| |
|
"Gift Delivery |
Services" |
|
|
|
|
Nine Months
Ended 3/31/05 |
BearGram Service |
PajamaGram Service |
Calyx & Corolla Service |
TastyGram
Service |
Retail Operations |
Corporate/
Wholesale |
Totals |
Net Revenues |
$ 22,918,697 |
$ 9,776,561 |
$ 12,326,651 |
$ 293,503 |
$ 2,284,547 |
$ 239,795 |
$ 47,839,754 |
Cost of Goods Sold |
8,976,297 |
4,165,349 |
6,763,618 |
211,924 |
860,154 |
135,848 |
21,113,190 |
Gross Margin |
$ 13,942,400 |
$ 5,611,212 |
$ 5,563,033 |
$ 81,579 |
$ 1,424,393 |
$ 103,947 |
$ 26,726,564 |
Gross Margin % |
60.8% |
57.4% |
45.1% |
27.8% |
62.3% |
43.3% |
55.9% |
|
|
|
|
|
|
|
|
|
|
"Gift Delivery |
Services" |
|
|
|
|
Nine Months
Ended 3/31/04 |
BearGram Service |
PajamaGram Service |
Calyx & Corolla Service |
TastyGram
Service |
Retail Operations |
Corporate/
Wholesale |
Totals |
Net Revenues |
$ 20,895,460 |
$ 4,560,637 |
$ 9,787,635 |
$ 248,433 |
$ 2,470,028 |
$ 505,818 |
$ 38,468,011 |
Cost of Goods Sold |
8,028,237 |
1,820,198 |
5,039,121 |
174,366 |
876,438 |
242,551 |
16,180,911 |
Gross Margin |
$ 12,867,223 |
$ 2,740,439 |
$ 4,748,514 |
$ 74,067 |
$ 1,593,590 |
$ 263,267 |
$ 22,287,100 |
Gross Margin % |
61.6% |
60.1% |
48.5% |
29.8% |
64.5% |
52.0% |
57.9% |
The Company believes that there is no discernable basis to identify assets and net income by segment. Revenues from any single customer, revenues between business segments, and revenues, operating profit and identifiable assets of foreign operations are not significant.
(11) Commitments and Contingencies
The Company has been a party in a suit against 538 Madison Realty Company pending in the Supreme Court of the State of New York, County of New York, seeking a declaration that a lease with 538 Madison Realty Company is terminated.
On October 24, 1996, the Company entered into a ten-year lease for 2,600 square feet on Madison Avenue in New York City. On December 7, 1997, the Company's 538 Madison Avenue location was closed due to structural problems at neighboring 540 Madison Avenue. On December 16, the Company announced that it was permanently closing that retail location. The City of New York deemed the 538 Madison Avenue building uninhabitable from December 8, 1997 to April 9, 1998, and the Company has not made any rent payments on the lease since December, 1997. On December 24, 1998, the Company received a notice from its landlord of 538 Madison Avenue alleging that it was in default under the lease for failure to resume occupancy, and demand for back rent for the period July 8, 1998 to December 31, 1998 in the amount of $144,355. Further on January 4, 1999 the Company received a demand to resume rent payments beginning January 1999. The Company disputed the landlord's position and be
lieved it was not obligated to resume occupancy or pay rent under the lease. As a result, on May 25, 1999, the Company commenced action in the Supreme Court of the State of New York, County of New York against 538 Madison Realty Company. The action sought breach of contract damages and a declaration that the contract at issue, the former lease between the parties, has been terminated. The landlord moved to dismiss the action based on purported documentary evidence, being the lease itself. That motion was denied by order entered April 12, 2000. After having unsuccessfully attempted to resolve the disputes and after engaging in document discovery, the Company moved for summary judgment on its claims and dismissal of the landlord's claims. That motion was granted by order dated July 25, 2001 and judgment was entered in favor of the Company and against the landlord in the amount of $211,146 on August 10, 2001. The landlord filed an appeal of that judgment and, as settlement discussions were unsuccessful,
posted a bond to stay enforcement of the judgment pending its appeal, which was argued on November 1, 2002. That judgment was affirmed by a 3-2 vote of New York's Appellate Division, First Department. Based on the two dissenting votes, the landlord had a right of appeal to New York's Court of Appeals. That appeal was fully briefed and then argued on February 10, 2004. On March 25, 2004, the New York Court of Appeals issued a decision reversing the Appellate Division, and denying the Company's summary judgment motion. This decision returned the case to the New York Supreme Court for a determination as to whether the Company's lease was terminated or continued in effect following the December 7, 1997 incident. The Company continued to pursue all of its legal remedies to resolve the litigation favorably by decision or settlement. The Company accrued management's estimated cost of $220,000 to settle this contingency, but no assurance could be given that this dispute could be settled for that amount. In the
event that no settlement could be reached and the Company was not successful in its suit against 538 Madison Realty Company, the remaining amount owed under the lease over its remaining term at face value was $2,825,000. The landlord also claimed damages, pursuant to the lease for interest, attorneys fees and its costs incurred in connection with re-letting the space. In the event there was a determination that the lease continued in effect, the Company would assert offsets to the damages claimed, based on other settlements reached by the landlord in connection with the December 7, 1997 incident and the current re-letting of the space. Nevertheless there was no assurance that this dispute could be resolved for less than the full amount claimed by the landlord. Discovery was scheduled to be completed in March 2005 and no trial date had been set. The Company had agreed to enter into mediation with the landlord and a mediation date, after prior cancellations, occurred on March 3, 2005. On March 18, 2005, f
ollowing mediation that occurred on March 3, 2005, and continuing settlement discussions, the Company increased the amount of its reserve for the litigation by $1,780,000 to reflect management's then current estimated cost of $2,000,000 to settle this contingency. On April 28, 2005, the Company executed a Settlement and Release Agreement (the "Settlement Agreement") with 538 Madison Realty Company. Under the Settlement Agreement, the Company agreed to pay 538 Madison Realty Company a settlement amount of $2.35 million and the parties exchanged releases. Of this settlement amount, $1.15 million was paid by the Company upon execution of the Settlement Agreement, including the release of a security deposit previously held by 538 Madison Realty Company in the amount of $150,000. The remaining $1.2 million will be paid by the Company on or before March 15, 2006, without interest. The Company recorded an additional $2,150,000 as a liability at March 31, 2005.
On April 29, 2005, in conjunction with the Settlement Agreement, the Company evaluated financial covenants and received consents from its lender, Banknorth, N.A. and W.P. Carey & Co. LLC, the Company's landlord in a sale-leaseback financing transaction relating to its retail/manufacturing facility in Shelburne, Vermont, to amend certain financial covenants in regards to the one-time charge of $2.35 million attributable to payments made to 538 Madison Realty Company LLC pursuant to the Settlement Agreement.
There are various other claims, lawsuits, and pending actions against the Company incident to the operations of its businesses. It is the opinion of management, after consultation with counsel, that the ultimate resolution of such claims, lawsuits and pending actions will not have a material adverse effect on the Company's consolidated financial position, results of operations or liquidity. There can be no assurance, however, that claims will not be made against the Company in the future. Such claims, if material, may adversely affect the Company's businesses and results of operations.
On July 29, 2004, the Company entered into a new ten year lease for its Shelburne warehouse and fulfillment center to incorporate a 60,400 square foot addition to its existing facility that is contiguous to the property on which the Company's factory headquarters are located. The addition replaces 25,000 square feet of month-to-month leased space in Williston, Vermont. The new consolidated lease for 120,800 square feet replacing the July 19, 2000 lease began in October 2004. The consolidated lease is for ten years with three five-year renewal options.
On May 16, 2005, the Company entered into a definitive Agreement and Plan of Merger (the "Merger Agreement") with Hibernation Holding Company, Inc., a Delaware Corporation, and Hibernation Company, Inc., a Delaware Corporation and wholly-owned subsidiary of Hibernation Holding Company, Inc. Pursuant to the Merger Agreement, with the exception of certain stockholders who will exchange their existing stock and warrants for stock and warrants of Hibernation Holding Co., Inc., the Company's common and preferred stockholders would receive $6.50 per share of common stock, on an as converted basis, in cash, upon the closing of the transaction. The consummation of the merger is subject to certain terms and conditions customary for transactions of this type, including stockholder approval and completion of committed debt and equity financing.
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis provides information that the Company's management believes is relevant to an assessment and understanding of the Company's results of operations and financial condition. The discussion should be read in conjunction with the financial statements and footnotes that appear elsewhere in this report filed on Form 10-Q. This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1993 and Section 21E of the Securities Exchange Act of 1934. The words "believe," "expect," "anticipate," "intend," "estimate," and other expressions that predict or indicate future events and trends, and that do not relate to historical matters, identify forward-looking statements. Such statements involve risks and uncertainties that could cause actual results to differ materially from those set forth in such forward-looking statements. The Company undertakes no obligation to pu
blicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise, except as required by applicable laws and regulations.
Restatement
Subsequent to the issuance of the 2004 consolidated financial statements, the Company has determined that amortization of a building and the related costs financed under a sales-leaseback arrangement should have been amortized over the financing period of twenty years rather than the estimated useful life of the building of thirty-seven years. As a result, the accompanying unaudited condensed consolidated balance sheet as of June 30, 2004 and the related unaudited condensed consolidated statements of income for the three and nine months ended March 31, 2004 and the related unaudited condensed consolidated statement of cash flows for the nine months period ended March 31, 2004 have been restated to correct these errors.
Additionally, the Company has determined that it should restate the basic weighted average common shares outstanding and basic per share calculations to include the effect of the Series C convertible preferred stock. Because the Series C Preferred is deemed to be participating, the shares assumed to be converted into common shares are included in the calculation of basic earnings per share. Basic earnings per common share have been restated accordingly. See Note 2 to the unaudited condensed consolidated financial statements for additional information.
The following Management's Discussion and Analysis gives effect to the restatement.
Other Matters
On April 28, 2005, the Company executed a Settlement and Release Agreement (the "Settlement Agreement") with 538 Madison Realty Company LLC ("538 Madison"). Under the Settlement Agreement, the Company agreed to pay 538 Madison a settlement amount of $2.35 million and the parties exchanged mutual releases. Of this settlement amount, $1.15 million was paid by the Company upon execution of the Settlement Agreement, including the release of a security deposit previously held by 538 Madison in the amount of $150,000. The remaining $1.2 million will be paid by the Company on or before March 15, 2006, without interest. See Note 11 to the unaudited condensed consolidated financial statements for additional information.
Subsequent Events
On May 16, 2005, the Company entered into a definitive Agreement and Plan of Merger (the "Merger Agreement") with Hibernation Holding Company, Inc., a Delaware Corporation, and Hibernation Company, Inc., a Delaware Corporation and wholly-owned subsidiary of Hibernation Holding Company, Inc. Pursuant to the Merger Agreement, with the exception of certain stockholders who will exchange their existing stock and warrants for stock and warrants of Hibernation Holding Co., Inc., the Company's common and preferred stockholders would receive $6.50 per share of common stock, on an as converted basis, in cash, upon the closing of the transaction. The consummation of the merger is subject to certain terms and conditions customary for transactions of this type, including stockholder approval and completion of committed debt and equity financing. Refer to the Company's filing on Form 8-K dated May 17, 2005 for additional information.
Executive Overview
The Company's sales are seasonal in nature and, therefore, the results for interim periods are not necessarily indicative of the results expected for the respective full years. It is more instructive to compare the Company's performance in each interim period to the performance in the same interim period of prior years, in the context of comparable seasonal forces. In the nine month period described in this report, net revenues increased substantially in the Company's Gift delivery segment over the same period in the prior year primarily due to increased PajamaGram revenues, BearGram revenues, TastyGram revenues, and increased revenues from the Calyx & Corolla floral delivery service. The Company realized revenues in the Calyx segment for the entire nine months ended March 31, 2005, whereas last year, the Company only realized Calyx revenues in the seven months following the August 29, 2003 acquisition of the Calyx business. Retail Store and Corporate/Wholesale segments r
evenues decreased in the same month period described in this report as compared to the same period last year. The Company's gross margin dollars increased in this period, due to increased margin dollars in the PajamaGram, BearGram, TastyGram and Calyx & Corolla segments, which offset decreased margins in the Retail and Corporate/Wholesale segments.
Package delivery costs have increased in all of the Company's business segments due to increased fuel and other ancillary surcharges imposed by common carriers. Increased package delivery costs were most significant in the Calyx segment as the Company continued to ship packages via Federal Express. During the second half of this year, the Company expects to move virtually all Calyx package delivery to United Parcel Service, its lower cost primary carrier.
The Company incurred higher unit costs in manufacturing for the BearGram segment attributed to reduced throughput earlier in this nine month period as the Company transitioned its teddy bear manufacturing operations to modular manufacturing. The Company began the transition to modular manufacturing in February 2004 primarily in response to escalating worker's compensation costs related to repetitive motion injuries. In modular processes, employees work in teams or "modules" and rotate between manufacturing tasks performed to complete a bear in significantly shortened manufacturing cycles. The anticipated benefits to modular manufacturing, in addition to reduced worker's compensation costs, include reduced levels of work in process inventory and improved quality as problems are detected and addressed immediately when each bear is completed within the shortened cycle. With the transition completed, the Company expects to achieve in the second half of this year, higher levels of manufa
cturing efficiency with lower direct labor costs and improved employee satisfaction as employees no longer focus on a single operation and can work in a team environment. Excess overhead that currently impacts negatively on the Company's cost of goods in the BearGram segment is being addressed as the Company reallocates manufacturing space to other operations and as throughput increases in the second half of the year.
The PajamaGram segment margins were impacted by the increased delivery costs and the result of increased revenues from products which traditionally have lower gross unit margins. This impact was partially offset by improved unit gross margins associated with the Company's transition to its own PajamaGram private labeled merchandise imported directly from its suppliers overseas.
Increases in marketing and selling expenses for the PajamaGram, Calyx & Corolla, BearGram, and Retail Store segments, along with call center costs were partially offset by decreases in marketing and selling expenses for the TastyGram and Corporate/Wholesale segments during the period. The Company realized marketing and selling expenses in the Calyx segment for the entire nine month period ended March 31, 2005 versus only seven months in nine month period ended March 31, 2004 following the acquisition of the Calyx business on August 29, 2003. Marketing and selling expenses, as a percentage of net revenues, decreased during the three and nine month periods described in this report as the Company increased television and catalog advertising.
The increase in General and Administrative expenses this period is primarily due to the costs related to the settlement of the New York lease dispute (see Note 11). The Company recorded an additional $2,150,000 in settlement costs and $303,000 in legal fees related to conducting discovery and preparing for a possible trial.
Critical Accounting Policies
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Future events and their impact cannot be determined with absolute certainty. Therefore the determination of estimates requires the exercise of judgment. Actual results inevitably will differ from those estimates, and such differences may be material to the financial statements.
We believe application of accounting policies, and the estimates inherently required therein, are reasonable. These accounting policies and estimates are constantly reevaluated, and adjustments are made when facts and circumstances dictate a change.
We have identified certain critical accounting policies, which are described below:
Providing for Litigation Contingencies
The Company is involved in litigation incidental to its business, the disposition of which is expected to have no material effect on the Company's financial position or results of operations. It is possible, however, that future results of operations for any particular quarterly or annual period could be materially affected by differences between the Company's assumptions related to these proceedings and actual results. The Company accrues its best estimate of the probable cost for the resolution of legal claims. Such estimates are developed in consultation with outside counsel handling these matters and are based upon a combination of litigation and settlement strategies. To the extent additional information arises, it is possible that the Company's best estimate of its probable liability in these matters may change.
Goodwill and Indefinite Lived Intangibles
The Company acquired Calyx & Corolla, Inc. on August 29, 2003. This acquisition resulted in $5,383,000 of goodwill and other indefinite lived intangible assets. The Company tests goodwill and other indefinite lived intangible assets for impairment at least annually. The Company expects to complete its impairment testing as of June 30, 2005. Management's estimates of market values, projections of future cash flows and other factors are significant factors in testing goodwill and indefinite lived intangible assets for impairment. If these estimates or projections change in the future, the Company may be required to record an impairment charge. These adjustments can have a significant impact on future operating results and financial position.
Income Tax Provision
The Company provides for income taxes at rates equal to our combined federal and state effective rates, however, certain estimates are made based on historical experience and various other assumptions that are believed to be reasonable under the circumstances. Subsequent revisions to the estimated net realizable value of deferred tax assets, deferred tax liabilities and other income tax liabilities could cause our provision for income taxes to vary significantly from period to period.
Results of Operations
Comparison of the three-month periods ended March 31, 2005 and 2004.
Net revenues for the three month period ended March 31, 2005 totaled $25,574,000, an increase of $5,496,000 from net revenues of $20,078,000 for the three month period ended March 31, 2004. By business segment, increases in PajamaGram revenues of $3,013,000, increased revenues attributable to the BearGram gift delivery service of $2,027,000, and increases of $680,000 generated from the Calyx & Corolla floral delivery segment were partially offset by $206,000 in decreased revenues attributable to the Corporate/Wholesale segment due to a smaller wholesale customer base, and $18,000 in decreased revenues attributable to the Retail Store segment. PajamaGram segment revenues increased as the Company increased television, radio and catalog advertising during the three months ended March 31, 2005. BearGram revenues increased as the Company increased television advertising in this segment. Calyx & Corolla revenues increased as the Company increased catalog advertising in the three mon
th period ended March 31, 2005. Revenues in the Retail Store segment declined due to fewer tourists visiting the Company's factory retail store in the three months ended March 31, 2005 compared to the three months ended March 31, 2004.
Gross margin increased $2,814,000 to $14,695,000 for the three month period ended March 31, 2005, from $11,881,000 for the three month period ended March 31, 2004. The gross margin dollars in the PajamaGram segment increased $1,549,000, gross margin in the BearGram segment increased $1,236,000, gross margin in the Calyx & Corolla segment increased $175,000, and gross margin in the TastyGram segment increased $11,000. These increases were offset by a gross margin decrease in the Corporate/Wholesale segment of $126,000 and $31,000 in the Retail Store segment. Package delivery costs have increased in all of the Company's business segments due to increased fuel and other ancillary surcharges imposed by common carriers. Gross margin as a percentage of net revenue decreased to 57.5 percent from 59.2 percent in the same period last year. The PajamaGram segment decrease of 5.6 percentage points resulted from increased delivery costs and the result of increased revenue
s from products which traditionally have lower unit margins. The PajamaGram gross margin decreases were partially offset by improved unit gross margins associated with the Company's transition to private label goods imported directly from suppliers in Asia. The decrease of 3.3 percentage points in the Calyx & Corolla segment resulted from increased delivery costs during the period. The Calyx & Corolla gross margin is less as a percentage of net revenues than the Company's overall gross margin percentage, contributing to the Company's decrease in consolidated gross margin as a percentage of net revenues. BearGram gross margin as a percentage of net revenues decreased 0.2 percentage points. The Corporate/Wholesale segment decreased 14.3 gross margin percentage points due to increased product mix of domestically made teddy bears, which traditionally have lower unit margins than the Company's imported teddy bear products. The Retail Store segment experienced a decrease of 5.4 gross margin percentage po
ints due to higher domestic unit costs in this segment and product mix. These gross margin percentage decreases were partially offset by the gross margin increase of 10.6 percentage points in the TastyGram gift delivery service segment due to increased product margins.
Corresponding to an increase of net revenues of approximately $5,496,000 in the third quarter, marketing and selling expenses increased $1,197,000 to $8,721,000 for the three month period ended March 31, 2005, from $7,524,000 for the three month period ended March 31, 2004. PajamaGram segment marketing and selling costs increased $855,000 as the Company increased the segment's television, radio and catalog advertising. Call center and customer service costs increased $258,000 due to higher revenues. Marketing and selling costs associated with the Calyx & Corolla segment increased $189,000 as the Company increased Calyx & Corolla catalog advertising. These increases were partially offset by decreased BearGram segment advertising costs, which include radio, television, catalog, Internet and print costs of $77,000. While the Company increased BearGram television advertising, this increase was more than offset by decreased radio advertising in this period. Corporate/Wholesale mar
keting and selling costs decreased $19,000, Retail segment's marketing and selling costs decreased $6,000, and TastyGram marketing and merchandising costs decreased $3,000 as compared to the three month period ended March 31, 2004. Marketing and selling expenses as a percent of net revenues decreased to 34.1 percent for the three-month period ended March 31, 2005 from 37.5 percent for the three-month period ended March 31, 2004 as a result of management's conscious efforts to control and monitor marketing and selling expenses.
General and Administrative expenses increased to $4,549,000 for the three month period ended March 31, 2005, compared to $1,762,000 for the three month period ended March 31, 2004. The largest component of the increase is the additional $2,150,000 expense related to the settlement of the New York lease dispute (see Note 11). The remaining $637,000 increase is primarily attributed to increased legal expenses, order processing fees, buildings and maintenance costs and telephone costs. The Company incurred additional legal expenses of $213,000 due to the renewed legal activity in conducting discovery and preparing for a possible trial in the New York lease dispute (see Note 11) and increased legal and financial advisory fees of $175,000. Order processing fees increased $145,000 as a result of higher revenues. Buildings and maintenance costs, and telephone costs were higher by $42,000 and $19,000, respectively in the three month period ended March 31, 2005 as compared to the same period l
ast year, as the result of unanticipated labor reductions and credits obtained in the prior year. As a percentage of net revenues, general and administrative expenses, including the additional expense related to the settlement of the New York lease dispute, increased to 17.8 percent for the three month period ended March 31, 2005, from 8.8 percent for the three month period ended March 31, 2004. The additional expense related to the settlement of the New York lease dispute represents 8.4 percent of net revenue for the three month period ended March 31, 2005.
Interest expense decreased to $157,000 for the three month period ended March 31, 2005 due to the reduction in long term debt obligations, compared to $169,000 for the three month period ended March 31, 2004. Interest income increased to $22,000 as a result of higher average cash balances in the three month period ended March 31, 2005, compared to $10,000 for the three month period ended March 31, 2004.
The Company has recorded a tax provision of $1,018,000 for the three month period ended March 31, 2005, which is comprised of a current provision of $527,000, an effective income tax rate of 40.9 percent, and a deferred provision of $491,000 resulting from the deferred settlement payment of $1,200,000 pursuant to the New York lease dispute (see Note 11). The Company recorded a tax provision of $998,000 for the three month period ended March 31, 2004, an effective income tax rate of 40.96 percent.
As a result of the foregoing factors and the Series A Preferred Stock dividends of $18,000, the Series C Preferred Stock dividends of $1,400, and the Series D Preferred Stock dividends of $31,000, the net income available to Common Stockholders for the three month period ended March 31, 2005 was $221,000, compared to a net income available to Common Stockholders of $1,388,000 for the three month period ended March 31, 2004.
Comparison of the nine month periods ended March 31, 2005 and 2004.
Net revenues for the nine month period ended March 31, 2005 totaled $47,840,000, an increase of $9,372,000 from net revenues of $38,468,000 for the nine month period ended March 31, 2004. By business segment, increases in PajamaGram revenues of $5,216,000, increases of $2,539,000 generated from the Calyx & Corolla floral delivery segment, increased revenues attributable to the BearGram gift delivery service of $2,023,000, and increased revenues of $45,000 in the TastyGram segment, were partially offset by $266,000 in decreased revenues to the Corporate/Wholesale segment due to a smaller wholesale customer base, and $185,000 in decreased revenues attributable to the Retail Store segment. PajamaGram segment revenues increased as the Company increased television and catalog advertising during the nine months ended March 31, 2005. Calyx & Corolla revenues increased as the Company increased catalog advertising and as the Company realized revenues during the entire nine month perio
d ending March 31, 2005. During the nine month period ended March 31, 2004, the Company realized Calyx & Corolla revenues in the seven months subsequent to the August 29, 2003 acquisition date. BearGram revenues increased as the Company increased television advertising in this segment. Revenues in the Retail Store segment declined due to fewer tourists visiting the Company's factory retail store.
Gross margin increased $4,440,000 to $26,727,000 for the nine month period ended March 31, 2005, from $22,287,000 for the nine month period ended March 31, 2004. The gross margin dollars in the PajamaGram segment increased $2,871,000, gross margin in the BearGram segment increased $1,075,000, and the gross margin in the TastyGram segment increased $7,000. Calyx & Corolla segment gross margin increased $815,000 as the Company realized gross margins during the entire nine month period ended March 31, 2005. During the nine month period ended March 31, 2004, the Company realized gross margins in the seven months subsequent to the August 29, 2003 acquisition date. These increases were offset by a gross margin decrease in the Retail Store segment of $169,000, and a gross margin decrease in the Corporate/Wholesale segment of $159,000. The gross margin dollar decreases in the Retail Store and Corporate/Wholesale segments were primarily the result of lower net revenues in each of these seg
ments. Package delivery costs have increased in all of the Company's business segments due to increased fuel and other ancillary surcharges imposed by common carriers. Gross margin as a percentage of net revenue decreased to 55.9 percent from 57.9 percent in the period compared to the same period in the previous year. The decrease of 3.4 percentage points in the Calyx & Corolla segment resulted from increased delivery costs during the period. The Calyx & Corolla gross margin is less as a percentage of net revenues than the Company's overall gross margin percentage, contributing to the Company's decrease in consolidated gross margin as a percentage of net revenues. The PajamaGram segment decrease of 2.7 percentage points resulted from increased delivery costs and the result of increased revenues from products which traditionally have lower unit margins. These PajamaGram gross margin decreases were partially offset by improved unit gross margins associated with the Company's transition to private lab
el goods imported directly from suppliers in Asia. The gross margin decrease of 2.0 percentage points in the TastyGram gift delivery service segment is primarily attributed to increased delivery costs. The Corporate/Wholesale segment decreased 8.7 gross margin percentage points due to increased product mix of domestically made teddy bears, which traditional have lower unit margins than the Company's imported teddy bear products. The Retail Store segment experienced a decrease of 2.2 gross margin percentage points due to higher domestic unit costs in this segment and the November factory seconds sale. Increased delivery costs, increased costs from the recently expanded fulfillment and distribution center and increased bear unit manufacturing costs resulted in a 0.8 percentage point decrease in BearGram gross margin as a percentage of net revenues. The Company incurred higher unit costs in manufacturing for the BearGram segment that is attributed to reduced throughput earlier in this period as the Company tra
nsitioned its teddy bear manufacturing operations to modular manufacturing. In modular processes, employees work in teams or "modules" and rotate between manufacturing tasks performed to complete a bear in significantly shortened manufacturing cycles. The anticipated benefits to modular manufacturing, in addition to reduced worker's compensation costs, include reduced levels of work in process inventory which is already recognized in the Company's inventory balances and improved quality as problems are detected and addressed immediately when each bear is completed within the shortened cycle. Excess overhead that impacts negatively on the Company's cost of goods in the BearGram segment will be addressed as the Company reallocates manufacturing space to other operations and as throughput increases later in the year.
Corresponding to an increase of net revenues of approximately $9,372,000 in the nine months ended March 31, 2005, marketing and selling expenses increased $2,706,000 to $17,270,000 for the nine month period ended March 31, 2005, from $14,564,000 for the nine month period ended March 31, 2004. PajamaGram segment marketing and selling costs increased $1,490,000 as the Company increased the segment's television and catalog advertising. Marketing and selling costs associated with the Calyx & Corolla segment increased $641,000 as the Company increased Calyx & Corolla catalog advertising and realized expenses primarily related to catalog cost amortization for the entire nine month period in fiscal 2005 as opposed to only seven months in fiscal 2004 following the August 29, 2003 acquisition. Call center and customer service costs increased $539,000 due to higher revenues during the period. BearGram segment advertising costs, which include radio, television, catalog, Internet and print
costs increased $73,000 and the Retail segment's marketing and selling costs increased $33,000. These increases were partially offset by decreased Corporate/Wholesale marketing and selling costs of $44,000 and decreased TastyGram marketing and merchandising costs of $26,000 as compared to the nine month period ended March 31, 2004. The Company is continuing to reallocate its advertising expenditures between business segments depending on segment response rates and performance at different times of the year. As a result of management's conscious efforts to control and monitor marketing and selling expenses, the Company reallocated advertising dollars between Calyx & Corolla, BearGram, and PajamaGram segments. Marketing and selling expenses as a percent of net revenues decreased to 36.1 percent for the nine month period ended March 31, 2005 from 37.9 percent for the nine month period ended March 31, 2004
General and Administrative expenses increased to $7,485,000 for the nine month period ended March 31, 2005, compared to $4,327,000 for the nine month period ended March 31, 2004. The largest component of the increase is the additional $2,150,000 expense related to the settlement of the New York lease dispute (see Note 11). The remaining $1,008,000 increase is primarily attributed to increased legal expenses, order processing fees, employee benefit costs, buildings and maintenance costs and telephone costs. The Company incurred additional legal expenses of $303,000 due to the renewed legal activity in conducting discovery and preparing for a possible trial in the New York lease dispute (see Note 11) and increased legal and financial advisory fees of $197,000. Order processing fees increased $252,000 as a result of higher revenues. Employee benefit costs increased year over year in the first nine months of the fiscal year by $25,000. Buildings and maintenance and telephone costs were hi
gher by $91,000 and $79,000, respectively in the nine month period ended March 31, 2005 as compared to the same period last year, as the result of unanticipated labor reductions and credits obtained in the prior year period. As a percentage of net revenues, general and administrative expenses, including the additional expense related to the settlement of the New York lease dispute, increased to 15.7 percent for the nine month period ended March 31, 2005, from 11.2 percent for the nine month period ended March 31, 2004. The additional expense related to the settlement of the New York lease dispute represents 4.5 percent of net revenue for the nine month period ended March 31, 2005.
Interest expense decreased to $489,000 for the nine month period ended March 31, 2005 due to the reduction of long-term debt obligations, compared to $509,000 for the nine month period ended March 31, 2004. Interest income increased to $32,000 as a result of higher average cash balances in the nine month period ended March 31, 2005, compared to $28,000 for the nine month period ended March 31, 2004.
The Company has recorded a tax provision of $1,113,000 for the nine month period ended March 31, 2005, which is comprised of a current provision of $622,000, an effective income tax rate of 40.9 percent, and a deferred provision of $491,000 resulting from the deferred settlement payment of $1,200,000 pursuant to the New York lease dispute (see Note 11). The Company recorded a tax provision of $1,195,000 for the nine month period ended March 31, 2004, an effective income tax rate of 40.96 percent.
As a result of the foregoing factors and the Series A Preferred Stock dividends of $54,000, the Series C Preferred Stock dividends of $4,000, and the Series D Preferred Stock dividends of $94,000, the net income available to Common Stockholders for the nine month period ended March 31, 2005 was $256,000, compared to a net income available to Common Stockholders of $1,571,000 for the nine month period ended March 31, 2004.
Liquidity and Capital Resources
The following is a summary of the Company's contractual commitments and other obligations as of March 31, 2005. The Company's Other Long-Term Obligations are comprised of employment contracts and certain consulting arrangements.
Payments due by fiscal period
Contractual
Obligations |
Total |
Amounts representing interest |
Sub total
|
1-3 years |
3-5 years |
More than 5 years |
Long-Term Debt Obligations |
$1,944,875 |
($144,554) |
$2,089,429 |
$1,661,935 |
$427,494 |
-- |
Capital Lease Obligations |
$4,846,732 |
($3,834,504) |
$8,681,236 |
$1,583,739 |
$1,407,768 |
$5,689,729 |
Operating Lease Obligations |
$8,737,997 |
-- |
$8,737,997 |
$2,799,809 |
$1,858,830 |
$4,079,358 |
Series A Preferred Stock Dividend |
$630,000 |
-- |
630,000 |
-- |
-- |
|
Series C & D Redeemable Preferred Stock Obligations |
$2,783,918 |
-- |
$2,783,918 |
$2,119,221 |
$664,697 |
-- |
Other Long-Term Liabilities |
$3,358,333 |
-- |
$3,358,333 |
$3,251,250 |
$107,083 |
-- |
Total |
$22,301,855 |
($3,979,058) |
$26,280,913 |
$11,415,954 |
$4,465,872 |
$9,769,087 |
(A) Amount represents Series A cumulative dividends inception to date. Timing of payments is unknown. Such amount will continue to accumulate at $72,000 per year.
As of March 31, 2005, the Company's cash position increased to $8,850,000, from $7,057,000 at June 30, 2004. Of the $8,850,000, $474,000 is classified as restricted cash in accordance with the terms of the Company's sale leaseback transaction. There was $471,000 of restricted cash at June 30, 2004. Cash increases provided by net income and increases in accrued expenses were partially offset by the seasonal increase in inventories.
The Company's sales are heavily seasonal, with Valentine's Day, Mother's Day and Christmas as the Company's largest sales seasons, resulting in fluctuations in working capital obligations similar to those incurred during the same periods in past years.
The Company intends to continue to invest in support of its growth strategy. These investments include primarily continued advertising and marketing programs designed to enhance the Company's brand name recognition, retain and acquire new customers, expand its current product offerings and further develop its web site and operating infrastructure.
The Company believes that its existing cash and cash equivalent balances, together with funds generated from operations and available borrowings under its line of credit commitment from Banknorth, N.A., will be sufficient to finance the Company's operations for at least the next twelve months.
Commitments & Contingencies
On October 24, 1996, the Company entered into a ten-year lease for 2,600 square feet on Madison Avenue in New York City. On December 7, 1997, the Company's 538 Madison Avenue location was closed due to structural problems at neighboring 540 Madison Avenue. On December 16, the Company announced that it was permanently closing that retail location. The City of New York deemed the 538 Madison Avenue building uninhabitable from December 8, 1997 to April 9, 1998, and the Company has not made any rent payments on the lease since December, 1997. On December 24, 1998, the Company received a notice from its landlord of 538 Madison Avenue alleging that it was in default under the lease for failure to resume occupancy, and demand for back rent for the period July 8, 1998 to December 31, 1998 in the amount of $144,355. Further on January 4, 1999 the Company received a demand to resume rent payments beginning January 1999. The Company disputed the landlord's position and believed it was not obliga
ted to resume occupancy or pay rent under the lease. As a result, on May 25, 1999, the Company commenced action in the Supreme Court of the State of New York, County of New York against 538 Madison Realty Company. The action sought breach of contract damages and a declaration that the contract at issue, the former lease between the parties, has been terminated. The landlord moved to dismiss the action based on purported documentary evidence, being the lease itself. That motion was denied by order entered April 12, 2000. After having unsuccessfully attempted to resolve the disputes and after engaging in document discovery, the Company moved for summary judgment on its claims and dismissal of the landlord's claims. That motion was granted by order dated July 25, 2001 and judgment was entered in favor of the Company and against the landlord in the amount of $211,146 on August 10, 2001. The landlord filed an appeal of that judgment and, as settlement discussions were unsuccessful, posted a bond to stay e
nforcement of the judgment pending its appeal, which was argued on November 1, 2002. That judgment was affirmed by a 3-2 vote of New York's Appellate Division, First Department. Based on the two dissenting votes, the landlord had a right of appeal to New York's Court of Appeals. That appeal was fully briefed and then argued on February 10, 2004. On March 25, 2004, the New York Court of Appeals issued a decision reversing the Appellate Division, and denying the Company's summary judgment motion. This decision returned the case to the New York Supreme Court for a determination as to whether the Company's lease was terminated or continued in effect following the December 7, 1997 incident. The Company continued to pursue all of its legal remedies to resolve the litigation favorably by decision or settlement. The Company accrued management's estimated cost of $220,000 to settle this contingency, but no assurance could be given that this dispute could be settled for that amount. In the event that no settlement
could be reached and the Company was not successful in its suit against 538 Madison Realty Company, the remaining amount owed under the lease over its remaining term at face value was $2,825,000. The landlord also claimed damages, pursuant to the lease for interest, attorneys fees and its costs incurred in connection with re-letting the space. In the event there was a determination that the lease continued in effect, the Company would assert offsets to the damages claimed, based on other settlements reached by the landlord in connection with the December 7, 1997 incident and the current re-letting of the space. Nevertheless there was no assurance that this dispute could be resolved for less than the full amount claimed by the landlord. Discovery was scheduled to be completed in March 2005 and no trial date had been set. The Company had agreed to enter into mediation with the landlord and a mediation date, after prior cancellations, occurred on March 3, 2005. On March 18, 2005, following mediation that
occurred on March 3, 2005, and continuing settlement discussions, the Company increased the amount of its reserve for the litigation by $1,780,000 to reflect management's then current estimated cost of $2,000,000 to settle this contingency. On April 27, 2005, the Company executed a Settlement and Release Agreement with 538 Madison Realty Company, providing for a comprehensive settlement of litigation pending in the Supreme Court of the State of New York, County of New York. In that litigation, the Company sought a declaration that a lease with 538 Madison Realty Company had been terminated. Under the Settlement Agreement, the Company shall pay 538 Madison Realty Company $2.35 million and the parties exchanged mutual releases. Of this settlement amount, $1.15 million was paid by the Company upon execution of the Settlement Agreement, including the release of a security deposit in the amount of $150,000 previously held by 538 Madison Realty Company, and the remaining $1.2 million shall be paid by the Comp
any to 538 Madison Realty Company on or before March 15, 2006, without interest.
On April 29, 2005, in conjunction with the Settlement Agreement, the Company evaluated financial covenants and received consents from its lender, Banknorth, N.A. and W.P. Carey & Co. LLC, the Company's landlord in a sale-leaseback financing transaction relating to its retail/manufacturing facility in Shelburne, Vermont, to amend certain financial covenants in regards to the one-time charge of $2.35 million attributable to payments made to 538 Madison Realty Company LLC pursuant to the Settlement Agreement.
There are various other claims, lawsuits, and pending actions against the Company incident to the operations of its businesses. It is the opinion of management, after consultation with counsel, that the ultimate resolution of such claims, lawsuits and pending actions will not have a material adverse effect on the Company's consolidated financial position, results of operations or liquidity. There can be no assurance, however, that claims will not be made against the Company in the future. Such claims, if material, may adversely affect the Company's businesses and results of operations.
On July 29, 2004, the Company entered into a new ten year lease for its Shelburne warehouse and fulfillment center to incorporate a 60,400 square foot addition to the existing facility that is contiguous to the property on which the Company's factory headquarters are located. The addition replaces 25,000 square feet of month-to-month leased space in Williston, Vermont. The new consolidated lease for 120,800 square feet replacing the July 19, 2000 lease began in October 2004. The consolidated lease is for ten years with three five-year renewal options.
On May 16, 2005, the Company entered into a definitive Agreement and Plan of Merger (the "Merger Agreement") with Hibernation Holding Company, Inc., a Delaware Corporation, and Hibernation Company, Inc., a Delaware Corporation and wholly-owned subsidiary of Hibernation Holding Company, Inc. Pursuant to the Merger Agreement, with the exception of certain stockholders who will exchange their existing stock and warrants for stock and warrants of Hibernation Holding Co., Inc., the Company's common and preferred stockholders would receive $6.50 per share of common stock, on an as converted basis, in cash, upon the closing of the transaction. The consummation of the merger is subject to certain terms and conditions customary for transactions of this type, including stockholder approval and completion of committed debt and equity financing. Refer to the Company's filing on Form 8-K dated May 17, 2005 for additional information.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
(a) Quantitative Information About Market Risk
Under its current policies, the Company does not use interest rate sensitive instruments to manage exposure to interest rate changes. A ten percent fluctuation in interest rates would not have a material impact on the Company's ability to meet its financial obligations.
(b) Qualitative Information About Market Risk
The Company's earnings and cash flows are subject to fluctuations due to changes in interest rates primarily from its investment of available cash balances in money market funds.
Item 4. Controls and Procedures
(a) Disclosure Controls and Procedures. The Company has established disclosure controls and procedures with the intent to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known on a timely basis to the officers who certify our financial reports and to other members of senior management and the Board of Directors.
In April 2005, subsequent to the period covered by this report, our management determined that its previously issued financial statements should be restated to correct our accounting practices applicable to leases. The Company undertook a review of its lease accounting practices as a result of the February 7, 2005 letter from the Office of the Chief Accountant of the SEC to the American Institute of Certified Public Accountants that clarified existing generally accepted accounting principles applicable to leases. As a result of this review, the Company has re-evaluated its accounting treatment with respect to a sale leaseback transaction. The Company has corrected the way it accounts for its one financing lease, executed in July 1997 as part of a sale leaseback transaction involving the Company's factory headquarters in Shelburne, Vermont. Accordingly, the Company has restated its consolidated financial statements dating back to its 1997 transaction and for each of the three and nine month periods ended
March 31, 2004 included in this Form 10-Q. Additionally, the Company restated its basic weighted average common shares outstanding and earnings per share calculation to include the effect of the Series C Convertible Preferred Stock as it meets the definition of a participating security. The restatements are further discussed in the "Explanatory Note" and in Note 2 to the consolidated financial statements included herein.
In connection with the restatement and the filing of this Form 10-Q, the Company's management, including the Chief Executive Officer and Chief Accounting Officer, re-evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of March 31, 2005, the end of the period covered by this Form 10-Q. In performing this evaluation, management reviewed the Company's accounting as discussed above. As a result of this review, the Company concluded that its previously established lease accounting practices and evaluation of its participating securities were not appropriate and that previously reported financial statements would need to be restated. Based on that evaluation, our management, including the Chief Executive Officer and Chief Accounting Officer concluded that the disclosure controls and procedures as of the end of the period covered by this Form 10-Q were not functioning effectively in ensuring that material information relating to the Company, required to be
disclosed in reports that it files or submits under the Securities Exchange Act of 1934 was recorded, processed, summarized and reported within the requisite time periods. The evaluation did not reveal any fraud, intentional misconduct or concealment on the part of Company personnel. The Company has remediated the ineffectiveness of its disclosure controls and procedures by conducting a review of its accounting practices with respect to leases, participating securities and certain other areas and correcting its accounting practices related to leases and participating securities.
(b) Internal Controls. Since the date of the evaluation described above, there have not been any significant changes in our internal accounting controls or in other factors that could significantly affect those controls, other than the remediation effects discussed above.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
On April 27, 2005, the Company executed a Settlement and Release Agreement with 538 Madison Realty Company, providing for a comprehensive settlement of litigation pending in the Supreme Court of the State of New York, County of New York. Under the Settlement Agreement, the Company shall pay 538 Madison Realty Company $2,350,000 and the parties will exchange mutual releases. Of this settlement amount, $1,150,000 was paid by the Company upon execution of the Settlement Agreement, including the release of a security deposit in the amount of $150,000 previously held by 538 Madison Realty Company, and the remaining $1,200,000 shall be paid by the Company to 538 Madison Realty Company on or before March 15, 2006, without interest. A description of the background of this action appears in Part I, Note 11 of this report under the heading Legal Proceedings and Part I, Item 2 of this report under Commitments & Contingencies.
There are various other claims, lawsuits, and pending actions against the Company incident to the operations of its businesses. It is the opinion of management, after consultation with counsel, that the ultimate resolution of such claims, lawsuits and pending actions will not have a material adverse effect on the Company's consolidated financial position, results of operations or liquidity. There can be no assurance, however, that claims will not be made against the Company in the future. Such claims, if material, may adversely affect the Company's businesses and results of operations.
Item 5. Other Information
Elisabeth B. Robert, the Company's Chief Executive Officer/Chief Financial Officer and Mark J. Sleeper, the Chief Accounting Officer, have furnished to the SEC the certification with respect to this Form 10-Q that is required by Section 906 of the Sarbanes-Oxley Act of 2002. See exhibit 32.
Item 6. Exhibits
(a) Exhibits
31 Rule 13a-14(a)/15d-14(a) Certifications.
- Certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 by Elisabeth B. Robert, President, Chief Executive Officer, Treasurer, and Chief Financial Officer and Mark J. Sleeper, Chief Accounting Officer (filed herein).
99 Discharge of Stock Pledge Agreement and Note for Elisabeth Robert
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
The Vermont Teddy Bear Co., Inc.
Date: May 17, 2005 /s/ Elisabeth B. Robert ,
Elisabeth B. Robert,
Chief Executive Officer and
Chief Financial Officer