on Stock Price
Sales of substantial amounts of Common Stock by shareholders of the
Company, or even the potential for such sales, may have a depressive effect on
the market price of the Common Stock. Of the 16,012,471 shares of Common Stock
outstanding, approximately 13,356,750 shares currently are eligible for resale
in the public market without restriction or further registration unless held by
an "affiliate" of the Company, as that term is defined under the Securities Act
of 1933, as amended (the "Securities Act"). The approximately 2,655,700
remaining shares of Common Stock outstanding are "restricted securities," as
that term is defined in Rule 144 under the Securities Act, and may be sold only
in compliance with Rule 144, pursuant to registration under the Securities Act,
or pursuant to an exemption therefrom. An aggregate of approximately 492,200
shares of such "restricted securities" have been registered for resale pursuant
to a registration statement. In addition, an aggregate of approximately
2,100,500 shares held by certain officers and directors currently are available
for sale under Rule 144.
Lack of Dividends
The Company has never paid any cash dividends on its Common Stock and
does not currently anticipate that it will pay dividends in the foreseeable
future. Instead, the Company intends to apply its earnings to the expansion and
development of its business.
17
Change in Control Provisions
The Company's Amended and Restated Articles of Incorporation (the
"Restated Articles"), Amended and Restated Bylaws, and Arizona law contain
provisions that may have the effect of making more difficult or delaying
attempts by others to obtain control of the Company, even when those attempts
may be in the best interests of shareholders. The Restated Articles also
authorize the Board of Directors, without shareholder approval, to issue one or
more series of preferred stock, which could have voting, liquidation, dividend,
conversion, or other rights that adversely affect or dilute the voting power of
the holders of Common Stock.
Cautionary Statement Regarding Forward-Looking Statements
Certain statements and information contained in this Report under the
headings "Business," "Special Considerations," and "Management's Discussion and
Analysis of Financial Condition and Results of Operations," concerning future,
proposed, and anticipated activities of the Company, certain trends with respect
to the Company's revenue, operating results, capital resources, and liquidity or
with respect to the markets in which the Company competes or the motorsports
industry in general, and other statements contained in this Report regarding
matters that are not historical facts are forward-looking statements, as such
term is defined in the Securities Act. Forward-looking statements, by their very
nature, include risks and uncertainties, many of which are beyond the Company's
control. Accordingly, actual results may differ, perhaps materially, from those
expressed in or implied by such forward-looking statements. Factors that could
cause actual results to differ materially include those discussed elsewhere
under this Item 1, "Business - Special Considerations."
ITEM 2. PROPERTIES
The Company leases a newly constructed, approximately 140,000 square
foot building in Phoenix, Arizona. The Company uses approximately 38,000 square
feet of this facility for its corporate headquarters and approximately 102,000
square feet for warehouse space and packaging operations. The initial term of
the lease expires in August 2007, with two five-year renewal options. The
Company has two options to extend the term for five years each. The Company
currently is seeking to sublease its previous Tempe facility, but there can be
no assurance that it will be able to do so on favorable terms or at all.
The Company also leases a 25,000 square foot facility in Charlotte,
North Carolina. The Company uses approximately 5,000 square feet of the
Charlotte facility for offices and approximately 20,000 square feet for
warehouse space and packaging operations. The term of the lease for the
Charlotte facility expires in April 1998. The Company also leases approximately
10,000 square feet of off-site storage space in Concord, North Carolina.
The Company has entered into a lease for a newly constructed,
approximately 121,000 square foot facility in Concord, North Carolina for its
operations in that area. The Company will utilize approximately 42,000 square
feet of the new facility for offices and approximately 79,000 square feet for
warehouse space and distribution operations. The initial term of the lease is 20
years, with four five-year renewal options. The Company anticipates that it will
occupy the new facility in April 1998.
The Company currently leases two facilities in Atlanta, Georgia, for
its Image Works operations. One facility consists of approximately 77,400 square
feet, of which the Company utilizes approximately 14,000 square feet for offices
and approximately 63,400 square feet for manufacturing and warehouse operations.
The lease on this facility expires in January 1999. The second facility consists
of approximately 21,900 square feet, of which the Company utilizes approximately
19,400 square feet for warehouse and distribution operations and approximately
2,500 square feet for offices. The lease on this facility expires in February
1999.
18
ITEM 3. LEGAL PROCEEDINGS
On May 17, 1993, the state of Arizona (the "State") instituted a
lawsuit against the Company and 29 other defendants in the United States
District Court for the District of Arizona. The State seeks recovery of certain
clean-up costs under federal and state environmental laws. Specifically, the
State seeks recovery of expenses that it has incurred to date for an
environmental investigation and clean-up of property formerly used as a site for
recycling hazardous wastes. The State alleges that the property has been
contaminated with hazardous substances. In addition, the State seeks a
declaratory judgment that the Company and the other defendants are jointly and
severally liable for all future costs incurred by the State for investigative
and remedial activities, and seeks a mandatory permanent injunction requiring
the Company to undertake appropriate assessment and remedial action at the
property. The State has not specified the amounts it seeks to collect from the
Company. The State alleges that F.W. Leisure Industries, Inc. and/or F.W. &
Associates, Inc. were predecessors of the Company that produced and arranged for
the transportation of hazardous substances to the property involved in the
lawsuit. The Company is defending this lawsuit on various bases including that
F.W. Leisure Industries, Inc. and/or F.W. & Associates, Inc. were not
predecessors of the Company and that neither the Company nor any predecessor of
the Company has ever produced or transported hazardous substances as alleged by
the State. The State has settled a portion of its claims with respect to a large
number of the other defendants to the lawsuit. The Company is not a party to
that settlement. On February 1, 1995, a number of the defendants that agreed to
the settlement with the State were granted leave to file, and subsequently did
file a cross-claim against the Company seeking indemnity from the Company based
on the same predecessor liability theory asserted by the State. The parties have
conducted discovery limited to the issue of any defendant's status as a
responsible party and regarding the Company's status as a successor corporation.
On March 25, 1997, the Court ruled that under federal environmental law the
Company would be treated as the successor to F.W. & Associates, Inc., and/or
F.W. Leisure Industries, Inc. The Company may appeal this ruling at the
appropriate time. Discovery is now ongoing with regard to the merits of the
underlying environmental claims and the amount of those claims. The Company
currently estimates the potential loss to be approximately $800,000 in the event
that its defense proves unsuccessful. The Company has made no provision in its
financial statements with respect to this matter.
A lawsuit, purportedly on behalf of Action Products, Inc. ("API"), a
dissolved Arizona corporation, was instituted on December 22, 1995 against the
Company, Fred W. Wagenhals, and others in the United States District Court for
the District of Arizona. The complaint requested damages, including punitive and
treble damages in an unspecified amount. The complaint alleged that the Company,
Mr. Wagenhals, and others breached contractual and other duties to API and
appropriated certain business opportunities of API and further claimed that
these activities were part of a fraudulent scheme. In July 1997, the Company,
Mr. Wagenhals, the other defendants, and the plaintiff settled the lawsuit for a
$4.9 millon payment by the Company to the plaintiff and the execution of mutual
releases. In connection with the proposed settlement, Mr. Wagenhals waived any
claims that he may have to the settlement proceeds as an approximately 20%
shareholder of APl.
On March 4, 1997, two class action lawsuits were filed against the
Company and approximately 28 other defendants in the United States District
Court for the Northern District of Georgia. The lawsuits allege that the
defendants engaged in price fixing and other anti-competitive activities in
violation of federal anti-trust laws. The Company was named as a defendant based
upon actions alleged to have been taken by Sports Image, Inc., a North Carolina
corporation ("Sports Image N.C.") and Creative Marketing & Promotions, Inc.
("CMP") prior to the Company's acquisitions of the assets and capital stock,
respectively, of those entities. The actions were subsequently consolidated by
order of the court. The caption of the consolidated action is "In re Motorsports
Merchandise Antitrust Litigation" and the files are maintained under Master File
No. 1-97-CV-0569-CC. On May 30, 1997, a consolidated amended complaint was
filed, which deleted the Company as a defendant with respect to claims based
upon actions alleged to have been taken by Sports Image N.C. and named the
Company's wholly owned subsidiary, Sports Image, Inc., an Arizona corporation
("Sports Image AZ"), as a defendant with respect to those claims. The Company
remains a defendant with respect to claims based upon actions alleged to have
been taken by CMP. On July 31, 1997, the Company acquired all of the outstanding
capital stock of RYP, which is another defendant in this matter. Accordingly,
the Company has assumed the defense of this matter with respect to claims based
upon actions
19
alleged to have been taken by RYP and has agreed to be responsible for and to
pay any costs, fees, expenses, damages, payments, credits, rebates, and
penalties arising out of this matter with respect to RYP, up to an aggregate of
$400,000 (the "$400,000 Cap"). The $400,000 Cap excludes attorneys fees and
certain other costs and expenses that the Company may incur in defending or
settling this matter. The plaintiffs have requested injunctive relief and
monetary damages of three times an unspecified amount of damages that the
plaintiffs claim to have actually suffered. On August 1, 1997, answers were
filed on behalf of the Company and Sports Image AZ denying the allegations of
the complaint. Pursuant to an agreement between the plaintiffs and Sports Image
AZ to toll the running of the statute of limitations with respect to any claims
against Sports Image AZ, on November 17, 1997 the plaintiffs filed a motion to
dismiss Sports Image AZ from the case without prejudice. The parties currently
are conducting class discovery. The Company intends to vigorously defend the
claims asserted in the amended and consolidated complaint.
On June 4, 1997, Petty Enterprises, Inc. Licensing Division filed a
lawsuit against the Company and Fred W. Wagenhals in the General Court of
Justice for Randolph County, North Carolina. The complaint alleges that the
Company engaged in activities that resulted in common law trademark
infringement, fraud, unfair competition, "palming off" unauthorized goods as
authorized products, marketing unlicensed products, misappropriation of business
opportunities, breach of contract, unjust enrichment, conversion, and violations
of the North Carolina Unfair and Deceptive Trade Practices Act and the Lanham
Act. In particular, the plaintiff alleges that the Company manufactured and sold
products in quantities greater than the amounts permitted under certain license
agreements, manufactured and sold certain products for which it did not have
licenses, misrepresented the number of licensed products actually manufactured
and sold, and underpaid royalties to the licensors. The complaint also alleges
that these acts constitute a pattern of improper activity. The complaint
requests an unspecified amount of actual damages plus treble and punitive
damages, as well as injunctive relief. On July 3, 1997, the Company and Mr.
Wagenhals were successful in removing the case to the United States District
Court for the Middle District of North Carolina. On July 11, 1997, each of the
Company and Mr. Wagenhals filed an answer denying the plaintiff's allegations
and each filed counterclaims against the plaintiff for breach of contract,
breach of a prior settlement agreement between the plaintiff and the Company,
violations of the North Carolina Unfair and Deceptive Trade Practices Act,
defamation and damage to reputation, and tortious interference with prospective
business relationships. On July 18, 1997, the Company and Mr. Wagenhals
collectively filed a third-party complaint against Brett Nelson, an affiliate of
the plaintiff, alleging violations of the North Carolina Unfair and Deceptive
Trade Practices Act, defamation and damage to reputation, and tortious
interference with actual and prospective business relationships. On August 8,
1997, Mr. Nelson filed an answer denying the allegations against him. After the
Court denied motions to dismiss by all parties, the plaintiff filed its amended
complaint and the Company and Mr. Wagenhals filed their respective amended
answer and counterclaims. The amended complaint and the amended answer and
counterclaims contain essentially the same allegations and defenses as the
original pleadings. The parties currently are in the early stages of discovery.
The Company and Mr. Wagenhals intend to vigorously pursue their counterclaims
and the third-party complaint and to vigorously defend this lawsuit.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
20
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
The Company's common stock, par value $.01 per share (the "Common
Stock") has been quoted on the Nasdaq National Market under the symbol "ACTN"
since April 27, 1993. The following table sets forth the quarterly high and low
closing sale prices of the Company's Common Stock for the calendar periods
indicated on the Nasdaq National Market, as adjusted for the two-for-one stock
split effected as a stock dividend on May 28, 1996.
Common Stock
------------
High Low
---- ---
1995:
First Quarter ............................ $ 3.69 $ 2.38
Second Quarter ........................... 4.63 3.19
Third Quarter ............................ 9.25 4.25
Fourth Quarter ........................... 9.81 6.13
1996:
First Quarter ............................ $11.63 $ 6.38
Second Quarter ........................... 20.50 10.75
Third Quarter ............................ 14.75 9.75
Fourth Quarter ........................... 19.50 12.50
1997:
First Quarter ............................ $24.25 $16.50
Second Quarter ........................... 29.00 18.00
Third Quarter ............................ 36.13 25.38
Fourth Quarter (through December 15, 1997) 33.84 23.00
As of December 15, 1997, there were approximately 200 holders of record
and approximately 5,000 beneficial owners of the Company's Common Stock. On
December 15, 1997, the closing sales price of the Company's Common Stock on the
Nasdaq National Market was $33.06 per share.
On August 1, 1997, the Company issued 8,180 shares of Common Stock
valued at $23.02 per share to Dale Jarrett in connection with a personal
services contract entered into by the Company and Mr. Jarrett on that date. The
Company issued the shares without registration under the Securities Act in
reliance on Section 4(2) of the Securities Act.
On August 8, 1997, the Company issued an aggregate of 19,324 shares of
Common Stock valued at $22.59 per share to E. J. Simpson as a portion of the
license fee pursuant to a license agreement entered into by the Company and Mr.
Simpson on that date. The Company issued the shares without registration under
the Securities Act in reliance on Section 4(2) of the Securities Act.
21
ITEM 6. SELECTED FINANCIAL DATA
The selected historical financial data presented below as of and for
the five years ended September 30, 1997 are derived from the Company's
consolidated financial statements, which have been audited by Arthur Andersen
LLP, independent public accountants. The selected financial data should be read
in conjunction with Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the Company's Consolidated Financial
Statements and the Notes thereto included elsewhere in this Report.
Fiscal Year Ended September 30,
-----------------------------------------------------------
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
(in thousands, except per share amounts)
Statement of Operations Data:
Sales:
Collectibles .................... $ 11,558 $ 12,802 $ 23,443 $ 40,904 $ 63,846
Apparel and souvenirs ........... -- 143 1,190 1,961 60,430
Promotional ..................... -- -- -- 1,351 5,085
Other(1)(2) ..................... 3,550 3,924 1,498 -- 1,019
--------- --------- --------- --------- ---------
Net sales(3) ................. 15,108 16,869 26,131 44,216 130,380
Cost of sales ...................... 9,730 10,488 15,882 25,296 80,995
--------- --------- --------- --------- ---------
Gross profit ....................... 5,378 6,381 10,249 18,920 49,385
Selling, general and administrative
expenses ........................ 6,552 5,808 6,115 9,262 31,250
Settlement costs ................... -- -- -- -- 5,400(5)
Amortization of goodwill and other
intangibles ..................... -- -- 4 4 1,286
--------- --------- --------- --------- ---------
Income (loss) from operations ...... (1,174) 573 4,130 9,654 18,135
Interest income (expense) and other,
net ............................. (66) (164) 24 216 (1,225)
--------- --------- --------- --------- ---------
Income (loss) before provision for
(benefit from) income taxes ..... (1,240) 409 4,154 9,870 16,910
Provision for (benefit from) income
taxes ........................... (69) (224) 1,384 3,917 6,764
--------- --------- --------- --------- ---------
Net income (loss) .................. $ (1,171) $ 633 $ 2,770 $ 5,953 $ 10,146
========= ========= ========= ========= =========
Net income (loss) per common
share, assuming full dilution(4) $ (0.21) $ 0.08 $ 0.25 $ 0.46 $ 0.69
========= ========= ========= ========= =========
Weighted average number of
common shares, assuming full
dilution(4) ..................... 5,662 9,640 11,570 13,069 14,671
Consolidated Balance Sheet Data
(at end of period):
Working capital .................... $ 3,186 $ 5,699 $ 11,922 $ 18,094 $ 56,975
Total assets ....................... 8,565 11,656 23,351 31,649 141,325
Total debt ......................... 452 266 288 365 22,586
Shareholders' equity ............... 5,744 6,909 18,890 26,996 103,168
- ---------------------
(1) Includes the revenue of the Company's M-CarTM operations through the
discontinuation of those operations in September 1994 and the revenue
of the Company's mini vehicle operations through the discontinuation of
those operations in March 1995.
(2) Includes royalty and license fees beginning in fiscal 1997.
(3) Fiscal 1997 results include the results of operations of Sports Image,
Motorsports Traditions, RYP, Image Works, and Simpson, beginning as of
their respective dates of acquisition. See Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of
Operations - Overview."
(4) Adjusted to reflect the two-for-one stock split effected as a stock
dividend on May 28, 1996.
(5) Represents a one-time charge of approximately $5.4 million for
settlement costs and related legal and other expenses. See Item 3,
"Legal Proceedings."
22
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS,
AND RESULTS OF OPERATIONS
Overview
The Company designs and markets licensed motorsports products,
including die-cast scaled replicas of motorsports vehicles, apparel, and
souvenirs. The Company also develops promotional programs for sponsors of
motorsports that feature the Company's die-cast replicas or other products and
are intended to increase brand awareness of the products or services of the
corporate sponsors. In addition, the Company represents popular race car drivers
in a broad range of licensing and other revenue-producing opportunities,
including product licenses, corporate sponsorships, endorsement contracts, and
speaking engagements. The Company's motorsports collectibles and most of the
Company's apparel and souvenirs are manufactured by third parties, generally
utilizing the Company's designs, tools, and dies. The Company screen prints and
embroiders a portion of the licensed motorsports apparel that it sells.
The Company was incorporated in Arizona in May 1992 and began marketing
die-cast collectibles in July 1992. In August 1994, the Company acquired certain
assets and liabilities of Fan Fueler, Inc. and began marketing licensed
motorsports consumer products. During fiscal 1994, the Company also conducted
the business of staging M-CarTM Grand Prix Races for charitable and other
organizations, in which participating sponsors purchased specialized
gas-powered, one-third scale racing vehicles from the Company. In September
1994, the Company sold the assets and liabilities related to its M-CarTM
operations and discontinued its M-CarTM Grand Prix Race operations. During
fiscal 1994 and the first two quarters of fiscal 1995, the Company designed and
marketed pedal, electric, and gas-powered mini vehicles, primarily as specialty
promotional items. The Company sold the assets related to its mini vehicle
operations in March 1995.
In November 1996, the Company acquired Sports Image and in January 1997
the Company acquired Motorsport Traditions, both of which marketed and
distributed licensed motorsports apparel, die-cast collectibles and other
souvenir items. In July 1997, the Company acquired RYP, which had operations
similar to those of Sports Image and Motorsport Traditions, and Image Works,
which manufacturers and markets licensed motorsports apparel through the
mass-merchandising markets. The Company acquired certain assets and assumed
certain liabilities related to the mini-helmet collectible business of Simpson
in August 1997. Following these acquisitions, the Company took a number of
actions intended to integrate the operations of the acquired companies with the
Company's existing operations and to reduce overall selling, general, and
administrative expenses associated with the acquired entities. These actions
included consolidating the operations and warehouse facilities of Motorsport
Traditions and RYP with Sports Image's existing operations and facility in
Charlotte, North Carolina; consolidating the operations of Simpson into the
Company's headquarters in Phoenix, Arizona; eliminating duplicative personnel
functions; and integrating the management information systems of the acquired
companies. These efforts had a meaningful impact on the Company's results of
operations beginning in the second half of fiscal 1997.
In addition to the cost savings described above, the Company believes
that the fiscal 1997 acquisitions provide the potential for enhanced revenue
opportunities as a result of the synergies created by expanded product offerings
and additional distribution channels. For example, in fiscal 1997 the Company
began developing new lines of licensed motorsports apparel and souvenirs for
exclusive sales through its Collectors' Club. The Company also believes that
these acquisitions will provide opportunities for additional sales growth of the
Company's die-cast products through trackside sales, promotional programs, and
fan clubs.
Prior to the fiscal 1997 acquisitions, the Company's revenue consisted
primarily of sales of die-cast collectibles, and the revenue of the acquired
businesses consisted primarily of sales of licensed motorsports apparel and
souvenirs. Promotional revenue consists of sales of products developed for
corporate promotion programs. The Company's fiscal 1997 revenue includes royalty
income as a result of the license agreement with Hasbro.
23
The Company's cost of sales consists primarily of the cost of products
procured from third-party manufacturers, royalty payments to licensors, and
depreciation of tooling and dies. Significant factors affecting the Company's
cost of sales as a percentage of net sales include (i) the overall percentage of
net sales represented by sales of die-cast collectible products, which typically
carry higher gross margins than the Company's other products, (ii) the
percentage of sales of die-cast collectible products represented by sales
through the Collectors' Club, which typically carry higher gross margins than
sales of such products through wholesale distributors, and (iii) the effect of
amortizing the fixed cost components of cost of sales, primarily depreciation of
tooling and dies, over varying levels of net sales. The Company believes that
the increased sales of licensed apparel and souvenirs following the acquisitions
of Sports Image and Motorsport Traditions will result in lower overall gross
margins as a result of lower gross margins generally associated with these
acquired product lines. The Company believes, however, that the effect of these
lower gross margins will be mitigated at least to some extent by cost reductions
and other operational efficiencies associated with the combination of the
acquired entities and by the license agreement with Hasbro. The agreement with
Hasbro provides the Company with a source of license royalties without
significant related cost of sales. In addition, the license agreement provides
the Company with access to the mass-merchandise market without committing
capital for manufacturing and with limited marginal expenditures for
administrative and marketing activities.
Selling, general, and administrative expenses include general corporate
expenses as well as goodwill amortization. The Company recorded goodwill of
approximately $47.7 million in connection with the fiscal 1997 acquisitions. The
goodwill is being amortized at the rate of $1.9 million per year over 25 years.
The Company anticipates that it will continue to achieve a reduction in selling,
general, and administrative expenses as a percentage of sales as a result of
consolidation and the cost-reduction efforts described above.
Results of Operations
The following table sets forth, for the periods indicated, the
percentage of total revenue represented by certain expense and revenue items.
Year Ended September 30,
-----------------------------------------------
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
Sales
Collectibles ................................. 76.5% 75.9% 89.7% 92.5% 49.6%
Apparel and souvenirs ........................ -- 0.8 4.6 4.4 46.2
Promotional .................................. -- -- -- 3.1 3.4
Other ........................................ 15.7 23.3 5.7 -- 0.8
----- ----- ----- ----- -----
Net Sales .................................. 100.0 100.0 100.0 100.0 100.0
Cost of sales ................................... 64.4 62.2 60.8 57.2 62.1
----- ----- ----- ----- -----
Gross profit .................................... 35.6 37.8 39.2 42.8 37.9
Selling, general and administrative
expenses ..................................... 43.4 34.4 23.4 21.0 18.9
Settlement costs ................................ -- -- -- -- 4.1
Amortization of goodwill and other
intangibles .................................. -- -- -- -- 1.0
----- ----- ----- ----- -----
Income (loss) from operations ................... (7.8) 3.4 15.8 21.8 13.9
Interest income (expense) and other, net ........ (0.4) (1.0) 0.1 0.5 (0.9)
----- ----- ----- ----- -----
Income (loss) before provision for
(benefit from) income taxes .................. (8.2) 2.4 15.9 22.3 13.0
Provision for (benefit from) income taxes ....... (0.4) (1.4) 5.3 8.8 5.2
----- ----- ----- ----- -----
Net income (loss) ............................... (7.8)% 3.8% 10.6% 13.5% 7.8%
===== ===== ===== ===== =====
24
Fiscal Year Ended September 30, 1997 Compared with Fiscal Year Ended September
30, 1996
Net sales increased 195% to $130.4 million for the year ended September
30, 1997 from $44.2 million for the year ended September 30, 1996. The Company
attributes the improvement in sales during fiscal 1997 primarily to (i) revenue
from Sports Image and Motorsport Traditions, which were acquired by the Company
during the first and second quarters of fiscal 1997, respectively, (ii) the
Company's ability to capitalize on the continued strong growth in the base of
motorsports enthusiasts and to produce and sell increased quantities of
souvenirs, apparel, and die-cast collectible goods; and (iii) an increase in
Collectors' Club membership. The number of members in the Collectors' Club
increased to approximately 100,000 members from approximately 72,000 members at
September 30, 1997 and September 30, 1996, respectively.
Gross profit increased to $49.4 million in fiscal 1997 from $18.9
million in fiscal 1996, representing 37.9% and 42.8% of net sales, respectively.
The decrease in gross profit as a percentage of net sales resulted from
increased sales of apparel and souvenirs, which typically provide lower margins
than sales of the Company's collectible products.
Selling, general and administrative expenses increased to $24.6 million
in fiscal 1997 from $9.3 million in fiscal 1996, representing 18.9% and 21.0% of
net sales, respectively. The decrease in such expenses as a percentage of sales
resulted primarily from cost savings achieved with the integration and
consolidation of operations for the acquired entities of Sports Image and
Motorsport Traditions. The integration and consolidation included the relocation
of Motorsport Traditions into Sport Image's facility, the integration of
management information systems, and a reduction in excess labor.
Settlement costs of $5.4 million for the year ended September 30, 1997
resulted from a one-time charge for the API settlement and related legal
charges. This settlement represents 4.1% of net sales. See Item 3, "Legal
Proceedings."
Amortization of goodwill and other intangibles increased to $1.3
million for the year ended September 30, 1997 from $4,000 for the year ended
September 30, 1996. The increase in amortization of goodwill and other
intangibles is related to the acquisitions of Sports Image, Motorsport
Traditions, and other entities. The Company recorded goodwill and other
intangible assets of $47.7 million in connection with the fiscal 1997
acquisitions. The Company is amortizing the goodwill and other intangible assets
over a period of 15 to 25 years.
The change in interest income (expense) and other, net, was primarily
attributable to an increase in interest expense of approximately $2.0 million
related to debt incurred in connection with the acquisitions of Sports Image and
Motorsport Traditions.
Fiscal Year Ended September 30, 1996 Compared with Fiscal Year Ended September
30, 1995
Net sales increased 69.2% to $44.2 million for the year ended September
30, 1996 from $26.1 million for the year ended September 30, 1995. The $18.1
million increase in net sales resulted primarily from an increase of $17.5
million in collectible sales. The increase in collectible sales is primarily
attributable to (i) the continued expansion of the collectible market and the
Company's ability to produce and sell increased quantities of collectibles; (ii)
an increase in the number of members in the Collectors' Club (which increased to
approximately 72,000 members from approximately 40,000 members at September 30,
1996 and September 30, 1995, respectively); and (iii) sales from recently
introduced product lines.
Gross profit increased to $18.9 million in fiscal 1996 from $10.2
million in fiscal 1995, representing 42.8% and 39.2% of net sales, respectively.
The increase in gross profit as a percentage of net sales resulted primarily
from (i) the effect of higher sales volume on fixed cost components of cost of
sales, primarily depreciation charges related to the Company's tooling
equipment; and (ii) increased sales through the Collectors' Club, which
typically carry higher margins.
25
Selling, general, and administrative expenses increased to $9.3 million
in fiscal 1996 from $6.1 million in fiscal 1995, representing 21.0% and 23.4% of
net sales, respectively. The increase in such expenses resulted from increased
expenditures for sales and marketing, particularly increased advertising
consistent with the Company's strategy to increase Collectors' Club memberships
and distributor sales.
Interest income (expense) and other, net, increased to approximately
$216,000 in fiscal 1996 from approximately $24,000 in fiscal 1995. This change
resulted primarily from the conversion of the 10% Convertible Subordinated
Debentures (the "Debentures") into shares of the Company's Common Stock during
fiscal 1995.
The provision for income taxes in fiscal 1996 resulted in an effective
tax rate of approximately 39.7% compared with an effective tax rate of
approximately 33.3% in fiscal 1995. The increase in the effective tax rate
occurred primarily as a result of the utilization of net operating loss
carryforwards in fiscal 1995.
Pro Forma Results of Operations
The following table sets forth the unaudited pro forma income statement
data of the Company for the years ended September 30, 1996 and 1997, giving
effect to the acquisitions of Sports Image, Motorsport Traditions, RYP, Image
Works, and Simpson as if they had occurred on October 1, 1995, using the
purchase method of accounting for business combinations. The unaudited pro forma
income statement data presented herein does not purport to represent what the
Company's actual results of operations would have been had those acquisitions
occurred on that date or to project the Company's results of operations for any
future period.
(in thousands, except per share data)
Year Ended Year Ended
September 30, September 30,
1996 1997
------------- -------------
(Unaudited) (Unaudited)
Net sales .......................... $137,930 $158,977
Net income(1) ...................... 8,419 9,338
Net income per common share(1) ..... $ 0.61 $ 0.63
- ----------------------
(1) Pro forma amounts for fiscal 1997 reflect the one-time charge of
approximately $5.4 million for legal settlement costs and related
expenses.
The pro forma results shown above do not account for efficiencies
gained upon the consolidation of operations, including the elimination of
duplicative functions and reduction of salaries expense and other related costs.
The difference in earnings per share on a pro forma basis for fiscal 1997 is
primarily attributable to lower gross margins as a result of the write-down of
inventory by Motorsport Traditions immediately prior to the date of acquisition.
The Company has implemented improvements to the management and control of
inventories of the acquired companies intended to reduce the need for seasonal
adjustments to inventory. The pro forma results of operations for the years
ended September 30, 1997 and 1996 reflect the amortization of goodwill and other
intangibles arising from the fiscal 1997 acquisitions and include additional
interest expense associated with the financing of the acquisitions of Sports
Image and Motorsport Traditions.
Quarterly Results of Operations
The following table sets forth certain unaudited quarterly results of
operations for each of the eight quarters in the period ended September 30,
1997. All quarterly information was obtained from unaudited financial statements
not otherwise contained herein. The Company believes that all necessary
adjustments have been made to present fairly the quarterly information when read
in conjunction with the Consolidated Financial Statements and Notes
26
thereto included elsewhere in this Report. The operating results for any quarter
are not necessarily indicative of the results for any future period.
(in thousands, except per share amounts)
Fiscal 1996
----------------------------------------------------------
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
----------- ----------- ----------- -----------
Net sales ........................... $ 8,006 $ 9,766 $12,283 $14,161
Gross profit ........................ 3,241 3,947 5,424 6,308
Income from operations .............. 1,370 1,852 2,938 3,494
Net income .......................... $ 878 $ 1,140 $ 1,777 $ 2,158
Net income per common share, assuming
full dilution .................... $ 0.07 $ 0.09 $ 0.14 $ 0.16
Weighted average number of common
shares, assuming full dilution ... 12,840 12,984 13,150 13,128
Fiscal 1997
----------------------------------------------------------
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
----------- ----------- ----------- -----------
Net sales ........................... $15,175 $28,302 $39,632 $47,270
Gross profit ........................ 6,395 10,781 14,684 17,525
Income from operations .............. 2,843 4,583 2,349 8,361
Net income .......................... $ 1,568 $ 2,437 $ 1,098 $ 5,043
Net income per common share, assuming
full dilution .................... $ 0.12 $ 0.17 $ 0.08 $ 0.31
Weighted average number of common
shares, assuming full dilution ... 13,476 14,129 14,430 16,450
The Company's revenue and operating results may be subject to quarterly
and other fluctuations as a result of a variety of factors. As a result of the
fiscal 1997 acquisitions, the Company believes that quarter-to-quarter
comparisons of its past financial results may not necessarily be meaningful and
should not be relied upon as an indication of future performance.
Seasonality
Because the auto racing season is concentrated between the months of
February and November, the second and third calendar quarters of each year (the
Company's third and fourth fiscal quarters) generally are characterized by
higher sales of motorsports products. The Company believes, however, that
holiday sales of its products are increasing, which has the effect of reducing
seasonal fluctuations in its sales.
Liquidity and Capital Resources
The Company's working capital position increased to $57.0 million at
September 30, 1997 from $18.1 million at September 30, 1996. The increase of
$38.9 million is primarily attributable to the Company's 1997 public offering
described below, the working capital acquired from the Company's fiscal 1997
acquisitions (primarily the purchases of Sports Image and Motorsport
Traditions), and results from operations.
Capital expenditures for the year ended September 30, 1997 totaled
approximately $11.1 million, of which approximately $7.0 million was utilized
for the Company's continued investment in tooling.
On January 16, 1997, the Company sold an aggregate of 187,500 shares of
Common Stock to Hasbro at a price of $14.50 per share, with net proceeds to the
Company of approximately $2.6 million. The Company has
27
agreed that, in the event that Hasbro sells such shares at a price lower than
$14.50 per share during the one-year period ending on April 16, 1998, the
Company will reimburse Hasbro for the amount of such loss, plus interest.
On June 24, 1997, the Company sold 1,770,000 shares of Common Stock in
connection with an underwritten public offering. The Company sold an additional
315,000 shares of its common stock on July 17, 1997 pursuant to the exercise of
the underwriters' over-allotment option. The net proceeds to the Company from
this offering were approximately $49.8 million, after deducting estimated
offering expenses and underwriting discounts and commissions.
During the year ended September 30, 1997, the Company issued 296,092
shares of Common Stock upon the exercise of stock options, resulting in total
proceeds to the Company of approximately $1.7 million.
In November 1996, the Company purchased substantially all of the assets
and assumed certain liabilities of Sports Image. The purchase price was
approximately $30.0 million, consisting of a $24.0 million promissory note due
January 2, 1997 and 403,361 shares of the Company's Common Stock. On January 2,
1997, the Company repaid the promissory note with the proceeds from the issuance
of senior notes and a portion of the borrowings under the credit facility
described below. The terms of this acquisition were determined by arms-length
negotiations between representatives of Sports Image and representatives of the
Company. In fiscal 1996, the Company derived approximately 16% of its net sales
from Sports Image, a distributor of the Company's die-cast collectible products.
In January 1997, the Company acquired substantially all of the assets
and assumed certain liabilities of Motorsport Traditions Limited Partnership and
acquired all of the capital stock of Creative Marketing & Promotions, Inc. for
approximately $13.0 million, consisting of cash in the amount of $5.4 million, a
promissory note in the principal amount of $1.6 million, and an aggregate of
342,857 shares of the Company's Common Stock. The terms of the acquisitions were
determined by arms-length negotiations between representatives of the sellers
and representatives of the Company.
On January 2, 1997, the Company entered into a $16.0 million credit
facility (the "Credit Facility"), with First Union National Bank of North
Carolina. The Credit Facility consists of a revolving line of credit (the "Line
of Credit") for up to $10.0 million through September 30, 1997 and up to $6.0
million from September 30, 1997 to March 31, 1998 and a $6.0 million letter of
credit/bankers' acceptances facility (the "Letter of Credit/BA Facility"). The
Line of Credit bears interest, at the Company's option, at a rate equal to
either (i) the greater of (a) the bank's publicly announced prime rate or (b) a
weighted average Federal Funds rate plus 0.5%, or (ii) LIBOR plus 1.9%. The Line
of Credit is guaranteed by Sports Image and Motorsport Traditions. The Company
utilized $4.0 million of the Line of Credit to provide part of the cash portion
of the purchase price for Motorsport Traditions and an additional $4.0 million
of the Line of Credit to repay a portion of the $24.0 million promissory note
issued in connection with the acquisition of Sports Image. The Company utilized
a portion of the proceeds of the June 1997 public offering described below to
repay its outstanding indebtedness under the Line of Credit. The Company had no
outstanding borrowings under the Line of Credit as of September 30,1997. The
Letter of Credit/BA Facility, as amended in April 1997, is available for
issuances of letters of credit and eligible bankers' acceptances in an aggregate
amount up to $10.0 million to enable the Company to finance purchases of
products from its overseas vendors. The Company had outstanding purchase
commitments of approximately $3.5 million under the Letter of Credit/BA Facility
as of September 30, 1997. The Credit Facility will mature on March 31, 1998. The
Credit Facility contains certain provisions that, among other things, require
the Company to comply with certain financial ratios and net worth requirements
and limit the ability of the Company and its subsidiaries to incur additional
indebtedness, to sell assets, or to engage in certain mergers or consolidations.
On January 2, 1997, the Company issued an aggregate of $20.0 million
principal amount of senior notes to three insurance companies (the "Senior
Notes"). The Senior Notes bear interest at the rate of 8.05% per annum, provide
for semi-annual payments of accrued interest, and mature on January 2, 1999. The
Company may not prepay the Senior Notes prior to maturity, but must offer to
redeem the Senior Notes in the event of a "Change of Control" of the Company, as
defined in the Senior Notes. The Senior Notes contain certain provisions that,
among other
28
things, require the Company to comply with certain financial ratios and net
worth requirements and limit the ability of the Company and its subsidiaries to
incur additional indebtedness, to sell assets or engage in certain mergers or
consolidations. The Senior Notes are guaranteed by Sports Image and Motorsport
Traditions. The Company utilized the proceeds from the Senior Notes to repay the
remainder of the promissory note issued in connection with the acquisition of
Sports Image.
On July 22, 1997, the Company acquired substantially all of the assets
and assumed certain liabilities of Image Works. The consideration paid by the
Company for the purchased assets consisted of (i) $4.25 million in cash plus
(ii) a three-year promissory note that provides for a minimum principal amount
of $750,000, with additional contingent payments of up to an aggregate of $1.4
million based upon the attainment of certain revenue objectives through
September 30, 2000. Image Works designs and manufactures screen printed and
embroidered motorsports apparel items for distribution through mass retailers
and corporate accounts. Image Works generated approximately $20.0 million in
revenue during calendar 1996. The terms of this acquisition were determined by
arms-length negotiations between representatives of Image Works and
representatives of the Company.
On July 31, 1997, the Company acquired all of the outstanding common
stock of RYP for cash of $5.7 million. RYP sells licensed motorsports products
through mobile trackside stores and generated approximately $5.0 million in
revenue during calendar 1996. In connection with the acquisition of RYP, the
Company entered into a 15-year license agreement with Robert Yates Racing, Inc.
See Item 1, "Business -- Licenses." The terms of this acquisition were
determined by arms-length negotiations between representatives of RYP and
representatives of the Company.
On August 8, 1997, the Company acquired certain assets and assumed
certain liabilities related to the licensed mini-helmet collectible business of
Simpson. The consideration paid by the Company for the purchased assets
consisted of approximately $653,000 in cash, with additional contingent payments
of up to an aggregate of $1.5 million based upon the attainment of certain
revenue objectives. In connection with the purchase of the assets and assumption
of liabilities of Simpson, the Company also entered into a 25-year license
agreement with respect to certain rights used in connection with the purchased
assets. Pursuant to the license agreement, the Company paid the licensor an
initial license fee consisting of cash plus 19,324 shares of the Company's
Common Stock. The terms of this acquisition were determined by arms-length
negotiations between representatives of the seller and representatives of the
Company.
The Company is a defendant in various lawsuits. See Item 3, "Legal
Proceedings." The Company has made no provision in its financial statements with
respect to these matters. The imposition of damages in one or more of the cases
against the Company could have a material adverse effect on the Company's
results of operation and financial position.
The Company believes that its current cash resources, the Credit
Facility, and expected cash flow from operations will be sufficient to fund the
Company's capital needs during the next 12 months at its current level of
operations, apart from capital needs resulting from additional acquisitions.
However, the Company way be required to obtain additional capital to fund its
planned growth during the next 12 months and beyond. Potential sources of any
such capital may include the proceeds from the exercise of outstanding options,
bank financing, strategic alliances, and additional offerings of the Company's
equity or debt securities. There can be no assurance that such capital will be
available from these or other potential sources, and the lack of such capital
could have a material adverse effect on the Company's business.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
29
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to the financial statements, the notes thereto and
reports thereon, commencing at page F-1 of this report, which financial
statements, report, notes and data are incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item relating to directors of the
Company is incorporated herein by reference to the definitive Proxy Statement to
be filed pursuant to Regulation 14A of the Securities Exchange Act of 1934, as
amended (the "Exchange Act") for the Company's 1998 Annual Meeting of
Shareholders. The information required by this Item relating to executive
officers of the Company is included in Item 1, "Business Executive Officers."
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated herein by
reference to the definitive Proxy Statement to be filed pursuant to Regulation
14A of the Exchange Act for the Company's 1998 Annual Meeting of Shareholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated herein by
reference to the definitive Proxy Statement to be filed pursuant to Regulation
14A of the Exchange Act for the Company's 1998 Annual Meeting of Shareholders.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this Item is incorporated herein by
reference to the definitive Proxy Statement to be filed pursuant to Regulation
14A of the Exchange Act for the Company's 1998 Annual Meeting of Shareholders.
30
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM
8-K
(a) Financial Statements and Financial Statement Schedules
(1) Financial Statements are listed in the Index to Consolidated
Financial Statements on page F-1 of this Report.
(2) No Financial Statement Schedules are included because such
schedules are not applicable, are not required, or because
required information is included in the Consolidated Financial
Statements or Notes thereto.
(b) Reports on Form 8-K
Not applicable.
(c) Exhibits
Exhibit
Number Exhibit
- ------ -------
1.0 Form of Underwriting Agreement(1)
3.1 First Amended and Restated Articles of Incorporation of Registrant(2)
3.2 Amended and Restated Bylaws of Registrant(2)
4.1 Form of Certificate of Common Stock(3)
10.4.2 1993 Stock Option Plan, as amended and restated through January 16,
1997(4)
10.8 Form of Indemnification Agreement entered into with the Directors of
the Registrant(3)
10.21 Lease between the Company and F.W. Investments dated January 1, 1994(5)
10.24.1 Commercial Credit Agreement dated March 6, 1995 between the Company and
the Hong Kong and Shanghai Banking Corporation Limited(6)
10.24.2 Optional Advance Time Note (Loans Against Imports) dated March 6, 1995
between the Company and the Hong Kong and Shanghai Banking
Corporation(6)
10.25 Bill of Sale and Asset Purchase Agreement between the Company, Fan
Fueler, Inc., Peter LaMonica, and Fred Miller, III dated August 12,
1994(7)
10.26 Bill of Sale and Asset Purchase Agreement between the Company, M-Car,
Incorporated, and Robert Scott Tremonti dated September 29, 1994(7)
10.27 Manufacturing Agreement between the Company and Early Light
International (Holdings) Ltd. dated December 5, 1994(7)
10.29 Asset Purchase Agreement dated March 31, 1995 between the Company and
Motorsports Promotion, Inc.(6)
10.30 Promissory Note dated March 31, 1995 between Motorsports Promotions,
Inc., as borrower, and the Company, as lender(6)
10.31 Security Agreement dated March 31, 1995 between Motorsports Promotions,
Inc., as debtor, and the Company, as secured party(6)
10.32 Credit Agreement by and between the Company and Wells Fargo HSBC Trade
Bank, N.A.(8)
10.33 Asset Purchase Agreement dated as of November 7, 1996, among Action
Performance Companies, Inc., SII Acquisition, Inc., Sports Image, Inc.,
and R. Dale Earnhardt and Teresa H. Earnhardt(9)
10.34 Promissory Note dated November 7, 1996, in the principal amount of
$24,000,000 issued by SII Acquisition, Inc., as Maker, to Sports Image,
Inc., as Payee, together with Guarantee of Action Performance
Companies, Inc.(9)
31
Exhibit
Number Exhibit
- ------ -------
10.35 Security Agreement dated November 7, 1996, between Sports Image, Inc.
and SII Acquisition, Inc.(9)
10.36 Registration Agreement dated as of November 7, 1996, among Action
Performance Companies, Inc., Sports Image, Inc., and R. Dale Earnhardt
and Teresa H. Earnhardt(9)
10.37 License Agreement dated as of November 7, 1996, among SII Acquisition,
Inc., Dale Earnhardt, and Action Performance Companies, Inc.(9)
10.38 Employment Agreement dated as of November 7, 1996, between Action
Performance Companies, Inc. and Joe Mattes(9)
10.39 Asset Purchase Agreement dated as of January 1, 1997, among Action
Performance Companies, Inc., MTL Acquisition, Inc., Motorsport
Traditions Limited Partnership, Midland Leasing, Inc., and Motorsports
By Mail, Inc.(10)
10.40 Exchange Agreement dated as of January 1, 1997, among Action
Performance Companies, Inc., Kenneth R. Barbee, and Jeffery M.
Gordon(10)
10.41 Promissory Note dated January 1, 1997, in the principal amount of
$1,600,000 issued by MTL Acquisition, Inc., as Maker, to Motorsport
Traditions Limited Partnership, as Payee, together with Guarantee of
Action Performance Companies, Inc.(10)
10.42 Note Purchase Agreement dated as of January 2, 1997, among Action
Performance Companies, Inc., Jefferson-Pilot Life Insurance Company,
Alexander Hamilton Life Insurance Company of America, and First
Alexander Hamilton Life Insurance Company, together with form of Note,
form of Subsidiary Guaranty, and form of Subsidiary Joinder(10)
10.43 Credit Agreement dated as of January 2, 1997, among Action Performance
Companies, Inc., Sports Image, Inc., MTL Acquisition, Inc., and First
Union National Bank of North Carolina(10)
10.44 Registration Agreement dated as of January 1, 1997, among Action
Performance Companies, Inc., Motorsport Traditions Limited Partnership,
Midland Leasing, Inc., and Motorsports By Mail, Inc.(10)
10.45 Registration Agreement dated as of January 1, 1997, among Action
Performance Companies, Inc., Kenneth R. Barbee, and Jeffery M.
Gordon(10)
10.46 Employment Agreement dated as of January 1, 1997, between Action
Performance Companies, Inc. and Kenneth R. Barbee(10)
10.47 Consulting Agreement dated as of January 1, 1997, between Action
Performance Companies, Inc. and John Bickford(10)
10.48 Common Stock Purchase Agreement dated January 16, 1997, between Hasbro,
Inc. and Action Performance Companies, Inc.(11)
10.49 Standard Form Industrial Lease dated April 8, 1997, between
Hewson/Breckner-Baseline, L.L.C. and Action Performance Companies, Inc.
10.50 Lease Agreement dated July 9, 1997, by and between Performance Park
Partners, LLC and Sports Image, Inc.
11.1 Computation of Primary Earnings Per Share
11.2 Computation of Fully Diluted Earnings Per Share
23.1 Consent of Arthur Andersen LLP
27.1 Financial Data Schedule
- ---------------------------
(1) Incorporated by reference to the Registrant's Registration Statement on
Form S-3 and Amendment No. 1 thereto (Registration No. 333-27485).
(2) Incorporated by reference to the Registrant's Form 10-QSB for the
quarter ended March 31, 1996, as filed with the Securities and Exchange
Commission on May 2, 1996.
(3) Incorporated by reference to the Registrant's Registration Statement on
Form SB-2 and amendments thereto (Registration No. 33-57414-LA).
(4) Incorporated by reference to the Registrant's Form 10-Q for the quarter
ended March 31, 1997, as filed with the Securities and Exchange
Commission on May 15, 1997.
32
Exhibit
Number Exhibit
- ------ -------
(5) Incorporated by reference to the Registrant's Form 10-QSB for the
quarter ended March 31, 1994, as filed with the Securities and Exchange
Commission on May 16, 1994.
(6) Incorporated by reference to the Registrant's Form 10-QSB for the
quarter ended March 31, 1995, as filed with the Securities and Exchange
Commission on May 15, 1995.
(7) Incorporated by reference to the Registrant's Form 10-KSB for the year
ended September 30, 1994, as filed with the Securities and Exchange
Commission on December 22, 1994.
(8) Incorporated by reference to the Registrant's Form 10-QSB for the
quarter ended June 30, 1996, as filed with the Securities and Exchange
Commission on August 14, 1996.
(9) Incorporated by reference to the Registrant's Form 8-K filed with the
Securities and Exchange Commission on November 22, 1996, as amended by
Form 8-K/A filed on January 13, 1997.
(10) Incorporated by reference to the Registrant's Form 8-K filed with the
Securities and Exchange Commission on January 23, 1997, as amended by
Form 8-K/A filed on February 24, 1997.
(11) Incorporated by reference to the Registrant's Registration Statement on
Form S-3 (Registration No. 333- 22943).
33
SIGNATURES
In accordance with Section 13 or 15(d) 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.
ACTION PERFORMANCE COMPANIES, INC.
Date: December 17, 1997 /s/ Fred W. Wagenhals
-----------------------------------------
Fred W. Wagenhals, Chairman of the Board,
President, and Chief Executive Officer
In accordance with the Securities Exchange Act of 1934, this report has
been signed below by the following persons on behalf of the registrant and in
the capacities and on the date indicated.
Signature Capacity Date
- --------- -------- ----
/s/ Fred W. Wagenhals Chairman of the Board, President, and Chief December 17, 1997
- --------------------------------- Executive Officer (Principal Executive Officer)
Fred W. Wagenhals
/s/ Tod J. Wagenhals Executive Vice President, Secretary, and Director December 17, 1997
- ---------------------------------
Tod J. Wagenhals
/s/ Christopher S. Besing Vice President, Chief Financial Officer, Treasurer, December 17, 1997
- --------------------------------- and Director (Principal Financial and
Christopher S. Besing Accounting Officer)
/s/ Melodee L. Volosin Director - Wholesale Division and Director December 17, 1997
- ---------------------------------
Melodee L. Volosin
Vice President - Strategic Alliances and Director December __, 1997
- ---------------------------------
John S. Bickford
/s/ Jack M. Lloyd Director December 17, 1997
- ---------------------------------
Jack M. Lloyd
/s/ Robert H. Manschot Director December 17, 1997
- ---------------------------------
Robert H. Manschot
Chief Operating Officer and Director December __, 1997
- ---------------------------------
Charles C. Blossom, Jr.
34
ACTION PERFORMANCE COMPANIES, INC.
Index to Consolidated Financial Statements
Page
----
Report of Independent Public Accountants........................... F-2
Consolidated Balance Sheets as of September 30, 1997 and 1996...... F-3
Consolidated Statements of Operations for the Years
Ended September 30, 1997, 1996, and 1995.................... F-4
Consolidated Statements of Shareholders' Equity for the Years
Ended September 30, 1997, 1996, and 1995.................... F-5
Consolidated Statements of Cash Flows for the Years
Ended September 30, 1997, 1996, and 1995.................... F-6
Notes to Consolidated Financial Statements......................... F-7
F-1
ARTHUR ANDERSEN LLP
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Action Performance Companies, Inc.:
We have audited the accompanying consolidated balance sheets of ACTION
PERFORMANCE COMPANIES, INC. (an Arizona corporation) and subsidiaries as of
September 30, 1997 and 1996, and the related consolidated statements of
operations, shareholders' equity and cash flows for each of the three years in
the period ended September 30, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Action Performance Companies,
Inc. and subsidiaries as of September 30, 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
September 30, 1997, in conformity with generally accepted accounting principles.
/s/ Arthur Andersen LLP
Phoenix, Arizona,
November 18, 1997, except with respect
to matters discussed in Note 13 as to
which the date is December 10, 1997.
F-2
ACTION PERFORMANCE COMPANIES, INC.
CONSOLIDATED BALANCE SHEETS
September 30, 1997 and 1996
(in thousands, except share data)
ASSETS 1997 1996
- ------ -------- --------
CURRENT ASSETS:
Cash and cash equivalents .......................... $ 29,318 $ 4,983
Accounts receivable, net of allowance for
doubtful accounts of $837 and $256,
respectively ...................................... 17,802 7,497
Inventories, net ................................... 17,855 5,834
Prepaid royalties .................................. 4,967 2,295
Prepaid expenses and other assets .................. 2,603 1,772
-------- --------
Total current assets ............................. 72,545 22,381
PROPERTY AND EQUIPMENT, net .......................... 20,017 8,188
GOODWILL AND OTHER INTANGIBLES, net .................. 46,409 56
NOTES RECEIVABLE AND OTHER ASSETS .................... 2,354 1,024
-------- --------
$141,325 $ 31,649
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
CURRENT LIABILITIES:
Accounts payable ................................... $ 6,680 $ 2,188
Accrued royalties .................................. 5,098 1,180
Accrued expenses and other ......................... 3,792 920
-------- --------
Total current liabilities ........................ 15,570 4,288
LONG-TERM DEBT:
Notes payable ...................................... 20,602 --
Other long-term debt ............................... 1,984 365
-------- --------
Total long-term debt ............................. 22,586 365
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY:
Preferred stock, no par value, 5,000,000 shares
authorized, no shares issued and outstanding ...... -- --
Common stock, $.01 par value, 25,000,000 shares
authorized; 15,952,083 and 12,609,769 shares
issued and outstanding, respectively .............. 160 126
Additional paid-in capital ......................... 84,984 18,991
Retained earnings .................................. 18,025 7,879
-------- --------
Total shareholders' equity ....................... 103,169 26,996
-------- --------
$141,325 $ 31,649
======== ========
The accompanying notes are an integral part of these consolidated
balance sheets
F-3
ACTION PERFORMANCE COMPANIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended September 30, 1997, 1996, and 1995
(in thousands, except per share data)
1997 1996 1995
-------- -------- --------
Sales:
Collectibles....................................... $ 63,846 $ 40,904 $ 23,443
Apparel and souvenirs .............................. 60,430 1,961 1,190
Promotional ........................................ 5,085 1,351 --
Other .............................................. 1,019 -- 1,498
-------- -------- --------
Net sales ........................................ 130,380 44,216 26,131
Cost of sales ........................................ 80,995 25,296 15,882
-------- -------- --------
Gross profit ......................................... 49,385 18,920 10,249
Operating expenses:
Selling, general and
administrative expenses .......................... 24,564 9,262 6,115
Settlement costs ................................... 5,400 -- --
Amortization of goodwill and
other intangibles ................................ 1,286 4 4
-------- -------- --------
Total operating expenses ......................... 31,250 9,266 6,119
-------- -------- --------
Income from operations ............................... 18,135 9,654 4,130
Other income (expense):
Interest income and other, net ..................... 796 296 208
Interest expense ................................... (2,021) (80) (184)
-------- -------- --------
Total other income (expense) ..................... (1,225) 216 24
-------- -------- --------
Income before provision for
income taxes ....................................... 16,910 9,870 4,154
Provision for income taxes ........................... 6,764 3,917 1,384
-------- -------- --------
NET INCOME........................................... $ 10,146 $ 5,953 $ 2,770
======== ======== ========
NET INCOME PER COMMON SHARE:
Primary ............................................ $ 0.69 $ 0.46 $ 0.27
======== ======== ========
Fully diluted ...................................... $ 0.69 $ 0.46 $ 0.25
======== ======== ========
WEIGHTED AVERAGE SHARES OUTSTANDING:
Primary ............................................ 14,624 13,028 10,116
======== ======== ========
Fully diluted ...................................... 14,671 13,069 11,570
======== ======== ========
The accompanying notes are an integral part of these
consolidated financial statements.
F-4
ACTION PERFORMANCE COMPANIES, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
For the Years Ended September 30, 1997, 1996, and 1995
(in thousands, except share data)
Convertible
Common Stock Preferred Stock Common
------------------------- --------------------- Stock
Shares Amount Shares Amount Subscribed
---------- ---------- ---------- ------ ----------
BALANCE, September 30, 1994 .................... 7,873,846 $ 79 -- $-- $ 125
Common stock issued upon
conversion of debentures ..................... 1,485,676 15 -- -- --
Issuance of convertible preferred stock ........ -- -- 500 -- --
Common Stock issued under consulting agreement . 200,000 2 -- -- --
Common stock issued for common stock subscribed 100,000 1 -- -- (125)
Common stock issued upon exercise
of options ................................... 541,000 5 -- -- --
Tax benefit from stock options ................. -- -- -- -- --
Redemption of warrants ......................... -- -- -- -- --
Common stock issued upon exercise of warrants .. 1,020,886 10 -- -- --
Net income ..................................... -- -- -- -- --
---------- ---------- ---------- ---- -------
BALANCE, September 30, 1995 .................... 11,221,408 $ 112 500 $-- $--
---------- ---------- ---------- ---- -------
Common stock issued upon conversion
of convertible preferred stock ............... 1,000,000 10 (500) -- --
Common stock issued upon exercise
of options ................................... 239,247 2 -- -- --
Tax benefit from stock options ................. -- -- -- -- --
Common stock issued upon exercise of warrants .. 149,114 2 -- -- --
Net income ..................................... -- -- -- -- --
---------- ---------- ---------- ---- -------
BALANCE, September 30, 1996 .................... 12,609,769 $ 126 -- $-- $--
---------- ---------- ---------- ---- -------
Common stock issued in conjunction with
purchase of businesses ....................... 765,542 8 -- -- --
Common stock issued upon exercise
of options ................................... 296,092 3 -- -- --
Common stock issued in public offering ......... 2,085,000 21 -- -- --
Tax benefit from stock options ................. -- -- -- -- --
Issuance of common stock in private placements . 195,680 2 -- -- --
Net income ..................................... -- -- -- -- --
---------- ---------- ---------- ---- -------
BALANCE, September 30, 1997 .................... 15,952,083 $ 160 -- $-- $--
========== ========== ========== ==== =======
(Accumulated
Additional Deficit)
Paid-In Retained
Capital Earnings Total
---------- --------- ---------
BALANCE, September 30, 1994 .................... $ 7,549 $ (844) $ 6,909
Common stock issued upon
conversion of debentures ..................... 2,433 -- 2,448
Issuance of convertible preferred stock ........ 2,000 -- 2,000
Common Stock issued under consulting agreement . 248 -- 250
Common stock issued for common stock subscribed 124 -- --
Common stock issued upon exercise
of options ................................... 1,275 -- 1,280
Tax benefit from stock options ................. 716 -- 716
Redemption of warrants ......................... (404) -- (404)
Common stock issued upon exercise of warrants .. 2,911 -- 2,921
Net income ..................................... -- 2,770 2,770
--------- --------- ---------
BALANCE, September 30, 1995 .................... $ 16,852 $ 1,926 $ 18,890
--------- --------- ---------
Common stock issued upon conversion
of convertible preferred stock ............... (10) -- --
Common stock issued upon exercise
of options ................................... 801 -- 803
Tax benefit from stock options ................. 838 -- 838
Common stock issued upon exercise of warrants .. 510 -- 512
Net income ..................................... -- 5,953 5,953
--------- --------- ---------
BALANCE, September 30, 1996 .................... $ 18,991 $ 7,879 $ 26,996
--------- --------- ---------
Common stock issued in conjunction with
purchase of businesses ....................... 10,041 -- 10,049
Common stock issued upon exercise
of options ................................... 1,708 -- 1,711
Common stock issued in public offering ......... 49,822 -- 49,843
Tax benefit from stock options ................. 1,651 -- 1,651
Issuance of common stock in private placements . 2,771 -- 2,773
Net income ..................................... -- 10,146 10,146
--------- --------- ---------
BALANCE, September 30, 1997 .................... $ 84,984 $ 18,025 $ 103,169
========= ========= =========
The accompanying notes are an integral part of these
consolidated financial statements.
F-5
ACTION PERFORMANCE COMPANIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended September 30, 1997, 1996 and 1995
(in thousands)
1997 1996 1995
-------- -------- --------
Cash Flows from Operating Activities:
Net income ................................... $ 10,146 $ 5,953 $ 2,770
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization .............. 4,477 1,692 906
Change in assets and liabilities, net of
businesses acquired:
Accounts receivable ...................... (3,623) (3,440) (1,400)
Inventories .............................. (5,009) (3,143) (701)
Prepaid royalties ........................ (2,672) (1,186) (471)
Prepaid expenses and other assets ........ (665) 922 (441)
Accounts payable ......................... (1,633) 565 859
Accrued royalties ........................ 2,395 320 (81)
Accrued expenses and other ............... 917 (823) 1,535
-------- -------- --------
Net cash provided by operating activities 4,333 860 2,976
Cash Flows from Investing Activities:
Purchase of property and equipment ......... (11,192) (3,879) (3,024)
Proceeds from sale of equipment ............ 321 -- 150
Acquisition of businesses, less
cash acquired ............................. (11,082) -- --
-------- -------- --------
Net cash used in investing activities .... (21,953) (3,879) (2,874)
Cash Flows from Financing Activities:
Borrowings on line of credit ............... 4,879 5,222 2,895
Payments on line of credit ................. (10,279) (5,222) (2,895)
Net proceeds from issuance of common stock,
stock options, and warrants ............... 54,327 1,315 3,767
Issuance of convertible preferred stock .... -- -- 2,000
Payments on long-term debt ................. (6,972) (105) (312)
Collections on notes receivable ............ -- 32 69
-------- -------- --------
Net cash provided by financing activities . 41,955 1,242 5,524
-------- -------- --------
Net change in cash and cash equivalents .... 24,335 (1,777) 5,626
Cash and cash equivalents,
beginning of year ......................... 4,983 6,760 1,134
-------- -------- --------
Cash and cash equivalents, end of year ..... $ 29,318 $ 4,983 $ 6,760
======== ======== ========
The accompanying notes are an integral part of
these consolidated financial statements.
F-6
ACTION PERFORMANCE COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1997, 1996, and 1995
(1) THE COMPANY
Operations
Action Performance Companies, Inc. (the "Company") designs and markets licensed
motorsports products, including die-cast scaled replicas of motorsports
vehicles, apparel, and souvenirs. The Company also develops promotional programs
for sponsors of motorsports that feature the Company's die-cast replicas or
other products and are intended to increase brand awareness of the products or
services of the corporate sponsors. In addition, the Company represents popular
race car drivers in a broad range of licensing and other revenue-producing
opportunities, including product licenses, corporate sponsorships, endorsement
contracts, and speaking engagements. The Company's motorsports collectibles and
most of the Company's apparel and souvenirs are manufactured by third parties,
generally utilizing the Company's designs, tools, and dies. The Company screen
prints and embroiders a portion of the licensed motorsports apparel that it
sells.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation and Presentation
The consolidated financial statements include the accounts of the Company and
its subsidiaries. All significant intercompany accounts and transactions have
been eliminated in consolidation.
Certain reclassifications have been made in prior period financial statements to
conform to the current presentation.
Revenue Recognition
The Company recognizes revenue upon shipment. Customer deposits received in
advance of delivery are deferred and recognized when the related product is
shipped.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements.
Estimates also affect the reported amounts of revenue and expenses during the
reporting period. Actual results could differ from those estimates. In
management's opinion, methodologies used to determine estimates are adequate and
consistent with prior periods.
Fair Value of Financial Instruments
The carrying amounts of cash, accounts receivable, and accounts payable
approximate fair value because of the short maturity of these financial
instruments. The carrying amounts of long-term debt and amounts outstanding
under the Company's line of credit approximate fair value based on current
market prices for similar debt instruments and bank lines of credit. Fair value
estimates are made at a specific point in time, based on relevant market
information about the financial instrument. These estimates are subjective in
nature and involve uncertainties and matters of significant judgment and
therefore cannot be determined with precision. Changes in assumptions could
significantly affect these estimates.
F-7
Inventories
Inventories are stated at the lower of cost (first-in, first-out method) or
market, and consist of the following at September 30, 1997 and 1996 (in
thousands):
1997 1996
------- -------
Purchased components ................. $ 2,418 $ 262
Finished goods ....................... 15,437 5,572
------- -------
$17,855 $ 5,834
======= =======
Property and Equipment
Property and equipment are recorded at cost and depreciated using the
straight-line method over the estimated useful lives of the respective assets,
which range from three to ten years.
Property and equipment consist of the following at September 30, 1997 and 1996
(in thousands):
1997 1996
-------- --------
Tooling and molds ........................ $ 15,237 $ 8,190
Furniture, fixtures and equipment ........ 6,667 2,501
Autos and trucks ......................... 2,578 342
Leasehold improvements ................... 2,066 518
-------- --------
26,548 11,551
Less - accumulated depreciation .......... (6,531) (3,363)
-------- --------
$ 20,017 $ 8,188
======== ========
Property and equipment includes assets acquired under capital leases of
approximately $1.9 million and $300,000 at September 30, 1997 and 1996,
respectively.
Maintenance and repairs of approximately $277,000, $64,000 and $55,000 for the
years ended September 30, 1997, 1996 and 1995, respectively, were charged to
expense as incurred. The cost of renewals and betterments that materially extend
the useful lives of assets or increase their productivity are capitalized.
Goodwill and Other Intangibles
Goodwill represents the cost in excess of the fair value of net assets acquired
in business combinations and is amortized on the straight-line method over
twenty-five years. Other intangibles are amortized on the straight-line method
over their estimated useful lives, which ranges from fifteen to twenty-five
years. The Company continually evaluates whether later events and circumstances
have occurred, subsequent to acquisition, that indicate the remaining estimated
useful lives of intangible assets may warrant revision or that the remaining
balance may not be recoverable. If the sum of the expected future cash flows
(undiscounted and without interest charges) from an asset to be held and used in
operations is less than the carrying value of the asset, an impairment loss must
be recognized in the amount of the difference between the carrying value and the
fair value. Amortization expense of $1.3 million, $4,000, and $4,000 is included
in selling, general and administrative expenses for the years ended September
30, 1997, 1996 and 1995, respectively. Accumulated amortization of goodwill and
other intangibles was approximately $1.3 million and $10,000 as of September 30,
1997 and 1996, respectively.
License Agreements
Royalties paid under various licensing agreements are recorded as expense at the
time the related sales are made.
F-8
Supplemental Cash Flow Information
The supplemental cash flow disclosures and non-cash transactions for the years
ended September 30, 1997, 1996, and 1995 are as follows (in thousands):
1997 1996 1995
------- ------- -------
Supplemental disclosures:
Interest paid ............................... $ 1,505 $ 79 $ 268
Income taxes paid ........................... 5,396 3,992 42
Non-cash transactions:
Common stock issued in acquisitions ......... $10,049 $ -- $ --
Debt and liabilities incurred or
assumed in acquisitions ................... 44,446 -- --
Acquisition of property and equipment
under capital leases ...................... 1,402 233 338
Tax benefits on various common
stock options ............................. 1,651 838 --
Conversion of debentures .................... -- -- 2,600
Common stock issued for common
stock subscribed .......................... -- -- 125
Sale of equipment for note receivable ....... 446 -- --
Net Income Per Common Share
Net income per common share is computed based on the weighted average number of
common shares and common share equivalents outstanding using the treasury stock
method, except when common share equivalents have an antidilutive effect. All
share amounts and per share data have been restated to reflect the two-for-one
stock split effected as a stock dividend on May 28, 1996. The calculation of
fully diluted net income per common share includes adjustments for interest
expense and equivalent shares related to the 10% Convertible Subordinated
Debentures, if dilutive. The calculation of fully diluted net income per common
share for the years ended September 30, 1997, 1996, and 1995 are as follows (in
thousands, except per share data):
1997 1996 1995
------- ------- -------
Shares:
Weighted average number of common
shares outstanding .......................... 14,047 11,789 9,087
Additional shares assuming conversion of:
Stock options ............................... 624 573 601
Warrants .................................... -- 40 598
Convertible debentures ...................... -- -- 784
Preferred stock ............................. -- 667 500
------- ------- -------
Weighted average shares outstanding ........... 14,671 13,069 11,570
======= ======= =======
Net income .................................... $10,146 $ 5,953 $ 2,770
Add:
Interest expense on convertible
debentures (assuming conversion) .......... -- -- 101
------- ------- -------
Net income attributable to fully diluted
weighted average shares outstanding ......... $10,146 $ 5,953 $ 2,871
======= ======= =======
Fully diluted earnings per share .............. $ 0.69 $ 0.46 $ 0.25
======= ======= =======
F-9
Recently Issued Financial Accounting Standards
Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
of," was issued by the Financial Accounting Standards Board in March 1995, and
adopted by the Company during the year ended September 30, 1997. The adoption of
SFAS No. 121 did not impact the Company's financial position or results of
operations.
Effective October 1, 1996, the Company adopted the disclosure option of SFAS No.
123, "Accounting for Stock-based Compensation." As permitted by SFAS No. 123,
the Company has not changed to the fair value method of accounting for
stock-based compensation and will continue to use Accounting Principles Board
Opinion No. 25 for measurement and recognition of stock-based transactions. SFAS
No. 123 requires companies that do not choose to account for stock-based
compensation as prescribed by the statement to disclose the pro forma effects on
earnings and earnings per share as if SFAS No. 123 had been adopted. See Note
11.
Accounting Pronouncements Not Yet Required to be Adopted
In fiscal 1998, the Company will be required to adopt SFAS No. 128, "Earnings
per Share," issued by the Financial Accounting Standards Board. Upon adoption of
SFAS No. 128, the Company will present basic earnings per share and diluted
earnings per share. Basic earnings per share will be computed based on the
weighted average number of shares outstanding during the period. Diluted
earnings per share will be computed based on the weighted average number of
shares outstanding during the period, increased by the effect of stock options,
warrants, and other dilutive securities using the treasury stock method. The
adoption of SFAS No. 128 is not expected to have a material effect on the
Company's financial statements.
In fiscal 1998, the Company will be required to adopt SFAS No. 130, "Reporting
Comprehensive Income," issued by the Financial Accounting Standards Board. SFAS
No. 130, establishes standards for reporting and display of comprehensive income
and its components in an entity's financial statements. The objective of SFAS
No. 130 is to give the effect of all changes in the equity of an enterprise that
result from transactions and other economic events of the period. Comprehensive
income is the total of net income and all other non-owner changes in equity.
SFAS No. 130 does not address issues of recognition or measurement for
comprehensive income and its components. As a result, SFAS No. 130 will not have
an impact on the financial condition or results of operation of the Company upon
adoption.
(3) ACQUISITIONS AND DISPOSALS
Disposition of Mini Vehicle Assets
In March 1995, the Company sold certain of its assets related to its mini
vehicle product line to Motorsports Promotions, Inc. ("MPI"), an unrelated
company. The assets sold consisted primarily of accounts receivable, inventory,
tooling, and equipment. The purchase agreement provided for total consideration
of $1,324,712, consisting of $237,567 in cash, assumed liabilities of $52,891,
and a promissory note of $1,034,254, subject to certain adjustments. Effective
November 1995, the Company and MPI agreed to adjust the total consideration to
be paid by MPI to $1,051,646. The Company recorded a non-operating gain of
approximately $290,000 on this transaction in the second quarter of fiscal 1995.
As a result of the purchase price adjustment described above, the Company
reduced the gain such that no gain or loss was recorded on this transaction for
fiscal 1995. During 1997, the Company exchanged its promissory note for an
equity position in MPI. No gain or loss was recorded on the transaction.
Acquisition of Sports Image, Inc.
In November 1996, the Company purchased substantially all of the assets and
assumed certain liabilities of Sports Image, Inc.("Sports Image"). The purchase
price was approximately $30,000,000, consisting of a $24,000,000 promissory note
due January 2, 1997 and 403,361 shares of the Company's Common Stock valued at
$12.10 per share. On January 2, 1997, the Company repaid the $24,000,000
promissory note with the proceeds from the issuance of senior notes and a
portion of the borrowings under the Company's new credit facility. See Note 4.
Sports Image sells and distributes a variety of licensed motorsports products
through wholesale distributor networks, corporate sponsors, and mobile trackside
stores. In fiscal 1996, the Company derived 16% of its net
F-10
sales from Sports Image, a distributor of the Company's die-cast collectible
products. Sports Image had sales of approximately $41,800,000 of apparel,
die-cast replicas, souvenirs, and other motorsports consumer products during the
period from January 1, 1996 to November 7, 1996 (which includes sales of
die-cast collectibles purchased from the Company at an aggregate cost of
approximately $5,800,000). This transaction was accounted for as a purchase.
Acquisitions of Motorsport Traditions Limited Partnership and Creative Marketing
& Promotions, Inc.
On January 8, 1997, the Company acquired the business and substantially all of
the assets and assumed certain liabilities of Creative Marketing & Promotions,
Inc. and Motorsport Traditions Limited Partnership (collectively "Motorsport
Traditions") from 1995 Nascar Winston Cup Champion driver Jeff Gordon, Kenneth
R. Barbee, certain entities controlled by Mr. Barbee, and certain other persons.
The effective date of the acquisition of Motorsport Traditions was January 1,
1997. The purchase price paid by the Company for Motorsport Traditions consisted
of (i) cash in the amount of $5,400,000; (ii) a promissory note in the principal
amount of $1,600,000 issued by a wholly owned subsidiary of the Company; and
(iii) an aggregate of 342,857 shares of the Company's Common Stock valued at
$13.80 per share. The promissory note bears interest at 4% per annum, matures on
December 31, 1998, and has been guaranteed by the Company. Motorsport Traditions
sells and distributes licensed motorsports products through a network of
wholesale distributors and mobile trackside stores. Prior to the acquisitions,
Motorsport Traditions generated approximately $33,000,000 in annual revenue from
its design, manufacturing, and sales and distribution activities. This
transaction was accounted for as a purchase.
Acquisition of Robert Yates Promotions, Inc.
In July 1997, the Company acquired all of the outstanding common stock of Robert
Yates Promotions, Inc. ("RYP") for $5.7 million in cash. RYP sells licensed
motorsports products through trackside trailers, and generated approximately
$5.0 million in revenue during calendar year 1996. Concurrent with the
acquisition of RYP, the Company entered into a 15-year license agreement with
Robert Yates Racing, Inc. ("Yates Racing"). Pursuant to the license agreement,
the Company will pay royalties for the use of certain trademark rights
associated with Yates Racing Nascar Winston Cup teams. This transaction was
accounted for as a purchase. RYP is a defendant in certain litigation. The
purchase price is preliminary with respect to such litigation. See Note 10.
Acquisition of Image Works, Inc.
In July 1997, the Company acquired substantially all of the assets and assumed
certain liabilities of Image Works, Inc. ("Image Works"). The Company paid $4.25
million in cash and issued a three-year promissory note for a minimum principal
amount of $750,000, with additional contingent payments of up to an aggregate of
$1.4 million based upon the attainment of certain revenue objectives through
September 30, 2000. Image Works designs and manufactures screen printed and
embroidered motorsports apparel items for distribution through mass retailers
and corporate accounts. Image Works generated approximately $22.0 million in
revenue during calendar year 1996. This transaction was accounted for as a
purchase.
Acquisition of Simpson Products, Inc.
In August 1997, the Company acquired certain assets and assumed certain
liabilities related to the licensed mini-helmet collectible business of Simpson
Products, Inc. ("Simpson"). The consideration paid by the Company for the
purchased assets consisted of approximately $653,000 in cash, with additional
contingent payments of up to an aggregate of $1.5 million based upon the
attainment of certain revenue objectives. In connection with the purchase of the
assets and assumption of liabilities of Simpson, the Company also entered into a
25-year license agreement with respect to certain rights used in connection with
the purchased assets. This transaction was accounted for as a purchase.
F-11
Unaudited Pro Forma Statements of Operations
The following unaudited pro forma combined statements of operations data for the
years ended September 30, 1997 and 1996 present the results of operations of the
Company as if the acquisitions of the businesses acquired during fiscal 1997 had
occurred as of October 1, 1995. Pro forma results are as follows (in thousands,
except per share data):
1997 1996
-------- --------
Revenues .............................. $158,977 $137,930
Net income ............................ 9,338 8,419
Net income per common share ........... $ 0.63* $ 0.61
* Includes a one time charge of $5.4 million, or $0.22 per share, for
legal settlement costs.
(4) FINANCING ACTIVITIES
Long-term debt at September 30, 1997 and 1996 consists of the following (in
thousands):
1997 1996
-------- --------
Senior notes, interest at 8.05% payable semi-
annually, principal payable January 1999, secured
by assets of certain subsidiaries ....................... $ 20,000 $ --
Note payable to an individual, principal and interest
at 4% payable monthly through December 31, 1998,
unsecured ............................................... 988 --
Note payable to an individual, interest imputed at
8%, payable annually through November 2000,
unsecured ............................................... 644 --
Note payable to an individual, interest imputed at
8%, payable in equal installments through 2011,
unsecured ............................................... 565 --
Obligations under capital leases of vehicles and
equipment, interest from 8.0% to 9.5%, payable monthly .. 1,863 482
-------- --------
Total ................................................... 24,060 482
Less: current portion .................................. (1,474) (117)
-------- --------
$ 22,586 $ 365
======== ========
Credit Facility
On January 2, 1997, the Company entered into a $16.0 million credit facility
(the "Credit Facility") with First Union National Bank of North Carolina. The
Credit Facility consists of a revolving line of credit for up to $10.0 million
through September 30, 1997, and up to $6.0 million from September 30, 1997 to
March 31, 1998 (the "Line of Credit") and a $6.0 million letter of
credit/bankers' acceptances facility (the "Letter of Credit/BA Facility"). The
Line of Credit bears interest, at the Company's option, at a rate equal to
either (i) the greater of (a) the bank's publicly announced prime rate or (b) a
weighted average Federal Funds rate plus 0.5%, or (ii) LIBOR plus 1.9%. The Line
of Credit is guaranteed by Sports Image and Motorsport Traditions. The Company
utilized $4.0 million of the Line of Credit to provide part of the cash portion
of the purchase price for Motorsport Traditions and an additional $4.0 million
of the Line of Credit to repay a portion of the $24.0 million promissory note
issued in connection with the acquisition of Sports Image. The Company utilized
a portion of the proceeds of the June 1997 public offering described in Note 5
to repay its outstanding indebtedness under the Line of Credit. The Company had
no outstanding borrowings under the Line of Credit as of September 30, 1997. The
Letter of Credit/BA Facility, as amended in April
F-12
1997, is available for issuances of letters of credit and eligible bankers'
acceptances in an aggregate amount up to $10.0 million to enable the Company to
finance purchases of products from its overseas vendors. The Company had
outstanding purchase commitments of approximately $3.5 million under the Letter
of Credit/BA Facility as of September 30, 1997.
Debt Covenants
The Company's senior notes and Credit Facility agreements contain certain
provisions that, among other things, require the Company to comply with certain
financial ratios and net worth requirements and will limit the ability of the
Company and its subsidiaries to incur additional indebtedness or to sell assets
or engage in certain mergers or consolidations. At September 30, 1997, the
Company was in compliance with all such covenants.
Future Maturities of Long-Term Debt
Aggregate future maturities of long-term debt are as follows (in thousands):
Year Ended
September 30,
-------------
1998 $ 1,474
1999 20,843
2000 666
2001 347
2002 310
Thereafter 420
-------
Total $24,060
=======
(5) SHAREHOLDERS' EQUITY
All share amounts and per share data have been restated to reflect the
two-for-one stock split effected as a stock dividend on May 28, 1996.
10% Convertible Subordinated Debentures
During the year ended September 30, 1995, the Company issued 1,485,676 shares of
Common Stock upon conversion of an aggregate of $2.6 million of principal amount
of 10% Convertible Subordinated Debentures (the "Debentures"), at a conversion
price of $1.75 per share, including 1,014,272 shares issued upon conversion of
an aggregate of $1,775,000 of principal amount of the Debentures that were
outstanding in April 1995 when the Company announced that it would redeem all of
the Debentures that remained outstanding on May 31, 1995, pursuant to the terms
of the Debentures.
Convertible Preferred Stock
In March 1995, the Company completed the sale of 500 shares of Class A
Convertible Preferred Stock (the "Preferred Stock") to an affiliate of its
principal manufacturer of die-cast collectibles, for a purchase price of $2.0
million. The sale was effected primarily as a long-term strategic transaction
intended to align the interests of the manufacturer with those of the Company.
The shares were converted into an aggregate of 1,000,000 shares of Common Stock
during May 1996.
Redemption of Warrants
On May 31, 1995, the Company redeemed warrants to purchase an aggregate of
1,614,731 shares of its Common Stock. The redemption price was $.25 per warrant,
or an aggregate payment of $403,683, pursuant to the terms of such warrants.
Prior to the redemption, each warrant entitled the holder to purchase two shares
of the Company's Common Stock at an exercise price of $3.75 per share. Certain
holders of such warrants exercised warrants to purchase an aggregate of 163,670
shares of Common Stock prior to the redemption, resulting in total proceeds to
the Company of approximately $613,000.
F-13
Issuance of Stock in Private Placements
In January 1997, the Company sold 187,500 shares of Common Stock to Hasbro, Inc.
at a price of $14.50 per share, with net proceeds to the Company of
approximately $2.6 million. In August 1997, the Company issued (i) 8,180 shares
of Common Stock valued at $23.02 per share to Dale Jarrett in connection with a
three-year personal services contract, and (ii) 19,324 shares of Common Stock
valued at $22.59 to E.J. Simpson as a portion of the license fee pursuant to a
license agreement.
1997 Public Offering
On June 24, 1997, the Company sold 1,770,000 shares of its Common Stock in
connection with an underwritten public offering. On July 17, 1997, the Company
sold an additional 315,000 shares of its Common Stock pursuant to the exercise
of the underwriters' over-allotment option. The net proceeds to the Company from
this offering were approximately $49.8 million, after deducting estimated
offering expenses and underwriting discounts and commissions.
Stock Options
Under the Company's 1993 Stock Option Plan (the "Plan"), the Board of Directors
may from time to time grant to key employees, consultants, and independent
contractors who provide valuable services to the Company (i) incentive stock
options and non-statutory stock options to purchase shares of the Company's
Common Stock, (ii) stock appreciation rights, (iii) shares of the Company's
Common Stock, or (iv) cash awards. The Plan also includes an automatic program
providing for automatic grants of stock options to non-employee directors of the
Company. The exercise price for all incentive stock options granted under the
Plan may not be less than the fair market value of the Company's Common Stock on
the date of the grant, except that the option price may not be less than 110% of
the fair market value of the Company's Common Stock on the date of the grant in
the case of incentive stock options granted to any person possessing more than
10% of the combined voting power of the Company's Common Stock or any parent or
subsidiary corporation. In the case of non-statutory stock options, the exercise
price may not be less than 85% of the fair market value of the Company's Common
Stock on the date of the grant. Options granted under the Plan generally have a
six-year term. Options that were granted prior to July 1995 are fully vested and
exercisable. The option agreements for options granted beginning in July 1995
generally provide that one-third of the options vest and become exercisable on
each of the first, second, and third anniversaries of the date of grant. A total
of 2,750,000 shares of Common Stock may be issued pursuant to the Plan. The Plan
expires in 2001.
(6) RELATED PARTY TRANSACTIONS
The Company currently leases a building in Tempe, Arizona, containing
approximately 46,000 square feet, which the Company utilized for its corporate,
administrative, sales offices, and warehouse facilities prior to September 1997.
Fred W. Wagenhals, a shareholder and officer of the Company, currently owns a
one-third interest in F.W. Investments, a partnership that owns this facility.
The Company paid F.W. Investments rent of approximately $183,000, $177,000, and
$177,000 for the years ended September 30, 1997, 1996, and 1995 respectively.
The Company is currently marketing the property for a sub-lease arrangement with
unaffiliated third parties.
(7) EMPLOYEE BENEFIT PLANS
In October 1994, the Company established a defined contribution plan that
qualifies as a cash or deferred profit sharing plan under Sections 401(a) and
401(k) of the Internal Revenue Code. The plan is available to substantially all
domestic employees. Under the plan, participating employees may defer from 1% to
15% of their pre-tax compensation. The Company contributes fifty cents for each
dollar contributed by the employee, with a maximum contribution of 2% of the
employee's defined compensation. In addition, the plan provides for an annual
employer profit sharing contribution in such amounts as the Board of Directors
may determine. The
F-14
Company expensed approximately $41,000 under the plan for the year ended
September 30, 1997 and $26,000 in each of the years ended September 30, 1996 and
1995.
The Company has no other programs that require payment by the Company of
post-employment benefits to current or retired employees.
(8) INCOME TAXES
The Company provides for income taxes under SFAS No. 109, "Accounting for Income
Taxes." SFAS No. 109 requires the use of an asset and liability approach in
accounting for income taxes. Deferred tax assets and liabilities are recorded
based on the differences between the financial statement and tax bases of assets
and liabilities and the tax rates in effect when these differences are expected
to reverse. The principal differences arise as a result of the use of
accelerated depreciation and amortization methods for federal income tax
reporting purposes, certain inventory costs required to be capitalized for tax
purposes, certain reserves expensed currently for financial reporting purposes,
and compensation not yet deductible for tax purposes.
SFAS No. 109 requires the reduction of deferred tax assets by a valuation
allowance if, based on the weight of available evidence, it is more likely than
not that some or all of the deferred tax assets will not be realized. The
ultimate realization of this deferred tax asset depends on the Company's ability
to generate sufficient taxable income in the future. A valuation allowance has
not been recorded as of September 30, 1997.
Net operating loss carryovers for federal income tax purposes of approximately
$856,000 at September 30, 1994, were fully utilized in the year ended September
30, 1995.
The provision for income taxes consists of the following for the years ended
September 30 (in thousands):
1997 1996 1995
------- ------- -------
Current, net of operating loss carryover:
Federal ............................... $ 5,828 $ 3,258 $ 1,050
State ................................. 822 753 275
------- ------- -------
6,650 4,011 1,325
Deferred income taxes ..................... 114 (94) 13
Utilization of net operating loss
carryforward ............................ -- -- 340
Change in valuation allowance ............. -- -- (294)
------- ------- -------
Provision for income taxes ................ $ 6,764 $ 3,917 $ 1,384
======= ======= =======
Reconciliation of the federal income tax rate to the Company's effective rate
for the years ended September 30 are as follows:
1997 1996 1995
------ ------ ------
Statutory federal rate .................... 35.00% 34.00% 34.00%
State taxes, net of federal benefit ....... 4.65% 5.03% 5.53%
Non-deductible expense .................... .35% .66% 0.86%
Change in valuation reserve ............... -- -- (7.06%)
------ ------ ------
40.00% 39.69% 33.33%
====== ====== ======
F-15
The components of deferred taxes are as follows at September 30 (in thousands):
1997 1996
------- -------
Deferred tax assets (liabilities):
Accelerated tax depreciation ............. $ (391) $ (216)
Accelerated tax amortization ............. (306) --
Inventory cost capitalization ............ 547 156
Vacation accrual ......................... 27 13
Valuation reserves ....................... 794 197
Deferred compensation .................... 247 882
------- -------
Net deferred tax asset ................. $ 918 $ 1,032
======= =======
(9) LEGAL SETTLEMENT
In June 1997, the Company agreed to settle a breach of contract suit with Action
Products, Inc. for $4.9 million (the "API Settlement"). Pursuant to the API
Settlement, in July 1997 the Company made a payment of $4.9 million to the
plaintiff, and all parties executed mutual releases. The accompanying financial
statements include a charge of $5.4 million for the API Settlement and related
legal fees.
(10) COMMITMENTS AND CONTINGENCIES
On May 17, 1993, the State of Arizona (the "State") instituted a lawsuit against
the Company and 29 other defendants in the United States District Court for the
District of Arizona. The State seeks recovery of certain clean-up costs under
federal and state environmental laws. Specifically, the State seeks recovery of
expenses that it has incurred to date for an environmental investigation and
clean-up of property formerly used as a site for recycling hazardous wastes. The
State alleges that the property has been contaminated with hazardous substances.
In addition, the State seeks a declaratory judgment that the Company and the
other defendants are jointly and severally liable for all future costs incurred
by the State for investigative and remedial activities, and seeks a mandatory
permanent injunction requiring the Company to undertake appropriate assessment
and remedial action at the property. The State has not specified the amounts it
seeks to collect from the Company. The State alleges that F. W. Leisure
Industries, Inc. and/or F. W. & Associates, Inc. were predecessors of the
Company that produced and arranged for the transportation of hazardous
substances to the property involved in the lawsuit. The Company is defending
this lawsuit on various bases including that F. W. Leisure Industries, Inc.
and/or F. W. & Associates, Inc. were not predecessors of the Company and that
neither the Company nor any predecessor of the Company has ever produced or
transported hazardous substances as alleged by the State. The State has settled
a portion of its claims with respect to a large number of the other defendants
to the lawsuit. The Company is not a party to that settlement. On February 1,
1995, a number of the defendants that agreed to the settlement with the State
were granted leave to file, and subsequently did file, a cross-claim against the
Company seeking indemnity from the Company based on the same predecessor
liability theory asserted by the State. The parties have conducted discovery
limited to the issue of any defendant's status as a responsible party and
regarding the Company's status as a successor corporation. On March 25, 1997,
the Court ruled that under federal environmental law the Company would be
treated as the successor to F.W. & Associates, Inc., and/or F.W. Leisure
Industries, Inc. The Company may appeal this ruling at the appropriate time.
Discovery is now ongoing with regard to the merits of the underlying
environmental claims and the amount of those claims. Should the Company's
defense prove unsuccessful, the Company currently estimates the potential loss
to be approximately $800,000. No provision with respect to this matter has been
made in the financial statements.
On March 4, 1997, two class action lawsuits were filed against the Company and
approximately 28 other defendants in the United States District Court for the
Northern District of Georgia. The lawsuits allege that the defendants engaged in
price fixing and other anti-competitive activities in violation of federal
anti-trust laws. The Company was named as a defendant based upon actions alleged
to have been taken by Sports Image, Inc., a North Carolina corporation ("Sports
Image N.C.") and Creative Marketing & Promotions, Inc. ("CMP") prior to the
Company's acquisitions of the assets and capital stock, respectively, of those
entities. The actions were subsequently consolidated by order of the court. The
caption of the
F-16
consolidated action is "In re Motorsports Merchandise Antitrust Litigation" and
the files are maintained under Master File No. 1-97-CV-0569-CC. On May 30, 1997,
a consolidated amended complaint was filed, which deleted the Company as a
defendant with respect to claims based upon actions alleged to have been taken
by Sports Image N.C. and named the Company's wholly owned subsidiary, Sports
Image, Inc., an Arizona corporation ("Sports Image AZ"), as a defendant with
respect to those claims. The Company remains a defendant with respect to claims
based upon actions alleged to have been taken by CMP. On July 31, 1997, the
Company acquired all of the outstanding capital stock of RYP, which is another
defendant in this matter. Accordingly, the Company has assumed the defense of
this matter with respect to claims based upon actions alleged to have been taken
by RYP and has agreed to be responsible for and to pay any costs, fees,
expenses, damages, payments, credits, rebates, and penalties arising out of this
matter with respect to RYP, up to an aggregate of $400,000 (the "$400,000 Cap").
The $400,000 Cap excludes attorneys fees and certain other costs and expenses
that the Company may incur in defending or settling this matter. The plaintiffs
have requested injunctive relief and monetary damages of three times an
unspecified amount of damages that the plaintiffs claim to have actually
suffered. On August 1, 1997, answers were filed on behalf of the Company and
Sports Image AZ denying the allegations of the complaint. Pursuant to an
agreement between the plaintiffs and Sports Image AZ to toll the running of the
statute of limitations with respect to any claims against Sports Image AZ, on
November 17, 1997 the plaintiffs filed a motion to dismiss Sports Image AZ from
the case without prejudice. The parties currently are conducting class
discovery. The Company intends to vigorously defend the claims asserted in the
amended and consolidated complaint.
On June 4, 1997, Petty Enterprises, Inc. Licensing Division filed a lawsuit
against the Company and Fred W. Wagenhals in the General Court of Justice for
Randolph County, North Carolina. The complaint alleges that the Company engaged
in activities that resulted in common law trademark infringement, fraud, unfair
competition, "palming off" unauthorized goods as authorized products, marketing
unlicensed products, misappropriation of business opportunities, breach of
contract, unjust enrichment, conversion, and violations of the North Carolina
Unfair and Deceptive Trade Practices Act and the Lanham Act. In particular, the
plaintiff alleges that the Company manufactured and sold products in quantities
greater than the amounts permitted under certain license agreements,
manufactured and sold certain products for which it did not have licenses,
misrepresented the number of licensed products actually manufactured and sold,
and underpaid royalties to the licensors. The complaint also alleges that these
acts constitute a pattern of improper activity. The complaint requests that an
unspecified amount of actual damages plus treble and punitive damages, as well
as injunctive relief. On July 3, 1997, the Company and Mr. Wagenhals were
successful in removing the case to the United States District Court for the
Middle District of North Carolina. On July 11, 1997, each of the Company and Mr.
Wagenhals filed an answer denying the plaintiff's allegations and each filed
counterclaims against the plaintiff for breach of contract, breach of a prior
settlement agreement between the plaintiff and the Company, violations of the
North Carolina Unfair and Deceptive Trade Practices Act, defamation and damage
to reputation, and tortious interference with prospective business
relationships. On July 18, 1997, the Company and Mr. Wagenhals collectively
filed a third-party complaint against Brett Nelson, an affiliate of the
plaintiff, alleging violations of the North Carolina Unfair and Deceptive Trade
Practices Act, defamation and damage to reputation, and tortious interference
with actual and prospective business relationships. On August 8, 1997, Mr.
Nelson filed an answer denying the allegations against him. After the Court
denied motions to dismiss by all parties, the plaintiff filed its amended
complaint and the Company and Mr. Wagenhals filed their respective amended
answer and counterclaims. The amended complaint and the amended answer and
counterclaims contain essentially the same allegations and defenses as the
original pleadings. The parties currently are in the early stages of discovery.
The Company and Mr. Wagenhals intend to vigorously pursue their counterclaims
and the third-party complaint and to vigorously defend this lawsuit.
The Company leases certain equipment and office space under noncancellable
operating leases. Rent expense related to these lease agreements totaled
approximately $935,000, $437,000 and $352,000 for the fiscal years ended
September 30, 1997, 1996, and 1995 respectively.
F-17
Future lease payments under the noncancellable leases are approximately as
follows (in thousands):
Year Ending
September 30,
-------------
1998 $ 2,286
1999 1,813
2000 1,483
2001 1,124
2002 1,078
Thereafter 4,765
-------
Total $12,549
=======
The Company is subject to certain other asserted and unasserted claims
encountered in the normal course of business. In the opinion of management, the
resolution of these matters will not have a material adverse effect on the
Company's financial position or results of operations.
(11) STOCK OPTION PLAN
The Company accounts for its stock-based compensation plans under APB No. 25,
under which no compensation expense has been recognized, as all options have
been granted with an exercise price equal to the fair value of the Company's
Common Stock on the date of grant (See Note 5 for a general discussion of the
Company's Stock Option Plan). The Company adopted SFAS No. 123 for disclosure
purposes in fiscal 1997. For SFAS No. 123 purposes, the fair value of each
option grant has been estimated as of the date of grant using the Black-Scholes
option pricing model with the following assumptions: risk-free interest rates
ranging between 5.29% and 6.34%; expected life of three years; dividend rate of
0.0%; and expected volatility of 51.88%. Using these assumptions, the fair value
of the stock options granted is $1,614,623 and $908,153 for the years ended
September 30, 1997 and 1996, respectively. These amounts would be amortized as
compensation expense over the vesting period of the options. Options generally
vest equally over three years. Had compensation costs been determined consistent
with SFAS No. 123, utilizing the assumptions detailed above, the Company's net
income and earnings per share would have been reduced to the following pro forma
amounts:
1997 1996
---------- ---------
Net Income:
As Reported ....................... $ 10,146 $ 5,953
Pro Forma ......................... $ 9,305 $ 5,650
Primary EPS:
As Reported ....................... $ 0.69 $ 0.46
Pro Forma ......................... $ 0.64 $ 0.43
Fully Diluted EPS:
As Reported ....................... $ 0.69 $ 0.46
Pro Forma ......................... $ 0.63 $ 0.43
Because the SFAS No. 123 method of accounting has not been applied to options
granted prior to October 1, 1995, the resulting pro forma compensation cost may
not be representative of that expected in future years.
F-18
A summary of the status of the Company's stock option plan at September 30, 1997
and 1996 and for the years then ended is presented in the table below:
1997 1996 1995
------------------------- ------------------------ ------------------------
Wtd Wtd Wtd
Number Avg Number Avg Number Avg
of Exercise of Exercise of Exercise
Shares Price Shares Price Shares Price
------------------------- ------------------------ ------------------------
Outstanding at
beginning of year 1,110,053 $ 4.16 1,111,200 $ 2.90 1,252,000 $ 2.07
Granted ........... 220,250 17.76 240,700 9.28 400,200 $ 4.78
Exercised ......... (296,092) 5.80 (239,247) 3.45 (541,000) $ 2.37
Canceled .......... (1,501) 9.43 (2,600) 5.25 --
--------- --------- --------- -------- --------- --------
Outstanding at
end of year ...... 1,032,710 6.58 1,110,053 4.16 1,111,200 $ 2.90
Options exercisable
at end of year ... 714,950 3.09 881,774 2.91 1,051,000 $ 2.79
Options available
for grant......... 396,951 365,700 103,800
Weighted average
fair value of
options granted... $ 7.33 $ 3.77
Options outstanding and exercisable by price range as of September 30, 1997 are
as follows:
Options Outstanding Options Exercisable
--------------------------------- ----------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Range of Options Contractual Exercise Options Exercise
Exercise Prices Outstanding Life Price Exercisable Price
- --------------- --------------------------------- ----------------------
$ 1.25 - $ 5.25 655,010 2.17 $ 2.38 597,723 $ 2.16
$ 6.50 - $10.63 194,950 4.75 9.76 79,483 9.34
$14.88 - $19.50 182,750 5.42 18.25 37,744 15.33
--------- ---- ------ --------- -------
$ 1.25 - $19.50 1,032,710 3.23 $ 6.58 714,950 $ 3.09
========= ==== ====== ========= =======
(12) SUBSEQUENT EVENTS
On October 3, 1997, the Company entered into a ten-year license agreement with
Richard Childress Racing Enterprises, Inc. ("RCR") with respect to various
rights used in connection with Dale Earnhardt licensed products. In connection
with this agreement, the Company paid RCR a license fee consisting of cash plus
34,940 shares of the Company's Common Stock. The license agreement also requires
the Company to pay to RCR certain minimum annual royalties during the term of
the agreement, plus royalties based on sales of licensed products in each year
during the term of the agreement.
In November 1997, the Company agreed in principle to purchase the assets and to
assume certain liabilities of the motorsport die-cast collectible business of
Revell Monogram, Inc. ("Revell") for approximately $15.0 million in cash. The
proposed transaction will include a ten-year license agreement that will enable
the Company to use certain "Revell" trademarks in connection with sales of
certain die-cast products, as well as other arrangements with respect to
licensing, manufacturing, and distributing various products by both the Company
and Revell. The agreement also includes a minimum contingent payment of $10.0
million over a ten-year period, based upon the attainment of certain future
financial objectives. The acquisition is subject to the completion of due
diligence and the preparation and execution of definitive agreements. Revell's
design and manufacturing activities for motorsport die-cast collectibles
generated approximately $16.2
F-19
million in revenue during calendar year 1996. This transaction will be accounted
for as a purchase.
(13) EVENTS SUBSEQUENT TO DATE OF AUDITORS' REPORT
On December 9, 1997, the Company acquired certain assets and assumed certain
liabilities related to sales of motorsports merchandise licensed by NASCAR
Winston Cup driver Rusty Wallace from an affiliate of Mr. Wallace. The purchase
price paid by the Company for the acquired assets consists of cash of $6.0
million, of which $2.5 million was paid at the closing and the remaining $3.5
million will be paid during fiscal 1998. In connection with the acquisition of
the assets and assumption of the liabilities, the Company entered into a
seven-year license agreement with another affiliate of Mr. Wallace for the name
and likeness of Mr. Wallace and acquired a five-year sublicense with a wholly
owned subsidiary of Penske Motorsports, Inc. The license agreement and
sublicense agreement both contain options that permit the Company to renew for
two five-year terms. The license agreement with the affiliate of Mr. Wallace
requires the Company to pay royalties on sales of licensed products, plus a
license fee if sales of licensed products exceed a specified amount each year
during the initial term of the license. The terms of the transaction were
determined by arms-length negotiations between the respective representatives of
the seller, the sublicensor and its parent, and the Company. This transaction
will be accounted for as a purchase.
F-20