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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-K
[ ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
OR
[X] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from January 1, 1999 to September 30, 1999
COMMISSION FILE NUMBER: 0-20330
GARDENBURGER, INC.
(Exact name of registrant as specified in its charter)
OREGON 93-0886359
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
1411 SW MORRISON STREET, SUITE 400, PORTLAND, OREGON 97205
(Address of principal executive offices)
Registrant's telephone number, including area code: (503)-205-1500
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, NO PAR VALUE
(Title of Class)
---------------
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. [X]
The aggregate market value of the voting stock held by non-affiliates of the
Registrant is $42,481,247 as of November 30, 1999 based upon the last closing
price as reported by the Nasdaq National Market System ($7.875).
The number of shares outstanding of the Registrant's Common Stock as of November
30, 1999 was 8,850,451 shares.
---------------
DOCUMENTS INCORPORATED BY REFERENCE
The Registrant has incorporated into Part III of Form 10-K by reference portions
of its Proxy Statement for its 2000 Annual Meeting of Shareholders.
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GARDENBURGER, INC.
1999 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
Page
----
PART I
Item 1. Business 2
Item 2. Properties 13
Item 3. Legal Proceedings 13
Item 4. Submission of Matters to a Vote of Security Holders 13
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters
14
Item 6. Selected Financial Data 15
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations
15
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 24
Item 8. Financial Statements and Supplementary Data 24
Item 9. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure
25
PART III
Item 10. Directors and Executive Officers of the Registrant 25
Item 11. Executive Compensation 25
Item 12. Security Ownership of Certain Beneficial Owners and
Management 25
Item 13. Certain Relationships and Related Transactions 25
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on
Form 8-K 26
Signatures 27
1
PART I
ITEM 1. BUSINESS
- ------- --------
GENERAL
Gardenburger, Inc. (the "Company" or "Gardenburger") was organized in 1985 as an
Oregon corporation under the name Wholesome & Hearty Foods, Inc. and completed
its initial public offering in 1992. The Company changed its name to
Gardenburger, Inc., in October 1997. The Company's Common Stock trades on the
National Market Tier of the Nasdaq Stock Market under the symbol "GBUR."
COMPANY OVERVIEW
Gardenburger is the leading producer and marketer of branded veggie burgers. The
Company's Gardenburger(R) product line, featuring the grain-based original
Gardenburger veggie burger, is the number one national brand in market share in
the retail grocery, food service, club store and natural foods channels of
distribution. The Company's net sales grew to $100.1 million for the year ended
December 31, 1998, a 76% increase over the same period of 1997. During 1999 the
Company elected to change its fiscal year to a September 30 fiscal year-end.
Results for 1999 will thus be reflected in a nine-month "stub" year. Sales for
the nine-month stub year were $60.1 million. The Company operates in one
segment. See Note 1 to the Company's financial statements included in this
report in accordance with Item 8.
As a result of innovative product development and its consumer and trade
marketing, the Company has emerged as the leader in the rapidly growing veggie
burger segment of the meat alternative category, which is one of the fastest
growing categories in the food industry. By making the Gardenburger brand the
premier name in this market segment and establishing broad distribution of its
products, the Company believes it is well-positioned to benefit as the veggie
burger increasingly becomes a mainstream consumer product.
The Company's objective is to be the leading provider of veggie burgers in the
four primary distribution channels in which the Company distributes its
products--retail grocery stores; food service, including restaurants,
universities and other commercial outlets; club stores; and natural foods
outlets. The Company currently distributes its products through more than 27,000
retail outlets, 35,000 food service outlets, 600 club store locations and 4,000
natural foods stores.
In 1997, the Company began a strategic initiative to penetrate the retail
grocery channel, which is the largest channel of distribution. At that time, the
Company had approximately 20,000 retail grocery placements of its products,
representing an all commodity volume ("ACV")1 penetration of 30%, and an average
of 1.8 product variations available in each retail outlet. Each product line is
commonly referred to as a stock keeping unit ("SKU"). As of September 30, 1999,
there were over 169,000 retail grocery placements of the Company's products in
more than 27,000 grocery stores, representing an ACV penetration level of 89%,
with an average of 5.4 SKUs per store. This rapid expansion in the availability
of the Company's products occurred following an aggressive national television
advertising campaign in 1998 and 1999.
- -------------------------
1 All commodity volume compares the total sales volume of the stores carrying
the Company's products to the total sales volume throughout the retail grocery
channel.
2
BUSINESS STRATEGY
Gardenburger's objective has been to capitalize on what it believes to be a
significant growth opportunity for veggie burgers by increasing household
penetration, consumer usage and product distribution throughout all channels of
distribution. Accordingly, Gardenburger's business strategy over the past two
years has consisted of the following key elements:
MAINSTREAMING OF VEGGIE BURGERS. The Company believes that its national
advertising efforts have acted as a significant catalyst for the conversion of
the veggie burger from a niche to a mainstream product. During 1998 the Company
captured over 80% of the unit volume increase in total veggie burger sales in
the retail grocery channel for that year, which in total were up 55 percent for
the year. During 1999, category growth slowed compared to the previous year
despite Gardenburger's continued aggressive national advertising campaign, with
unit volume up only 4 percent through September 30, 1999, according to A.C.
Nielsen Scantrak data. For this same period, the Gardenburger brand was up 21
percent on a dollar basis and 10 percent on a unit basis.
The Company believes that its success during 1998 was partially attributable to
exposure it received from airing one of its television commercials during the
last episode of the comedy series "Seinfeld", which was viewed by 106 million
people and led to over 400 media stories. In addition, during 1998 several
unusual external events transpired that likely aided the Company's sales
efforts, including several beef-related e. Coli outbreaks in the U.S. and Mad
Cow disease in the United Kingdom.
Based on 1999 results, Gardenburger has determined to reduce its advertising and
other discretionary marketing spending in fiscal 2000 as it evaluates the
availability of other growth opportunities in the category.
CAPTURE THE VEGGIE BURGER SEGMENT. Gardenburger's goal has been to make the
Gardenburger brand the premier name in the meat alternative category. By doing
so, the Company believes it can maximize its share of this category on a
long-term basis and sustain the premium pricing levels associated with
category-leading branded products. The Company's objective has been for
consumers to associate the Gardenburger brand name with the veggie burger in the
way consumers associate Campbell's with soups, Heinz with ketchup and Gatorade
with sports drinks. As a result of its efforts over the last two years,
Gardenburger has achieved a 45 percent market share in the grocery channel at
September 30, 1999 and market-leading positions in its other channels of
distribution.
PENETRATE MULTIPLE DISTRIBUTION CHANNELS. The Company is already the leader in
the retail grocery, food service, club store and natural foods distribution
channels. The Company's goal is to maintain its market leadership position in
these channels. In addition, Gardenburger believes other distribution channels,
such as convenience stores, present growth opportunities.
3
INTRODUCE NEW PRODUCTS TO REINFORCE BRAND AWARENESS. Gardenburger intends to
continue to improve its existing products as well as develop new product
varieties. The Company has introduced a number of new flavor varieties during
the last two years, including four gourmet, veggie-grain based products and
several soy-based hamburger analogs. Gardenburger believes that innovative
product improvements and new product introductions will support its efforts to
increase shelf space in retail grocery stores and reinforce the Gardenburger
brand.
FUTURE FOCUS ON ACHIEVING PROFITABILITY. During fiscal 2000, Gardenburger's
management plans to shift from a strategy of rapid growth to one focused on
achieving near-term profitability. To achieve this goal, Gardenburger intends to
spend substantially less on product advertising. This business model is expected
to result in slower growth and could even lead to a reduction in sales revenue.
There can be no assurance that Gardenburger will be able to successfully execute
its shift in strategy to one of maintaining sales levels while significantly
reducing discretionary spending on advertising.
PRODUCTS
Gardenburger is committed to offering healthy, great tasting and convenient
meatless food choices to consumers. The Company's principal products are veggie
burgers, either veggie-grain based or soy based, which are currently offered in
eight flavors. Gardenburger also offers specialized products in certain
channels, including Gardenburger Sub(R), GardenSausage(R) and GardenVegan(R).
Gardenburger's recipes for its products are proprietary although they contain
commonly known ingredients. Veggie-grain based burgers contain fresh mushrooms,
brown rice, onions, rolled oats, low-fat cheeses, bulgur wheat, egg whites,
natural seasonings and spices and contain no artificial additives. Soy based
burgers are seasoned to taste like ground beef. All of the Company's veggie
burgers are considerably lower in fat and calories than hamburgers of comparable
weight.
4
The Company's products are as follows:
2.5 OZ. VEGGIE-GRAIN BASED PRODUCTS
CHARACTERIZING
PRODUCT DESCRIPTION INGREDIENTS LOW/NO FAT CALORIES
- ------------------------------------ -------------------- ------------------------ ------------------- --------------
Gardenburger(R) Original Veggie-grain based Mushrooms, brown rice, Low fat 130
burger onions, rolled oats and
low-fat cheese
Gardenburger Spicy, Mexican Red and black beans, Low fat 120
Santa Fe(R) flavor burger Anaheim chilies, red and
yellow bell peppers,
cilantro
Gardenburger Veggie Medley(R) Vegetable emphasis Soy cheese, broccoli, No fat 100
burger carrots, red and yellow
bell peppers
Gardenburger Savory Mushroom(TM) Gourmet burger Portabella mushrooms, Low fat 120
wild rice
Gardenburger Fire Roasted Gourmet burger Roasted garlic, Low fat 120
Vegetable(TM) sun-dried tomatoes
Gardenburger Classic Greek(TM) Gourmet burger Kalamata olives, feta Low fat 120
cheese
Gardenburger Tayburn Smoked Gourmet burger Hardwood smoked cheddar Low fat 120
Cheddar(TM) cheese
2.5 OZ. SOY BASED PRODUCTS
CHARACTERIZING
PRODUCT DESCRIPTION INGREDIENTS LOW/NO FAT CALORIES
- ------------------------------------ -------------------- ------------------------ ------------------- --------------
Gardenburger Hamburger Style(R) Hamburger analog Soy, wheat gluten No fat 90
burger
Gardenburger Hamburger Style(R) Hamburger analog Soy, wheat gluten, Low fat 110
Sauteed Onion burger sauteed onions
- --------------------------
All of the Company's products are frozen. The Company believes that its colorful
product packaging, which features recipes and prominent Gardenburger script logo
on all sides of the package, contributes to brand recognition and easy consumer
identification of Gardenburger products, and is superior to that of its
competitors.
Gardenburger veggie burgers sold in retail grocery stores weigh 2.5 ounces and
come in boxes containing four patties. Gardenburger veggie burgers sold in the
food service channel are available in both 3.4-ounce and 5-ounce sizes.
Gardenburger veggie burgers are distributed to club stores in packages of 12 or
15 burgers of 3.4 ounces each.
5
DISTRIBUTION
The Company primarily distributes its products into four channels: retail
grocery, food service, club stores and natural foods stores.
RETAIL GROCERY. Beginning in 1997, the Company began aggressively expanding
distribution of its veggie burgers in the retail grocery channel, and
Gardenburger veggie burgers can now be found in more than 27,000 grocery stores.
The Company's ACV penetration in the U.S. retail grocery channel has risen from
less than 30% at the beginning of 1996, with an average of 1.8 SKUs, to an ACV
penetration of 89% as of September 30, 1999, with an average of 5.4 SKUs. The
Company has increased its retail grocery placements from approximately 20,000 at
the beginning of 1997 to over 169,000 as of September 30, 1999. The Company's
products are currently carried in most major U.S. retail grocery chains.
FOOD SERVICE. The Company distributes its products to more than 35,000 food
service outlets throughout the U.S. and Canada, including restaurant chains such
as Applebee's, Denny's, Fuddruckers, Marie Callenders, Red Robin, Subway and
T.G.I. Friday's. In many of these restaurants, the Gardenburger brand name
appears directly on the menu. Additional points of food service distribution
include academic institutions, hotels and other outlets, including amusement
parks and sports stadiums. In the United States, there are approximately 800,000
outlets in the food service channel. The Company relies primarily on
distributors such as Sysco for distribution to this channel.
CLUB STORES. The Company's products are distributed to club stores with over 600
locations, including Costco and Sam's Club. Currently, these stores carry the
Gardenburger Original veggie burger in the 3.4 ounce food service size.
NATURAL FOODS. The Company's products are distributed to more than 4,000 natural
food stores, including Whole Foods and Wild Oats. The Company utilizes food
brokers that specialize in natural foods stores.
The Company's ability to expand distribution in each of the described channels
will depend in part on consumer preferences, and to a certain extent on
continuation of the current trends of health awareness, emphasis on a reduced
fat diet and reduced consumption of red meat, as well as safety concerns
associated with red and white meat. There is always a risk that further
development of low fat red or white meat products or technological advances that
limit food-borne disease risks may lead to a change in consumer preferences and
reduce demand for meat replacement products. Demand for the Company's products
may be adversely affected by such changes, which may occur rapidly and without
warning. Because of the Company's dependence on a single product line, any
change in consumer preferences or increase in competition in the veggie burger
market segment would adversely affect the Company's business to a greater degree
than if it had multiple product lines.
The Company sells its products in North America primarily through approximately
60 independent, commissioned food brokers and 500 active distributors. The
retail food brokers have close working relationships with the leading grocery
chains, club stores and natural food stores and arrange for sales of
Gardenburger products, which the Company then ships directly to the retailers'
warehouses. Products sold into the food service channel are purchased from the
Company by distributors who arrange for shipment by temperature-controlled truck
to their frozen storage warehouses in principal cities throughout the United
States and Canada for distribution to food service outlets. The Company has no
long-term contracts with its food brokers and distributors and occasionally
6
changes brokers or distributors in an effort to increase coverage in a
geographic region. The Company could experience a substantial temporary or
permanent decline in net sales if one or more of the Company's major food
brokers or distributors were to discontinue handling the Company's products, go
out of business or decide to emphasize distributing products of the Company's
competitors.
The following table lists selected retailers, distributors and food service
outlets that offer the Company's products for sale to consumers:
RETAIL FOOD SERVICE (CONTINUED)
- ------ ------------------------
GROCERY RESTAURANTS
A&P Applebee's
Albertsons Arctic Circle
Burris Foods Wholesale A&W
C&S Wholesale Burgerville
Dominick's BW3
Fleming Wholesale Carrows
Food Lion Coco's
Fred Meyer Dairy Queen
Giant Eagle Damon's
Giant Food Denny's
HEB Flamers
Hannaford Foster Freeze
Jewel Fuddruckers
Kroger IHOPruckers
Meijers Lyons
Nash Finch Wholesale Marie Callendars
Publix Super Markets Red Robin
Raley's Sizzler
Ralph's Subway
Safeway T.G.I. Friday's
Shaw's
Supervalu Wholesale
Thriftway HOTELS
Von's Holiday Inn
Wakefern Marriott
Wal-Mart Sheraton
White Rose Wholesale
Winn-Dixie UNIVERSITIES
Stanford
NATURAL FOODS UCLA
Wild Oats University of California, Berkeley
Whole Foods Harvard
MIT
CLUB STORES DePaul
Costco Princeton
Sam's Club USC
University of Chicago
FOOD SERVICE Purdue
DISTRIBUTORS Indiana University
Sysco Johns Hopkins University
U.S. Food Service (formerly Rykoff-Sexton)
SPORTS/ENTERTAINMENT
CONTRACT MANAGEMENT COMPANIES Dodger Stadium
ARAMARK Yankee Stadium
Bon Apetit Rose Garden
Compass Six Flags
Gukenheimer Universal Studios
Sodexho/Marriott
7
Prior to 1997, the Company focused primarily on distribution of its products in
the Western United States. However, in connection with the Company's penetration
into the retail grocery channel, product sales have become increasingly
broad-based:
% OF NET SALES
--------------
REGION FY 1999 FY 1998 FY 1997
- ------ ------- ------- -------
Northeast 27% 32% 26%
Southwest 9% 9% 9%
Midwest 14% 14% 11%
Northwest 34% 28% 38%
Southeast 13% 14% 11%
Canada 3% 3% 5%
---- ---- ----
100% 100% 100%
To date, the Company has focused its sales efforts primarily in North America,
and international sales have not been material. The Company believes, however,
that opportunities exist for international distribution of Gardenburger
products.
SALES AND MARKETING
SALES. Gardenburger's sales objective is to maintain its veggie burgers as the
number one brand in the retail grocery, food service, club store and natural
foods store channels. The Company's use of regional food brokers as its
representatives allows it to maintain contact with the nation's major retail
grocery chains and food service outlets without a large internal sales force.
Brokers are paid sales commissions on all volume sold. Commission rates as a
percentage of net sales have declined as the Company has grown.
Gardenburger's Vice President of Retail Sales and Senior Vice President of Food
Service Sales and Marketing, located in Portland, Oregon and Chicago, Illinois,
respectively, coordinate the Company's sales efforts. Gardenburger's regional
sales force, located strategically in the Company's primary geographic sales
regions and in proximity to its brokers, is divided into a food service division
and a retail grocery division. The regional sales managers, who joined the
Company from major food products companies such as Campbell's, Nestle, Quaker
Oats and Sara Lee, have substantial sales and industry experience. These
regional sales managers coordinate the efforts of the food brokers and
distributors.
MARKETING. Gardenburger's primary marketing objective has been to build
awareness of the veggie burger in general and the Gardenburger brand in
particular in order to increase the market for veggie burgers and to make the
Gardenburger brand the premier name in the veggie burger segment. Gardenburger
spent approximately $14.6 million on media advertising in 1998 and approximately
$11.8 million in 1999. Advertising and marketing strategies are directed by the
Company's Vice President of Marketing and developed in collaboration with an
outside advertising agency. The Company has advertised through a wide variety of
media, including television, print, restaurant menus and point-of-sale displays.
Gardenburger's marketing efforts have been timed to take advantage of seasonal
increases in demand attributable to the summer grilling season and the tendency
of Americans to renew their commitment to a healthy life style each January.
Gardenburger's plan to reduce advertising and other discretionary marketing
expenses in fiscal 2000 could adversely affect the Company's ability to continue
increasing sales and brand awareness.
8
In 1998 and 1999, Gardenburger undertook a significant national television ad
campaign, featuring three animated commercials, some of which aired during
prime-time on NBC, CBS, Fox and selected cable networks. The pinnacle of this
campaign was a 30-second spot that aired during the final episode of "Seinfeld"
in May 1998. This spot received national attention prior to airing, including
articles in THE WALL STREET JOURNAL and news stories on NBC Nightly News with
Tom Brokaw and CNN Financial News.
Print advertisements for the Gardenburger brand have appeared in a number of
magazines with national circulation. In 1998, the Company used five different
"cartoon" print ads. There was no print advertising during 1999.
During 1999, Gardenburger's marketing included four free-standing newspaper
inserts with coupons, which appeared throughout the United States. Gardenburger
also invested heavily in grocery trade programs including product
demonstrations, introductory allowances and temporary price reductions to
support its rapid distribution gains and to encourage trial of the Company's
products. The Company expects investment in trade programs to continue,
especially in the short-term, as advertising and coupon programs will likely be
scaled back due to the Company's move to a profit-driven business model.
RESEARCH AND DEVELOPMENT
Gardenburger's research and development activities are focused on the
development of new varieties of the Gardenburger(R) veggie burger and the
improvement of existing flavors, as well as improvement and increased efficiency
in the manufacturing process. In addition to its permanent R&D staff, the
Company involves other employees as well as outside consultants on an as-needed
basis for specific projects. Gardenburger's R&D staff developed the Gardenburger
Hamburger Style(R) and the gourmet flavors of veggie burgers introduced during
the last two years. The Company is also working on expanding its line of
soy-based hamburger analogs as soy continues to garner positive national
attention. Recently, the Company introduced into the natural foods channel the
Gardenburger LifeBurgerTM, which is a burger high in soy protein. In promoting
the LifeBurger (and its other soy-based products), Gardenburger is relying on
the October 1999 announcement by the U.S. Food and Drug Administration ("FDA")
that certain amounts of soy consumed as part of a healthy diet may reduce the
risk of heart disease. The Company conducts its research and development
activities at its facilities in both Portland, Oregon and Clearfield, Utah.
In 1999, 1998 and 1997, the Company spent approximately $553,000, $1,121,000 and
$565,000, respectively, on research and development activities.
MANUFACTURING
The Company historically produced its line of veggie burgers using a batch
process in its Portland, Oregon plant. The Portland facility was shut down in
March 1999, and all manufacturing was moved to the Clearfield, Utah plant. The
Company operates the Clearfield plant under a five-year lease, with an option to
renew for two successive five-year terms.
9
The 120,000 square-foot Clearfield facility handles multiple manufacturing lines
for the Company's products. The first line commenced operations in early 1998. A
second line began producing in June 1999. The Company believes the Clearfield
facility will be able to support up to approximately $240 million of annual net
sales at current price levels. Clearfield, Utah is a more central location than
Portland, Oregon, with better distribution routes.
The production process involves cleaning, chopping and mixing the ingredients,
then forming, baking and quick-freezing the veggie burgers and finally packaging
them. Gardenburger's manufacturing process at its Clearfield facility is highly
automated, mixing and baking products in assembly-line fashion with minimal
human interaction. The Clearfield facility also utilizes newly-developed,
proprietary ovens that quickly cook the products. Products are shipped fully
cooked, frozen and packaged via temperature controlled truck to distributors
throughout North America and by temperature controlled container to Europe.
A significant disruption in the Clearfield facility's production capacity as a
result of, for instance, fire, severe weather, regulatory actions, work
stoppages or other factors could disable the Company's capacity to manufacture
its products. If Gardenburger veggie burgers became less available, consumers
may switch to another brand of veggie burger and grocery stores may reduce shelf
space allocated to Gardenburger's products. Any significant disruption in
manufacturing would likely have a material adverse effect on the Company's
results of operations and financial condition.
COMPETITION
The market for veggie burgers and other meat alternative products is highly
competitive. The Company's products compete primarily on the basis of taste,
quality of natural ingredients, ease of preparation, availability, price,
consumer awareness and brand preference.
Gardenburger believes that its products compare favorably to those offered by
its competitors. The Company prices its products competitively or at a slight
premium to its primary competitors. The calorie and fat content of
Gardenburger(R) products is generally equivalent to that of competitors'
products.
The Company believes that its principal competitors are Worthington Foods, Inc.,
which distributes its products under the "Morningstar Farms" label to the food
service and retail grocery channels, and Boca Burger, Inc., which distributes
soy-based meat analog burgers primarily in the retail grocery and natural food
channels. In January 1999, Worthington Foods acquired the "Harvest Burger" brand
from Archer Daniels Midland and began marketing and selling the brand in early
1999. Previously, Harvest Burger was marketed and sold by Pillsbury under the
"Green Giant" brand name pursuant to a joint venture with Archer Daniels
Midland. On October 1, 1999, Worthington Foods, Inc. announced that it had
entered into an agreement to be acquired by The Kellogg Company. In addition,
other major national food products companies could decide to produce veggie
burgers at any time in the future.
10
The Company's products also compete indirectly with low fat meat products, such
as ConAgra's Healthy Choice 96 percent Extra Lean Ground Beef burger, and
chicken or turkey based low fat products distributed by several large companies
such as Tyson Foods, and with frozen, mass-produced low calorie/low fat entrees,
including national brands such as Healthy Choice, Lean Cuisine and Weight
Watchers. These products are produced by large companies with substantially
greater financial resources, name recognition and marketing experience than the
Company.
SIGNIFICANT CUSTOMERS
For the nine months ended September 30, 1999, one customer, Norpac Food Sales,
accounted for approximately 11 percent of revenue and 5 percent of the accounts
receivable balance at September 30, 1999.
SOURCES OF SUPPLY
Gardenburger uses natural ingredients such as mushrooms, oats, rice, onions, and
egg whites. These are common agricultural items typically available in most
parts of the United States. In addition, Gardenburger uses packaging and other
materials that are common in the food industry. As a result, the Company
believes, but cannot assure, that its sources of supply are reasonably reliable
and that the Company is at no greater risk regarding supply issues than other
similar food processors and producers.
EMPLOYEES
As of November 30, 1999, the Company had approximately 205 full-time equivalent
employees, including 54 employees at its headquarters in Portland and 127 at its
Clearfield facility. None of the Company's employees is subject to a collective
bargaining agreement, and the Company considers its relations with its employees
to be excellent.
INTELLECTUAL PROPERTY
Gardenburger has approximately 19 U.S. registered trademarks, including
"Gardenburger," "Gardenburger Hamburger Style," "Gardenburger Sub" and
"GardenSausage." The Company has registered certain trademarks in Australia,
Canada, France, Germany and the United Kingdom, along with other smaller
countries, and applied for registration of certain trademarks in various other
foreign countries, including but not limited to Japan, Mexico and Thailand.
The Company actively monitors use of its trademarks by food service customers
and others and takes action it believes appropriate to halt infringement or
improper usage. The Company defends its intellectual property aggressively and,
from time to time, has been engaged in infringement protection activities.
Nonetheless, in the event third parties infringe or misappropriate the Company's
trademarks, the Company may have to incur substantial costs to protect its
intellectual property or risk losing its rights. Any large expenditure or loss
of rights could have a material adverse effect on the Company's results of
operations and financial position.
The Company generally does not hold any patents covering its recipes or
production methods and, therefore, can protect them only as trade secrets. Some
or all of these trade secrets could be obtained by others or could enter the
public domain, which could place the Company at a competitive disadvantage.
11
MANAGEMENT INFORMATION SYSTEMS
The Company has utilized a number of computer systems in its business. In March
1999, the Company upgraded its existing systems by replacing its Cimpro, general
ledger, and EDI systems with a single Baan enterprise resource planning system.
This upgrade is expected to meet the Company's information systems needs for the
next several years. In addition to integrating manufacturing, sales and
accounting functions, the new Baan system will increase the availability of
real-time information for management analysis and use in operations. The Baan
system will enhance the Company's production planning (planning of raw material
purchases) and demand forecasting (matching supply to distribution centers with
order volume) capabilities. The Baan system also includes pallet tagging, bar
coding and scanning applications that will facilitate tracking of raw materials
and finished goods through the Company's manufacturing operation. The new system
should enable the Company to expand its use of EDI if desired by customers and
suppliers, which the Company believes will expedite order entry, payment and
cash collection processes.
Gardenburger's Clearfield, Utah manufacturing facility is highly automated,
using a number of computerized process level controllers. The Company is
considering implementing a manufacturing enterprise system to further facilitate
integration of manufacturing information with information available through the
Baan system.
GOVERNMENT REGULATION
The manufacturing, packaging, storage, distribution and labeling of food
products are subject to extensive federal and state laws and regulations. The
FDA has issued regulations governing the ingredients that may be used in food
products, the content of labels on food products and the labeling claims that
may be made for foods. Foods may only include additives, colors and ingredients
that are either approved by the FDA or generally recognized as safe.
Gardenburger(R) veggie burgers must be manufactured in compliance with the FDA's
current Good Manufacturing Practice regulations applicable to food.
Regulators have broad powers to protect public health, including the power to
inspect the Company's products and facilities, to order the shutdown of a
facility or to seize or stop shipment of the Company's products and order a
recall of previously shipped products, as well as the power to impose
substantial fines and seek criminal sanctions against the Company or its
officers. The Company does not currently carry insurance against the cost of a
product recall, and a significant recall would have an adverse effect on the
Company's results of operations and financial condition. In addition, negative
publicity may result if regulators take any of the foregoing actions against the
Company or if the Company were to voluntarily recall products to avoid
regulatory enforcement.
INSURANCE
The Company maintains insurance against various risks related to its business.
This includes property and casualty, business interruption, director and officer
liability, food spoilage, products liability (but not product recalls) and
workers' compensation insurance. The Company currently maintains $2 million of
product liability insurance coverage and $20 million of general umbrella
coverage. The Company considers its policies adequate to cover the major risks
in its business, but there can be no assurance that this coverage will be
sufficient to cover the cost of defense or damages in the event of a significant
product liability claim.
12
ITEM 2. PROPERTIES
- ------- ----------
The Company leases approximately 19,000 square feet of administrative office
space at 1411 SW Morrison, Suite 400 in Portland, Oregon, pursuant to a two-year
extension to its original lease that terminates on December 31, 2000. Current
monthly rent is approximately $24,100.
The Company leases additional space for research and development and production
at 1416 S.E. Eighth Avenue in Portland, Oregon. The facility is leased pursuant
to a one-year lease agreement from Frank S. Card, a shareholder of the Company,
at a rental rate of $2,700 per month, which the Company considers to be
consistent with rental rates charged by unaffiliated property owners in the same
market area. The lease has been renewed on a month-to-month basis with 60 days'
notice required for termination beginning January 1, 2000.
The Company leases 120,000 square feet of production space at Freeport Center,
Building A-16, in Clearfield, Utah, pursuant to a five-year lease that
terminates on December 31, 2002. The Company has the option to renew the lease
for two successive five-year terms. The Company began utilizing such space for
production in the first quarter of 1998. The monthly rent on this facility is
currently $28,000.
The Company also leases 16,000 square feet of storage space at the Freeport
Center in Clearfield. The lease commenced February 15, 1999 and will expire
December 31, 2002. The Company has an option to renew the lease for an
additional three-year term. The monthly rent for the storage space is $3,200.
The Company previously owned approximately 18 acres of land near the Portland
International Airport. The property was originally purchased as a site for
expansion of the Company's manufacturing capabilities, but the Company decided
in 1997 to lease the Clearfield facility rather than build a new manufacturing
plant in Portland. The Company sold this property in November 1999.
The Company also owns and previously utilized a 40,000 square foot production
facility at 1005 S.E. Washington Street, Portland, Oregon, and a 1,200 square
foot annex at the same location.
ITEM 3. LEGAL PROCEEDINGS
- ------- -----------------
There are currently no material, pending legal proceedings to which the Company
or its subsidiaries are a party. From time to time, the Company becomes involved
in ordinary, routine or regulatory legal proceedings incidental to the business
of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------- ---------------------------------------------------
No matters were submitted to a vote of security holders during the quarter ended
September 30, 1999.
13
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
- ------- ---------------------------------------------------------------------
The Company's Common Stock trades on the National Market tier of The Nasdaq
Stock Market under the symbol GBUR. The Common Stock traded under the symbol
WHFI until October 17, 1997, when the symbol was changed to GBUR in connection
with the change in the Company's name from Wholesome & Hearty Foods, Inc. to
Gardenburger, Inc.
The high and low sales prices for the two years in the period ended September
30, 1999 were as follows:
Fiscal 1998 High Low
------------------------------------------- ---------- --------
Quarter 1 $12.00 $ 8.13
Quarter 2 13.88 8.00
Quarter 3 16.13 10.13
Quarter 4 15.13 9.25
Fiscal 1999 High Low
------------------------------------------- ---------- --------
Quarter 1 $13.75 $ 8.63
Quarter 2 12.50 9.50
Quarter 3 10.25 7.50
Quarter 4 9.00 5.00
The number of shareholders of record and approximate number of beneficial owners
of the Company's Common Stock at December 10, 1999 were 833 and 10,500,
respectively.
There were no cash dividends declared or paid in 1999 or 1998 on the Company's
Common Stock. The Company does not anticipate declaring cash dividends on its
Common Stock in the foreseeable future. The Company may not, without the consent
of Dresdner Kleinwort Benson Private Equity Partners, LP ("Dresdner"), declare
or pay any cash dividends or make any distributions with respect to its capital
stock or other equity securities to the extent that at least $5,000,000 in
principal amount remains outstanding under the Company's convertible senior
subordinated notes and Dresdner owns a majority of the then outstanding
principal amount.
In addition, no cash dividends may be paid on the Company's Common Stock unless
dividends have been paid on all outstanding shares of the Company's Series A and
Series B Convertible Preferred Stock in an amount equal to 12% cumulative
dividends accrued on such preferred shares through the record date for the
common stock dividend (or, if greater, the amount of the common stock dividend
payable on the preferred shares on an as-converted basis). The quarterly
dividend accruing on the preferred shares is $975,000.
14
ITEM 6. SELECTED FINANCIAL DATA
- ------- -----------------------
NINE MONTHS
ENDED YEAR ENDED DECEMBER 31,
-----------------------------------------------------
IN THOUSANDS, SEPTEMBER 30,
EXCEPT PER SHARE AMOUNTS 1999 1998 1997 1996 1995
- ------------------------------------------ ----------------- ---------- --------- ---------- ----------
STATEMENT OF OPERATIONS DATA(1)
Net sales $ 60,106 $100,120 $ 56,837 $ 40,527 $ 36,818
Gross margin 25,772 49,550 29,601 20,621 18,720
Sales and marketing expense 48,021 58,513 26,191 13,583 11,151
General and administrative expense 5,064 5,387 5,471 4,963 3,871
Restructuring and other charges 2,684 - - 612 -
Operating income (loss) (29,997) (14,350) (2,061) 1,463 3,698
Preferred dividends 1,980 - - - -
Net income (loss) available for common
shareholders $(22,146) $(10,042) $ (1,393) $ 1,063 $ 2,510
Basic net income (loss) per share $ (2.51) $ (1.16) $ (0.16) $ 0.13 $ 0.33
Diluted net income (loss) per share $ (2.51) $ (1.16) $ (0.16) $ 0.12 $ 0.29
BALANCE SHEET DATA
Working capital $ 11,741 $ 7,354 $ 11,504 $ 13,393 $ 11,978
Total assets 52,702 55,048 26,470 24,934 19,325
Long-term convertible notes payable 15,000 15,000 - - -
Convertible redeemable preferred stock
32,147 - - - -
Shareholders' equity (deficit) (10,319) 10,926 19,839 20,979 16,955
(1)Statement of operations data for 1999 includes only nine months of activity
due to the Company's change in its fiscal year during 1999 from a calendar
year to a fiscal year ended September 30.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- ------- -----------------------------------------------------------------------
OF OPERATIONS
-------------
GENERAL
FORWARD-LOOKING STATEMENTS
This report contains certain "forward-looking statements" within the meaning of
the Private Securities Litigation Reform Act of 1995 that involve known and
unknown risks and uncertainties. The Company's actual results, performance, or
achievements could differ materially from historical results or from any future
results anticipated by the forward-looking statements. In addition to statements
that explicitly describe such risks and uncertainties, readers should consider
statements containing words like "believes," "expects," "intends," "anticipates"
or "plans" to be uncertain and forward-looking. Important risks that could cause
actual results, performance or achievements to differ from those expressed or
implied by the forward-looking statements are described below and elsewhere in
this Form 10-K. Investors are cautioned not to place undue reliance on the
forward-looking statements.
15
GENERAL
The Company's net sales are attributable almost entirely to the Gardenburger(R)
veggie burger (and related veggie patty products). If demand for the
Gardenburger veggie burger declines or does not increase at the rate currently
anticipated, whether as a result of competition, lower consumer demand or other
unforeseen events, the Company's business will be adversely affected to a
greater degree than if it had multiple product lines. Any decrease in the
Company's net sales levels may lead to reductions in the amount of shelf space
allocated to the Company's products at grocery stores, or menu space devoted to
such products at food service outlets.
RESULTS OF OPERATIONS
The following table is derived from the Company's Statements of Operations for
the periods indicated and presents the results of operations as a percentage of
net sales.
Year ended (1) September 30, 1999 December 31, 1998 December 31, 1997
- ------------------------------- ----------------------- --------------------- ---------------------
Net sales 100.0% 100.0% 100.0%
Cost of goods sold 57.1 50.5 47.9
----------------------- --------------------- ---------------------
Gross margin 42.9 49.5 52.1
Sales and marketing expense
79.9 58.4 46.1
General and administrative
expense 8.4 5.4 9.6
Restructuring charges 4.5 -- --
----------------------- --------------------- ---------------------
Operating loss (49.9) (14.3) (3.6)
Other expense (2.3) (1.5) --
----------------------- --------------------- ---------------------
Loss before income taxes (52.2) (15.8) (3.6)
Income tax benefit 18.7 5.8 1.1
----------------------- --------------------- ---------------------
Income before preferred
dividends (33.5) (10.0) (2.5)
Preferred dividends (3.3) -- --
----------------------- --------------------- ---------------------
Net loss (36.8)% (10.0)% (2.5)%
======================= ===================== =====================
(1) Statement of operations data for 1999 includes only nine months of activity
due to the Company's change in its fiscal year during 1999 from a calendar year
to a fiscal year ended September 30.
1999 COMPARED TO 1998
GENERAL During 1999, the Company changed its fiscal year end to September 30
from December 31. Accordingly, the following discussion compares the nine-month
period ended September 30, 1999 (herein referred to as "fiscal 1999") with the
twelve-month period ended December 31, 1998, herein referred to as the change in
the Company's fiscal year.
NET SALES Net sales for fiscal 1999 decreased to $60.1 million from $100.1
million for 1998. The decrease is attributable to both the change in the
Company's fiscal year and a decrease in unit sales. During the 1998 period
external events, such as e. coli outbreaks in the U.S. and mad cow disease in
the U.K., brought attention to the dangers of eating red meat. Management
believes that these events worked synergistically with the Company's advertising
campaign during 1998 to increase unit sales. No similar events occurred during
1999. In addition, the Company experienced lower than anticipated new consumer
trial during 1999 and unfavorable weather conditions adversely affected the 1999
grilling season. In addition, to a lesser extent, the lower sales figures in
fiscal 1999 reflect the impact of the Company's strong December 1998 sales, as
16
customers, especially in the grocery channel, stocked up on product in
anticipation of extensive January 1999 consumer promotions.
The Company's market share in the grocery channel averaged 46 percent during
1999 compared to 42 percent during 1998. During 1999, the Company maintained its
U.S. All Commodity Volume ("ACV") at 89 percent. ACV compares the total sales
volume of the stores carrying the Company's products to the total sales volume
throughout the retail grocery channel.
GROSS MARGIN Gross margin decreased to $25.8 million (42.9 percent of net sales)
for fiscal 1999 from $49.6 million (49.5 percent of net sales) for 1998. The
decrease in the gross margin is a result of the reduction in sales discussed
above as well as a lower gross margin percentage. The decrease in the gross
margin percentage is primarily a result of start-up costs related to bringing up
the second production line at the Clearfield facility and of operating
manufacturing facilities at less than 100 percent of capacity in order to reduce
product inventories due to lowered sales expectations for 1999. The Company
expects its gross margin percentage to return to 48% to 50% during fiscal 2000.
SALES AND MARKETING EXPENSE Sales and marketing expense decreased to $48.0
million (79.9 percent of net sales) for fiscal 1999 from $58.5 million (58.4
percent of net sales) for 1998. The decrease in spending in fiscal 1999 is
primarily a result of the change in fiscal year. Of the $48.0 million spent in
fiscal 1999, approximately $35.8 million was for discretionary spending such as
television advertising, couponing and trade programs. The Company expects to
substantially reduce sales and marketing expenses going forward as it changes to
a more profit driven business model.
GENERAL AND ADMINISTRATIVE EXPENSE General and administrative expense ("g&a")
decreased to $5.1 million (8.4 percent of net sales) for fiscal 1999 from $5.4
million (5.4 percent of net sales) for 1998. The decrease is due primarily to
the change in the Company's fiscal year, offset in part by costs related to
implementing a new year 2000 compliant management information system and the
associated depreciation expense.
RESTRUCTURING CHARGE The Company incurred a restructuring charge of $2.7 million
during fiscal 1999 related to the closure of its Portland, Oregon production
facility, a fair market value adjustment for one of the Company's Portland,
Oregon area properties and the write-off of an older information system. At
September 30, 1999, no amounts remained in accrued liabilities related to these
charges. In November 1999, the Company sold the Portland area property referred
to above for net proceeds of approximately $1.5 million and recognized a gain on
the sale of approximately $174,000 in the first quarter of fiscal 2000.
OPERATING LOSS Operating loss was $30.0 million in fiscal 1999 compared to an
operating loss of $14.4 million for 1998 as a result of the individual line item
changes discussed above, including in particular the decreased gross margin
percentage and increased sales and marketing expense as a percentage of net
sales.
17
INCOME TAXES Income taxes are based on an estimated rate of approximately 36
percent for fiscal 1999 compared to the approximately 37 percent rate used for
1998.
PREFERRED DIVIDENDS The Company accrues a 12 percent cumulative annual
dividend on its convertible preferred stock payable upon redemption of the
stock. The convertible preferred stock was issued in April 1999. The quarterly
dividend is $975,000. In addition, the $2.3 million of related issuance costs
are being accreted over five years, the life of the preferred stock, and total
approximately $117,000 per quarter.
NET LOSS AVAILABLE FOR COMMON SHAREHOLDERS Net loss available for common
shareholders was $22.1 million in fiscal 1999 compared to a net loss of $10.0
million in 1998 as a result of the individual line item changes discussed above.
The Company believes that the impact of inflation was not material for fiscal
years 1999 and 1998.
1998 COMPARED TO 1997
NET SALES Net sales for 1998 increased 76.2 percent to $100.1 million from $56.8
million for 1997. The Company increased its sales levels in its retail grocery,
food service and club store channels during 1998. The increase in overall net
sales is primarily related to increased unit sales in the Company's grocery
channel as a result of the Company's investment in efforts to expand this
channel, including its national advertising campaign. The Company increased
prices on certain products in its grocery channel an average of 7 percent in the
fourth quarter of 1997, which also contributed to the increase in net sales in
1998. Net sales were higher in the 1998 third and fourth quarters than in the
second quarter. The Company's market share in the grocery channel reached an
all-time high of 56 percent during the third quarter of 1998 and averaged 42
percent during all of 1998. During 1998, the Company increased its U.S. ACV to
89 percent from 68 percent at the end of 1997.
GROSS MARGIN Gross margin increased 67.4 percent to $49.6 million (49.5 percent
of net sales) for 1998 from $29.6 million (52.1 percent of net sales) for 1997.
The decrease in the annualized gross margin percentage is primarily a result of
start-up costs associated with the Company's new manufacturing facility in
Clearfield, Utah. The Company achieved a gross margin percentage of 51.9 percent
in the fourth quarter of 1998. The improvement in gross margin during the fourth
quarter of 1998 compared to the average for the year was primarily a result of
declining start-up costs and increased manufacturing efficiencies at the
Clearfield facility.
SALES AND MARKETING EXPENSE Sales and marketing expense increased to $58.5
million (58.4 percent of net sales) for 1998 from $26.2 million (46.1 percent of
net sales) for 1997. The increase in spending in 1998 was primarily a result of
costs associated with the Company's aggressive 1998 advertising plan, including
a national television advertising campaign during the second and third quarters,
and the introduction of new products into the retail grocery channel. The
Company spent approximately $11.0 million on media advertising during the first
half of 1998 and approximately $3.6 million on media advertising during the
second half of 1998.
18
GENERAL AND ADMINISTRATIVE EXPENSE General and administrative expense ("g&a")
decreased to $5.4 million (5.4 percent of net sales) for 1998 from $5.5 million
(9.6 percent of net sales) for 1997. The Company was able to maintain its g&a
expenditures at 1997 levels while increasing sales, thereby decreasing g&a as a
percentage of net sales. The Company received a $240,000 insurance settlement in
the first quarter of 1997 that lowered g&a expense in 1997.
OPERATING LOSS Operating loss was $14.4 million in 1998 compared to an operating
loss of $2.1 million for 1997 as a result of the individual line item changes
discussed above, including in particular the increased advertising expenses
incurred by the Company in 1998.
OTHER INCOME (EXPENSE) Other income (expense) was a net expense of $1.5 million
in 1998 compared to net income of $9,000 in 1997 primarily as a result of
increased interest expense during 1998 related to debt incurred during 1998 to
help fund the Company's increased sales and marketing activities.
INCOME TAXES Income taxes are based on an estimated rate of approximately 37
percent for 1998 compared to the approximately 32 percent rate used for 1997.
The increase in the rate is primarily attributable to a decrease in meals and
entertainment expense and non-deductible goodwill amortization in relation to
the reported net loss of the Company, offset in part by a decrease in tax exempt
dividends and interest.
NET LOSS Net loss was $10.0 million in 1998 compared to a net loss of $1.4
million in 1997 as a result of the individual line item changes discussed above.
The Company believes that the impact of inflation on the net loss was not
material for fiscal years 1998 and 1997.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1999, the Company had working capital of $11.7 million, which
included $7.0 million of cash and cash equivalents, compared to $7.4 million in
working capital at December 31, 1998, including $2.3 million of cash and cash
equivalents. The $4.3 million increase in available working capital is primarily
due to the issuance of $30.2 million of convertible preferred stock, net of
issuance costs, offset by $14.9 million used in operations, $10.0 million net
payments on the Company's line of credit and purchases of $1.0 million of
property and equipment.
Accounts receivable decreased $8.8 million to $6.1 million at September 30, 1999
from $15.0 million at December 31, 1998, due primarily to significantly higher
sales during the fourth quarter of 1998 compared to the quarter ended September
30, 1999. Days sales outstanding decreased to 32 at September 30, 1999 from 43
at December 31, 1998.
Inventories decreased $5.2 million to $7.3 million at September 30, 1999 from
$12.5 million at December 31, 1998 as a result of efforts to reduce finished
goods inventories in order to bring them in line with current sales
expectations. Inventory turned 5.5 times on an annualized basis during the
quarter ended September 30, 1999, compared to 5.3 times on an annualized basis
during the fourth quarter of 1998.
19
Deferred taxes increased to $17.5 million at September 30, 1999 from $6.2
million at December 31, 1998 primarily as a result of tax benefits relating to
net operating loss carryforwards. The Company has tax net operating loss
carryforwards (NOLs) totaling approximately $41.2 million, which expire as
follows: 2018 - $11.8 million and 2019 - $29.4 million. Statement of Financial
Accounting Standards No. 109 "Accounting for Income Taxes" (SFAS 109) requires
that the tax benefit of such NOLs be recorded as an asset to the extent that
management assesses the utilization of such NOLs to be "more likely than not".
Otherwise, a valuation allowance is required to be recorded. Management has
determined, based primarily on a strategic shift in the third quarter of fiscal
1999 to a more profit driven business model, as outlined below, that taxable
income of the Company will more likely than not be sufficient to utilize fully
the $41.2 million of NOLs in the next three to five years. Accordingly, no
valuation allowance has been recorded.
The NOLs available for future utilization were generated principally as a result
of the Company's strategic initiative, begun in 1997, to penetrate the retail
grocery channel, which is the largest channel of distribution. The Company began
a more aggressive advertising and marketing program, including a national
television advertising program in 1998 and 1999, in order to expand distribution
and grow the veggie burger category. The Company invested over $40 million in
discretionary marketing spending during fiscal 1998 and an additional $35.8
million in discretionary marketing spending during fiscal 1999. Prior to this
strategic initiative, the Company had historically been profitable, but had
spent very little on discretionary advertising and marketing. The increased
advertising and marketing spending resulted in more than doubling the sales
levels that existed back in 1996. The Company plans to adjust its rapid growth
strategy during fiscal 2000 to a lower expense, more profit driven business
model. This will be accomplished primarily by a substantial reduction in the
discretionary advertising and marketing spending that has occurred during the
last three years. Management does not believe that such reductions will have a
significant impact on recent historical sales levels. Additionally, the Company
has already begun streamlining its operations at its Clearfield plant, through
reductions in workforce of approximately 25% along with workforce reductions at
its corporate headquarters of 20%. At the same time, the Company anticipates
achieving greater operating efficiencies at its Clearfield plant as a result of
the consolidation of manufacturing locations and the automation of the Company's
manufacturing processes. Operating efficiencies gained by the changes in
operations are expected to result in improved performance, measured primarily by
gross margin dollars.
Realization of the future tax benefits is dependent on the Company's ability to
generate taxable income within the carryforward period. Management anticipates
that increases in taxable income, as a result of the changes in operating
strategy outlined above, will be sufficient to utilize fully the NOLs prior to
their ultimate expiration date.
Future levels of operating income are dependent upon general economic
conditions, including continued growth of the meatless burger category,
competitive pressures on sales and gross margins and other factors beyond the
Company's control, and no assurance can be given that sufficient taxable income
will be generated for full utilization of the NOLs. Management has considered
the above factors in reaching its conclusion that it is likely that taxable
income will be sufficient to utilize fully the NOLs in the near term and prior
to their ultimate expiration date. However, the Company may be required to
record a valuation allowance against the deferred tax asset for net operating
losses in future periods if its revised business goals are not achieved.
20
Accounts payable decreased to $6.7 million at September 30, 1999 from $9.7
million at December 31, 1998 primarily as a result of lower expenditures for
inventories as a result of the Company's efforts to reduce inventory levels.
Payroll and related liabilities decreased to $0.9 million at September 30, 1999
from $1.8 million at December 31, 1998 primarily as a result of bonus accruals
at December 31, 1998 that did not exist at September 30, 1999.
Capital expenditures of $1.0 million during 1999 primarily resulted from
expenditures for the Company's new management information system and for
production equipment in Clearfield not covered under the Company's operating
leases. Capital expenditures are estimated to be approximately $2.4 million in
fiscal 2000 primarily for information systems and production equipment.
The Company has outstanding $15 million of 7 percent Convertible Senior
Subordinated Notes (the "Notes") held by Dresdner Kleinwort Benson Private
Equity Partners L.P. ("Dresdner"). The Notes are convertible into shares of the
Company's Common Stock at the option of the holder until maturity in 2003, at
which time they will be due in full if not previously converted. The Company may
also elect to redeem the Notes, if not previously converted, at any time after
March 27, 2000. The conversion price of the Notes at September 30, 1999 was
$12.10 per share, as adjusted to reflect the issuance of convertible preferred
stock as discussed below and stock option grants. Upon adjustment of the
conversion price of the Company's Series B convertible preferred stock as
discussed below, the conversion price of the Notes will likely decrease to
$11.49 per share. Under the terms of the Note Purchase Agreement relating to the
Notes, the Company must comply with certain covenants and maintain certain
financial ratios as follows:
1. current assets to current liabilities of at least 1.575 to 1.0,
measured monthly;
2. total liabilities, exclusive of the Notes and convertible redeemable
preferred stock, to tangible net worth, inclusive of the Notes and
convertible redeemable preferred stock, not to exceed 1.1 to 1.0,
measured monthly; and
3. a minimum fixed charge coverage ratio, as defined in the Note Purchase
Agreement, of 1.08 to 1.0, measured annually.
At September 30, 1999, the Company was in compliance with all of its financial
ratio covenants under the Notes.
In April 1999, the Company closed a stock purchase agreement selling $32.5
million of convertible preferred stock to several investors. Under the terms of
the agreement, the Company sold an aggregate of 2,763,000 shares of Series A
convertible preferred stock and 487,000 shares of Series B convertible preferred
stock to members of the investor group, at a price of $10 per share for each
series, or an aggregate consideration of $32.5 million, and received net
proceeds of $30.2 million. At September 30, 1999, the preferred shares were
convertible at a price of $10 per share (subject to antidilution adjustments) at
any time following issuance at the discretion of the holder. The Company is
required to meet certain performance targets for the twelve months ending
December 31, 1999 under the Series B preferred stock agreement. These targets
are: 1) $135.0 million in net sales, and 2) an operating loss of not more than
$1.0 million. It is anticipated that the Series B conversion price will be
adjusted to $3.75 per share due to the likelihood that the Company will not meet
the specified performance targets for calendar 1999. If the conversion price is
21
adjusted, the Company will be required to record approximately $8.1 million of
additional preferred dividends to account for this beneficial conversion
feature. Such non-cash charge represents the implied value of the beneficial
conversion feature and would be recorded in the first quarter of fiscal 2000.
Both series of preferred stock are entitled to a 12 percent cumulative annual
dividend payable upon redemption of the stock or in the event of a sale or
liquidation of the Company. Shares may not be redeemed until five years after
the original date of issuance, at which time they may be redeemed at the
election of the holders or, under certain conditions, at the discretion of the
Company. The redemption value of the Series A and Series B convertible preferred
stock is $27.6 million and $4.9 million, respectively. The difference between
the carrying amount and the redemption value of the convertible preferred stock
is being accreted as additional preferred dividends over the period until
redemption.
In April 1999, the Company entered into an Amended and Restated Business Loan
Agreement (the "Agreement") with Bank of America NT & SA. The Agreement provides
for a credit line of up to $20 million with interest at the Bank's Reference
Rate or, at the option of the Company, at LIBOR plus 1.25 percentage points or
at the Offshore Rate plus 1.25 percentage points. The line of credit is
available until June 1, 2000. The Agreement also provides for a standby letter
of credit of up to $400,000 (included in the $20 million limit) with a maximum
maturity of March 31, 2001. The Agreement provides that the line of credit is to
be secured by all machinery, equipment, inventory, receivables and intangible
assets of the Company. At September 30, 1999, the Company had $5.0 million
outstanding under this line of credit at a per annum interest rate of 6.65
percent.
The Company is required to meet certain financial covenants under the Agreement
as follows:
1. to maintain a current ratio of at least 1.5:1.0 measured monthly;
2. not to incur an operating loss of more than $5 million for the year
ending December 31, 1999; and
3. to maintain a minimum fixed charge coverage ratio of at least 1.25:1.00
measured on a rolling four-quarter basis, beginning December 31, 2000.
At September 30, 1999, the Company anticipated being out of compliance with the
operating loss covenant at December 31, 1999. In December 1999, the Company
signed a letter of commitment for a new line of credit. See "Note 14. Subsequent
Events" of the Notes to Financial Statements.
The Company leases various food processing, production and other equipment in
use at its Clearfield, Utah production facility pursuant to two lease agreements
between the Company and BA Leasing & Capital Corporation ("BA Capital"), an
affiliate of Bank of America. Each lease agreement contains a cross-default
provision stating that any default under any other borrowing or credit agreement
that includes a failure to make payment when due or gives the holder a right of
acceleration constitutes an event of default under each lease agreement. If any
event of default by the Company occurred under the lease agreements with BA
Capital, the Company's manufacturing capacity would be significantly curtailed
or even eliminated if BA Capital were to exercise its right to sell the
equipment. In addition, neither lease agreement contains express provisions
giving the Company a right to purchase the equipment at the end of the lease
term, which terms range from five to seven years, depending upon the equipment.
22
Management believes that the Company's existing working capital, in combination
with cash flow from operations and funds available under credit facilities, will
be sufficient to support working capital requirements in the near term.
YEAR 2000
INFORMATION SYSTEMS The Company utilizes packaged application strategies for all
critical information systems functions, which have all been certified to be year
2000 compliant by the vendors. This includes enterprise software, operating
systems, networking components, application and data servers, PC hardware, and
core office automation software. The Company performed various component tests
to verify full year 2000 operational readiness and modification was completed on
all non-compliant equipment. In addition to the information system component
testing, the Company has conducted a system wide test, including all components
from the desktop to the data center, to ensure that all of the compliant
components will function properly as a whole. The focus of these tests was to
assure that the Company's business processes will run end-to-end with no year
2000 errors or issues.
SUPPLIER AND CUSTOMER BASE The Company has completed a year 2000 supplier and
customer audit program. As a part of this program, the Company contacted all of
its critical suppliers and significant customers to inform them of the Company's
year 2000 expectations and requested copies of their compliance programs.
Although the Company discovered a number of non-compliant products and vendors,
none of these vendors or products were key to the Company's operations.
COST The Company incurred approximately $20,000 of incremental costs to assess
year 2000 readiness of its information systems. All system hardware and software
upgrades were budgeted in the normal course of business regardless of the year
2000 issue.
RISKS Despite the Company's efforts to identify all internal systems with year
2000 issues, it is likely that unexpected problems will arise. As with most
businesses, the Company will also be at risk from external infrastructure
failures that could arise from year 2000 failures. It is possible, for example,
that electrical power, telephone and financial networks across the nation will
experience breakdowns in the days and weeks following January 1, 2000. There is
also a real possibility of failures of key components in the national
transportation infrastructure or delays in rail, over-the-road and air shipments
due to failures in transportation control systems due to the year 2000 problem.
Investigation and assessment of risks associated with such ubiquitous and
interconnected utility systems and transportation systems are beyond the
resources of the Company. The failure by the Company or third parties to correct
a material year 2000 problem could result in an interruption in, or a failure
of, certain of the Company's normal business activities or operations. Such
failures could materially and adversely affect the Company's results of
operations, liquidity and financial condition.
23
CONTINGENCY PLANS The Company intends to have two weeks of inventory on hand to
support a possible interruption in production. The Company is also scheduling
work and projects so that an interruption of either the information system or
production would not cause a work stoppage. An emergency call list will be in
place when the system comes up on January 2, 2000 in case of an emergency.
NEW ACCOUNTING PRONOUNCEMENT
In June 1999, the FASB issued Statement of Financial Accounting Standards No.
137, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS
137"). SFAS 137 is an amendment to Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities". SFAS
137 establishes accounting and reporting standards for all derivative
instruments. SFAS 137 is effective for fiscal years beginning after June 15,
2000. The Company does not currently have any derivative instruments and,
accordingly, does not expect the adoption of SFAS 137 to have an impact on its
financial position or results of operations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- -------- ----------------------------------------------------------
The Company's only financial instrument with market risk exposure is its
variable rate line of credit. At September 30, 1999, the Company had $5.0
million outstanding under this credit line at an annual interest rate of 6.65
percent. A hypothetical 10 percent change in interest rates would not have a
material impact on the Company's cash flows.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- ------- -------------------------------------------
The financial statements and notes thereto required by this item begin on page
F-1 as listed in Item 14 of Part IV of this document.
Unaudited quarterly financial data for each of the seven quarters in the period
ended September 30, 1999 is as follows:
IN THOUSANDS, EXCEPT PER SHARE DATA 1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER(1)
- ----------------------------------- ----------- ----------- ----------- --------------
1999
Net sales $ 13,563 $ 22,228 $ 24,315 n/a
Gross margin 6,210 9,177 10,385 n/a
Net loss (2) 5,456) (11,428) (5,262) n/a
Basic and diluted net loss per share (0.62) (1.29) (0.60) n/a
1998
Net sales $ 13,040 $ 25,739 $ 32,630 $ 28,711
Gross margin 6,153 12,302 16,192 14,903
Net income (loss) (4,318) (6,240) 182 334
Basic net income (loss) per share (0.50) (0.72) 0.02 0.04
Diluted net income (loss) per share (0.50) (0.72) 0.02 0.03
(1) Quarterly statement of operations data for 1999 includes only three quarters
of activity due to the Company's change in its fiscal year during 1999 from a
calendar year to a fiscal year ended September 30. (2)Included in net loss in
the first and second quarters of 1999, respectively, is a restructuring charge
totaling $1,100 and $1,584 on a pre-tax basis.
24
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
- ------- ---------------------------------------------------------------
FINANCIAL DISCLOSURE
--------------------
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
- -------- --------------------------------------------------
Information required by this item is included under the captions ELECTION OF
DIRECTORS, EXECUTIVE OFFICERS and SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING
COMPLIANCE, in the Company's Proxy Statement for its 2000 Annual Meeting of
Shareholders and is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
- -------- ----------------------
Information required by this item is included under the captions EXECUTIVE
COMPENSATION, DIRECTOR COMPENSATION, EMPLOYMENT CONTRACTS AND SEVERANCE AND
CHANGE-IN-CONTROL ARRANGEMENTS and COMPENSATION COMMITTEE INTERLOCKS AND INSIDER
PARTICIPATION IN COMPENSATION DECISIONS in the Company's Proxy Statement for its
2000 Annual Meeting of Shareholders and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- -------- --------------------------------------------------------------
Information required by this item is included under the caption SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT in the Company's Proxy
Statement for its 2000 Annual Meeting of Shareholders and is incorporated herein
by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- -------- ----------------------------------------------
Information required by this item is included under the caption COMPENSATION
COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION IN COMPENSATION DECISIONS AND
MANAGEMENT TRANSACTIONS in the Company's Proxy Statement for its 2000 Annual
Meeting of Shareholders and is incorporated herein by reference.
25
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
- -------- ---------------------------------------------------------------
(a) FINANCIAL STATEMENTS AND SCHEDULES
Page
----
Report of Arthur Andersen LLP F-1
Balance Sheets - September 30, 1999 and December 31, 1998 F-2
Statements of Operations - nine months ended September 30, 1999
and years ended December 31, 1998 and 1997 F-3
Statements of Shareholders' Equity (Deficit) - nine months ended
September 30, 1999 and years F-4 ended December 31, 1998 and 1997
Statements of Cash Flows - nine months ended September 30, 1999 and
years ended December 31, 1998 and 1997 F-5
Notes to Financial Statements F-6
Report of Independent Public Accountants on Financial Statement
Schedule
F-17
Schedule II Valuation and Qualifying Accounts F-18
(b) REPORTS ON FORM 8-K
There was one report on Form 8-K filed during the quarter ended September 30,
1999 under Item 8. Change in Fiscal Year, dated July 13, 1999 and filed July 23,
1999.
(c) EXHIBITS
Exhibits are listed on the Index to Exhibits following the financial statements
included in this report.
26
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.
Date: December 24, 1999
-----------------
GARDENBURGER, INC.
By: /s/ Lyle G. Hubbard
--------------------------------
Lyle G. Hubbard
President and 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 indicated on December 24, 1999.
Signature Title
- --------- -----
/s/ Lyle G. Hubbard Director, President and Chief Executive Officer
- ------------------------ (Principal Executive Officer)
Lyle G. Hubbard
/s/ Richard C. Dietz Executive Vice President,
- ------------------------ Chief Financial Officer, Secretary and Treasurer
Richard C. Dietz (Principal Financial and Accounting Officer)
/s/ Kyle A. Anderson Director
- ------------------------
Kyle A. Anderson
/s/ Alexander P. Coleman Director
- ------------------------
Alexander P. Coleman
/s/ Jason M. Fish Director
- ------------------------
Jason M. Fish
/s/ Ronald C. Kesselman Director
- ------------------------
Ronald C. Kesselman
/s/ Richard L. Mazer Director
- ------------------------
Richard L. Mazer
/s/ Mary O. McWilliams Director
- ------------------------
Mary O. McWilliams
/s/ Michael L. Ray Director
- ------------------------
Michael L. Ray
/S/ E. Kay Stepp Chairman of the Board
- ------------------------
E. Kay Stepp
/s/ Paul F. Wenner Founder, Chief Creative Officer
- ------------------------ and Director
Paul F. Wenner
27
Exhibit Index
Exhibit No. Description
- ----------- -----------
3.1 Restated Articles of Incorporation, as amended April 14, 1999 (18)
3.2 1995 Restated Bylaws, as amended July 13, 1999 (20)
10.1 Amended and Restated Rights Agreement between the Company and
First Chicago Trust Company of New York, dated July 15, 1999 (20)
10.2 Purchase and Sale Agreement and Receipt For Earnest Money between
the Iseli Family Partnership (Seller) and the Company (Buyer), as
amended, dated May 8, 1995 (5)
10.3 Purchase and Sale Agreement and Receipt for Earnest Money between
the Company and Ironwood Investments, dated August 11, 1999
10.4 Amended and Restated Business Loan Agreement, dated April 14,
1999, between Bank of America NT & SA and Gardenburger, Inc. (18)
10.5 Amendment No. 1, dated May 21, 1999, to Business Loan Agreement,
dated April 14, 1999, between the Company and Bank of America NT
& SA (19)
10.6 Amendment No. 2, dated July 9, 1999, to Business Loan Agreement,
dated April 14, 1999, between the Company and Bank of America NT
& SA (19)
10.7 Plant Lease-1416 S.E. 8th, Portland, Oregon (1)
10.8 First Amendment to Plant Lease - 1416 S.E. 8th, Portland,
Oregon (11)
10.9 Second Amendment to Plant Lease - 1416 S.E. 8th, Portland,
Oregon (12)
10.10 Third Amendment to Plant Lease - 1416 S.E. 8th, Portland, Oregon,
dated January 1, 1999 (17)
10.11 Consent to Assignment and Option to purchase 1005 S.E. Washington,
Portland, Oregon (1)
10.12 Morrison Plaza Office Lease, dated October 29, 1996 (10)
10.13 First Amendment to Morrison Plaza Office Lease, dated December 9,
1997 (11)
10.14 Lease extension for Morrison Plaza Office Building, dated
September 11, 1998 (14)
10.15 Facility Lease by and between Freeport Center Associates, a Utah
general partnership and the Company, dated May 28, 1997 (9)
10.16 Addendum, dated August 1, 1997, to Facility Lease by and between
Freeport Center Associates, and the Company (11)
10.17 Warehouse Lease between Freeport Center Associates and the
Company, dated January 25, 1999 (17)
10.18 Lease Agreement between BA Leasing & Capital Corporation and the
Company, dated as of December 17, 1997 (11)
10.19 First Amendment, dated June 4, 1998, to Lease Agreement, dated
December 17, 1997 between BA Leasing & Capital Corporation and the
Company (13)
E-1
Exhibit No.
- -----------
10.20 Lease Agreement between BA Leasing & Capital Corporation and the
Company, dated as of May 28, 1998 (14)
10.21 First Amendment, dated January 14, 1999, to Lease Agreement
between BA Leasing & Capital Corporation and the Company, dated as
of May 28, 1998 (17)
10.22 Purchase Agreement Assignment, dated June 23, 1999, between
Gardenburger, Inc. and BA Leasing & Capital Corporation (19)
10.23 Note Purchase Agreement, dated as of March 27, 1998, between
the Company and Dresdner Kleinwort Benson Private Equity
Partners L.P. (12)
10.24 Convertible Senior Subordinated Note, dated March 27, 1998 (12)
10.25 Registration Rights Agreement, dated as of March 27, 1998, between
the Company and Dresdner Kleinwort Benson Private Equity
Partners L.P. (12)
10.26 Stock Purchase Agreement, dated March 29, 1999, by and between
Gardenburger, Inc. and Rosewood Capital III, L.P., Farallon
Capital Management LLC, Gruber & McBaine Capital Management, LLC,
BT Capital Investors LP and certain other purchasers identified
therein (16)
10.27 Amendment and Waiver of Stock Purchase Agreement, dated April 14,
1999, by and between Gardenburger, Inc., and the Purchasers
identified on Exhibit A thereto (18)
10.28 Investor Rights Agreement, dated April 14, 1999, by and between
Gardenburger, Inc., and the investors identified on Exhibit A
thereto (18)
10.29 1992 First Amended and Restated Combination Stock Option Plan, as
amended (15)(19)
10.30 Form of Incentive Stock Option Agreement for Option grants to
executive officers after May 24, 1995 (15)(17)
10.31 Form of Non-Statutory Stock Option Agreement for Option grants to
executive officers after May 24, 1995 (15)(17)
10.32 Paul F. Wenner Stock Option Agreement (2)(15)
10.33 Lyle Hubbard Employment Agreement, dated April 14, 1996 (10)(15)
10.34 Agreement to Extend and Amend Employment Agreement, dated November
16, 1998, to Lyle Hubbard Employment Agreement, dated April 14,
1996 (15)(17)
10.35 Agreement to Extend and Amend Employment Agreement, dated March
5, 1999, to Lyle Hubbard Employment Agreement, dated April 14,
1996 (15)(17)
10.36 Third Amendment to Employment Agreement, dated December 9, 1999,
between the Company and Lyle Hubbard (15)
10.37 Paul F. Wenner Employment Agreement and Amendment thereto (1)(15)
10.38 Form of Severance Agreement for Executive Officers (10)(15)
10.39 Form of Indemnification Agreement between the Company and its
Officers and Directors (15)(17)
10.40 2000 Executive Annual Incentive Plan (15)
E-2
Exhibit No.
- -----------
10.41 Retention Incentive Agreement, dated December 9, 1999, between the
Company and Lyle Hubbard (15)
10.42 Form of Retention Incentive Agreement between the Company and nine
senior executives (15)
10.43 Form of Change in Control Agreement between the Company and nine
senior executives (15)
23 Consent of Arthur Andersen LLP
27 Financial Data Schedule
99 Description of Common Stock of Gardenburger, Inc. (18)
(1) Incorporated by reference to the Company's Form S-1 Registration Statement
(Commission File No. 33-46623), filed May 6, 1992.
(2) Incorporated by reference to the Company's 1992 Form 10-K Annual Report,
filed March 23, 1993.
(3) Incorporated by reference to the Company's 1993 Form 10-K Annual Report,
filed March 23, 1994.
(4) Incorporated by reference to the Company's 1994 Form 10-K Annual Report,
filed March 30, 1995.
(5) Incorporated by reference to the Company's 1995 Form 10-K Annual Report,
filed March 29, 1996.
(6) Incorporated by reference to the Company's Form 10-Q Quarterly Report for
the quarter ended September 30, 1996, filed November 4, 1996.
(7) Incorporated by reference to the Company's Form 8-K Current Report, filed
May 8, 1996.
(8) Incorporated by reference to the Company's Form 10-Q Quarterly Report for
the quarter ended September 30, 1997, filed November 4, 1997.
(9) Incorporated by reference to the Company's Form 10-Q Quarterly Report for
the quarter ended June 30, 1997, filed August 14, 1997.
(10) Incorporated by reference to the Company's 1996 Form 10-K Annual Report,
filed March 25, 1997.
(11) Incorporated by reference to the Company's 1997 Form 10-K Annual Report,
filed March 31, 1998.
(12) Incorporated by reference to the Company's Form 10-Q for the quarter ended
March 31, 1998, filed May 15, 1998.
(13) Incorporated by reference to the Company's Form 10-Q for the quarter ended
June 30, 1998, filed August 12, 1998.
(14) Incorporated by reference to the Company's Form 10-Q for the quarter ended
September 30, 1998, filed November 5, 1998.
(15) Management contract or compensatory plan or arrangement.
(16) Incorporated by reference to the Company's Form 8-K Current Report, filed
April 1, 1999.
(17) Incorporated by reference to the Company's Form 10-K for the year ended
December 31, 1998, filed March 31, 1999.
(18) Incorporated by reference to the Company's Form 10-Q for the quarter ended
March 31, 1999, filed May 17, 1999.
(19) Incorporated by reference to the Company's Form 10-Q for the quarter ended
June 30, 1999, filed August 13, 1999.
(20) Incorporated by reference to the Company's Registration Statement on Form
S-8 (No. 333-92665), filed December 13, 1999.
E-3
Report of Independent Public Accountants
To the Board of Directors and Shareholders of
Gardenburger, Inc.:
We have audited the accompanying balance sheets of Gardenburger, Inc. (an Oregon
corporation) as of September 30, 1999 and December 31, 1998 and the related
statements of operations, shareholders' equity (deficit) and cash flows for the
nine months ended September 30, 1999 and for each of the two years in the period
ended December 31, 1998. 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 generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Gardenburger, Inc. as of
September 30, 1999 and December 31, 1998, and the results of its operations and
its cash flows for the nine months ended September 30, 1999 and each of the two
years in the period ended December 31, 1998, in conformity with generally
accepted accounting principles.
Portland, Oregon,
November 5, 1999 (except for the matters discussed in Note 14, as to which the
date is December 8, 1999).
F-1
GARDENBURGER, INC.
BALANCE SHEETS
(In thousands, except share amounts)
September 30, December 31,
1999 1998
------------------- -------------------
ASSETS
Current Assets:
Cash and cash equivalents $ 7,033 $ 2,320
Accounts receivable, net of allowances of
$301 and $148 6,133 14,969
Inventories, net 7,268 12,457
Prepaid expenses 2,207 4,515
Deferred income taxes 4,775 1,989
------------------- -------------------
Total Current Assets 27,416 36,250
Property, Plant and Equipment, net of accumulated
depreciation of $3,960 and $3,174 10,275 12,238
Deferred Income Taxes 12,691 4,242
Other Assets, net of accumulated amortization of
$804 and $534 2,320 2,318
------------------- -------------------
Total Assets $ 52,702 $ 55,048
=================== ===================
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current Liabilities:
Short-term note payable $ 5,000 $ 15,000
Accounts payable 6,669 9,708
Payroll and related liabilities payable 941 1,822
Other current liabilities 3,065 2,366
------------------- -------------------
Total Current Liabilities 15,675 28,896
Other Long-Term Liabilities 199 226
Convertible Notes Payable 15,000 15,000
Convertible Redeemable Preferred Stock 32,147 -
Shareholders' Equity (Deficit):
Preferred Stock, no par value, 5,000,000 shares
authorized - -
Common Stock, no par value, 25,000,000 shares
authorized; shares issued and outstanding:
8,841,451 and 8,733,811 10,619 9,717
Additional paid-in capital 4,277 4,275
Retained deficit (25,215) (3,066)
------------------- -------------------
Total Shareholders' Equity (Deficit) (10,319) 10,926
------------------- -------------------
Total Liabilities and Shareholders' Equity (Deficit) $ 52,702 $ 55,048
=================== ===================
The accompanying notes are an integral part of these balance sheets.
F-2
GARDENBURGER, INC.
STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
For the Nine
Months Ended
September 30, For the Year Ended December 31,
------------------------------------------
1999 1998 1997
------------------- -------------------- -------------------
Net sales $ 60,106 $ 100,120 $ 56,837
Cost of goods sold 34,334 50,570 27,236
------------------- -------------------- -------------------
Gross margin 25,772 49,550 29,601
Operating expenses:
Sales and marketing 48,021 58,513 26,191
General and administrative 5,064 5,387 5,471
Restructuring charge 2,684 - -
------------------- -------------------- -------------------
55,769 63,900 31,662
------------------- -------------------- -------------------
Operating loss (29,997) (14,350) (2,061)
Other income (expense):
Interest income 197 115 185
Interest expense (1,596) (1,404) (40)
Other, net 7 (200) (136)
------------------- -------------------- -------------------
(1,392) (1,489) 9
------------------- -------------------- -------------------
Loss before benefit from income taxes (31,389) (15,839) (2,052)
Benefit from income taxes 11,223 5,797 659
------------------- -------------------- -------------------
Loss before preferred dividends (20,166) (10,042) (1,393)
Preferred dividends (1,980) - -
=================== ==================== ===================
Net loss available for common shareholders $ (22,146) $ (10,042) $ (1,393)
=================== ==================== ===================
Net loss per share - basic and diluted $ (2.51) $ (1.16) $ (0.16)
=================== ==================== ===================
Shares used in per share calculations 8,812 8,659 8,584
=================== ==================== ===================
The accompanying notes are an integral part of these statements.
F-3
GARDENBURGER, INC.
STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
For the Nine Months Ended September 30, 1999
and the Years Ended December 31, 1998 and 1997
(In thousands, except share amounts)
Common Stock Additional Retained Total
--------------------------- Paid-In Earnings Shareholders'
Shares Amount Capital (Deficit) Equity (Deficit)
------------ ------------ ------------- ------------- ----------------
Balance at December 31, 1996 8,566,456 $ 8,468 $ 4,139 $ 8,372 $ 20,979
Exercise of common stock options 41,798 183 - - 183
Income tax benefit of non-qualified stock
option exercises and disqualifying
dispositions - - 64 - 64
Foreign currency translation - - - 6 6
Net loss - - - (1,393) (1,393)
------------ ------------ ------------- ------------- ----------------
Balance at December 31, 1997 8,608,254 8,651 4,203 6,985 19,839
Exercise of common stock options 74,586 541 - - 541
Income tax benefit of non-qualified stock
option exercises and disqualifying
dispositions - - 72 - 72
Issuance of shares in exchange for
interest on convertible notes payable 50,971 525 - - 525
Foreign currency translation - - - (9) (9)
Net loss - - - (10,042) (10,042)
------------ ------------ ------------- ------------- ----------------
Balance at December 31, 1998 8,733,811 9,717 4,275 (3,066) 10,926
Exercise of common stock options 55,660 377 - - 377
Income tax benefit of non-qualified stock
option exercises and disqualifying
dispositions - - 2 - 2
Issuance of shares in exchange for
interest on convertible notes payable 51,980 525 - - 525
Accrual of preferred dividends - - - (1,980) (1,980)
Foreign currency translation - - - (3) (3)
Loss before preferred dividends - - - (20,166) (20,166)
------------ ------------ ------------- ------------- ----------------
Balance at September 30, 1999 8,841,451 $ 10,619 $ 4,277 $ (25,215) $ (10,319)
============ ============ ============= ============= ================
The accompanying notes are an integral part of these statements.
F-5
GARDENBURGER, INC.
STATEMENTS OF CASH FLOWS
(In thousands)
For the Nine
Months Ended For the Year Ended December 31,
September 30, ------------------------------------
1999 1998 1997
---------------- ---------------- -----------------
Cash flows from operating activities:
Loss before preferred dividends $ (20,166) $ (10,042) $ (1,393)
Effect of exchange rate on operating accounts (3) (9) 6
Adjustments to reconcile loss before preferred
dividends to net cash flows used in operating activities:
Depreciation and amortization 1,600 1,637 977
Non-cash portion of restructuring charge 1,584 - -
Other non-cash expenses 212 409 -
Loss on sale of fixed assets 19 75 145
Deferred income taxes (11,235) (5,956) (307)
(Increase) decrease in:
Accounts receivable, net 8,836 (6,896) (5,273)
Inventories, net 5,189 (9,254) 1,587
Prepaid expenses 2,308 (2,194) (1,943)
Income taxes receivable, net - 475 178
Increase (decrease) in:
Accounts payable (3,039) 6,543 992
Payroll and related liabilities (881) 206 937
Other accrued liabilities 699 1,264 501
---------------- ---------------- -----------------
Net cash used in operating activities (14,877) (23,742) (3,593)
Cash flows from investing activities:
Payments for purchase of property and equipment (1,031) (11,282) (12,141)
Proceeds from sale of equipment 33 5,355 10,477
Other assets, net 42 (102) (143)
---------------- ---------------- -----------------
Net cash used in investing activities (956) (6,029) (1,807)
Cash flows from financing activities:
Proceeds from (payments on) line of credit, net (10,000) 15,000 -
Proceeds from issuance of convertible notes payable - 15,000 -
Financing fees from issuance of convertible notes payable - (1,124) -
Issuance of preferred stock, net of issuance costs 30,167 - -
Proceeds from exercise of common stock options and warrants 377 541 183
Income tax benefit of non-qualified stock option
exercises and disqualifying dispositions 2 72 64
---------------- ---------------- -----------------
Net cash provided by financing activities 20,546 29,489 247
---------------- ---------------- -----------------
Increase (decrease) in cash and cash equivalents 4,713 (282) (5,153)
Cash and cash equivalents:
Beginning of period 2,320 2,602 7,755
---------------- ---------------- -----------------
End of period $ 7,033 $ 2,320 $ 2,602
================ ================ =================
The accompanying notes are an integral part of these statements.
F-5
GARDENBURGER, INC.
NOTES TO FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS AND AS OTHERWISE INDICATED)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- --------------------------------------------------------------------
ORGANIZATION AND NATURE OF OPERATIONS
Gardenburger, Inc. was incorporated in Oregon in 1985 to provide a line of
meatless food products in response to the public's awareness of the importance
of diet to overall health and fitness. Toward this end, the Company developed
and now produces and distributes frozen, meatless food products that are
generally low in cholesterol and fat, consisting primarily of various flavors
and styles of veggie burgers. The Company's products are principally sold to
retail and food service customers throughout the United States.
CHANGE IN REPORTING PERIOD
In July 1999, the Company changed its fiscal year end to September 30. Fiscal
1999 ended on September 30, 1999 and fiscal 2000 began October 1, 1999. For
purposes of these footnotes, the nine month period ended September 30, 1999 will
be referred to herein as the year ended September 30, 1999. See Note 8.
Unaudited Fiscal Year Operating Results. Summary operating results for the nine
months ended September 30, 1998 are as follows:
Net sales $ 71,409
Cost of goods sold 36,762
Gross margin 34,647
Operating expenses 50,031
Operating loss (15,384)
Net loss available for common shareholders (10,362)
Net loss per share - basic and diluted $ (1.20)
Shares used in per share calculations 8,639
ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from those estimates. Management believes that the estimates used
are reasonable.
CASH EQUIVALENTS
Cash equivalents consist of highly liquid investments with maturities at the
date of purchase of 90 days or less.
INVENTORIES
Inventories are valued at standard cost, which approximates the lower of cost
(using the first-in, first-out (FIFO) method), or market, and include materials,
labor and manufacturing overhead.
F-6
OTHER ASSETS
Other assets consist principally of $1,151 and $1,085 in deferred financing
fees, net of accumulated amortization, as of September 30, 1999 and December 31,
1998, respectively. Other assets also includes $780 and $873 in goodwill, net of
accumulated amortization, as of September 30, 1999 and December 31, 1998,
respectively. Deferred financing fees are being amortized over the maturity
period of the related debt and goodwill is being amortized using the
straight-line method over ten years.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are stated at cost. Depreciation and amortization
are provided using the straight-line method over the estimated useful lives of
the assets. Leasehold improvements are amortized over the lease term or the
estimated useful life of the asset, whichever is shorter. Estimated useful lives
are as follows:
BUILDINGS AND IMPROVEMENTS 3-40 YEARS MACHINERY AND EQUIPMENT 7-30 YEARS
OFFICE FURNITURE AND EQUIPMENT 3-10 YEARS VEHICLES 5 YEARS
LONG-LIVED ASSETS
In accordance with SFAS 121, long-lived assets held and used by the Company are
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. For purposes of
evaluating the recoverability of long-lived assets, the recoverability test is
performed using undiscounted net cash flows of the asset.
SEGMENT REPORTING
The Company adopted Statement of Financial Accounting Standards No. 131 (SFAS
131), DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION for
the year ended December 31, 1998. Based upon definitions contained within SFAS
131, the Company has determined that it operates in one segment. In addition,
virtually all sales are domestic.
CONCENTRATIONS OF CREDIT RISK AND SIGNIFICANT CUSTOMERS The Company invests its
excess cash with high credit quality financial institutions, which bear minimal
risk, and, by policy, limits the amount of credit exposure to any one financial
institution.
For the year ended September 30, 1999, one customer accounted for approximately
11 percent of revenue and 5 percent of the accounts receivable balance at
September 30, 1999.
For the year ended December 31, 1998, one customer accounted for approximately
14 percent of revenue and 8 percent of the accounts receivable balance at
December 31, 1998.
For the year ended December 31, 1997, two customers accounted for approximately
19 percent and 10 percent of revenue and 10 percent and 7 percent of the
accounts receivable balance at December 31, 1997, respectively.
Historically, the Company has not incurred significant losses related to its
accounts receivable.
F-7
REVENUE RECOGNITION
Revenue from the sale of products is generally recognized at time of shipment to
the customer. Promotional and other discounts are accrued at time of shipment
based on historical experience.
ADVERTISING COSTS
Advertising costs, including media advertising, couponing and other advertising,
which are included in sales and marketing expense, are expensed when the
advertising first takes place. Advertising expense was approximately $17,313,
$19,904 and $3,844 in 1999, 1998 and 1997, respectively.
SLOTTING FEES
Slotting fees associated with a new product or new territory are initially
recorded as an asset and the related expense is recognized ratably over the
12-month period beginning with the initial introduction of the product. Slotting
agreements refer to oral arrangements pursuant to which the retail grocer allows
the Company's products to be placed on the store's shelves in exchange for a
slotting fee. If a slotting fee agreement were breached, the Company would
pursue available legal remedies to enforce the agreement as appropriate.
RESEARCH AND DEVELOPMENT COSTS
Research and development costs are expensed as incurred. Research and
development expense was approximately $553 in 1999, $1,121 in 1998 and $565 in
1997.
NET LOSS PER SHARE
Basic earnings per share (EPS) is calculated using the weighted average number
of common shares outstanding for the period and diluted EPS is computed using
the weighted average number of common shares and dilutive common equivalent
shares outstanding.
Basic EPS and diluted EPS are the same for all periods presented since the
Company was in a loss position in all periods.
Potentially dilutive securities that are not included in the diluted EPS
calculation because they would be antidilutive are as follows:
DECEMBER 31,
SEPTEMBER 30, ------------------------------
1999 1998 1997
------------------- ----------- ------------
Stock options 3,247 2,768 2,447
Convertible notes 1,237 1,163 -
Convertible preferred stock 3,250 - -
=================== =========== ============
Total 7,734 3,931 2,447
=================== =========== ============
RECLASSIFICATIONS
Certain amounts in the prior year financial statements have been reclassified to
conform to the current year presentation.
F-8
2. INVENTORIES
- ----------------
Detail of inventories at September 30, 1999 and December 31, 1998 is as follows:
1999 1998
---------------- -----------------
Raw materials $ 2,672 $ 2,843
Packaging and supplies 538 275
Finished goods 4,058 9,339
================ =================
$ 7,268 $12,457
================ =================
3. PROPERTY, PLANT AND EQUIPMENT
- ----------------------------------
Detail of property, plant and equipment at September 30, 1999 and December 31,
1998 is as follows:
1999 1998
------------------ --------------------
Land 721 $ 787
Building and improvements 2,504 3,104
Machinery and equipment 6,807 7,320
Office furniture and equipment 4,203 4,201
------------------ --------------------
14,235 15,412
Less accumulated depreciation (3,960) (3,174)
================== ====================
$10,275 $12,238
================== ====================
4. LINE OF CREDIT
- -------------------
In April 1999, the Company entered into an Amended and Restated Business Loan
Agreement (the "Agreement") with Bank of America NT & SA. The Agreement provides
for a credit line of up to $20 million with interest at the Bank's Reference
Rate or, at the option of the Company, at LIBOR plus 1.25 percentage points or
at the Offshore Rate plus 1.25 percentage points. The line of credit is
available until June 1, 2000. The Agreement also provides for a standby letter
of credit of up to $400 (included in the $20 million limit) with a maximum
maturity of March 31, 2001. The Agreement provides that the line of credit is to
be secured by all machinery, equipment, inventory, receivables and intangible
assets of the Company. At September 30, 1999, the Company had $5,000 outstanding
under the line of credit at an annual interest rate of 6.65 percent.
The Company is required to meet certain financial covenants under the Agreement
as follows:
- - To maintain a current ratio of at least 1.5:1.0 measured monthly;
- - Not to incur an operating loss of more than $5 million for the year ending
December 31, 1999; and
- - To maintain a minimum fixed charge coverage ratio of at least 1.25:1.00
measured on a rolling four-quarter basis, beginning December 31, 2000.
At September 30, 1999, the Company anticipated being out of compliance with the
operating loss covenant at December 31, 1999. In December 1999, the Company
signed a letter of commitment for a new line of credit.
See Note 14. Subsequent Events.
F-9
5. LEASE COMMITMENTS
- ----------------------
Future minimum lease payments at September 30, 1999 are as follows:
YEAR ENDED SEPTEMBER 30,
- --------------------------------------
2000 $ 3,714
2001 3,473
2002 3,558
2003 3,345
2004 3,244
Thereafter 3,589
------------
Total $20,923
============
Rental expense for the years ended September 30, 1999, December 31, 1998 and
1997 was $2,355, $2,613 and $601, respectively.
6. CONVERTIBLE NOTES PAYABLE
- ------------------------------
The Company has outstanding $15 million of 7 percent Convertible Senior
Subordinated Notes (the "Notes") held by Dresdner Kleinwort Benson Private
Equity Partners L.P. ("Dresdner"). The Notes are convertible into shares of the
Company's Common Stock at the option of the holder until maturity in 2003, at
which time they will be due in full if not previously converted. The Company may
also elect to redeem the Notes, if not previously converted, at any time after
March 27, 2000. The conversion price of the Notes at September 30, 1999 was
$12.10 per share, as adjusted to reflect the issuance of convertible preferred
stock as discussed in Note 9 and stock option grants. Upon adjustment of the
conversion price of the Company's Series B convertible preferred stock as
discussed in Note 9, the conversion price of the Notes will likely decrease to
$11.49 per share. Under the terms of the Note Purchase Agreement relating to the
Notes, the Company must comply with certain covenants and maintain certain
financial ratios as follows:
- - current assets to current liabilities of at least 1.575 to 1.0, measured
monthly;
- - total liabilities, exclusive of the Notes and convertible redeemable
preferred stock, to tangible net worth, inclusive of the Notes and
convertible redeemable preferred stock, not to exceed 1.1 to 1.0, measured
monthly; and
- - a minimum fixed charge coverage ratio, as defined in the Note Purchase
Agreement, of 1.08 to 1.0, measured annually.
At September 30, 1999, the Company was in compliance with all of its financial
ratio covenants under the Notes.
7. INCOME TAXES
- -----------------
The Company accounts for income taxes under Statement of Financial Accounting
Standards 109, ACCOUNTING FOR INCOME TAXES. The Company realizes tax benefits as
a result of the exercise of nonqualified stock options and the exercise and
subsequent sale of certain incentive stock options (disqualifying dispositions).
For financial reporting purposes, any reduction in income tax obligations as a
result of these tax benefits is credited to additional paid-in capital. Tax
F-10
benefits of $2, $72 and $64 were credited to additional paid-in capital in 1999,
1998 and 1997, respectively. The provision for (benefit from) income taxes is as
follows:
1999 1998 1997
------------ ----------- ----------
CURRENT:
Federal $ - $ 129 $ (352)
State 12 30 -
------------ ----------- ----------
12 159 (352)
DEFERRED (11,235) (5,956) (307)
============ =========== ==========
$(11,223) $ (5,797) $ (659)
============ =========== ==========
Total deferred income tax assets were $17,907 and $6,751 and liabilities were
$441 and $520 at September 30, 1999 and December 31, 1998, respectively.
Individually significant temporary differences are as follows:
1999 1998
------------ ------------
Net operating loss carryforwards $15,055 $ 4,602
Provision for trade promotions and discounts 558 1,046
The Company recorded a benefit from income taxes of $15.0 million related to
$41.2 million of net operating loss carryforwards. No valuation allowance has
been recorded against the deferred tax asset for the Company's net operating
losses because the Company believes it is more likely than not that the net
operating losses will be recognized as a result of future operating profits. The
Company's basis for such assertion is due to its expectation that the high level
of discretionary expenses incurred in recent years will decline substantially as
the Company moves to a more profit driven business model. In addition, the
Company believes its recent workforce downsizing and production facility
consolidation will have a significant positive impact on future results of
operations. However, the Company may be required to record a valuation allowance
against the deferred tax asset for net operating losses in future periods if its
revised business goals are not achieved. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations" contained elsewhere
in this document for additional information regarding the Company's strategy and
assertions regarding the realization of the net operating loss carryforwards.
At September 30, 1999, the Company had available federal and state income tax
carryforwards, net of tax, of $14,116 and $939, respectively. The federal and
state income tax carryforwards expire through the fiscal years 2019 and 2014,
respectively.
The reconciliation between the effective tax rate and the statutory federal
income tax rate is as follows:
1999 1998 1997
---------- ------------ ----------
Statutory federal income tax rate (34.0)% (34.0) % (34.0) %
State taxes, net of federal income tax benefit (1.3) (3.9) (3.5)
Tax exempt interest and dividends -- (0.1) (1.7)
Trademark and goodwill amortization 0.1 0.2 1.5
Meals and entertainment 0.1 0.4 1.8
Revision of prior year estimates -- -- 1.6
Other (0.7) 0.8 2.2
---------- ------------ ----------
Effective tax rate (35.8)% (36.6) % (32.1) %
========== ============ ==========
F-11
8. UNAUDITED FISCAL YEAR OPERATING RESULTS
- --------------------------------------------
The following statement of operations data is included for informational
purposes only and is unaudited.
FISCAL YEAR ENDED SEPTEMBER 30, 1999 1998 1997 1996 1995
- --------------------------------------- ----------- ----------- --------- ----------- ----------
Net sales $ 88,817 $ 88,406 $48,144 $ 40,258 $ 36,141
Cost of goods sold 48,141 44,295 23,888 19,924 17,339
Gross margin 40,676 44,111 24,256 20,334 18,802
Operating expenses 69,639 57,755 28,465 18,247 14,521
Operating income (loss) (28,963) (13,644) (4,209) 2,087 4,281
Net income (loss) available for
common shareholders (21,826) (9,384) (2,667) 1,675 2,913
9. CONVERTIBLE PREFERRED STOCK
- --------------------------------
In April 1999, the Company closed a stock purchase agreement selling $32.5
million of convertible preferred stock to several investors. Under the terms of
the agreement, the Company sold an aggregate of 2,763 shares of Series A
convertible preferred stock and 487 shares of Series B convertible preferred
stock to members of the investor group, at a price of $10 per share for each
series, or an aggregate consideration of $32.5 million, and received net
proceeds of $30.2 million. At September 30, 1999, the preferred shares were
convertible at a price of $10 per share (subject to antidilution adjustments) at
any time following issuance at the discretion of the holder. The Company is
required to meet certain performance targets for the twelve months ending
December 31, 1999 under the Series B preferred stock agreement. These targets
are: 1) $135.0 million in net sales, and 2) an operating loss of not more than
$1.0 million. It is anticipated that the Series B conversion price will be
adjusted to $3.75 per share due to the likelihood that the Company will not meet
the specified performance targets for calendar 1999. If the conversion price is
adjusted, the Company will be required to record approximately $8.1 million of
additional preferred dividends to account for this beneficial conversion
feature. Such non-cash charge represents the implied value of the beneficial
conversion feature and would be recorded in the first quarter of fiscal 2000.
Both series of preferred stock are entitled to a 12 percent cumulative annual
dividend payable upon redemption of the stock or in the event of a sale or
liquidation of the Company. Shares may not be redeemed until five years after
the original date of issuance, at which time they may be redeemed at the
election of the holders or, under certain conditions, at the discretion of the
Company. The redemption value of the Series A and Series B convertible preferred
stock is $27.6 million and $4.9 million, respectively. The difference between
the carrying amount and the redemption value of the convertible preferred stock
is being accreted as additional preferred dividends over the period until
redemption.
10. RELATED PARTY TRANSACTIONS
- -------------------------------
The Company leases its S.E. 8th Avenue plant facility from a shareholder of the
Company for $3 per month. The lease is for a one-year term ending December 31,
1999, which has been renewed on a month-to-month basis terminable upon 60 days'
notice.
F-12
11. SHAREHOLDERS' EQUITY
- -------------------------
PREFERRED STOCK
The Company has authorized 5,000 shares of preferred stock, of which 3,250
shares have been issued (see Note 9). Such stock may be issued by the Board of
Directors in one or more series, with the preferences, limitations and rights of
each series to be determined by the Board of Directors.
PREFERRED SHARE PURCHASE RIGHTS
In April 1996, the Company declared a dividend distribution of one preferred
share purchase right on each outstanding share of the Company's Common Stock.
Each right, when exercisable, will entitle shareholders to buy one one-hundredth
of a share of Series A Junior Participating Preferred Stock of the Company at an
exercise price of $47 per share. The rights will become exercisable if a person
or group (an "Acquiring Person") acquires 15 percent or more of the Company's
Common Stock (with certain exceptions) or announces a tender offer for 15
percent or more of the Common Stock. With the exception of certain cash tender
offers, if a person becomes an Acquiring Person, or in the event of certain
mergers of the Company with an Acquiring Person, the rights will become
exercisable for shares of Common Stock with a market value of two times the
exercise price of the right. The Company's Board of Directors is entitled to
redeem the rights at $.01 per right at any time before a person has acquired 15
percent or more of the outstanding Common Stock.
STOCK OPTIONS
PLAN OPTIONS
- ------------
The Company has a 1992 First Amended and Restated Combination Stock Option Plan
(the "Plan"), which provides for the issuance of incentive stock options
("ISOs") to employees and officers of the Company and non-statutory stock
options ("NSOs") to employees, officers, directors and consultants of the
Company. Under the Plan, the exercise price of an ISO cannot be less than the
fair market value on the date of grant and the exercise price of an NSO cannot
be less than 85 percent of fair market value on the date of grant. Options
granted under the Plan generally vest three to five years from the date of grant
and generally expire ten years from the date of grant. Vesting may accelerate
upon a change in control of the Company. At September 30, 1999, the Company had
1,961 shares of Common Stock reserved for issuance under the Plan.
Activity under the Plan is summarized as follows:
SHARES AVAILABLE SHARES SUBJECT TO WEIGHTED AVERAGE
FOR GRANT OPTIONS EXERCISE PRICE
--------------------- --------------------- ----------------------
BALANCES, DECEMBER 31, 1996 761 1,373 $ 8.87
Options granted (172) 172 7.17
Options canceled 60 (60) 9.12
Options exercised -- (42) 4.37
--------------------- --------------------- ----------------------
BALANCES, DECEMBER 31, 1997 649 1,443 8.78
Options granted (172) 172 11.50
Options canceled 101 (101) 8.12
Options exercised -- (75) 7.27
--------------------- --------------------- ----------------------
BALANCES, DECEMBER 31, 1998 578 1,439 9.24
Options granted (516) 516 9.96
Options canceled 57 (57) 8.90
Options exercised -- (56) 7.18
===================== ===================== ======================
BALANCES, SEPTEMBER 30, 1999 119 1,842 $ 9.51
===================== ===================== ======================
F-13
NON-PLAN OPTIONS
- ----------------
On March 10, 1992, the Company granted a non-statutory stock option to its then
Chief Executive Officer exercisable for 1,650 shares of the Company's Common
Stock. Such option is exercisable for a period of ten years from the date of
grant at an exercise price of $1.00 per share, the fair market value of the
Company's Common Stock on the date of grant. During 1996, an option covering 625
of the shares was exercised. At September 30, 1999, an option to purchase 1,025
shares of Common Stock was outstanding and exercisable in full. At September 30,
1999, 1,025 shares of the Company's Common Stock were reserved for issuance
under this option grant.
On April 14, 1996, the Company granted an option to its Chief Executive Officer
exercisable for 300 shares of the Company's Common Stock. Such option is
exercisable for a period of ten years from the date of grant at an exercise
price of $8.69 per share, subject to vesting provisions over a four year period.
At September 30, 1999, the entire option remained outstanding and the Company
had 300 shares reserved for issuance under this option grant. 240 of the shares
covered by this option were exercisable at September 30, 1999.
During 1999, the Company granted options to certain employees and two
consultants covering a total of 80 shares of the Company's Common Stock at an
average exercise price of $11.16, all of which were outstanding at September 30,
1999. The Company had 80 shares of its Common Stock reserved for issuance under
these options. The fair value of options granted to non-employees was not
material.
STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 123
During 1995, the Financial Accounting Standards Board issued SFAS 123 which
defines a fair value based method of accounting for employee stock options and
similar equity instruments and encourages all entities to adopt that method of
accounting for all of their employee stock compensation plans. However, it also
allows an entity to continue to measure compensation cost for those plans using
the method of accounting prescribed by APB 25. Entities electing to continue to
use the accounting treatment in APB 25 must make pro forma disclosures of net
income and, if presented, earnings per share, as if the fair value based method
of accounting defined in SFAS 123 had been adopted.
The Company has elected to account for its stock-based compensation plans under
APB 25; however, the Company has computed, for pro forma disclosure purposes,
the value of all options granted during 1999, 1998 and 1997 using the
Black-Scholes option pricing model as prescribed by SFAS 123 using the following
weighted average assumptions for grants:
1999 1998 1997
--------------- -------------- --------------
Risk-free interest rate 6.00% 5.50% 6.25%
Expected dividend yield 0% 0% 0%
Expected lives 6.5 years 6.5 years 6.5 years
Expected volatility 61.49% 60.77% 58.11%
Using the Black-Scholes methodology, the total value of options granted during
1999, 1998 and 1997 was $3,816, $1,058 and $760, respectively, which would be
amortized on a pro forma basis over the vesting period of the options (typically
three to four years). The weighted average per share fair value of options
granted during 1999, 1998 and 1997 was $6.41, $4.92 and $4.45, respectively.
F-14
If the Company had accounted for its stock-based compensation plans in
accordance with SFAS 123, the Company's net loss available to common
shareholders and net loss per share would approximate the pro forma disclosures
below:
1999 1998 1997
------------------------- ------------------------ --------------------------
As Pro As Pro As Pro
Reported Forma Reported Forma Reported Forma
---------- ---------- ---------- ---------- ----------- ----------
Net loss available to common
shareholders $(22,146) $(24,404) $(10,042) $(11,870) $(1,393) $(3,518)
Basic and diluted net loss
per share $(2.51) $(2.77) $(1.16) $(1.37) $(0.16) $(0.41)
The following table summarizes information about all stock options outstanding
at September 30, 1999:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- ------------------------------------------------------------------------------- -----------------------------------
Weighted
Average Weighted Number of Weighted
Range of Exercise Number Remaining Average Shares Average
Prices Outstanding at Contractual Exercise Exercisable at Exercise
9/30/99 Life - Years Price 9/30/99 Price
- -------------------- ---------------- ---------------- -------------- ---------------- --------------
$ 1.00 1,025 2.3 $1.00 1,025 $1.00
3.08 1 4.3 3.08 1 3.08
6.12 - 6.78 206 7.2 6.54 109 6.64
6.87 - 7.94 331 7.2 7.52 232 7.45
8.69 - 8.97 695 6.9 8.78 434 8.75
9.56-10.41 312 9.2 10.05 34 9.89
10.90 - 11.75 589 6.1 11.58 351 11.60
12.31 - 13.56 88 7.5 12.79 71 12.74
==================== ================ ================ ============== ================ ==============
$ 1.00 - 13.56 3,247 5.6 $ 6.79 2,257 $ 5.58
==================== ================ ================ ============== ================ ==============
At December 31, 1998 and 1997, 2,010 and 1,783 options, respectively, were
exercisable at weighted average exercise prices of $5.08 per share and $4.54 per
share, respectively.
12. 401(K) PLAN
- ----------------
The Company has a 401(k) Salary Deferral Plan, which covers all employees who
have reached the age of 18. The covered employees may elect to have an amount
deducted from their wages for investment in a retirement plan. The Company
matches 100 percent of employee contributions up to two percent of compensation.
The Company's contribution to this plan was approximately $112 in 1999, $137 in
1998 and $106 in 1997.
F-15
13. SUPPLEMENTAL CASH FLOW INFORMATION
- ---------------------------------------
Supplemental disclosure of cash flow information is as follows:
1999 1998 1997
------------- ------------- ---------------
Cash paid during the period for interest $ 637 $ 552 $ --
Cash paid during the period for income taxes 10 11 13
Issuance of Common Stock in exchange for interest expense
on Convertible Notes 525 525 --
Preferred dividends 1,980 -- --
14. SUBSEQUENT EVENTS
- ----------------------
In November 1999, the Company sold approximately 18 acres of land it owned in
Portland, Oregon for net proceeds to the Company of approximately $1,500,
resulting in a gain of $174, which will be reflected in other income in the
first quarter of fiscal 2000.
In December 1999, the Company signed a letter of commitment for a new line of
credit. The new line of credit is expected to have a $25 million limit with
similar provisions to the existing line of credit. The Company expects the only
financial covenant to be a limitation on cumulative net cash losses (as defined)
of $5 million during the three-year term of the agreement.
F-16
Report of Independent Public Accountants
on Financial Statement Schedule
We have audited in accordance with generally accepted auditing standards, the
financial statements included in Gardenburger, Inc.'s Form 10-K, and have issued
our report thereon dated November 5, 1999. Our audit was made for the purpose of
forming an opinion on those statements taken as a whole. The schedule included
on page F-18 is the responsibility of the Company's management and is presented
for purposes of complying with the Securities and Exchange Commission's rules
and is not part of the basic financial statements. This schedule has been
subjected to the auditing procedures applied in our audit of the basic financial
statements and, in our opinion, fairly states, in all material respects, the
financial data required to be set forth therein in relation to the basic
financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Portland, Oregon,
November 5, 1999
F-17
SCHEDULE II
GARDENBURGER, INC.
VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 31, 1997 AND 1998 AND NINE MONTHS ENDED SEPTEMBER 30, 1999
(In thousands)
Column A Column B Column C Column D Column E
- ------------------------------------ -------------- --------------------------------- ------------ ------------
Balance Charged Charged to Balance
at Beginning to Costs and Other Accounts - Deductions - at End
Description of Period Expenses Describe Describe (a) of Period
- ------------------------------------ -------------- ------------- ---------------- ------------ ------------
Year Ended December 31, 1997:
Reserves deducted from asset accounts:
Allowance for uncollectible accounts $ 177 $ 128 $ - $ 30 $ 275
Year Ended December 31, 1998:
Reserves deducted from asset accounts:
Allowance for uncollectible accounts $ 275 $ 146 $ - $ 273 $ 148
Nine Months Ended September 30, 1999:
Reserves deducted from asset accounts:
Allowance for uncollectible accounts $ 148 $ 190 $ - $ 37 $ 301
(a) Charges to the account included in this column are for the purposes for
which the reserve was created as well as a reduction in the reserve to
levels estimated to be appropriate by the Company.
F-18