UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended March 31, 2006
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
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 (IRS Employer
incorporation or organization) Identification No.)
2441 Viscount Row
Orlando, Florida 32809
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (407) 855-5500
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share None
(Title of Class) (Name of exchange on which registered)
Indicate by check mark if registrant is a well-known seasoned issuer, as defined
in Rule 405 of the Securities Act.
Yes |_| No |X|
Indicate by check mark if registrant is not required to file reports pursuant to
Section 15(d) of the Act.
Yes |_| No |X|
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |_|
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|
1
The aggregate market value of the voting and non-voting common equity held by
non-affiliates as of September 30, 2005 (the last business day of the
registrant's most recently completed second fiscal quarter) was $14,610,399
based on the closing price of such common equity of $1.61 per share on that
date. All executive officers and directors of the registrant and all persons
filing a Schedule 13D or a Schedule 13G with the Securities and Exchange
Commission in respect to the registrant's common stock have been deemed, solely
for the purpose of the foregoing calculation, to be "affiliates" of the
registrant.
The number of shares outstanding of the registrant's common stock as of July 13,
2006 was 17,109,894.
DOCUMENTS INCORPORATED BY REFERENCE: None
2
PART I
FORWARD LOOKING STATEMENTS
This Form 10-K contains forward-looking statements within the meaning of the
federal securities laws that 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," "could," "should," "potential," or "continue" or the negative or
variations of these words or similar expressions are intended to identify
forward-looking statements. Additionally, these forward-looking statements
include, but are not limited to statements regarding:
o Refinancing certain debt obligations;
o Difficulty or inability to raise additional financing, if needed on
terms acceptable to us;
o Improving cash flows from operations;
o Marketing our existing products and those under development;
o Our estimates of future revenue and profitability;
o Our expectations regarding future expenses, including cost of goods
sold, delivery, selling, general and administrative, research and
development expenses, and disposal costs;
o Our estimates regarding capital requirements and our needs for
additional financing;
o Competition in our market;
o Our ability to continue to operate as a going concern.
Although we believe that these forward-looking statements are reasonable at the
time they are made, 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 those set forth under
"Risk Factors" and elsewhere in, or incorporated by reference into, this Form
10-K. We are not required and 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.
ITEM 1. BUSINESS
General
Galaxy Nutritional Foods, Inc. develops and globally markets 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. Our overall strategy is to enhance the value of the Galaxy Nutritional
Foods' brands by developing nutritious products that meet the taste and dietary
needs of today's increasingly health conscious consumers. In this report, the
terms "Company," "we," "us," or "our" means Galaxy Nutritional Foods, Inc.
Veggie, the leading brand in the cheese alternative category of the grocery
channel and our top selling product group, is primarily merchandised in the
produce section and provides calcium and protein without cholesterol, saturated
fat or trans fat. In the natural foods channel, our brands include: Rice, Veggy,
Vegan, and Wholesome Valley, which are primarily merchandised in the cheese
alternative or dairy sections. We also have Galaxy imitation and private label
products including processed slices and shreds. These products are primarily
sold in the grocery, mass markets and food service channels.
3
We sell our products through leading grocery store chains including Publix,
Kroger, Safeway, Albertson's, Wakefern, H.E. Butt and natural food stores
including Whole Foods, Wild Oats and several independents. We seek to build core
brand recognition and a broader consumer base through marketing, including
product sampling and advertising programs to educate consumers on the benefits
of healthier eating. Our strategy for the future is to continue our marketing
efforts primarily in the retail market to capitalize on the continuing interest
among consumers in eating foods low in cholesterol, saturated fat and trans fat.
We believe that one of the leading contributors of cholesterol and saturated fat
in the American diet is conventional cheese. By providing good tasting cheese
alternatives in convenient forms and flavors, we believe that we will be able to
attract an increasing number of consumers interested in improving their diet and
eating habits.
Our Company was founded by Angelo S. Morini in 1972 under the original name of
Fiesta Foods & Galaxy Foods in New Castle, Pennsylvania. In 1980, the name was
changed to Galaxy Cheese Company and subsequently reincorporated under the laws
of the State of Delaware in 1987. In June 1991, we moved from New Castle,
Pennsylvania to Orlando, Florida and in November 2000 became Galaxy Nutritional
Foods, Inc. to more clearly define our position in the food category.
Change in Operations
During the fiscal year ended March 31, 2006, we determined that our
manufacturing capacity was significantly in excess of our requirements and that
it would be advantageous to outsource manufacturing and distribution operations.
On June 30, 2005, Galaxy Nutritional Foods, Inc. 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. 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 November 2005, Schreiber began to deliver such products directly to our
customers. The prices for such products are based on cost plus a processing fee
as 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.
4
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.
In November 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 March 31, 2006 consists primarily of
certain stock levels of inventory we maintain at a public storage facility in
Canada in order to distribute to our Canadian customers quickly and efficiently.
On June 30, 2005, we also entered into a definitive agreement (the "Asset
Purchase Agreement") for the sale of substantially all of our manufacturing and
production equipment to Schreiber for $8,700,000 in cash and on December 8,
2005, we completed this sale. This sale was approved by our stockholders at a
Special Meeting held on December 5, 2005. The $8,700,000 in proceeds was
primarily used to pay accrued tangible personal property taxes and to terminate
certain debt obligations on the assets that were sold.
As a result of the above agreements, our Company eliminated its manufacturing
and distribution operations and is now a branded marketing company that will
continue to develop, market and sell our products. Additionally, we have
eliminated the need to carry large amounts of inventory in order to manufacture
our products prior to distribution to our customers. With the exception of
inventory for samples and certain Canadian customers, we do not take possession
of our inventory prior to its shipment from Schreiber to our customers.
Development Of Business
While most companies place their dairy products in the supermarket dairy
section, we adopted a sales and marketing strategy whereby Veggie products are
merchandised in the produce section. In this section, Veggie brand products are
sold next to other natural and organic items.
The natural channel business began with soy-based cheese alternatives under the
brand names Soyco and Soymage, now Veggy and Vegan respectively. To further
develop the natural channel business, in fiscal 1996, we introduced a soy free
rice-based line to meet the needs of consumers with soy allergies. In recent
years, all three natural channel brands were repositioned under the Galaxy
Nutritional Foods umbrella brand. The natural brands, previously sold only to
natural foods retailers, are now distributed in the grocery channel with the
introduction of natural foods sections in most supermarkets. In response to the
growth in the organic food category, in fiscal 1997, we introduced the Wholesome
Valley Organic brand in the natural channel, followed shortly by the grocery
channel.
Historically, our foodservice business primarily consisted of imitation cheese
products. The foodservice business has since been expanded to include branded
cheese alternatives similar to the retail products.
Principal Products Produced
We market a variety of 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 under the brands Veggie, Veggy, Rice,
Vegan, Wholesome Valley Organic, and Galaxy. Each brand's corresponding
nutritional benefits are noted below:
Veggie Brand - Leading Cheese Alternative in Grocery - Our flagship brand, sold
in the produce section of supermarkets, is produced in a variety of forms
including slices, shreds, spreads and more. Veggie cheese alternatives are an
excellent source of calcium without cholesterol, saturated or trans fat. Future
Veggie brand line extensions include Galaxy Super Stix, a convenient
individually wrapped mozzarella flavored stick, which provides calcium and
protein without trans fat, saturated fat or cholesterol.
5
Veggy Brand - Soy-based Cheese Alternatives - Similar to our grocery brand,
Veggie, and without preservatives, Veggy branded products are an excellent
source of calcium without cholesterol, saturated or trans fat. This soy-based
alternative is primarily sold in natural food stores and is available in a wide
variety of individually wrapped slices and a grated topping.
Rice Brand - Soy Free Cheese Alternatives - Our Rice products, sold primarily in
natural food stores, are a leading soy free cheese alternative without
cholesterol or trans fat. Also, preservative and gluten free, this brand is
available in a wide variety of flavors in slices, shreds, blocks, grated
topping, sour cream, cream cheese and butter alternatives. Recent fiscal 2006
line extensions include Rice Vegan slices, the first soy and casein free cheese
alternative.
Vegan Brand - Casein Free Dairy Alternatives - Our Vegan brand products are sold
primarily in the natural food stores in individually wrapped slices, blocks,
sour cream style topping, cream cheese style spread, and a grated topping. Vegan
brand products are soy-based, casein (a dried skim milk protein), preservative
and gluten free.
Wholesome Valley Organic Brand - Organic Cheese Products - Our Wholesome Valley
Organic brand is a cheese product made without the use of antibiotic growth
hormones or dangerous pesticides and chemicals and is available in slices,
shreds, and block varieties in both natural food and grocery stores.
Galaxy Brand Products - Imitation and Processed Cheese Alternative Products -
Our Galaxy brand includes value priced processed cheese products sold primarily
in the supermarket dairy section. Galaxy brand products are cholesterol and
trans fat free and are available in various flavors in the form of sandwich
slices and shreds.
Our only branded product line, which accounts for more than 10% of our gross
sales for the fiscal year ended March 31, 2006, is the Veggie line of products.
This line of products contributed approximately 53%, 46% and 60% of gross sales
for the fiscal years ended March 31, 2006, 2005 and 2004, respectively. Our
non-branded imitation, private label and sandwich slice business contributed
approximately 31%, 35% and 22% of gross sales for the fiscal years ended March
31, 2006, 2005 and 2004, respectively.
Principal Markets
Our products are sold primarily in two commercial markets: retail and food
service.
In the retail market, we sell our products to national and regional supermarket
chains, mass merchandisers and natural foods or to distributors that sell and
deliver to these retail establishments. These sales are facilitated through our
in-house sales managers and a nationwide network of non-exclusive commissioned
brokers. We believe our products appeal to a wide range of consumers seeking
lower fat, lower cholesterol, and no lactose products. In the retail market,
where we believe taste and nutrition generally outweigh price considerations, we
market our Veggie and Galaxy natural branded products at prices generally
comparable to or higher than the prices of conventional cheeses.
In the food service market, we sell directly to food distributors and other
customers in the food service market through our in-house sales managers and a
nationwide network of non-exclusive commissioned brokers. In this market we
offer more expensive premium products such as our Veggie line to customers who
place importance on taste and nutrition and our less expensive Galaxy branded
products to customers whose primary consideration is cost. The food service
products are primarily sold to distributors who supply food to restaurants,
cafeterias, hospitals, correctional institutions, and schools. We also market
our products directly to franchisees of large national restaurant chains.
For the fiscal years ended March 31, 2006, 2005 and 2004, our gross sales were
$41,492,717, $48,421,384 and $40,041,371, respectively. The following chart sets
forth the percentage of gross sales that the retail and food service markets
represented for the fiscal years ended March 31, 2006, 2005 and 2004:
6
Percentage of Gross Sales
Fiscal Years Ended March 31,
Category 2006 2005 2004
- -----------------------------------------------------
Retail sales 85% 85% 87%
Food service sales 15% 15% 13%
Methods of Distribution
Pursuant to the Supply Agreement with Schreiber, beginning in November 2005, our
products are primarily distributed from Schreiber's distribution centers in
Green Bay, Wisconsin; Carthage, Missouri; and Logan, Utah. In order to
distribute to our Canadian customers quickly and efficiently, we store and
distribute products through a public storage facility in Canada. We maintain a
certain stock level at this facility and pay the Canadian facility a processing
fee for its services.
Sources and Availability of Raw Materials
Prior to November 2005, we purchased the ingredients used in our manufacturing
operations, i.e., casein, vegetable proteins and oils, enzymes and other
ingredients, from several sources, and we believe that all of these ingredients
are readily available from numerous suppliers. Due to more cost effective
conditions in other countries, suppliers from such countries are often able to
supply casein, a dried skim milk protein, at prices lower than domestic
suppliers. Accordingly, we purchased our major ingredient, casein, from foreign
suppliers. Because our casein is imported, its availability is subject to a
variety of factors, including strength of the United States Dollar, foreign
production limitations and federal import regulations. Our increased costs for
casein throughout the fiscal year ended March 31, 2005 had an adverse impact on
our results of operations for such fiscal year.
For the fiscal years ended March 31, 2006, 2005 and 2004, we purchased
approximately $6,242,977, $10,947,000, $6,134,000, respectively, of casein, the
principal raw material used to manufacture substantially all of our products.
The following table sets forth the name of each supplier along with the
percentage they supplied of casein which either alone, or together with their
affiliates, provided 10% or more casein to our Company, based on our dollar
volume purchased:
Percent of Casein Purchases
Fiscal Years Ended March 31,
Type of Raw Material Name of Supplier 2006 2005 2004
- ----------------------- ---------------------------------------- ----------- ----------- ------------
Casein Lactalis f/n/a Besnier-Scerma U.S.A. 34% 30% 20%
Glanbia f/n/a Avonmore Food Products 26% 21% 29%
Irish Dairy Board -- 15% 24%
Bluegrass Dairy & Food, LLC 26% 12% --
Eurial Poitouraine/Euro Proteins 5% 4% 20%
Since November 2005, pursuant to the Supply Agreement with Schreiber, we depend
solely on Schreiber to obtain the necessary ingredients, manufacture and
distribute all of our products to our customers. The prices for such products
are based on cost plus a processing fee as determined by the parties from time
to time. Purchases from Schreiber accounted for 38% of product purchases for the
fiscal year ended March 31, 2006.
7
Working Capital Practices
The majority of our customers are required to make payment on goods within 30
days of invoicing. Our credit department makes calls on payments that are 10 to
15 days past due and then places accounts on credit hold if they have not made
arrangements for those payments that are 30 to 45 days past due. After all
efforts have been exhausted to contact the customer and collect the past due
balances, the credit manager will provide authorization to write off the past
due balance. We typically average less than 1% of gross sales in credits related
to bad debt.
We provide a guarantee of sale to many of our retail customers in natural food
stores, conventional grocery stores and the mass merchandising industry. If the
product is not sold during its shelf life, we will allow a credit for the unsold
merchandise. Since the shelf life of our products range from 6 months to one
year, we historically average less than 2% of gross sales in credits for unsold
product.
Since November 2005, pursuant to the Supply Agreement with Schreiber, we depend
solely on Schreiber to manufacture and distribute all of our products to our
customers. We are required to pay Schreiber for our products within 20 days of
shipment to our customers. As a result of the Supply Agreement, we have
eliminated the need to carry large amounts of inventory in order to manufacture
our products prior to distribution to our customers. With the exception of
inventory for samples and certain Canadian customers, we do not take possession
of our inventory prior to its shipment from Schreiber to our customers.
Customers
We sell to customers throughout the United States and 14 other countries. For
the fiscal years ended March 31, 2006, 2005 and 2004, our gross sales were
$41,492,717, $48,421,384 and $40,041,371, respectively. Gross sales derived from
foreign countries were approximately $5,158,000, $4,896,000 and $4,297,000 for
the fiscal years ended March 31, 2006, 2005 and 2004, respectively. These sales
represent 12%, 10% and 11% of gross sales in the fiscal years ended March 31,
2006, 2005 and 2004, respectively. Gross sales are attributed to individual
countries based on the customer's shipping address. We have no long-term assets
located outside of the United States.
The following table sets forth the percentage of foreign gross sales to each
country, which accounted for 5% or more of our foreign gross sales for the
fiscal years ended March 31, 2006, 2005 and 2004:
Percentage of Gross Foreign Sales
Fiscal Years Ended March 31,
Country 2006 2005 2004
- -------------------------------------------------------
Canada 60.0% 47.9% 44.4%
Puerto Rico 22.8% 33.4% 32.9%
Israel * * 5.9%
*Less than 5% of foreign gross sales for the stated fiscal year
The following table sets forth the name of each customer, which either alone, or
together with its affiliates, accounted for 5% or more of our gross sales for
the fiscal years ended March 31, 2006, 2005 and 2004:
Percentage of Gross Sales
Fiscal Years Ended March 31,
Customer Name 2006 2005 2004
- -------------------------------------------------------------------------
United Natural Foods 9.3% 9.4% 8.5%
Distribution Plus Incorporated (DPI) 8.3% 7.4% 7.8%
Publix 6.9% 5.9% 7.2%
Wal-Mart 7.4% * *
Del Sunshine LLC * 11.6% *
Kroger * * 5.9%
*Less than 5% of gross sales for the stated fiscal year.
8
During the fiscal year ended March 31, 2005, we produced certain private label
products for Del Sunshine who then sold the products to Wal-Mart. In the fourth
quarter of fiscal 2005, we reserved nearly $1,760,000 in accounts receivable and
inventory related to Del Sunshine LLC that we believed collection thereon was
questionable. As of March 31, 2006, all amounts owed by Del have been written
off as uncollectible. In the fiscal year ended March 31, 2006, we began selling
these products directly to Wal-Mart instead of through Del Sunshine.
Competitive Conditions
We operate in a highly competitive environment. In the retail cheese market, we
compete with large national and regional manufacturers of conventional, organic,
and imitation cheese products. Competitors such as Kraft, Borden's and ConAgra,
among others are well established and have significantly more brand name
recognition, marketing personnel, and cash resources at their disposal.
Conventional "Lite" cheese generally has a lower fat content than regular
cheese. But, unlike most of our products, it still contains cholesterol and
lactose. Further, we believe that the perceived healthfulness, quality and
excellent taste of our product lines provide a competitive advantage over many
companies with more traditional products.
Within the retail cheese alternative niche market, there are a number of
additional competitors such as Tree of Life, Tofutti Brands, Inc., Yves (a
subsidiary of Hain Celestial Group), Follow Your Heart, and Melissa's. Like our
product lines, these competitors offer dairy and cheese alternatives to grocery
and natural foods stores. In addition, their offerings are similar to ours in
that they have comparable perceived benefits and are distributed or positioned
in the same retail shelf space as our products.
In the food service markets, our substitute and imitation cheese products
compete with other numerous substitute and imitation cheese products, as well as
with conventional cheeses.
We believe that we are superior to the competition in our niche in the most
important competitive factors, which are brand awareness, taste, perceived
nutritional value, product appearance, product distribution, and overall
consumer purchase interest. Finally, we believe that the breadth and depth of
our product lines make it difficult for our smaller competitors to have a
significant impact on our market leading share in the cheese alternative
category.
Trademarks And Other Intellectual Property
We own several registered and unregistered trademarks, which are used in the
marketing and sale of our products. Our material product trademarks are those
mentioned above under Principal Products Produced. The registrations of these
trademarks in the United States and foreign jurisdictions are effective for
varying periods of time, and may be renewed periodically, provided that we, as
the registered owner of the trademarks, comply with all pertinent renewal
requirements.
Trademarks include registered brand names, logos, symbols, or copyrights used to
identify our products or services. As such, this prevents other manufacturers
from using any words or symbols for which we hold the trademark. This is
important as it helps provide competitive insulation around our products in the
marketplace and enables consumers to identify with one particular brand or
another. We will continue to market our trademarks in order to increase brand
awareness for our products. Although our trademarks are valuable to our
business, they are not, at this time, assets that are critical to our business.
In the event that we would be prohibited from using one or more of our
trademarks, we do not believe that this would have a material adverse affect on
our continued operations.
9
Although we believe that our formulas and processes are proprietary and the key
to our success, we have not sought and do not intend to seek patent protection
for such technology. In not seeking patent protection, we are instead relying on
the complexity of our technology, on trade secrecy laws, and on employee and
inter-company confidentiality agreements. We believe that our technology has
been independently developed and does not infringe on the patents or trade
secrets of others.
Governmental Regulation
Our United States product labels are subject to regulation by the United States
Food and Drug Administration ("FDA"). Such regulation includes standards for
product descriptions, nutritional claims, label format, minimum type sizes,
content and location of nutritional information panels, nutritional comparisons,
and ingredient content panels. Our labels, ingredients, and manufacturing
techniques and facilities are subject to inspection by the FDA. Labeling
regulations require specific details of ingredients and their components along
with nutritional information on labels and also impose restrictions on product
claims that can be included on labels.
We have a team of individuals from our marketing, quality assurance, and
research and development departments who review all new labels for compliance
with our Company standards and current laws and regulations. We believe that we
are in material compliance with all applicable governmental regulations
regarding our current products and have obtained the necessary government
permits, licenses, qualifications, and approvals, which are required for our
operations.
Environmental Regulation
Prior to the outsourcing of our manufacturing and distribution operations in
November 2005, our facility and manufacturing processes were subject to
inspections by several agencies including the Florida Department of Agriculture
and Consumer Services and our insurance providers. We were also required to
comply with environmental regulations in connection with the development of our
products and the operation of our business. We believe that we are in material
compliance with the federal, state and local environmental laws and regulations
applicable to our Company. We believe that continued compliance with any current
or reasonably foreseeable future environmental laws and regulations will not
have a material adverse effect on the capital expenditures, earnings, financial
condition or competitive position of our Company.
Employees
As of July 13, 2006, we had a total of 30 full-time employees. We employ all
personnel directly. We are an affirmative action employer providing equal
employment opportunity to all applicants. We consider our relations with
employees to be satisfactory. No employee is a member of a trade union.
10
ITEM 1A. RISK FACTORS
Forward-Looking Information
Statements other than historical information contained in this Form 10-K 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," "could," "should," "potential," or "continue" or the negative or
variations of these words or similar expressions are intended to identify
forward-looking statements. Although we believe that these forward-looking
statements are reasonable at the time they are made, 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 statement as a result of a variety of factors as set
forth below. We are not required and 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-K, the following are some
of the factors as of July 13, 2006, 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 are in default on certain related party unsecured notes payable.
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 required
monthly interest-only payments at 3% above the bank prime rate of interest per
the Federal Reserve Bank (the "Prime Rate") and matured on June 15, 2006. We
received a letter on June 20, 2006, from all of the Note Holders other than Mr.
DeLuca, notifying the Company that its failure to pay the amounts due and owing
on the maturity date constitutes a default under $1.2 million of the Notes held
by those Note Holders. Pursuant to the terms of the Notes, since we did not cure
the default within 10 days after receipt of the notice of default, we are
obligated to pay interest at the default rate of 8% above the Prime Rate.
We do not currently have the short-term liquidity to pay the Notes in accordance
with their original terms and are negotiating with the Note Holders regarding
extending the maturity of the Notes, refinancing the Notes and/or converting all
or a portion of the Notes into equity. There can be no assurance that we will be
successful in our negotiations with the Note Holders or that the terms of any
such refinancing or conversions will not result in the issuance, or potential
issuance, of a significant amount of equity securities. In the event we are not
successful, any collection actions by the Note Holders could have a material
adverse affect on the liquidity and financial condition of the Company or our
ability to secure additional financing.
We may not be able continue as a going concern on a long-term basis.
We have incurred substantial losses in recent years and, as a result, have a
stockholders deficit of $3,682,660 as of March 31, 2006. Losses for the years
ended March 31, 2006, 2005 and 2004 were $24,148,553, $3,859,783 and $3,299,277,
respectively. We received a report from our independent accountants relating to
our audited financial statements as of March 31, 2006 containing a paragraph
stating that because we are in default of our notes payable, have suffered
recurring losses from operations and at March 31, 2006 have deficiencies in
working capital and equity, there is substantive doubt as to our ability to
continue as a going concern. Our ability to continue as a going concern depends
upon successfully obtaining sufficient cash resources to refinance our $2.4
million of unsecured notes payable that matured on June 15, 2006 and obtaining
positive cash flow from operations to sustain normal business operations.
11
Our current business plan eliminates certain low margin private label and Galaxy
imitation business from our sales mix. The elimination of these low margin items
and the elimination of excess overhead that was part of our former manufacturing
operations should result in higher gross margins with lower operating costs in
fiscal 2007 and produce positive cash flows from operations. However, the
expected improvement in cash flows from operations will not be sufficient to
repay the short-term notes without additional financing. Management is currently
negotiating with the existing note holders and other parties regarding extending
the maturity of the notes, refinancing the notes and/or converting all or a
portion of the notes into equity. There can be no assurance that we will be
successful in our business plan, our negotiations with the Note Holders and
other parties or that the terms of any such refinancing or conversions will not
result in the issuance, or potential issuance, of a significant amount of equity
securities that will cause substantial dilution to our stockholders. If we are
not successful in refinancing the $2.4 million in short-term notes or in
otherwise entering into a financing, sale, or business transaction that infuses
sufficient cash resources into our Company in the near future, any collection
actions by the Note Holders could have a material adverse affect on the
liquidity and financial condition of the Company or our ability to secure
additional financing and we may not be able to continue as a going concern.
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, stockholder and a 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 his purchase of
2,914,286 shares of our common stock into a single stockholder note receivable
in the amount of $12,772,200 that was due on June 15, 2006. This stockholder
note receivable is non-interest bearing and non-recourse and is secured by the
2,914,286 shares of our common stock (the "Shares"). For the fiscal year ended
March 31, 2006, we reserved $10,120,200 against this stockholder note receivable
under the assumption that we would not be able to collect proceeds in excess of
the $2,652,000 value of the Shares as of such date. The value of the Shares was
computed using the closing price of our common stock on March 31, 2006 of $0.91
multiplied by the 2,914,286 shares.
On June 16, 2006, Mr. Morini failed to repay the non-recourse note obligation to
our Company. On June 20, 2006, we delivered notice to Mr. Morini that we
intended to exercise our rights to the Shares and retain all the Shares in full
satisfaction of his obligations under the stockholder note receivable. On July
6, 2006, Mr. Morini consented to our acceptance of the Shares in full
satisfaction of his obligations under the stockholder note receivable. As a
result, we are in the process of canceling the Shares along with an additional
30,443 treasury shares. Our total number of issued and outstanding shares of
common stock is now 17,109,894 shares. Based upon the $0.42 closing price of our
common stock as quoted on the OTC Bulletin Board on June 16, 2006, the Shares
have an approximate value of $1,224,000. Accordingly, we will recognize an
additional expense of $1,428,000 in the first quarter of fiscal 2007 in order to
record the additional decline in the value of the Shares from its $2,652,000
value as of March 31, 2006.
Although this expense resulted in a material loss to our operations, it does not
have any affect on the balance sheet since the stockholder note receivable was
already shown as a reduction to Stockholders' Equity (Deficit).
12
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"), since November 2005, 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 or
result in a reduction in sales of our products.
We may be required to pay substantial penalties under our Supply Agreement and
may not have the ability to do so.
The initial term of the Supply Agreement with Schreiber 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.
Additionally, 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. The short-fall payment is based on formula that calculates the payment as
follows: ((required pounds shipped - actual pounds shipped) / required pounds
shipped) * $8,700,000. Thus, if we did not purchase any products from Schreiber
during between September 1, 2006 and August 31, 2008, the payment could be as
high as $8,700,000.
In either event, we may not have the ability to pay the required penalty and
Schreiber may use its contractual rights in order to collect and may cease
production and shipment of our products. Such an action would have a material
adverse affect on the liquidity and financial condition of the Company and it is
unlikely that we would be able to continue as a going concern.
Delisting of our common stock may make it more difficult for investors to sell
shares, may potentially lead to future market declines and may increase our
costs related to registration statements.
On April 20, 2006, we received a letter from AMEX, notifying us that it intended
to proceed with the filing of an application with the Securities and Exchange
Commission to strike our common stock from listing and registration on the
Exchange. We did not appeal this determination by AMEX and on May 5, 2006, AMEX
suspended trading in our common stock and submitted an application to the
Securities and Exchange Commission to strike our common stock from listing and
registration on AMEX.
Since May 8, 2006, our common stock is now traded in the over-the-counter market
on what is commonly referred to as the OTC Bulletin Board. As a result, an
investor could find it more difficult to dispose of or to obtain accurate
quotations as to the market value of our securities. The delisting may make
trading our shares more difficult for investors, potentially leading to further
declines in our share price. Among other consequences, delisting from AMEX may
cause difficulty in obtaining future financing.
In addition, we are no longer eligible to use short form registration statements
with the respect to the sale of our securities. This could substantially
increase our costs of registering securities in the future and make it more
expensive and difficult to maintain the effectiveness of certain currently
effective registration statements involving selling stockholders of our Company.
Although most of these stockholders would be eligible to sell their shares over
the public markets pursuant to Rule 144, in the event we are not able to timely
maintain the effectiveness of such registration statements, we may be held
liable for damages suffered by such selling stockholders.
13
Our common stock may become subject to certain "Penny Stock" rules which may
make it a less attractive investment.
Since the trading price of our common stock is less than $5.00 per share,
trading in our common stock would be subject to the requirements of Rule 15g-9
of the Exchange Act if our net tangible assets fall below $2 million. Under Rule
15g-9, brokers who recommend penny stocks to persons who are not established
customers and accredited investors, as defined in the Exchange Act, must satisfy
special sales practice requirements, including requirements that make and
individualized written suitability determination for the purchaser and receive
the purchaser's written consent prior to the transaction. The Securities
Enforcement Remedies and Penny Stock Reform Act of 1990 also requires additional
disclosures in connection with any trades involving penny stock, including the
delivery, prior to any penny stock transaction, of a disclosure schedule
explaining the penny stock market and the risks associated with that market.
Such requirements may severely limit the market liquidity of our common stock
and the ability of investors in our equity securities to sell their securities
in the secondary market. For all of these reasons, an investment in our equity
securities may not be attractive to our potential investors.
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 may not be able to implement Section 404 of the Sarbanes-Oxley Act on a
timely basis.
The Securities and Exchange Commission (the "SEC"), as directed by Section 404
of The Sarbanes Oxley Act, adopted rules generally requiring each public company
to include a report of management on the company's internal controls over
financial reporting in its annual report on Form 10-K that contains an
assessment by management of the effectiveness of the company's internal controls
over financial reporting. In addition, the company's independent registered
accounting firm must attest to and report on management's assessment of the
effectiveness of the company's internal controls over financial reporting. This
requirement will first apply to our annual report on Form 10-K for the fiscal
year ending March 31, 2008.
14
We have not yet developed a Section 404 implementation plan. We have in the past
discovered, and may in the future discover, areas of our internal controls that
need improvement. How companies should be implementing these new requirements
including internal control reforms to comply with Section 404's requirements and
how independent auditors will apply these requirements and test companies'
internal controls, is still reasonably uncertain.
We expect that we will need to hire and/or engage additional personnel and incur
incremental costs in order to complete the work required by Section 404. There
can be no assurance that we will be able to complete a Section 404 plan on a
timely basis. Our liquidity position in fiscal 2007 and fiscal 2008 may also
impact our ability to adequately fund our Section 404 efforts.
Additionally, upon completion of a Section 404 plan, we may not be able to
conclude that our internal controls over financial reporting are effective, or
in the event that we conclude that our internal controls are effective, our
independent accountants may disagree with our assessment and may issue a report
that is qualified. This could subject our Company to regulatory scrutiny and a
loss of public confidence in our internal controls. Any failure to implement
required new or improved controls, or difficulties encountered in their
implementation, could negatively affect our operating results or cause us to
fail to meet our reporting obligations.
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 are subject to borrowing restrictions under our primary credit facility.
On June 23, 2006, we entered into a Receivables Purchase Agreement with Systran
Financial Services Corporation, a subsidiary of Textron Financial Corporation
("Systran"), whereby Systran will provide financing to our Company through
advances against certain trade receivable invoices due to our Company (the
"Systran Advance"). The Systran Agreement is secured by our accounts receivable
and all other assets. Generally, subject to a maximum principal amount of
$3,500,000 which can be borrowed under the Systran Agreement, the amount
available for borrowing is equal to 85% of our eligible accounts receivable
invoices less a dilution reserve and any required fixed dollar reserves, which
Systran may increase or decrease at its sole discretion. The dilution and fixed
dollar reserves have been initially set at 7% and $100,000, respectively.
Advances under the Systran Agreement bear interest at a variable rate equal to
the prime rate plus 1.5% per annum (9.5% on June 23, 2006).
The initial term of the Systran Agreement ends on June 23, 2009 and may renew
automatically for consecutive twelve-month terms unless terminated sooner. The
Systran Agreement may be accelerated in the event of certain defaults by our
Company including among other things, a default in our payment and/or
performance of any obligation to Systran or any other financial institution,
creditor, or bank; and any change in the conditions, financial or otherwise, of
our Company which reasonably causes Systran to deem itself insecure. In such an
event, interest on our borrowings would accrue at the greater of twelve percent
per annum or the variable rate of prime plus 1.5% and we would be liable for an
early termination premium ranging from 1% to 3% of the maximum principal amount
available under the Systran Agreement.
There is no guarantee that Systran will maintain or lower the current reserves
on our borrowing availability. Additionally, we may experience future credit
tightening by Systran by virtue of reserves they may require, receivables they
may deem ineligible or other rights they have under the Systran Agreement. Such
restrictions would adversely affect our cash flows.
15
We may issue securities with rights superior to those of the common stock, which
could materially limit the ownership rights of existing stockholders.
We may offer debt or equity securities in private and/or public offerings in
order to raise working capital and to refinance our debt. The board of directors
has the right to determine the terms and rights of any debt securities and
preferred stock without obtaining further approval of the stockholders. It is
likely that any debt securities or preferred stock that we sell would have terms
and rights superior to those of the common stock and may be convertible into
common stock. Any sale of securities could adversely affect the interests or
voting rights of the holders of common stock, result in substantial dilution to
existing stockholders, or adversely affect the market price of our common stock.
A private investor owns a large percentage of the outstanding shares, which
could materially limit the ownership rights of investors. As of July 13, 2006,
Frederick DeLuca, a private investor, owned approximately 23% of our issued and
outstanding common stock and held warrants which, if exercised and assuming the
exercise of no other outstanding options or warrants, would give him
approximately 24% of our issued and outstanding common stock. Investors who
purchase common stock in our Company may be unable to elect any specific members
of the board of directors or exercise significant control over us or our
business as a result of Mr. Deluca's ownership. Mr. DeLuca may be able to
exercise significant influence over our policies and Board composition.
Stockholders may experience further dilution.
We have a substantial number of outstanding options and warrants to acquire
shares of common stock. As of July 13, 2006, we have a total of 5,947,119 shares
reserved for issuance upon exercise of options and warrants that we have granted
or may grant in the future. Of this total, there are no exercisable options and
warrants that are "in the money." "In the money" generally means that the
current market price of the common stock is above the exercise price of the
shares subject to the warrant or option. The issuance of common stock upon the
exercise of these options and warrants could adversely affect the market price
of the common stock or result in substantial dilution to our existing
stockholders. In addition, any future securities issuances by our Company,
including in connection with the refinancing of $2.4 million in past due notes,
could result in the issuance, or potential issuance, of a significant amount of
equity securities that will cause substantial dilution to our stockholders,
particularly given the current low trading price of our common stock.
The facility lease for our corporate headquarters is set to expire in November
2006 and we have not secured a new location.
We entered into a lease agreement for the corporate headquarters with Anco
Company, a Florida general partnership, on November 13, 1991. The lease expires
in November 2006, unless renewed pursuant to terms mutually agreeable to the
landlord and our Company. We are currently searching for new office space for
our corporate headquarters. However, we can make no assurances that we will be
able to find and move to a new location prior to November 2006 or that we will
be able to renew our existing lease on terms acceptable to us. In the event that
we are not successful, we may be subject to higher than normal lease rates or
possible disruption of normal business operations.
Rising interest rates could negatively affect our results of operations.
The interest rates of most of our outstanding debts fluctuate based upon changes
in the prime rate. Increases in the prime rate will result in an increase in our
cost of funds, and would negatively affect our results of operations. We are
anticipating future increases in interest rates during the fiscal year ending
March 31, 2007. We have not entered into any derivative instruments such as
interest rate swap or hedge agreements to manage our exposure to rising interest
rates.
16
Competition in our industry is intense.
Competition in the natural food segment of the food industry is intense. We
believe that as consumers become more interested in healthy food alternatives
the competition in our markets will increase substantially. Therefore, the
effectiveness of our advertising, marketing and promotional programs and the
financial resources necessary for their implementation is an important part of
our sales growth plan.
In the retail cheese market, we compete with large national and regional
manufacturers of conventional, organic, and imitation cheese products.
Competitors such as Kraft, Borden's and ConAgra, among others are well
established and have significantly more brand name recognition, marketing
personnel, and cash resources at their disposal. Within the retail cheese
alternative niche market, there are a number of additional competitors such as
Tree of Life, Tofutti Brands, Inc., Yves (a subsidiary of Hain Celestial Group),
Follow Your Heart, and Melissa's. Like our product lines, these competitors
offer dairy and cheese alternatives to grocery and natural foods stores. In
addition, their offerings are similar to ours in that they have comparable
perceived benefits and are distributed or positioned in the same retail shelf
space as our products.
In the food service markets, our substitute and imitation cheese products
compete with other numerous substitute and imitation cheese products, as well as
with conventional cheeses.
While we believe that we are superior to the competition in our niche and that
the breadth and depth of our product lines make it difficult for our smaller
competitors to have a significant impact on our market leading share in the
cheese alternative category, our competitors may succeed in developing new or
enhanced products, which are better than our products. These companies may also
prove to be more successful than us in marketing and selling these products. We
cannot assure you that we will be able to compete successfully with any of these
companies or achieve a greater market share than we currently possess. Increased
competition as to any of our products or services could result in price
reductions, reduced margins, and loss of market share, which could negatively
affect our business, prospects, results of operations and financial condition.
Consumer eating habits and shopping trends may change and negatively impact
demand for our products.
There could be a decrease in demand for our products as consumers' tastes,
preferences, shopping behavior, and overall evaluation of health benefits change
over time. Historically, this was demonstrated in the change in consumer eating
habits with the publicly recognized trend toward low-carbohydrate diets, which
led to decreased consumption of items such as bread and our complementary
product of cheese alternative slices. Additionally, the number of consumers
shopping in the retail grocery and natural foods stores continues to shift with
the national expansion of Wal-Mart superstores and other similar superstores
which include extensive grocery operations. Additionally, with the growth in the
aging population of U.S. consumers, there could be price pressure on our
products due to the fixed income nature of this population segment.
Demand for our products could be hindered due to changing conditions within the
distribution channels through which we sell our products.
Our sales could suffer based upon market place abnormalities such as retailer,
distributor, and/or food service operator labor strikes. Further, consolidation
within the industry could result in store closings, store layouts, and operating
strategies that are incompatible with our product requirements.
We rely on the protection of our trademarks, and the loss of a trademark would
negatively impact the products associated with the trademark.
We own several registered and unregistered trademarks, which are used in the
marketing and sale of our products. We have invested a substantial amount of
money in promoting our trademarked brands. However, the degree of protection
that these trademarks afford us is unknown. Further, we may not have the money
necessary to engage in actions to prevent infringement on our trademarks. A loss
of a material trademark would negatively impact the products associated with it,
and could negatively affect our business, prospects, results of operations,
financial condition and cash flows.
17
We do not have patent protection for our formulas and processes, and a loss of
ownership of any of our formulas and processes would negatively impact our
business.
We believe that we own our formulas and processes. However, we have not sought,
and do not intend to seek, patent protection for our formulas and processes.
Instead, we rely on the complexity of our formulas and processes, trade secrecy
laws, and employee and inter-company confidentiality agreements. However, we
cannot assure you that other companies will not acquire our confidential
information or trade secrets or will not independently develop equivalent or
superior products or technology and obtain patent or similar rights. Although we
believe that our formulas and processes have been independently developed and do
not infringe the patents or rights of others, a variety of components of our
processes could infringe existing or future patents, in which event we may be
required to modify our processes or obtain a license. We cannot assure you that
we will be able to do so in a timely manner or upon acceptable terms and
conditions. The failure to do either of the foregoing would negatively affect
our business, results of operations, financial condition and cash flows.
Because we sell food products, we face the risk of exposure to product liability
claims.
We, like any other seller of food products, face the risk of exposure to product
liability claims in the event that our manufacturer's quality control procedures
fail and the consumption of our products causes injury or illness. With respect
to product liability claims, our insurance may not continue to be available at a
reasonable cost, or, if available, may not be adequate to cover liabilities. We
generally seek contractual indemnification and insurance coverage from parties
supplying us products, but this indemnification or insurance coverage is
limited, as a practical matter, to the creditworthiness of the indemnifying
party, and their carriers, if any, as well as the limits of any insurance
provided by suppliers. If we do not have adequate insurance or contractual
indemnification available, product liability claims relating to defective
products could have a material adverse effect on our financial condition,
results of operations and cash flows.
ITEM 2. PROPERTIES
We lease two facilities, which are close in proximity, approximating a total of
119,000 square feet of industrial property in Orlando, Florida. Our first
facility is the location of our corporate headquarters. It is approximately
55,000 square feet and is comprised of approximately 8,500 square feet in office
space, approximately 31,500 square feet in dock-height, air-conditioned
manufacturing space, and approximately 15,000 square feet in cooler space. This
facility is situated on 2.4 acres of a 5.2 acre site in an industrial park. We
entered into a lease agreement for the corporate headquarters with Anco Company,
a Florida general partnership, on November 13, 1991. The lease was renewed for a
5-year period in November 1996 and again in November 2001. The lease expires in
November 2006, unless renewed pursuant to terms mutually agreeable to the
landlord and our Company. In the event that the landlord elects to sell or lease
the remaining 2.8 acres of remaining land, we have a right of first refusal to
purchase or lease property upon 20 days notice to the landlord. The lease is a
"triple net" lease, which means that we are responsible for all taxes,
insurance, maintenance and repair of the facilities, in addition to rental
payments. The total monthly rent through the stated expiration of the lease is
$35,596.
Prior to November 2005, we produced all of our products at our Orlando
manufacturing facility. We maintained production equipment for mixing, blending,
cooking and heating ingredients, and for shredding, dicing, slicing, chopping,
grating, packaging and labeling our products. We also maintained cold storage
areas for cooling finished products and warehouse areas for storing supplies and
finished goods. We estimate that our production capacity utilization during the
fiscal years ended March 31, 2006, 2005 and 2004 were at approximately 12%, 15%
and 10%, respectively, of our capacity.
18
Our second facility is the primary receiving, storage and shipping facility for
our inventory. It includes office space, shipping and receiving docks, warehouse
and cooler space totaling approximately 64,000 square feet. We entered into a
lease agreement with Cabot Industrial Properties, a Florida limited partnership,
on July 28, 1999 for this second facility. In May 2004, we renegotiated and
renewed the lease until July 31, 2009. The lease provides for escalating base
rental payments ranging from $18,225 to $22,942 per month through the end of the
lease period. The lease is a "triple net lease", which means we are responsible
for all taxes, insurance, maintenance, and repair of the facility, in addition
to rental payments.
Since November 2005, pursuant to a Supply Agreement dated June 30, 2005 between
our Company and Schreiber, Schreiber began to manufacture and distribute all of
our products to our customers. Additionally, in December 2005, we sold
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.
As a result of these changes, we abandoned our second facility and ceased to use
the production portion of our first facility in December 2005.
Effective April 15, 2006 through October 31, 2006, we entered into a sublease
agreement for a portion of some of our unused manufacturing and parking space in
the first facility whereby we expect to receive approximately $83,901 in rental
income to offset our lease payment obligations in fiscal 2007.
We believe that our properties are adequately covered by casualty insurance. We
are currently searching for new office space for our corporate headquarters.
However, we can make no assurances that we will be able to find and move to a
new location prior to November 2006 or that we will be able to renew our
existing lease on terms acceptable to us. In the event that we are not
successful, we may be subject to higher than normal lease rates or possible
disruption of normal business operations.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the fourth
quarter of the fiscal year ended March 31, 2006.
19
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
From August 1999 to May 5, 2006, our common stock, $.01 par value per share, was
traded on the American Stock Exchange ("AMEX") under the symbol "GXY". The
following table sets forth the high and low closing sales prices of our common
stock during each quarter as reported by AMEX for the fiscal years ended March
31, 2006 and 2005:
Period High Closing Sales Price Low Closing Sales Price
- --------------------------------------------------------------------------------------------
2006 Fiscal Year, quarter ended:
June 30, 2005 $ 2.53 $ 1.85
September 30, 2005 $ 2.10 $ 1.61
December 31, 2005 $ 1.91 $ 1.23
March 31, 2006 $ 1.42 $ 0.85
2005 Fiscal Year, quarter ended:
June 30, 2004 $ 2.45 $ 1.90
September 30, 2004 $ 2.15 $ 1.24
December 31, 2004 $ 1.98 $ 1.16
March 31, 2005 $ 2.83 $ 1.80
On April 20, 2006, we received a letter from AMEX, notifying us that it intended
to proceed with the filing of an application with the Securities and Exchange
Commission to strike our common stock from listing and registration on the
Exchange. We did not appeal this determination by AMEX and on May 5, 2006, AMEX
suspended trading in our common stock and submitted an application to the
Securities and Exchange Commission to strike our common stock from listing and
registration on AMEX. Commencing May 8, 2006, we began trading under the symbol
"GXYF" in the over-the-counter market on what is commonly referred to as the OTC
Bulletin Board.
Holders
On July 13, 2006, there were approximately 616 stockholders of record for our
common stock. This does not reflect persons or entities that hold our common
stock in nominee or "street" name through various brokerage firms.
Dividends
We have not paid any dividends with respect to our common stock and do not
expect to pay dividends on our common stock in the foreseeable future. It is the
present policy of our Board of Directors to retain future earnings to finance
the growth and development of our business. Any future dividends will be
declared at the discretion of the Board of Directors and will depend upon, among
other things, the financial condition, capital requirements, earnings and
liquidity of our Company. See Management's Discussion and Analysis of Financial
Condition and Results of Operations for a discussion of our current capital
position.
20
Securities Authorized for Issuance under Equity Compensation Plans
Please see the section titled "Equity Compensation Plan Information" in Item 12
in Part III of this Form 10-K.
Recent Sales of Unregistered Securities
There were no sales of unregistered securities in the quarter ended March 31,
2006.
Share Reacquisition
In June 1999, in connection with an amended and restated employment agreement
for Angelo S. Morini, our Founder, stockholder and a 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 his purchase of
2,914,286 shares of our common stock into a single stockholder note receivable
in the amount of $12,772,200 that was due on June 15, 2006. This stockholder
note receivable is non-interest bearing and non-recourse and is secured by the
2,914,286 shares of our common stock (the "Shares").
On June 16, 2006, Mr. Morini failed to repay the non-recourse note obligation to
our Company. On June 20, 2006, we delivered notice to Mr. Morini that we
intended to exercise our rights to the Shares and retain all the Shares in full
satisfaction of his obligations under the stockholder note receivable. On July
6, 2006, Mr. Morini consented to our acceptance of the Shares in full
satisfaction of his obligations under the stockholder note receivable. As a
result, we are in the process of canceling the Shares along with an additional
30,443 treasury shares. Taking into account such cancellation, our total number
of issued and outstanding shares of common stock is now 17,109,894 shares.
21
ITEM 6. SELECTED FINANCIAL DATA
Fiscal Years Ended March 31,
(1) (1) (1) (2)
2006 2005 2004 2003 2002
------------ ------------ ------------ ------------ ------------
Net sales $ 37,775,862 $ 44,510,487 $ 36,176,961 $ 40,008,769 $ 42,927,104
Reserve on stockholder note
receivable(3) (10,120,200) -- -- -- --
Cost of disposal activities(3) (1,646,490) -- -- -- --
Impairment of fixed assets(3) (7,896,554) -- -- -- --
Employment contract expense (3) -- (444,883) (1,830,329) -- --
Income tax benefit (expense) -- -- -- -- (1,560,000)
Net income (loss) (24,148,553) (3,859,783) (3,299,277) (957,221) (16,721,1494)
Net income (loss) to common
stockholders (24,148,553) (4,261,855) (4,757,087) (2,530,390) (18,748,345)
Net income (loss) per common share
- basic & diluted (1.23) (0.25) (0.32) (0.21) (1.78)
Total assets((4)) 5,250,070 27,769,666 29,961,816 33,325,334 36,115,051
Long-term obligations 597,184 8,000,627 9,740,094 10,170,195 12,511,461
Redeemable Convertible Preferred
Stock -- -- 2,573,581 2,324,671 2,156,311
(1) See Material Historical Events under Business Environment in Item 7 for a
summary of the major events during the fiscal years ended March 31, 2006,
2005 and 2004.
(2) In addition to the line items detailed above, the net loss for fiscal year
ended March 31, 2002 included approximately $5.4 million in accounts
receivable and inventory write-downs, non-cash compensation expense of
approximately $400,000, approximately $1 million in fixed asset disposals
and unused trade credit write-offs, and approximately $2.4 in non-cash
interest, derivative and fair value expenses.
(3) See Results of Operations in Item 7 below for a detailed description of
these items.
(4) Total assets decreased by approximately $22,500,000 from March 31, 2005 to
March 31, 2006 as a result of our reduction in inventory and equipment
related to the outsourcing of our manufacturing and distribution functions
and the sale of substantially all of our manufacturing equipment.
22
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following 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 contained in Item 8. Terms such as "fiscal 2007", "fiscal 2006", "fiscal
2005" or "fiscal 2004" refer to our fiscal years ending March 31, 2007, 2006,
2005 and 2004, respectively.
This MD&A contains the following sections:
o Basis of Presentation; Going Concern
o Business Environment
o Critical Accounting Policies
o Results of Operations
o Liquidity and Capital Resources
o Contractual Obligations
o Recent Accounting Pronouncements
Basis Of Presentation; Going Concern
Certain matters discussed below under "Liquidity and Capital Resources" raise
substantial doubt about our ability to continue as a going concern. In addition,
we received a report from our independent accountants relating to our audited
financial statements as of March 31, 2006 containing a paragraph stating that
because we are in default of our notes payable, have suffered recurring losses
from operations and at March 31, 2006 have deficiencies in working capital and
equity, there is substantive doubt as to our ability to continue as a going
concern. Our financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America
assuming that we will continue on a going concern basis. This assumes the
realization of assets and the satisfaction of liabilities in the normal course
of business. Accordingly, our financial statements do not include any
adjustments relating to the recoverability of assets and classification of
liabilities that might be necessary should we be unable to continue as a going
concern.
Business Environment
General
Galaxy Nutritional Foods, Inc. (our "Company") is principally engaged in
developing and globally 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 foodservice 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.
In fiscal 2006, we determined that the manufacturing capacity was significantly
in excess of our requirements and that it would be advantageous to outsource
manufacturing and distribution operations. On June 30, 2005, Galaxy Nutritional
Foods, Inc. 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. In November
2005, Schreiber began to deliver such products directly to our customers.
23
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 consumers shifting
to cheese alternatives from natural cheese. Our strategy is to broaden the
consumer base to include younger, less price sensitive consumers seeking
products with overall health and nutrition attributes. Historically, our
products and marketing efforts appealed to older consumers purchasing cheese
alternatives for specific dietary concerns.
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 fiscal 2006, we launched a regional consumer marketing campaign to educate
conventional cheese users on the benefits and location of Galaxy branded
products. The campaign drivers included traditional consumer advertising, price
based promotions, secondary placement and event marketing.
The consumer focused advertising included a 30 second TV commercial in key
markets on major networks including Food Network, Lifetime, Travel Channel,
Oxygen and USA during September 2005 and January 2006. Price based promotions
included a cents off coupon in free standing inserts distributed in major
regional newspapers in September 2005 and January 2006. We also tested secondary
placement with select retailers in Florida, Los Angeles and Chicago. Event
marketing included sponsorship of the Komen Race for the Cure in New York and
Houston. This provided an opportunity to educate women on the benefits of cheese
alternatives and introduce them to our brands with samples, coupons and product
information.
The fiscal 2006 marketing campaign provided valuable insight as to what types of
marketing efforts produced short-term and long-term benefits for brand
recognition and accomplished our goal to broaden the consumer base within the
cheese alternative category. We are using the results from fiscal 2006, to focus
the fiscal 2007 marketing campaign as we enter the year as a branded marketing
company.
Historical Summary
Fiscal 2006
During fiscal 2006, we entered into a Supply Agreement with Schreiber, whereby
we agreed we would cease our manufacturing and distribution operations and that
Schreiber would become our sole source of supply for substantially all of our
products. In November 2005, Schreiber began to deliver such products directly to
our customers. On December 8, 2005, we completed the sale of substantially all
of our manufacturing and production equipment to Schreiber for $8.7 million.
Additionally, during fiscal 2006, we secured $2.4 million in short-term
unsecured notes for working capital purposes. As a result of these transactions
in fiscal 2006, we reduced our total assets by nearly $20 million, incurred $9.5
million in expenses (of which approximately $8 million is a non-cash expense)
and reduced our liabilities by over $11 million compared to fiscal 2005.
24
Fiscal 2005
During fiscal 2005, we redeemed the remaining 30,316 Series A convertible
preferred shares that were outstanding as of October 6, 2004 for $2,279,688. The
cash for the redemption was obtained through an equity financing (see Equity
Financing under Liquidity and Capital Resources for further details). In early
fiscal 2005, we made the decision to take on a few additional private-label
manufacturing contracts at lower margins in order to utilize some of our excess
production capacity. One of the new contract customers accounted for 12% of our
sales during fiscal 2005, which attributed to 65% of the increase in sales over
fiscal 2004. In the fourth quarter of fiscal 2005, we reserved nearly $1,550,000
in accounts receivable and $210,000 in inventory related to this customer due to
questionable collectibility. See Del Sunshine LLC under Fiscal 2006 for further
details. Also during fiscal 2005, we experienced a sharp increase in our cost of
goods sold primarily as a result of a 32% (or nearly $2.7 million) increase in
the price of casein, our primary ingredient used in production. Only a portion
of this overall increase could be passed on to our customers. Additionally, the
price increase cannot be implemented immediately.
Fiscal 2004
During fiscal 2004, we refinanced or paid in full all of our credit facilities
that were in existence at the end of fiscal 2003. This payoff and refinancing
was accomplished through a new asset based lender, renewing and increasing our
loans with our bank and through equity financings. This financial restructuring
improved our operations and financial position and reduced interest expense
nearly $1.6 million during fiscal 2004. Additionally, in fiscal 2004, we nearly
doubled the positive cash flow from operations due to the restructuring and
continued focus on producing only high margin items.
Recent Material Developments
Outsourcing Effect
We believe that the long-term benefits in the transition from a manufacturing
company to a branded marketing company will substantially 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 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.
Some of the effects of the transaction are as follows:
o We are solely a branded marketing company without any manufacturing
and distribution functions.
o In December 2005, we ceased to use the manufacturing portion of our
main leased facility in Orlando, Florida where our administrative
offices are located, but we plan to stay in this location through
the end of our lease in November 2006. If the lease is not
terminated sooner, future lease payments due on this facility are
approximately $267,000 for the balance of the term. Effective April
15, 2006 through October 31, 2006, we entered into a sublease
agreement for a portion of some of our unused manufacturing and
parking space in the first facility whereby we expect to receive
approximately $83,901 in rental income to offset our lease payment
obligations in fiscal 2007.
o In December 2005, we abandoned our distribution facility that has a
lease termination date of July 31, 2009. We are currently working
with the landlord to terminate the lease. If the lease is not
terminated or subleased, total estimated future lease payments due
on this facility are approximately $1,176,000.
o We eliminated 104 employee positions related to the manufacturing
and distribution of our products and created 2 new employee
positions. We now maintain 30 full time positions.
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.
25
o We anticipate substantial savings on delivery charges related to the
distribution of our products to our customers. In the fourth quarter
of fiscal 2006, delivery expenses amounted to 4% of net sales
compared to 6% of net sales for the prior three quarters.
o We anticipate substantial savings on costs of goods sold and
improved gross margins as a result of reduced overhead and lower
material costs. In the fourth quarter of fiscal 2006, gross margin
was approximately 34% of net sales compared to 23% of net sales for
the prior three quarters.
Debt Maturity and Going Concern Issues
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 required
monthly interest-only payments at 3% above the bank prime rate of interest per
the Federal Reserve Bank (the "Prime Rate") and matured on June 15, 2006. We
received a letter on June 20, 2006, from all of the Note Holders other than Mr.
DeLuca, notifying the Company that its failure to pay the amounts due and owing
on the maturity date constitutes a default under $1.2 million of the Notes held
by those Note Holders. Pursuant to the terms of the Notes, since we did not cure
the default within 10 days after receipt of the notice of default, we are
obligated to pay interest at the default rate of 8% above the Prime Rate.
We do not currently have the short-term liquidity to pay the Notes in accordance
with their original terms and are negotiating with the Note Holders and other
parties regarding extending the maturity of the Notes, refinancing the Notes
and/or converting all or a portion of the Notes into equity. There can be no
assurance that we will be successful in our negotiations with the Note Holders
and other parties or that the terms of any such refinancing or conversions will
not result in the issuance, or potential issuance, of a significant amount of
equity securities. In the event we are not successful, any collection actions by
the Note Holders could have a material adverse affect on the liquidity and
financial condition of the Company or our ability to secure additional financing
and we may not be able to continue as a going concern.
Material Losses
Our Statement of Operations is showing an increase in loss from operations of
approximately $20 million in the fiscal year ended March 31, 2006 compared to
the fiscal year ended March 31, 2005. This increase in loss is primarily due to
a $10,120,200 reserve on a stockholder note receivable, a $7,896,554 impairment
on fixed assets and disposal costs of $1,646,490 related to our asset sale and
outsourcing arrangements with Schreiber as discussed in further detail under
Results of Operations.
Del Sunshine LLC
Pursuant to an oral contract manufacturing and distribution arrangement among
our Company, Del Sunshine LLC ("Del"), a Delaware limited liability company, and
Non-Dairy Specialty Foods, LLC ("Non-Dairy"), a Nevada limited liability company
and affiliate of Del, we began manufacturing certain private label products for
Del and delivering them directly to Del's customers, including Del's major
customer, Wal-Mart, Inc. in April 2004. These private label products were
produced using label and packaging trademarks owned by Del. Sales to Del
accounted for 12% of our sales during fiscal 2005, which attributed to 65% of
the increase in sales over fiscal 2004.
On April 11, 2005, we executed with Del a Trademark License Agreement and an
Assignment of Accounts Receivable Agreement. Pursuant to the Trademark License
Agreement, Del licensed to us the rights in certain Del trademarks, which
allowed us to sell products directly to Del's customers, including Wal-Mart,
Inc. and other food retailers, using such trademarks. In consideration for the
license, we agreed to pay to Del a 5% royalty on the net sales of such products.
In accordance with the Trademark License Agreement, we can offset any royalties
that we may owe to Del under the agreement against our account receivable and
other amounts owed to us by Del.
26
Pursuant to the Assignment of Accounts Receivable Agreement, Del assigned to us
any and all accounts receivable owed to Del by Wal-Mart, Inc. and other food
retailers, plus monies owed to Del under current purchase orders. It was
intended that the assignment of the accounts receivable and purchase order
amounts would offset, in part, our account receivable from Del. We also agreed
not to commence any legal proceedings against Del or Non-Dairy to collect
amounts owed to us by them, excluding defenses and counterclaims against Del or
Non-Dairy made in any legal proceeding brought by them.
The effectiveness of the Trademark License Agreement and the Assignment of
Accounts Receivable Agreement was conditioned upon Del providing us with proof,
satisfactory to us, that (a) Del would be transferring to us under the
Assignment of Accounts Receivable Agreement accounts receivable and purchase
orders in excess of $400,000 and (b) that Wal-Mart, Inc. would consent to the
transactions contemplated under both agreements. Del has not satisfied either of
the foregoing conditions and we do not believe that it is likely that Del will
be able to satisfy the conditions in the future. Although we waived the
conditions as they relate to the Trademark License Agreement, we did not waive
them with respect to the Assignment of Accounts Receivable Agreement. Currently,
we are exploring our options in addressing the issues with Del related to the
effectiveness and continuation of the Assignment of Accounts Receivable
Agreement and Del's payment of our account receivable. On or about June 15,
2006, we ceased selling products under Del's trademarks and we allowed the
Trademark License Agreement to expire according to its terms on September 30,
2005.
In the fourth quarter of fiscal 2005, we reserved nearly $1,550,000 in accounts
receivable and wrote off $210,000 in inventory related to Del based upon our
determination in April 2005 that collection from Del was questionable as of
March 31, 2005. During the first quarter of fiscal 2006, we accrued
approximately $40,000 in royalties under the Trademark License Agreement and
offset them against the receivable owed to us by Del. During the year ended
March 31, 2006, we recorded approximately $279,000 in additional bad debt
related to Del. As of March 31, 2006, all amounts owed by Del have been written
off as uncollectible.
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,
non-cash compensation related to stock based transactions, disposal
costs and fixed asset impairment charges
o EBITDA excluding certain employment contract expenses and non-cash
compensation related to stock based transactions, disposal costs and
fixed asset impairment charges
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.
27
Management has discussed the selection of critical accounting policies and
estimates with our Board of Directors and the Board of Directors has reviewed
our disclosure relating to critical accounting policies and estimates in this
annual report on Form 10-K. Our significant accounting policies are described in
Note 1 to our financial statements for fiscal 2006. The critical accounting
policies used by management and the methodology for its 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 $1,769,000 and $2,299,000 for
known and anticipated future credits and doubtful accounts at March 31, 2006 and
2005, respectively. 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. Actual bad debt expense increased from 1% of gross
sales during fiscal 2004 to 3% of gross sales during fiscal 2005 due to the
$1,550,000 reserve for Del Sunshine as described under Material Historical
Events, but it decreased back to 1% of gross sales during fiscal 2006.
Valuation of Stockholder Note Receivable
We evaluated the collection of the $12,772,200 stockholder note receivable that
was due on June 15, 2006 from Angelo S. Morini, our Founder, stockholder and a
member of our Board of Directors. This stockholder note receivable 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
stockholder note was due to be paid. Due to the uncertainty that the value of
these shares would exceed the stockholder note value prior to its maturity, we
reserved $10,120,200 during the fiscal year ended March 31, 2006 for the
difference between the $2,652,000 share value and the $12,772,200 loan value as
of such date. The value of the shares was computed using the closing price of
our common stock on March 31, 2006 of $0.91 multiplied by the 2,914,286 shares.
On June 16, 2006, Mr. Morini failed to repay the non-recourse note obligation to
our Company and we subsequently reacquired the 2,914,286 shares. Based upon the
$0.42 closing price of our common stock as quoted on the OTC Bulletin Board on
June 16, 2006, the shares have an approximate value of $1,224,000. Accordingly,
we will recognize an additional expense of $1,428,000 in the first quarter of
fiscal 2007 in order to record the additional decline in the value of the shares
from its $2,652,000 value as of March 31, 2006.
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.
28
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
We currently have two stock-based employee compensation plans. Prior to April 1,
2003, we accounted for our employee stock 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 years ended March 31, 2006, 2005 and 2004
ranged from nearly zero to $0.03.
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:
Fiscal Years Ended March 31, 2006 March 31, 2005 March 31, 2004
-------------- -------------- --------------
Dividend Yield None None None
Volatility 11% to 46% 45% to 46% 41% to 45%
Risk Free Interest Rate 3.35% to 4.30% 3.38% to 4.12% 2.01% to 4.28%
Expected Lives in Months 1 to 120 60 to 120 36 to 120
In addition to non-cash compensation expense related to new stock-based
transactions, prior to March 31, 2006, 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
resulted in an expense or income, respectively, of approximately $35,000.
Effective April 1, 2006, we will adopt SFAS No. 123R at which time this variable
accounting treatment will be discontinued.
29
Disposal Costs
We have recorded 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. If we do not sublease our facilities, our
estimate of excess facility expenses will increase.
Results Of Operations
2006- 2005-
2006-2005 2005-2004 2005 2004 2006 2005 2004
-------------------------------------------------------------------
12 Months $ $ % % % of % of % of
Ending March 31, 2006 2005 2004 Change Change Change Change Sales Sales Sales
- ---------------------------------------------------------------------------------------------------------------------------
Net Sales 37,775,862 44,510,487 36,176,961 (6,734,625) 8,333,526 -15.1% 23.0% 100.0% 100.0% 100.0%
Cost of Goods Sold 28,142,732 34,736,594 24,864,289 (6,593,862) 9,872,305 -19.0% 39.7% 74.5% 78.0% 68.7%
-------------------------------------------------------------------------------------------------------
Gross Margin 9,633,130 9,773,893 11,312,672 (140,763) (1,538,779) -1.4% -13.6% 25.5% 22.0% 31.3%
=======================================================================================================
Sales
For the fiscal years ended March 31, 2006, 2005 and 2004, our gross sales were
$41,492,717, $48,421,384 and $40,041,371, respectively. The following chart sets
forth the percentage of gross sales derived from our product brands during the
fiscal years ended March 31, 2006, 2005 and 2004:
Percentage of Gross Sales
Fiscal Years Ended March 31,
Brand 2006 2005 2004
- -------------------------------------------------------------------------------
Veggie 52.5% 46.5% 59.9%
Private Label, Imitation & Other 31.1% 35.4% 22.4%
Rice 7.8% 6.6% 7.9%
Veggy 3.8% 4.7% 6.2%
Wholesome Valley Organic 2.8% 5.0% 1.1%
Vegan 2.0% 1.8% 2.5%
30
Net sales, after discounts, returns and allowances, in fiscal 2006 decreased 15%
from net sales in fiscal 2005 due to a decline in private label sales volume to
Wal-Mart. Prior to fiscal 2006, we produced certain private label products for
Del Sunshine who then sold the product to Wal-Mart. In fiscal 2006, we began
selling these products directly to Wal-Mart instead of through Del Sunshine (See
Del Sunshine LLC under Recent Material Developments for further details). During
fiscal 2006, combined sales to Wal-Mart and Del Sunshine accounted for
approximately 7% of gross sales, compared to nearly 14% of gross sales in fiscal
2005. This decrease in sales accounted for 8% of the sales decline in fiscal
2006.
The remaining 7% decrease in sales was due to overall consumer resistance to the
multiple price increases we implemented in late fiscal 2005 and early fiscal
2006 to offset our rising production costs. We statistically linked the majority
of the reduction in sales of our Veggie Slices to average unit price and plan to
implement more effective price promotions in fiscal 2007.
Net sales for fiscal 2005 increased by 23% over net sales for fiscal 2004
primarily due to increased sales in private label and Wholesome Valley(R)
Organic products. During fiscal 2005, we had one new private label customer that
accounted for approximately 12% of gross sales. This customer accounted for
nearly 65% of the increase in fiscal 2005 sales. However, we are no longer
selling to this customer due to a shift in sales between customers as discussed
above.
During fiscal 2007, we plan to reduce marginally profitable private label and
Galaxy imitation sales and as a result, improve our gross margins. We anticipate
that our sales in fiscal 2007 will decline next year due to our specific focus
to eliminate marginally profitable private label and other products.
Cost of Goods Sold
Cost of goods sold decreased from 78% of net sales in fiscal 2005 to 74% of net
sales in fiscal 2006. This four percentage point decrease in cost of goods sold
was primarily due to the reduced production overhead through the outsourcing of
our manufacturing operations since November 2005 as discussed under Recent
Material Developments.
Cost of goods sold increased from 69% of net sales in fiscal 2004 to 78% of net
sales in fiscal 2005. This nine percentage point increase in cost of goods sold
was primarily due to rising raw material costs. Of this nine percentage point
increase in cost of goods sold in relation to net sales, six percentage points
were a direct result of higher key raw material costs (including primarily
casein, and to a lesser extent packaging and film supplies) and the balance of
the increase was due to the addition of certain private label items that were
sold at a lower margin resulting in a higher cost in relation to net sales.
The principal raw material used by our Company is casein, which accounted for
approximately 35% and 47% of our raw material purchases in fiscal 2006 and
fiscal 2005, respectively. As casein is a significant component of our product
formulation, we were vulnerable to short-term and long-term changes in casein
pricing, which at times has been volatile.
We experienced a 32% increase in average casein prices in fiscal 2005 compared
to average casein prices in fiscal 2004, which resulted in an increase in cost
of goods of approximately $2.7 million. In fiscal 2006, we continued to
experience high casein prices, the averages of which were approximately 30%
higher than the average prices for fiscal 2005. In October 2005, the prices of
casein began to decline. Schreiber, our outsourcing manufacturer, is now
responsible for securing these ingredients, but fluctuations in casein prices
will be passed on directly to us when we purchase the finished product from
them. In order to offset the high casein costs, we incorporated alternative
formula modifications in some of our products. We also passed along some of the
increased costs to our customers during fiscal 2005 and will implement
additional price increases as appropriate. However, these price increases often
cannot be passed on to the customers at the same time or in proportion to the
increase in our costs and therefore, we experience lower margins on the sales of
our products.
31
Gross Margin
Despite the sharp decline in sales, gross margin dollars in fiscal 2006 was only
slightly lower than fiscal 2005 due to the elimination of the private label
sales to Wal-Mart and the elimination of our high fixed overhead in the fourth
quarter of fiscal 2006. In the fourth quarter of fiscal 2006, our gross margin
averaged 34% compared to the annual fiscal 2006 average of 26%. Private label
and imitation sales consist primarily of products that generate high sales
volumes but lower gross margins.
In fiscal 2007, we expect our gross profit percentage to improve over the fiscal
2006 levels despite the reduction in sales levels due to the elimination of
certain low margin private label and Galaxy imitation business and the reduction
in excess overhead. Our anticipated higher margin sales combined with our lower
overhead burden, should produce higher gross margins in dollars and as a
percentage of sales.
EBITDA
We utilize certain GAAP measures such as Operating Income and Net Income and
certain non-GAAP measures, such as an adjusted Operating Income, Net Income and
EBITDA, in order to compute 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 to 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:
2006-2005 2005-2004 2006-2005
12 Months Ending March 31, 2006 2005 2004 $ Change $ Change % Change
- -----------------------------------------------------------------------------------------------------------------------------
Gross Margin 9,633,130 9,773,893 11,312,672 (140,763) (1,538,779) -1.4%
--------------------------------------------------------------------------------------
Operating Expenses:
Selling 5,571,097 5,148,426 4,981,996 422,671 166,430 8.2%
Delivery 2,251,318 2,307,166 1,877,682 (55,848) 429,484 -2.4%
Employment contract expense(2) -- 444,883 1,830,329 (444,883) (1,385,446) -100.0%
General and administrative, including
$926,263, $409,746 and $651,273
non-cash stock compensation(1) 4,750,624 4,380,436 3,954,303 370,188 426,133 8.5%
Research and development 321,016 309,054 260,410 11,962 48,644 3.9%
Reserve on stockholder note
receivable(2) 10,120,200 -- -- 10,120,200 -- 100.0%
Cost of disposal activities(2) 1,646,490 -- -- 1,646,490 -- 100.0%
Impairment of fixed assets(2) 7,896,554 -- -- 7,896,554 -- 100.0%
(Gain)Loss on disposal of assets (3,628) (4,500) 8,519 872 (13,019) -19.4%
--------------------------------------------------------------------------------------
Total operating expenses 32,553,671 12,585,465 12,913,239 19,968,206 (327,774) 158.7%
--------------------------------------------------------------------------------------
Loss from Operations(3) (22,920,541) (2,811,572) (1,600,567) (20,108,969) (1,211,005) 715.2%
Other Income (Expense), Net
Interest expense, net (1,616,743) (1,129,977) (1,361,606) (486,766) 231,629 43.1%
Derivative income (expense) -- 62,829 (94,269) (62,829) 157,098 -100.0%
Gain (loss) on FV of warrants 388,731 18,937 (242,835) 369,794 261,772 1952.8%
--------------------------------------------------------------------------------------
Total (1,228,012) (1,048,211) (1,698,710) (179,801) 650,499 17.2%
--------------------------------------------------------------------------------------
NET LOSS (24,148,553) (3,859,783) (3,299,277) (20,288,770) (560,506) 525.6%
Interest expense, net 1,616,743 1,129,977 1,361,606 486,766 (231,629) 43.1%
Depreciation 1,517,287 2,172,566 2,205,053 (655,279) (32,487) -30.2%
--------------------------------------------------------------------------------------
EBITDA, a non-GAAP measure (21,014,523) (557,240) 267,382 (20,457,283) (824,622) 3671.2%
======================================================================================
EBITDA, a non-GAAP measure:
2005-2004 2006 2005 2004
12 Months Ending March 31, % Change % of Sales % of Sales % of Sales
- ------------------------------------------------------------------------------------------
Gross Margin -13.6% 25.5% 22.0% 31.3%
---------------------------------------------------
Operating Expenses:
Selling 3.3% 14.7% 11.6% 13.8%
Delivery 22.9% 6.0% 5.2% 5.2%
Employment contract expense(2) -75.7% 0.0% 1.0% 5.1%
General and administrative, including
$926,263, $409,746 and $651,273
non-cash stock compensation(1) 10.8% 12.6% 9.8% 10.9%
Research and development 18.7% 0.8% 0.7% 0.7%
Reserve on stockholder note
receivable(2) 0.0% 26.8% 0.0% 0.0%
Cost of disposal activities(2) 0.0% 4.4% 0.0% 0.0%
Impairment of fixed assets(2) 0.0% 20.9% 0.0% 0.0%
(Gain)Loss on disposal of assets -152.8% 0.0% 0.0% 0.0%
---------------------------------------------------
Total operating expenses -2.5% 86.2% 28.3% 35.7%
---------------------------------------------------
Loss from Operations(3) 75.7% -60.7% -6.3% -4.4%
Other Income (Expense), Net
Interest expense, net -17.0% -4.3% -2.5% -3.8%
Derivative income (expense) -166.6% 0.0% 0.1% -0.3%
Gain (loss) on FV of warrants -107.8% 1.0% 0.0% -0.7%
---------------------------------------------------
Total -38.3% -3.3% -2.4% -4.7%
---------------------------------------------------
NET LOSS 17.0% -63.9% -8.7% -9.1%
Interest expense, net -17.0% 4.3% 2.5% 3.8%
Depreciation -1.5% 4.0% 4.9% 6.1%
---------------------------------------------------
EBITDA, a non-GAAP measure -308.4% -55.6% -1.3% 0.7%
===================================================
32
(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 market price of our
common shares 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,
disposal costs and fixed asset impairment charges 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.
(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, disposal costs and fixed
asset impairment charges 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 along with certain fixed costs for
employee salaries and benefits and marketing campaigns. We have experienced
increased selling expenses each fiscal year primarily due to the increase in
marketing efforts. During fiscal 2006, we increased our television costs by
$296,000 and implemented a new television marketing campaign. Additionally, we
paid over $100,000 for a subscription service that enables us to obtain detailed
information about product sales during the year. During fiscal 2005, we
increased our marketing costs by approximately $190,000 over fiscal 2004, but
shifted our marketing efforts from trade promotions to consumer advertising. The
large consumer advertising costs were primarily related to a strategic
television campaign, which was undertaken to promote our Veggie products during
the second and third quarter of fiscal 2005.
We expect fixed selling expenses for advertising and market research in fiscal
2007 to be nearly the same level as in fiscal 2006, but with a more focused use
of funds. We sell our products through our internal sales force and an
independent broker network.
Delivery
Delivery expense is primarily a function of sales, and has remained consistent
at approximately 5% of net sales. In fiscal 2006, delivery expense increased to
6% of net sales due to higher fuel prices and surcharges charged by our
transportation companies. In November 2005, Schreiber began to deliver our
products directly to our customers pursuant to the Supply Agreement between our
Company and Schreiber dated June 30, 2005. After the outsourcing of the
distribution function, our delivery expense decreased. In the fourth quarter of
fiscal 2006, delivery expenses amounted to 4% of net sales compared to 6% of net
sales for the prior three quarters.
Due to our Supply Agreement, we anticipate additional savings on delivery
charges related to the distribution of our products to our customers in fiscal
2007 as compared to fiscal 2006.
33
Employment Contract Expense
In connection with a Separation and Settlement Agreement dated July 8, 2004
between our Company and Christopher J. New (as further described under Item 11),
we accrued and expensed $444,883 as the two-year cost of this agreement under
employment contract expense in the second quarter of fiscal 2005. As of March
31, 2006, the remaining balance unpaid and accrued balance reflected in
short-term liabilities was $67,809.
In October 2003, our Company and Angelo S. Morini entered into a Second Amended
and Restated Employment Agreement (as further described under Item 11). In
connection with this agreement, we accrued and expensed the five-year cost of
this agreement as employment contract expense in the third quarter of fiscal
2004. The total estimated costs expensed under this agreement are $1,830,329 of
which $925,982 remained unpaid and accrued ($366,305 as short-term liabilities
and $559,677 as long-term liabilities) as of March 31, 2006. The long-term
portion will be paid out in nearly equal monthly installments ending in October
2008.
General and administrative
During fiscal 2006, general and administrative expenses increased approximately
$370,000 compared to fiscal 2005 primarily due to increases of approximately
$517,000 in additional non-cash compensation related to stock-based
transactions, as detailed below, $285,000 in liquidated damages related to a
registration rights agreement as discussed below under Equity Financing,
$130,000 additional director and officer insurance costs due to higher coverages
and increased premiums, $237,000 in consulting fees for our outsourcing and sale
arrangements, and $448,000 in additional professional fees for legal and audit
services due to our additional review of strategic alternatives (including the
potential sale of our Company that was abandoned in April 2006) and SEC filings
during fiscal 2006. These increases were reduced by a decrease of nearly $1.2
million in bad debt expense from fiscal 2005 as discussed under Recent Material
Developments.
During fiscal 2005, we noted an increase of approximately $426,000 in expenses
compared to fiscal 2004. This increase is the net effect of approximately a $1.6
million increase in bad debt expense (see Del Sunshine LLC under Recent Material
Developments for further details) and decreases in non-cash compensation income
related to stock-based transactions, as detailed below, personnel costs and
professional fees for legal and audit services. Personnel costs declined nearly
$250,000 due to the change in the employment status of Angelo S. Morini per the
amended employment agreement in October 2003. Additionally, legal fees decreased
in fiscal 2005 due to the settlement of the Schreiber lawsuit in May 2004 and
the completion of the financial restructuring in early fiscal 2004.
Excluding the effects of non-cash compensation related to stock-based
transactions, we anticipate that in fiscal 2007, general and administrative
expenses will decrease on an annual basis due to the non-recurrence of the
highly intensive consulting, legal and audit services related to major
contracts, review of strategic alternatives and additional SEC filings that were
required in fiscal 2006. Additionally, we do not anticipate the reoccurrence of
liquidated damages related to stock registration that were incurred in fiscal
2006.
The change in non-cash compensation related to stock-based transactions that are
included in general and administrative expenses are detailed as follows:
2006-2005 2005-2004 2006-2005 2005-2004
$ $ % %
12 Months Ending March 31, 2006 2005 2004 Change Change Change Change
- --------------------------------------------------------------------------------------------------------------------
Stock-based award issuances
1,118,819 194,097 643,272 924,722 (449,175) 476.4% -69.8%
Option modifications under
APB 25 awards (192,556) 215,649 8,001 (408,205) 207,648 -189.3% 2595.3%
---------------------------------------------------------------------------------------
Non-cash compensation
related to stock based
transactions 926,263 409,746 651,273 516,517 (241,527) 126.1% -37.1%
=======================================================================================
34
Effective April 1, 2003, we elected to record compensation expense measured at
fair value for all stock-based award transactions on or after April 1, 2003
under the provisions of SFAS 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 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. FIN 44 covers
specific events that occurred after December 15, 1998 and was effective as of
July 1, 2000.
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 on two primary items:
a. Stock-Based Award Issuances
During the fiscal years ended March 31, 2006, 2005 and 2004, we recorded
$1,118,819, $194,097, and $643,272, respectively, as 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 was to continue until the related options were
cancelled, expired or exercised. Effective April 1, 2006, we will adopt
SFAS No. 123R at which time this variable accounting treatment will be
discontinued. We recorded non-cash compensation (income) expense of
($192,556), $193,649 and $8,001 related to these modified options for the
fiscal years ended March 31, 2006, 2005 and 2004. There are 3,494,091
outstanding modified stock options remaining as of March 31, 2006.
In connection with a Separation and Settlement Agreement dated July 8,
2004 between our Company and Mr. New (as further described under Item 11),
we agreed that Mr. New's stock option rights under that certain
Non-Qualified Stock Option Agreement dated December 5, 2002 (for 25,000
shares at an exercise price of $1.67 per share) and that certain
Non-Qualified Stock Option Agreement dated July 16, 2001 (for 100,000
shares at an exercise price of $2.05 per share) would continue in full
force and effect as if he were still employed by our Company. The stock
price on the date of the modification was $2.15. In accordance with FIN 44
for modifications that renew or increase the life on existing options, we
recorded $22,000 as additional non-cash compensation expense in the fiscal
year ended March 31, 2005.
Reserve on stockholder note receivable
In June 1999, in connection with an amended and restated employment agreement
for Angelo S. Morini, our Founder, stockholder and a 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 his purchase of
2,914,286 shares of our common stock into a single stockholder note receivable
in the amount of $12,772,200 that was due on June 15, 2006. This stockholder
note receivable is non-interest bearing and non-recourse and is secured by the
2,914,286 shares of our common stock (the "Shares"). For the fiscal year ended
March 31, 2006, we reserved $10,120,200 against this stockholder note receivable
under the assumption that we would not be able to collect proceeds in excess of
the $2,652,000 value of the Shares as of such date. The value of the Shares was
computed using the closing price of our common stock on March 31, 2006 of $0.91
multiplied by the 2,914,286 shares.
35
Although this expense resulted in a material loss to our operations, it does not
have any affect on the balance sheet since the stockholder note receivable was
already shown as a reduction to Stockholders' Equity (Deficit).
On June 16, 2006, Mr. Morini failed to repay the non-recourse note obligation to
our Company and we subsequently reacquired the 2,914,286 shares. Based upon the
$0.42 closing price of our common stock as quoted on the OTC Bulletin Board on
June 16, 2006, the Shares have an approximate value of $1,224,000. Accordingly,
we will recognize an additional expense of $1,428,000 in the first quarter of
fiscal 2007 in order to record the additional decline in the value of the Shares
from its $2,652,000 value as of March 31, 2006.
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
fiscal year ended March 31, 2006, we incurred and reported $1,646,490 as Costs
of Disposal Activities in the Statement of Operations. As of March 31, 2006, all
104 employee positions related to the manufacturing and distribution of our
products had been eliminated. The remaining employee termination costs are
expected to be paid in fiscal 2007. 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 fiscal year ended March 31,
2006 is as follows:
Employee
Termination Excess Other Exit
Costs Facilities Costs Total
---------- ---------- ---------- ----------
Disposal Costs Incurred $ 451,002 $ 518,479 $ 677,009 $1,646,490
========== ========== ========== ==========
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.
Impairment of property and equipment and loss on sale of assets
In light of the Schreiber transactions discussed above under Recent Material
Developments, we determined that it is more likely than not that a majority of
our fixed assets related to production activities would be sold or disposed
prior to the end of their useful life. In accordance with SFAS No. 144,
"Accounting for the Impairment or 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 in November 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.
36
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 fiscal year ended March 31, 2006, we recorded a $3,628
gain on the sale of assets related to the remaining value of assets sold or
abandoned after production ceased in December 2005.
We have reclassified our remaining assets available for sale as Assets Held for
Sale in the Balance Sheet and expect to sell these remaining assets by September
2006. We have estimated the fair value of these assets to be $61,950. 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.
Other Income and Expense
Interest expense increased approximately $487,000 or 43% in fiscal 2006. The
increase was primarily the result of increased amortization related to loan
costs and debt discounts. The amortization of loan costs increased by
approximately $242,000 due to additional loan fees charged by our lenders and
due to the acceleration of the loan fee amortization 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. We recorded the $444,731 initial fair value
of the warrants as a discount to debt. In fiscal 2006, we amortized $317,752 of
this non-cash debt discount that is being amortized from September 2005 through
June 2006 and is included in interest expense. Due to average lower debt
balances in fiscal 2006 as compared to fiscal 2005, our additional interest
expense related to debt securities declined in excess of $73,000.
Several of our loans and default provisions accrue interest based on a variable
prime plus rate. Due to the increases in the prime rate (currently at 8%), we
will experience higher interest rates in fiscal 2007 as compared to fiscal 2006
(in which prime averaged 6.7%). However, we anticipate that our interest expense
will decrease nearly 50% in fiscal 2007, despite the higher interest rates, due
to lower debt balances and the completion of the non-cash debt discount
amortization in June 2006 as discussed above.
Interest expense decreased $231,629 or 17% in fiscal 2005. The decrease in
fiscal 2005 compared to fiscal 2004 resulted primarily due to the elimination of
interest on a mezzanine loan from FINOVA Mezzanine Capital that was recorded in
the first two months of fiscal 2004 and lower lender fees charged on our debt
facilities in fiscal 2005.
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
period. For the fiscal years ended March 31, 2005 and 2004, we recorded a
derivative income/(expense) of $62,829 and ($94,269), respectively, related to
the change in the fair value of the embedded derivative instruments. There was
no income or expense 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 we 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 fiscal years ended March 31, 2006, 2005 and 2004, we recorded a
gain/(loss) on the fair value of warrants of $388,731, 18,937 and ($242,835),
respectively, related to the change in the fair values of the warrants.
37
Liquidity And Capital Resources
Future Capital Needs
With the reduction in overall debt and property taxes, we expect to see annual
interest savings in excess of $800,000 in fiscal 2007. Additionally, we
anticipate improved gross margins to provide over $1 million in additional cash
in fiscal 2007. With these improvements, we believe that will have enough cash
to meet our needs for general operations in fiscal 2007.
However, we received a report from our independent accountants relating to our
audited financial statements as of March 31, 2006 containing a paragraph stating
that because we are in default of our notes payable, have suffered recurring
losses from operations and at March 31, 2006 have deficiencies in working
capital and equity, there is substantive doubt as to our ability to continue as
a going concern. Our ability to continue as a going concern depends upon
successfully obtaining sufficient cash resources to refinance our $2.4 million
of unsecured related party notes payable that matured on June 15, 2006 and
obtaining positive cash flow from operations to sustain normal business
operations.
Our current business plan eliminates certain low margin private label and Galaxy
imitation business from our sales mix. The elimination of these low margin items
and the elimination of excess overhead that was part of our former manufacturing
operations should result in higher gross margins with lower operating costs in
fiscal 2007 and produce positive cash flows from operations. However, the
expected improvement in cash flows from operations will not be sufficient to
repay the short-term notes without additional financing. Management is currently
negotiating with the existing note holders and other parties regarding extending
the maturity of the notes, refinancing the notes and/or converting all or a
portion of the notes into equity. There can be no assurance that we will be
successful in our business plan, our negotiations with the existing note holders
and other parties or that the terms of any such refinancing or conversions will
not result in the issuance, or potential issuance, of a significant amount of
equity securities that will cause substantial dilution to our stockholders. If
we are not successful in refinancing the $2.4 million in short-term notes or in
otherwise entering into a financing, sale, or business transaction that infuses
sufficient cash resources into our Company in the near future, any collection
actions by the existing note holders could have a material adverse affect on the
liquidity and financial condition of the Company or our ability to secure
additional financing and we may not be able to continue as a going concern.
Cash Flows from Operating Activities and Investing Activities
2006-2005 2005-2004 2006-2005 2005-2004
$ $ % %
12 Months Ending March 31, 2006 2005 2004 Change Change Change Change
- ----------------------------------------------------------------------------------------------------------------------
Cash from (used in) operating
activities (436,678) 779,746 2,236,350 (1,216,424) (1,456,604) -156.0% -65.1%
Cash from (used in) investing
activities 8,547,933 (65,002) (231,778) 8,612,935 166,776 -13250.3% -72.0%
Cash used in financing
activities (8,237,157) (602,641) (1,556,491) (7,634,516) 953,850 1266.8% -61.3%
---------------------------------------------------------------------------------------
Net increase (decrease) in
cash (125,902) 112,103 448,081 (238,005) (335,978) -212.3% -75.0%
=======================================================================================
38
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 fiscal 2006 due to higher
operating expenses and the disposal costs as described under Results of
Operations.
During fiscal 2005 and fiscal 2004, we achieved positive cash flow from
operations. This was achieved mainly through higher sales volumes in fiscal 2005
and improved margins on sales fiscal 2004. In fiscal 2005, we noted a 65%
decrease in cash from operating activities compared to fiscal 2004. This was
primarily attributable to an approximate 17% increase in net accounts receivable
associated with our increase in sales. This increase in cash used was offset by
further reductions in inventory levels and increases in accounts payable. We are
continually reviewing our collection practices, payment terms to vendors and
inventory levels in order to maximize cash flow from operations.
Cash used in investing activities primarily relates to our purchases and sales
of office and manufacturing equipment in each fiscal year. In fiscal 2006, we
received over $8.8 million in proceeds from the sale of the majority of our
assets as a result of the discontinuance of our manufacturing operations. We do
not anticipate any large capital expenditures during fiscal 2007.
In fiscal 2007, we expect to see improved cash from operations due to improved
gross margin on sales and a reduction in overhead costs. These improved
operating cash flows will be used to reduce certain related party notes payable
as discussed under "Equity Financing" below and to continue our focused
marketing investment in our branded products.
Cash Flows Used In Financing Activities
12 Months Ending March 31, 2006 2005 2004
- --------------------------------------------------------------------------------
Net borrowings (payments) on line
of credit and bank overdrafts (3,539,477) 853,202 (1,485,893)
Issuances of debt 2,400,000 -- 2,000,000
Payments of debt and capital leases (8,767,323) (1,417,103) (6,226,625)
Issuances of stock 1,669,643 2,240,948 4,156,027
Redemption of preferred stock -- (2,279,688) --
-------------------------------------------
Cash used in financing activities (8,237,157) (602,641) (1,556,491)
===========================================
During fiscal 2006, we used the proceeds received from the sale of our
manufacturing equipment as discussed above, and proceeds received from certain
related parties to pay in full our term loan to Beltway Capital Partners LLC
(successor by assignment of Wachovia Bank, N.A.) and reduce our asset-based line
of credit from Textron Financial Corporation. See "Debt Financing and Equity
Financing" below for further details.
During fiscal 2005, we increased our line of credit with Textron Financial
Corporation to primarily fund our business growth. Additionally, we issued
2,000,000 shares of our common stock for aggregate gross proceeds of $2,300,000.
These proceeds were then used to redeem the remaining 30,316 Series A
convertible preferred shares held by the holders of such Series A convertible
preferred shares for a total price of $2,279,688. See "Equity Financing" below
for further details.
39
During fiscal 2004, we refinanced all of our credit facilities that were in
existence at the end of fiscal 2003. This refinancing was accomplished through
the payment of $4,000,000 to FINOVA Mezzanine by renewing and increasing our
loan with Wachovia Bank by $2,000,000 and through $3,850,000 in private
placement equity financings. Additionally, we replaced FINOVA Capital
Corporation with Textron Financial Corporation as our new asset based lender.
This financial restructuring improved our operations and financial position and
reduced interest expense nearly $1.6 million during fiscal 2004. The remaining
proceeds from the refinancing were used for operations and to further reduce our
accounts payable and debt balances.
Debt Financing
Line of Credit
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 and subsequent amendments (the "Textron Loan
Agreement"). The Textron Loan was secured by our inventory, accounts receivable
and all other assets. Advances under the Textron Loan bore interest at a
variable rate equal to the prime rate plus 1.75% per annum (9.5% at March 31,
2006) calculated on the average cash borrowings for the preceding month. We paid
down the Textron Loan over $3.5 million in fiscal 2006.
The Textron Loan Agreement contained 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
during fiscal 2006, 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 amended and replaced
several financial covenants, allowed eligibility for borrowing on inventory
until December 31, 2005 and provided that the Textron Loan would 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 paid additional administrative fees as follows: $5,000 on February
1, 2006, $10,000 on March 1, 2006, $15,000 on April 1, 2006 and $20,000 May 1,
2006.
On May 26, 2006, we executed a Sixth Amendment to the Textron Loan Agreement.
The Sixth Amendment provided for an extension of the Textron Loan from May 26,
2006 until June 27, 2006 and reduced the maximum principal amount which could be
borrowed under the Textron Loan to $3,000,000. In exchange for the amendment and
extension, we paid a fee of $10,000.
40
On June 23, 2006, we entered into a Receivables Purchase Agreement with Systran
Financial Services Corporation, a subsidiary of Textron Financial Corporation
("Systran"), whereby Systran will provide financing to our Company through
advances against certain trade receivable invoices due to our Company (the
"Systran Agreement"). The Systran Agreement is secured by our accounts
receivable and all other assets. Generally, subject to a maximum principal
amount of $3,500,000 which can be borrowed under the Systran Agreement, the
amount available for borrowing is equal to 85% of our eligible accounts
receivable invoices less a dilution reserve and any required fixed dollar
reserves. The dilution and fixed dollar reserves have been initially set at 7%
and $100,000, respectively. Advances under the Systran Agreement bear interest
at a variable rate equal to the prime rate plus 1.5% per annum (9.5% on June 23,
2006). We paid a one-time closing fee of $35,000 and are also obligated to pay a
$1,500 monthly service fee. The initial term of the Systran Agreement ends on
June 23, 2009 and may renew automatically for consecutive twelve-month terms
unless terminated sooner.
On June 23, 2006, Systran advanced $2,379,262 under the Systran Agreement of
which $1,839,086 was used to pay in full and terminate our obligations under our
line of credit with Textron Financial Corporation which was to terminate on June
27, 2006.
Term Notes Payable
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 was to mature and be payable in full on July 31, 2006 instead of
June 1, 2009; 2) the principal payments were to 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 were waived and compliance was not required by us through the intended
maturity date 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.
Related Party Notes Payable
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 required
monthly interest-only payments at 3% above the bank prime rate of interest per
the Federal Reserve Bank and matured 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.
41
We did not currently have the short-term liquidity to pay our related party Note
Holders on the $2.4 million Notes that matured on June 15, 2006 in accordance
with their original terms. We received a letter on June 20, 2006 all the Note
Holders, other than Mr. DeLuca, notifying the Company that its failure to pay
the amounts due and owing on the maturity date constitutes a default under $1.2
million of the Notes held by those Note Holders. Pursuant to the terms of the
Notes, since we did not cure the default within 10 days after receipt of the
notice of default, we are obligated to pay interest at the default rate of 8%
above the Prime Rate.
We are negotiating with the Note Holders regarding extending the maturity of the
Notes, refinancing the Notes and/or converting all or a portion of the Notes
into equity. There can be no assurance that we will be successful in our
negotiations with the Note Holders or that the terms of any such refinancing or
conversions will not result in the issuance, or potential issuance, of a
significant amount of equity securities that will cause substantial dilution to
our stockholders.
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 $317,752 in fiscal 2006. As of March 31,
2006, the outstanding principal balance of $2,400,000 on the Notes less the
remaining debt discount was $2,273,021.
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, 2005 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.
42
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 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).
Contractual Obligations
We lease our operating facilities and certain equipment under operating and
capital leases, expiring at various dates through fiscal year 2010. In addition,
we have several loan obligations as described in detail above. The table below
summarizes the principal balances of our obligations for indebtedness and lease
obligations as of March 31, 2006 in accordance with their required payment
terms:
Payments due by fiscal period
---------------------------------------------------------------
Contractual Obligations Total 2007 2008-2009 2010-2011 Thereafter
- --------------------------------------------------------------------------------------------------
Textron credit facility (1) $ 1,919,002 $ 1,919,002 $ -- $ -- $ --
Related party notes payable 2,400,000 2,400,000 -- -- --
Interest on debt facilities (2) 84,134 84,134 -- -- --
Contractual employment agreements 993,791 434,114 559,677 --
Capital Lease Obligations (3) 63,227 23,498 39,729 -- --
Operating Lease Obligations (4) 1,549,873 679,934 747,116 122,823 --
---------------------------------------------------------------
Total $ 7,010,027 $ 5,540,682 $ 1,346,522 $ 122,823 $ --
===============================================================
(1) In accordance with EITF 95-22, "Balance Sheet Classification of
Borrowings Outstanding under Revolving Credit Agreements that
involve both a Subjective Acceleration Clause and a Lock-Box
Arrangement," the $1,919,002 balance owed to Textron is reflected as
current on the balance sheet and in the above schedule.
(2) The Textron credit facility bears interest at prime plus 1.75% and
the related party notes payable bear interest at prime plus 3%.
Interest is estimated assuming that the credit facility balance will
remain unchanged, all obligations are paid when due and that the
prime rate will remain at its level on March 31, 2006 of 7.75%.
(3) Includes the principal and interest portion of capital lease
payments to be paid.
43
(4) Effective April 15, 2006 through October 31, 2006, we entered into a
sublease agreement for a portion of some of our unused manufacturing
and parking space whereby we expects to receive approximately
$83,901 in rental income to offset our lease payment obligations in
fiscal 2007.
In addition to the foregoing contractual obligations, we have several contingent
obligations under our Supply Agreement with Schreiber that could be material and
adverse to us as follows:
The initial term of the Supply Agreement dated June 30, 2005 between our Company
and Schreiber 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.
Additionally, 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. The short-fall payment is based on formula that calculates the payment as
follows: ((required pounds shipped - actual pounds shipped) / required pounds
shipped) * $8,700,000. Thus, if we did not purchase any products from Schreiber
during between September 1, 2006 and August 31, 2008, the payment could be as
high as $8,700,000.
On May 22, 2003, we entered into a Master Distribution and Licensing Agreement
with Fromageries Bel S.A., ("Bel") a leading branded cheese company in Europe
who is a greater than 5% stockholder in our Company. Under the agreement, we
granted Bel exclusive distribution rights for our products in a territory
comprised of the European Union States and to more than 21 other European
countries and territories (the "Territory"). We also granted Bel the exclusive
option during the term of the agreement to elect to manufacture the products
designated by Bel for distribution in the Territory. The term of the agreement
was ten years. The parties could mutually agree to continue operating under the
agreement, to convert the agreement to a manufacturing and license agreement, or
to terminate the agreement. This agreement was terminated effective July 1,
2005, pursuant to a Termination, Settlement and Release Agreement signed on July
22, 2005. In accordance with the termination agreement, we received $150,000
from Fromageries Bel S.A.
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. 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.
44
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 has
not had 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.
In February 2006, the FASB issued SFAS No. 155, "Accounting for Certain Hybrid
Financial Instruments - An Amendment of FASB Statements No. 133 and 140." SFAS
No. 155 provides entities with relief from having to separately determine the
fair value of an embedded derivative that would otherwise be required to be
bifurcated from its host contract in accordance with SFAS No. 133. It also
allows an entity to make an irrevocable election to measure such a hybrid
financial instrument at fair value in its entirety, with changes in fair value
recognized in earnings. SFAS No. 155 is effective for all financial instruments
acquired, issued, or subject to a remeasurement (new basis) event occurring for
fiscal years beginning after September 15, 2006. We believe that the adoption of
this standard will not have a significant impact on our financial position,
results of operations or cash flows.
45
ITEM 7A. 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 as of March 31, 2006, to
Textron and our related party 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 March 31, 2006 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 $43,200 per year or $10,800 per quarter.
Our sales during the fiscal years ended March 31, 2006, 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. 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.
46
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Registered Public Accounting Firm
To the Board of Directors and Stockholders
Galaxy Nutritional Foods, Inc.
Orlando, Florida
We have audited the accompanying balance sheets of Galaxy Nutritional Foods,
Inc. as of March 31, 2006 and 2005 and the related statements of operations,
stockholders' equity (deficit) and cash flows for each of the three years in the
period ended March 31, 2006. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit includes examining,
on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Galaxy Nutritional Foods, Inc.
as of March 31, 2006 and 2005 and the results of its operations and its cash
flows for each of the three years in the period ended March 31, 2006 in
conformity with accounting principles generally accepted in the United States of
America.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company is in default of its notes payable, has
suffered recurring losses from operations and, at March 31, 2006, has
deficiencies in working capital and equity that raise substantive doubt as to
its ability to continue as a going concern. Management's plan in regard to these
matters are also described in Note 1. The financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
/s/ BDO Seidman, LLP
Atlanta, Georgia
July 13, 2006
47
GALAXY NUTRITIONAL FOODS, INC.
Balance Sheets
MARCH 31, MARCH 31,
Notes 2006 2005
------ ------------ ------------
ASSETS
CURRENT ASSETS:
Cash $ 435,880 $ 561,782
Trade receivables, net of allowance for
doubtful accounts of $1,769,000 and $2,299,000 2 4,018,806 4,644,364
Inventories 3 273,528 3,811,470
Prepaid expenses and other 70,717 219,592
------------ ------------
Total current assets 4,798,931 9,237,208
PROPERTY AND EQUIPMENT, NET 4,9,10 226,349 18,246,445
ASSETS HELD FOR SALE 4,10 61,950 --
OTHER ASSETS 162,840 286,013
------------ ------------
TOTAL $ 5,250,070 $ 27,769,666
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Line of credit 5 $ 1,919,002 $ 5,458,479
Accounts payable 2,665,963 3,057,266
Accrued disposal costs 9 480,404 --
Accrued and other current liabilities 6 542,811 2,130,206
Related party notes payable 5 2,273,021 --
Current portion of accrued employment contracts 7 434,114 586,523
Current portion of term notes payable 5 -- 1,320,000
Current portion of obligations under capital leases 7 20,231 194,042
------------ ------------
Total current liabilities 8,335,546 12,746,516
ACCRUED EMPLOYMENT CONTRACTS, less current portion 7 559,677 993,305
TERM NOTES PAYABLE, less current portion 5 -- 6,921,985
OBLIGATIONS UNDER CAPITAL LEASES, less current portion 7 37,507 85,337
------------ ------------
Total liabilities 8,932,730 20,747,143
------------ ------------
COMMITMENTS AND CONTINGENCIES 7,9 -- --
TEMPORARY EQUITY:
Common stock, subject to registration, $.01 par value; 2,000,000
shares issued and outstanding 6 -- 2,220,590
STOCKHOLDERS' EQUITY (DEFICIT):
Common stock, $.01 par value; authorized 85,000,000 shares; 20,054,623
and 16,411,474 shares issued 200,546 164,115
Additional paid-in capital 71,345,556 65,838,227
Accumulated deficit (72,456,301) (48,307,748)
------------ ------------
(910,199) 17,694,594
Less: Notes receivable arising from the exercise of stock options 7 (2,652,000) (12,772,200)
Treasury stock, 30,443 shares, at cost (120,461) (120,461)
------------ ------------
Total stockholders' equity (deficit) (3,682,660) 4,801,933
------------ ------------
TOTAL $ 5,250,070 $ 27,769,666
============ ============
See accompanying notes to financial statements
48
GALAXY NUTRITIONAL FOODS, INC.
Statements of Operations
Fiscal Years Ended March 31, 2006 2005 2004
------------ ------------ ------------
NET SALES $ 37,775,862 $ 44,510,487 $ 36,176,961
COST OF GOODS SOLD 28,142,732 34,736,594 24,864,289
------------ ------------ ------------
Gross margin 9,633,130 9,773,893 11,312,672
------------ ------------ ------------
OPERATING EXPENSES:
Selling 5,571,097 5,148,426 4,981,996
Delivery 2,251,318 2,307,166 1,877,682
Employment contract expense-general and administrative
(Note 7) -- 444,883 1,830,329
General and administrative, including $926,263,
$409,746 and $651,273 non-cash compensation related
to stock based transactions (Note 8) 4,750,624 4,380,436 3,954,303
Research and development 321,016 309,054 260,410
Reserve on stockholder note receivable (Note 7) 10,120,200 -- --
Cost of disposal activities (Note 9) 1,646,490 -- --
Impairment of equipment (Note 10) 7,896,554 -- --
(Gain) loss on disposal of assets (Note 10) (3,628) (4,500) 8,519
------------ ------------ ------------
Total operating expenses 32,553,671 12,585,465 12,913,239
------------ ------------ ------------
LOSS FROM OPERATIONS (22,920,541) (2,811,572) (1,600,567)
------------ ------------ ------------
OTHER INCOME (EXPENSE):
Interest expense (1,616,743) (1,129,977) (1,361,606)
Derivative income (expense) -- 62,829 (94,269)
Gain (loss) on fair value of warrants (Note 8) 388,731 18,937 (242,835)
------------ ------------ ------------
Total other income (expense) (1,228,012) (1,048,211) (1,698,710)
------------ ------------ ------------
NET LOSS $(24,148,553) $ (3,859,783) $ (3,299,277)
Less:
Preferred Stock Dividends (Note 8) -- 82,572 201,791
Preferred Stock Accretion to Redemption Value (Note 8) -- 319,500 1,256,019
------------ ------------ ------------
NET LOSS TO COMMON STOCKHOLDERS $(24,148,553) $ (4,261,855) $ (4,757,087)
============ ============ ============
BASIC AND DILUTED NET LOSS PER COMMON SHARE (Note 12) $ (1.23) $ (0.25) $ (0.32)
============ ============ ============
See accompanying notes to financial statements
49
GALAXY NUTRITIONAL FOODS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
Notes
Common Stock Additional Receivable
-------------------------- Paid-In Accumulated for Common Treasury
Shares Par Value Capital Deficit Stock Stock Total
----------------------------------------------------------------------------------------------------
Balance at March 31,
2003 12,761,685 $ 127,617 $ 59,018,430 $(41,148,688) $(12,772,200) $ (120,461) $ 5,104,698
Exercise of options 7,911 79 16,138 -- -- -- 16,217
Exercise of warrants 200,000 2,000 358,000 -- -- -- 360,000
Issuance of common
stock under
employee stock
purchase plan 16,339 163 28,364 -- -- -- 28,527
Issuance of common
stock 2,211,478 22,115 3,929,242 -- -- -- 3,951,357
Conversion of
preferred stock 459,908 4,599 794,921 -- -- -- 799,520
Fair value of
stock-based
transactions -- -- 491,308 -- -- -- 491,308
Non-cash compensation
related to variable
securities -- -- 8,001 -- -- -- 8,001
Dividends on
preferred stock -- -- (201,791) -- -- -- (201,791)
Accretion of discount
on preferred stock -- -- (503,970) -- -- -- (503,970)
Net loss -- -- -- (3,299,277) -- -- (3,299,277)
----------------------------------------------------------------------------------------------------
Balance at March 31,
2004 15,657,321 156,573 63,938,643 (44,447,965) (12,772,200) (120,461) 6,754,590
Exercise of options 13,893 139 18,717 -- -- -- 18,856
Issuance of common
stock under
employee stock
purchase plan 18,894 189 23,813 -- -- -- 24,002
Costs associated with
issuance of common
stock -- -- (22,500) -- -- -- (22,500)
Conversion of
preferred stock 721,366 7,214 840,215 -- -- -- 847,429
Fair value of
stock-based
transactions -- -- 83,224 -- -- -- 83,224
Non-cash compensation
related to variable
securities -- -- 215,649 -- -- -- 215,649
Dividends on
preferred stock -- -- (82,572) -- -- -- (82,572)
Accretion of discount
on preferred stock -- -- 823,038 -- -- -- 823,038
Net loss -- -- -- (3,859,783) -- -- (3,859,783)
----------------------------------------------------------------------------------------------------
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 options 2,250 22 2,858 -- -- -- 2,880
Exercise of warrants 1,130,000 11,300 1,257,700 -- -- -- 1,269,000
Issuance of common
stock under
employee stock
purchase plan 10,899 109 15,344 -- -- -- 15,453
Transfer of common
stock from
temporary equity 2,500,000 25,000 2,577,900 -- -- -- 2,602,900
Fair value of
stock-based
transactions -- -- 1,846,083 -- -- -- 1,846,083
Non-cash compensation
related to variable
securities -- -- (192,556) -- -- -- (192,556)
Reserve on
stockholder note
receivable -- -- -- -- 10,120,200 -- 10,120,200
Net loss -- -- -- (24,148,553) -- -- (24,148,553)
----------------------------------------------------------------------------------------------------
Balance at March 31,
2006 20,054,623 $ 200,546 $ 71,345,556 $(72,456,301) $ (2,652,000) $ (120,461) $ (3,682,660)
====================================================================================================
See accompanying notes to financial statements
50
GALAXY NUTRITIONAL FOODS, INC.
Statements of Cash Flows
Fiscal Years Ended March 31, 2006 2005 2004
------------ ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES: (Note 13)
Net Loss $(24,148,553) $ (3,859,783) $ (3,299,277)
Adjustments to reconcile net loss to net cash from (used in)
operating activities:
Depreciation and amortization 1,517,287 2,172,566 2,205,053
Amortization of debt discount and financing costs 675,886 116,522 236,321
Provision for promotional deductions and losses on trade
receivables (Note 2) 1,485,266 1,666,000 (221)
Provision for loss on stockholder note receivable(Note 7) 10,120,200 -- --
Derivative (income) expense -- (62,829) 94,269
(Gain) loss on fair value of warrants (388,731) (18,937) 242,835
Non-cash compensation related to stock-based transactions
(Note 8) 926,263 409,746 651,273
(Gain) loss on disposal of assets (Note 10) 7,892,926 (4,500) 8,519
(Increase) decrease in:
Trade receivables (859,708) (2,346,166) 999,049
Inventories 3,537,942 821,373 661,657
Prepaid expenses and other 148,875 46,709 189,012
Increase (decrease) in:
Accounts payable (391,303) 1,790,920 (1,426,143)
Accrued and other liabilities (953,028) 48,125 1,674,003
------------ ------------ ------------
NET CASH FROM (USED IN) OPERATING ACTIVITIES (436,678) 779,746 2,236,350
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (294,236) (104,339) (221,585)
Proceeds from sale of equipment 8,842,169 4,500 --
(Increase) decrease in other assets -- 34,837 (10,193)
------------ ------------ ------------
NET CASH FROM (USED IN) INVESTING ACTIVITIES 8,547,933 (65,002) (231,778)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Decrease in book overdrafts -- -- (1,151,276)
Net borrowings (payments) on line of credit (3,539,477) 853,202 (334,617)
Borrowings on term notes payable 2,400,000 -- 2,000,000
Repayments on term notes payable (8,241,985) (1,140,000) (1,572,760)
Repayments on subordinated note payable -- -- (4,000,000)
Financing costs for long term debt (303,697) (37,500) (288,230)
Principal payments on capital lease obligations (221,641) (239,603) (365,635)
Proceeds from exercise of common stock options 2,880 18,856 16,217
Proceeds from exercise of common stock warrants, net of costs 1,651,310 -- 360,000
Proceeds from issuance of common stock under employee stock
purchase plan 15,453 24,002 28,527
Proceeds from issuance of common stock, net of costs -- 2,198,090 3,751,283
Redemption of preferred stock -- (2,279,688) --
------------ ------------ ------------
NET CASH FROM (USED IN) FINANCING ACTIVITIES (8,237,157) (602,641) (1,556,491)
------------ ------------ ------------
NET INCREASE (DECREASE) IN CASH (125,902) 112,103 448,081
CASH, BEGINNING OF YEAR 561,782 449,679 1,598
------------ ------------ ------------
CASH, END OF YEAR $ 435,880 $ 561,782 $ 449,679
============ ============ ============
See accompanying notes to financial statements.
51
GALAXY NUTRITIONAL FOODS, INC.
NOTES TO FINANCIAL STATEMENTS
(1) Summary of Significant Accounting Policies
Nature of Business and Going Concern
Galaxy Nutritional Foods, Inc. (the "Company") is principally engaged in
developing and globally 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 foodservice
accounts. The Company is dedicated to developing nutritious products to
meet the taste and dietary needs of today's increasingly health conscious
consumers. These products are sold throughout the United States and
internationally to customers in the retail and food service markets. The
Company's headquarters are located in Orlando, Florida.
During fiscal 2006, the Company transitioned its manufacturing and
distribution operations to an outside supplier. In November 2005,
Schreiber Foods, Inc., a Wisconsin corporation ("Schreiber"), began
manufacturing and distributing substantially all of the Company's products
in accordance with a Supply Agreement that was signed on June 30, 2005.
The prices for such products are based on cost plus a processing fee as
determined by the parties from time to time. Additionally, in December
2005, the Company sold substantially all of its manufacturing and
production equipment to Schreiber for $8,700,000 in cash pursuant to an
Asset Purchase Agreement dated June 30, 2005.
The Company has incurred substantial losses in recent years and, as a
result, has a stockholders deficit of $3,682,660 as of March 31, 2006.
Losses for the years ended March 31, 2006, 2005 and 2004 were $24,148,553,
$3,859,783 and $3,299,277, respectively. The Company's ability to continue
as a going concern depends upon successfully obtaining sufficient cash
resources to refinance its $2.4 million of unsecured related party notes
payable that matured on June 15, 2006 (See Note 5) and obtaining positive
cash flow from operations to sustain normal business operations. The
accompanying financial statements have been prepared on a going concern
basis, which assumes continuity of operations and realization of assets
and liabilities in the ordinary course of business. The financial
statements do not include any adjustments that might result if the Company
was forced to discontinue its operations.
The Company's current business plan eliminates certain low margin private
label and Galaxy imitation business from its sales mix. The elimination of
these low margin items and the elimination of excess overhead that was
part of the Company's former manufacturing operations should result in
higher gross margins with lower operating costs in fiscal 2007 and produce
positive cash flows from operations. However, the expected improvement in
cash flows from operations will not be sufficient to repay the short-term
notes without additional financing. Management is currently negotiating
with the existing note holders and other parties regarding extending the
maturity of the notes, refinancing the notes and/or converting all or a
portion of the notes into equity. There can be no assurance that the
Company will be successful in its business plan, its negotiations with the
existing note holders and other parties or that the terms of any such
refinancing or conversions will not result in the issuance, or potential
issuance, of a significant amount of equity securities that will cause
substantial dilution to the Company's stockholders. If the Company is not
successful in refinancing the $2.4 million in short-term notes or in
otherwise entering into a financing, sale, or business transaction that
infuses sufficient cash resources into the Company in the near future, any
collection actions by the existing note holders could have a material
adverse affect on the liquidity and financial condition of the Company or
its ability to secure additional financing.
Cash
Periodically, the Company maintains cash in financial institutions in
excess of amounts insured by the federal government. The Company has not
experienced any losses on such accounts.
Accounts Receivable
Accounts receivable are customer obligations due under normal trade terms.
The Company evaluates the collectibility of its accounts receivable using
a combination of factors. In circumstances where it is aware of a specific
customer's inability to meet its financial obligations, it records a
specific allowance to reduce the amounts recorded to what it believes will
be collected. In addition to reserving for potential uncollectible
accounts, the Company uses its allowance for trade receivables account to
estimate future credits that will be issued to customers for items such as
rebates, sales promotions, coupons, and spoils that relate to current
period sales. The Company also records these additional reserves for
potential uncollectible amounts and future credits based on certain
percentages, which are determined based on historical experience and its
assessment of the general financial conditions affecting its customer
base. After all attempts to collect a receivable have been exhausted and
failed, the receivable is written off against the allowance.
52
Inventories
Inventories are valued at the lower of cost (weighted average, which
approximates FIFO) or market. Prior to November 2005, the cost elements
included in inventories were direct material costs, direct labor and
overhead allocations. Material cost consisted of the cost of ingredients
and packaging that go into the production of the item. Labor consisted of
the wages for those employees directly making the item. Overhead was
applied to inventory units based on the normal capacity of the production
facilities and consisted of factory overhead costs such as indirect labor,
benefits, supplies, repairs, depreciation and utilities expended during
the production process. As of March 31, 2006, the cost elements included
in inventories only consist of direct material costs.
Property and Equipment
Property and equipment are stated at cost. Depreciation is computed over
the estimated useful lives of the assets by the straight-line method for
financial reporting and by accelerated methods for income tax purposes.
Capital leases are recorded at the lower of fair market value or the
present value of future minimum lease payments. Assets under capital
leases are amortized by the straight-line method over their useful lives.
Revenue Recognition
Sales are recognized upon shipment of products to customers. The Company
offers a right of return policy on certain products sold to certain retail
customers in the conventional grocery stores and mass merchandising
industry. If the product is not sold during its shelf life, the Company
will allow a credit for the unsold merchandise. Since the shelf life of
the Company's products range from 6 months to one year, the Company
historically averages less than 2% in credits for unsold product. The
Company's reserve on accounts receivable takes these potential future
credits into consideration. Certain expenses such as slotting fees,
rebates, coupons and other discounts are accounted for as a reduction to
Revenues.
Marketing and Advertising
The Company expenses the production costs of advertising the first time
the advertising takes place and expenses slotting fees and direct response
advertising costs in the period incurred. Advertising expense was
approximately $1,331,000, $1,539,000 and $910,000 during the fiscal years
ended March 31, 2006, 2005 and 2004, respectively.
Shipping and Handling Costs
The Company accounts for certain shipping and handling costs related to
the acquisition of goods from its vendors as Cost of Goods Sold. However,
shipping and handling costs related to the shipment of goods to customers
is classified as Delivery expense.
Impairment of Long-Lived Assets
In accordance with Statement of Financial Accounting Standard ("SFAS") No.
144, "Accounting for the Impairment or 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 10.
Disposal Costs
The Company has recorded 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 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.
53
Stock Based Compensation
The Company has two stock-based employee compensation plans. Prior to
April 1, 2003, the Company accounted for its employee 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.
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:
Fiscal Years Ended March 31, 2006 March 31, 2005 March 31, 2004
-------------------- ------------------- --------------------
Dividend Yield None None None
Volatility 11% to 46% 45% to 46% 41% to 45%
Risk Free Interest Rate 3.35% to 4.30% 3.38% to 4.12% 2.01% to 4.28%
Expected Lives in Months 1 to 120 60 to 120 36 to 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:
Fiscal Years Ended March 31, 2006 March 31, 2005 March 31, 2004
-------------------- ------------------- --------------------
Net loss to common stockholders as reported $ (24,148,553) $ (4,261,855) $ (4,757,087)
Add: Stock-based compensation expense included
in reported net income 926,263 409,746 651,273
Deduct: Stock-based compensation expense
determined under fair value based method for
all awards (966,456) (519,024) (1,070,997)
-------------------- ------------------- --------------------
Pro forma net loss to common stockholders (24,188,746) (4,371,133) $ (5,176,811)
==================== =================== ====================
Net loss per common share:
Basic & diluted - as reported $ (1.23) $ (0.25) $ (0.32)
==================== =================== ====================
Basic & diluted - pro forma $ (1.23) $ (0.26) $ (0.35)
==================== =================== ====================
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
54
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.
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
sells to customers throughout the United States and 14 other countries.
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.
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 has not had
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.
In February 2006, the FASB issued SFAS No. 155, "Accounting for Certain
Hybrid Financial Instruments - An Amendment of FASB Statements No. 133 and
140." SFAS No. 155 provides entities with relief from having to separately
determine the fair value of an embedded derivative that would otherwise be
required to be bifurcated from its host contract in accordance with SFAS
No. 133. It also allows an entity to make an irrevocable election to
measure such a hybrid financial instrument at fair value in its entirety,
with changes in fair value recognized in earnings. SFAS No. 155 is
effective for all financial instruments acquired, issued, or subject to a
remeasurement (new basis) event occurring for fiscal years beginning after
September 15, 2006. 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.
55
Income Taxes
Deferred income taxes are recognized for the tax consequences of temporary
differences between the financial reporting bases and the tax bases of the
Company's assets and liabilities in accordance with SFAS No. 109.
Valuation allowances are established when necessary to reduce deferred tax
assets to the amount expected to be realized. Income tax expense is the
tax payable or refundable for the period plus or minus the change during
the period in deferred tax assets and liabilities.
Financial Instruments
Statement of Financial Accounting Standards No. 107, "Disclosures about
Fair Value of Financial Instruments," requires disclosure of fair value
information about financial instruments. Fair value estimates discussed
herein are based upon certain market assumptions and pertinent information
available to management as of March 31, 2006.
The respective carrying value of certain on-balance-sheet financial
instruments approximated their fair values. These financial instruments
include cash, trade receivables, accounts payable and accrued liabilities.
Fair values were assumed to approximate carrying values for these
financial instruments since they are short term in nature and their
carrying amounts approximate fair values or they are receivable or payable
on demand. The fair value of the Company's line of credit, long-term debt,
and capital leases is estimated based upon the quoted market prices for
the same or similar issues or on the current rates offered to the Company
for debt of the same remaining maturities.
(2) Schedule of Valuation Account
Balance at Charged to Write-Offs,
Beginning of Costs and Retirements and Balance at
Year Expenses Collections End of Year
---------------------------------------------------------------------------------------------------------
Fiscal Years Ended March 31, 2004:
Allowance for trade receivables $ 633,221 $ 2,433,458 $ (2,433,679) $ 633,000
Fiscal Years Ended March 31, 2005:
Allowance for trade receivables $ 633,000 $ 2,477,931 $ (811,931) $ 2,299,000
Fiscal Years Ended March 31, 2006:
Allowance for trade receivables $ 2,299,000 $ 4,087,750 $ (4,617,750) $ 1,769,000
In addition to reserving for potential uncollectible accounts, the Company
uses its allowance for trade receivables account to estimate future
credits that will be issued to customers for items such as discounts,
rebates, sales promotions, coupons, slotting fees and spoils that relate
to current period sales. For the fiscal years ended March 31, 2006, 2005
and 2004, the Company recorded an expense of $427,271, $1,609,134, and
$59,908, respectively related to bad debt. For those years, the bad debt
expense was approximately 1.1%, 3.6% and 0.2% of net sales, respectively.
(3) Inventories
Inventories are summarized as follows:
March 31, 2006 March 31, 2005
-------------- --------------
Raw materials $ 38,986 $ 1,451,588
Finished goods 234,542 2,359,882
-------------- --------------
Total $ 273,528 $ 3,811,470
============== ==============
56
(4) Property and Equipment
Property and equipment are summarized as follows:
Useful Lives March 31, 2006 March 31, 2005
------------ ------------------ ------------------
Leasehold improvements 10-25 years $ 89,079 $ 3,254,805
Machinery and equipment 3-20 years 1,034,447 28,139,177
Equipment under capital leases 7-10 years -- 923,255
Construction in progress -- 112,649
----------------- ------------------
1,123,526 32,429,886
Less accumulated depreciation and amortization 897,177 14,183,441
----------------- ------------------
Property and equipment, net $ 226,349 $ 18,246,445
================= ==================
The Company has reclassified its remaining fixed assets available for sale
as Assets Held for Sale in the Balance Sheet and expects it will sell
these remaining assets by September 2006. The Company has estimated the
fair value of these assets to be $61,950. 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.
(5) Line of Credit and Notes Payable
Line of Credit
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 and
subsequent amendments (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 was 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 (9.50% at March 31, 2006) calculated on
the average cash borrowings for the preceding month. As of March 31, 2006,
the outstanding principal balance on the Textron Loan was $1,919,002.
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 8 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%.
Due to the cost of disposal activities and impairment of property and
equipment (as discussed in Notes 9 and 10), 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 amended and replaced several financial covenants, allowed
eligibility for borrowing on inventory until December 31, 2005 and
provides that the Textron Loan would 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 immediately paid a fee of $50,000, and paid additional
administration fees as follows: $5,000 on February 1, 2006, $10,000 on
March 1, 2006, $15,000 on April 1, 2006 and $20,000 May 1, 2006.
57
On May 26, 2006, the Company executed a Sixth Amendment to the Textron
Loan Agreement. The Sixth Amendment provided for an extension of the
Textron Loan from May 26, 2006 until June 27, 2006 and reduced the maximum
principal amount which could be borrowed under the Textron Loan to
$3,000,000. In exchange for the amendment and extension, the Company
agreed to pay a fee of $25,000 of which $10,000 is to be paid immediately
and $15,000 is to be paid upon the termination date. If the Company
refinances the Textron Loan with Textron or an affiliate of Textron, it
will not be required to pay the $15,000 fee upon termination.
The Company paid in full the Textron Loan and terminated its obligations
under the Textron Loan Agreement on June 23, 2006 as further detailed in
Note 19.
Term Notes Payable
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 was to mature and be payable in
full on July 31, 2006 instead of June 1, 2009; 2) the principal payments
were to 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 were waived and compliance was not required by the Company through
the intended maturity date 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 in December 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.
In October 2000, the Company obtained a $1.5 million bridge loan from
Wachovia Bank, which was guaranteed by Angelo S. Morini, the Company's
founder, and secured by the pledge of one million shares of the Company's
common stock owned by him. Interest on this note was at the prime rate.
The loan was paid in full in February 2004 and the collateral shares were
returned to the Company.
Related Party Notes Payable
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 matured 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.
58
The Company does not currently have the short-term liquidity to pay its
related party Note Holders on the $2.4 million Notes that matured on June
15, 2006 in accordance with their original terms. The Company received a
letter on June 20, 2006 from all of the Note Holders, other than Mr.
DeLuca, notifying the Company that its failure to pay the amounts due and
owing on the maturity date constitutes a default under $1.2 million of the
Notes held by those Note Holders. Pursuant to the terms of the Notes,
since the Company did not cure the default within 10 days after receipt of
the notice of default, it is obligated to pay interest at the default rate
of 8% above the Prime Rate. The Company is negotiating with the Note
Holders regarding extending the maturity of the Notes, refinancing the
Notes and/or converting all or a portion of the Notes into equity. There
can be no assurance that the Company will be successful in its
negotiations with the Note Holders or that the terms of any such
refinancing or conversions will not result in the issuance, or potential
issuance, of a significant amount of equity securities. In the event the
Company is not successful, any collection actions by the Note Holders
could have a material adverse affect on the liquidity and financial
condition of the Company or its ability to secure additional financing.
Additionally, it is unlikely that the Company would be able to continue as
a going concern.
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 $317,752 in
the fiscal year ended March 31, 2006. As of March 31, 2006, the
outstanding principal balance of $2,400,000 on the Notes less the
remaining debt discount is $2,273,021.
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, 2005 was recorded as a gain on fair value of warrants in the Statement
of Operations.
In March 2002, Angelo S. Morini, the Company's founder, loaned $330,000 to
the Company in order for it to pay down certain notes payable that were
coming due. This loan bore interest at the prime rate and was due on or
before June 15, 2006. In connection with a Second Amended and Restated
Employment Agreement effective October 13, 2003 between Mr. Morini and the
Company, the Company offset $167,603 of unreimbursed advances owed to it
by Mr. Morini and certain family members against the balance of the loan
and issued an aggregate of 55,087 shares of the Company's common stock
(valued at approximately $2.95 per share) as payment in full.
Other
On August 15, 2002, the Company executed and delivered to Target
Container, Inc. a $347,475 promissory note in satisfaction of its accounts
payable obligation to this vendor. This note bore interest at 7% per annum
and was due in twelve equal monthly installments of $30,066. This note was
paid in full by September 30, 2003.
On September 30, 1999, the Company obtained a $4 million subordinated loan
from FINOVA Mezzanine to finance additional working capital and capital
improvement needs. This loan was paid in full as of May 30, 2003 by the
proceeds from the new loan from Wachovia Bank, as discussed above, and
from the equity proceeds raised in the private placements in May 2003, as
discussed in Note 8.
(6) Accrued and Other Current Liabilities
Accrued and other current liabilities are summarized as follows:
March 31, 2006 March 31, 2005
-------------- --------------
Tangible personal property taxes $ -- $ 1,049,841
Warrant liability -- 740,000
Registration rights penalty 285,104 --
Other 257,707 340,365
-------------- --------------
Total $ 542,811 $ 2,130,206
============== ==============
59
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. The Company recorded the $2,220,590 value of common stock subject
to registration as temporary equity as of March 31, 2005. Additionally, 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. Using the Black-Scholes pricing model, the fair value of the
warrant on October 6, 2004, was estimated at $315,000. On March 31, 2005,
the fair value of the warrant was re-measured and estimated at $740,000.
Subsequently in June 2005, the Company agreed to reduce the per-share
exercise price on the warrant to $0.92, in order to induce the investor to
exercise his warrants. The warrant was exercised on June 16, 2005 into
500,000 common shares for $460,000. Upon the effective registration in
December 2005, the Company reclassified the $2,680,590 value of common
stock that was registered less an additional $77,690 in registration costs
into permanent equity.
(7) Commitments and Contingencies
Leases
The Company leases its operating facilities and certain equipment under
operating and capital leases, expiring at various dates through its fiscal
year 2009. The following schedule presents the Company's obligations as of
March 31, 2006, regarding (1) future minimum lease payments under capital
leases, together with the present value of the net minimum lease payments
and (2) future minimum rental payments required under operating leases
that have initial or remaining terms in excess of one year:
Capital Operating
Leases Leases
-------------- --------------
2007 $ 23,498 $ 679,934
2008 23,498 381,904
2009 16,231 365,212
2010 -- 122,823
-------------- --------------
Total net minimum lease payments 63,227 $ 1,549,873
==============
Less amount representing interest (5,489)
--------------
Present value of the net minimum lease payments 57,738
Less current portion (20,231)
--------------
Long-term obligations under capital leases $ 37,507
==============
The total capitalized cost for equipment under capital lease is $69,600
with accumulated depreciation of $17,731. These costs are included under
Assets Held for Sale in the Balance Sheet as of March 31, 2006.
Rental expense was approximately, $1,305,000, $1,055,000 and $1,088,000
for the fiscal years ended March 31, 2006, 2005 and 2004, respectively.
60
Employment Agreements
o 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 stockholder and 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 are $1,830,329 of which $925,982 remained unpaid and accrued
($366,305 as short-term liabilities and $559,677 as long-term liabilities)
as of March 31, 2006. 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 his purchase of 2,914,286 shares of the Company's common
stock into a single stockholder note receivable in the amount of
$12,772,200 that is due on June 15, 2006. This stockholder note receivable
is non-interest bearing and non-recourse and is secured by the 2,914,286
shares of the Company's common stock (the "Shares"). 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.
There have been no actions that have caused the loan to be forgiven.
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 Shares are below the value
of the stockholder note receivable. For the fiscal year ended March 31,
2006, the Company reserved $10,120,200 against this stockholder note
receivable under the assumption that it would not be able to collect
proceeds in excess of the $2,652,000 value of the Shares as of such date.
The value of the Shares was computed using the closing price of the
Company's common stock on March 31, 2006 of $0.91 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 stockholder note receivable was already shown as a
reduction to Stockholders' Equity (Deficit). See Note 19 for subsequent
information.
o 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. In addition to the compensation, the Company agreed
that Mr. New's stock option rights under that certain Non-Qualified Stock
Option Agreement dated December 5, 2002 (for 25,000 shares at an exercise
price of $1.67 per share) and that certain Non-Qualified Stock Option
Agreement dated July 16, 2001 (for 100,000 shares at an exercise price of
$2.05 per share) will continue in full force and effect as if he was still
employed by the Company. This settlement will be paid out in nearly equal
installments over two years payable on the Company's regular payroll
dates. As of March 31, 2006, the remaining unpaid and accrued balance
reflected in short-term liabilities was $67,809.
In connection with the modification of the stock options as described
above, the Company recorded $22,000 as additional non-cash compensation
expense in the fiscal year ended March 31, 2005 pursuant to FIN 44 for
modifications that renew or increase the life on existing options. The
stock price on the date of the modification was $2.15.
61
o Michael E. Broll
On July 8, 2004, Michael E. Broll, a member of the Company's Board of
Directors, was appointed as the Chief Executive Officer upon the
resignation of Mr. New. The Company entered into a one-year employment
agreement with Mr. Broll pursuant to which Mr. Broll is entitled to
receive an annual base salary of $200,000 plus a performance bonus at the
discretion of the Board, standard health benefits, a housing allowance of
up to $3,500 per month and an auto allowance of $1,500 per month. The
employment agreement renews automatically for one-year periods unless
cancelled by either party ninety days prior to the end of the term. In the
event Mr. Broll's employment is terminated without cause, he will be
entitled to receive one year of his base salary as severance. Mr. Broll
received a discretionary cash bonus of $25,000 in the fiscal year ended
March 31, 2005.
The Company currently has employment agreements with several of its key
employees that provide for up to five-year severance in the event they are
terminated without cause.
(8) Capital Stock
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 on
or after April 1, 2003 under the provisions of SFAS 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
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. FIN 44 covers specific events that occurred after
December 15, 1998 and was effective as of July 1, 2000.
In accordance with the above accounting standards, the Company calculates
and records non-cash compensation related to its securities in the general
and administrative line item in the Statements of Operations on two
primary items:
a. Stock-Based Award Issuances
During the fiscal years ended March 31, 2006, 2005 and 2004, the
Company recorded $1,118,819, $194,097, and $643,272, respectively,
as 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 was to continue until the related options were cancelled,
expired or exercised. Effective April 1, 2006, the Company will
adopt SFAS No. 123R at which time this variable accounting treatment
will be discontinued. The Company recorded non-cash compensation
(income) expense of ($192,556), $193,649 and $8,001 related to these
modified options for the fiscal years ended March 31, 2006, 2005 and
2004. There are 3,494,091 outstanding modified stock options
remaining as of March 31, 2006.
In connection with a Separation and Settlement Agreement dated July
8, 2004 between the Company and Mr. New, the Company agreed that Mr.
New's stock option rights under that certain Non-Qualified Stock
Option Agreement dated December 5, 2002 (for 25,000 shares at an
exercise price of $1.67 per share) and that certain Non-Qualified
Stock Option Agreement dated July 16, 2001 (for 100,000 shares at an
exercise price of $2.05 per share) would continue in full force and
effect as if he were still employed by the Company. The stock price
on the date of the modification was $2.15. In accordance with FIN 44
for modifications that renew or increase the life on existing
options, the Company recorded $22,000 as additional non-cash
compensation expense in the fiscal year ended March 31, 2005.
62
Employee Stock Purchase Plan
In January 1992, the Company's stockholders approved the 1991 Employee
Stock Purchase Plan (the "1991 Purchase Plan"). The 1991 Purchase Plan
provided for the sale of up to an aggregate of 85,714 shares of common
stock to eligible employees. Up to 500 shares may be purchased by each
eligible employee at the lesser of 85% of the fair market value of the
shares on the first or last business day of the six-month purchase periods
ending August 31 and February 28. Substantially all full-time employees
were eligible to participate in the plan. During the fiscal year ended
March 31, 2006, 10,899 shares were issued under this plan at prices of
$1.56 and $1.09 per share. During the fiscal year ended March 31, 2005,
18,894 shares were issued under this plan at prices of $1.31 and $1.23 per
share. During the fiscal year ended March 31, 2004, 16,339 shares were
issued under this plan at prices of $1.49 and $1.96 per share. The
weighted average exercise price of the shares issued were $1.42, $1.27 and
$1.75 per share for the fiscal years ended March 31, 2006, 2005 and 2004,
respectively. In January 2006, the Board moved the last purchase period
from February 28, 2006 to January 31, 2006, prior to the 1991 Purchase
Plan's expiration on January 31, 2006. The Board has not replaced the 1991
Purchase Plan with any new stock purchase plan. As of March 31, 2006,
there were no shares available for purchase under the 1991 Purchase Plan.
Stock Options
At March 31, 2006, the Company has three employee stock option plans,
which were adopted in 1987, 1991, and 1996 and has granted additional
non-plan stock options. Under the Company's stock option plans, qualified
and nonqualified stock options to purchase up to 200,500 shares of the
Company's common stock may be granted to employees and members of the
Board of Directors. The maximum and typical term of options granted under
the plans is ten years. Generally, options vest from zero to three years.
The Company estimated the fair value of all options issued during the
periods using the Black-Scholes option-pricing model. This model uses the
assumptions listed in Note 1 under Stock Based Compensation for each
period. The estimated fair value is then recorded as a charge to non-cash
compensation in the general and administrative line item in the Statement
of Operations. During the fiscal years ended March 31, 2006, 2005 and
2004, the Company recorded $25,583, $150,763 and $347,158, respectively,
as non-cash compensation expense related to options that were issued to
and vested by employees and directors.
The following table summarizes information about activity under all stock
option plans:
Weighted-Average Weighted-Average
Exercise Price Fair Value of
Shares per Share Options Granted
-------------- -------------- --------------
Balance, March 31, 2003 105,306 $ 2.66 --
Granted - at market 914 2.90 $ 1.65
Exercised (7,911) 2.05 --
Forfeited or Expired (2,948) 4.96 --
-------------- --------------
Balance, March 31, 2004 95,361 2.64 --
Granted - at market 63,930 1.28 $ 0.77
Exercised (13,893) 1.36 --
Forfeited or Expired (429) 19.25 --
-------------- --------------
Balance, March 31, 2005 144,969 2.11 --
Granted - at market 1,430 1.75 $ 1.07
Exercised (2,250) 1.28 --
Forfeited or Expired (14,583) 1.67 --
-------------- --------------
Balance, March 31, 2006 129,566 $ 2.17 --
============== ==============
63
The Company has also made individual issuances of non-qualified, non-plan
options. The following table summarizes information about non-plan stock
option activity:
Weighted-Average Weighted-Average
Exercise Price Fair Value of
Shares per Share Options Granted
-------------- -------------- --------------
Balance, March 31, 2003 4,546,840 $ 3.17 --
Granted - at market 400,000 2.73 $ 0.77
Forfeited or Expired (300,000) 2.24 --
-------------- --------------
Balance, March 31, 2004 4,646,840 3.19 --
Granted - at market 270,000 1.69 $ 0.48
Forfeited or Expired -- -- --
-------------- --------------
Balance, March 31, 2005 4,916,840 3.02 --
Forfeited or Expired (200,000) 2.17 --
-------------- --------------
Balance, March 31, 2006 4,716,840 $ 3.15 --
============== ==============
On September 30, 2003, the stockholders of the Company approved the
issuance of 4,375,411 of these non-plan options of which 4,075,411 are
still outstanding as of March 31, 2006.
The following table summarizes information about plan and non-plan stock
options outstanding and exercisable at March 31, 2006:
Weighted- Weighted- Weighted-
Average Average Average Weighted-
Range of Exercise Options Remaining Exercise Options Remaining Average
Prices Outstanding Life Price Exercisable Life Exercise Price
--------------------- ------------------ ------------- ------------ ------------- -------------- ----------------
$ 1.20 - 1.99 374,431 5.2 years $ 1.61 324,431 5.5 years $ 1.62
$ 2.00 - 2.99 1,539,358 3.0 years $ 2.10 1,536,358 3.0 years $ 2.10
$ 3.00 - 3.99 1,921,198 3.4 years $ 3.41 1,921,198 3.4 years $ 3.41
$ 4.00 - 4.99 576,430 3.9 years $ 4.29 576,430 3.9 years $ 4.29
$ 5.00 - 5.99 432,797 1.3 years $ 5.20 432,797 1.3 years $ 5.20
$ 6.00 -10.28 2,192 2.2 years $ 8.39 2,192 2.2 years $ 8.39
------------------ -------------
4,846,406 4,793,406
================== =============
Stock Warrants
At March 31, 2006, the Company had outstanding warrants to purchase the
Company's common stock, which were issued in connection with sales
consulting, financial consulting, and financing arrangements. Information
relating to these warrants is summarized as follows:
64
Expiration Date Number of Warrants Exercise Price
-------------------------- -------------------- --------------------
July 2006 10,000 5.00
January 2007 42,592 5.74
June 2007 122,549 5.52
May 2008 50,000 2.05
August 2008 1,429 2.05
October 2008 600,000 1.53
January 2009 1,429 2.05
June 2009 100,000 1.97
June 2009 153,000 2.05
October 2009 50,000 1.20
June 2012 2,143 2.05
--------------------
1,133,142
====================
The Company estimates the fair value of all warrants issued during the
periods using the Black-Scholes option-pricing model. This model uses the
assumptions listed in Note 1 under Stock Based Compensation for each
period. The estimated fair value is then recorded as a charge to non-cash
compensation in the general and administrative line item in the Statement
of Operations or as a charge to additional paid-in capital in
Stockholders' Equity (Deficit) depending on the situation in which the
warrant was issued. During the fiscal years ended March 31, 2006, 2005 and
2004, the Company granted warrants totaling 600,000, 1,050,000 and 700,000
shares, respectively, to non-employees and non-directors. During the
fiscal years ended March 31, 2006, 2005 and 2004, the Company recorded
$68,736, $468,334, $296,114, respectively, as non-cash compensation
expense related to warrants that were issued to and vested by
non-employees and non-directors.
Since the conversion of the Company's Series A convertible preferred stock
could have resulted in a conversion into an indeterminable numbers of
commons shares, the Company 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 recorded 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 as a liability. The
fair value of the warrants and options was determined using the
Black-Scholes pricing model. Any changes in the fair value of the
securities after the initial valuation in April 2001 were recorded as a
gain or loss in the Statement of Operations during the reporting periods.
During the fiscal years ended March 31, 2005 and 2004, the Company
recorded a loss/(gain) on the fair value of warrants of ($443,937) and
$242,835, respectively, related to the change in the fair value of the
underlying warrants. There is no derivative liability as of March 31, 2006
or 2005 because the Series A convertible preferred stock was partially
converted and the remaining shares redeemed on October 6, 2004.
Reserved
At March 31, 2006, the Company has reserved common stock for future
issuance under all of the above arrangements totaling 6,005,909 shares.
Series A Convertible Preferred Stock
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.
65
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, BH
Capital Investments, LP and Excalibur Limited Partnership, the holders of
the Company's Series A convertible preferred stock (the "Series A
Preferred Holders"), converted 10,278 Series A convertible preferred
shares into approximately 600,000 shares of common stock. The value of
these converted Series A convertible preferred shares including accrued
dividends was $644,068. Simultaneously, the remaining 30,316 Series A
convertible preferred shares held by the Series A Preferred Holders were
acquired by the Company 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. As part of the transaction, each former
Series A Preferred Holder also received a warrant to purchase up to
250,000 shares of common stock at an exercise price of $2.00 per share for
a period of five years. The market price of the Company's common stock on
October 6, 2004 was $1.30. The fair value of the warrants is $205,000.
The Series A Preferred Holders had the right to receive on any outstanding
Series A convertible preferred stock a ten percent dividend on the shares,
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 fiscal years ended March
31, 2005 and 2004, the Company recorded preferred dividends of $82,572 and
$201,791, respectively, on the outstanding shares of the Series A
convertible preferred stock.
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 fiscal
years ended March 31, 2005 and 2004, the Company recorded $319,500 and
$1,256,019, respectively, related to the accretion of the redemption value
of preferred stock.
Common Stock Issuances
Fiscal Year Ended March 31, 2006
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. Using the Black-Scholes pricing model, the fair
value of the warrant on October 6, 2004, was estimated at $315,000. On
March 31, 2005, the fair value of the warrant was re-measured and
estimated at $740,000. The increase of $425,000 was reflected as a loss in
the fair value of warrants line item in the Statement of Operations during
the fiscal year ended March 31, 2005. Upon exercise of the warrant on June
16, 2005, the fair value was re-measured and estimated to be $400,000. The
$340,000 change in fair value from the value at March 31, 2005 was
reflected as a gain on the fair value of warrants line item in the
Statement of Operations during the fiscal year ended March 31, 2006. The
warrant liability was reclassified to temporary equity upon the exercise
of the warrant in June 2005 and then to permanent equity upon registration
of the shares through an effective registration statement in December
2005.
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.
66
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 5
and the remaining proceeds from the warrant exercises were used for
working capital purposes.
Fiscal Year Ended March 31, 2005
On October 6, 2004, the Company completed a private placement of its
common stock, whereby it issued a total of 2,000,000 shares to an existing
stockholder of the Company for aggregate gross proceeds to the Company of
$2,300,000. These proceeds were used to redeem the Company's Series A
convertible preferred stock as discussed above. The purchase price of the
shares was $1.15 per share (95% of the prior 5-day trading closing stock
price average). The stockholder also received a warrant to purchase up to
500,000 shares of the Company's common stock at an exercise price of $1.15
per share for a period of five years.
In October 2003, pursuant to an employment contract, the Company issued
17,500 shares of its common stock with a total value of $37,650 to a
former employee for his services from January 2003 to July 2003. This
expense was recorded as non-cash compensation during the fiscal year ended
March 31, 2004.
Fiscal Year Ended March 31, 2004
In March 2002, Angelo S. Morini, the Company's founder, loaned $330,000 to
the Company in order for it to pay down certain notes payable that were
coming due. This loan bore interest at the prime rate and was due on or
before June 15, 2006. In connection with a Second Amended and Restated
Employment Agreement effective October 13, 2003 between Mr. Morini and the
Company, the Company offset $167,603 of unreimbursed advances owed to it
by Mr. Morini and certain family members against the balance of the loan
and issued an aggregate of 55,087 shares of the Company's common stock
(valued at approximately $2.95 per share) as payment in full.
Pursuant to seven Securities Purchase Agreements dated May 21, 2003, the
Company issued a total of 2,138,891 shares of its common stock at a price
per share equal to $1.80 for aggregate gross proceeds to the Company of
$3,850,000. Sales to related parties under the Securities Purchase
Agreements include: 555,556 shares of common stock sold at an aggregate
sales price of $1,000,000 to Frederick DeLuca, a then greater than 5%
stockholder; 55,556 shares of common stock sold at an aggregate sales
price of $100,000 to David H. Lipka, a Director of the Company; 83,333 and
55,556 shares of common stock sold at an aggregate sales price of $150,000
and $100,000, respectively, to Ruggieri of Windermere Family Limited
Partnership and Ruggieri Financial Pension Plan, respectively, each an
affiliate of John Ruggieri, the Company's former Vice President of
Manufacturing; 1,111,112 shares of common stock sold at an aggregate sales
price of $2,000,000 to Fromageries Bel S.A., a leading branded cheese
company in Europe which signed a Master Distribution and Licensing
Agreement effective May 22, 2003 with the Company. Sales to non-related
parties under the Securities Purchase Agreements totaled 277,778 shares of
common stock sold at an aggregate sales price of $500,000.
The Company used $2,000,000 of the proceeds generated from these May 2003
private placements to pay down the balance of the Company's mezzanine loan
from FINOVA Mezzanine Capital, Inc. The Company then applied the
additional proceeds from the new loan from Wachovia Bank, as discussed in
Note 5, to pay the remaining $2,000,000 on the FINOVA Mezzanine loan. The
Company utilized the remainder of the private placement proceeds for
working capital and general corporate purposes.
In accordance with a warrant agreement dated September 30, 1999, the
exercise price on 200,000 warrants still held by FINOVA Mezzanine on May
30, 2003, was reduced from $3.41 to $1.80 per share based on the sales
price of the Company's common stock in May 2003. FINOVA Mezzanine
exercised these warrants to purchase 200,000 shares of the Company's
common stock on June 2, 2003. The Company received net proceeds of
$119,000 after a deduction of $241,000 due to FINOVA Capital Corporation
for waiver fees pursuant to a certain Amendment and Limited Waiver to
Security Agreement dated June 26, 2002.
67
(9) 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. In
November 2005, Schreiber began to deliver such products directly to the
Company's customers. The prices for such products are based on cost plus a
processing fee as 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 March 31,
2006, all 104 employee positions related to the manufacturing and
distribution of the Company's products had been eliminated. The remaining
employee termination costs are expected to be paid in fiscal 2007. 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.
68
As of March 31, 2006, the Company has accrued the following quarterly
costs associated with the above transactions:
Employee
Termination Excess Other 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
Charges 39,590 122,282 142,414 304,286
Payments (220,277) (168,530) (37,837) (426,644)
------------ ------------ ------------ ------------
Accrued Balance, March 31, 2006 $ 25,878 $ 349,949 $ 104,577 $ 480,404
============ ============ ============ ============
For the fiscal year ended March 31, 2006, the Company incurred and
reported $1,646,490 as Costs of Disposal Activities in the Statement of
Operations. A summary of the disposal costs recognized for the year ended
March 31, 2006 is as follows:
Employee
Termination Excess Other Exit
Costs Facilities Costs Total
------------ ------------ ------------ ------------
Disposal Costs Incurred $ 451,002 $ 518,479 $ 677,009 $ 1,646,490
============ ============ ============ ============
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.
(10) Impairment of Property and Equipment
In light of the asset sale and supply arrangements discussed in Note 9,
the Company determined that it is more likely than not that a majority of
its fixed assets related to production activities would be sold or
disposed prior to the end of their useful life. In accordance with SFAS
No. 144, "Accounting for the Impairment or 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 in Note 9 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 in
December 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.
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 fiscal year ended
March 31, 2006, the Company recorded a $3,628 gain on the disposal 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 to sell these
remaining assets by September 2006. The Company has estimated the fair
value of these assets to be $61,950. 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.
69
(11) Income Taxes
The components of the net deferred tax assets consist of the following:
March 31, 2006 2005
--------------------------------------------------------------------------------------------------------------
Deferred tax assets:
Net operating loss carry forwards $16,355,000 $14,732,000
Non-deductible reserves 4,475,000 1,033,000
Investment, alternative minimum and general business tax credits 85,000 80,000
Accrued employment contract 328,000 520,000
Depreciation and amortization 10,000 --
Other 668,000 983,000
--------------------------------------------------------------------------------------------------------------
Gross deferred income tax assets 21,921,000 17,348,000
Valuation allowance (21,921,000) (13,191,000)
--------------------------------------------------------------------------------------------------------------
Total deferred income tax assets -- 4,157,000
Deferred income tax liabilities:
Depreciation and amortization -- (4,157,000)
--------------------------------------------------------------------------------------------------------------
Net deferred income tax assets -- --
==============================================================================================================
The valuation allowance increased by $8,730,000, $1,375,000 and $787,000
for the fiscal years ended March 31, 2006, 2005 and 2004, respectively.
The Company has recorded a valuation allowance to state its deferred tax
assets at estimated net realizable value due to the uncertainty related to
realization of these assets through future taxable income.
The following summary reconciles differences from taxes at the federal
statutory rate with the effective rate:
Fiscal Years Ended March 31, 2006 2005 2004
------------------------------------------------------------------------------------------------------
Federal income taxes at statutory rates (34.0%) (34.0%) (34.0%)
Change in deferred tax asset valuation allowance 32.6% 31.5% 26.6%
Non deductible expenses:
Imputed interest on note receivable 0.9% 4.8% 7.0%
Other 0.5% (2.3%) 0.4%
-------------- ---------------- ----------------
Income taxes (benefit) at effective rates -- -- --
============== ================ ================
Unused net operating losses for income tax purposes, expiring in various
amounts from 2008 through 2026, of approximately $43,500,000 are available
at March 31, 2006 for carry forward against future years' taxable income.
Under Section 382 of the Internal Revenue Code, the annual utilization of
this loss may be limited in the event there are changes in ownership.
70
(12) Earnings Per Share
The following is a reconciliation of basic net loss per share to diluted
net loss per share:
Fiscal Years Ended March 31, 2006 2005 2004
-------------------------------------------------------------------------------------------------------------
Net loss to common stockholders $(24,148,553) $(4,261,855) $(4,757,087)
====================================================
Weighted average shares outstanding - basic & diluted 19,704,483 17,007,791 14,937,005
====================================================
Basic & Diluted net loss per common share $ (1.23) $ (0.25) $ (0.32)
====================================================
Options for 4,846,406 shares and warrants for 1,133,142 shares have not
been included in the computation of diluted net loss per common share for
the fiscal year ended March 31, 2006 as their effects were antidilutive.
Options for 5,061,809 shares and warrants for 2,285,356 shares have not
been included in the computation of diluted net loss per common share for
the fiscal year ended March 31, 2005 as their effects were antidilutive.
Potential conversion of the Series A convertible preferred stock for
1,522,658 shares, options for 4,742,201 shares and warrants for 1,242,856
shares have not been included in the computation of diluted net loss per
common share for the fiscal year ended March 31, 2004 as their effects
were antidilutive.
(13) Supplemental Cash Flow Information
Fiscal Years Ended March 31, 2006 2005 2004
------------------------------------------------------------------------------------------------------------------
Non-cash financing and investing activities:
Purchase of equipment through capital lease obligations and term
notes payable $ -- $ 82,583 $ 55,672
Reduction in accounts payable through issuance of common stock -- -- 37,650
Reduction in notes payable through issuance of common stock -- -- 162,424
Accrued preferred stock dividends -- 82,572 201,791
Accretion of discount on preferred stock -- 319,500 1,256,019
Cash paid for:
Interest 975,742 967,303 1,160,098
Income taxes -- -- --
(14) 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 stockholder and 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 $925,982 remained unpaid but accrued
($366,305 as short-term liabilities and $559,677 as long-term liabilities)
as of March 31, 2006. 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 his purchase of 2,914,286 shares of the Company's common
stock into a single stockholder note receivable in the amount of
$12,772,200 that is due on June 15, 2006. This stockholder note receivable
is non-interest bearing and non-recourse and is secured by the 2,914,286
shares of the Company's common stock (the "Shares"). 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.
There have been no actions that have caused the loan to be forgiven.
71
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 Shares are below the value
of the stockholder note receivable. For the fiscal year ended March 31,
2006, the Company reserved $10,120,200 against this stockholder note
receivable under the assumption that it would not be able to collect
proceeds in excess of the $2,652,000 value of the Shares as of such date.
The value of the Shares was computed using the closing price of the
Company's common stock on March 31, 2006 of $0.91 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 stockholder note receivable was already shown as a
reduction to Stockholders' Equity (Deficit). See Note 19 for subsequent
information.
In connection with the October 2003 Second Amended and Restated Employment
Agreement, the Company issued an aggregate of 55,087 shares of the
Company's common stock to Mr. Morini (valued at approximately $2.95 per
share based on the average of the closing prices for the five trading days
preceding the effective date of the Agreement) in order to repay $162,397
of net advances that he had provided to the Company.
In October 2000, the Company obtained a $1.5 million bridge loan from
Wachovia Bank (as discussed in Note 5), which was guaranteed by Angelo S.
Morini and secured by one million of his above-mentioned 2,914,286 shares
of the Company's common stock. These one million shares were returned to
the Company when the loan was paid in full in February 2004.
On October 24, 2002, the Company entered into a special services agreement
with Angelo S. Morini, authorizing him to author and promote
"Veggiesizing, the stealth/health diet" book, which promotes the Company's
products. In consideration of these services and for his continued
personal pledges, the Company granted him 900,000 shares at the market
price of $2.05 on October 24, 2002. On December 4, 2002, as a result of
discussions and negotiations with certain major stockholders, Mr. Morini
cancelled these options with the Company and accepted new options to
acquire 510,060 shares of common stock - 200,000 options were granted at
an exercise price of $4.08 per share and 310,060 were granted at an
exercise price of $2.05 per share. These options expire on December 4,
2007. As a result of the cancellation and reissuance of options, the
Company will account for these options in accordance with variable
accounting standards.
Other Related Party Transactions
Beginning January 13, 2003, the Company entered into a vendor arrangement
with one of its employees pursuant to which the employee purchased raw
materials for the Company approximating $500,000. The amounts paid for the
purchased materials, plus interest at the rate of 15% per annum on such
amounts, was due and paid in full by May 31, 2003.
On April 10, 2003, the Company entered into a credit arrangement with one
of its greater than 5% stockholders pursuant to which the stockholder
purchased raw materials for the Company in an aggregate amount that did
not exceed $500,000. The amounts paid for the purchased materials, plus
interest at the rate of 15% per annum on such amounts, was due and payable
in full on July 9, 2003. In consideration of the credit arrangement, the
Company issued to the stockholder a warrant to purchase 100,000 shares of
the Company's common stock at an exercise price of $1.70. The fair value
of this warrant was estimated at $63,000 and was recorded as non-cash
compensation expense in the quarter ended June 30, 2003. All amounts owed
under the credit arrangement were repaid in full and such credit
arrangement was terminated on June 27, 2003.
On May 22, 2003, the Company entered into a Master Distribution and
Licensing Agreement with Fromageries Bel S.A. ("Bel"), a leading branded
cheese company in Europe who is a greater than 5% stockholder in the
Company. Under the agreement, the Company granted Bel exclusive
distribution rights for the Company's products in a territory comprised of
the European Union States and to more than 21 other European countries and
territories (the "Territory"). The Company also granted Bel the exclusive
option during the term of the agreement to elect to manufacture the
products designated by Bel for distribution in the Territory. The term of
the agreement is ten years, provided that either of the parties may elect
to terminate the agreement by delivery of notice to the other between
March 24, 2007 and May 22, 2007, which termination shall be effective as
of the first anniversary of the date of the notice of termination.
Alternatively, the parties may mutually agree to continue operating under
the agreement, to convert the agreement to a manufacturing and license
agreement, or to terminate the agreement. Pursuant to a Termination,
Settlement and Release Agreement signed on July 22, 2005 with Bel, the
Company received $150,000.
72
A former director of the Company was paid $37,500 and $59,000 for his
consulting services on marketing issues during each of the fiscal years
ended March 31, 2006 and 2005, respectively. Another director was paid
$33,500 for her consulting services on marketing plans and materials
provided to the Company during the fiscal year ended March 31, 2006.
(15) Economic Dependence and Segment Information
For the fiscal years ended March 31, 2006 and 2004, the Company did not
have any customer that comprised more than 10% of net sales.
For the fiscal year ended March 31, 2005, the Company had one customer
that accounted for approximately 12% of net sales. As of March 31, 2005,
the customer owed the Company approximately $1,550,000 or 22% of the
Company's gross trade receivable balance.
The Company sells to customers throughout the United States and 14 other
countries. For the fiscal years ended March 31, 2006, 2005 and 2004, the
Company's gross sales were $41,492,717, $48,421,384 and $40,041,371,
respectively. Gross sales derived from foreign countries were
approximately $5,158,000, $4,896,000 and $4,297,000 for the fiscal years
ended March 31, 2006, 2005 and 2004, respectively. These sales represent
12%, 10% and 11% of gross sales in the fiscal years ended March 31, 2006,
2005 and 2004, respectively. Gross sales are attributed to individual
countries based on the customer's shipping address. The Company has no
long-term assets located outside of the United States.
The following table sets forth the percentage of foreign gross sales to
each country, which accounted for 5% or more of the Company's foreign
gross sales for the fiscal years ended March 31, 2006, 2005 and 2004:
Percentage of Gross Foreign Sales
Fiscal Years Ended March 31,
Country 2006 2005 2004
---------------------------------------------------------
Canada 60.0% 47.9% 44.4%
Puerto Rico 22.8% 33.4% 32.9%
Israel * * 5.9%
*Less than 5% of foreign gross sales for the stated fiscal year
For the fiscal year ended March 31, 2006, the Company purchased $9,094,000
of products from two suppliers totaling approximately 51% of total raw
material purchases for the fiscal year. For the fiscal year ended March
31, 2005, the Company purchased $9,193,000 of products from four suppliers
totaling approximately 40% of total raw material purchases for the fiscal
year. For the fiscal year ended March 31, 2004, the Company did not have
any supplier that comprised more than 10% of total raw material purchases.
(16) Employee Benefit Plan
The Company has a 401(k) defined contribution plan covering all employees
meeting certain minimum age and service requirements. The Company's
matching contributions to the plan are determined by the Board of
Directors. On August 1, 2003, the Company match was raised from 25% to a
maximum of 50% of the employee's contribution up to 6% of the employee's
compensation. Company contributions to the plan amounted to $47,845,
$56,170 and $35,807 for the fiscal years ended March 31, 2006, 2005 and
2004, respectively.
(17) Fourth Quarter Adjustments
There were no significant or unusual adjustments in the fourth quarter of
fiscal 2006 or fiscal 2004.
73
During the fourth quarter of fiscal 2005, the Company recorded the
following adjustments:
Bad debt on accounts receivable $ 1,605,783
Inventory write-offs 676,181
As of March 31, 2005, a customer owed the Company approximately $1,550,000
or 22% of the Company's gross trade receivable balance. Additionally, the
Company had approximately $210,000 of inventory in stock as of March 31,
2005 related to this customer. Based on information that arose in April
2005 after the products were shipped, the Company determined that
collection of the outstanding receivable balance and inventory amounts
were in question as of March 31, 2005 and therefore, reserved 100% of
these amounts in its reserve for trade receivables and inventory at
year-end. In March 2005, the Company reviewed its inventory and wrote off
the value of unsalable items that it would no longer use in production due
to low margins, low volume, change in inventory formulas or loss of
customer.
(18) Quarterly Operating Results (Unaudited)
Unaudited quarterly operating results are summarized as follows:
Three Months Ended (Unaudited)
------------------------------------------------------------
2006 March 31 December 31 September 30 June 30
---- ------------ ------------ ------------ ------------
Net sales $ 8,414,387 $ 9,072,097 $ 10,438,225 $ 9,851,153
Gross margin 2,854,363 1,889,595 2,620,874 2,268,298
Net income (loss) (1,833,320) (11,754,981) (1,416,138) (9,144,114)
Net income (loss) for common stockholders (1,833,320) (11,754,981) (1,416,138) (9,144,114)
Basic & diluted net income (loss) per common
share (0.09) (0.59) (0.07) (0.49)
Stockholders' equity (deficit) (3,682,660) (2,806,092) (3,224,401) 873,278
Three Months Ended (Unaudited)
------------------------------------------------------------
2005 March 31 December 31 September 30 June 30
---- ------------ ------------ ------------ ------------
Net sales $ 10,785,379 $ 10,632,877 $ 11,900,553 $ 11,191,678
Gross margin 1,909,635 2,343,326 2,580,584 2,940,348
Net income (loss) (2,545,790) (1,015,473) 223,091 (521,611)
Net income (loss) for common stockholders (2,545,790) (1,061,807) 410,389 (1,064,647)
Basic & diluted net income (loss) per common
share (0.14) (0.06) 0.03 (0.07)
Stockholders' equity 4,801,933 7,129,196 6,528,219 6,014,676
(19) Subsequent Events
On June 16, 2006, Angelo S. Morini failed to repay the non-recourse note
obligation to the Company in the amount of $12,772,200. The stockholder
note receivable is non-recourse to Mr. Morini and is secured by a pledge
of 2,914,286 shares of the Company's common stock (the "Shares"). On June
20, 2006, the Company delivered notice to Mr. Morini that it intended to
exercise its rights to the Shares and retain all the Shares in full
satisfaction of his obligations under the stockholder note receivable. On
July 6, 2006, Mr. Morini consented to the Company's acceptance of the
Shares in full satisfaction of his obligations under the stockholder note
receivable. As a result, the Company is in the process of canceling the
Shares along with an additional 30,443 treasury shares. The Company's
total number of issued and outstanding shares of common stock is now
17,109,894 shares. Based upon the $0.42 closing price of the Company's
common stock as quoted on the OTC Bulletin Board on June 16, 2006, the
Shares have an approximate value of $1,224,000. Accordingly, the Company
will recognize an additional expense of $1,428,000 in the first quarter of
fiscal 2007 in order to record the additional decline in the value of the
Shares from its $2,652,000 value as of March 31, 2006.
74
On June 23, 2006, the Company entered into a Receivables Purchase
Agreement with Systran Financial Services Corporation, a subsidiary of
Textron Financial Corporation ("Systran"), whereby Systran will provide
financing to the Company through advances against certain trade receivable
invoices due to the Company (the "Systran Agreement"). The Systran
Agreement is secured by the Company's accounts receivable and all other
assets. Generally, subject to a maximum principal amount of $3,500,000
which can be borrowed under the Systran Agreement, the amount available
for borrowing is equal to 85% of the Company's eligible accounts
receivable invoices less a dilution reserve and any required fixed dollar
reserves. The dilution and fixed dollar reserves have been initially set
at 7% and $100,000, respectively. Advances under the Systran Agreement
bear interest at a variable rate equal to the prime rate plus 1.5% per
annum (9.5% on June 23, 2006). The Company paid a one-time closing fee of
$35,000 and is also obligated to pay a $1,500 monthly service fee. The
initial term of the Systran Agreement ends on June 23, 2009 and may renew
automatically for consecutive twelve-month terms unless terminated sooner.
The Systran Agreement may be accelerated in the event of certain defaults
by the Company including among other things, a default in the Company's
payment and/or performance of any obligation to Systran or any other
financial institution, creditor, or bank; and any change in the
conditions, financial or otherwise, of the Company which reasonably causes
Systran to deem itself insecure. In such an event, interest on the
Company's borrowings would accrue at the greater of twelve percent per
annum or the variable rate of prime plus 1.5% and the Company would be
liable for an early termination premium ranging from 1% to 3% of the
maximum principal amount available under the Systran Agreement.
On June 23, 2006, Systran advanced $2,379,262 under the Systran Agreement
of which $1,839,086 was used to pay in full and terminate the Company's
obligations under its line of credit with Textron Financial Corporation
which was to terminate on June 27, 2006.
Effective April 15, 2006 through October 31, 2006, the Company entered
into a sublease agreement for a portion of some of its unused
manufacturing and parking space whereby it expects to receive
approximately $83,901 in rental income to offset its lease payment
obligations in fiscal 2007.
75
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
As of March 31, 2006, 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
the 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. During the quarter ended March 31, 2006, there have been no changes
in our internal controls over financial reporting or in other factors that have
materially affected, or are reasonably likely to materially affect those
controls.
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.
ITEM 9B. OTHER INFORMATION
None.
76
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth the current directors and executive officers of
our Company as of July 13, 2006, as well as their respective ages and positions
with our Company:
Name Age Positions
- --------------------------------------------------------------------------------
David H. Lipka 76 Director, Chairman of the Board of Directors
Joanne R. Bethlahmy 51 Director
Michael E. Broll 57 Director, Chief Executive Officer
Angelo S. Morini 63 Director
Salvatore J. Furnari 41 Chief Financial Officer
John W. Jackson 48 Vice President of Sales
Christopher E. Morini 50 Vice President of New Business Development
and Key Accounts
Thomas J. Perno 51 Vice President of Contract Manufacturing
Kulbir Sabharwal 63 Vice President of Technical Services
The Board of Directors is comprised of the five positions, but we currently have
one vacancy. Two of the four remaining directors are non-employee directors. The
Chairman of the Board and the directors hold office until the next annual
meeting of stockholders and until their successors have been duly elected and
qualified. The executive officers of our Company are elected annually at the
first Board of Directors meeting following the annual meeting of stockholders,
and hold office until their respective successors are duly elected and
qualified, unless sooner displaced.
Since January 2006, due to the vacancies created through resignations on the
Board of Directors, the Board of Directors has been operating without a formal
audit committee and compensation committee. Any issues that arise are addressed
by the remaining independent directors or the entire Board of Directors, as
necessary.
Directors
David H. Lipka spent forty years (1955-1995) with DCA Food Industries Inc., an
international manufacturer of food ingredients and equipment with combined sales
in excess of $1 billion per annum, holding positions of president, chief
executive officer, and chief operating officer. Since 2001, Mr. Lipka served on
the board of directors of Doctor's Associates Inc. (Subway Stores) and has
served on numerous boards including Dunkin Donuts Inc. (1989-1994), Allied-Lyons
Inc. (1988-1994), and Kerry Group PLC (1995-1996). Mr. Lipka has also been
chairman and chief executive officer of Pennant Foods and Leons Baking Company.
He obtained a B.S. degree from Brooklyn College and attended the Graduate School
of Business at New York University. Since December 2002, Mr. Lipka has agreed to
serve as a director of our Company at the request of Frederick A. DeLuca, a
beneficial owner of more than ten percent (10%) of our common stock. Both Mr.
Lipka and Mr. DeLuca are members of the Board of Directors of Doctor's
Associates Inc.
Joanne R. Bethlahmy was appointed as a director of our Company on October 1,
2004 to fill the vacancy created upon the resignation of Christopher J. New in
July 2004. Ms. Bethlahmy has been the Managing Partner of Illuminate Consulting,
a management consulting firm specializing in market strategy for
consumer-oriented industries since 2000. She worked with Chef Solutions Inc., a
subsidiary of LSG Lufthansa, a business specializing in providing convenient
baked foods and prepared meals to food service and retail, as a consultant and
interim Senior Vice President of Marketing from 2000-2002. Ms. Bethlahmy's
twenty years of experience in strategy development, general management and
marketing includes major executive assignments with Andersen Consulting (now
Accenture 1993-1999), Maybelline (1992-1993), the Quaker Oats Company
(1988-1991) and Frito-Lay (1984-1988). She obtained an M.B.A. in Marketing from
U.C. Berkeley, a J.D. from Hastings College of Law (both in 1981) and a B.A. in
History from U.C. Davis in 1976.
77
Michael E. Broll was appointed as a director of our Company in December 2003 and
as Chief Executive Officer ("CEO") of our Company in July 2004 upon the
resignation of Christopher J. New. Mr. Broll is a private investor and
consultant in the food industry, and most recently was President and Chief
Executive Officer, from 1999 to 2002, of Chef Solutions Inc., a subsidiary of
Lufthansa Service Group ("LSG"), a business specializing in providing convenient
baked foods and prepared meals to food service and retail segments of the food
industry. As an executive of SCIS/Sky Chef's a subsidiary of ONEX Corporation, a
Canadian based private equity group, Mr. Broll assembled a group of six
companies in the bakery and prepared food business to ultimately form and merge
into a one new entity called Chef Solutions Inc., an ONEX controlled company.
Chef Solutions Inc. was subsequently sold to LSG in 2001. Mr. Broll's career
also includes major executive assignments with Allied-Domecq Retailing as the
head of its total supply chain for North America from 1997 to 1999, Ready Pac
Produce, Inc. as President and Chief Operating Officer from 1995 to 1997, Nestle
USA as the head of all supply chains for the chilled food group in North America
from 1993 to 1995, and Pillsbury Company as Vice President of Operations for the
bakery group supply chain from 1991 to 1993. Mr. Broll received his B.S. in
Economics from the University of Illinois in 1978.
Angelo S. Morini was the Founder and inventor of our Company's healthier dairy
alternative formula and was our President since its inception in 1980 until
October 2003. On December 17, 2002, Mr. Morini resigned from his positions as
Chief Executive Officer and Chairman of the Board of our Company and became the
Vice-Chairman of the Board. Effective October 13, 2003, Mr. Morini resigned from
his positions as Vice-Chairman and President of our Company and he is no longer
involved in the daily operations of the Company. He retains the title of Founder
and was named Chairman Emeritus. Between 1972 and 1980, Mr. Morini was the
general manager of Galaxy Cheese Company, which operated as a sole
proprietorship until its incorporation in May 1980. Prior to 1974, he was
associated with the Food Service Division of Pillsbury Company and the Post
Division of General Foods Company. In addition, he worked in Morini Markets, his
family-owned and operated chain of retail grocery stores in the New Castle,
Pennsylvania area. Mr. Morini received a B.S. degree in Business Administration
from Youngstown State University in 1968. Mr. Morini's brother, Christopher E.
Morini, works for our Company as Vice President of New Business Development and
Key Accounts. Mr. Morini's brother, Ronald Morini, worked for our Company until
October 31, 2003 as an engineering consultant and was paid $61,310 in consulting
fees and benefits during the fiscal year ended March 31, 2004.
Executive Officers
Salvatore J. Furnari, CPA was appointed as our Chief Financial Officer in July
2002. From November 2001 until July 2002, Mr. Furnari served as our Controller.
Prior to joining our Company, Mr. Furnari was Corporate Controller and Treasurer
of Pritchard Industries, Inc., a national commercial cleaning company. From 1998
through 1999, he served as Chief Financial Officer and Vice President of Finance
for Garage Management Corporation; and from 1993 until 1998, he was Chief
Financial Officer of American Asset Corporation. Mr. Furnari received his B.S.
in Accounting from Queens College in New York City in May 1987.
John W. Jackson has been Vice President of Sales for our Company since 1993.
From 1985 through 1992, Mr. Jackson was director of sales for H.J. Heinz
Company. Mr. Jackson received his B.S. in Business Administration and Accounting
from Mars Hill College in 1980.
Christopher E. Morini has been the Vice President of New Business Development
and Key Accounts since September 2001, having formerly served as Vice President
of Marketing and International Sales for our Company since 1993. From 1986
through 1993, Mr. Morini was a Vice President of our Company, where he has been
responsible for various sales and marketing divisions of our Company, including
the Food Service, International Sales and Retail Sales divisions. Mr. Morini
started with our Company as an area salesman in 1983 and became sales manager in
1984. Mr. Morini received a B.S. in Economics from Slippery Rock University in
1978. Christopher E. Morini's brother, Angelo S. Morini, is the Founder of our
Company.
78
Thomas J. Perno has worked for our Company since 1983. He began as a Shipping
and Receiving Supervisor, he was later promoted to Plant Manager and then to
Vice President of Operations. In December 2006, his title changed to Vice
President of Contract Manufacturing. Mr. Perno received his M.S. in Electrical
Engineering from Penn State University in 1976.
Kulbir Sabharwal has been Vice President of Technical Services for our Company
since 1991. Dr. Sabharwal worked as the Director of Research and Quality Control
for Gilardies Frozen Foods from 1987 to 1990 and for Fisher Cheese Company from
1972 to 1986. Dr. Sabharwal received his Ph.D. in Food Science and Nutrition
from Ohio State University in 1972.
Audit Committee
Until January 2006, we maintained a separately designated standing audit
committee in accordance with Section 3(a)(58)(A) of the Securities Exchange Act
of 1934, as amended. From April 1, 2005 until January 21, 2006, the audit
committee members were Thomas R. Dyckman, Joanne R. Bethlahmy and Patrice M.A.
Videlier. Mr. Dyckman and Mr. Videlier resigned from the Board of Directors and
audit committee on January 21, 2006 and May 2, 2006, respectively. Ms. Bethlahmy
resigned from the audit committee on January 21, 2006 in order to receive
compensation for her consulting and marketing services she provided to our
Company.
Prior to January 2006, the Board of Directors determined that all members of the
audit committee were financially capable and that Thomas R. Dyckman, the audit
committee chairman, was an "audit committee financial expert" within the meaning
of the regulations of the Securities and Exchange Commission. Mr. Dyckman was
considered an audit committee financial expert related to his significant and
relevant accounting and financial experience as an author and Professor of
Accounting at the S.C. Johnson Graduate School of Management at Cornell
University. We have determined that all audit committee members were
"independent" as that term is defined in Item 7(d)(3)(iv) of Schedule 14A
promulgated under the Exchange Act. No other member of the audit committee
received any payments from our Company other than compensation received for
their service as a director of our Company prior to January 2006. After her
resignation from the audit committee, Joanne R. Bethlahmy was paid $33,500 for
her consulting and marketing plans and materials that she provided to our
Company during the fiscal year ended March 31, 2006.
Since January 2006, due to the vacancies created through resignations on the
Board of Directors, the Board has been operating without a formal audit
committee in accordance with Section 3(a)(58)(B) of the Securities Exchange Act
of 1934, as amended. Any issues that arise are addressed by the remaining
independent directors or the entire Board of Directors, as necessary.
Nominating Committee
On November 15, 2004 the Board of Directors determined that it would not
establish a formal nominating committee and it adopted certain procedural
guidelines for director nominations. There have been no material changes to
these procedures since their adoption in the prior fiscal year.
79
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires our
executive officers, directors and persons who own more than 10% of a registered
class of our equity securities, to file reports of ownership and changes in
ownership with the Securities and Exchange Commission and the American Stock
Exchange. Officers, directors and stockholders owning more than 10% of our
common stock are required by SEC regulations to provide our Company with copies
of all the reports they file pursuant to Section 16(a).
Based solely upon our review of those reports required by Section 16(a) and
filed by or on behalf of our officers, directors and stockholders owning greater
than 10% of our common stock, or written representations that no such reports
were required to be submitted by such persons, we believe that during the fiscal
year ended March 31, 2006, all of the officers, directors and stockholders
owning greater than 10% of our common stock complied with all applicable Section
16(a) filing requirements except for Salvatore J. Furnari, our Chief Financial
Officer, John W. Jackson, our Vice President of Sales, Thomas J. Perno, our Vice
President of Operations, and Kulbir Sabharwal, our Vice President of Technical
Services. Each named individual filed one Form 4 report containing one
transaction related to the acquisition of stock on the open market after the
required two-day reporting period.
Code of Ethics
We have adopted a code of ethics as defined in Item 406 of Regulation S-K
promulgated under the Securities Act of 1933, as amended, which code applies to
all of our directors and employees, including our principal executive officer,
principal financial officer, principal accounting officer and persons performing
similar functions. Additionally, we have adopted corporate governance guidelines
and charters for our Audit and Compensation Committees. All of these materials
are available free of charge on our website at www.galaxyfoods.com or by
requesting a copy by writing to: Corporate Secretary, Galaxy Nutritional Foods,
Inc. 2441 Viscount Row, Orlando, FL 32809.
80
ITEM 11. EXECUTIVE COMPENSATION
Summary Compensation Table
The following table sets forth the compensation during the fiscal years ended
March 31, 2006, 2005 and 2004 paid to the following individuals (each, a "Named
Executive Officer"): (i) all individuals serving as our Chief Executive Officer
during the last fiscal year, (ii) our four other most highly compensated
executive officers who were serving as executive officers as of March 31, 2006,
and (iii) up to two additional individuals for whom disclosure would have been
provided pursuant to clause (ii) above, but for the fact that the individual was
not serving as an executive officer at the end of the last completed fiscal
year. However, in the cases of clauses (ii) and (iii) above, no disclosure is
provided for any individual whose total annual salary and bonus does not exceed
$100,000:
SUMMARY COMPENSATION TABLE
Long Term Compensation
---------------------------------------
Annual Compensation Awards Payouts
------------------------------------- ------------------------ ------------
(a) (b) (c) (d) (e) (f) (g) (h) (i)
Securities
Name and Other Annual Restricted Underlying All Other
Principal Compensation Stock Options/SARs LTIP Compensation
Position Year Salary ($) Bonus($) ($) Award(s)($) (#) Payouts ($) ($)(15)
- -----------------------------------------------------------------------------------------------------------------------
Michael E. Broll (1)
CEO 2006 200,000 -- 55,740(2) -- -- -- --
2005 143,846 25,000 32,310(2) -- -- -- --
2004 -- -- -- -- 200,000(3) -- --
Salvatore J. Furnari (5)
CFO 2006 147,788 3,000 18,000(4) -- -- -- --
2005 145,000 -- 28,516(4) -- 70,000(6) -- --
2004 134,577 -- 25,600(4) -- -- -- --
John W. Jackson (7)
VP of Sales 2006 162,900 -- 18,000(4) -- -- -- --
2005 144,820 -- 17,500(4) -- 7,000(8) -- --
2004 138,000 -- 11,510(4) -- -- -- --
Angelo S. Morini (9)
Founder and 2006 300,000 -- 39,000(10) -- -- -- --
Director 2005 300,000 -- 39,000(10) -- -- -- 17,914(11)
2004 300,000 -- 38,512(10) -- -- -- --
Christopher E. Morini (12)
VP of New 2006 155,000 -- 19,398(13) -- -- -- --
Business 2005 155,000 -- 21,747(13) -- 1,000(14) -- --
Development 2004 155,000 -- 18,135(13) -- -- -- --
(1) On July 8, 2004, Michael E. Broll, a member of our Board of Directors, was
appointed as our Company's Chief Executive Officer. We entered into a
one-year employment agreement with Mr. Broll pursuant to which Mr. Broll
is entitled to receive an annual base salary of $200,000 plus a
performance bonus at the discretion of the Board, standard health
benefits, a housing allowance of up to $3,500 per month and an auto
allowance of $1,500 per month. The employment agreement renews
automatically for one-year periods unless cancelled by either party ninety
days prior to the end of the term. In the event Mr. Broll's employment is
terminated without cause, he will be entitled to receive one year of his
base salary as severance. In March 2005, Mr. Broll received a
discretionary bonus of $25,000.
81
(2) "Other Annual Compensation (e)" represents $18,000 received for an auto
allowance plus $37,740 received for a housing allowance during the fiscal
year ended March 31, 2006 and $12,000 received for an auto allowance plus
$20,310 received for a housing allowance during the fiscal year ended
March 31, 2005.
(3) Upon appointment to our Board of Directors on December 17, 2003, we
granted Mr. Broll an option to acquire 200,000 shares of our common stock
at an exercise price of $3.29 per share, which is equal to 130% of the
market price on the date of grant. Such options are fully exercisable and
expire December 17, 2008.
(4) Amounts in "Other Annual Compensation (e)" represent the amounts paid by
our Company during the fiscal years ended March 31, 2006, 2005 and 2004
for auto allowances including auto leases and insurance.
(5) On July 8, 2002, Salvatore J. Furnari was appointed Chief Financial
Officer of our Company. From November 2002 to July 8, 2002, he worked as
our Controller. Effective January 1, 2004, our Board of Directors approved
an increase in his annual compensation from $130,000 to $145,000. During
the fiscal year ended March 31, 2006, Mr. Furnari received compensation
for a week of unused vacation time so that his total salary was reported
as $147,788.
(6) In consideration for past performance and continued employment, on October
1, 2004, we granted Mr. Furnari an option to acquire 70,000 shares of our
common stock at an exercise price of $2.05 per share. The market price on
the date of grant was $1.20 per share. This option is fully exercisable
with an expiration date of October 1, 2014.
(7) Effective April 1, 2004, John W. Jackson's employment agreement provides
for an annual base salary of $144,900. Previously, his annual base salary
was $138,000.
(8) In consideration for past performance and continued employment, on October
1, 2004, we granted to Mr. Jackson an option to acquire 7,000 shares of
our common stock at an exercise price of $1.28 per share. The market price
on the date of grant was $1.20 per share. This option is fully exercisable
with an expiration date of October 1, 2014.
(9) In a Second Amended and Restated Employment Agreement effective October
13, 2003, Angelo S. Morini our Founder, Vice-Chairman and President
resigned from his positions with our Company as Vice-Chairman and
President and he is no longer be involved in the daily operations of our
Company. He retains the title of Founder and has been named Chairman
Emeritus. Mr. Morini continues to be an employee, stockholder and a member
of our Board of Directors. The agreement is for a five-year period
beginning October 13, 2003 and provides for an annual base salary of
$300,000, plus life insurance, standard health insurance benefits, club
dues and an auto allowance. For the fiscal year ended March 31, 2005, we
paid $7,170 for life insurance and $9,767 for health insurance for Mr.
Morini.
(10) For each of the fiscal years ended March 31, 2006 and 2005, we paid
$23,400 for auto allowance and $15,600 for club dues for Mr. Morini. For
the fiscal year ended March 31, 2004, we paid $24,584 in auto lease and
auto allowance payments and $13,928 for club dues for Mr. Morini.
(11) For the fiscal year ended March 31, 2006, we paid $7,170 for life
insurance and $10,744 for health insurance for Mr. Morini. For the fiscal
year ended March 31, 2005, we paid $7,170 for life insurance and $9,767
for health insurance for Mr. Morini.
(12) Christopher E. Morini's employment agreement provides for an annual base
salary of $155,000.
(13) For the fiscal year ended March 31, 2006, we paid $13,200 for an auto
allowance and $6,198 for club dues for Mr. C. Morini. For the fiscal year
ended March 31, 2004, we paid $12,595 For the fiscal year ended March 31,
2005, we paid $14,452 for auto lease payments, $1,368 for automobile
insurance, and $4,172 for club dues for Mr. C. Morini. For the fiscal year
ended March 31, 2004, we paid $12,595 for auto lease payments, $1,368 for
automobile insurance, and $4,172 for club dues for Mr. C. Morini.
(14) In consideration for past performance and continued employment, on October
1, 2004, we granted Mr. C. Morini an option to acquire 1,000 shares of our
common stock at an exercise price of $1.28 per share. The market price on
the date of grant was $1.20 per share. This option is fully exercisable
with an expiration date of October 1, 2014.
82
(15) Other than the information described in the footnotes above, there were no
other annual compensation, perquisites or other personal benefits,
securities or property equal to the lesser of $50,000 or 10% of the total
annual salary and bonus reported for such Named Executive Officer.
Option/SAR Grants Table
There were no grants of stock options or freestanding SARs made during the
fiscal year ended March 31, 2006 to any Named Executive Officer.
Aggregate Option/SAR Exercises and Fiscal Year-End Option/SAR Value Table
The following table summarizes for each Named Executive Officer each exercise of
stock options during the fiscal year ended March 31, 2006 and the fiscal
year-end value of unexercised options:
Aggregate Option/SAR Exercises in Last Fiscal Year and Fiscal Year-End Option/SAR Values
Shares Number of Securities Value of
Acquired Underlying Unexercised Unexercised
on Value Options/SARS at In-the-Money Options/SARS
Name Exercise Realized Fiscal Year-End at Fiscal Year-End
(#) ($) (#) ($)
- --------------------------------------------------------------------------------------------------------------------
Exercisable Unexercisable Exercisable Unexercisable
-------------- ----------------- -------------- -----------------
Michael E. Broll -- -- 200,000 -- -- --
Salvatore J. Furnari -- -- 100,000 -- -- --
John W. Jackson -- -- 103,429 -- -- --
Angelo S. Morini -- -- 3,038,447 -- -- --
Christopher E. Morini -- -- 97,429 -- -- --
The value of unexercised in-the-money options at March 31, 2006 is calculated as
the difference between the per share exercise price and the market value of
$0.91, the closing price of our common stock on March 31, 2006 as reported by
the American Stock Exchange ("AMEX").
Compensation of Directors
Standard Arrangements
Each non-employee director who served on the Board of Directors during the
fiscal year ended March 31, 2006 was entitled to receive a fee of $1,500 plus
expenses for each Board of Directors meeting in which they attended in person.
Additionally, each of our non-employee directors is entitled to receive, on
October 1 of each year, options to purchase a number of shares of common stock
equal to (i) 286 shares, if such director served for a full year prior to the
October 1 anniversary date, or (ii) a pro rated amount equal to 24 shares for
each full month served during the year prior to such anniversary date, if such
director did not serve for a full year prior to the anniversary date. Such
options are granted pursuant to our 1991 Non-Employee Director Stock Option
Plan, which was adopted by the Board of Directors on October 1, 1991, and
approved by the stockholders of our Company on January 31, 1992, and was amended
by that certain 1996 Amendment and Restatement of the 1991 Non-Employee Director
Stock Option Plan (as amended, the "Director Plan").
Other Arrangements
David H. Lipka received $60,000 for his service as Chairman of the Board during
the fiscal year ended March 31, 2006. Joanne R. Bethlahmy received $33,500 for
her consulting and marketing plans and materials that she provided to our
Company during the fiscal year ended March 31, 2006. During the fiscal year
ended March 31, 2006, Charles L. Jarvie received total compensation of $37,500
for his marketing consulting services to our Company.
83
Compensation of Management
Employment Agreements
Michael E. Broll. On July 8, 2004, Michael E. Broll, a member of our Board of
Directors, was appointed as the Chief Executive Officer. We entered into a
one-year employment agreement with Mr. Broll pursuant to which Mr. Broll is
entitled to receive an annual base salary of $200,000 plus a performance bonus
at the discretion of the Board, standard health benefits, a housing allowance of
up to $3,500 per month and an auto allowance of $1,500 per month. The employment
agreement renews automatically for one-year periods unless cancelled by either
party ninety days prior to the end of the term. In the event Mr. Broll's
employment is terminated without cause, he will be entitled to receive one year
of his base salary as severance.
Salvatore J. Furnari. On November 11, 2001, Mr. Furnari was appointed as
Controller and on July 8, 2002, he was appointed as our Chief Financial Officer.
Under the terms of his current employment agreement, which has no stated end, he
will receive an annual base salary of $145,000. Mr. Furnari is entitled to
standard health benefits and an auto allowance of $1,500 per month. In the event
Mr. Furnari's employment is terminated without cause, he will be entitled to
receive one year of his base salary, vacation pay, auto allowance and health
benefits as severance.
Angelo S. Morini. In a Second Amended and Restated Employment Agreement
effective October 13, 2003, Angelo S. Morini our Founder, Vice-Chairman and
President resigned from his positions with as Vice Chairman and President and he
is no longer involved in the daily operations of our Company. He retains the
title of Founder and has been named Chairman Emeritus. Mr. Morini continues to
be a stockholder and a member of our 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 our Company, we
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
$925,982 remained unpaid but accrued ($366,305 as short-term liabilities and
$559,677 as long-term liabilities) as of March 31, 2006. 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 Angelo S. Morini, our Founder, stockholder and a 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 his purchase of
2,914,286 shares of our common stock into a single stockholder note receivable
in the amount of $12,772,200 that was due on June 15, 2006. This stockholder
note receivable is non-interest bearing and non-recourse and is secured by the
2,914,286 shares of our common stock (the "Shares"). For the fiscal year ended
March 31, 2006, we reserved $10,120,200 against this stockholder note receivable
under the assumption that we would not be able to collect proceeds in excess of
the $2,652,000 value of the Shares as of such date. The value of the Shares was
computed using the closing price of our common stock on March 31, 2006 of $0.91
multiplied by the 2,914,286 shares.
On June 16, 2006, Mr. Morini failed to repay the non-recourse note obligation to
our Company and we subsequently reacquired the 2,914,286 shares. Based upon the
$0.42 closing price of our common stock as quoted on the OTC Bulletin Board on
June 16, 2006, the Shares have an approximate value of $1,224,000. Accordingly,
we will recognize an additional expense of $1,428,000 in the first quarter of
fiscal 2007 in order to record the additional decline in the value of the Shares
from its $2,652,000 value as of March 31, 2006.
84
John W. Jackson. In August 1993, Mr. Jackson was appointed as Vice President of
Sales. Mr. Jackson's current employment agreement has no stated end and provides
for a base salary of $144,900 and an auto allowance of $1,500 per month. Mr.
Jackson will also be entitled to a bonus that shall not exceed 40% of his base
salary based on certain personal and Company goals as established by our Chief
Executive Officer. In the event of a change in ownership of our Company which
results in his termination, Mr. Jackson will be entitled to receive three years
of his base salary as severance. In the event Mr. Jackson's employment is
otherwise terminated, he is entitled to receive one year of his base salary as
severance.
Christopher E. Morini. Angelo S. Morini's brother, Christopher E. Morini, works
for our Company as Vice President of New Business Development and Key Accounts.
From February of 1993 until October 2001, Mr. C. Morini served as Vice President
of Marketing. Mr. C. Morini's current employment agreement has no stated end and
provides for a base salary of $155,000 per year, an auto allowance of $1,100 per
month and monthly country club dues. Mr. C. Morini will also be entitled to a
bonus that shall not exceed 40% of his base salary based on certain personal and
Company goals as established by our Chief Executive Officer. In the event Mr. C.
Morini's employment is terminated without cause, Mr. C. Morini will be entitled
to receive five years of his base salary, club dues and an auto allowance as
severance.
Compensation Committee Interlocks and Insider Participation
Until January 2006, the Compensation Committee members consisted of Charles L.
Jarvie (chairman), Thomas R. Dyckman and Joanne R. Bethlahmy. Mr. Jarvie and Mr.
Dyckman resigned from the Board of Directors in January 2006. Since January
2006, due to the vacancies created through resignations on the Board of
Directors, the Board of Directors has been operating without a formal
compensation committee. Any issues that arise are addressed by the remaining
independent directors or the entire Board of Directors, as necessary.
None of the members of the Compensation Committee were or had been an officer or
employee of our Company. All members were independent within the meaning of the
listing standards of the AMEX.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
Equity Compensation Plan Information
The following table describes our compensation plans under which our common
stock is authorized for issuance as of March 31, 2006:
85
Equity Compensation Plan Information Table
(a) (b) (c)
Plan Category Number of securities Weighted-average Number of securities
to be issued upon exercise price of remaining available
exercise of outstanding options, for future issuance
outstanding options, warrants and rights under equity
warrants and rights compensation plans
(excluding securities
reflected in column
(a))
Equity compensation plans approved by
security holders 4,204,977 $ 3.14 26,361
Equity compensation plans not
approved by security holders (1) 641,429 $ 3.00 N/A
-----------------------------------------------------------------------
Total 4,846,406 $ 3.08 26,361
=======================================================================
(1) These securities were issued pursuant to individual compensation
arrangements prior to July 2, 1997 or after December 15, 2003 and
have not been approved by security holders.
- ---------------------------------------------------------------------------------------------------------------------
Security Ownership of Certain Beneficial Owners
The following table describes the beneficial ownership of our common stock by
each person or entity known to our Company to be the beneficial owner of more
than 5% of the outstanding shares of our capital stock outstanding as of July
13, 2006. The total number of shares of our common stock outstanding as of July
13, 2006 is 17,109,894. Beneficial ownership has been determined in accordance
with the rules of the Securities and Exchange Commission to include securities
that a named person or entity has the right to acquire within sixty (60) days.
Name and Address Amount and Nature of
of Beneficial Owner Beneficial Ownership (1) Percent of Class (2)
-------------------------------------- --------------------------------- -------------------------
Frederick A. DeLuca
c/o Doctor's Associates, Inc.
325 Bic Drive
Milford, Connecticut 06460 4,169,842 (3) 24.0%
Angelo S. Morini
2441 Viscount Row
Orlando, Florida 32809 3,623,520 (4) 18.0%
Royce & Associates LLC
1414 Avenue of the Americas
New York, NY 10019 1,363,600 (5) 8.0%
John Hancock Advisers LLC
601 Congress Street
Boston, Massachusetts 02210 1,139,348 (6) 6.7%
BH Capital Investments L.P.
175 Bloor Street East
South Tower, Suite 705
Toronto, Ontario, Canada M4W 3R8 1,630,109 (7) 9.5%
BC Advisors LLC
300 Crescent Court, Suite 1111
Dallas, Texas 75201 1,118,808 (8) 6.5%
Fromageries Bel S.A.
4 rue d Anjou
Paris, France 75008 1,111,112 (9) 6.5%
86
(1) The inclusion herein of any shares deemed beneficially owned does not
constitute an admission of beneficial ownership of these shares.
(2) The percentages are calculated on the basis of the amount of shares
outstanding plus shares which may be acquired through the exercise of
options, warrants, rights or conversion privileges by such holder within
sixty (60) days of July 13, 2006.
(3) Includes a warrant to acquire 300,000 shares of our common stock at $1.53
per share. Such option expires on October 17, 2008. The information is
based solely on a Schedule 13D/A filed with the SEC on September 27, 2005.
Mr. Frederick A. DeLuca has direct beneficial ownership of and has sole
voting and investment dispositive power over all the reported shares.
(4) Includes options to acquire 3,038,197 shares of our common stock, which
are currently exercisable at prices ranging from $2.05 to $5.25 per share.
Options expire as to 13,072 shares on October 1, 2006, as to 432,797 on
July 1, 2007, as to 517,203 shares on December 4, 2007, as to 1,357,000
shares on June 15, 2009, as to 343,125 on December 15, 2010, and as to
375,000 on April 19, 2011. Also includes a warrant to purchase 250 shares
at an exercise price of $5.744 per share, which expires on January 17,
2007. With the exception of the options, 10,500 shares held in a nominee
name, 286 shares held in joint tenancy and 714 shares held individually,
all of Mr. Morini's shares and warrant are held by Morini Investments
Limited Partnership, a Delaware limited partnership, of which Mr. Morini
is the sole limited partner and Morini Investments LLC, a Delaware limited
liability company, is the sole general partner. Mr. Morini is the sole
member of Morini Investments LLC.
(5) The information is based solely on a Schedule 13G/A filed with the SEC on
January 20, 2006. Royce & Associates LLC has direct beneficial ownership
of and has sole voting and dispositive power over all the reported shares.
(6) The information is based solely on a Schedule 13G/A filed with the SEC on
February 9, 2006 by Manulife Financial Corporation ("MFC"). MFC may be
deemed to have beneficial ownership of the shares through its indirect,
wholly-owned subsidiary John Hancock Advisers, LLC. John Hancock Advisers,
LLC has direct beneficial ownership of and has sole voting and dispositive
power over all the reported shares.
(7) The information is based solely on a Schedule 13G/A filed with the SEC on
February 1, 2006. Each of the following reporting persons are deemed to
beneficially own and have sole voting and dispositve power over a pro rata
share of the total 1,630,109 shares: BH Capital Investments, L.P., HB and
Co., Inc., Henry Brachfeld, Excalibur Limited Partnership, Excalibur
Capital Management, Inc. and William S. Hechter. Lillian Brachfeld is the
sole stockholder of HB and Co, Inc. and the wife of Henry Brachfeld.
Lillian Brachfeld has disclaimed pursuant to Rule 13d-4 of the Securities
Exchange Act of 1934, as amended, beneficial ownership of all shares she
may be deemed to beneficially own by reason of such status. The address of
the principal business office of BH Capital Investments, L.P., HB and Co.,
Inc., Henry Brachfeld and Lillian Brachfeld is 175 Bloor Street East,
South Tower, Suite 705, Toronto, Ontario Canada M4W 3R8. The address of
the principal business office of Excalibur Limited Partnership, Excalibur
Capital Management, Inc. and William S. Hechter is 33 Prince Arthur
Avenue, Toronto, Ontario, Canada M5R 1B2.
87
(8) Includes options to acquire 150,000 shares of our common stock at $1.53
per share. Such options expire on October 17, 2008. The information is
based solely on a Schedule 13G/A filed with the SEC on January 3, 2006. BC
Advisors LLC ("BCA") has direct beneficial ownership of and has sole
voting and dispositive power over all the reported shares. BC Advisors LLC
acquired the shares for the account of SRB Greenway Capital, L.P.
("SRBGC"), SRB Greenway Capital (Q.P.), L.P. ("SRBQP"), and SRB Greenway
Offshore Operating Fund, L.P. ("SRB Offshore"). BCA is the general partner
of SRB Management, L.P. which is the general partner of SRBGC, SRBQP and
SRB Offshore. Steven R. Becker is the sole principal of BCA.
(9) The information is based solely on a Schedule 13D filed with the SEC on
June 9, 2003, by Fromageries Bel S.A. Fromageries Bel S.A. has direct
beneficial ownership of all the reported shares. Unibel, a French limited
partnership, is deemed to beneficially own the reported shares by reason
of the provisions of Rule 13d-3 promulgated under the Securities Exchange
Act of 1934, as amended. Each of Fromageries Bel S.A. and Unibel, a French
limited partnership, has shared voting power and shared dispositive power
over all the reported shares of our common stock.
Security Ownership of Management
The following table describes the beneficial ownership of our common stock by
(i) each Named Executive Officer, (ii) each director, and (iii) all of our
directors and executive officers as a group, outstanding as of July 13, 2006.
Beneficial ownership has been determined in accordance with the rules of the
Securities and Exchange Commission to include securities that a named person has
the right to acquire within sixty (60) days:
Amount and Nature of
Name of Beneficial Owner Beneficial Ownership (1) Percent of Class (2)
------------------------------------- -------------------------------- ---------------------------
David H. Lipka 259,353 (3) 1.5%
Joanne R. Bethlahmy 200,286 (4) 1.2%
Michael E. Broll 201,114 (5) 1.2%
Angelo S. Morini 3,623,520 (6) 18.0%
Salvatore J. Furnari 103,912 (7) *
John W. Jackson 100,223 (8) *
Christopher E. Morini 90,286 (9) *
-------------------------------- ---------------------------
All executive officers and
directors as a group 4,578,694 21.8%
================================ ===========================
* Less than 1%.
(1) The inclusion herein of any shares deemed beneficially owned does not
constitute an admission of beneficial ownership of these shares.
(2) The total number of shares of our common stock outstanding as of July 13,
2006 is 17,109,894. The percentages are calculated on the basis of the
amount of shares outstanding plus shares which may be acquired through the
exercise of options, warrants, rights or conversion privileges by such
holder within sixty (60) days of July 13, 2006.
(3) Includes currently exercisable options to acquire 200,000 shares of our
common stock at $2.17 per share, which expire on December 17, 2007. Also,
includes currently exercisable options to acquire 225 shares of our common
stock at $2.90 per share, which expire on October 1, 2013, currently
exercisable options to acquire 286 shares of our common stock at $1.20 per
share, which expire on October 1, 2014 and currently exercisable options
to acquire 286 shares of our common stock at $1.75 per share, which expire
on October 1, 2015.
88
(4) Includes currently exercisable options to acquire 200,000 shares of our
common stock at $1.56 per share, which expire on October 1, 2009 and
currently exercisable options to acquire 286 shares of our common stock at
$1.75 per share, which expire on October 1, 2015.
(5) Includes currently exercisable options to acquire 200,000 shares of our
common stock at $3.29 per share, which expire on December 17, 2008.
(6) Includes options to acquire 3,038,197 shares of our common stock, which
are currently exercisable at prices ranging from $2.05 to $5.25 per share.
Options expire as to 13,072 shares on October 1, 2006, as to 432,797 on
July 1, 2007, as to 517,203 shares on December 4, 2007, as to 1,357,000
shares on June 15, 2009, as to 343,125 on December 15, 2010, as to 375,000
on April 19, 2011. Also includes a warrant to purchase 250 shares at an
exercise price of $5.744 per share, which expires on January 17, 2007.
With the exception of the options, 10,500 shares held in a nominee name,
286 shares held in joint tenancy and 714 shares held individually, all of
Mr. Morini's shares and warrant are held by Morini Investments Limited
Partnership, a Delaware limited partnership, of which Mr. Morini is the
sole limited partner and Morini Investments LLC, a Delaware limited
liability company, is the sole general partner. Mr. Morini is the sole
member of Morini Investments LLC.
(7) Includes currently exercisable options to acquire 20,000 and 10,000 shares
of our common stock at $2.05 per share, which expire on November 12, 2011
and July 8, 2012, respectively. These options had an original exercise
price of $5.60 and $4.55 per share, respectively, but were repriced to
$2.05 on October 11, 2002. Also, includes currently exercisable options to
acquire 70,000 shares of our common stock at $2.05 per share, which expire
on October 1, 2014.
(8) Includes currently exercisable options to acquire 96,286 shares of our
common stock at $2.05 per share. These options had an original exercise
prices ranging from $2.84 to $8.47 per share, but were repriced to $2.05
on October 11, 2002. Options expire as to 14,286 shares on September 24,
2008 and as to 75,000 shares on April 19, 2011. Also, includes currently
exercisable options to acquire 7,000 shares of our common stock at $1.28
per share, which expire on October 1, 2014.
(9) Includes currently exercisable options to acquire 90,286 shares of our
common stock at $2.05 per share. These options had an original exercise
prices ranging from $2.84 to $8.47 per share, but were repriced to $2.05
on October 11, 2002. Options expire as to 14,286 shares on September 24,
2008 and as to 75,000 shares on April 19, 2011. Also, includes currently
exercisable options to acquire 1,000 shares of our common stock at $1.28
per share, which expire on October 1, 2014.
89
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Transactions with Management and Others
Transactions with Officers and Directors
Please see "ITEM 11. EXECUTIVE COMPENSATION."
Transactions with Others
Frederick A. DeLuca, greater than 10% Common Stockholder
On October 6, 2004, we completed a private placement of our common stock,
whereby we issued a total of 2,000,000 shares to Mr. Fredrick DeLuca (an
existing stockholder of our Company) for aggregate gross proceeds to our Company
of $2,300,000. These proceeds were used to redeem our Series A convertible
preferred stock. The purchase price of the shares was $1.15 per share (95% of
the prior 5-day trading closing stock price average). Mr. DeLuca also received a
warrant to purchase up to 500,000 shares of our common stock at an exercise
price of $1.15 per share for a period of five years. In June 2005, we agreed to
reduce the per-share exercise price on this warrant to $0.92. We also reduced
the per share exercise price on a warrant issued dated April 10, 2003 to
purchase up to 100,00 shares of our common stock from $1.70 to $1.36. Such
reductions were made in order to induce Mr. DeLuca to exercise his warrants. All
of these warrants were exercised on June 16, 2005 for total proceeds of
$596,000.
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 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).
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. The loan is
evidenced by an unsecured promissory note (the "Note") held by Mr. DeLuca. The
Note required monthly interest-only payments at 3% above the bank prime rate of
interest per the Federal Reserve Bank and matured on June 15, 2006. In
consideration for the Note 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 a warrant to purchase up to 300,000 shares 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
warrant 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 Note, we
granted Mr. DeLuca "piggy back" registration rights with respect to the shares
underlying the warrant. These shares were registered on December 30, 2005.
BC Advisors LLC, greater than 5% Common Stockholder
In October 2005, pursuant to several Note and Warrant Purchase Agreements dated
September 28, 2005, we received 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 $600,000. The loans are evidenced by unsecured promissory notes (the
"Notes") held by the above referenced parties (the "Note Holders"). The Notes
required monthly interest-only payments at 3% above the bank prime rate of
interest per the Federal Reserve Bank and matured 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 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 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.
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We received a letter on June 20, 2006, from all of the Note Holders notifying
the Company that its failure to pay the amounts due and owing on the maturity
date constitutes a default under $1.2 million of the Notes held by those Note
Holders. Pursuant to the terms of the Notes, since we did not cure the default
within 10 days after receipt of the notice of default, we are obligated to pay
interest at the default rate of 8% above the Prime Rate.
Fromageries Bel S.A., greater than 5% Common Stockholder
Effective May 22, 2003, we entered into a Master Distribution and Licensing
Agreement with Fromageries Bel S.A., a leading branded cheese company in Europe.
Under the agreement, we granted Bel exclusive distribution rights for our
products in a territory comprised of the European Union States and to more than
21 other European countries and territories (the "Territory"). We also granted
Bel the exclusive option during the term of the agreement to elect to
manufacture the products designated by Bel for distribution in the Territory.
The term of the agreement was ten years. The parties could mutually agree to
continue operating under the agreement, to convert the agreement to a
manufacturing and license agreement, or to terminate the agreement. This
agreement was terminated effective July 1, 2005, pursuant to a Termination,
Settlement and Release Agreement signed on July 22, 2005. In accordance with the
termination agreement, we received $150,000 from Fromageries Bel S.A.
Indebtedness of Management
In June 1999, in connection with an amended and restated employment agreement
for Angelo S. Morini, our Founder, stockholder and a 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 his purchase of
2,914,286 shares of our common stock into a single stockholder note receivable
in the amount of $12,772,200 that was due on June 15, 2006. This stockholder
note receivable is non-interest bearing and non-recourse and is secured by the
2,914,286 shares of our common stock (the "Shares"). For the fiscal year ended
March 31, 2006, we reserved $10,120,200 against this stockholder note receivable
under the assumption that we would not be able to collect proceeds in excess of
the $2,652,000 value of the Shares as of such date. The value of the Shares was
computed using the closing price of our common stock on March 31, 2006 of $0.91
multiplied by the 2,914,286 shares.
On June 16, 2006, Mr. Morini failed to repay the non-recourse note obligation to
our Company and we subsequently reacquired the 2,914,286 shares. Based upon the
$0.42 closing price of our common stock as quoted on the OTC Bulletin Board on
June 16, 2006, the Shares have an approximate value of $1,224,000. Accordingly,
we will recognize an additional expense of $1,428,000 in the first quarter of
fiscal 2007 in order to record the additional decline in the value of the Shares
from its $2,652,000 value as of March 31, 2006.
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ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Audit Fees
With respect to the fiscal years ended March 31, 2006 and 2005, the aggregate
fees (including expenses) charged to our Company by BDO Seidman, LLP for
auditing the annual financial statements and reviewing interim financial
statements were $271,904 and $181,316, respectively. Audit fees consist of those
fees incurred in connection with statutory and regulatory filings or
engagements; fees necessary to perform an audit or review in accordance with
Generally Accepted Auditing Standards; and services that generally only an
independent accountant reasonably can provide, such as comfort letters,
statutory audits, attest services, consents and assistance with and review of
documents filed with the Securities and Exchange Commission ("SEC"). These fees
also include charges for the review and responses to SEC comment letters,
accounting research and audit committee meeting attendance.
Approximately 55% and 75% of the total hours spent by the auditors in carrying
out the audit of our financial statements for the fiscal years ended March 31,
2006 and 2005, respectively were spent by Cross, Fernandez and Riley LLP
("CFR"), an independent member of the BDO Seidman Alliance network of firms. CFR
and its employees are not full-time, permanent employees of BDO Seidman, LLP.
Audit-Related Fees
BDO Seidman, LLP did not render any audit-related services during the fiscal
years ended March 31, 2006 and 2005.
Tax Fees
BDO Seidman, LLP did not render any tax services during the fiscal years ended
March 31, 2006 and 2005.
All Other Fees
There were no fees for other services charged to our Company by BDO Seidman, LLP
during the fiscal years ended March 31, 2006 and 2005.
The Audit Committee has considered and determined that BDO Seidman, LLP's
provision of non-audit services to our Company during the fiscal years ended
March 31, 2006 and 2005 is compatible with maintaining their independence.
Audit Committee Pre-Approval Policies and Procedures
The Audit Committee's pre-approval policy is as follows:
o The Audit Committee will review and pre-approve on an annual basis
any known audit, audit-related, tax and all other services, along
with acceptable cost levels, to be performed by any audit firm. The
Audit Committee may revise the pre-approved services during the
period based on subsequent determinations. Pre-approved services
typically include: statutory audits, quarterly reviews, regulatory
filing requirements, consultation on new accounting and disclosure
standards, employee benefit plan audits, reviews and reporting on
our internal controls and specified tax matters.
o Any proposed service that is not pre-approved on the annual basis
requires a specific pre-approval by the Audit Committee, including
cost level approval.
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o The Audit Committee may delegate pre-approval authority to the Audit
Committee chairman. The chairman must report to the Audit Committee,
at the next Audit Committee meeting, any pre-approval decisions
made.
The Audit Committee is responsible for approving all engagements to perform
audit or non-audit services prior to Company engaging BDO Seidman, LLP or Cross,
Fernandez and Riley, LLP. All of the services under the headings Audit Fees,
Audit-Related Fees, Tax Fees, and All Other Fees were approved by the Audit
Committee pursuant to Rule 2-01 paragraph (c)(7)(i)(C) of Regulation S-X of the
Exchange Act.
Since January 2006, due to the vacancies created through resignations on the
Board of Directors, the Board of Directors has been operating without a formal
audit committee. Any issues that arise are addressed by the remaining
independent directors or the entire Board of Directors, as necessary.
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PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
Financial Statements
The following financial statement documents are filed as part of this Form 10-K:
Balance Sheets at March 31, 2006 and 2005
Statements of Operations for the fiscal years ended March 31, 2006, 2005
and 2004
Statement of Stockholders' Equity for the fiscal years ended March 31,
2006, 2005 and 2004
Statements of Cash Flows for the fiscal years ended March 31, 2006,
2005 and 2004
Notes to Financial Statements
Exhibits
The following Exhibits are filed as part of this Form 10-K:
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.)
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* 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.)
* 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 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.)
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* 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.)
* 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.)
96
* 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 10.19 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.)
* 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.)
* 10.29 Sixth Amendment to Loan and Security Agreement dated May 26,
2006 between Galaxy Nutritional Foods, Inc. and Textron
Financial Corporation (Filed as Exhibit 10.29 on Form 8-K
filed June 1, 2006.)
* 10.30 Receivables Purchase Agreement, together with Addendum, dated
June 23, 2006 between Galaxy Nutritional Foods, Inc. and
Systran Financial Services Corporation (Filed as Exhibit 10.30
on Form 8-K filed June 29, 2006.)
* 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.)
23.1 BDO Seidman, LLP Consent Letter (Filed herewith.)
31.1 Section 302 Certification of our Chief Executive Officer
(Filed herewith.)
31.2 Section 302 Certification of our Chief Financial Officer
(Filed herewith.)
97
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.
98
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
GALAXY NUTRITIONAL FOODS, INC.
(Registrant)
Date: July 14, 2006 /s/ Michael E. Broll
------------------------------------
Michael E. Broll
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
Date: July 14, 2006 /s/ Michael E. Broll
------------------------------------
Michael E. Broll
Chief Executive Officer & Director
(Principal Executive Officer)
Date: July 14, 2006 /s/ Salvatore J. Furnari
------------------------------------
Salvatore J. Furnari
Chief Financial Officer &
Vice President of Finance
(Principal Financial &
Accounting Officer)
Date: July 14, 2006 /s/ David H. Lipka
------------------------------------
David H. Lipka
Director and Chairman of the Board
Date: July 14, 2006 /s/ Joanne R. Bethlahmy
------------------------------------
Joanne R. Bethlahmy
Director
Date: July 14, 2006
------------------------------------
Angelo S. Morini
Director
99