10-Q 1 koala10-q63002.txt FORM 10-Q FOR JUNE 30, 2002 U.S. Securities and Exchange Commission Washington, D.C. 20549 Form 10-Q (Mark One) [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2002 [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT For the transition period from _________ to _________ Commission file number 0-22464 KOALA CORPORATION --------------------------- (Exact name of small business issuer as specified in its charter) Colorado 84-1238908 ------------------------------- ----------------------------------- (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) 7881 South Wheeling Court, Englewood, CO 80112 ---------------------------------------------- (Address of principal executive offices) (303) 539-8300 -------------- (Issuer's telephone number) -------------------------------------------- (Former name, former address, and former fiscal year, if changed since last report) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ...X... No...... The number of shares outstanding of the issuer's common stock, $.10 par value, as of July 30, 2002 was 6,778,334 shares. PART 1 - FINANCIAL INFORMATION Item 1. Financial Statements

See Notes to Condensed Consolidated Financial Statements 2

See Notes to Condensed Consolidated Financial Statements 3

See Notes to Condensed Consolidated Financial Statements 4 KOALA CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS FOR THE SIX MONTHS ENDED JUNE 30, 2002 (UNAUDITED) 1. Unaudited Information: The accompanying financial statements are presented in accordance with the requirements of Form 10-Q and consequently do not include all of the disclosures normally required by accounting principles generally accepted in the United States or those normally made in the Company's annual Form 10-K filing. Accordingly, the reader of this Form 10-Q should refer to the Company's 10-K for the year ended December 31, 2001 for further information. The quarterly financial information has been prepared in accordance with the Company's customary accounting practices and has not been audited. In the opinion of management, the information presented reflects all adjustments necessary for a fair statement of interim results. Except as otherwise described in these notes, all such adjustments are of a normal and recurring nature. The results of operations for the interim period ended June 30, 2002 are not necessarily indicative of the results for a full year. 2. Revenue Recognition The Company recognizes revenue for the majority of its operations at either the time its products are shipped, or when installation is complete in cases where the Company performs the installation services. At SCS Interactive (included in the Company's modular play equipment segment) the percentage of completion method of accounting is utilized because the build to install timeline of its jobs is of longer duration. The percentage of completion is measured using actual costs compared to total estimated costs. Revenues from shipping and handling are included in sales. Shipping and handling costs are included in cost of sales. 3. Inventory: Inventories are stated at the lower of cost (first-in, first-out method) or market. Inventory as of June 30, 2002 and December 31, 2001, consists of the following: June 30, 2002 December 31, 2001 ------------- ----------------- Raw materials and component parts $ 3,497,947 $ 6,457,436 Work in process and finished goods 6,528,994 4,526,389 ----------- ------------ $ 10,026,941 $ 10,983,825 4. Credit Facility: The Company currently has a $12.5 million revolving credit facility and a $27.0 million term loan. This facility is secured by substantially all of the assets of the Company. The availability under the revolving credit facility is determined by a formula based on inventory and accounts receivable balances. At June 30, 2002, the Company had approximately $1.2 million available under the revolving line of credit facility. There are no compensating balance requirements and the credit facility requires compliance with financial loan covenants related to leverage, interest coverage, fixed charges and capital expenditures. A commitment fee of .50% per annum is payable quarterly in arrears based on the average daily unused portion of the revolving line of credit. 5 KOALA CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS FOR THE SIX MONTHS ENDED JUNE 30, 2002 (UNAUDITED) 4. Credit Facility (continued): The term loan requires payments of $500,000 per quarter for 2002 (the second quarter payment was made July 1, 2002), $1 million per quarter from 2003 to September 26, 2004 when the remaining balance is due, and requires $2 million in additional principal payments on April 15, 2003 if the Company meets certain EBITDA targets for 2002. The Company is also required to obtain $10 million in additional capital, which is to be used to pay down the balance of the term loan. The interest rate on the revolving line of credit and the term loan is variable based upon the bank's prime rate. At June 30, 2002 and December 31, 2001 the rate was 7.25%. At June 30, 2002, the Company was in default of the covenants under the loan agreement. The lenders waived the default, extended the due date of the line of credit and the due date for the requirement to obtain the $10 million in additional capital to July 15, 2003 and reduced the amount available under the line of credit to $12.5 million to more accurately reflect the Company's expected level of borrowing. In addition, the lenders removed the goodwill impairments from the covenant calculations. As a result of the potential for non-compliance with the covenants in future quarters, the Company has classified the entire balance of the credit facility as a current liability in accordance with EITF 86-30. The Company has initiated negotiations with the lenders to further restructure the loan agreement. 5. Earnings per Share: The following table provides a reconciliation of the numerator and denominator for earnings per share:

Options outstanding of 924,038 and 1,044,167 for the three months and 989,903 and 1,024,415 for the six months ended June 30, 2002 and 2001, respectively, have been excluded from the above calculation because they were not considered common share equivalents or because their effect would have been anti-dilutive. 6. Business Segments: The Company's sales are derived from two business segments: (1) Family Convenience and Children's Activity Products, and (2) Children's Modular Play Equipment. The Company's 6 KOALA CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS FOR THE SIX MONTHS ENDED JUNE 30, 2002 (UNAUDITED) 6. Business Segments (continued): reportable segments are strategic business units that offer different products. They are managed separately based on the fundamental differences in the operations. The Company's convenience and activity products include the flagship product, the baby changing station ("BCS") which is assembled at the Company's facilities in Colorado. Other significant products in this segment are the sanitary paper liners for the BCS, the child protection seat, the infant seat kradle, the high chair, safety straps for shopping carts and activity products which are manufactured for the Company primarily in the United States. These products are sold directly and through distribution channels, both in the United States and internationally. The Company's modular play equipment includes indoor/outdoor play equipment, including water play equipment, and playground surfacing materials. The indoor play equipment is custom designed for the customer. A catalog is used to promote and advertise the outdoor play equipment. However, custom modifications are often made to accommodate the customers' needs and desires. These products are manufactured by the Company at its facilities located in Colorado, British Columbia, Florida and Oregon. The playground surfacing materials are manufactured by a national network of sub-contractors. These products are sold directly and through manufacturers' representatives/dealers both in the United States and internationally. The Company evaluates the performance of its segments based primarily on operating profit before amortization and impairment of intangibles, corporate expenses and interest income and expense. The Company allocates corporate expenses to individual segments based on segment sales. Corporate expenses consist primarily of labor costs of executive management, facility costs, legal costs, systems costs and shareholder relations costs. The following table presents sales and other financial information by business segment (in thousands): --------------------------------------------- Three Months Ended June 30, 2002 --------------------------------------------- Convenience Modular and Activity Play Products Equipment Total ------------ ----------- --------- Sales $ 3,541 $ 8,612 $ 12,153 Operating income (loss) (480) (2,005) (2,485) Capital expenditures 20 51 71 Total assets 19,793 37,994 57,787 7 KOALA CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS FOR THE SIX MONTHS ENDED JUNE 30, 2002 (UNAUDITED) 6. Business Segments (continued): --------------------------------------------- Three Months Ended June 30, 2001 --------------------------------------------- Convenience Modular and Activity Play Products Equipment Total ------------ ----------- --------- Sales $ 3,658 $11,753 $15,411 Operating income 477 822 1,299 Capital expenditures 146 67 213 Total assets 20,503 69,974 90,477 --------------------------------------------- Six Months Ended June 30, 2002 --------------------------------------------- Convenience Modular and Activity Play Products Equipment Total ------------ ----------- --------- Sales $ 7,333 $ 17,080 $ 24,413 Operating income (loss) 343 (1,800) (1,457) Capital expenditures 190 80 270 Total assets 19,793 37,994 57,787 --------------------------------------------- Six Months Ended June 30, 2001 --------------------------------------------- Convenience Modular and Activity Play Products Equipment Total ------------ ----------- --------- Sales $ 7,803 $21,912 $29,715 Operating income 1,612 1,848 3,460 Capital expenditures 220 160 380 Total assets 20,503 69,974 90,477 7. New Accounting Pronouncements: Effective January 1, 2002, the Company adopted Statement of Financial Accounting Standard (SFAS) No. 142 "Goodwill and Other Intangible Assets" and SFAS No. 144 "Accounting for the Impairment or Disposal of Long-lived Assets." In accordance with SFAS 142, the Company stopped amortizing goodwill effective January 1, 2002. The Company has also identified certain of its trademarks as indefinite lived assets and has ceased amortization for those assets effective January 1, 2002. In addition, SFAS 142 changes the way the Company evaluates goodwill for impairment from a discounted cash flow approach to a fair value approach. Under SFAS 142, the Company is required to split the two segments, children's activity and convenience products and children's 8 KOALA CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS FOR THE SIX MONTHS ENDED JUNE 30, 2002 (UNAUDITED) 7. New Accounting Pronouncements (continued): modular play equipment, into reporting units. Goodwill impairment is evaluated separately for each reporting unit by comparing the fair value of the reporting unit with its underlying book value at January 1, 2002 in order to determine any transitional impairment. For reporting units where the fair value of the reporting unit was less than its book value, the Company performed an additional test to determine the amount of the impairment. This test consisted of determining the fair value of the assets and liabilities in the reporting unit, adding the book value of the goodwill, and then comparing that value to the overall fair value determined above. The impairment amount for goodwill consists of the excess of the detailed fair values plus goodwill over the fair value of the reporting unit. As a result of this test, the Company recorded a transitional impairment charge of $21,838,717 (net of income taxes of $2,893,692) in the second quarter of 2002, which is shown as the cumulative effect of an accounting change in the accompanying consolidated statement of operations. The fair value of the reporting units giving rise to the impairment charge was estimated by an independent valuation firm using the expected present value of future cash flows and other methodologies. The impairments were primarily the result of decreases in operating revenues and cash flows as compared to forecasts prepared at the dates the respective companies were acquired. SFAS 144 requires that the Company evaluate its amortizable identified intangible assets other than goodwill for impairment based upon undiscounted future cash flow streams. If an impairment is identified, the amount of the impairment is determined by comparing the carrying value to its estimated fair market value. SFAS 142 requires that unamortized intangible assets be evaluated for impairment by comparing the carrying amount with its fair value. No impairment has been recognized for these assets.

Amortization expense was $308,515 and $597,185 for the three months ended June 30, 2002 and 2001, respectively, and $630,441 and $1,194,662 for the six months ended June 30, 2002 and 2001, respectively. 9 KOALA CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS FOR THE SIX MONTHS ENDED JUNE 30, 2002 (UNAUDITED) 7. New Accounting Pronouncements (continued): Estimated amortization expense for each of the following years ending December 31 is as follows: 2002 $1,266,000 2003 1,258,000 2004 1,241,000 2005 1,238,000 2006 1,238,000 The weighted average amortization period for each of the amortized intangible assets at June 30, 2002 is as follows: Patents 15.1 years Trade secrets 25.1 years Product designs 30.0 years Other 8.6 years Total 22.9 years The changes in the carrying amounts of goodwill are as follows for the six months ended June 30, 2002:

10 KOALA CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS FOR THE SIX MONTHS ENDED JUNE 30, 2002 (UNAUDITED) 7. New Accounting Pronouncements (continued): The following table shows the pro forma impact of not amortizing goodwill and the trademarks in the prior year on income before cumulative effect of change in accounting principle and earnings per share:

8. Reclassifications: Certain items have been reclassified in the prior year financial statements to conform to the current year presentation. These consist primarily of a reclassification of shipping and handling costs out of revenue and into cost of sales. These reclassifications had no effect on net income or cash flows. 11 KOALA CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS FOR THE SIX MONTHS ENDED JUNE 30, 2002 (UNAUDITED) 9. Comprehensive Income: SFAS 130, Reporting Comprehensive Income, requires the disclosure of comprehensive income (loss), which includes, in addition to net income (loss), other comprehensive income (loss) consisting of foreign currency translation adjustments, which are not included in the traditional statement of operations. A reconciliation of net income (loss) to comprehensive income (loss) is as follows:

10. CEO Resignation: On April 30, 2002, Mark Betker, the Company's Chief Executive Officer, resigned from the Company and entered into a Release Agreement that contains the terms of Mr. Betker's discontinuation of service. The Release Agreement replaces a Separation Agreement, executed on August 29, 2001, between Mr. Betker and the Company. Some of the key terms of the Release Agreement are as follows: o The Company repurchased from Mr. Betker 14,000 shares of common stock for $1.69 per share, the closing market price on April 29, 2002. o The Company agreed to pay Mr. Betker severance of $250,000 over the 12 month period ending April 30, 2003. o The Company will forgive a promissory note from Mr. Betker for $715,195 on the date it becomes due (April 29, 2003) provided that he remains in material compliance with the terms of the agreement. o Mr. Betker returned the 80,000 shares of common stock purchased with part of the proceeds of the promissory note. o For a period of two years, Mr. Betker agreed not to compete with the Company or to solicit any employees of the Company. o The parties entered into a consulting agreement whereby Mr. Betker will provide consulting services at the request of the Board of Directors. To date, no such services have been provided and no consulting fees have been paid to Mr. Betker. The Company recorded a pre-tax expense of $872,565 to recognize this transaction during the second quarter of 2002, of which $619,995 represents a non-cash charge related to the forgiveness of the note. 12 FORWARD LOOKING STATEMENTS This report contains forward-looking statements that describe our business and our expectations. All statements, other than statements of historical fact, included in this report that address activities, events or developments that we expect, believe, intend or anticipate will or may occur in the future, are forward-looking statements. When used in this report, the words "may," "will," "expect," "anticipate," "continue," "estimate," "project," "intend," "believe" and similar expressions are intended to identify forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 regarding events, conditions and financial trends that may affect our future plan of operations, business, strategy, operating results and financial position. Forward-looking statements are inherently subject to risks and uncertainties, many of which cannot be predicted with accuracy and some of which might not even be anticipated. Future events and actual results, financial and otherwise, could differ materially from those set forth in or contemplated by the forward-looking statements herein. These risks and uncertainties include, but are not limited to, the risks associated with the Company's significant outstanding indebtedness, including the potential for additional defaults thereunder; the uncertainties associated with sales fluctuations, customer order patterns and relationships with manufacturer's sales representatives; continuing weakness in the economy; the uncertainties associated with the introduction of new products; management of growth, including the ability to attract and retain qualified employees; the ability to integrate acquisitions made by the Company and the costs associated with such acquisitions; dependence on James Zazenski, our chief operating officer; substantial competition from larger companies with greater financial and other resources than the Company; our dependence on suppliers for manufacture of some of our products; currency fluctuations and other risks associated with foreign sales and foreign operations; quarterly fluctuations in revenues, income and overhead expense; government regulations including those promulgated by the Consumer Product Safety Commission; and potential product liability risk associated with our existing and future products. See "Risk Factors" in the Company's Form 10-K for the year ended December 31, 2001. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview We are a leading designer, producer and worldwide marketer of innovative commercial products, systems and solutions that create attractive family-friendly environments for businesses and other public venues. Our sales are derived from two business segments, family convenience and children's activity products and children's modular play equipment. Our family convenience and activity products include baby changing stations and high chairs, activity tables, carpets and foam play products. Children's modular play equipment includes indoor and outdoor playground equipment, outdoor playground surfacing and interactive play equipment used in water parks, family entertainment centers and amusement parks. We intend to capitalize on the brand name recognition established through our market-leading Koala Bear Kare Baby Changing Station. We market and sell our products, systems and custom solutions to a wide range of businesses and public facilities that serve customers and visitors who bring children to their establishments. We market our products through an integrated program of direct sales and distribution through a network of independent manufacturer's sales representatives and dealers. We are continually working to expand our sales and marketing efforts through the addition of manufacturer's sales representatives, dealers and Company sales representatives. We recognize revenue for the majority of our operations at either the time our products are shipped, or when installation is complete in cases where we perform the installation services. At SCS Interactive (included in our modular play equipment segment) the percentage of completion method of accounting is utilized because the build to install timeline of its jobs is of longer duration. The percentage of completion is measured using actual costs compared to total 13 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS estimated costs. Revenues from shipping and handling are included in sales. Shipping and handling costs are included in cost of sales. For a discussion of other accounting policies that we believe are material to our business see "Critical Accounting Policies and Estimates" in our Form 10-K for the year ended December 31, 2001. Our quarterly revenues and net income are subject to fluctuation based on customer order patterns and our shipping activity. Because of these fluctuations, comparisons of operating results from quarter to quarter for the current year or for comparable quarters of the prior year may be difficult. Except as set forth below, these fluctuations are not expected to be significant when considered on an annual basis. Results of Operations Three Months Ended June 30, 2002 compared to Three Months Ended June 30, 2001 (dollars in thousands). Sales decreased 21.1% to $12,153 for the second quarter of 2002 compared to $15,411 for the second quarter of 2001. Convenience and activity product segment sales were comparable at $3,541 for the second quarter of 2002 compared to $3,658 for the second quarter of 2001. Modular play equipment segment sales decreased 26.7% to $8,612 for the second quarter of 2002 compared to $11,753 for the second quarter of 2001. The decrease was due to continued weakness within key target markets, timing delays in certain large orders and the effects of a change in sales representatives at certain of our Modular play divisions. Gross profit for the second quarter of 2002 was $3,691 (30.4% of sales) compared with $6,165 (40.0% of sales) for the second quarter of 2001. The decrease in gross profit as a percentage of sales was primarily because of the impact of the lower sales relative to our fixed production costs and product mix in the modular play segment. In the convenience and activities segment, as part of a more comprehensive inventory management process, we sold approximately $400 of slow moving inventory at very low margins. We anticipate that this could continue in 2002 as we continue to work to reduce our inventory balances. This decline in gross profit was partially offset by our overall lower level of costs resulting from the operational restructuring and workforce reductions we undertook in the fourth quarter of 2001. Selling, general and administrative expenses increased for the second quarter of 2002 to $5,304 (43.6% of sales) from $4,867 (31.6% of sales) for the same period in 2001. Sales and marketing expenses decreased $373 to $1,493 for the second quarter of 2002 compared to $1,866 for the second quarter of 2001. This decrease was due to the lower sales and resulting lower sales commissions and a focus on cost containment, including selected employee reductions. General and administrative expenses increased $810 to $3,811 for the second quarter of 2002 compared to $3,001 for the second quarter of 2001. The increase in general and administrative expenses was primarily the result of one-time costs of approximately $400 as we aggressively worked to settle various disputes, as well as higher auditing costs, costs associated with the implementation of our new Oracle accounting system, and increased rent on our new facility, partially offset by the employee reductions that we made in the fourth quarter of 2001. As discussed in Note 10 to the condensed consolidated financial statements, on April 30, 2002, Mark Betker, our Chief Executive Officer, resigned from the Company and entered into a Release Agreement that contains the terms of Mr. Betker's discontinuation of service. The Release Agreement replaced a Separation Agreement, executed on August 29, 2001, between Mr. Betker and the Company. We recorded a pre-tax expense of $873 to recognize this transaction during the second quarter of 2002, of which $620 represents a non-cash charge related to the forgiveness of the note. 14 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Amortization expense from intangible assets decreased for the second quarter of 2002 to $309 from $597 for the same period of 2001, primarily because we stopped amortizing goodwill and certain of our trademarks effective January 1, 2002 with the adoption of SFAS 142. See Note 7 to the condensed consolidated financial statements for further discussion. We incurred interest expense of $705 during the quarter ended June 30, 2002 compared to $792 during the quarter ended June 30, 2001. The decrease in interest expense is due to lower borrowings in the second quarter of 2002 compared to 2001. Our effective tax rate is a benefit of approximately 11.8% for the quarter ended June 30, 2002. The lower effective tax rate is due to the non-deductibility of a portion of the goodwill impairment charge associated with SCS Interactive and the establishment of a valuation allowance for deferred tax assets related to a portion of the remaining goodwill impairment charge. We do not believe that it meets the "more likely than not" criteria set forth in SFAS 109. Loss before cumulative effect of accounting change increased in the second quarter of 2002 to a loss of $3,063 from a loss of $57 for the second quarter of 2001. The increased loss is due primarily to the lower level of sales compared to 2001, severance costs and the higher level of selling, general and administrative expenses discussed above, partially offset by the employee reductions that we made in the fourth quarter of 2001. As discussed in Note 7 to the condensed consolidated financial statements, we recorded a transitional impairment charge of $21,839 (net of taxes of $2,894) during the second quarter of 2002 to reflect the implementation of SFAS 142. The impact of this charge is shown as the cumulative effect of an accounting change in the consolidated statement of operations. Net loss per share (assuming dilution) for the second quarter of 2002 increased to $(3.64) per share (assuming dilution) compared to $(0.01) per share (assuming dilution) for the second quarter of 2001. Six Months Ended June 30, 2002 compared to Six Months Ended June 30, 2001 (dollars in thousands). Sales decreased 17.8% to $24,413 for the six months ended June 30, 2002 compared to $29,715 for the six months ended June 30, 2001. Convenience and activity product segment sales decreased 6.0% to $7,333 for the six months ended June 30, 2002 compared to $7,803 for the six months ended June 30, 2001. The decrease was due primarily to soft economic conditions in the first quarter of 2002. Modular play equipment segment sales decreased 22.1% to $17,080 for the first six months of 2002 compared to $21,912 for the first six months of 2001. The decrease was due to continued weakness within key target markets, timing delays in certain large orders and the effects of a change in sales representatives at certain modular play divisions. Gross profit for the first six months of 2002 was $9,087 (37.2% of sales) compared with $12,515 (42.1% of sales) for the first six months of 2001. The decrease in gross profit as a percentage of sales was primarily because of the impact of the lower sales relative to our fixed production costs and product mix in the modular play segment. During the second quarter of 2002, we sold approximately $400 worth of product at very low margins as part of our more comprehensive inventory management strategy. We anticipate that these type of sales could continue in 2002 as we work to reduce our inventory balances. This decline in gross profit was partially offset by our overall lower level of costs resulting from the operational restructuring and workforce reductions we undertook in the fourth quarter of 2001. Selling, general and administrative expenses increased for the first six months of 2002 to $9,671 (39.6% of sales) from $9,055 (30.5% of sales) for the same period in 2001. Sales and marketing expenses decreased $849 to $2,819 for the first six months of 2002 compared to $3,668 for the first six months of 2001. This decrease was due primarily to the lower sales and resulting lower 15 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS sales commissions. General and administrative expenses increased $1,465 to $6,852 for the six months ended June 30, 2002 compared to $5,387 for the six months ended June 30, 2001. The increase in general and administrative expenses was primarily the result of one-time costs of $520 as we aggressively worked to settle disputes, as well as higher auditing costs, costs associated with the implementation of our new Oracle accounting system, and increased rent on our new facility, partially offset by the employee reductions that we made in the fourth quarter of 2001. Amortization expense from intangible assets decreased for the first six months of 2002 to $630 from $1,195 for the same period of 2001, primarily because we stopped amortizing goodwill and trademarks effective January 1, 2002 with the adoption of SFAS 142. See Note 7 to the condensed consolidated financial statements for further discussion. We incurred interest expense of $1,427 during the six months ended June 30, 2002 compared to $1,641 during the six months ended June 30, 2001. The decrease in interest expense is due to lower borrowings in the first six months of 2002 compared to 2001. Our effective tax rate is a benefit of approximately 11.7% for the six months ended June 30, 2002. The lower effective tax rate is due to the non-deductibility of a portion of the goodwill impairment charge associated with SCS Interactive and the establishment of a valuation allowance for deferred tax assets related to a portion of the remaining goodwill impairment charge. We do not believe that it meets the "more likely than not" criteria set forth in SFAS 109. Loss before cumulative effect of accounting change was $3,056 for the six months ended June 30, 2002 compared to income of $417 for the six months ended June 30, 2001. The decrease is due primarily to the lower level of sales compared to 2001, severance and the higher level of selling, general and administrative expenses discussed above, partially offset by the employee reductions that we made in the fourth quarter of 2001. Net income (loss) per share (assuming dilution) for the six months ended June 30, 2002 was $(3.63) per share (assuming dilution) compared to $0.06 per share (assuming dilution) for the six months ended June 30, 2001. Liquidity and Capital Resources (dollars in thousands) We finance our business activities primarily from cash provided by operating activities and from borrowings on our credit facility. Cash provided by (used in) operating activities for the six months ended June 30, 2002 and 2001 was $2,622 and $(557), respectively. The increase in cash provided by operating activities for the six months ended June 30, 2002 compared to the six months ended June 30, 2001 is due primarily to changes in working capital items. Lower inventory balances resulted in additional cash from operations in 2002 as we continued to focus on reducing inventories. In addition, our accounts payable and accrued liability balances increased in 2002 as we more closely managed our vendor relationships. At June 30, 2002 and December 31, 2001, working capital was $(20,013) and $14,957, and cash balances were $0 and $0, respectively. The decrease in working capital is due to the reclassification of the credit facility as short-term as required by EITF 86-30, under which reclassification is required if the potential exists for non-compliance in future quarters. The zero cash balances are due to our practice of applying all excess cash against the line of credit to minimize interest expense payable on line of credit balances. We have used our operating cash flow and our credit facility primarily for capital expenditures and working capital. Net cash used in investing activities was $317 and $551 for the six months ended June 30, 2002 and 2001, respectively. The decrease in cash used in investing activities was 16 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS primarily due to larger expenditures made on intellectual property in 2001 offset by capital expenditures associated with the move into our new headquarters and manufacturing facility in January 2002 and the implementation of our new Oracle accounting system. Net cash used in financing activities was $2,247 in 2002 compared to net cash provided by financing activities of $1,460 in 2001. The use of cash in 2002 is primarily due to payments on our revolving credit facility and term loan. We currently have a $12.5 million revolving credit facility and a $27.0 million term loan. This facility is secured by substantially all of our assets. The availability under the revolving credit facility is determined by a formula based on inventory and accounts receivable balances. At June 30, 2002, we had approximately $1.2 million available under the revolving line of credit facility. There are no compensating balance requirements and the credit facility requires compliance with financial loan covenants related to leverage, interest coverage, fixed charges and capital expenditures. A commitment fee of .50% per annum is payable quarterly in arrears based on the average daily unused portion of the revolving line of credit. The term loan requires payments of $500 per quarter for 2002 (the second quarter payment was made on July 1, 2002), $1 million per quarter from 2003 to September 26, 2004 when the remaining balance is due, and requires $2 million in additional principal payments on April 15, 2003 if we meet certain EBITDA targets for 2002. The interest rate on the revolving line of credit and the term loan is variable based upon the bank's prime rate. At June 30, 2002 and December 31, 2001, the rate was 7.25%. We were in default of certain covenants under our credit facility at September 30, 2001. We obtained a waiver of such non-compliance which is contained in Amendment No. 1 to the new credit facility. The waiver required, among other things, the infusion of $10 million of capital into the Company by March 31, 2002, which would be used to reduce the balance outstanding under our term loan. At December 31, 2001 and March 31, 2002, we were again in default of certain covenants under that indebtedness. On April 1, 2002, we obtained a waiver of such non-compliance which is contained in Amendment No. 2 to the new credit facility. Under the amendment, the due date of our line of credit was extended to April 15, 2003, the date to obtain the $10 million of additional capital was changed to April 1, 2003, the quarterly payments for 2002 were reduced to $500,000 per quarter for 2002, and the covenants were reset. The amendment also required us to make up to $2 million in additional principal payments on April 15, 2003 if we meet certain EBITDA targets for 2002. At June 30, 2002, we were again in default of certain covenants. On August 13, 2002, the lenders waived the default, extended the due date of the line of credit and the due date for the requirement to obtain the additional $10 million in capital to July 15, 2003 and reduced the total line of credit commitment to $12.5 million to more accurately reflect our expected level of borrowings. These changes are contained in Amendment No. 4 to the credit facility. In addition, the lenders excluded any goodwill impairments from the covenant calculations. We are currently in discussions with the lenders to further restructure the credit agreement. If we are unable to successfully restructure our credit agreement, we expect to be in default for the remainder of 2002. Our revolving line of credit and term loan will require significant cash payments in the future. We have various other contractual obligations, primarily lease agreements, that also require significant future cash payments. These obligations have not materially changed from those disclosed in our report on Form 10-K for the year ended December 31, 2001. If we are able to successfully restructure our credit agreement, we believe that our cash flow from operations and the availability under our revolving line of credit will be sufficient to fund our operations through June 30, 2003. We may also consider selling certain assets to reduce the outstanding balance of the loans. 17 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS We are required under our amended credit agreement to obtain an additional $10 million of capital by July 15, 2003 to reduce amounts currently outstanding under our term loan. We have engaged an investment banker to assist us with raising the additional financing, but do not believe it is feasible at the current time to complete such a transaction. If we are unable to successfully restructure our loan agreement, the lenders may take additional steps including forcing us to sell assets, limiting our borrowing capacity or foreclosure. On August 8, 2002, the we were notified by Nasdaq that for the last 30 consecutive trading days, the price of the our common stock has closed below the minimum $1.00 per share requirement for continued inclusion on the National Market. We have 90 calendar days, or until November 6, 2002, to regain compliance. Compliance during this 90 day period can be demonstrated if the bid price of our common stock closes at $1.00 per share or more for a minimum of 10 consecutive trading days. If compliance cannot be demonstrated by November 6, 2002, our shares will be delisted. We are currently considering alternatives, including applying to transfer to The Nasdaq SmallCap Market. If we submit the application by November 6, 2002, and the application is approved, we will be afforded the 180 calendar day SmallCap Market grace period. This would allow us until February 4, 2003 to satisfy the continued inclusion requirements for the SmallCap Market. We may also be eligible for an additional 180 calendar day grace period, or until August 4, 2003, provided that we meet the initial listing criteria for the SmallCap Market. Furthermore, we may be eligible to transfer back to The Nasdaq National Market if, by August 4, 2003, our bid price maintains the $1.00 per share requirement for 30 consecutive trading days and we have maintained compliance with all other continued listing requirements for the National Market. If we are unable to maintain a Nasdaq listing, investors may find it more difficult to dispose of, or to obtain accurate quotations as to the market value of our stock. 18 PART II - OTHER INFORMATION Item 1-3 None Item 4. Submission of Matters to a Vote of Security Holders On May 16, 2002, the Company held its Annual Meeting of Shareholders. At such meeting, the Company's shareholders (i) elected four directors to serve until the Company's next annual meeting; (ii) ratified the selection of Ernst & Young LLP to serve as the Company's independent auditors for the year ending December 31, 2002. The number of votes cast in these matters is set forth below: 1. Election of Directors Votes Against or Broker Name Votes For Withheld Abstentions Non-Votes ---- --------- -------- ----------- --------- Michael C. Franson 5,926,422 85,341 0 0 John T. Pfannenstein 5,895,674 116,089 0 0 Nancy Pierce 5,917,432 94,331 0 0 Randy Stein 5,916,228 95,535 0 0 2. Ratification of Selection of Ernst & Young LLP Votes Against or Broker Votes For Withheld Abstentions Non-Votes --------- ---------------- ----------- --------- 5,724,868 272,336 14,559 0 Item 5. None Item 6. Exhibits and Reports on Form 8-K (a) Exhibits Exhibit 10.15 Amendment No. 3 to the Amended and Restated Revolving Credit, Term Loan and Security Agreement Exhibit 10.16 Amendment No. 4 to the Amended and Restated Revolving Credit, Term Loan and Security Agreement Exhibit 99.1 Certification of James A. Zazenski Exhibit 99.2 Certification of Jeffrey L. Vigil (b) Reports on Form 8-K On April 30, 2002 a report was filed reporting items 5 and 7 of the 8-K rules. 19 SIGNATURES In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereto duly authorized. KOALA CORPORATION August 14, 2002 /s/James A. Zazenski ---------------------- ----------------------------------------- President and Chief Operating Officer (Principal Executive Officer) August 14, 2002 /s/Jeffrey L. Vigil ---------------------- ----------------------------------------- Vice President Finance and Administration (Principal Financial and Accounting Officer) 20

KOALA CORP /CO/ 10-Q