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Form 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended May 24, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
For the transition period from to
Commission file number 1-9637.
LILLIAN VERNON CORPORATION
--------------------------
(Exact Name of Registrant as Specified in its Charter)
Delaware 13-2529859
- --------------------------------- -----------------------------------
(State or other jurisdiction IRS Employer Identification Number)
of incorporation or organization)
1 Theall Road, Rye, New York 10580
---------------------------------------------------
(Address of principal executive offices) (Zip Code)
914-925-1200
---------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No ____
-------
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes ____ No X
-------
Number of shares outstanding of each of the issuer's classes of common stock:
8,430,599 Shares of Common Stock, $.01 par value, as of July 1, 2003.
LILLIAN VERNON CORPORATION AND SUBSIDIARIES
Form 10-Q
May 24, 2003
Part I. Financial Information Page #
Item 1.
Consolidated Balance Sheets
as of May 24, 2003, May 25, 2002
and February 22, 2003 (unaudited) 3
Consolidated Statements of Operations
for the quarters ended May 24,
2003 and May 25, 2002 (unaudited) 4
Consolidated Statements of Cash Flows
for the quarters ended May 24,
2003 and May 25, 2002 (unaudited) 5
Notes to Consolidated Financial
Statements (unaudited) 6-12
Item 2.
Management's Discussion and Analysis
of Financial Condition and Results
of Operations 12-17
Item 3.
Quantitative and Qualitative Disclosures
About Market Risk 17-18
Item 4.
Controls and Procedures 18
Part II. Other Information 18
Item 6.
Exhibits and Reports on Form 8-K 18
Signatures 19
Officers' Certifications 20-21
Sarbanes-Oxley Act Section 906 Certification 22
Page 2 of 22
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
LILLIAN VERNON CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
MAY 24, MAY 25, FEBRUARY 22,
ASSETS 2003 2002 2003
------ ---- ---- ----
Current assets:
Cash and cash equivalents $ 23,457 $ 27,000 $ 24,218
Accounts receivable, net of allowances of $336, $290,
and $509, respectively 5,173 6,643 14,455
Merchandise inventories 21,916 24,717 17,135
Deferred income taxes 488 268 621
Prepayments and other current assets 4,000 8,012 3,269
--------- --------- ---------
Total current assets 55,034 66,640 59,698
Property, plant and equipment, net 25,714 30,458 28,406
Deferred catalog costs 4,075 5,152 4,013
Deferred income taxes 3,681 3,714 3,343
Other assets 4,979 7,037 5,450
--------- --------- ---------
Total $ 93,483 $ 113,001 $ 100,910
--------- --------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current liabilities:
Trade accounts payable and accrued expenses $ 15,996 $ 15,260 $ 17,971
Cash overdrafts 1,112 1,150 361
Customer deposits 1,939 1,837 1,954
--------- --------- ---------
Total current liabilities 19,047 18,247 20,286
Other liabilities 3,783 8,015 6,444
--------- --------- ---------
Total liabilities 22,830 26,262 26,730
--------- --------- ---------
Stockholders' equity:
Preferred stock, $.01 par value; 2,000,000 shares
authorized; no shares issued and outstanding -- -- --
Common stock, $.01 par value; 100,000,000 shares
authorized; issued - 10,386,324 shares, 10,389,674 shares and
and 10,386,324 shares, respectively 104 104 104
Additional paid-in capital 31,332 31,332 31,332
Retained earnings 64,128 82,400 68,109
Accumulated other comprehensive losses, net of taxes (610) (1,458) (667)
Treasury stock, at cost -1,955,725 shares, 2,067,052 shares
and 1,987,694 shares, respectively (24,301) (25,639) (24,698)
--------- --------- ---------
Total stockholders' equity 70,653 86,739 74,180
--------- --------- ---------
Total $ 93,483 $ 113,001 $ 100,910
--------- --------- ---------
See Notes to Consolidated Financial Statements
Page 3 of 22
LILLIAN VERNON CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
FISCAL QUARTERS ENDED
---------------------
MAY 24, MAY 25,
2003 2002
---- ----
Revenues $ 23,460 $ 36,889
Costs and expenses:
Product and delivery costs 14,759 22,026
Selling, general and administrative expenses 16,798 21,057
Restructuring credit -- (387)
-------- --------
31,557 42,696
-------- --------
Operating loss (8,097) (5,807)
Gain on sale of land and building 1,846 --
Gain on settlement of paper collar contract 2,745 --
Interest income 70 124
Financing expense (164) (1,563)
-------- --------
Loss before benefit from
income taxes (3,600) (7,246)
Provision for (benefit from) income taxes:
Current 0 116
Deferred 117 (2,507)
-------- --------
117 (2,391)
Net loss (3,717) (4,855)
-------- --------
Net loss per common share - Basic and Diluted $ (0.44) $ (0.58)
-------- --------
Weighted average number of common shares -
Basic and Diluted 8,418 8,315
-------- --------
See Notes to Consolidated Financial Statements.
Page 4 of 22
LILLIAN VERNON CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
FISCAL QUARTERS ENDED
---------------------
MAY 24, MAY 25,
2003 2002
---- ----
Cash flows from operating activities:
Net loss ($3,717) ($4,855)
Adjustments to reconcile net loss to net cash provided by
(used in ) operating activities:
Financing expense for paper collar contract 92 1,495
Gain on settlement of paper collar contract (2,745) --
Derivative losses transferred to earnings 90 163
Depreciation 420 563
Amortization 526 544
Gain on disposal of assets (1,846) --
Decrease in accounts receivable 9,282 8,313
(Increase) decrease in merchandise inventories (4,781) 1,901
(Increase) decrease in prepayments and other current assets (731) 69
(Increase) decrease in deferred catalog costs (62) 1,293
Decrease (increase) in other assets 42 (21)
Decrease in trade accounts payable and accrued expenses (1,930) (4,146)
Decrease in customer deposits (15) (1,060)
Increase in deferred income taxes (238) (2,697)
Decrease in other liabilities (55) (32)
-------- --------
Net cash (used in) provided by operating activities (5,668) 1,530
-------- --------
Cash flows from investing activities:
Purchases of property, plant and equipment (176) (223)
Purchases of software (96) --
Proceeds from sale of assets 4,295 --
-------- --------
Net cash provided by (used in) investing activities 4,023 (223)
-------- --------
Cash flows from financing activities:
Increase in cash overdrafts 751 661
Payments to acquire treasury stock -- (3)
Reissuance of treasury stock for stock options and employee benefit plans 133 141
-------- --------
Net cash provided by financing activities 884 799
-------- --------
Net (decrease) increase in cash and cash equivalents (761) 2,106
-------- --------
Cash and cash equivalents at beginning of period 24,218 24,894
-------- --------
Cash and cash equivalents at end of period $ 23,457 $ 27,000
-------- --------
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Income taxes $ 10 $ 109
-------- --------
See Notes to Consolidated Financial Statements.
Page 5 of 22
LILLIAN VERNON CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
The unaudited consolidated financial statements included herein have been
prepared by the Company in accordance with generally accepted accounting
principles for interim financial information and pursuant to the rules and
regulations of the Securities and Exchange Commission. The year-end consolidated
balance sheet data as of February 22, 2003 was derived from audited financial
statements, but does not include all Notes to Financial Statements and
Statements of Stockholders' Equity required by generally accepted accounting
principles. The interim financial statements furnished with this report reflect
all adjustments, consisting only of items of a normal recurring nature, which
are, in the opinion of management, necessary for the fair statement of the
consolidated financial condition and consolidated results of operations for the
interim periods presented. It is suggested that these financial statements be
read in conjunction with the financial statements and notes thereto included in
the Company's Form 10-K for the year ended February 22, 2003.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Stock Based Compensation
The Company follows the provisions of APB Opinion No. 25,
"Accounting for Stock Issued to Employees," in accounting for stock-based
compensation arrangements. Under the guidelines of APB Opinion No. 25,
compensation cost for stock-based employee compensation plans is recognized
based on the difference, if any, between the quoted market price of the stock on
the date of grant and the amount an employee must pay to acquire the stock.
As all options are fixed and have been granted at fair value, no
compensation cost has been recognized for its non-qualified stock options
granted. In addition, no compensation cost has been recognized for shares issued
through its Employee Stock Purchase Plan as the plan is considered
noncompensatory. If compensation cost for the Company's non-qualified stock
options issued and shares purchased through its stock purchase plan had been
determined based on the fair value at the grant dates for awards under those
plans consistent with the requirements of FAS 123, "Accounting for Stock-Based
Compensation," the Company's net loss and loss per share would have been equal
to the pro forma amounts indicated below (dollars in thousands, except per share
amounts):
Page 6 of 22
Quarter Ended
-------------
May 24, May 25,
2003 2002
---- ----
Net loss as reported $( 3,717) $(4,855)
Deduct:
Total stock-based employee compensation expense
determined under the fair value based method for all
stock option awards and shares purchased, net of the
related tax effects $ (256) $ (372)
-------- -------
Pro forma net loss $(3,973) $(5,227)
Loss per share:
Basic and Diluted As reported $ (.44) $ (.58)
loss per share Pro forma $ (.47) $ (.63)
Goodwill and Other Intangibles
Effective February 24, 2002, the Company adopted Statement of Financial
Accounting Standard No.142 "Goodwill and Other Intangible Assets." ("FAS 142").
Under FAS 142, goodwill and intangible assets with indefinite lives are no
longer amortized, but are assessed for impairment annually and upon the
occurrence of an event that indicates impairment may have occurred. In
accordance with FAS 142, the Company has not amortized goodwill for fiscal 2003
and the first quarter of fiscal 2004.
At May 24, 2003 and May 25, 2002, goodwill and intangible assets were as
follows (in thousands):
May 24, 2003
------------
Gross
Carrying Accumulated Net
Amount Amortization Amount
------ ------------ ------
Goodwill $2,782 $ (348) $2,434
Intangible Assets $ 100 $ (63) $ 37
May 25, 2002
------------
Gross
Carrying Accumulated Net
Amount Amortization Amount
------ ------------ ------
Goodwill $2,782 $ (348) $2,434
Intangible Assets $ 100 $ (43) $ 57
Page 7 of 22
The amortization expense of the above intangible assets for the first
quarter of both fiscal years 2004 and 2003 was $5,000. Amortization expense in
fiscal 2004, 2005 and 2006 will be $20,000, $20,000 and $1,667 respectively.
Reclassifications
Certain reclassifications have been made to the prior years' financial
statements to conform with the first quarter of fiscal 2004 presentation.
2. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment is summarized as follows (in thousands):
May 24, May 25, February 22,
2003 2002 2003
---- ---- ----
Land and buildings $29,839 $33,006 $33,072
Machinery and equipment 29,589 30,403 29,714
Furniture and fixtures 3,966 4,210 4,144
Leasehold improvements 752 1,002 718
------- ------- -------
Total property, plant &
equipment, at cost 64,146 68,621 67,648
Less: accumulated depreciation
and amortization 38,432 38,163 39,242
------- ------- -------
Property, plant and equipment, net $25,714 $30,458 $28,406
------- ------- -------
The Company sold the smaller of its two warehouse buildings (the "Annex")
on May 15, 2003 for net proceeds of $4,303,000. The Annex, which consisted of
land and building in the amount of $2,449,000 net of accumulated depreciation,
had been classified as assets held for sale at February 2003. Once the assets
were classified as held for sale, depreciation was suspended. The sale of the
Annex resulted in a pretax gain of $1,846,000 after related expenses and was
recorded in the first quarter of fiscal 2004.
In July 2003, the Company entered into a sale and leaseback transaction of
the National Distribution Center in Virginia Beach, Virginia, which has a net
book value of $18,160,000 as of May 24, 2003. See Note 7.
Page 8 of 22
3. LOSS PER SHARE
Basic and diluted loss per share was calculated as follows (amounts in
thousands):
Fiscal Quarter Ended
May 24, 2003 May 25, 2002
------------ ------------
Net loss - Basic and Diluted ($3,717) ($4,855)
Weighted average shares for
Basic and Diluted EPS 8,418 8,315
For the fiscal periods ended May 24, 2003 and May 25, 2002, options on
2,024,000 and 1,748,000 shares of common stock, respectively, were not included
in the calculation of weighted average shares for Diluted EPS because their
effects were antidilutive.
4. PAPER COLLAR CONTRACT
The Company's earnings are impacted by fluctuating paper prices. In order
to partially mitigate this risk, the Company entered into a paper collar
contract in December 1998. This contract covered certain grades of paper used by
the Company to produce its catalogs. There was a floor and ceiling on paper
prices within the contract. If paper prices remained within the range of the
contract, there would have been no payment to either party to the contract. If
paper prices exceeded the established ceiling the Company would have been
entitled to be reimbursed by the counterparty for the excess. Conversely, if
paper prices fell below the established floor the Company would have been
required to pay the counterparty. The Company did not pay a premium at the
inception of the contract. The contract had an expiration date of August 2005.
The paper collar contract had been designated, and was effective, as a
hedge through November 2001. During the nine months ended November 24, 2001,
ineffectiveness related to the paper collar contract was not significant.
Due to the financial situation of the counterparty, Enron North America
Corporation ("Enron"), the Company discontinued hedge accounting subsequent to
November 2001. As a result, $1,736,000 previously recorded in Accumulated Other
Comprehensive Losses under hedge accounting through November 24, 2001 are being
reclassified to earnings as a component of selling, general and administrative
expenses (catalog costs) in the period in which earnings are affected by the
paper costs, through the end of the contract. For the first quarter of fiscal
years 2004 and 2003 these amounts were $57,000 and $42,000 respectively. In
addition, any changes in the fair value of the contract subsequent to November
24, 2001 will be recorded in earnings as financing expense. For the first
quarter of fiscal years 2004 and 2003 these amounts were $92,000 and $1,495,000,
respectively, on a pre-tax basis.
Page 9 of 22
On May 12, 2003, the Company entered into a Settlement Agreement and
Mutual Release with Enron, whereby the Company agreed to pay $3,000,000 as
consideration for the release and settlement of all claims under the paper
collar contract. The Settlement Agreement and Mutual Release have been approved
by Enron's creditors' committee and the Bankruptcy Court. Prior to the effective
date of the settlement, the Company had $3,287,000 included in accounts payable
and accrued expenses relating to this obligation in addition to the fair value
of the contract of $2,458,000 included in other liabilities. Thus the Company
recorded a pretax gain of $2,745,000 ($3,287,000 + $2,458,000 = $5,745,000 -
$3,000,000 = $2,745,000) in the first quarter of fiscal 2004 relating to the
release and settlement of the paper collar contract. The $3,000,000 settlement
owed to Enron has been included in accrued expenses as of May 24, 2003 and was
paid in June 2003. The Company will continue to reclassify derivative losses
currently recorded in other comprehensive income in shareholders equity, to
earnings through the termination date of the original contract, August 2005.
Hedging activity affected Accumulated Other Comprehensive Losses, net of
income taxes, during the quarter ended May 24, 2003 as follows (dollars in
thousands):
Balance as of February 22, 2003 ($667)
Derivative losses transferred to earnings: 57
-----
Balance as of May 24, 2003 ($610)
5. INCOME TAXES
The company has recorded a tax expense of $117,000 on a loss before income
taxes of $3,600,000. The effective income tax rate differs from the statutory
tax rate due to the effect of state income taxes, a higher tax rate on
significant and infrequently-occurring items and an increase to the deferred
income tax valuation allowance.
As of February 22, 2003, the Company had net operating loss carryforwards
of approximately $15,300,000 and $7,700,000 for federal and state income tax
purposes, respectively, which expire beginning in fiscal 2022 through fiscal
2023. The Company has generated additional tax losses for the first quarter
ended May 24, 2003 of approximately $10,100,000 and $3,600,000 for federal and
state purposes, respectively. The potential future tax benefit of such loss
carryforwards are included in the deferred tax assets. The ultimate realization
of these tax benefits is dependent upon the generation of sufficient amounts of
future taxable income during the years in which the related net expenses become
deductible and the related net operating loss and tax credit carryforwards may
be utilized prior to expiration. The Company's ability to generate sufficient
taxable income in future periods is contingent upon a number of factors,
including general economic conditions and the Company's sales levels in future
periods. Although management has developed plans which should enable the Company
to achieve sufficient income levels in the future, there can be no assurance
that the plans will be successful in enabling the Company to generate sufficient
taxable income from operations in the periods in which the net expenses become
deductible and prior to the expiration of the net operating loss carryforwards.
On July 2, 2003, the Company completed the merger transaction approved by its
stockholders on June 23, 2003, whereby the Company was acquired by a private
equity fund managed by Ripplewood Holdings L.L.C. As part of the financing in
connection with the transaction, the Company sold its National Distribution
Center in Virginia Beach for $37,000,000 and leased it back under a 20 year
lease. The sale resulted in taxable income of approximately $19,500,000 in the
second quarter of fiscal 2004. The taxable income generated by the sale of the
National Distribution Center will not be sufficient to fully utilize the
Company's net operating loss carryforward. The Company may not be able to
Page 10 of 22
fully realize the benefit of the remaining future net deductible expenses and
net operating loss and tax credit carryforwards prior to expiration. Therefore,
the Company has recorded a deferred income tax valuation allowance in the amount
of $5,468,000 at May 24, 2003. The increase in the valuation allowance during
the first quarter totaled $917,000. The Company expects to record a valuation
allowance on future tax benefits until it can be determined that it is more
likely than not that the deferred tax asset will be realized.
Pursuant to Internal Revenue Code Section 382, certain substantial
ownership changes, such as the merger discussed in Note 7, may result in an
annual limitation on the amount of net operating loss or tax credit carry
forwards that may be utilized to offset future income tax liabilities.
6. RECENTLY ADOPTED ACCOUNTING STANDARDS
In July 2002, the Financial Accounting Standards Board ("FASB") issued FAS
146 "Accounting for Costs Associated with Exit or Disposal Activities", which
the Company adopted as of the beginning of fiscal 2004. FAS 146 requires
companies to recognize certain costs associated with exit or disposal activities
when they are incurred rather than at the date of a commitment to an exit or
disposal plan. The provisions of FAS 146 are effective for any exit and disposal
activities initiated in fiscal 2004.
In November 2002, the FASB issued Interpretation No. 45, ("FIN 45")
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others" which requires certain guarantees
to be recorded at fair value rather than the current practice of recording a
liability only when a loss is probable and reasonably estimatable and also
requires a guarantor to make new guaranty disclosures, even when the likelihood
of making any payments under the guarantee is remote. The accounting
requirements of FIN 45 are effective for guarantees issued or modified after
December 31, 2002, and the disclosure requirements are effective for financial
statements of interim or annual periods ending after December 15, 2002. The
Company does not expect the adoption of the accounting requirements of FIN 45 to
have a material impact on its consolidated financial position or results of
operations and the Company has adopted the disclosure requirements.
7. SUBSEQUENT EVENTS
On July 2, 2003, the Company completed the merger transaction approved by
its stockholders on June 23, 2003, whereby the Company was acquired by a private
equity fund managed by Ripplewood Holdings L.L.C. Trading in the Company's
Common Stock on the American Stock Exchange officially ended. The Company
recorded expenses totaling $384,000 related to the costs of the merger
transaction as of May 24, 2003. These costs consisted principally of legal and
other professional fees and have been included in the Company's general and
administrative expenses. The lawsuit filed by North Border Investments, which
alleges, among other things, that the cash price per share paid to stockholders
in connection with the Merger was unfair and inadequate and the Company's
directors breached their fiduciary duties to the Company's stockholders in
approving the Merger Agreement did not impede the consummation of the merger. On
July 2, 2003, the Company sold its National Distribution Center in Virginia
Beach, Virginia for $37,000,000, and leased it back under a 20 year lease. The
proceeds of the
Page 11 of 22
sale/leaseback were used as part of the merger consideration to pay the
Company's stockholders. The Company also signed a new revolving credit agreement
with The CIT Group / Business Credit Inc. The new facility provides for a
maximum available credit line totaling $40 million. The credit line has been
collateralized by certain assets of the Company including accounts receivable,
inventory and equipment.
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Results of Operations
Quarter Ended May 24, 2003
On July 2, 2003, the Company completed the merger transaction approved by
its stockholders on June 23, 2003, whereby the Company was acquired by a private
equity fund managed by Ripplewood Holdings L.L.C. Trading in the Company's
Common Stock on the American Stock Exchange officially ended. Ripplewood's
Industrial Partner, ZelnickMedia, will be responsible for the day-to-day
management of the Company. The Company will continue to operate in the catalog
and direct marketing business. Following the acquisition, Ms. Lillian Vernon,
the founder, and formerly the Chairman of the Board and largest stockholder of
the Company, serves as the Company's non-executive Chairman as well as the
Company's spokesperson.
The net loss for the first quarter of fiscal 2004 was $3.7 million, or
$.44 per share, compared to a net loss of $4.9 million, or $.58 per share for
the same period last year. Revenues declined approximately $13.4 million for the
current quarter because of planned reduced catalog circulation. The impact of
the reduced revenues on the loss for the quarter was partially offset by lower
cost of sales on less products sold and a higher gross profit margin as a result
of less inventory liquidation during the first quarter of fiscal 2004. The
Company reduced its selling, general, and administrative expenses. The Company
recorded a pretax gain of approximately $1.8 million related to the sale of the
smaller of its two warehouse facilities (the "Annex") on May 15, 2003. The
Company also recorded a pretax gain of approximately $2.7 million related to the
Settlement Agreement and Mutual Release with Enron under the paper collar
contract. The Company's business is seasonal. Net losses are generally incurred
during the first and second fiscal quarters.
Revenues for the quarter ended May 24, 2003 decreased 36.4% to $23.5
million compared to $36.9 million last year, primarily due to the Company's
decision to scale back catalog circulation to eliminate marginal catalogs and
reduce costs. For the first quarter of fiscal 2004, catalog circulation
decreased 43.4% compared to the prior year. While orders processed for the first
quarter decreased 38.7% from the prior year, revenue per catalog increased 11.8%
and average revenue per order increased 3.4%. Internet orders represented
approximately 24% of the total for the first quarter of fiscal 2004, compared to
approximately 19% in the first quarter last year.
Product and delivery costs of $14.8 million in the first quarter of fiscal
2004 decreased 33.0% from $22.0 million for the comparable period last year.
Page 12 of 22
Product and delivery costs include the cost of merchandise sold and the cost of
receiving, personalizing, filling and shipping orders for the Company's
customers. The decrease in product and delivery costs was principally a result
of the decline in volume and the reduced number of orders shipped. As a
percentage of revenue, product and delivery costs increased from 59.7% in the
first quarter of fiscal 2003 to 62.9% in the first quarter of fiscal 2004. There
was an increase in the Company's product gross profit margin in the current
quarter, principally as a result of less inventory liquidation. This was offset
however, principally by the impact of fixed costs of the National Distribution
Center as a percentage of lower revenue.
Selling, general and administrative (SG&A) expenses were $16.8 million in
the first quarter of fiscal 2004 compared to $21.1 million in the first quarter
of fiscal 2003, a decrease of $4.3 million or 20.2%. The cost of producing,
printing, and mailing the Company's catalogs represents the single largest
component of SG&A expenses. These costs decreased principally because of a
decrease of approximately 43.4% in the number of catalogs circulated in the
current quarter. As a percentage of revenue, SG&A expenses increased from 57.1%
in the first quarter of fiscal 2003 to 71.6% in the first quarter of fiscal
2004, principally because of the effect of relatively fixed costs on lower
revenue. Also there was an increase in professional fees of approximately $ .4
million associated with the Merger Agreement which was approved at the special
meeting of stockholders held on June 23, 2003. Higher Internet advertising
expenditures of $.2 million also contributed to the higher percentage of costs
for the current quarter.
Interest income of $.1 million for the first quarter of fiscal 2004 was
comparable to the first quarter of fiscal 2003.
Financing expense for the first quarter of fiscal 2004 was $.2 million
compared to $1.6 million for the first quarter of fiscal 2003. In the first
quarter of fiscal 2004, the Company recorded a financing charge of $92,000 to
record the change in the fair market value of the Company's paper price collar
contract, compared to $1.5 million in the first quarter of fiscal 2003. On May
12, 2003, the Company entered into a Settlement Agreement and Mutual Release
with Enron, whereby the Company agreed to pay $3 million as consideration for
the release and settlement of all claims under the paper collar contract. The
Settlement Agreement and Mutual Release have been approved by Enron's creditors'
committee and the Bankruptcy Court. Prior to the effective date of the
settlement, the Company had $3.3 million included in accounts payable and
accrued expenses relating to this obligation in addition to the fair value of
the contract of $2.4 million included in other liabilities. Thus the Company
recorded a gain of $2.7 million ($3.3 million + $2.4 million = $5.7 million -
$3.0 million = $2.7 million) in the first quarter of fiscal 2004 relating to the
release and settlement of the paper collar contract. The $3 million settlement
owed to Enron has been included in accrued expenses as of May 24, 2003 and was
paid in June 2003. The Company will continue to reclassify, from other
comprehensive income, those derivative losses arising prior to the contract
having no longer been designated as a hedging instrument to earnings through the
termination date of the original contract, August 2005. (See Item
3-"Quantitative and Qualitative Disclosures about Market Risk").
Page 13 of 22
The Company sold the smaller of its two warehouse buildings (the Annex) on
May 15, 2003 for net proceeds of $4.3 million. The sale of the Annex which
consisted of land and building in the amount of $ 2.5 million net of accumulated
depreciation, resulted in a pretax gain of $1.8 million, after related expenses
and was recorded in the first quarter of fiscal 2004.
The Company has recorded a tax expense of $.1 million on a loss before
income taxes of $3.6 million. The effective income tax rate differs from the
statutory tax rate due to the effect of state income taxes, a higher tax rate on
significant and infrequently-occurring items and an increase to the deferred
income tax valuation allowance.
As of May 24, 2003, the Company has recorded a net deferred tax asset of
$4.2 million after the recording of the valuation allowance. The ultimate
realization of the Company's net deferred tax asset is dependent upon the
generation of sufficient amounts of future taxable income during the years in
which the related net expenses become deductible and the related net operating
loss and tax credit carryforwards may be utilized prior to expiration. The
Company's ability to generate sufficient taxable income in future periods is
contingent upon a number of factors, including general economic conditions and
the Company's sales levels in future periods. Although management has developed
plans which should enable the Company to achieve sufficient income levels in
the future, there can be no assurance that the plans will be successful in
enabling the Company to generate sufficient taxable income from operations in
the periods in which the net expenses become deductible and prior to the
expiration of net operating loss carryforwards. On July 2, 2003, the Company
completed the merger transaction approved by its stockholders on June 23, 2003,
whereby the Company was acquired by a private equity fund managed by Ripplewood
Holdings L.L.C. As part of the financing in connection with the transaction,
the Company sold its National Distribution Center for $37 million, and leased
it back under a 20 year lease. The sale resulted in taxable income of
approximately $19.5 million in the second quarter of fiscal 2004. The taxable
income generated by the sale of the National Distribution Center will not be
sufficient to fully utilize the Company's net operating loss carryforward. The
Company may not be able to fully realize the benefit of the remaining future net
deductible expenses and operating loss and tax credit carryforwards prior to
expiration. Therefore, the Company has recorded a deferred income tax valuation
allowance of $5.5 million at May 24, 2003. The increase in the valuation
allowance during the first quarter of fiscal 2004 totaled $.9 million. The
Company expects to record a valuation allowance on future tax benefits until it
can be determined that it is more likely than not that the deferred tax asset
will be realized.
Financial Condition
Cash and cash equivalents were $23.5 million as of May 24, 2003. The
current ratio was 3.0:1 as of May 24, 2003, compared to 3.7:1 as of May 25,
2002. The reduction in the current ratio was due principally to lower inventory
and prepayments and other current assets as of May 24, 2003 compared to the same
period last year.
Page 14 of 22
Included in prepayments and other current assets was an income tax receivable of
$3.8 million at May 25, 2002 and there was no comparable receivable at May 24,
2003. The Company's working capital needs were met with funds on hand and
generated from operations.
The Company's use of funds for operating activities for the current
quarter ended May 24, 2003 was $5.7 million or $7.2 million more than the same
period last year. The principal difference was in the amount of cash used for
inventory transactions.
In the first quarter of fiscal 2004 the Company's investing activities
generated $4.0 million, principally because the Company received $4.3 million
from the sale of the "Annex". Capital spending of $.3 million for the three
months ended May 24, 2003 was comparable to the same period last year. These
expenditures were made principally to upgrade the Company's software, computer
equipment and distribution machinery and equipment.
The Company generated $.1 million of cash from the issuance of common
stock through its employee benefit plans during the three months ended May 24,
2003, the same amount as for the three months ended May 25, 2002.
At its February 28, 2002 meeting, the Board of Directors voted to
discontinue the regular quarterly cash dividend to conserve cash for
reinvestment in the business.
As of May 24, 2003, the Company had repurchased 1,178,442 shares at a
total cost of approximately $11.4 million under its current 1.5 million share
open market stock repurchase program, which was authorized by the Board of
Directors on October 7, 1998 and September 28, 1999. No shares have been
purchased since February 28, 2002.
On May 8, 2003, the Company amended its revolving credit facility to
provide for an available credit line totaling $15 million. This facility matured
on July 2, 2003, the date on which the merger transaction between the Company
and Ripplewood Holdings L.L.C. was consummated. Under its terms, a portion of
the credit facility (up to $5 million) was able to be used for general
corporate purposes including working capital needs and capital expenditures and
the balance of the facility (up to $10 million,) for letters of credit to
purchase inventory. At the Company's option interest was payable at a) LIBOR
plus 100 basis points, b) prime rate, c) bankers' acceptance rate plus 100 basis
points, or d) a fixed rate. The Company was subject to various quarterly
financial covenants principally relating to its earnings, working capital, net
worth, interest coverage ratio and capital spending restrictions. In connection
with the merger transaction, the Company signed a new revolving credit agreement
with The CIT Group/Business Credit Inc. The Company has not borrowed under the
credit line in the first quarter of fiscal 2004 nor in the same period of the
prior year, and all its working capital needs for the past four fiscal years
were met with funds on hand and generated from operations. On July 2, 2003, the
Company sold its National Distribution Center in Virginia Beach, Virginia for
$37 million, and leased it back under a 20 year lease.
Page 15 of 22
The Company continues to focus on returning to profitability through
evaluating business operations and implementing changes that will increase
efficiency, reduce costs and improve cash flow. For the balance of fiscal 2004,
the Company plans to scale back catalog circulation to eliminate marginal
catalogs and circulation and also plans to reduce its SG&A expenses. The Company
is also testing new forms of advertising; particularly on the Internet, in order
to increase revenues.
The Company believes that its cash flow from operations, funds on hand and
its available credit facility will be sufficient to meet its operating needs for
the balance of the fiscal year.
Recently Adopted Accounting Standards
In July 2002, the Financial Accounting Standards Board ("FASB")
issued FAS 146 "Accounting for Costs Associated with Exit or Disposal
Activities", which the Company adopted as of the beginning of fiscal 2004. FAS
146 requires companies to recognize certain costs associated with exit or
disposal activities when they are incurred rather than at the date of a
commitment to an exit or disposal plan. The provisions of FAS 146 will be
effective for any exit and disposal activities initiated in fiscal 2004.
In November 2002, the FASB issued Interpretation No. 45, ("FIN 45")
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others" which requires certain guarantees
to be recorded at fair value rather than the current practice of recording a
liability only when a loss is probable and reasonably estimatable and also
requires a guarantor to make new guaranty disclosures, even when the likelihood
of making any payments under the guarantee is remote. The accounting
requirements of FIN 45 are effective for guarantees issued or modified after
December 31, 2002, and the disclosure requirements are effective for financial
statement of interim or annual periods ending after December 15, 2002. The
Company does not expect the adoption of the accounting requirements of FIN 45 to
have a material impact on its consolidated financial position or results of
operations and the Company has adopted the disclosure requirements.
Forward Looking Statements
Except for historical information contained herein, statements included in
this Form 10-Q may constitute forward-looking statements within the meaning of
the Private Securities Litigation Reform Act of 1995. These statements relate to
the Company's future performance, including, without limitation, statements with
respect to the Company's anticipated results of operations, revenues, cash flows
and/or level of business. Such statements represent the Company's current
expectations only and are subject to certain risks, assumptions and
uncertainties. Should one or more of these risks or uncertainties materialize,
or should underlying assumptions prove incorrect, actual results may vary
materially from those anticipated or projected. Among the factors that could
cause actual results to materially differ include the overall strength of the
economy, the level of consumer confidence and spending, customer preferences,
circulation changes and other initiatives, increased competition in the direct
mail industry and from the
Page 16 of 22
growing Internet market, changes in government regulations, risks associated
with the social, political, economic and other conditions affecting foreign
sourcing, including possible disruptions caused by the current unstable global
situation, and possible future increases in operating costs including postage
and paper costs. For further information, see Part I of Form 10-K for the fiscal
year ended February 22, 2003.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's earnings are impacted by fluctuating paper prices. In order
to partially mitigate this risk the Company entered into a paper collar contract
in December 1998. This contract covered certain grades of paper used by the
Company to produce its catalogs. There was a floor and ceiling on paper prices
within the contract. If paper prices remained within the range of the contract,
there would have been no payment to either party to the contract. If paper
prices exceeded the established ceiling the Company would have been entitled to
be reimbursed by the counterparty for the excess. Conversely, if paper prices
fell below the established floor, the Company would have been required to pay
the counterparty. The Company did not pay a premium at the inception of the
contract. The contract's expiration date was August 2005.
The paper collar contract had been designated, and was effective, as a
hedge through November 2001. During the nine months ended November 24, 2001,
ineffectiveness related to the paper collar contract was not significant.
Due to the financial situation of the counterparty, Enron North America
Corporation ("Enron"), the Company discontinued hedge accounting subsequent to
November 2001. As a result, $1.7 million previously recorded in Accumulated
Other Comprehensive Losses under hedge accounting through November 24, 2001 are
being reclassified to earnings as a component of selling, general and
administrative expenses (catalog costs) in the period in which earnings are
affected by the paper costs, through the end of the contract. For the first
quarter of fiscal years 2004 and 2003 these amounts were $57,000 and $42,000
respectively. In addition, any changes in the fair value of the contract
subsequent to November 24, 2001 will be recorded in earnings as financing
expense. For the first quarter of fiscal years 2004 and 2003 these amounts were
$92,000 and $1.5 million respectively, on a pre-tax basis.
On May 12, 2003, the Company entered into a Settlement Agreement and
Mutual Release with Enron, whereby the Company agreed to pay $3 million as
consideration for the release and settlement of all claims under the paper
collar contract. The Settlement Agreement and Mutual Release has been approved
by Enron's creditors' committee and the Bankruptcy Court. Prior to the effective
date of the settlement, the Company had $3.3 million included in accounts
payable and accrued expenses relating to this obligation in addition to the fair
value of the contract of $2.4 million included in other liabilities. Thus the
Company recorded a gain of $2.7 million ($3.3 million + $2.4 million = $5.7
million - $3.0 million = $2.7 million) in the first quarter of fiscal 2004
relating to the release and settlement of the paper collar contract.
Page 17 of 22
The $3 million settlement owed to Enron has been included in accrued expenses as
of May 24, 2003 and was paid in June 2003. The Company will continue to
reclassify, from other comprehensive income, those derivative losses arising
prior to the contract having no longer been designated as a hedging instrument
to earnings through the termination date of the original contract, August 2005.
ITEM 4. CONTROLS AND PROCEDURES
Within the 90 days prior to the filing date of this report, the Company carried
out an evaluation, under the supervision and with the participation of the
Company's management, including the Company's Chief Executive Officer and the
Company's Executive Vice President / Chief Operating Officer / Chief Financial
Officer, of the effectiveness of the design and operation of the Company's
disclosure controls and procedures pursuant to Rule 13a-14 under the Securities
Exchange Act of 1934. Based upon that evaluation, the Company's Chief Executive
Officer and Executive Vice President / Chief Operating Officer / Chief Financial
Officer concluded that the Company's disclosure controls and procedures are
effective in timely alerting them to material information relating to the
Company (including its consolidated subsidiaries) required to be included in the
Company's periodic SEC filings. Since the date of the evaluation, there have
been no significant changes in the Company's internal controls or in other
factors that could significantly affect the controls.
PART II. OTHER INFORMATION
ITEMS 1, 2, 3, 4 and 5 are not applicable and have been omitted.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
Exhibit No. 10.1 - Settlement Agreement and Mutual Release of paper collar
contract with Enron North America Corp.
Reports on Form 8-K: On April 17, 2003, the Registrant announced the
signing of a definitive merger agreement with
Ripplewood Holdings LLC ("Ripplewood") pursuant to
which Ripplewood will acquire the Registrant
for $7.25 per share in cash.
Page 18 of 22
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Lillian Vernon Corporation
Date: July 17, 2003 By: /s/ Richard P. Randall
-----------------------------
Richard P. Randall
Executive Vice President
Chief Operating Officer/
Chief Financial Officer
Page 19 of 22
CHIEF FINANCIAL OFFICER
CERTIFICATION
I, Richard P. Randall, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Lillian Vernon
Corporation;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect
to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented
in this quarterly report.
4. I am responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules 13a-14 and
15d-14) for the registrant and I have:
a. designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries, is
made known to me by others within those entities,
particularly during the period in which this quarterly
report is being prepared;
b. evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date within
90 days prior to the filing date of this quarterly
report (the "Evaluation Date"); and
c. presented in this quarterly report my conclusions about
the effectiveness of the disclosure controls and
procedures based on my evaluation as of the Evaluation
Date;
5. I have disclosed, based on my most recent evaluation, to the
registrant's auditors and the audit committee of registrant's board
of directors (or persons performing the equivalent function):
a. all significant deficiencies in the design or operation
of internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weakness in internal
controls; and
b. any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and
Page 20 of 22
6. I have indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors that
could significantly affect internal controls subsequent to the date
of my most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: July 17, 2003
By: /s/ Richard P. Randall
------------------------
Richard P. Randall
Executive Vice President
Chief Operating Officer/
Chief Financial Officer
Page 21 of 22
CERTIFICATION
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, the
undersigned, being the Chief Financial Officer of Lillian Vernon Corporation
(the "Issuer"), hereby certifies that:
1. The 10-Q Report of the Issuer for the quarter ended May 24, 2003
("10-Q Report") fully complies with the requirements of Section
13(a) of the Securities Exchange Act of 1934, and that
2. The 10-Q Report fairly presents, in all material respects, the
financial condition and results of operations of the Issuer.
Date: July 17, 2003
LILLIAN VERNON CORPORATION
By: /s/ Richard P. Randall
----------------------------
Richard P. Randall
Executive Vice President
Chief Operating Officer/
Chief Financial Officer
Page 22 of 22