UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
------------------------------------------------------------------
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2005
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from_______ to ______
Commission File Number 1-15345
GALAXY NUTRITIONAL FOODS, INC.
(Exact name of registrant as specified in its charter)
Delaware 25-1391475
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2441 Viscount Row
Orlando, Florida 32809
(Address of principal (Zip Code)
executive offices)
(407) 855-5500
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES |X| NO |_|
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, or a non-accelerated filer. See definition of
"accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange
Act (Check one): Large accelerated filer |_| Accelerated filer |_|
Non-accelerated filer |X|
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). YES |_| NO |X|
On February 20, 2006, there were 20,054,623 shares of common stock, $.01
par value per share, outstanding.
1
GALAXY NUTRITIONAL FOODS, INC.
Index to Form 10-Q
For the Quarter Ended December 31, 2005
PAGE NO.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Balance Sheets 3
Statements of Operations 4
Statement of Stockholders' Equity (Deficit) 5
Statements of Cash Flows 6
Notes to Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 18
Item 3. Quantitative and Qualitative Disclosures About Market Risk 33
Item 4. Controls and Procedures 34
PART II. OTHER INFORMATION
Item 1A. Risk Factors 35
Item 4. Submission of Matters to a Vote of Security Holders 37
Item 6. Exhibits 39
SIGNATURES 43
2
PART I. FINANCIAL INFORMATION
GALAXY NUTRITIONAL FOODS, INC.
Balance Sheets
DECEMBER 31, MARCH 31,
Notes 2005 2005
----- ------------ ------------
(Unaudited)
ASSETS
CURRENT ASSETS:
Cash $ 378,954 $ 561,782
Trade receivables, net 5,432,736 4,644,364
Inventories 565,673 3,811,470
Prepaid expenses and other 634,856 219,592
------------ ------------
Total current assets 7,012,219 9,237,208
PROPERTY AND EQUIPMENT, NET 6 283,167 18,246,445
ASSETS HELD FOR SALE 6 90,000 --
OTHER ASSETS 247,334 286,013
------------ ------------
TOTAL $ 7,632,720 $ 27,769,666
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Line of credit 2 $ 2,238,722 $ 5,458,479
Accounts payable 3,545,015 3,057,266
Accrued disposal costs 7 602,762 --
Accrued and other current liabilities 3 700,550 2,130,206
Current portion of accrued employment contracts 10 491,147 586,523
Current portion of term notes payable 2 2,120,645 1,320,000
Current portion of obligations under capital leases 31,464 194,042
------------ ------------
Total current liabilities 9,730,305 12,746,516
ACCRUED EMPLOYMENT CONTRACTS, less current portion 10 655,020 993,305
TERM NOTES PAYABLE, less current portion 2 -- 6,921,985
OBLIGATIONS UNDER CAPITAL LEASES, less current portion 53,487 85,337
------------ ------------
Total liabilities 10,438,812 20,747,143
------------ ------------
COMMITMENTS AND CONTINGENCIES -- --
TEMPORARY EQUITY:
Common stock, subject to registration 3 -- 2,220,590
STOCKHOLDERS' EQUITY (DEFICIT):
Common stock 200,513 164,115
Additional paid-in capital 71,379,694 65,838,227
Accumulated deficit (70,622,981) (48,307,748)
------------ ------------
957,226 17,694,594
Less: Note receivable arising from the exercise of stock options, net 10 (3,642,857) (12,772,200)
Treasury stock (120,461) (120,461)
------------ ------------
Total stockholders' equity (deficit) (2,806,092) 4,801,933
------------ ------------
TOTAL $ 7,632,720 $ 27,769,666
============ ============
See accompanying notes to financial statements
3
GALAXY NUTRITIONAL FOODS, INC.
Statements of Operations
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
---------------------------- ----------------------------
Notes 2005 2004 2005 2004
----- ------------ ------------ ------------ ------------
4 RESTATED RESTATED
NET SALES $ 9,072,097 $ 10,632,877 $ 29,361,475 $ 33,725,108
COST OF GOODS SOLD 7,182,502 8,289,551 22,582,708 25,860,850
------------ ------------ ------------ ------------
Gross margin 1,889,595 2,343,326 6,778,767 7,864,258
------------ ------------ ------------ ------------
OPERATING EXPENSES:
Selling 1,161,751 1,213,549 3,655,543 4,246,419
Delivery 544,665 549,379 1,886,214 1,757,962
Employment contract expense - general
and administrative 10 -- -- -- 444,883
General and administrative, including
$52,676, $176,186, $923,513 and
$217,388 non-cash compensation
related to stock based transactions 5 1,394,599 771,382 3,999,362 2,011,894
Research and development 75,961 74,861 256,055 226,479
Reserve on stockholder note receivable 10 9,129,343 -- 9,129,343 --
Cost of disposal activities 7 668,936 -- 1,342,204 --
Impairment of property and equipment 6 -- -- 7,896,554 --
Loss on sale of assets 6 65,360 -- 70,966 --
------------ ------------ ------------ ------------
Total operating expenses 13,040,615 2,609,171 28,236,241 8,687,637
------------ ------------ ------------ ------------
LOSS FROM OPERATIONS (11,151,020) (265,845) (21,457,474) (823,379)
------------ ------------ ------------ ------------
OTHER INCOME (EXPENSE):
Interest expense (595,692) (288,556) (1,246,490) (812,380)
Derivative income (expense) 4 -- (258,658) -- 62,829
Gain/(loss) on fair value of warrants 2,4 (8,269) (202,414) 388,731 258,937
------------ ------------ ------------ ------------
Total other income (expense) (603,961) (749,628) (857,759) (490,614)
------------ ------------ ------------ ------------
NET LOSS $(11,754,981) $ (1,015,473) $(22,315,233) $ (1,313,993)
Less:
Preferred stock dividends 4 -- 2,174 -- 82,572
Preferred stock accretion to
redemption value 4 -- 44,160 -- 319,500
------------ ------------ ------------ ------------
NET LOSS TO COMMON STOCKHOLDERS $(11,754,981) $ (1,061,807) $(22,315,233) $ (1,716,065)
============ ============ ============ ============
BASIC AND DILUTED NET LOSS PER COMMON SHARE 8 $ (0.59) $ (0.06) $ (1.14) $ (0.10)
============ ============ ============ ============
See accompanying notes to financial statements.
4
GALAXY NUTRITIONAL FOODS, INC.
Statements of Stockholders' Equity (Deficit)
(UNAUDITED)
Common Stock Note
---------------------- Receivable
Additional Accumulated for Common Treasury
Shares Par Value Paid-In Capital Deficit Stock Stock Total
---------- --------- --------------- --------------- -------------- ---------- ------------
Balance at March 31,
2005 16,411,474 $ 164,115 $ 65,838,227 $ (48,307,748) $ (12,772,200) $ (120,461) $ 4,801,933
Exercise of warrants 1,130,000 11,300 1,257,700 -- -- -- 1,269,000
Exercise of options 2,250 22 2,858 -- -- -- 2,880
Issuance of common
stock under
employee stock
purchase plan 7,603 76 11,785 -- -- -- 11,861
Transfer of common
stock from
temporary equity 2,500,000 25,000 2,618,347 2,643,347
Fair value of
stock-based
transactions -- -- 1,843,333 -- -- -- 1,843,333
Non-cash compensation
related to variable
securities -- -- (192,556) -- -- -- (192,556)
Reserve on
stockholder note
receivable -- -- -- -- 9,129,343 -- 9,129,343
Net loss -- -- -- (22,315,233) -- -- (22,315,233)
---------- --------- --------------- --------------- -------------- ---------- ------------
Balance at December
31, 2005 20,051,327 $ 200,513 $ 71,379,694 $ (70,622,981) $ (3,642,857) $ (120,461) $ (2,806,092)
========== ========= =============== =============== ============== ========== ============
See accompanying notes to financial statements.
5
GALAXY NUTRITIONAL FOODS, INC.
Statements of Cash Flows
(UNAUDITED)
Nine Months Ended December 31, Notes 2005 2004
----- ------------ -----------
RESTATED
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Loss $(22,315,233) $(1,313,993)
Adjustments to reconcile net loss to net cash from (used in)
operating activities:
Depreciation and amortization 1,463,036 1,633,256
Amortization of debt discount and financing costs 424,016 65,881
Provision for promotional deductions and losses on trade
receivables 1,543,025 109,000
Provision for loss on stockholder note receivable 10 9,129,343 --
Impairment and loss on sale of property and equipment 6 7,967,520 --
Change in fair value of derivative instrument 4 -- (62,829)
(Gain) Loss on fair value of warrants 2,4 (388,731) (258,937)
Non-cash compensation related to stock-based transactions 1,5 923,513 217,388
(Increase) decrease in:
Trade receivables (2,331,397) (1,398,623)
Inventories 3,245,797 (370,817)
Prepaid expenses and other (415,264) 51,759
Increase (decrease) in:
Accounts payable 487,749 1,026,304
Accrued and other liabilities (520,555) 120,973
------------ -----------
NET CASH FROM (USED IN) OPERATING ACTIVITIES (787,181) (180,638)
------------ -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (304,353) (77,207)
Proceeds from sale of equipment 6 8,747,075 34,482
------------ -----------
NET CASH FROM (USED IN) INVESTING ACTIVITIES 8,442,722 (42,725)
------------ -----------
CASH FLOWS FROM FINANCING ACTIVITIES: 9
Net borrowings (payments) on line of credit (3,219,757) 941,426
Borrowing on term notes payable 2 2,400,000 --
Repayments on term notes payable 2 (8,241,985) (810,000)
Principal payments on capital lease obligations (194,428) (190,282)
Financing costs for long term debt (288,697) --
Redemption of preferred stock -- (2,279,688)
Proceeds from issuance of common stock, net of costs -- 2,211,366
Proceeds from issuance of common stock under employee stock
purchase plan 11,861 12,480
Proceeds from exercise of common stock options 2,879 --
Proceeds from exercise of common stock warrants, net of costs 4 1,691,758 --
------------ -----------
NET CASH FROM (USED IN) FINANCING ACTIVITIES (7,838,369) (114,698)
------------ -----------
NET INCREASE (DECREASE) IN CASH (182,828) (338,061)
CASH, BEGINNING OF PERIOD 561,782 449,679
------------ -----------
CASH, END OF PERIOD $ 378,954 $ 111,618
============ ===========
See accompanying notes to financial statements.
6
GALAXY NUTRITIONAL FOODS, INC.
Notes To Financial Statements
(UNAUDITED)
(1) Summary of Significant Accounting Policies
The unaudited financial statements have been prepared by Galaxy
Nutritional Foods, Inc. (the "Company"), in accordance with accounting
principles generally accepted in the United States of America ("GAAP") for
interim financial information and applicable rules and regulations of the
Securities and Exchange Commission. The accompanying financial statements
contain all normal recurring adjustments which are, in the opinion of
management, necessary for the fair presentation of such financial
statements. Certain information and disclosures normally included in the
financial statements prepared in accordance with GAAP have been omitted
under such rules and regulations although the Company believes that the
disclosures are adequate to make the information presented not misleading.
The March 31, 2005 balance sheet data was derived from the audited
financial statements, but does not include all disclosures required by
GAAP. These unaudited financial statements should be read in conjunction
with the financial statements and notes included on Form 10-K/A for the
fiscal year ended March 31, 2005. Interim results of operations for the
nine-month period ended December 31, 2005 may not necessarily be
indicative of the results to be expected for the full year.
Impairment of Long-Lived Assets
In accordance with Statement of Financial Accounting Standard ("SFAS") No.
144, "Accounting for the Impairment of Disposal of Long-Lived Assets," the
Company evaluates the carrying value of long-lived assets when
circumstances indicate the carrying value of those assets may not be fully
recoverable. The Company evaluates recoverability of long-lived assets
held for use by comparing the net carrying value of an asset group to the
estimated undiscounted cash flows (excluding interest) during the
remaining life of the asset group. If such an evaluation indicates that
the future undiscounted cash flows of certain long-lived asset groups are
not sufficient to recover the carrying value of such asset groups, the
assets are then adjusted to their fair values. The Company recorded an
impairment of property and equipment in the first quarter of fiscal 2006
as discussed more fully in Note 6.
Disposal Costs
The Company has recorded significant accruals in connection with the asset
sale and outsourcing arrangements with Schreiber Foods, Inc. These
accruals include estimates pertaining to employee termination costs and
abandonment of excess equipment and facilities and other potential costs.
Actual costs may differ from these estimates or the Company's estimates
may change. In accordance with SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities," costs associated with
restructuring activities are recognized when they are incurred rather than
at the date of a commitment to an exit or disposal plan. Given the
significance and complexity of these activities, and the timing of the
execution of such activities, the accrual process involves periodic
reassessments of estimates made at the time the original decisions were
made, including evaluating estimated employment terms, contract
cancellation charges and real estate market conditions for sub-lease
rents. The Company will continually evaluate the adequacy of the remaining
liabilities under its restructuring initiatives. Although the Company
believes that these estimates accurately reflect the costs of its
activities, actual results may differ, thereby requiring the Company to
record additional provisions or reverse a portion of such provisions.
Stock Based Compensation
The Company has three stock-based employee compensation plans. Prior to
April 1, 2003, the Company accounted for those plans under the recognition
and measurement provisions of Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," (APB No. 25), and related
Interpretations.
Effective April 1, 2003, the Company adopted the fair value recognition
provisions of SFAS No. 123, "Accounting for Stock-Based Compensation," and
applies SFAS No. 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure," prospectively to all employee awards granted
on or after April 1, 2003. These standards require the Company to provide
pro-forma information regarding net income (loss) and earnings (loss) per
share amounts as if compensation cost for all the Company's employee and
director stock-based awards had been determined in accordance with the
fair value method prescribed in SFAS No. 123. Awards from the Company's
plans vest over periods ranging from immediate to five years. Therefore,
the cost related to stock-based compensation included in the determination
of net income for the periods is less than that which would have been
recognized if the fair value based method had been applied to all awards
since the original effective date of SFAS No. 123.
7
The Company estimated the fair value of each stock-based award during the
periods presented by using the Black-Scholes pricing model with the
following assumptions:
Nine Months Ended: December 31, December 31,
2005 2004
------------ ------------
Dividend Yield None None
Volatility 24.9%-46.0% 44.0%-59.0%
Risk Free Interest Rate 3.35%-4.30% 1.46%-4.14%
Expected Lives in Months 1-120 1-120
Under the accounting provisions of SFAS No. 123, the Company's net loss
and net loss per basic and diluted share would have been reduced to the
pro forma amounts indicated below:
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
---------------------------- ---------------------------
2005 2004 2005 2004
------------ ------------ ------------ -----------
RESTATED RESTATED
Net loss to common stockholders as reported $(11,754,981) $ (1,061,807) $(22,315,233) $(1,716,065)
Add: Stock-based compensation
expense included in reported net
income (loss) 52,676 176,186 923,513 217,388
Deduct: Stock-based compensation
expense determined under fair value
based method for all awards (62,568) (203,064) (953,814) (304,381)
------------ ------------ ------------ -----------
Pro forma net loss to common
stockholders $(11,764,873) $ (1,088,685) $(22,345,534) $(1,803,058)
============ ============ ============ ===========
Net loss per common share:
Basic & Diluted - as reported $ (0.59) $ (0.06) $ (1.14) $ (0.10)
============ ============ ============ ===========
Basic & Diluted - pro forma $ (0.59) $ (0.06) $ (1.14) $ (0.11)
============ ============ ============ ===========
Net Income (Loss) per Common Share
Net income (loss) per common share is computed by dividing net income or
loss by the weighted average shares outstanding. Diluted income (loss) per
common share is computed on the basis of weighted average shares
outstanding plus potential common shares which would arise from the
exercise of stock options and warrants.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America 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 and reported amounts
of revenues and expense during the reporting period. The Company's
significant estimates include the allowance for doubtful accounts
receivable, which is made up of reserves for promotions, discounts and bad
debts, reserve on stockholder note receivable, provision for obsolete
inventory, valuation of deferred taxes, valuation of compensation expense
on options and warrants, and accruals for disposal costs. Actual results
could differ from those estimates.
Reclassifications
Certain items in the financial statements of the prior period have been
reclassified to conform to current period presentation.
Segment Information
The Company does not identify separate operating segments for management
reporting purposes. The results of operations are the basis on which
management evaluates operations and makes business decisions. The
Company's sales are generated primarily within the United States of
America.
Recent Accounting Pronouncements
In November 2004, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 151, "Inventory Costs, an amendment of Accounting Research
Bulletin No. 43, Chapter 4." SFAS No. 151 requires that abnormal amounts
of idle facility expense, freight, handling costs and wasted materials
(spoilage) be recorded as current period charges and that the allocation
of fixed production overheads to inventory be based on the normal capacity
of the production facilities. SFAS No. 151 is effective during fiscal
years beginning after June 15, 2005, although earlier application is
permitted. The Company believes that the adoption of this standard will
not have a significant impact on its financial position, results of
operations or cash flows.
8
In December 2004, the FASB issued SFAS No. 123 (revised 2004),
"Share-Based Payment" ("SFAS No. 123R"), which addresses the accounting
for share-based payment transactions in which a company receives employee
services in exchange for (a) equity instruments of the company or (b)
liabilities that are based on the fair value of the company's equity
instruments or that may be settled by the issuance of equity instruments.
SFAS No. 123R supercedes APB Opinion No. 25 and amends SFAS No. 95,
"Statement of Cash Flows." Under SFAS No. 123R, companies are required to
record compensation expense for all share-based payment award transactions
measured at fair value as determined by an option valuation model.
Currently, the Company uses the Black-Scholes pricing model to calculate
the fair value of its share-based transactions. This statement is
effective for fiscal years beginning after June 15, 2005. Since the
Company currently recognizes compensation expense at fair value for
share-based transactions in accordance with SFAS No. 123, it does not
anticipate adoption of this standard will have a significant impact on its
financial position, results of operations, or cash flows.
In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary
Assets an Amendment of APB Opinion No. 29." SFAS No. 153 amends APB
Opinion No. 29 to eliminate the exception for nonmonetary exchanges of
similar productive assets from being measured based on the fair value of
the assets exchanged. SFAS No. 153 now provides a general exception for
exchanges of nonmonetary assets that do not have commercial substance.
SFAS No. 153 is effective for fiscal periods beginning after June 15,
2005. The Company believes that the adoption of this standard will not
have a significant impact on its financial position, results of operations
or cash flows.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections - a replacement of APB Opinion No. 20 and SFAS No. 3." SFAS
No. 154 changes the requirements for the accounting for and reporting of a
change in accounting principle and a change required by an accounting
pronouncement when the pronouncement does not include specific transition
provisions. SFAS No. 154 requires retrospective application of changes as
if the new accounting principle had always been used. SFAS No. 154 is
effective for fiscal years beginning after December 15, 2005. The Company
believes that the adoption of this standard will not have a significant
impact on its financial position, results of operations or cash flows.
(2) Line of Credit, Notes Payable and Going Concern On May 27, 2003, the
Company obtained from Textron Financial
Corporation ("Textron") a revolving credit facility (the "Textron Loan")
with a maximum principal amount of $7,500,000 pursuant to the terms and
conditions of a Loan and Security Agreement dated May 27, 2003 (the
"Textron Loan Agreement"). The Textron Loan is secured by the Company's
inventory, accounts receivable and all other assets. Generally, subject to
the maximum principal amount which can be borrowed under the Textron Loan
and certain reserves that must be maintained during the term of the
Textron Loan, the amount available under the Textron Loan for borrowing by
the Company from time to time is equal to the sum of (i) 85% of the net
amount of its eligible accounts receivable plus (ii) until December 31,
2005, 60% of the Company's eligible inventory not to exceed $3,500,000.
After December 31, 2005, there is no borrowing available on inventory
since it is not produced or held by the Company. Advances under the
Textron Loan bear interest at a variable rate, adjusted on the first (1st)
day of each month, equal to the prime rate plus 1.75% per annum (9.0% at
December 31, 2005) calculated on the average cash borrowings for the
preceding month. The initial term of the Textron loan ends on May 26,
2006. As of December 31, 2005, the outstanding principal balance on the
Textron Loan was $2,238,722.
The Textron Loan Agreement contains certain financial and operating
covenants. On June 3, 2005, the Company executed a fourth amendment to the
Textron Loan Agreement that provided a waiver on all the existing defaults
for the fiscal quarters ended December 31, 2004 and March 31, 2005, and
amended the fixed charge coverage ratio and the adjusted tangible net
worth requirements for periods after March 31, 2005. Additionally, the
fourth amendment allowed the Textron Loan to be in an over-advance
position not to exceed $750,000 until July 31, 2005. In exchange for the
waiver and amendments, the Company's interest rate on the Textron Loan was
set at Prime plus 4.75% and the Company paid a fee of $50,000.
On June 16, 2005, the Company used a portion of the proceeds from the
warrant exercises described in Note 4 to satisfy the $750,000 over-advance
with Textron. In connection with the satisfaction of the over-advance, the
Company agreed to immediately terminate Textron's obligation to permit any
over-advances under the Textron Loan, which obligation was to expire on
July 31, 2005. With the termination of the over-advance facility, the
interest rate on the Textron Loan returned to its prior level of Prime
plus 1.75%.
9
Due to the cost of disposal activities and impairment of property and
equipment (as discussed in Notes 6 and 7), the Company fell below the
requirements in the fixed charge coverage ratio and the adjusted tangible
net worth calculation from June 30, 2005 through September 30, 2005.
Effective October 1, 2005, the Company executed a fifth amendment to the
Textron Loan Agreement that provided a waiver for the defaults in the
fixed charge coverage ratio and the adjusted tangible net worth
requirements, in addition to certain over-advances on the Textron Loan,
during the periods from June 2005 through September 2005. The fifth
amendment amends and replaces several financial covenants, allows
eligibility for borrowing on inventory until December 31, 2005 and
provides that the Textron Loan will expire at the end of the initial term
on May 26, 2006. Additionally, Textron consented to the sale of the
Company's manufacturing equipment to Schreiber and the terminated their
liens on those assets. In exchange for the waiver and amendments, the
Company paid a fee of $50,000, and has agreed to pay an administration fee
in the following installments if the Textron Loan has not then been paid
in full: $5,000 on February 1, 2006, $10,000 on March 1, 2006, $15,000 on
April 1, 2006 and $20,000 May 1, 2006. The Company anticipates that it
will be in compliance with the amended covenants and reporting
requirements through the end of the term of the Textron Loan on May 26,
2006.
Simultaneous with the closing of the Textron Loan in May 2003, Wachovia
Bank, N.A. successor by merger to SouthTrust Bank ("Wachovia") extended
the Company a new term loan in the principal amount of $2,000,000. This
term loan was consolidated with the Company's March 2000 term loan with
Wachovia, which had a then outstanding principal balance of $8,131,985 for
a total term loan amount of $10,131,985. This term loan was secured by all
of the Company's equipment and certain related assets. Additionally, the
term loan bore interest at Wachovia's Base Rate plus 1%.
On June 30, 2005, the Company entered into a Loan Modification Agreement
with Wachovia regarding its term loan. The agreement modified the
following terms of the loan: 1) the loan will mature and be payable in
full on July 31, 2006 instead of June 1, 2009; 2) the principal payments
will remain at $110,000 per month with accrued interest at Wachovia's Base
Rate plus 1% instead of increasing to $166,250 on July 1, 2005 as provided
by the terms of the promissory note evidencing the loan; and 3) all
covenants related to the Company's tangible net worth, total liabilities
to tangible net worth, and maximum funded debt to EBITDA ratios are waived
and compliance is not required by the Company through the maturity of the
loan on July 31, 2006. In connection with the agreement, the Company paid
$60,000, of which $30,000 was paid upon execution of the agreement and
$30,000 was paid on August 1, 2005.
In September 2005, Wachovia assigned this term loan to Beltway Capital
Partners LLC. This loan was paid in full upon the sale of the equipment to
Schreiber on December 8, 2005. Beltway received proceeds of $7,374,299 of
which $7,361,985 was for principal and $12,314 was for interest and
associated closing costs.
Pursuant to a Note and Warrant Purchase Agreement dated September 12,
2005, the Company received $1,200,000 as a loan from Mr. Frederick A.
DeLuca, a greater than 10% shareholder. In October 2005, pursuant to
several Note and Warrant Purchase Agreements dated September 28, 2005, the
Company received a $600,000 loan from Conversion Capital Master, Ltd., a
$485,200 loan from SRB Greenway Capital (Q.P.), L.P., a $69,600 loan from
SRB Greenway Capital, L.P., and a $45,200 loan from SRB Greenway Offshore
Operating Fund, L.P. The combined total of these loans is $2,400,000. The
loans are evidenced by unsecured promissory notes (the "Notes") held by
the above referenced parties (the "Note Holders"). The Notes require
monthly interest-only payments at 3% above the bank prime rate of interest
per the Federal Reserve Bank and mature on June 15, 2006. In consideration
for the Notes and in accordance with an exemption from registration
provided by Section 4(2) of the Securities Act of 1933, as amended, the
Company issued to Mr. DeLuca, Conversion Capital Master, Ltd., SRB
Greenway Capital (Q.P.), L.P., SRB Greenway Capital, L.P., and SRB
Greenway Offshore Operating Fund, L.P., warrants to purchase up to 300,000
shares, 150,000 shares, 121,300 shares, 17,400 shares, and 11,300 shares,
respectively, of the Company's common stock at an exercise price equal to
$1.53 (95% of the lowest closing price of the Company's common stock in
the sixty calendar days immediately preceding October 17, 2005). The
warrants fully vested on October 17, 2005 and can be exercised on or
before the expiration date of October 17, 2008. Also in consideration for
the Notes, the Company granted the Note Holders "piggy back" registration
rights with respect to the shares underlying the warrants. These shares
were registered on December 30, 2005.
In accordance with the accounting provisions of SFAS No. 123, the Company
recorded the $444,731 initial fair value of the warrants, upon their
issuance, as a discount to debt. This discount is being amortized from
September 2005 through June 2006. The Company amortized $152,376 and
$165,376 in the three and nine months ended December 31, 2005,
respectively. As of December 31, 2005, the outstanding principal balance
of $2,400,000 on the Notes less the remaining debt discount is $2,120,645.
10
Since the exercise price for the warrants was not fixed until October 17,
2005, the Company revalued the warrants on October 17, 2005 and calculated
a fair value of $396,000. The $48,731 difference between the initial
$444,731 value of the warrants and the value of the warrants on October
17, 205 was recorded as a gain on fair value of warrants in the Statement
of Operations.
If the Company is unable to generate enough cash from operations and the
sale of its remaining assets that are held for sale and it is unable to
refinance or renew the Company's existing credit facilities with Textron
and the Note Holders, or if additional financing is not available on terms
acceptable to us, the Company will be unable to satisfy such facilities by
their maturity dates in May 2006 and June 2006, respectively. In such an
event, Textron and the Note Holders could exercise their respective rights
under their loan documents, which could include, among other things,
declaring defaults under the loans and pursuing foreclosure on the
Company's assets that are pledged as collateral for such loans. If such an
event occurred, it would be substantially more difficult for us to
effectively continue the operation of the Company's business, and it is
unlikely that the Company would be able to continue as a going concern.
(3) Accrued and Other Current Liabilities
Accrued and other current liabilities are summarized as follows:
December 31, 2005 March 31, 2005
----------------- --------------
Tangible personal property taxes $ -- $ 1,049,841
Warrant liability -- 740,000
Registration rights penalty 285,104 --
Other 415,446 340,365
----------------- --------------
Total $ 700,550 $ 2,130,206
================= ==============
In accordance with a registration rights agreement dated October 6, 2004,
the Company agreed that within 180 days it would file with the Securities
and Exchange Commission ("SEC") and obtain effectiveness of a registration
statement that included 2,000,000 shares issued in a private placement and
500,000 shares related to a stock purchase warrant. Per the terms of the
agreement, if a registration statement was not filed, or did not become
effective within 180 days, then in addition to any other rights the
investor may have, the Company would be required to pay certain liquidated
damages. The Company filed a registration statement on Form S-3 on March
14, 2005. However, the registration was not declared effective until
December 30, 2005. The investor granted an extension of time to have the
registration statement declared effective by the SEC and waived all
damages and remedies for failure to have an effective registration
statement until September 1, 2005. From September 2, 2005 through December
29, 2005, the Company accrued liquidated damages of $285,104 (2.5% times
the product of 2,500,000 registerable shares and the share price of $1.15
per share every thirty days).
In accordance with Emerging Issues Task Force ("EITF") Issue 00-19
"Accounting for Derivative Financial Instruments Indexed To, and
Potentially Settled in the Company's Own Stock," and EITF 05-04 "The
Effect of a Liquidated Damages Clause on a Freestanding Financial
Instrument Subject to EITF 00-19," because the maximum potential
liquidated damages as described above may be greater than the difference
in fair values between registered and unregistered shares, the value of
the common stock subject to registration was classified as temporary
equity. In December 2005, the Company reclassified the $2,680,590 value of
common stock that was registered less an additional $37,243 in
registration costs into permanent equity.
(4) Capital Stock
Common Stock Issuances
In accordance with a warrant agreement dated April 10, 2003, the Company
issued to Mr. Frederick DeLuca, a greater than 10% shareholder, a warrant
to purchase up to 100,000 shares of common stock of the Company at an
exercise price of $1.70 per share. Additionally, in accordance with a
warrant agreement dated October 6, 2004, the Company issued to Mr. DeLuca
a warrant to purchase up to 500,000 shares of common stock of the Company
at an exercise price of $1.15 per share. Subsequently in June 2005, the
Company agreed to reduce the per-share exercise price on these warrants to
$1.36 and $0.92, respectively, in order to induce Mr. DeLuca to exercise
his warrants. All of the warrants were exercised on June 16, 2005 for
total proceeds of $596,000.
In accordance with EITF 00-19 and the terms of the above warrant for
500,000 shares of common stock, the fair value of the warrant was
accounted for as a liability, with an offsetting reduction to the carrying
value of the common stock. On March 31, 2005, the fair value of the
warrant was estimated using the Black-Scholes pricing model to be $740,000
and on June 16, 2005, the fair value was estimated to be $400,000. The
$340,000 change in fair value was reflected as a gain on the fair value of
warrants line item in the Statement of Operations during the three months
ended June 30, 2005. The warrant liability was moved to equity upon the
exercise of the warrant.
11
On each of April 24, 2003 and October 6, 2004, BH Capital Investments, LP
and Excalibur Limited Partnership each received warrants to purchase up to
250,000 shares of common stock at an exercise price of $2.00 per share.
Also, Excalibur Limited Partnership received a warrant to purchase up to
30,000 shares of common stock at an exercise price of $2.05 per share on
June 26, 2002. Subsequently in June 2005, the Company agreed to reduce the
per-share exercise price on all such warrants to $1.10 in order to induce
BH Capital Investments, LP and Excalibur Limited Partnership to exercise
their warrants. All of the warrants were exercised on June 16, 2005 for
total proceeds of $1,133,000.
In accordance with the accounting provisions of SFAS No. 123, the Company
recorded $1,024,500 in non-cash compensation expense related to the
reduction in the exercise price of the warrants in June 2005.
The Company used a portion of the proceeds from the warrant exercises to
satisfy the $750,000 over-advance provided by Textron under the Fourth
Amendment and Waiver to the Textron Loan Agreement, as described in Note 2
and the remaining proceeds from the warrant exercises were used for
working capital purposes.
Preferred Stock Issuances and Restatement
On April 6, 2001, the Company received from BH Capital Investments, LP and
Excalibur Limited Partnership (the "Series A Preferred Holders") proceeds
of approximately $3,082,000 less costs of $181,041 for the issuance of
72,646 shares of the Company's Series A convertible preferred stock with a
face value of $3,500,000 and warrants to purchase shares of the Company's
common stock. The shares were subject to certain designations, preferences
and rights including the right to convert such shares into shares of
common stock at any time. The per share conversion price was equal to the
quotient of $48.18, plus all accrued and unpaid dividends for each share
of the Series A convertible preferred stock, divided by the lesser of (x)
$1.75 or (y) 95% of the average of the two lowest closing bid prices of
the Company's common stock on the American Stock Exchange ("AMEX") out of
the fifteen trading days immediately prior to conversion.
In total, the Series A Preferred Holders converted 42,330 shares of the
Series A convertible preferred stock plus accrued dividends, into
1,806,210 shares of common stock prior to the redemption of the Series A
convertible preferred stock on October 6, 2004. The conversion prices
ranged from $1.07 to $1.75 based on the above formula.
In connection with a Stock Repurchase Agreement dated October 6, 2004, the
Company redeemed the remaining 30,316 Series A convertible preferred
shares held by the Series A Preferred Holders for a total price of
$2,279,688. All previously outstanding shares of the Series A convertible
preferred stock of the Company have now been cancelled.
The Company originally concluded under EITF 00-19, that the conversion
feature was conventional and that there was no need to separate the
conversion right during the period the Series A convertible preferred
shares were outstanding. Subsequent to the redemption of the remaining
preferred shares, it has been determined that certain features of the
conversion option resulted in treatment different from that historically
reflected.
The preferred stock was a fixed-income security with no participating
rights and the dividend was 10% per annum in the first year and 8% per
annum in the second, third and fourth years. Therefore, consistent with
paragraph 61(l) of SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities," the Company has concluded that the conversion
option was not clearly and closely related to the host instrument.
Ordinarily, an issuer does not need to separate a conversion right from a
convertible instrument. However, in accordance with paragraph 4 of EITF
00-19, the Company has determined that, due to the fact that the embedded
conversion option contained a provision that could have resulted in a
conversion into an indeterminable number of common shares, the conversion
feature was in fact "unconventional". Further, since the conversion right
embedded in the preferred stock has been considered a derivative, the
related dividends are also considered derivative instruments. As a result,
the embedded derivative was a liability that was required to be separated
from the preferred stock and this liability should have been marked to
market during reporting periods. The fair value of the derivative
instruments was determined using the Black-Scholes pricing model. Based on
this determination, the Company adjusted its results for the three and
nine months ended December 31, 2004 to reflect a derivative (expense)
income of ($258,658) and $62,829, respectively, related to the change in
the fair value of the embedded derivative instruments. There is no
derivative liability as of December 31, 2004 because the Series A
convertible preferred stock was partially converted and the remaining
shares redeemed on October 6, 2004.
12
Additionally, since the conversion of the Series A convertible preferred
stock could have resulted in a conversion into an indeterminable number of
common shares, the Company has determined that under the guidance in
paragraph 24 of EITF 00-19, it was prohibited from concluding that it had
sufficient authorized and unissued shares to net-share settle any warrants
or options issued to non-employees. Therefore, the Company has
reclassified to a liability the fair value of all warrants and options
issued to non-employees that were outstanding during the period that the
Series A convertible preferred stock was outstanding from April 2001 to
October 2004. The fair value of the warrants was determined using the
Black-Scholes pricing model. Any changes in the fair value of the
securities after the initial valuation in April 2001 should have been
marked to market during reporting periods. During the three and nine
months ended December 31, 2004, the Company reclassified an expense of
$185,000 related to the revaluation of warrants out of general and
administrative and into the fair value of warrants. For the three and nine
months ended December 31, 2004, the Company has restated to record a
(loss) gain on the fair value of warrants of ($202,414) and $258,937,
respectively.
The following table summarizes the changes in the Statement of Operations
for the three months ended December 31, 2004:
As Previously
Reported Adjustment As Restated
------------- ---------- -----------
Income (Loss) From Operations $ (450,845) $ 185,000 $ (265,845)
Interest Expense (288,556) -- (288,556)
Derivative Income (Expense) -- (258,658) (258,658)
Gain (loss) on Fair Value of Warrants -- (202,414) (202,414)
------------- ---------- -----------
Net Income (Loss) (739,401) (276,072) (1,015,473)
Less:
Preferred Stock Dividends -- 2,174 2,174
Preferred Stock Accretion to
Redemption Value -- 44,160 44,160
------------- ---------- -----------
Net Income (Loss) to Common Stockholders $ (739,401) $ (322,406) $(1,061,807)
============= ========== ===========
Basic and Diluted Net Loss per Common Share $ (0.04) $ (0.02) $ (0.06)
============= ========== ===========
The following table summarizes the changes in the Statement of Operations
for the nine months ended December 31, 2004:
As Previously
Reported Adjustment As Restated
------------- ---------- -----------
Income (Loss) From Operations $ (1,008,379) $ 185,000 $ (823,379)
Interest Expense (812,380) -- (812,380)
Derivative Income (Expense) -- 62,829 62,829
Gain (loss) on Fair Value of Warrants -- 258,937 258,937
------------- ---------- -----------
Net Income (Loss) (1,820,759) 506,766 (1,313,993)
Less:
Preferred Stock Dividends 82,572 -- 82,572
Preferred Stock Accretion to
Redemption Value 203,605 115,895 319,500
------------- ---------- -----------
Net Income (Loss) to Common Stockholders $ (2,106,936) $ 390,871 $(1,716,065)
============= ========== ===========
Basic and Diluted Net Loss per Common Share $ (0.13) $ 0.03 $ (0.10)
============= ========== ===========
The Series A Preferred Holders had the right to receive on any outstanding
share of Series A convertible preferred stock a ten percent dividend,
payable one year after the issuance of such preferred stock, and an eight
percent dividend for the subsequent three years thereafter, payable in
either cash or shares of preferred stock. For the three and nine months
ended December 31, 2004, the Company recorded preferred dividends of
$2,174 and $82,572, respectively, on the outstanding shares of the Series
A convertible preferred stock.
13
On April 6, 2001, the Company recorded the initial carrying value of the
preferred stock as $521,848. Each quarter the Company calculated an
estimated redemption value of the remaining preferred stock and then
calculated the difference between the initial carrying value and this
estimated redemption value. The difference was then accreted over the
redemption period (48 months beginning April 2001) using the straight-line
method, which approximates the effective interest method. For the three
and nine months ended December 31, 2004, the Company recorded $44,160 and
$319,500, respectively, related to the accretion of the redemption value
of preferred stock.
(5) Non-Cash Compensation Related to Stock-Based Transactions
Effective April 1, 2003, the Company elected to record compensation
expense measured at fair value for all stock-based award transactions
(including, but not limited to, restricted stock awards, stock option
grants, and warrant issuances) granted on or after April 1, 2003 under the
provisions of SFAS No. 123. Prior to April 1, 2003, the Company only
recorded the fair value of stock-based awards granted to non-employees or
non-directors under the provisions of SFAS No. 123. The fair value of the
stock-based award is determined on the date of grant using the
Black-Scholes pricing model and is expensed over the vesting period of the
related award. Prior to April 1, 2003, the Company accounted for its
stock-based employee and director compensation plans under the accounting
provisions of APB No. 25 as interpreted by FASB Interpretation No. 44
("FIN 44"). Any modifications of fixed stock options or awards granted to
employees or directors originally accounted for under APB No. 25 may
result in additional compensation expense under the provisions of FIN 44.
In accordance with the above accounting standards, the Company calculates
and records non-cash compensation related to its securities in the general
and administrative expense line item in the Statements of Operations based
on two primary items:
a. Stock-Based Award Issuances and Modifications under SFAS No. 123
During the three months ended December 31, 2005 and 2004, the Company
recorded $52,676 and $176,186, respectively, in non-cash compensation
expense related to stock-based transactions that were issued to and vested
by employees, officers, directors and consultants. During the nine months
ended December 31, 2005 and 2004, the Company recorded $1,116,069 and
$217,388, respectively, in non-cash compensation expense related to
stock-based transactions that were issued to and vested by employees,
officers, directors and consultants.
b. Option Modifications for Awards granted to Employees or Directors under
APB No. 25
On October 11, 2002, the Company repriced all outstanding options granted
to employees prior to October 11, 2002 (4,284,108 shares at former prices
ranging from $2.84 to $10.28) to the market price of $2.05 per share.
Prior to the repricing modification, the options were accounted for as a
fixed award under APB No. 25. In accordance with FIN 44, the repricing of
the employee stock options requires additional compensation expense to be
recognized and adjusted in subsequent periods for changes in the price of
the Company's common stock that are in excess of the $2.05 stock price on
the date of modification (additional intrinsic value). If there is a
decrease in the market price of the Company's common stock compared to the
prior reporting period, the reduction is recorded as compensation income
to reverse all or a portion of the expense recognized in prior periods.
Compensation income is limited to the original base exercise price (the
intrinsic value) of the options. This variable accounting treatment for
these modified stock options began with the quarter ended December 31,
2002 and such variable accounting treatment will continue until the
related options have been cancelled, expired or exercised. There are
3,498,163 outstanding modified stock options remaining as of December 31,
2005. The Company recorded non-cash compensation income of $192,556 for
the nine months ended December 31, 2005 related to the modified options
described above. The Company did not record any income or expense related
to these variable options during the three months ended December 31, 2005
and 2004 and during the nine months ended December 31, 2004, as the stock
price was below $2.05 at the beginning and end of the periods.
(6) Impairment of Property and Equipment
In light of the asset sale and supply arrangements discussed in Note 7,
the Company determined that it is more likely than not that a majority of
its fixed assets related to production activities will be sold or disposed
prior to the end of their useful life. In accordance with SFAS No. 144,
"Accounting for the Impairment of Disposal of Long-Term Assets," the
Company wrote down the value of its assets to their estimated fair values
in June 2005. The Company estimated the fair value based on the $8,700,000
sales price discussed below and the anticipated sales price related to any
other assets to be held for sale plus future cash flows related to the
assets from July 1, 2005 until the end of production on December 8, 2005.
Based on this estimate, the Company recorded an impairment of property and
equipment of $7,896,554 in order to reflect a net fair value of its
equipment in June 2005.
14
All assets continued to be used and depreciated under Property and
Equipment until the sale of substantially all of the Company's production
machinery and equipment on December 8, 2005. For the nine months ended
December 31, 2005, the Company recorded a $70,966 loss on the sale of
assets related to the remaining value of assets sold or abandoned after
production ceased in December 2005.
The Company has reclassified its remaining assets available for sale as
Assets Held for Sale in the Balance Sheet and expects this process to be
completed by June 2006. The Company has estimated the fair value of these
assets to be $90,000. Any difference between the actual proceeds received
and this estimated fair value will be recognized as a gain or loss on the
sale of assets in the period that they are sold.
(7) Disposal Activities
On June 30, 2005, the Company entered into a definitive agreement (the
"Asset Purchase Agreement") for the sale of substantially all of its
manufacturing and production equipment to Schreiber Foods, Inc., a
Wisconsin corporation ("Schreiber"), for $8,700,000 in cash.
Schreiber is a privately held cheese manufacturing company whose primary
business is contract manufacturing cheese, cheese alternative and other
dairy products for many well-known companies and brands.
In connection with the Asset Purchase Agreement, the Company also entered
into a Supply Agreement with Schreiber (the "Supply Agreement") on June
30, 2005. Pursuant to the Supply Agreement, Schreiber has become the
Company's sole source of supply for substantially all of its products. As
of November 14, 2005, Schreiber began to deliver such products directly to
the Company's customers. The prices for such products are based on cost
conversions determined by the parties from time to time. Other material
terms of the Supply Agreement are as follows:
o The initial term of the Supply Agreement is for a period of five years
from the effective date of September 1, 2005 and is renewable at the
Company's option for up to two additional five-year periods (for a total
term of up to fifteen years). Since October 2005, Schreiber has begun to
purchase the Company's remaining raw materials, ingredients and packaging
at cost. If the Company does not exercise its first option to extend the
term, then the Company will be obligated to pay Schreiber $1,500,000. If
the Company has exercised the first option to extend the term, but does
not exercise its second option to extend the term, then the Company will
be obligated to pay Schreiber $750,000.
o The Supply Agreement provides for a contingent short-fall payment
obligation by the Company if a specified production level is not met
during the one-year period from September 1, 2006 to August 31, 2007. If a
contingent short-fall payment is accrued after such one-year period, it
may be reduced by the amount by which production levels in the one-year
period from September 1, 2007 to August 31, 2008 exceeds the specified
target level of production, if any.
On December 8, 2005, the Company completed the sale of substantially all
of its manufacturing and production equipment to Schreiber. This sale was
approved by the Company's stockholders at a Special Meeting held on
December 5, 2005. The $8,700,000 in proceeds was used to pay $1,319,583
for tangible personal property taxes due primarily on the sold assets and
$7,374,299 to Beltway Capital Partners LLC (successor by assignment of
Wachovia Bank, N.A.) for the termination of the Company's term loan. The
remaining proceeds balance of $6,118 was used to reduce the Company's
asset-based line of credit from Textron Financial Corporation.
The Company is accounting for the costs associated with these transactions
in accordance with SFAS No. 146, "Accounting for Costs Associated with an
Exit or Disposal Activity," because the above arrangements are planned and
controlled by management and materially change the manner in which the
Company's business will be conducted. In accordance with SFAS No. 146,
costs associated with disposal activities should be reported as a
reduction of income from operations. The above transactions were
communicated to the Company's employees on July 6, 2005. As of December
31, 2005, 97 employee positions had been eliminated with the final five
employee positions to be eliminated by February 28, 2006. The majority of
the remaining employee termination costs are expected to be paid in the
fourth quarter of fiscal 2006. In December 2005, the Company abandoned its
distribution facility and the production portion of its administrative
facility and accrued $396,197 related to abandonment of these facilities.
This amount was calculated as the present value of the remaining lease
rentals, reduced by the estimated market value of sublease rentals. If the
Company does not sublease these facilities, the actual loss will exceed
this estimate. Other exit costs consist primarily of legal and
professional fees related to the disposal activities.
15
As of December 31, 2005, the Company has accrued the following quarterly
costs associated with the above transactions:
Employee Other
Termination Excess Exit
Costs Facilities Costs Total
----------- ----------- --------- ---------
Accrued Balance March 31, 2005 $ -- $ -- $ -- $ --
Charges -- -- 189,069 189,069
Payments -- -- (189,069) (189,069)
----------- ----------- --------- ---------
Accrued Balance, June 30, 2005 -- -- -- --
Charges 359,774 -- 124,425 484,199
Payments -- -- (124,425) (124,425)
----------- ----------- --------- ---------
Accrued Balance, September 30, 2005 359,774 -- -- 359,774
Charges 51,638 396,197 221,101 668,936
Payments (204,847) -- (221,101) (425,948)
----------- ----------- --------- ---------
Accrued Balance, December 31, 2005 $ 206,565 $ 396,197 $ -- $ 602,762
=========== =========== ========= =========
For the three and nine months ended December 31, 2005, the Company
incurred and reported $668,936 and $1,342,204 as Costs of Disposal
Activities in the Statement of Operations. A summary of the disposal costs
recognized for the nine months ended December 31, 2005 is as follows:
Employee Other
Termination Excess Exit
Costs Facilities Costs Total
------------ ------------ ------------ -------------
Disposal Costs Incurred $ 411,412 $ 396,197 $ 534,595 $ 1,342,204
============ ============ ============ =============
The Company anticipates that in future periods, there will be additional
disposal costs related to professional fees, contract cancellation charges
and higher lease abandonment charges to reflect the cost of abandoned
facilities that were not subleased during the period. The Company may be
required to adjust its accrual and estimated expense related to employee
termination costs if the actual timing of the terminations changes from
original estimates.
(8) Earnings Per Share
The following is a reconciliation of basic net earnings (loss) per share
to diluted net earnings (loss) per share:
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
---------------------------- ----------------------------
2005 2004 2005 2004
------------- ----------- ------------ ------------
RESTATED RESTATED
Net loss to common stockholders $ (11,754,981) $(1,061,807) $(22,315,233) $ (1,716,065)
============= =========== ============ ============
Weighted average shares outstanding -
basic and diluted 20,051,278 18,218,651 19,590,263 16,554,208
============= =========== ============ ============
Basic and diluted net loss per
common share $ (0.59) $ (0.06) $ (1.14) $ (0.10)
============= =========== ============ ============
Options for 5,057,775 shares and warrants for 1,166,713 shares have not
been included in the computation of diluted net loss per common share for
the three and nine months ended December 31, 2005, as their effect would
be antidilutive. Options for 5,075,702 shares and warrants for 2,285,356
shares have not been included in the computation of diluted net loss per
common share for the nine months ended December 31, 2004, as their effect
would be antidilutive.
(9) Supplemental Cash Flow Information
For purposes of the statement of cash flows, all highly liquid investments
with a maturity date of three months or less are considered to be cash
equivalents.
16
Nine months ended December 31, 2005 2004
- --------------------------------------------- -------- --------
Non-cash financing and investing activities:
Accrued preferred stock dividends $ -- $ 82,572
Accretion of discount on preferred stock -- 319,500
Purchase of equipment through a capital lease -- 82,583
Cash paid for:
Interest 852,267 701,121
(10) Related Party Transactions
Angelo S. Morini
In a Second Amended and Restated Employment Agreement effective October
13, 2003, Angelo S. Morini the Company's Founder, Vice-Chairman and
President resigned from his positions with the Company as Vice Chairman
and President and he is no longer involved in the daily operations of the
Company. He retains the title of Founder and has been named Chairman
Emeritus. Mr. Morini continues to be a member of the Company's Board of
Directors. Additionally, he may carry out special assignments designated
to him by the Chairman of the Board. The agreement is for a five-year
period beginning October 13, 2003 and provides for an annual base salary
of $300,000, plus standard health insurance benefits, club dues and an
auto allowance.
Because Mr. Morini is no longer performing ongoing services for the
Company, the Company accrued and expensed the five-year cost of this
agreement in October 2003. The total estimated costs expensed under this
agreement were $1,830,329 of which $1,021,325 remained unpaid but accrued
($366,305 as short-term liabilities and $655,020 as long-term liabilities)
as of December 31, 2005. The long-term portion will be paid out in nearly
equal monthly installments ending in October 2008.
In June 1999, in connection with an amended and restated employment
agreement for Mr. Morini, the Company consolidated two full recourse notes
receivable ($1,200,000 from November 1994 and $11,572,200 from October
1995) related to the exercise of 2,914,286 shares of the Company's common
stock into a single note receivable in the amount of $12,772,200 that is
due on June 15, 2006. This single consolidated note is non-interest
bearing and non-recourse and is secured by the 2,914,286 underlying shares
of the Company's common stock. Per the terms of the June 1999 Employment
Agreement that was amended and restated by the October 2003 Second Amended
and Restated Employment Agreement between the Company and Mr. Morini, this
loan may be forgiven upon the occurrence of any of the following events:
1) Mr. Morini is terminated without cause; 2) there is a material breach
in the terms of Mr. Morini's employment agreement; or 3) there is a change
in control of the Company for which Mr. Morini did not vote "FOR" in his
capacity as a director or a stockholder.
In the event that the $12,772,200 loan is forgiven, the Company would
reflect this amount as a forgiveness of debt in the Statement of
Operations. In the event that Mr. Morini is unable to pay the loan when
due and the Company forecloses on the shares, the Company would reflect a
loss on collection for the amount that the value of the 2,914,286
underlying collateral shares are below the value of the note. In December
2005, the Company reserved $9,129,343 against this stockholder note
receivable under the assumption that it will not be able to collect
proceeds in excess of the $3,642,857 value of the underlying collateral
shares. The value of the underlying collateral shares was computed using
the market price of the Company's common stock on December 31, 2005 of
$1.25 multiplied by the 2,914,286 shares. Although this reserve resulted
in a material loss to the Company's operations, it does not have any
affect on the balance sheet since the $12,772,200 loan amount was already
shown as a reduction to Stockholders' Equity (Deficit).
Christopher J. New
On July 8, 2004, Christopher J. New resigned from his position as Chief
Executive Officer in order to pursue other opportunities. In accordance
with the Separation and Settlement Agreement between the Company and Mr.
New, the Company recorded $444,883 related to the employment contract
expense in July 2004. This settlement will be paid out in nearly equal
installments over two years payable on the Company's regular payroll
dates. As of December 31, 2005, the remaining unpaid but accrued balance
reflected in short-term liabilities was $124,842.
(11) Economic Dependence
The Company had one customer that accounted for approximately 15% and 13%
of sales in the three and nine months ended December 31, 2004. There is no
one customer that comprises greater than 10% of sales in the three and
nine months ended December 31, 2005.
17
GALAXY NUTRITIONAL FOODS, INC.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
INFORMATION IN THIS MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS ("MD&A") IS INTENDED TO ENHANCE A READER'S
UNDERSTANDING OF THE FINANCIAL CONDITION, CHANGES IN FINANCIAL CONDITION AND
RESULTS OF OPERATIONS OF OUR COMPANY. THIS MD&A IS A SUPPLEMENT TO AND SHOULD BE
READ IN CONJUNCTION WITH OUR FINANCIAL STATEMENTS AND NOTES THERETO APPEARING
ELSEWHERE IN THIS REPORT. THE FOLLOWING DISCUSSION CONTAINS CERTAIN
FORWARD-LOOKING STATEMENTS, WITHIN THE MEANING OF THE "SAFE-HARBOR" PROVISIONS
OF THE PRIVATE SECURITIES REFORM ACT OF 1995, THE ATTAINMENT OF WHICH INVOLVES
VARIOUS RISKS AND UNCERTAINTIES. THESE STATEMENTS RELATE TO FUTURE EVENTS OR OUR
FUTURE FINANCIAL PERFORMANCE. THESE FORWARD-LOOKING STATEMENTS ARE BASED ON OUR
CURRENT EXPECTATIONS, ESTIMATES AND PROJECTIONS ABOUT OUR INDUSTRY, MANAGEMENT'S
BELIEFS AND CERTAIN ASSUMPTIONS MADE BY OUR COMPANY. WORDS SUCH AS "ANTICIPATE,"
"EXPECT," "INTEND," "PLAN," "BELIEVE," "SEEK," "PROJECT," "ESTIMATE," "MAY,"
"WILL," AND VARIATIONS OF THESE WORDS OR SIMILAR EXPRESSIONS ARE INTENDED TO
IDENTIFY FORWARD-LOOKING STATEMENTS. THESE STATEMENTS ARE NOT GUARANTEES OF
FUTURE PERFORMANCE AND ARE SUBJECT TO CERTAIN RISKS, UNCERTAINTIES AND
ASSUMPTIONS THAT ARE DIFFICULT TO PREDICT. THEREFORE, ACTUAL RESULTS MAY DIFFER
MATERIALLY FROM OUR HISTORICAL RESULTS AND THOSE EXPRESSED OR FORECASTED IN ANY
FORWARD-LOOKING STATEMENTS AS A RESULT OF A VARIETY OF FACTORS, INCLUDING BUT
NOT LIMITED TO, COMPETITION IN THE MARKET FOR OUR PRODUCTS, DEPENDENCE ON
SUPPLIERS, OUR MANUFACTURING EXPERIENCE, PRODUCTION DELAYS OR INEFFICIENCIES,
AND CHANGES IN ACCOUNTING STANDARDS. PLEASE SEE THE SECTION TITLED "RISK
FACTORS" IN OUR ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED MARCH 31, 2005,
AND ITEM 1A CONTAINED HEREIN, FOR FURTHER DISCUSSION OF THESE AND OTHER FACTORS
THAT COULD AFFECT FUTURE RESULTS. WE UNDERTAKE NO OBLIGATION TO PUBLICLY UPDATE
OR REVISE ANY FORWARD-LOOKING STATEMENTS FOR ANY REASON, EVEN IF NEW INFORMATION
BECOMES AVAILABLE OR OTHER EVENTS OCCUR IN THE FUTURE.
Terms such as "fiscal 2006" or "fiscal 2005" refer to our fiscal years ending
March 31, 2006 and 2005, respectively. Terms such as "first quarter," "second
quarter," "third quarter," or "fourth quarter" refer to the fiscal quarters
ending June 30, September 30, December 31, or March 31, respectively.
This MD&A contains the following sections:
o Restatement
o Business Environment
o Critical Accounting Policies
o Recent Accounting Pronouncements
o Results of Operations
o Liquidity and Capital Resources
Restatement
This Form 10-Q and the restated fiscal 2005 financial statements included herein
reflect a correction of our accounting and disclosure primarily related to the
warrants that were outstanding during the term of our Series A convertible
preferred stock, from April 2001 through October 2004. The issue relates to
accounting for securities that are reflected as income or expense through
earnings as non-cash charges. These non-cash charges do not affect our revenues,
cash flows from past or future operations, or our liquidity. As discussed in
Note 4 of the financial statements, for the three and nine months ended December
31, 2004, we have restated our financial statements to reflect a net loss of
$1,061,807 and $1,716,065, which reflects an additional (loss) income of
($322,406) and $390,871, respectively, from what was previously reported for
these periods in the Form 10-Q for the quarterly period ended December 31, 2004.
Business Environment
General
Galaxy Nutritional Foods, Inc. (our "Company") is principally engaged in
developing and marketing plant-based cheese and dairy alternatives, as well as
processed organic cheese and cheese food to grocery and natural foods retailers,
mass merchandisers and food service accounts. Veggie, the leading brand in the
grocery cheese alternative category and our Company's top selling product group,
is primarily merchandised in the produce section and provides calcium and
protein without cholesterol, saturated fat or trans-fat. Other popular brands
include: Rice, Veggy, Vegan, and Wholesome Valley. We are dedicated to
developing nutritious products to meet the taste and dietary needs of today's
increasingly health conscious consumers. Our company headquarters are located in
Orlando, Florida.
18
Our Company is currently in a transition period with respect to our
manufacturing operations. We determined that our manufacturing capacity was
significantly in excess of our requirements, and that it would be advantageous
for us to outsource our manufacturing, packaging and delivery operations. On
June 30, 2005, our Company and Schreiber Foods, Inc., a Wisconsin corporation
("Schreiber"), entered into a Supply Agreement, whereby we agreed that Schreiber
would become our sole source of supply for substantially all of our products. As
of November 14, 2005, Schreiber began to deliver such products directly to our
customers. The prices for such products are based on cost conversions determined
by the parties from time to time. The actual cost savings from the elimination
of the fixed plant overhead are expected to be evidenced more clearly in the
fourth quarter of fiscal 2006.
On December 8, 2005, we completed the sale of substantially all of our
manufacturing and production equipment to Schreiber for $8,700,000 in cash
pursuant to an Asset Purchase Agreement dated June 30, 2005. Our Company has now
converted from a manufacturing company into a branded marketing company that
will continue to develop, market and sell our products.
Cheese Alternative Category
We are the market leader within our cheese alternative category niche, but in
being so, the category increases or decreases partly as a result of our
marketing and pricing efforts. We believe that the greatest source of future
growth in the cheese alternative category will come through customers shifting
to cheese alternatives from natural cheese. Rather than focusing primarily on
consumers with a preference or medical condition predisposing them to non-dairy
cheese and comparing our products to other cheese alternative brands, we intend
to focus on educating cheese consumers on the healthy attributes of cheese
alternatives versus traditional cheese.
We use several internal and external reports to monitor sales by brand, segment,
form and channel of sale to determine the outside factors affecting the sales
levels. These reports provide management information on which brand, segments,
forms and/or channel sales are increasing or decreasing both in units sold and
price per unit. By reviewing these reports along with industry data from
publications, syndicated retail consumption reports, and conversations with
major retailers, other manufacturers in the food and beverage industry, and
ingredient and service suppliers, we make decisions on which brands to promote
and analyze trends in the consumer marketplace.
In the second quarter of fiscal 2006, we launched a consumer marketing sales
campaign. We are rolling out the second wave of this campaign in the fourth
quarter of fiscal 2006. This campaign is focused on the following three primary
strategies:
o Consumer focused advertising. We are increasing consumer advertising
(in TV, magazine, and event sponsorship) and consumer promotions
(for example, on-pack "cents off" coupons, "cents off" coupons
delivered via newspapers, secondary placement and product benefit
communication at the point of purchase/shelf) that highlight and
communicate the benefits of our products to meet the consumer demand
for low fat, no cholesterol and high calcium products.
o Increase retailer penetration and geographical distribution. By
increasing our presence on the store shelves, we seek to increase
household penetration and build market share in specific markets.
o Increase brand awareness. We seek to increase sales by increasing
our customer base and generating consumer awareness of new products
or flavors through product trials and generating more repeat
purchases on our Veggie(TM) brand through improved taste, color,
aroma, texture and packaging.
We began the consumer television advertising campaign the first week in
September 2005 for the West Coast, InterMountain and Minneapolis markets. In
support of that advertising, we distributed coupons through the newspapers in
all those markets as well. Initial sales data from these markets in the four
weeks following the promotions, indicate that sales increased more than 10% from
sales in the four weeks prior to the promotions. At this time, we are unable to
determine if we will experience continued positive effects from the advertising
campaigns. Thus, sales improvements in these four weeks are not necessarily
indications of future results. We will begin our second wave of advertising
campaigns in January and February 2006. We have also secured distribution of our
new product snack dips and chipotle- flavored chunks with over 70% of our
current customers. These new products have not had enough market time to impact
sales, but we are hopeful that by the end fiscal 2006, they will contribute to
increased sales and improved margins.
19
We believe that the combination of "healthy" product attributes, improved taste
and product functionality will lead to better than expected consumer experiences
with our products. Our focus is to transfer those improved consumer experiences
into enhanced market share and increased sales of our higher margin products.
Recent Material Developments
Material Losses
Our Statement of Operations is showing an increase in operating loss of
approximately $11,000,000 and $21,000,000 in the three and nine months ended
December 31, 2005 compared to the three and nine months ended December 31, 2004.
This increase in loss is primarily due to a $9,129,343 reserve on a stockholder
note receivable, an impairment on fixed assets of $7,896,554 and disposal costs
of $1,342,204 related to our asset sale and outsourcing arrangements with
Schreiber Foods, Inc., and a decline in gross margin of $1,085,491 as discussed
in further detail under Results of Operations.
Schreiber Transactions
On June 30, 2005, we entered into a definitive agreement (the "Asset Purchase
Agreement") for the sale of substantially all of our manufacturing and
production equipment to Schreiber Foods, Inc., a Wisconsin corporation
("Schreiber"), for $8,700,000 in cash.
Schreiber is a privately held cheese manufacturing company whose primary
business is contract manufacturing cheese, cheese alternative and other dairy
products for many well-known companies and brands.
In connection with the Asset Purchase Agreement, we also entered into a Supply
Agreement with Schreiber (the "Supply Agreement") on June 30, 2005. Pursuant to
the Supply Agreement, Schreiber has become our sole source of supply for
substantially all of our products. As of November 14, 2005, Schreiber began to
deliver such products directly to our customers. The prices for such products
are based on cost conversions determined by the parties from time to time. Other
material terms of the Supply Agreement are as follows:
o The initial term of the Supply Agreement is for a period of five
years from the effective date of September 1, 2005 and is renewable
at our option for up to two additional five-year periods (for a
total term of up to fifteen years). If we do not exercise our first
option to extend the term, then we will be obligated to pay
Schreiber $1,500,000. If we exercise our first option to extend the
term, but do not exercise our second option to extend the term, then
we will be obligated to pay Schreiber $750,000.
o The Supply Agreement provides for a contingent short-fall payment
obligation by our Company if a specified production level is not met
during the one-year period from September 1, 2006 to August 31,
2007. If a contingent short-fall payment is accrued after such
one-year period, it may be reduced by the amount by which production
levels in the one-year period from September 1, 2007 to August 31,
2008 exceeds the specified target level of production, if any.
o Schreiber is required to deliver products to our Company or our
customers that are in compliance with our standards and
specifications and all applicable laws. Schreiber will deliver all
products within 10 business days of the effective date of such
order, which is one business day after receipt of the order.
o We may not manufacture any products governed by the Supply Agreement
during the term of the Supply Agreement.
o Schreiber may not manufacture our products or use any of our
intellectual property other than pursuant to the terms of the Supply
Agreement.
On December 8, 2005, we completed the sale of substantially all of our
manufacturing and production equipment to Schreiber. This sale was approved by
our stockholders at a Special Meeting held on December 5, 2005. The $8,700,000
in proceeds was used to pay $1,319,583 for tangible personal property taxes due
primarily on the sold assets and $7,374,299 to Beltway Capital Partners LLC
(successor by assignment of Wachovia Bank, N.A.) for the termination of our term
loan. The remaining proceeds balance of $6,118 was used to reduce our
asset-based line of credit from Textron Financial Corporation.
20
Prior to December 31, 2005, we sold all of our usable raw material inventory to
Schreiber at our cost and transferred our finished goods inventory to
Schreiber's facility. Our inventory balance as of December 31, 2005 consists of
the finished goods items that Schreiber had not yet begun to manufacture. Prior
to the sale of our assets to Schreiber, we manufactured additional finished
goods inventory to fill the estimated customer orders in the period of
manufacturing downtime when the manufacturing equipment was transferred from our
location to Schreiber. We retain title to this finished goods inventory that was
transferred to Schreiber's facility until it is sold and shipped with future
customer orders.
Transaction Effect
We believe that the long-term benefits in the transition from a manufacturing
company to a branded marketing company will far outweigh the short-term costs of
the transition. Without the cash-flow burden of carrying inventory and managing
manufacturing overhead and production issues, we believe that we can focus a
substantially greater amount of time and resources on the sale of our products.
Additionally, we plan to enhance our marketing efforts in order to increase our
consumer base and sales volume.
Some of the effects of the transaction are as follows:
o We will no longer be a manufacturing company, but will be solely a
branded marketing company.
o We have two facilities that we lease in Orlando, Florida - a
manufacturing and administrative facility and a distribution
facility. In December 2005, we abandoned the distribution facility
that has a lease termination date of July 31, 2009. We are currently
working with the landlord to terminate the lease or sublease the
facility. If the lease is not terminated or subleased, future lease
payments due on this facility are approximately $1,254,000. We
ceased to use the manufacturing portion of our second facility where
our administrative offices are located and plan to stay in this
location through the end of our lease in November 2006. If the lease
is not terminated or subleased, future lease payments due on this
facility are approximately $368,000. We may sublease the
manufacturing portion of this facility if an opportunity arises
prior to the lease termination.
o We have eliminated 102 employee positions and created 2 new employee
positions. Our anticipated total number of permanent full-time
employees after December 31, 2005 is 30.
o We used the proceeds from the sale of our manufacturing equipment to
reduce a substantial portion of our outstanding debt and liabilities
as detailed above. Repayment of these liabilities will result in
annual interest savings in excess of $800,000.
o We will no longer have the carrying value of inventory nor need to
use asset based financing to support the production of inventory. In
the recent past, we averaged 50 to 60 days of sales in inventory.
o We anticipate substantial savings on delivery charges related to the
distribution of our products to our customers.
Debt Maturity and Going Concern Issues
We have incurred substantial debt in connection with the financing of our
business. The aggregate principal amount outstanding under our credit facilities
is approximately $4,638,722 as of December 31, 2005. This amount includes a
revolving line of credit from Textron Financial Corporation ("Textron") in the
amount of $2,238,722, and several notes payable to certain Note Holders (as
described under Debt Financing) totaling $2,400,000. We will need to refinance
or raise proceeds to pay the Textron line of credit on or before its maturity
date of May 26, 2006 and the notes payable to the Note Holders on or before
their maturity date of June 15, 2006.
If we cannot generate enough cash from operations and the sale of our remaining
assets that are held for sale by these maturity dates, and we are unable to
refinance or renew these loans, or if additional financing is not available on
terms acceptable to us, we will be unable to satisfy such facilities by their
maturity dates. In such an event, Textron and the Note Holders could exercise
their respective rights under their loan documents, which could include, among
other things, declaring defaults under the loans and pursuing foreclosure on our
assets that are pledged as collateral for such loans. If such an event occurred,
it would be substantially more difficult for us to effectively continue the
operation of our business, and it is unlikely that we would be able to continue
as a going concern.
Measurements of Financial Performance
We focus on several items in order to measure our performance. We are working
towards obtaining positive trends in the following areas:
o Operating cash flow
o Gross margin in dollars and % of gross sales
o Operating income excluding certain employment contract expenses and
non-cash compensation related to stock based transactions
21
o EBITDA excluding certain employment contract expenses and non-cash
compensation related to stock based transactions
o Liquidity
o Key financial ratios (such as accounts receivable and accounts
payable turnover ratios)
Critical Accounting Policies
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America 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 and reported amounts of income and expense during the
reporting periods presented. Our significant estimates include the allowance for
doubtful accounts receivable, reserve on stockholder note receivable, provision
for obsolete inventory, valuation of deferred taxes, valuation of compensation
expense on options and warrants, and accruals for disposal costs. Although we
believe that these estimates are reasonable, actual results could differ from
those estimates given a change in conditions or assumptions that have been
consistently applied.
The critical accounting policies used by management and the methodology for
estimates and assumptions are as follows:
Valuation of Accounts Receivable and Chargebacks
We record revenue upon shipment of products to our customers and reasonable
assurance of collection on the sale. We generally provide credit terms to
customers based on net 30-day terms. We perform ongoing credit evaluations of
our accounts receivable balances and based on historical experience, make
reserves for anticipated future customer credits for promotions, discounts,
spoils, and other reasons. In addition, we evaluate the accounts for potential
uncollectible amounts based on a specific identification methodology and record
a general reserve for all remaining balances.
Based on the age of the receivable, cash collection history and past dilution in
the receivables, we make an estimate of our anticipated bad debt, anticipated
future authorized deductions due to current period activity and anticipated
collections on non-authorized amounts that customers have currently deducted on
past invoices. Based on this analysis, we reserved $1,673,000 and $742,000 for
known and anticipated future credits and doubtful accounts at December 31, 2005
and 2004, respectively. The reserve is higher at December 31, 2005 primarily due
to additional promotions that we initiated in fiscal 2006 which we are expecting
to be deducted by the customers. We believe that this estimate is reasonable,
but there can be no assurance that our estimate will not change given a change
in economic conditions or business conditions within the food industry, our
individual customer base or our Company.
Valuation of Stockholder Note Receivable
We have evaluated the collection of the non-recourse $12,772,200 loan to Angelo
S. Morini, our Founder and member of our Board of Directors, that is due on June
15, 2006. This note is non-recourse and is secured only by 2,914,286 shares of
our common stock. During our evaluation, among other things, we considered the
current value of the 2,914,286 shares of our common stock and the remaining time
before the loan is due to be paid. Due to the uncertainty that the value of
these shares would exceed the loan value within the next six months, we have
reserved for the $9,129,343 difference between the $3,642,857 share value and
the $12,772,200 loan value. The value of the shares was computed using the
market price of our common stock on December 31, 2005 of $1.25 multiplied by the
2,914,286 shares. A $0.01 increase or decrease in our common stock price will
result in a reduction or increase in the reserve on stockholder note receivable,
respectively, of approximately $29,000. Due to the volatility of the market
price of our common stock, we are incapable of predicting whether this reserve
will increase or decrease in the future.
Inventory
Inventories are valued at the lower of cost or market. Cost is determined using
a weighted average, first-in, first out method. We review our inventory
valuation each month and write off the inventory related to obsolete and damaged
inventory. In addition, we reduce the value of any finished good item to market
value when that value is believed to be less than the cost of the inventory.
Deferred Taxes
Valuation allowances are established when necessary to reduce deferred tax
assets to the amount expected to be realized. We have reserved our net deferred
tax assets in full.
Valuation of Non-Cash Compensation
22
We have three stock-based employee compensation plans. Prior to April 1, 2003,
we accounted for those plans under the recognition and measurement provisions of
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," (APB No. 25), and related Interpretations.
Effective April 1, 2003, we adopted the fair value recognition provisions of
Statement of Financial Accounting Standard ("SFAS") No. 123, "Accounting for
Stock-Based Compensation," and apply SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure," prospectively to all employee awards
granted on or after April 1, 2003. Awards from our plans vest over periods
ranging from immediate to five years. Therefore, the cost related to stock-based
compensation included in the determination of net income for the periods is less
than that which would have been recognized if the fair value based method had
been applied to all awards since the original effective date of SFAS No. 123.
The fair value of the stock-based award (including, but not limited to,
restricted stock awards, stock option grants, and warrant issuances) is
determined on the date of grant using the Black-Scholes pricing model and is
expensed over the vesting period of the related award. The difference between
the proforma and reported net loss per common share related to the issuance of
employee stock options during the three and nine months ended December 31, 2005
and 2004 ranged from nearly zero to $0.01.
Several management estimates are needed to compute the fair value of the
stock-based transactions including anticipated life, risk free interest rates,
and volatility of our stock price. Currently, we estimate the life of all awards
granted assuming that the award will remain outstanding and not be exercised
until the end of its term. This results in the highest possible value of the
award. If we were to change our estimate of the anticipated life to something
less than the maximum term, then the fair value expense per share would decrease
by approximately $.01 to $.02 per month. If we were to change our estimate of
the volatility percentage, the fair value expense per share would change by
approximately $.02 per percentage change in the volatility. If we were to change
our estimate of the interest rate, the fair value expense per share would change
by approximately $.03 per percentage change in the interest rate.
SFAS No. 123 requires that we provide pro-forma information regarding net income
(loss) and earnings (loss) per share amounts as if compensation cost for all our
employee and director stock-based awards had been determined in accordance with
the fair value method prescribed in SFAS No. 123. We estimated the fair value of
each stock-based award during the periods presented by using the Black-Scholes
pricing model with the following assumptions:
December 31, December 31,
Nine Months Ended: 2005 2004
------------ ------------
Dividend Yield None None
Volatility 24.9%-46.0% 44.0%-59.0%
Risk Free Interest Rate 3.35%-4.30% 1.46%-4.14%
Expected Lives in Months 1-120 1-120
In addition to non-cash compensation expense related to new stock-based
transactions, we also record non-cash compensation expense in accordance with
the Financial Accounting Standards Board ("FASB") Interpretation No. 44 ("FIN
44") related to modifications of fixed stock options or awards granted to
employees or directors that were granted prior to April 1, 2003 and accounted
for under the accounting provisions of APB No. 25.
FIN 44 states that when an option is repriced or there are items that
effectively reduce the price of an option, it is treated as a variable option
that is marked to market each quarter. Accordingly, any increase in the market
price of our common stock over the exercise price of the option that was not
previously recorded is recorded as compensation expense at each reporting
period. If there is a decrease in the market price of our common stock compared
to the prior reporting period, the reduction is recorded as compensation income
to reverse all or a portion of the expense recognized in prior periods.
Compensation income is limited to the original base exercise price (the
intrinsic value) of the options. Each period we may record non-cash compensation
expense or income related to our analysis on approximately 3.5 million option
shares. Assuming that the stock price exceeds the intrinsic value on all the
variable option shares, a $0.01 increase or decrease in our common stock price
results in an expense or income, respectively, of approximately $35,000. Due to
the volatility of the market price of our common stock, we are incapable of
predicting whether this expense will increase or decrease in the future.
Disposal Costs
We have recorded significant accruals in connection with the asset sale and
outsourcing arrangements with Schreiber. These accruals include estimates
pertaining to employee termination costs and abandonment of excess equipment and
facilities and other potential costs. Actual costs may differ from these
estimates or our estimates may change. In accordance with SFAS No. 146,
"Accounting for Costs Associated with Exit or Disposal Activities", costs
associated with restructuring activities are recognized when they are incurred
rather than at the date of a commitment to an exit or disposal plan. Given the
significance and complexity of these activities, and the timing of the execution
of such activities, the accrual process involves periodic reassessments of
estimates made at the time the original decisions were made, including
evaluating estimated employment terms, contract cancellation charges and real
estate market conditions for sub-lease rents. We will continually evaluate the
adequacy of the remaining liabilities under our restructuring initiatives.
Although we believe that these estimates accurately reflect the costs of our
activities, actual results may differ, thereby requiring us to record additional
provisions or reverse a portion of such provisions. Should the timing of
employee terminations change and if we do not sublease our facilities, our
estimate of restructuring expenses will increase.
23
Recent Accounting Pronouncements
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs, an amendment
of Accounting Research Bulletin No. 43, Chapter 4." SFAS No. 151 requires that
abnormal amounts of idle facility expense, freight, handling costs and wasted
materials (spoilage) be recorded as current period charges and that the
allocation of fixed production overheads to inventory be based on the normal
capacity of the production facilities. SFAS No. 151 is effective during fiscal
years beginning after June 15, 2005, although earlier application is permitted.
We believe that the adoption of this standard will not have a significant impact
on our financial position, results of operations or cash flows.
In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-Based
Payment" ("SFAS No. 123R"), which addresses the accounting for share-based
payment transactions in which a company receives employee services in exchange
for (a) equity instruments of the company or (b) liabilities that are based on
the fair value of the company's equity instruments or that may be settled by the
issuance of equity instruments. SFAS No. 123R supercedes APB Opinion No. 25 and
amends SFAS No. 95, "Statement of Cash Flows." Under SFAS No. 123R, companies
are required to record compensation expense for all share-based payment award
transactions measured at fair value as determined by an option valuation model.
Currently, we use the Black-Scholes pricing model to calculate the fair value of
our share-based transactions. This statement is effective for fiscal years
beginning after June 15, 2005. Since we currently recognize compensation expense
at fair value for share-based transactions in accordance with SFAS No. 123, we
do not anticipate adoption of this standard will have a significant impact on
our financial position, results of operations, or cash flows.
In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary Assets
an Amendment of APB Opinion No. 29." SFAS No. 153 amends APB Opinion No. 29 to
eliminate the exception for nonmonetary exchanges of similar productive assets
from being measured based on the fair value of the assets exchanged. SFAS No.
153 now provides a general exception for exchanges of nonmonetary assets that do
not have commercial substance. SFAS No. 153 is effective for fiscal periods
beginning after June 15, 2005. We believe that the adoption of this standard
will not have a significant impact on our financial position, results of
operations or cash flows.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections - a replacement of APB Opinion No. 20 and SFAS No. 3." SFAS No. 154
changes the requirements for the accounting for and reporting of a change in
accounting principle and a change required by an accounting pronouncement when
the pronouncement does not include specific transition provisions. SFAS No. 154
requires retrospective application of changes as if the new accounting principle
had always been used. SFAS No. 154 is effective for fiscal years beginning after
December 15, 2005. We believe that the adoption of this standard will not have a
significant impact on our financial position, results of operations or cash
flows.
Results of Operations
3-Months Ended December 31, 2005 9-Months Ended December 31, 2005
---------------------------------------------- -----------------------------------------------
$ % $ %
2005 2004 Change Change 2005 2004 Change Change
- ------------------------------------------------------------------- -----------------------------------------------
Net Sales 9,072,097 10,632,877 (1,560,780) -14.7% 29,361,475 33,725,108 (4,363,633) -12.9%
Cost of Goods Sold 7,182,502 8,289,551 (1,107,049) -13.4% 22,582,708 25,860,850 (3,278,142) -12.7%
---------------------------------------------- -----------------------------------------------
Gross Margin 1,889,595 2,343,326 (453,731) -19.4% 6,778,767 7,864,258 (1,085,491) -13.8%
============================================== ===============================================
Gross Profit % 20.8% 22.0% 23.1% 23.3%
======================= ========================
24
Net Sales
Net sales in the three and nine months ended December 31, 2005 decreased 15% and
13% from net sales in such periods in the prior year primarily due to a decline
in private label sales volume to Wal-Mart. During fiscal 2005, we sold
indirectly to Wal-Mart through Del Sunshine, a private label customer, but
beginning in April 2005, we began selling direct to Wal-Mart. During the three
and nine months ended December 31, 2004, Del Sunshine accounted for
approximately 15% and 13% of net sales. During the three and nine months ended
December 31, 2005, private label sales volume to Wal-Mart accounted for less
than 5% of net sales. Sales also decreased due to overall consumer resistance to
the multiple price increases we have taken in late fiscal 2005 and early fiscal
2006 to offset our rising production costs. We statistically linked 84% of the
variance in our Veggie Slices to average unit price and recently implemented a
reduced-price market test with a major retailer. If the market test results in
an increase in unit sales, pricing will be adjusted across all markets to
optimize sales and profitability of Veggie Slices.
Certain key initiatives and tactical actions were initiated by our Company
during fiscal 2005 and will be continued throughout fiscal 2006. Such key
initiatives and tactical actions for fiscal 2006 include, but are not limited
to, the following:
o Creating and communicating a new more meaningful brand position for
our flagship Veggie(TM) brand and adding new products. The recent
focus is to highlight the superior nutritional factors such as
cholesterol and trans-fat free, as well as targeting a broader
universe of consumers. We are attempting to attract incremental
users by convincing users of conventional cheese that the Veggie(TM)
brand items can satisfy their needs with great tasting nutrition.
This is a departure from our past product positioning where
physiological and medical requirements were a key driver in why
consumers should buy the "healthy alternatives."
o Improving product quality in terms of taste, color, aroma, and
texture of our Veggie(TM) and Rice and Vegan products.
o Reducing or eliminating most of our contract manufacturing customers
due to the continued high cost of certain raw materials which result
in gross margins that are below our acceptance level.
o Continued emphasis and resource allocation of our marketing strategy
to increase sales through consumer advertising (in TV, magazine, and
event sponsorship) and consumer promotions (for example, on-pack
"cents off" coupons, "cents off" coupons delivered via newspapers,
secondary placement, product benefit communication at the point of
purchase/shelf).
In January and February 2006 we are launching the second wave of an advertising
campaign that began in September 2005. While initial response from the
advertising campaign in September 2005 in the limited markets are positive, we
are unable to determine if we will experience continued positive effects from
the advertising campaigns.
Due to the reduction of lower margin sales to Wal-Mart in fiscal 2006, we
anticipate a decline of 10% to 15% in net sales in fiscal 2006 compared to
fiscal 2005, but we expect to show improved margins in the fourth quarter of
fiscal 2006 due to the outsourcing arrangement with Schreiber Foods, Inc. as
discussed under Recent Material Developments.
Cost of Goods Sold
Cost of goods sold was approximately 77% of net sales for each of the first nine
months of fiscal 2006 and 2005. However, we noted a 1% percentage point increase
in cost of goods sold to 79% of net sales in the third quarter of fiscal 2006
compared to 78% of net sales in the third quarter of fiscal 2005. This
percentage point increase in cost of goods sold was primarily due to inventory
disposals and additional overhead costs during the outsourcing transition in
third quarter of fiscal 2006. During fiscal 2006 prior to full outsourcing in
mid-December, we experienced lower costs in direct labor and overhead costs as a
result of improved production efficiencies and changes in the allocation of
certain overhead costs to various departments. Certain allocation costs are
allocated based on a square footage method. As a result of lower square footage
in our production areas in fiscal 2006 compared to prior fiscal years, there is
a higher percentage of overhead allocated to non-production departments
beginning in April 2005. We anticipate that the cost of goods sold will also
decrease as a result of the outsourcing arrangement with Schreiber. However,
actual results could differ from our expectations.
Gross Margin
Despite the decline in sales, gross margin has remained at 23% for the first
nine months of fiscal 2006 due to the elimination of the private label sales to
Wal-Mart. Private label and imitation sales consist primarily of products that
generate high sales volumes but lower gross margins. Gross margins declined in
the third quarter of fiscal 2006 as a result of the additional overhead costs
during the transition of manufacturing operations to Schreiber in this quarter.
However, gross margins are expected to improve in the fourth quarter of fiscal
2006 now that our manufacturing activities have ceased and excess production
overhead has been eliminated.
25
EBITDA
We utilize certain GAAP measures such as Operating Income and Net Income and
certain non-GAAP measures such as EBITDA and exclude non-cash compensation
related to stock based transactions included in general and administrative
expenses and certain non-standard expenses such as employment contract costs,
disposal costs, and asset impairments in order to compute our key financial
measures that are reviewed by management, lenders and investors in order to
effectively review our current on-going operations and analyze trends related in
our financial condition and results of operations. Additionally, these measures
are key factors upon which we prepare our budgets and forecasts, and calculate
bonuses. These adjusted measures are not in accordance with, or an alternative
for, generally accepted accounting principles and may be different from non-GAAP
measures reported by other companies.
EBITDA, (a non-GAAP measure):
3-Months Ended December 31, 2005
----------------------------------------------------
2005 2004 $ Change % Change
- ---------------------------------------------------------------------------------------
Gross Margin 1,889,595 2,343,326 (453,731) -19.4%
----------------------------------------------------
Selling 1,161,751 1,213,549 (51,798) -4.3%
Delivery 544,665 549,379 (4,714) -0.9%
Employment contract expense(2) -- -- -- 0.0%
General and administrative,
including $52,676, $176,186,
$923,513 and $217,388 in
non-cash stock compensation(1) 1,394,599 771,382 623,217 80.8%
Research and development 75,961 74,861 1,100 1.5%
Reserve on stockholder note
receivable(2) 9,129,343 -- 9,129,343 100.0%
Cost of disposal activities(2) 668,936 -- 668,936 100.0%
Impairment of fixed assets(2) -- -- -- 0.0%
Loss on sale of assets 65,360 -- 65,360 100.0%
----------------------------------------------------
Total operating expenses 13,040,615 2,609,171 10,431,444 399.8%
----------------------------------------------------
Loss from Operations(3) (11,151,020) (265,845) (10,885,175) 4094.6%
Other Income (Expense), Net
Interest expense (595,692) (288,556) (307,136) 106.4%
Derivative income (expense) -- (258,658) 258,658 -100.0%
Gain/(loss) on FV of warrants (8,269) (202,414) 194,145 -95.9%
----------------------------------------------------
Total (603,961) (749,628) 145,667 -19.4%
----------------------------------------------------
NET LOSS (11,754,981) (1,015,473) (10,739,508) 1057.6%
Interest expense 595,692 288,556 307,136 106.4%
Depreciation 387,184 541,170 (153,986) -28.5%
----------------------------------------------------
EBITDA, (a non-GAAP measure) (10,772,105) (185,747) (10,586,358) 5699.3%
====================================================
As a Percentage of Net Sales -118.7% -1.7%
=========================
9-Months Ended December 31, 2005
-----------------------------------------------------
2005 2004 $ Change % Change
- ----------------------------------------------------------------------------------------
Gross Margin 6,778,767 7,864,258 (1,085,491) -13.8%
-----------------------------------------------------
Selling 3,655,543 4,246,419 (590,876) -13.9%
Delivery 1,886,214 1,757,962 128,252 7.3%
Employment contract expense(2) -- 444,883 (444,883) -100.0%
General and administrative,
including $52,676, $176,186,
$923,513 and $217,388 in
non-cash stock compensation(1) 3,999,362 2,011,894 1,987,468 98.8%
Research and development 256,055 226,479 29,576 13.1%
Reserve on stockholder note
receivable(2) 9,129,343 -- 9,129,343 100.0%
Cost of disposal activities(2) 1,342,204 -- 1,342,204 100.0%
Impairment of fixed assets(2) 7,896,554 -- 7,896,554 100.0%
Loss on sale of assets 70,966 -- 70,966 100.0%
-----------------------------------------------------
Total operating expenses 28,236,241 8,687,637 19,548,604 225.0%
-----------------------------------------------------
Loss from Operations(3) (21,457,474) (823,379) (20,634,095) 2506.0%
Other Income (Expense), Net
Interest expense (1,246,490) (812,380) (434,110) 53.4%
Derivative income (expense) -- 62,829 (62,829) -100.0%
Gain/(loss) on FV of warrants 388,731 258,937 129,794 50.1%
-----------------------------------------------------
Total (857,759) (490,614) (367,145) 74.8%
-----------------------------------------------------
NET LOSS (22,315,233) (1,313,993) (21,001,240) 1598.3%
Interest expense 1,246,490 812,380 434,110 53.4%
Depreciation 1,463,036 1,633,256 (170,220) -10.4%
-----------------------------------------------------
EBITDA, (a non-GAAP measure) (19,605,707) 1,131,643 (20,737,350) -1832.5%
=====================================================
As a Percentage of Net Sales -66.8% 3.4%
=========================
(1) In our calculation of key financial measures, we exclude the non-cash
compensation related to stock-based transactions because we believe that
this item does not accurately reflect our current on-going operations.
Many times non-cash compensation is calculated based on fluctuations in
our stock price, which can skew the financial results dramatically up and
down. The price of our common shares as traded on AMEX is outside our
control and typically does not reflect our current operations.
(2) In our calculation of key financial measures, we exclude the employment
contract expenses related to Angelo S. Morini and Christopher J. New, the
reserve on stockholder note receivable, and fixed asset impairment charges
and disposal costs because we believe that these items do not reflect
expenses related to our current on-going operations. See below for a
detailed description of these items.
26
(3) Operating Loss has increased due the increase in non-cash stock
compensation expense as discussed below under general and administrative,
and certain non-standard expenses such as the reserve on stockholder note
receivable, and fixed asset impairment charges and disposal costs related
to the Asset Purchase Agreement and the Supply Agreement with Schreiber as
discussed under Recent Material Developments.
Selling
Selling expense is partly a function of sales through variable costs such as
brokerage commissions and promotional costs. Our selling expense typically
averages between 12% and 13% of net sales. In each of the first nine months of
fiscal 2006 and 2005 selling expense averaged 13% of net sales. In addition to
the variable costs, selling expense consists of certain fixed costs such as
advertising, employee salaries and benefits, travel and administrative overhead.
The consistency as a percentage of sales often relates to the timing of
advertising and promotional spending. We expect to spend $400,000 to $500,000
more on advertising in fiscal 2006 than in fiscal 2005, but the second wave of
advertising will occur in the fourth quarter of fiscal 2006 resulting in a
higher percentage of selling expense for the fourth quarter of fiscal 2006
compared to fiscal 2005, but still consistent on an annual basis. We sell our
products through our internal sales force and an independent broker network.
Delivery
Delivery expense is primarily a function of sales. In the past, delivery expense
remained consistent at approximately 5% of net sales. However, this increased to
6% of net sales in the third quarter and the first nine months of fiscal 2006
due to higher fuel prices and surcharges charged by the transportation
companies.
Since we transferred all production and distribution responsibilities to
Schreiber by the end of the third quarter of fiscal 2006, we expect our delivery
expenses to decrease significantly as a result of an agreed upon delivery price
per pound of product with Schreiber that is lower than our current delivery cost
per pound of product.
General and administrative
General and administrative expenses increased approximately $623,000 in the
third quarter of fiscal 2006 compared to the third quarter of fiscal 2005
primarily due to increases of approximately $300,000 in additional bad debt
costs primarily related to the transition from indirect to direct sales to
Wal-mart as discussed above under Net Sales, $213,000 in liquidated damages
accrued in related to a registration rights agreement as discussed below under
Equity Financing, $33,000 additional insurance costs due to higher coverages and
increased premiums effective in April 2005, $109,000 in consulting fees for our
outsourcing and sale arrangements, and $109,000 in additional professional fees
for legal and audit services due to additional review of strategic alternatives
and SEC filings during the third quarter of fiscal 2006. These increases were
reduced by a decrease in non-cash compensation related to stock-based
transactions of approximately $124,000, as detailed below.
General and administrative expenses increased approximately $1,987,000 in the
first nine months of fiscal 2006 compared to the first nine months of fiscal
2005 primarily due to increases of approximately $706,000 in additional non-cash
compensation related to stock-based transactions, as detailed below, $567,000 in
additional bad debt costs primarily related to the transition from indirect to
direct sales to Wal-mart as discussed above under Net Sales, $285,000 in
liquidated damages accrued in related to a registration rights agreement as
discussed below under Equity Financing, $98,000 additional insurance costs due
to higher coverages and increased premiums effective in April 2005, $109,000 in
consulting fees for our outsourcing and sale arrangements, and $326,000 in
additional professional fees for legal and audit services due to additional
review of strategic alternatives and SEC filings during the first nine months of
fiscal 2006. These increases were reduced by $150,000 of income we received
pursuant to a Termination, Settlement and Release Agreement signed on July 22,
2005 with Fromageries Bel S.A.
Excluding the effects of non-cash compensation related to stock-based
transactions, which cannot be predicted, we anticipate that general and
administrative expenses in the fourth quarter of fiscal 2006 will be
significantly reduced due to the non-recurrence of the $1.6 million in bad debt
expense that occurred in the fourth quarter of fiscal 2005.
The change in non-cash compensation related to stock-based transactions that are
included in general and administrative expenses are detailed as follows:
27
3-Months Ended December 31, 2005 9-Months Ended December 31, 2005
------------------------------------- -------------------------------------------
$ % $ %
2005 2004 Change Change 2005 2004 Change Change
- ---------------------------------------------------------------------- -------------------------------------------
Stock-based award compensation
under SFAS No. 123 52,676 176,186 (123,510) -70.1% 1,116,069 217,388 898,681 413.4%
Option modifications under
APB 25 awards -- -- -- 0.0% (192,556) -- (192,556) -100.0%
------------------------------------- -------------------------------------------
Non-cash compensation related
to stock based transactions 52,676 176,186 (123,510) -70.1% 923,513 217,388 706,125 324.8%
===================================== ===========================================
Effective April 1, 2003, we elected to record compensation expense measured at
fair value for all stock-based award transactions (including, but not limited
to, restricted stock awards, stock option grants, and warrant issuances) granted
on or after April 1, 2003 under the provisions of SFAS No. 123. Prior to April
1, 2003, we only recorded the fair value of stock-based awards granted to
non-employees or non-directors under the provisions of SFAS No. 123. The fair
value of the stock-based award is determined on the date of grant using the
Black-Scholes pricing model and is expensed over the vesting period of the
related award. Prior to April 1, 2003, we accounted for our stock-based employee
and director compensation plans under the accounting provisions of APB No. 25 as
interpreted by FASB Interpretation No. 44 ("FIN 44"). Any modifications of fixed
stock options or awards granted to employees or directors originally accounted
for under APB No. 25 may result in additional compensation expense under the
provisions of FIN 44.
In accordance with the above accounting standards, we calculate and record
non-cash compensation related to our securities in the general and
administrative line item in our Statements of Operations based on two primary
items:
a. Stock-Based Award Issuances and Modification under SFAS No. 123
During the three months ended December 31, 2005 and 2004, we recorded
$52,676 and $176,186, respectively, in non-cash compensation expense
related to stock-based transactions that were issued to and vested by
employees, officers, directors and consultants. During the nine months
ended December 31, 2005 and 2004, we recorded $1,116,069 and $217,388,
respectively, in non-cash compensation expense related to stock-based
transactions that were issued to and vested by employees, officers,
directors and consultants.
b. Option Modifications for Awards granted to Employees or Directors under
APB No. 25
On October 11, 2002, we repriced all outstanding options granted to
employees prior to October 11, 2002 (4,284,108 shares at former prices
ranging from $2.84 to $10.28) to the market price of $2.05 per share.
Prior to the repricing modification, the options were accounted for as a
fixed award under APB No. 25. In accordance with FIN 44, the repricing of
the employee stock options requires additional compensation expense to be
recognized and adjusted in subsequent periods for changes in the price of
our common stock that are in excess of the $2.05 stock price on the date
of modification (additional intrinsic value). If there is a decrease in
the market price of our common stock compared to the prior reporting
period, the reduction is recorded as compensation income to reverse all or
a portion of the expense recognized in prior periods. Compensation income
is limited to the original base exercise price (the intrinsic value) of
the options. This variable accounting treatment for these modified stock
options began with the quarter ended December 31, 2002 and such variable
accounting treatment will continue until the related options have been
cancelled, expired or exercised. There are 3,498,163 outstanding modified
stock options remaining as of December 31, 2005. We recorded non-cash
compensation income of $192,556 for the nine months ended December 31,
2005 related to the modified options described above. We did not record
any income or expense related to these variable options during the three
months ended December 31, 2005 and 2004 and during the nine months ended
December 31, 2004, as the stock price was below $2.05 at the beginning and
end of the periods.
Reserve on stockholder note receivable
In June 1999, in connection with an amended and restated employment agreement
for Angelo S. Morini,, our Founder and member of our Board of Directors, we
consolidated two full recourse notes receivable ($1,200,000 from November 1994
and $11,572,200 from October 1995) related to the exercise of 2,914,286 shares
of our common stock into a single note receivable in the amount of $12,772,200
that is due on June 15, 2006. This single consolidated note is non-interest
bearing and non-recourse and is secured by the 2,914,286 underlying shares of
our common stock. Per the terms of the June 1999 Employment Agreement that was
amended and restated by the October 2003 Second Amended and Restated Employment
Agreement between our Company and Mr. Morini, this loan may be forgiven upon the
occurrence of any of the following events: 1) Mr. Morini is terminated without
cause; 2) there is a material breach in the terms of Mr. Morini's employment
agreement; or 3) there is a change in control of the Company for which Mr.
Morini did not vote "FOR" in his capacity as a director or a stockholder.
28
In the event that the $12,772,200 loan is forgiven, we would reflect this amount
as a forgiveness of debt in the Statement of Operations. In the event that Mr.
Morini is unable to pay the loan when due and we foreclose on the shares, we
would reflect a loss on collection for the amount that the value of the
2,914,286 underlying collateral shares are below the value of the note. In
December 2005, we reserved $9,129,343 against this stockholder note receivable
under the assumption that we will not be able to collect proceeds in excess of
the $3,642,857 value of the underlying collateral shares. The value of the
underlying collateral shares was computed using the market price of our common
stock on December 31, 2005 of $1.25 multiplied by the 2,914,286 shares. Although
this reserve resulted in a material loss to our operations, it does not have any
affect on the balance sheet since the $12,772,200 loan amount was already shown
as a reduction to Stockholders' Equity (Deficit).
Cost of disposal activities
We are accounting for the costs associated with the Schreiber transactions in
accordance with SFAS No. 146, "Accounting for Costs Associated with an Exit or
Disposal Activity," because the arrangements are planned and controlled by
management and materially change the manner in which our business will be
conducted. In accordance with SFAS No. 146, costs associated with disposal
activities should be reported as a reduction of income from operations. For the
three and nine months ended December 31, 2005, we incurred and reported $668,936
and $1,342,204 as Costs of Disposal Activities in the Statement of Operations.
As of December 31, 2005, 97 employee positions had been eliminated with the
final five employee positions to be eliminated by February 28, 2006. The
majority of the remaining employee termination costs are expected to be paid in
the fourth quarter of fiscal 2006. In December 2005, we abandoned our
distribution facility and the production portion of our administrative facility
and accrued $396,197 related to abandonment of these facilities. This amount was
calculated as the present value of the remaining lease rentals, reduced by the
estimated market value of sublease rentals. If we do not sublease these
facilities, the actual loss will exceed this estimate. Other exit costs consist
primarily of legal and professional fees related to the disposal activities.
A summary of the disposal costs recognized for the nine months ended December
31, 2005 is as follows:
Employee
Termination Excess Other Exit
Costs Facilities Costs Total
-------------- ---------- ---------- ----------
Disposal Costs Incurred $ 411,412 $ 396,197 $ 534,595 $1,342,204
============== ========== ========== ==========
We anticipate that in future periods, there will be additional disposal costs
related to professional fees, contract cancellation charges and higher lease
abandonment charges to reflect the cost of abandoned facilities that were not
subleased during the period. We may be required to adjust our accrual and
estimated expense related to employee termination costs if the actual timing of
the terminations changes from original estimates.
Impairment of property and equipment and loss on sale of assets
In light of the Schreiber transactions discussed above under Recent Material
Developments, in the second quarter of fiscal 2006, we determined that it is
more likely than not that a majority of our fixed assets related to production
activities will be sold or disposed prior to the end of their useful life. In
accordance with SFAS No. 144, "Accounting for the Impairment of Disposal of
Long-Term Assets," we wrote down the value of our assets to their estimated fair
values in June 2005. We estimated the fair value based on the $8,700,000 sales
price to Schreiber and the anticipated sales price related to any other assets
to be held for sale plus future cash flows related to the assets from July 1,
2005 until the end of production on December 8, 2005. Based on this estimate, we
recorded an impairment of property and equipment of $7,896,554 in order to
reflect a net fair value of our equipment in June 2005.
All assets continued to be used and depreciated under Property and Equipment
until the sale of substantially all of our production machinery and equipment on
December 8, 2005. For the nine months ended December 31, 2005, we recorded a
$70,966 loss on the sale of assets related to the remaining value of assets sold
or abandoned after production ceased in December 2005.
Other income and expense
Interest expense increased approximately $307,000 and $434,000 in the three and
nine months ended December 31, 2005, respectively. The increases were primarily
the result of increased amortization related to loan costs and debt discounts.
The amortization of loan costs increased by $150,000 and $193,000 in the three
and nine months ended December 31, 2005, respectively, due to additional loan
fees charged by our lenders and due to the acceleration of the amortization
related to loan fees on the Beltway loan that was paid in full in December 2005,
as further described under Debt Financing. Additionally, pursuant to several
Note and Warrant Purchase Agreements, as further described under Debt Financing,
we issued warrants to purchase up to 600,000 shares of our common stock. In
accordance with the accounting provisions of SFAS No. 123, we recorded the
$444,731 initial fair value of the warrants as a discount to debt. This non-cash
discount is being amortized from September 2005 through June 2006 and is
included in interest expense. We amortized $152,376 and $165,376 in the three
and nine months ended December 31, 2005. We are incurring increased interest
expense due to higher prime rates in fiscal 2006 compared to fiscal 2005 (on
average 2.0% higher), which is the basis for the floating interest rates used by
our lenders. However, due to lower debt balances in the fourth quarter of fiscal
2006 as compared to the fourth quarter of fiscal 2005 we expect actual cash paid
for interest to decrease by approximately $150,000. Total interest expense in
the fourth quarter of fiscal 2006 should approximate or exceed the fourth
quarter of fiscal 2005 due to the amortization of the non-cash debt discount
until June 2006 as discussed above.
29
Derivative income/expense represents the adjustment for the change in the fair
value of the embedded derivative in our Series A convertible preferred stock,
which met the criteria for bifurcation and separate accounting under SFAS No.
133. The fair value of the embedded derivative was computed based on several
factors including the underlying value of our common stock at the end of each
quarter. For the three and nine months ended December 31, 2004, we recorded a
derivative (expense) income of ($258,658) and $62,829, respectively, related to
the change in the fair value of the embedded derivative instruments. There was
no income or expense in these comparative periods in fiscal 2006 because the
Series A convertible preferred stock was partially converted and the remaining
shares redeemed in the third quarter of fiscal 2005.
Since the conversion of our Series A convertible preferred stock could have
resulted in a conversion into an indeterminable number of common shares, we
determined that under the guidance in paragraph 24 of EITF 00-19, "Accounting
for Derivative Financial Instruments Indexed To, and Potentially Settled in the
Company's Own Stock," we were prohibited from concluding that we had sufficient
authorized and unissued shares to net-share settle any warrants or options
issued to non-employees. Therefore, we reclassified to a liability the fair
value of all warrants and options issued to non-employees that were outstanding
during the period that the Series A convertible preferred stock was outstanding
from April 2001 to October 2004. Additionally, in accordance with EITF 00-19, if
a contract requires settlement in registered shares, then it may be required to
record the value of the securities as a liability and/or temporary equity. Any
changes in the fair value of the securities based on the Black-Scholes pricing
model after the initial valuation are marked to market during reporting periods.
During the three and nine months ended December 31, 2005, we recorded a gain
(loss) of ($8,269) and $388,731, respectively, related to the change in the fair
values of the warrants. During the three and nine months ended December 31,
2004, we recorded a gain (loss) of ($202,414) and $258,937, respectively,
related to the change in the fair values of the warrants.
Liquidity And Capital Resources
9-Months Ended
-------------------------------------------------
December 31, $ %
2005 2004 Change Change
- --------------------------------------------------------------------------------------------
Cash from (used in) operating activities (787,181) (180,638) (606,543) 335.8%
Cash from (used in) investing activities 8,442,722 (42,725) 8,485,447 -19860.6%
Cash from (used in) financing activities (7,838,369) (114,698) (7,723,671) 6733.9%
-------------------------------------------------
Net increase (decrease) in cash (182,828) (338,061) 155,233 -45.9%
=================================================
Operating and Investing Activities
On December 8, 2005, we completed the sale of substantially all of our
manufacturing and production equipment to Schreiber. This sale was approved by
our stockholders at a Special Meeting held on December 5, 2005. The $8,700,000
in proceeds was used to pay $1,319,583 for tangible personal property taxes due
primarily on the sold assets and $7,374,299 to Beltway Capital Partners LLC
(successor by assignment of Wachovia Bank, N.A.) for the termination of our term
loan. The remaining proceeds balance of $6,118 was used to reduce our
asset-based line of credit from Textron Financial Corporation.
Cash from operating activities declined during the first nine months of fiscal
2006 due to higher operating expenses and the disposal costs as described under
Results of Operations. Additionally, accounts receivable is increasing back to
its normal levels similar to those as of December 2004. The accounts receivable
balance as of March 31, 2005 was lower than average for the sales volume due to
a large reserve of nearly $1.6 million that was recorded as of March 31, 2005.
We are continually reviewing our collection practices and payment terms to
vendors in order to maximize cash flow from operations.
30
As part of the outsourcing transition, we expect to see a decrease in cash from
operations due to the additional disposal costs remaining to be paid. However,
upon complete implementation in the fourth quarter of fiscal 2006, we expect to
improve cash flows from operations due to the elimination of excess overhead
costs and inventory costs.
Financing Activities
9-Months Ended
--------------------------------------------------
December 31, $ %
2005 2004 Change Change
- ------------------------------------------------------------------------------------------
Net borrowings (payments) on line of
credit and bank overdrafts (3,219,757) 941,426 (4,161,183) -442.0%
Net borrowings (payments) of debt and
capital leases & associated costs (6,325,110) (1,000,282) (5,324,828) 532.3%
Issuances of stock & associated costs 1,706,498 2,223,846 (517,348) -23.3%
Redemption of preferred stock -- (2,279,688) 2,279,688 -100.00%
--------------------------------------------------
Cash from (used in) financing
activities (7,838,369) (114,698) (7,723,671) 6733.9%
==================================================
Debt Financing
On May 27, 2003, we obtained from Textron Financial Corporation ("Textron") a
revolving credit facility (the "Textron Loan") with a maximum principal amount
of $7,500,000 pursuant to the terms and conditions of a Loan and Security
Agreement dated May 27, 2003 (the "Textron Loan Agreement"). The Textron Loan is
secured by our inventory, accounts receivable and all other assets. Generally,
subject to the maximum principal amount which can be borrowed under the Textron
Loan and certain reserves that must be maintained during the term of the Textron
Loan, the amount available under the Textron Loan for borrowing by our Company
from time to time is equal to the sum of (i) 85% of the net amount of our
eligible accounts receivable plus (ii) until December 31, 2005, 60% of our
eligible inventory not to exceed $3,500,000. After December 31, 2005, there is
no borrowing available on inventory since it is not produced or held by us.
Advances under the Textron Loan bear interest at a variable rate, adjusted on
the first (1st) day of each month, equal to the prime rate plus 1.75% per annum
(9.0% at December 31, 2005) calculated on the average cash borrowings for the
preceding month. The initial term of the Textron Loan ends on May 26, 2006. As
of December 31, 2005, the outstanding principal balance on the Textron Loan was
$2,238,722.
The Textron Loan Agreement contains certain financial and operating covenants.
On June 3, 2005, we executed a fourth amendment to the Textron Loan Agreement
that provided a waiver on all the existing defaults for the fiscal quarters
ended December 31, 2004 and March 31, 2005, and amended the fixed charge
coverage ratio and the adjusted tangible net worth requirements for periods
after March 31, 2005. Additionally, the fourth amendment allowed the Textron
Loan to be in an over-advance position not to exceed $750,000 until July 31,
2005. In exchange for the waiver and amendments, our interest rate on the
Textron Loan was set at Prime plus 4.75% and we paid a fee of $50,000.
On June 16, 2005, we used a portion of the proceeds from the warrant exercises
described below under Equity Financing to satisfy the $750,000 over-advance with
Textron. In connection with the satisfaction of the over-advance, we agreed to
immediately terminate Textron's obligation to permit any over-advances under the
Textron Loan, which obligation was to expire on July 31, 2005. With the
termination of the over-advance facility, the interest rate on the Textron Loan
returned to its prior level of Prime plus 1.75%.
Due to the cost of disposal activities and impairment of property and equipment,
we fell below the requirements in the fixed charge coverage ratio and the
adjusted tangible net worth calculation from June 30, 2005 through September 30,
2005. Effective October 1, 2005, we executed a fifth amendment to the Textron
Loan Agreement that provided a waiver for the defaults in the fixed charge
coverage ratio and the adjusted tangible net worth requirements, in addition to
certain over-advances on the Textron Loan, during the periods from June 2005
through September 2005. The fifth amendment amends and replaces several
financial covenants, allows eligibility for borrowing on inventory until
December 31, 2005 and provides that the Textron Loan will expire at the end of
the initial term on May 26, 2006. Additionally, Textron consented to the sale of
our manufacturing equipment to Schreiber and terminated their liens on those
assets. In exchange for the waiver and amendments, we paid a fee of $50,000, and
has agreed to pay an administration fee in the following installments if the
Textron Loan has not then been paid in full: $5,000 on February 1, 2006, $10,000
on March 1, 2006, $15,000 on April 1, 2006 and $20,000 May 1, 2006. We
anticipate that we will be in compliance with the amended covenants and
reporting requirements through the end of the term of the Textron Loan on May
26, 2006.
31
Simultaneous with the closing of the Textron Loan in May 2003, Wachovia Bank,
N.A. successor by merger to SouthTrust Bank ("Wachovia") extended our Company a
new term loan in the principal amount of $2,000,000. This term loan was
consolidated with our March 2000 term loan with Wachovia, which had a then
outstanding principal balance of $8,131,985 for a total term loan amount of
$10,131,985. This term loan was secured by all of our equipment and certain
related assets. Additionally, the term loan bore interest at Wachovia's Base
Rate plus 1%.
On June 30, 2005, we entered into a Loan Modification Agreement with Wachovia
regarding our term loan. The agreement modified the following terms of the loan:
1) the loan will mature and be payable in full on July 31, 2006 instead of June
1, 2009; 2) the principal payments will remain at $110,000 per month with
accrued interest at Wachovia's Base Rate plus 1% instead of increasing to
$166,250 on July 1, 2005 as provided by the terms of the promissory note
evidencing the loan; and 3) all covenants related to our tangible net worth,
total liabilities to tangible net worth, and maximum funded debt to EBITDA
ratios are waived and compliance is not required by us through the maturity of
the loan on July 31, 2006. In connection with the agreement, we paid $60,000, of
which $30,000 was paid upon execution of the agreement and $30,000 was paid on
August 1, 2005.
In September 2005, Wachovia assigned this term loan to Beltway Capital Partners
LLC. As discussed under the Schreiber Transactions in Recent Material
Developments above, this loan was paid in full upon the sale of the equipment to
Schreiber on December 8, 2005. Beltway received proceeds of $7,374,299 of which
$7,361,985 was for principal and $12,314 was for interest and associated closing
costs.
Pursuant to a Note and Warrant Purchase Agreement dated September 12, 2005, we
received $1,200,000 as a loan from Mr. Frederick A. DeLuca, a greater than 10%
shareholder. In October 2005, pursuant to several Note and Warrant Purchase
Agreements dated September 28, 2005, we received a $600,000 loan from Conversion
Capital Master, Ltd., a $485,200 loan from SRB Greenway Capital (Q.P.), L.P., a
$69,600 loan from SRB Greenway Capital, L.P., and a $45,200 loan from SRB
Greenway Offshore Operating Fund, L.P. The combined total of these loans is
$2,400,000. The loans are evidenced by unsecured promissory notes (the "Notes")
held by the above referenced parties (the "Note Holders"). The Notes require
monthly interest-only payments at 3% above the bank prime rate of interest per
the Federal Reserve Bank and mature on June 15, 2006. In consideration for the
Notes and in accordance with an exemption from registration provided by Section
4(2) of the Securities Act of 1933, as amended, we issued to Mr. DeLuca,
Conversion Capital Master, Ltd., SRB Greenway Capital (Q.P.), L.P., SRB Greenway
Capital, L.P., and SRB Greenway Offshore Operating Fund, L.P., warrants to
purchase up to 300,000 shares, 150,000 shares, 121,300 shares, 17,400 shares,
and 11,300 shares, respectively, of our common stock at an exercise price equal
to $1.53 (95% of the lowest closing price of our common stock in the sixty
calendar days immediately preceding October 17, 2005). The warrants fully vested
on October 17, 2005 and can be exercised on or before the expiration date of
October 17, 2008. Also in consideration for the Notes, we granted the Note
Holders "piggy back" registration rights with respect to the shares underlying
the warrants. These shares were registered on December 30, 2005.
In accordance with the accounting provisions of SFAS No. 123, we recorded the
$444,731 initial fair value of the warrants, upon their issuance, as a discount
to debt. This discount is being amortized from September 2005 through June 2006.
We amortized $152,376 and $165,376 in the three and nine months ended December
31, 2005, respectively. As of December 31, 2005, the outstanding principal
balance of $2,400,000 on the Notes less the remaining debt discount is
$2,120,645.
Since the exercise price for the warrants was not fixed until October 17, 2005,
we revalued the warrants on October 17, 2005 and calculated a fair value of
$396,000. The $48,731 difference between the initial $444,731 value of the
warrants and the value of the warrants on October 17, 205 was recorded as a gain
on fair value of warrants in the Statement of Operations.
Equity Financing
In accordance with a warrant agreement dated April 10, 2003, we issued to Mr.
Frederick DeLuca, a greater than 10% shareholder, a warrant to purchase up to
100,000 shares of our common stock at an exercise price of $1.70 per share.
Additionally, in accordance with a warrant agreement dated October 6, 2004, we
issued to Mr. DeLuca a warrant to purchase up to 500,000 shares of our common
stock at an exercise price of $1.15 per share. Subsequently in June 2005, we
agreed to reduce the per-share exercise price on these warrants to $1.36 and
$0.92, respectively, in order to induce Mr. DeLuca to exercise his warrants. All
of the warrants were exercised on June 16, 2005 for total proceeds of $596,000.
On each of April 24, 2003 and October 6, 2004, BH Capital Investments, LP and
Excalibur Limited Partnership each received warrants to purchase up to 250,000
shares of our common stock at an exercise price of $2.00 per share. Also,
Excalibur Limited Partnership received a warrant to purchase up to 30,000 shares
of our common stock at an exercise price of $2.05 per share on June 26, 2002.
Subsequently in June 2005, we agreed to reduce the per-share exercise price on
all such warrants to $1.10 in order to induce BH Capital Investments, LP and
Excalibur Limited Partnership to exercise their warrants. All of the warrants
were exercised on June 16, 2005 for total proceeds of $1,133,000.
32
In accordance with the accounting provisions of SFAS No. 123, we recorded
$1,024,500 in non-cash compensation expense related to the reduction in the
exercise price of the above-mentioned warrants in June 2005.
We used a portion of the proceeds from the warrant exercises to satisfy the
$750,000 over-advance provided by Textron under the Fourth Amendment and Waiver
to the Textron Loan Agreement, as described under Debt Financing and the
remaining proceeds from the warrant exercises were used for working capital
purposes.
In accordance with a registration rights agreement dated October 6, 2004 with
Mr. Frederick DeLuca, we agreed that within 180 days we would file with the
Securities and Exchange Commission ("SEC") and obtain effectiveness of a
registration statement that included 2,000,000 shares issued in a private
placement and 500,000 shares related to a stock purchase warrant. Per the terms
of the agreement, if a registration statement was not filed, or did not become
effective within 180 days, then in addition to any other rights the Mr. DeLuca
may have, we would be required to pay certain liquidated damages. We filed a
registration statement on Form S-3 on March 14, 2005. However, the registration
was not declared effective until December 30, 2005. Mr. DeLuca granted an
extension of time to have the registration statement declared effective by the
SEC and waived all damages and remedies for failure to have an effective
registration statement until September 1, 2005. From September 2, 2005 through
December 29, 2005, we accrued liquidated damages of $285,104 (2.5% times the
product of 2,500,000 registerable shares and the share price of $1.15 per share
every thirty days).
Summary
As we continue with the sale of the remaining assets held for sale and the
outsourcing transition, we anticipate that we will see additional gains and/or
losses from the sale of various assets and non-recurring expenses for disposal
costs. However, with the reduction in overall debt and property taxes, we expect
to see annual interest savings in excess of $800,000.
We believe that with the above debt service savings and anticipated reductions
in our costs of goods sold beginning in January 2006, we will have enough cash
to meet our needs for general operations through December 31, 2006. However, it
is uncertain at this time if we will have enough cash from operations to repay
the Textron Loan that matures in May 2006 and the aggregate of $2,400,000 in
loans from the Note Holders that mature in June 2006 as discussed under Debt
Financing. If we cannot generate enough cash from operations and the sale of our
remaining assets that are held for sale by these maturity dates, and we are
unable to refinance or renew these loans, or if additional financing is not
available on terms acceptable to us, we will be unable to satisfy such
facilities by their maturity dates. In such an event, Textron and the Note
Holders could exercise their respective rights under their loan documents, which
could include, among other things, declaring defaults under the loans and
pursuing foreclosure on our assets that are pledged as collateral for such
loans. If such an event occurred, it would be substantially more difficult for
us to effectively continue the operation of our business, and it is unlikely
that we would be able to continue as a going concern.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Our exposure to market risk results primarily from fluctuations in interest
rates. The interest rates on our outstanding debts to Textron and Note Holders
are floating and based on the prevailing market interest rates. For market-based
debt, interest rate changes generally do not affect the market value of the debt
but do impact future interest expense and hence earnings and cash flows,
assuming other factors remain unchanged. A theoretical 1% increase or decrease
in market rates in effect on December 31, 2005 with respect to our debt as of
such date would increase or decrease interest expense and hence reduce or
increase the net income of our Company by approximately $46,000 per year or
$11,500 per quarter.
Our sales during the quarters ended December 31, 2005 and 2004, which were
denominated in a currency other than U.S. Dollars, were less than 5% of gross
sales and no net assets were maintained in a functional currency other than U.
S. Dollars during such periods. However, further declines in the U.S. Dollar on
the international market, may cause our foreign suppliers of raw materials,
particularly casein, to increase their U.S. Dollar prices on future orders from
our Company. Therefore, while we believe that the effects of changes in foreign
currency exchange rates have not historically been significant to our operations
or net assets, we are unable to forecast the effects that foreign currency
exchange rates may have on our future operations.
33
Item 4. Controls and Procedures
As of December 31, 2005, an evaluation was performed under the supervision and
with the participation of our management, including the Chief Executive Officer
("CEO"), and the Chief Financial Officer ("CFO"), of the effectiveness of the
design and operation of our disclosure controls and procedures to insure that
our Company records, processes, summarizes and reports in a timely and effective
manner the information required to be disclosed in reports filed with or
submitted to the Securities and Exchange Commission. Based on that evaluation,
our management, including the CEO and CFO, concluded that our disclosure
controls and procedures were effective in timely bringing to their attention
material information related to our Company required to be included in our
periodic Securities and Exchange Commission filings, except for the control
noted below. Since the date of this evaluation, there have been no changes in
our internal controls or in other factors that are reasonably likely to
materially affect those controls, except as noted below.
The CEO and CFO considered the restatement of our financial statements in
October 2005 for the periods from March 31, 2001 through June 30, 2005 and
concluded that such restatements were the result of a material weakness relating
to the accounting and disclosure for complex and non-standard stockholders'
equity transactions. To address our Company's material weakness related to the
accounting and disclosure for complex and non-standard stockholders' equity
transactions, we have enhanced our internal control processes in order to be
able to comprehensively review the accounting and disclosure implications of
such transactions on a timely basis. As part of the enhancement, we have
subscribed to additional outside research materials and will consult with
additional outside consultants to confirm our understanding of complex
transactions, as necessary.
34
PART II. OTHER INFORMATION
Item 1A. Risk Factors
Statements other than historical information contained in this Form 10-Q are
considered "forward-looking statements" as defined under the Private Securities
Litigation Reform Act of 1995. These statements relate to future events or our
future financial performance. These forward-looking statements are based on our
current expectations, estimates and projections about our industry, management's
beliefs and certain assumptions made by our company. Words such as "anticipate,"
"expect," "intend," "plan," "believe," "seek," "project," "estimate," "may,"
"will," and variations of these words or similar expressions are intended to
identify forward-looking statements. These statements are not guarantees of
future performance and are subject to certain risks, uncertainties and
assumptions that are difficult to predict. Therefore, actual results may differ
materially from our Company's historical results and those expressed or
forecasted in any forward-looking statement as a result of a variety of factors
as set forth below. We believe that these forward-looking statements are
reasonable at the time they are made. However, we undertake no obligation to
publicly update or revise any forward-looking statements for any reason, even if
new information becomes available or other events occur in the future.
In addition to the other information in this Form 10-Q and the risk factors
previously disclosed in our Annual Report on Form 10-K for the year ended March
31, 2005, the following are some of the factors that could cause our Company's
actual results to differ materially from the expected results described in or
underlying our Company's forward-looking statements. These factors should be
considered carefully while evaluating our business and prospects. If any of the
following risks actually occur, they could seriously harm our business,
financial condition, results of operations or cash flows.
We will need additional financing and such financing may not be available.
We have incurred substantial debt in connection with the financing of our
business. The aggregate principal amount outstanding under our credit facilities
is approximately $4,638,722 as of December 31, 2005. This amount includes a
revolving line of credit from Textron Financial Corporation ("Textron") in the
amount of $2,238,722, and several notes payable to certain Note Holders (as
described under Debt Financing) totaling $2,400,000. We will need to refinance
or raise proceeds to pay the Textron line of credit on or before its maturity
date of May 26, 2006 and the notes payable to the Note Holders on or before
their maturity date of June 15, 2006.
If we cannot generate enough cash from operations and the sale of our remaining
assets that are held for sale by these maturity dates, and we are unable to
refinance or renew these loans, or if additional financing is not available on
terms acceptable to us, we will be unable to satisfy such facilities by their
maturity dates. In such an event, Textron and the Note Holders could exercise
their respective rights under their loan documents, which could include, among
other things, declaring defaults under the loans and pursuing foreclosure on our
assets that are pledged as collateral for such loans. If such an event occurred,
it would be substantially more difficult for us to effectively continue the
operation of our business, and it is unlikely that we would be able to continue
as a going concern.
Forgiveness of or foreclosure on our note receivable will result in a material
affect to our reported earnings.
In June 1999, in connection with an amended and restated employment agreement
for Angelo S. Morini,, our Founder and member of our Board of Directors, we
consolidated two full recourse notes receivable ($1,200,000 from November 1994
and $11,572,200 from October 1995) related to the exercise of 2,914,286 shares
of our common stock into a single note receivable in the amount of $12,772,200
that is due on June 15, 2006. This single consolidated note is non-interest
bearing and non-recourse and is secured by the 2,914,286 underlying shares of
our common stock. Per the terms of the June 1999 Employment Agreement that was
amended and restated by the October 2003 Second Amended and Restated Employment
Agreement between our Company and Mr. Morini, this loan may be forgiven upon the
occurrence of any of the following events: 1) Mr. Morini is terminated without
cause; 2) there is a material breach in the terms of Mr. Morini's employment
agreement; or 3) there is a change in control of the Company for which Mr.
Morini did not vote "FOR" in his capacity as a director or a stockholder.
In the event that the $12,772,200 loan is forgiven, we would reflect this amount
as a forgiveness of debt in the Statement of Operations. In the event that Mr.
Morini is unable to pay the loan when due and we foreclose on the shares, we
would reflect a loss on collection for the amount that the value of the
2,914,286 underlying collateral shares are below the value of the note. In
December 2005, we reserved $9,129,343 against this stockholder note receivable
under the assumption that we will not be able to collect proceeds in excess of
the $3,642,857 value of the underlying collateral shares. The value of the
underlying collateral shares was computed using the market price of our common
stock on December 31, 2005 of $1.25 multiplied by the 2,914,286 shares. Although
this reserve resulted in a material loss to our operations, it does not have any
affect on the balance sheet since the $12,772,200 loan amount was already shown
as a reduction to Stockholders' Equity (Deficit).
35
We lack an operating history as a branded marketing company and we may not be
successful.
There can be no assurance that we will be successful as a branded marketing
company. While we have marketed our products ourselves in the past, we lack an
operating history as solely a branded marketing company for investors to
evaluate our business and prospects. We have limited meaningful historical
financial data upon which to plan future operating expenses. Accordingly, we
face risks and uncertainties relating to our ability to successfully implement
our strategy. Investors must consider the risks, expenses, difficulties and
uncertainties frequently encountered by companies in their early stage of
transition. Failure to accurately forecast our revenues and future operating
expenses could cause quarterly fluctuations in our operating results, including
cash flows, and may result in further volatility of or a decline in our stock
price.
We depend on one supplier to manufacture and distribute all of our products to
our customers.
Pursuant to a Supply Agreement dated June 30, 2005 between our Company and
Schreiber Foods, Inc. ("Schreiber"), we depend solely on Schreiber to
manufacture and distribute all of our products to our customers. We will rely
solely on Schreiber to produce our products at prices that are competitive in
the market, to maintain the quality of our products, and to supply our customers
with the products they order on a timely basis. If Schreiber is unable to
deliver its services according to the negotiated terms of the Supply Agreement
for any reason, including the deterioration of its financial condition or
over-commitment of its resources, we may lose customers and we may be required
to purchase outsourcing services from another source at a higher price. Either
of these occurrences will likely reduce our profits to be realized or result in
a reduction in sales of our products.
We have received a notice of failure to satisfy a continued listing rule or
standard from the American Stock Exchange and we are in jeopardy of being
delisted from the American Stock Exchange.
On September 29, 2005, we received a deficiency letter from the American Stock
Exchange ("AMEX") advising that, based on its review of our Quarterly Report on
Form 10-Q for the quarter ended June 30, 2005, we are not in compliance with
AMEX's continued listing requirements. Specifically, the AMEX notice stated that
we are not in compliance with (i) Section 1003(a)(i) of the AMEX Company Guide,
because our shareholders' equity is less than $2,000,000 and we sustained losses
from continuing operations and/or net losses in two out of our three most recent
fiscal years; (ii) Section 1003(a)(ii) of the AMEX Company Guide, because our
shareholders' equity is less than $4,000,000 and we sustained losses from
continuing operations and/or net losses in three out of our four most recent
fiscal years; and (iii) Section 1003(a)(iv) of the AMEX Company Guide, because
we have sustained losses which are so substantial in relation to our overall
operations or our existing financial resources, or our financial condition has
become so impaired that it appears questionable, in the opinion of AMEX, as to
whether we will be able to continue operations and/or meet our obligations as
they mature.
On October 7, 2005, we filed an Amended Annual Report on Form 10-K/A for the
year ended March 31, 2005 and an Amended Quarterly Report on Form 10-Q/A for the
quarter ended June 30, 2005. Based on the revised financial information, we
notified AMEX on October 11, 2005 that we are also not in compliance with
Section 1003(a)(iii) of the AMEX Company Guide, because our shareholders' equity
is less than $6,000,000 and we sustained losses from continuing operations
and/or net losses in our five most recent fiscal years.
On October 28, 2005, we submitted a plan to AMEX, advising AMEX of actions that
we have taken, or will take, that would bring our Company into compliance with
Section 1003(a)(i), Section 1003(a)(ii), Section 1003(a)(iii) and Section
1003(a)(iv) of the AMEX Company Guide. Our plan noted that we have pursued and
continue to pursue four primary strategic alternatives: first, we sought and
have since obtained certain waivers and modifications of financial covenants
from our line of credit lender, Textron Financial Corporation; second, we
borrowed $2,400,000 on a short-term basis to alleviate cash flow difficulties;
third, we are in the process of transitioning into a branded marketing company
as a result of the outsourcing and equipment sale transactions with Schreiber,
which when completed should enable us to reduce our debt, lower our product and
distribution costs and improve our profitability; and finally, we have engaged
Goldman, Sachs & Co. to explore strategic alternatives for the enhancement of
shareholder value, including the possible sale of our Company.
36
On December 16, 2005, AMEX notified us that it accepted our plan to regain
compliance and granted our Company an extension until March 29, 2007 to regain
compliance with the continued listing standards. We will continue to be listed
during the extension period. However, we will be subject to periodic review by
AMEX during the extension period. If we do not make progress consistent with the
plan during the extension period or are not in compliance with the continued
listing standards at the end of the extension period, AMEX staff has advised us
that it would likely initiate delisting proceedings pursuant to Section 1009 of
the AMEX Company Guide.
On January 25, 2006, we notified AMEX that two members of our audit committee
resigned on January 21, 2006. Since we have only one remaining independent
director on the audit committee, we are not in compliance Section 121B(2)(a) of
the AMEX Company Guide which states that we must continue to have an audit
committee consisting of three members. We are currently in the process of
searching for two independent (for audit committee purposes) replacements who
would be qualified to fill the vacancies on the audit committee and are
currently using our three independent Board members to carry out the audit
committee responsibilities until the two replacements are found and appointed.
In the event we are delisted from AMEX, our securities may be eligible for
trading on the OTC Bulletin Board or on other unlisted markets such as The Pink
Sheets, although there can be no assurance that our securities will be eligible
for trading on any alternative exchanges or markets. As a consequence of such
delisting, an investor could find it more difficult to dispose of or to obtain
accurate quotations as to the market value of our securities. Among other
consequences, delisting from AMEX may cause a decline in the stock price and
difficulty in obtaining future financing.
As of September 30, 2005, we had a material weakness in our internal control
over financial reporting, and we might find other material weaknesses in the
future which may adversely affect our ability to provide timely and reliable
financial information and satisfy our reporting obligations under federal
securities laws.
As of September 30, 2005, we did not maintain effective controls over the
completeness and accuracy relating to the accounting and disclosure for complex
and non-standard stockholders' equity transactions. Specifically, we did not
have effective controls over accounting for our Series A convertible preferred
stock during the periods from April 2001 through October 2004 and other
mark-to-market securities, including warrants and shares exercised through a
note receivable, during the periods from March 2001 through June 2005. This
control deficiency resulted in the restatement of our financial statements for
the fiscal years ended March 31, 2005, 2004, 2003, 2002 and 2001, and the
restatement of the quarterly data for the first quarter ended June 30, 2005. Our
management therefore determined that this control deficiency constituted a
"material weakness" in our internal control over financial reporting relating to
the accounting and disclosure for complex and non-standard stockholders' equity
transactions.
To address our material weakness related to the accounting and disclosure for
complex and non-standard stockholders' equity transactions, we have enhanced our
internal control processes in order to be able to comprehensively review the
accounting and disclosure implications of such transactions on a timely basis.
As part of the enhancement, we have subscribed to additional outside research
materials and will consult with additional outside consultants to confirm our
understanding of complex transactions, as necessary.
We might find other material weaknesses in our internal control over financial
reporting in future periods. To the extent that any significant or material
weaknesses exist in our internal control over financial reporting, such
weaknesses may adversely affect our ability to provide timely and reliable
financial information necessary for the conduct of our business and satisfaction
of our reporting obligations under federal securities laws.
We have been subject to borrowing restrictions under our primary credit
facility.
In accordance with the fifth amendment to our loan agreement with Textron,
Textron requires us to maintain excess borrowing availability under the Textron
Loan in an amount no less than $500,000. Additionally, we may experience further
restrictions by Textron by virtue of reserves Textron may require, receivables
it may deem ineligible or other rights they have under the loan agreement. Such
restrictions would adversely affect our cash flows and results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
On December 5, 2005, we held a Special Meeting of Stockholders to approve the
sale of substantially all of our manufacturing and production equipment to
Schreiber Foods, Inc., a Wisconsin corporation ("Schreiber"), for $8,700,000 in
cash.
37
As of the record date on November 8, 2005, there were 20,051,327 shares of
common stock issued, outstanding and eligible to vote. The sale was approved by
74% of the stockholders with the vote tabulation as follows: VOTES CAST FOR -
14,860,768; VOTES CAST AGAINST - 21,311; ABSTENTIONS - 17,915; BROKER NON-VOTES
- - none.
The $8,700,000 in proceeds was used to pay $1,319,583 for tangible personal
property taxes due primarily on the sold assets and $7,374,299 to Beltway
Capital Partners LLC (successor by assignment of Wachovia Bank, N.A.) for the
termination of our term loan. The remaining proceeds balance of $6,118 was used
to reduce our asset-based line of credit from Textron Financial Corporation.
38
PART II. OTHER INFORMATION
Item 6. Exhibits
The following exhibits are filed as part of this Form 10-Q.
Exhibit No Exhibit Description
- ---------- -------------------
* 3.1 Restated Certificate of Incorporation of the Company as filed with
the Secretary of State of the State of Delaware on December 23,
2002 (Filed as Exhibit 3.2 on Form 10-Q for the fiscal quarter
ended December 31, 2002.)
* 3.2 By-laws of the Company, as amended (Filed as Exhibit 3.2 to
Registration Statement on Form S-18, No. 33-15893-NY.)
* 4.1 Stock Purchase Option Agreement and Stock Purchase Warrant by and
between Excalibur Limited Partnership and BH Capital Investments,
L.P. and Galaxy Nutritional Foods dated as of April 24, 2003 (Filed
as Exhibit 10.52 on Form 10-Q for the fiscal quarter ended June 30,
2003.)
* 4.2 Warrant to Purchase Securities of Galaxy Nutritional Foods, Inc.
dated as of May 29, 2003 in favor of Wachovia Bank (Filed as
Exhibit 10.7 on Form 8-K filed June 2, 2003.)
* 4.3 Securities Purchase Agreement dated as of May 21, 2003 between
Galaxy Nutritional Foods, Inc. and Fromageries Bel S.A. (Filed as
Exhibit 10.8 on Form 8-K filed June 2, 2003.)
* 4.4 Registration Rights Agreement dated as of May 21, 2003 between
Galaxy Nutritional Foods, Inc. and Fromageries Bel S.A. (Filed as
Exhibit 10.9 on Form 8-K filed June 2, 2003.)
* 4.5 Securities Purchase Agreement dated as of May 21, 2003 between
Galaxy Nutritional Foods, Inc. and Frederick A. DeLuca (Filed as
Exhibit 10.10 on Form 8-K filed June 2, 2003.)
* 4.6 Registration Rights Agreement dated as of May 21, 2003 between
Galaxy Nutritional Foods, Inc. and Frederick A. DeLuca (Filed as
Exhibit 10.11 on Form 8-K filed June 2, 2003.)
* 4.7 Securities Purchase Agreement dated as of May 21, 2003 between
Galaxy Nutritional Foods, Inc. and Apollo Capital Management Group,
L.P. (Filed as Exhibit 10.12 on Form 8-K filed June 2, 2003.)
* 4.8 Registration Rights Agreement dated as of May 21, 2003 between
Galaxy Nutritional Foods, Inc. and Apollo Capital Management Group,
L.P. (Filed as Exhibit 10.13 on Form 8-K filed June 2, 2003.)
* 4.9 Securities Purchase Agreement dated as of May 21, 2003 between
Galaxy Nutritional Foods, Inc. and Apollo MicroCap Partners, L.P.
(Filed as Exhibit 10.14 on Form 8-K filed June 2, 2003.)
* 4.10 Registration Rights Agreement dated as of May 21, 2003 between
Galaxy Nutritional Foods, Inc. and Apollo MicroCap Partners, L.P.
(Filed as Exhibit 10.15 on Form 8-K filed June 2, 2003.)
* 4.11 Securities Purchase Agreement dated as of May 21, 2003 between
Galaxy Nutritional Foods, Inc. and Ruggieri of Windermere Family
Limited Partnership (Filed as Exhibit 10.16 on Form 8-K filed June
2, 2003.)
* 4.12 Registration Rights Agreement dated as of May 21, 2003 between
Galaxy Nutritional Foods, Inc. and Ruggieri of Windermere Family
Limited Partnership (Filed as Exhibit 10.17 on Form 8-K filed June
2, 2003.)
* 4.13 Securities Purchase Agreement dated as of May 21, 2003 between
Galaxy Nutritional Foods, Inc. and Ruggieri Financial Pension Plan
(Filed as Exhibit 10.18 on Form 8-K filed June 2, 2003.)
39
* 4.14 Registration Rights Agreement dated as of May 21, 2003 between
Galaxy Nutritional Foods, Inc. and Ruggieri Financial Pension Plan
(Filed as Exhibit 10.19 on Form 8-K filed June 2, 2003.)
* 4.15 Securities Purchase Agreement dated as of May 21, 2003 between
Galaxy Nutritional Foods, Inc. and David Lipka (Filed as Exhibit
10.20 on Form 8-K filed June 2, 2003.)
* 4.16 Registration Rights Agreement dated as of May 21, 2003 between
Galaxy Nutritional Foods, Inc. and David Lipka (Filed as Exhibit
10.21 on Form 8-K filed June 2, 2003.)
* 4.17 Stockholder Agreement dated as of October 13, 2003 between Galaxy
Nutritional Foods, Inc. and Angelo S. Morini (Filed as Exhibit
10.55 on Form 10-Q for the fiscal quarter ended September 30,
2003.)
* 4.18 Securities Purchase Agreement dated as of October 6, 2004 between
Galaxy Nutritional Foods, Inc. and Frederick A. DeLuca (Filed as
Exhibit 4.18 on Form 8-K filed October 8, 2004.)
* 4.19 Registration Rights Agreement dated as of October 6, 2004 between
Galaxy Nutritional Foods, Inc. and Frederick A. DeLuca (Filed as
Exhibit 4.19 on Form 8-K filed October 8, 2004.)
* 4.20 Warrant to Purchase Securities of Galaxy Nutritional Foods, Inc.
dated as of October 6, 2004 in favor of Frederick A. DeLuca (Filed
as Exhibit 4.20 on Form 8-K filed October 8, 2004.)
* 4.21 Stock Repurchase Agreement dated as of October 6, 2004 by and among
Galaxy Nutritional Foods, Inc., BH Capital Investments L.P. and
Excalibur Limited Partnership (Filed as Exhibit 4.21 on Form 8-K
filed October 8, 2004.)
* 4.22 Registration Rights Agreement dated as of October 6, 2004 by and
among Galaxy Nutritional Foods, Inc., BH Capital Investments L.P.
and Excalibur Limited Partnership (Filed as Exhibit 4.22 on Form
8-K filed October 8, 2004.)
* 4.23 Warrant to Purchase Securities of Galaxy Nutritional Foods, Inc.
dated as of October 6, 2004 in favor of BH Capital Investments L.P.
(Filed as Exhibit 4.23 on Form 8-K filed October 8, 2004.)
* 4.24 Warrant to Purchase Securities of Galaxy Nutritional Foods, Inc.
dated as of October 6, 2004 in favor of Excalibur Limited
Partnership (Filed as Exhibit 4.24 on Form 8-K filed October 8,
2004.)
* 4.25 Investor relations contract between Galaxy Nutritional Foods, Inc.
and R.J. Falkner dated as of September 29, 2004 (Filed as Exhibit
4.25 on Form S-3 filed March 14, 2005.)
* 4.26 Asset Purchase Agreement dated June 30, 2005 between Galaxy
Nutritional Foods, Inc. and Schreiber Foods, Inc. (Filed as Exhibit
4.25 on Form 8-K filed July 6, 2005.)
* 10.1 Master Distribution and License Agreement dated as of May 22, 2003
between Galaxy Nutritional Foods, Inc. and Fromageries Bel S.A.
(Filed as Exhibit 10.22 on Form 8-K filed June 2, 2003.)
* 10.2 Loan and Security Agreement dated as of May 27, 2003 between Galaxy
Nutritional Foods, Inc. and Textron Financial Corporation (Filed as
Exhibit 10.1 on Form 8-K filed June 2, 2003.)
* 10.3 Patent, Copyright and Trademark Collateral Security Agreement dated
as of May 27, 2003 between Galaxy Nutritional Foods, Inc. and
Textron Financial Corporation (Filed as Exhibit 10.2 on Form 8-K
filed June 2, 2003.)
* 10.4 Renewal Promissory Note in the principal amount of $10.131,984.85
dated as of May 28, 2003 by Galaxy Nutritional Foods, Inc. in favor
of Wachovia Bank (Filed as Exhibit 10.3 on Form 8-K filed June 2,
2003.)
* 10.5 Renewal Promissory Note in the principal amount of $501,000.00
dated as of May 28, 2003 by Galaxy Nutritional Foods, Inc. in favor
of Wachovia Bank (Filed as Exhibit 10.4 on Form 8-K filed June 2,
2003.)
40
* 10.6 Amendment of Loan Agreement dated as of May 28, 2003 between Galaxy
Nutritional Foods, Inc. and Wachovia Bank (Filed as Exhibit 10.5 on
Form 8-K filed June 2, 2003.)
* 10.7 Amendment of Security Agreement dated as of May 28, 2003 between
Galaxy Nutritional Foods, Inc. and Wachovia Bank (Filed as Exhibit
10.6 on Form 8-K filed June 2, 2003.)
* 10.8 Waiver Letter from Textron Financial Corporation to the Company
dated August 13, 2003 (Filed as Exhibit 10.53 on Form 10-Q for the
fiscal quarter ended June 30, 2003.)
* 10.9 Second Amended and Restated Employment Agreement dated as of
October 13, 2003 between Galaxy Nutritional Foods, Inc. and Angelo
S. Morini (Filed as Exhibit 10.1 on Form 8-K filed October 20,
2003.)
* 10.10 Settlement Agreement dated May 6, 2004 between Galaxy Nutritional
Foods, Inc. and Schreiber Foods, Inc. (Filed as Exhibit 10.1 on
Form 8-K filed May 11, 2004.)
* 10.11 Modification Letter on the Security Agreement dated as of May 21,
2004 between Galaxy Nutritional Foods, Inc. and Wachovia Bank
(Filed as Exhibit 10.11 on Form 10-K for the fiscal year ended
March 31, 2004.)
* 10.12 Second Amendment to Loan and Security Agreement dated June 25, 2004
between Galaxy Nutritional Foods, Inc. and Textron Financial
Corporation (Filed as Exhibit 10.12 on Form 10-K for the fiscal
year ended March 31, 2004.)
* 10.13 Third Amendment to Lease Agreement dated June 10, 2004 between
Galaxy Nutritional Foods, Inc. and Cabot Industrial Properties,
L.P. (Filed as Exhibit 10.13 on Form 10-K for the fiscal year ended
March 31, 2004.)
* 10.14 Separation and Settlement Agreement dated July 8, 2004 between
Galaxy Nutritional Foods, Inc. and Christopher J. New (Filed as
Exhibit 10.14 on Form 8-K filed July 13, 2004.)
* 10.15 Employment Agreement dated July 8, 2004 between Galaxy Nutritional
Foods, Inc. and Michael E. Broll (Filed as Exhibit 10.15 on Form
8-K filed July 13, 2004.)
* 10.16 Third Amendment to Loan and Security Agreement dated November 10,
2004 between Galaxy Nutritional Foods, Inc. and Textron Financial
Corporation (Filed as Exhibit 10.16 on Form 10-Q for the fiscal
quarter ended December 31, 2004.)
* 10.17 Fourth Amendment to Loan and Security Agreement dated June 3, 2005
between Galaxy Nutritional Foods, Inc. and Textron Financial
Corporation (Filed as Exhibit 10.17 on Form 8-K filed June 22,
2005.)
* 10.18 Letter Agreement dated June 17, 2005 between Galaxy Nutritional
Foods, Inc. and Textron Financial Corporation (Filed as Exhibit
10.18 on Form 8-K filed June 22, 2005.)
* 10.19 Supply Agreement dated June 30, 2005 between Galaxy Nutritional
Foods, Inc. and Schreiber Foods, Inc. (Filed as Exhibit 10.19 on
Form 8-K filed July 6, 2005.)
* 10.20 Loan Modification Agreement June 30, 2005 between Galaxy
Nutritional Foods, Inc. and Wachovia Bank N.A (formerly SouthTrust
Bank). (Filed as Exhibit 10.20 on Form 8-K filed July 6, 2005.)
* 10.21 Termination, Settlement and Release Agreement dated July 20, 2005
between Galaxy Nutritional Foods, Inc. and Fromageries Bel S.A.
(Filed as Exhibit 10.21 on Form 8-K filed July 26, 2005.)
* 10.22 Note and Warrant Purchase Agreement dated September 12, 2005
between Galaxy Nutritional Foods, Inc. and Frederick A. DeLuca
(Filed as Exhibit 10.22 on Form 8-K filed September 16, 2005.)
41
* 10.23 Note and Warrant Purchase Agreement dated September 28, 2005
between Galaxy Nutritional Foods, Inc. and Conversion Capital
Master, Ltd. (Filed as Exhibit 10.23 on Form 8-K filed October 4,
2005.)
* 10.24 Note and Warrant Purchase Agreement dated September 28, 2005
between Galaxy Nutritional Foods, Inc. and SRB Greenway Capital,
L.P. (Filed as Exhibit 10.24 on Form 8-K filed October 4, 2005.)
* 10.25 Note and Warrant Purchase Agreement dated September 28, 2005
between Galaxy Nutritional Foods, Inc. and SRB Greenway Capital
(Q.P.), L.P. (Filed as Exhibit 10.25 on Form 8-K filed October 4,
2005.)
* 10.26 Note and Warrant Purchase Agreement dated September 28, 2005
between Galaxy Nutritional Foods, Inc. and SRB Greenway Offshore
Operating Fund, L.P. (Filed as Exhibit 10.26 on Form 8-K filed
October 4, 2005.)
* 10.27 First Amendment to Note and Warrant Purchase Agreement dated
October 7, 2005 between Galaxy Nutritional Foods, Inc. and
Frederick A. DeLuca (Filed as Exhibit 10.27 on Form 10-Q for the
fiscal quarter ended September 30, 2005.)
* 10.28 Fifth Amendment to Loan and Security Agreement dated November 14,
2005 between Galaxy Nutritional Foods, Inc. and Textron Financial
Corporation (Filed as Exhibit 10.28 on Form 10-Q for the fiscal
quarter ended September 30, 2005.)
* 14.1 Code of Ethics (Filed as Exhibit 14.1 on Form 10-K for the fiscal
year ended March 31, 2005.)
* 20.1 Audit Committee Charter (Filed as Exhibit 20.1 on Form 10-Q for the
fiscal quarter ended September 30, 2003.)
* 20.2 Compensation Committee Charter (Filed as Exhibit 20.2 on Form 10-Q
for the fiscal quarter ended September 30, 2003.)
31.1 Section 302 Certification of our Chief Executive Officer (Filed
herewith.)
31.2 Section 302 Certification of our Chief Financial Officer (Filed
herewith.)
32.1 Section 906 Certification of our Chief Executive Officer (Filed
herewith.)
32.2 Section 906 Certification of our Chief Financial Officer (Filed
herewith.)
* Previously filed and incorporated herein by reference.
42
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
GALAXY NUTRITIONAL FOODS, INC.
Date: February 21, 2006 /s/ Michael E. Broll
------------------------------
Michael E. Broll
Chief Executive Officer
(Principal Executive Officer)
Date: February 21, 2006 /s/ Salvatore J. Furnari
------------------------------
Salvatore J. Furnari
Chief Financial Officer
(Principal Accounting and Financial Officer)
43