FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
__________________________________________________________________
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2002
______________________________
COMMISSION FILE NUMBER 0-16251
GALAXY NUTRITIONAL FOODS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 25-1391475
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2441 VISCOUNT ROW
ORLANDO, FLORIDA 32809
(Address of principal executive offices) (Zip Code)
(407) 855-5500
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). YES [ ] NO [X]
On February 14, 2003, there were 12,755,286 shares of Common Stock $.01 par
value per share, outstanding.
1
GALAXY NUTRITIONAL FOODS, INC.
INDEX TO FORM 10-Q
FOR QUARTER ENDED DECEMBER 31, 2002
PAGE NO.
--------
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Balance Sheets 3
Statements of Operations 4
Statement of Stockholders' Equity 5
Statements of Cash Flows 6
Notes to Financial Statements 7-12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS 14
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 22
ITEM 4. CONTROLS AND PROCEDURES 22
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 23
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS 23
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 24
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 24
ITEM 5. OTHER INFORMATION 24
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 25
SIGNATURES & CERTIFICATIONS 29
2
PART I. FINANCIAL INFORMATION
-----------------------------
GALAXY NUTRITIONAL FOODS, INC.
BALANCE SHEETS
DECEMBER 31, MARCH 31,
2002 2002
------------ ------------
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash $ 1,628 $ 168
Trade receivables, net 4,315,262 5,283,187
Inventories 5,127,731 5,748,652
Prepaid expenses and other 599,773 555,520
------------ ------------
Total current assets 10,044,394 11,587,527
PROPERTY AND EQUIPMENT, NET 22,763,681 24,180,636
OTHER ASSETS 508,286 479,387
------------ ------------
TOTAL $ 33,316,361 $ 36,247,550
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Book overdrafts $ 576,858 $ 1,192,856
Line of credit 4,166,084 5,523,875
Accounts payable 3,158,340 5,399,143
Accrued liabilities 1,695,890 994,341
Current portion of term notes payable 2,182,913 1,809,000
Current portion of subordinated note payable 4,000,000 --
Current portion of obligations under capital leases 379,170 349,380
------------ ------------
Total current liabilities 16,159,255 15,268,595
TERM NOTES PAYABLE, less current portion 7,528,734 8,391,535
SUBORDINATED NOTE PAYABLE -- 3,385,770
OBLIGATIONS UNDER CAPITAL LEASES, less current portion 459,493 734,156
------------ ------------
Total liabilities 24,147,482 27,780,056
------------ ------------
COMMITMENTS AND CONTINGENCIES -- --
REDEEMABLE CONVERTIBLE PREFERRED STOCK 1,712,969 2,156,311
STOCKHOLDERS' EQUITY:
Common stock 127,553 115,400
Additional paid-in capital 60,575,301 60,717,914
Accumulated deficit (40,354,283) (41,629,470)
------------ ------------
20,348,571 19,203,844
Less: Notes receivable arising from the exercise of stock
options and sale of common stock (12,772,200) (12,772,200)
Treasury stock, 26,843 shares, at cost (120,461) (120,461)
------------ ------------
Total stockholders' equity 7,455,910 6,311,183
------------ ------------
TOTAL $ 33,316,361 $ 36,247,550
============ ============
See accompanying notes to financial statements.
3
GALAXY NUTRITIONAL FOODS, INC.
STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
---------------------------- ----------------------------
2002 2001 2002 2001
------------ ------------ ------------ ------------
NET SALES $ 9,829,420 $ 10,325,699 $ 29,993,813 $ 33,500,132
COST OF GOODS SOLD 6,805,863 7,355,250 21,089,597 25,524,884
------------ ------------ ------------ ------------
Gross margin 3,023,557 2,970,449 8,904,216 7,975,248
------------ ------------ ------------ ------------
OPERATING EXPENSES:
Selling 1,314,235 1,983,565 3,773,908 5,499,661
Delivery 478,331 595,162 1,561,847 1,807,783
Non-cash compensation related
to options & warrants 190,720 (1,559,024) (2,794,630) 2,070,243
General and administrative 864,399 786,634 2,453,148 3,197,175
Research and development 60,674 43,075 174,888 140,931
------------ ------------ ------------ ------------
Total operating expenses 2,908,359 1,849,412 5,169,161 12,715,793
------------ ------------ ------------ ------------
INCOME (LOSS) FROM OPERATIONS 115,198 1,121,037 3,735,055 (4,740,545)
Interest expense (536,766) (913,523) (2,404,868) (2,310,635)
Other expense (55,000) (57,520) (55,000) (57,520)
------------ ------------ ------------ ------------
NET INCOME (LOSS) $ (476,568) $ 149,994 $ 1,275,187 $ (7,108,700)
Preferred Stock Dividends 69,017 87,500 209,017 262,500
Preferred Stock Accretion to
Redemption Value 198,852 244,147 273,549 1,271,038
------------ ------------ ------------ ------------
NET INCOME (LOSS) AVAILABLE TO
COMMON SHAREHOLDERS $ (744,437) $ (181,653) $ 792,621 $ (8,642,238)
============ ============ ============ ============
BASIC NET INCOME (LOSS) PER
COMMON SHARE $ (0.06) $ (0.02) $ 0.07 $ (0.84)
============ ============ ============ ============
DILUTED NET INCOME (LOSS) PER
COMMON SHARE $ (0.06) $ (0.02) $ 0.06 $ (0.84)
============ ============ ============ ============
See accompanying notes to financial statements.
4
GALAXY NUTRITIONAL FOODS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
(UNAUDITED)
Notes
Common Stock Receivable
--------------------------- Additional Accumulated for Common Treasury
Shares Par Value Paid-In Capital Deficit Stock Stock Total
-----------------------------------------------------------------------------------------------------------
Balance at March 31,
2002 11,540,041 $ 115,400 $ 60,717,914 $(41,629,470) $(12,772,200) $ (120,461) $ 6,311,183
Exercise of options 1,000 10 4,240 -- -- -- 4,250
Issuance of common
stock 1,210,764 12,108 3,146,025 -- -- -- 3,158,133
Issuance of common
stock under
employee stock
purchase plan 3,481 35 9,709 9,744
Issuance of warrants -- -- 70,000 -- -- -- 70,000
Non-cash compensation
related to variable
options and warrants -- -- (2,871,605) -- -- -- (2,871,605)
Dividends on
preferred stock -- -- (209,017) -- -- -- (209,017)
Accretion of discount
on preferred stock (291,965) -- -- -- (291,965)
Net income -- -- -- 1,275,187 -- -- 1,275,187
-----------------------------------------------------------------------------------------------------------
Balance at December
31, 2002 12,755,286 $ 127,553 $ 60,575,301 $(40,354,283) $(12,772,200) $ (120,461) $ 7,455,910
===========================================================================================================
See accompanying notes to financial statements.
5
GALAXY NUTRITIONAL FOODS, INC.
STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED DECEMBER 31, 2002 2001
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income (Loss) $ 1,275,187 $ (7,108,700)
Adjustments to reconcile net income (loss) to net cash
from (used in) operating activities:
Depreciation 1,707,586 1,551,983
Amortization of debt discount 614,230 511,859
Provision for losses on trade receivables (136,700) 425,000
Non-cash compensation related to variable options and stock
issued under non-recourse note receivable (2,871,605) 1,726,857
Amortization of consulting and director fee expense paid
through issuance of common stock warrants 76,975 343,386
(Increase) decrease in:
Trade receivables 1,104,625 573,229
Inventories 620,921 3,024,332
Prepaid expenses and other (44,253) 133,298
Increase (decrease) in:
Accounts payable (1,054,170) (2,933,124)
Accrued liabilities 609,200 247,283
------------ ------------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES 1,901,996 (1,504,597)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (195,868) (565,110)
Increase in other assets (35,874) --
------------ ------------
NET CASH USED IN INVESTING ACTIVITIES (231,742) (565,110)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase (decrease) in book overdrafts (615,998) (446,829)
Net payments on line of credit (1,357,791) (2,737,304)
Borrowings on term note payable 500,000 --
Repayments on term notes payable (1,336,363) (1,266,964)
Principal payments on capital lease obligations (339,636) (135,512)
Proceeds from issuance of common stock, net of offering costs 1,476,744 3,017,745
Proceeds from exercise of common stock options 4,250 19,521
Proceeds from exercise of common stock warrants, net of costs -- 800,000
Proceeds from issuance of preferred stock, net of costs -- 2,900,959
------------ ------------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES (1,668,794) 2,151,616
------------ ------------
NET INCREASE IN CASH 1,460 81,909
CASH, BEGINNING OF PERIOD 168 500
------------ ------------
CASH, END OF PERIOD $ 1,628 $ 82,409
============ ============
See accompanying notes to financial statements.
6
GALAXY NUTRITIONAL FOODS, INC.
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
------------------------------------------
The unaudited financial statements have been prepared by the Company, under
the rules and regulations of the Securities and Exchange Commission. The
accompanying financial statements contain all normal recurring adjustments
which are, in the opinion of management, necessary for the fair
presentation of such financial statements. Certain information and
disclosures normally included in the financial statements prepared in
accordance with generally accepted accounting principles have been omitted
under such rules and regulations although the Company believes that the
disclosures are adequate to make the information presented not misleading.
The March 31, 2002 balance sheet data was derived from the audited
financial statements, but does not include all disclosures required by
accounting principles generally accepted in the United States of America.
These unaudited financial statements should be read in conjunction with the
financial statements and notes included on Form 10-K for the fiscal year
ended March 31, 2002. Interim results of operations for the nine-month
period ended December 31, 2002 may not necessarily be indicative of the
results to be expected for the full year.
Net Income (Loss) per Common Share
----------------------------------
Net income (loss) per common share is computed by dividing net income or
loss by the weighted average shares outstanding. Diluted income (loss) per
common share is computed on the basis of weighted average shares
outstanding plus potential common shares which would arise from the
exercise of stock options, warrants and conversion of the Series A
preferred stock.
Use of Estimates
----------------
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and reported amounts of
revenues and expense during the reporting period. The Company's significant
estimates include the allowance for doubtful accounts receivable, provision
for obsolete inventory, and valuation of deferred taxes and warrants.
Actual results could differ from those estimates.
New Accounting Pronouncements
-----------------------------
In July 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 146 "Accounting
for Costs Associated with Exit or Disposal Activities," which is effective
January 1, 2003. SFAS 146 provides than an exit cost liability should not
always be recorded at the date of an entity's commitment to an exit plan,
but instead should be recorded when the obligation is incurred. An entity's
commitment to a plan, by itself, does not create an obligation that meets
the definition of a liability. The Company does not expect SFAS 146 to have
a material impact on its financial condition and results of operations.
In December 2002, the FASB issued Statement of Financial Accounting
Standards No. 148, "Accounting for Stock-Based Compensation-Transition and
Disclosure-an amendment of FAS 123" ("SFAS 148"). This statement amends
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" ("SFAS 123"), to provide alternative methods of
transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation and amends the disclosure
requirements to SFAS 123 to require prominent disclosures in both annual
and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on
reported results. The transition and annual disclosure provisions of SFAS
148 are effective for fiscal years ending after December 15, 2002. The
Company will adopt SFAS 148 during its fourth quarter ending March 31,
2003.
Reclassifications
-----------------
Certain items in the financial statements of the prior period have been
reclassified to conform to current period presentation.
Segment Information
-------------------
The Company does not identify separate operating segments for management
reporting purposes. The results of operations are the basis on which
management evaluates operations and makes business decisions. The Company's
sales are generated primarily within the United States of America.
7
(2) INVENTORIES
-----------
Inventories are summarized as follows:
December 31, 2002 March 31, 2002
----------------- --------------
(UNAUDITED)
Raw materials $ 2,518,322 $ 2,482,458
Finished goods 2,609,409 3,266,194
------------ ------------
Total $ 5,127,731 $ 5,748,652
============ ============
(3) LINE OF CREDIT AND NOTES PAYABLE
--------------------------------
As of December 31, 2002, the Company had a line of credit with a maximum
principal amount of $7.5 million from FINOVA Capital Corporation ("FINOVA
Capital"), the proceeds of which are for working capital purposes. The
amount that the Company can borrow under the line of credit is based on a
formula of up to 80% of eligible accounts receivable plus a certain
percentage of eligible inventories not to exceed $3 million, as defined in
the agreement. Pursuant to a certain Amendment and Limited Waiver to
Security Agreement dated June 26, 2002, the inventory advance rate
decreases by 1% per month beginning July 1, 2002 from a level of 50% at
June 30, 2002 to 37% by the maturity date (44% at December 31, 2002). The
line of credit is secured by all accounts receivable, inventory, machinery,
equipment, trademarks and patents owned by the Company. Interest is payable
monthly on the outstanding draws on the line of credit at a rate of prime
plus four percent (8.25% at December 31, 2002). The line of credit expires
on July 1, 2003, at which time the entire outstanding principal amount of
the line of credit, and all accrued but unpaid interest thereon, is due and
payable in full. As of December 31, 2002, the Company had an outstanding
balance of $4,166,084 under this line.
On September 30, 1999, the Company obtained a $4 million subordinated loan
from FINOVA Mezzanine Capital, Inc. ("FINOVA Mezzanine"). The Company
received loan proceeds in the amount of $3,620,000 after paying loan costs
of $380,000. Amounts outstanding under the loan are secured by a
subordinated lien on substantially all of the Company's assets. A balloon
payment of the entire principal amount of the loan, and all accrued but
unpaid interest thereon, is due upon maturity on July 1, 2003. Interest on
the loan is payable monthly at a rate of 15.5% per annum. In consideration
of the loan, the Company issued to FINOVA Mezzanine a warrant to purchase
915,000 shares of the Company's common stock (of which 100,000 shares
remain unexercised) at an exercise price of $3.41 per share which
represented 80% of the fair value of the Company's stock on the date the
warrant was issued. The warrant was valued at $786,900 which was recorded
as a debt discount and was amortized to interest expense from the date of
issuance of the note to an original earlier maturity date of the note in
October 2002. As of December 31, 2002, this discount has been fully
amortized to interest expense and the Company had an outstanding balance of
$4,000,000 under this loan.
The line of credit and subordinated loan described above contain certain
financial and operating covenants. In June 2002, the Company notified
FINOVA Capital and FINOVA Mezzanine that it had failed to comply with the
minimum operational cash flow to contractual debt service ratio and the
funded debt to EBITDA ratio. FINOVA Capital agreed to waive those
violations for the fiscal year ended March 31, 2002 and the fiscal quarter
ended June 30, 2002 and to amend such covenants for the fiscal quarters
beginning July 1, 2002, pursuant to a certain Amendment and Limited Waiver
to Security Agreement dated June 26, 2002. FINOVA Mezzanine also agreed to
waive the violations of its covenants for the fiscal year ended March 31,
2002 and the fiscal quarter ended June 30, 2002, and to amend those
covenants for future fiscal quarters pursuant to a letter agreement dated
June 26, 2002 and amendments to the subordinated notes. In consideration of
the waivers and covenant amendments, the Company agreed to pay a facility
fee of $413,500, which was deemed fully earned on June 26, 2002. The
facility fee is payable as follows: $172,500 is due and payable on the
earliest of (a) $28,750 per month beginning January 2003, (b) the
occurrence of an event of default, or (c) the date on which the Company
repays either all of the obligations to FINOVA Capital under the Loan
Agreement or any portion of the principal obligations to FINOVA Mezzanine
under the FINOVA Mezzanine loan documents, with the balance of $241,000 due
and payable only upon FINOVA Mezzanine's exercise of its remaining 100,000
warrants. The Company was in compliance with all amended covenants for the
quarter ended December 31, 2002.
In March 2000, the Company obtained a $10 million term loan from SouthTrust
Bank, N.A. This note bears interest at prime rate (4.25% at December 31,
2002) and is due in monthly principal installments of $93,000 plus
interest. In a letter agreement dated September 27, 2002, the bank deferred
the four principal payments, due in June 2002 through September 2002, until
the maturity of the note. The note matures in March 2005. The balance
outstanding on this note as of December 31, 2002 was $8,397,313. This term
loan is secured by certain machinery and equipment.
8
In October 2000, the Company obtained a $1.5 million short-term bridge loan
from SouthTrust Bank, N.A. which is secured by one million shares of the
Company's common stock owned by the Company's President. Interest on this
note is at the prime rate (4.25% at December 31, 2002). The loan is being
paid down by monthly principal payments of $50,000 plus interest. In a
letter agreement dated September 27, 2002, the bank deferred the four
principal payments, due in June 2002 through September 2002, until the
maturity of the note. The note matures in October 2003. The balance
outstanding on this note as of December 31, 2002 was $750,000.
The term loan and the short-term bridge loan from SouthTrust Bank, N.A.
contain certain financial and operating covenants. The Company was in
violation of all financial covenants at March 31, 2002. On June 27, 2002,
the Company received a waiver for the year ended March 31, 2002 and for all
future periods through July 1, 2003. On February 13, 2003, the Company
received a waiver for all future periods through March 31, 2004.
The Company's ability to continue as a going concern depends upon
successfully obtaining sufficient financing to pay down or replace the
FINOVA debts due in July 2003. In the event the Company cannot extend the
loans, or raise the capital to pay off or replace the debt in July 2003,
FINOVA Capital and FINOVA Mezzanine could exercise their respective rights
under their loan documents to, among other things, declare a default under
the loans and pursue foreclosure of the Company's assets which are pledged
as collateral for such loans. In the event that FINOVA exercises their
right to pursue foreclosure, then SouthTrust has the ability to do the same
based on a cross-default provision in their loan agreement. The Company is
seeking to obtain the necessary funds through its positive cash flows from
operating activities, equity financing, and/or refinancing with FINOVA or a
substitute lender. There are no assurances, however, that such financing,
if available will be at a price that will not cause substantial dilution to
the Company's shareholders.
In March 2002, Angelo S. Morini, the Company's President, loaned $330,000
to the Company in order for it to pay down certain notes payable that were
coming due. This loan bears interest at prime (4.25% at December 31, 2002)
and is due on or before June 15, 2006.
On June 26, 2002, the Company signed a $550,000 promissory note with
Excalibur Limited Partnership, one of the holders of the Company's Series A
Preferred Stock. In consideration of the note, the Company issued Excalibur
Limited Partnership a warrant to purchase 30,000 shares of Common Stock,
which are exercisable until June 26, 2007 at a price equal to $5.50 per
share. This note was non-interest bearing assuming that it was repaid on or
before July 26, 2002. This note was secured by 250,000 shares of Common
Stock owned by the Angelo S. Morini, the Company's President. In
consideration of his pledge, the Company granted Mr. Morini stock options
to acquire 289,940 shares of Common Stock at an exercise price of $5.17
(110% of market) per share. These options shall expire on July 1, 2007. On
June 26, 2002, the Company received loan proceeds in the amount of $500,000
in cash from Excalibur Limited Partnership. The additional $50,000 was
retained by Excalibur Limited Partnership as payment for consulting fees
due to Excalibur Limited Partnership in accordance with a consulting
agreement entered into on June 26, 2002, which expired December 31, 2002.
This note was paid in full on June 28, 2002 from proceeds derived from the
issuance of common stock to Stonestreet Limited Partnership as discussed in
Note 5.
On August 15, 2002, the Company signed a $347,475 promissory note with
Target Container, Inc. in satisfaction of its accounts payable obligation
to this vendor. This note bears interest at 7% per annum and is due in
twelve equal monthly installments of $30,066. The balance outstanding on
this note as of December 31, 2002 was $234,334.
(4) COMMITMENTS AND CONTINGENCIES
-----------------------------
On May 17, 2002, Schreiber Foods, Inc. of Green Bay Wisconsin filed a
lawsuit against the Company in the federal district court for the Eastern
District of Wisconsin ("Wisconsin lawsuit"), being Case No. 02-C-0498,
alleging various acts of patent infringement. The Complaint alleges that
the Company's machines for wrapping of individual cheese slices,
manufactured by Kustner Industries, S.A. of Switzerland, known as models KE
and KD, and the Company's machines for producing individually wrapped
slices manufactured by Hart Design Mfg., Inc. of Green Bay, Wisconsin,
infringe unspecified claims of U.S. Patents Nos. 5,440,860, 5,701,724 and
6,085,680. Additionally, the Complaint refers to U.S. Patent No. 5,112,632,
but it does not explicitly allege infringement of that patent; because the
case is in the earliest stages, there has not yet been an opportunity to
determine whether Schreiber Foods intends to pursue allegations of
infringement of the 5,112,632 Patent against the Company. Schreiber Foods
is seeking a preliminary and permanent injunction prohibiting the Company
from further infringing acts and is also seeking damages in the nature of
either lost profits or reasonable royalties. The Company initially
challenged Schreiber's claim that it had sufficient rights in the patents
in suit to permit it to bring the lawsuit in Wisconsin. After preliminary
investigation of
9
the matter, the Company has chosen to withdraw its challenge and to await
the discovery of additional information on the subject.
The Company is not in a position at this time to express a view on the
likelihood that it will succeed in its position, nor in the amount of
damages that might be awarded against it should it be unsuccessful in that
regard.
(5) CAPITAL STOCK
-------------
On April 6, 2001, in accordance with an exemption from registration under
Regulation D promulgated under the Securities Act of 1933, as amended, the
Company received proceeds of approximately $3,082,000 less costs of
$181,041 for the issuance of 72,646 shares of the Company's Series A
convertible preferred stock and warrants to purchase shares of the
Company's common stock. The shares are subject to certain designations,
preferences and rights, including the right to convert each preferred share
into ten shares of common stock, the right to a ten percent stock dividend
after one year of issuance payable in shares of preferred stock, and an
eight percent stock dividend for the subsequent three years thereafter
payable in either cash or shares of preferred stock. The per share
conversion price is the lower of (x) $4.08 or (y) 95% of the average of the
two lowest closing bid prices on the American Stock Exchange of the common
stock out of the fifteen trading days prior to conversion. The liquidation
preference of each preferred share is $48.18 plus accrued dividends ($55.89
at December 31, 2002).
The holders of the preferred stock have the right to require the Company to
redeem their shares of preferred stock on April 6, 2005 or upon occurrence
of other events, as defined. The redemption price shall be paid in cash at
a price per preferred share equal to the greater of (a) 100% of the
preference amount ($48.18 plus accrued dividends) or (b) an amount equal to
the product of (1) the number of shares of common stock then issuable to
the holders upon conversion of the preferred stock being redeemed and (2)
the market price on the date of redemption.
On December 26, 2002, Excalibur Limited Partnership and BH Capital
Investments, L.P. converted 10,378 and 4,884 shares of Series A Preferred
Stock, respectively, plus accrued dividends, into 424,950 and 199,986
shares of common stock, respectively. The conversion rate was $1.3633 based
on 95% of the average of the two lowest closing bid prices on AMEX for the
fifteen trading days immediately prior to conversion.
For the nine months ended December 31, 2002 and 2001, the Company recorded
accrued dividends of $209,017 and $262,500, respectively, in connection
with the issuance of the preferred stock and warrants. In fiscal 2002, the
Company recorded a discount on preferred stock of $2,003,770 related to the
beneficial conversion feature ($1,449,370), the fair value of the initial
warrants ($277,200) and redemption warrants ($277,200) and the fair value
of the mandatory redemption price. The excess of the initial redemption
value of $4,391,861 over the initial carrying value of $523,830 is
$3,868,031 and is being accreted and recorded as dividends over the
redemption period (48 months beginning April 2001) using the straight line
method, which approximates the effective interest method. In addition, the
redemption value is recalculated every quarter based on changes in the
Company's stock price. The resulting change in the redemption value is then
added to or subtracted from the $3,868,031 initial amount to be accreted.
For the nine months ended December 31, 2002 and 2001, the Company recorded
$273,549 and $1,271,038, respectively, related to the beneficial conversion
feature of accrued dividends and the accretion of the redemption value of
preferred stock. As of December 31, 2002, the value of the remaining 57,384
shares of redeemable convertible preferred stock is $1,712,969.
In accordance with Regulation D and pursuant to a certain Common Stock and
Warrants Purchase Agreement dated June 28, 2002, the Company sold 367,647
shares of Common Stock on June 28, 2002 for $4.08 (85% of an average market
price) and issued warrants to purchase 122,549 shares of Common Stock at a
price equal to $5.52 per share to Stonestreet Limited Partnership. In
connection with such sale, the Company issued 7,812 shares of Common Stock
to Stonestreet Corporation and 4,687 shares of Common Stock to H&H
Securities Limited in exchange for their services as finders. Per the terms
of the agreement, the Company received net proceeds of $930,000, after the
repayment of a $550,000 promissory note dated June 26, 2002 in favor of
Excalibur Limited Partnership and payment of $20,000 for Stonestreet
Limited Partnership's costs and expenses related to the purchase of these
shares of Common Stock.
In accordance with Section 4(2) of the Securities Act of 1933, as amended,
and pursuant to a Food Service Brokerage Agreement dated June 25, 2002, the
Company issued 140,273 shares of Common Stock for $4.08 per share on
September 9, 2002 to certain food brokers in consideration for prior
services rendered valued at $572,310.
10
In accordance with Section 4(2) of the Securities Act of 1933, as amended,
and pursuant to a Securities Purchase Agreement dated August 27, 2002, the
Company issued 65,404 shares of Common Stock for $4.08 per share in
settlement of an outstanding payable to Hart Design and Manufacturing, Inc.
in the amount of $266,848.
(6) RELATED PARTY TRANSACTIONS
--------------------------
In June 1999, in connection with an amended and restated employment
agreement for Angelo S. Morini, the Company consolidated two full recourse
notes receivable ($1,200,000 from November 1994 and $11,572,200 from
October 1995) related to the exercise of 2,914,286 shares of the Company's
common stock into a single note receivable in the amount of $12,772,200
that is due on June 15, 2006. This new consolidated note is non-interest
bearing and non-recourse and is secured by the 2,914,286 shares of common
stock. As of December 31, 2002, the Company has not yet perfected its
security interest in the pledged shares. Per the June 1999 employment
contract, this loan may be forgiven upon the occurrence of any of the
following events: 1) Mr. Morini is terminated without cause; 2) there is a
material breach in the terms of Mr. Morini's employment agreement; or 3)
there is a change in control of the Company for which Mr. Morini did not
vote "FOR" in his capacity as a director or a shareholder. In October 2000,
the Company obtained a $1.5 million short-term bridge loan from SouthTrust
Bank, N.A. which is secured by one million of the above mentioned 2,914,286
shares of the Company's common stock owned by the Company's President.
These one million shares are expected to be released upon full payment of
the short-term bridge loan.
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees (APB 25) indicates that the exercise of options with a
non-recourse note should be treated as the grant of a stock option. The
Financial Accounting Standards Board issued Interpretation No. 44 ("FIN
44"), which clarifies the application of APB 25 relating to the accounting
consequences of various modifications to fixed stock options. FIN 44 states
that when an option is repriced, it is treated as a variable option and is
marked to market each quarter. In accordance with FIN 44, the underlying
options related to the $12,772,200 note receivable are treated as variable
due to the nature of the note being a non-interest bearing and non-recourse
note. Accordingly, any differences between the exercise price of the
options ($4.38) and the market price of the Company's common stock is
recorded as compensation income or expense at each reporting period. During
the nine months ended December 31, 2002, the market value of the Company's
stock decreased from $5.43 at March 31, 2002 to $2.28 at December 31, 2002.
Therefore, the Company recorded a $3,060,000 decrease in the compensation
(or income) related to this decrease in stock value to the floor of $4.38.
In March 2002, Angelo S. Morini, the Company's President, loaned $330,000
to the Company in order for it to pay down certain notes payable that were
coming due. This loan bears interest at prime (4.25% at December 31, 2002)
and is due on or before June 15, 2006. On May 24, 2002, in consideration of
this personal loan to the Company and his continued pledge of one million
of his shares of the Company's common stock for the loan with SouthTrust
Bank, N.A. (See Note 3), the Company granted Mr. Morini stock options to
acquire 1,163,898 shares of Common Stock at an exercise price of $5.72
(110% of market) per share. On December 4, 2002, Mr. Morini canceled these
options with the Company as a result of discussions and negotiations with
certain major shareholders for the purpose of improving shareholder value
and lessening potential financial statement expense.
On July 1, 2002, in consideration of his pledge of 250,000 shares of common
stock to secure a $550,000 promissory note by the Company in favor of
Excalibur Limited Partnership (See Note 3), the Company granted Mr. Morini
stock options to acquire 289,940 shares of common stock at an exercise
price of $5.17 (110% of market) per share. These options expire on July 1,
2007.
On October 24, 2002, the Company entered into a special services agreement
with Angelo S. Morini, authorizing him to author and promote "Veggiesizing,
the stealth/health diet" book, which promotes the Company's products. In
consideration of these services and for his continued personal pledges, the
Company granted him 900,000 shares at the market price of $2.05 on October
24, 2002. On December 4, 2002, as a result of discussions and negotiations
with certain major shareholders, Mr. Morini canceled these options with the
Company and accepted new options to acquire 510,060 shares of common stock
- 200,000 options were granted at an exercise price of $4.08 per share and
310,060 were granted at an exercise price of $2.05 per share. These options
expire on December 4, 2012. As a result of the cancellation and reissuance
of options, the Company will account for these options in accordance with
variable accounting standards.
Beginning January 13, 2003, the Company entered into a vendor arrangement
with one of its employees whereby they would purchase ingredients from him
at the Company's cost plus up to 1.25% per month on the outstanding
balance.
11
(7) EARNINGS PER SHARE
The following is a reconciliation of basic net earnings (loss) per share to
diluted net earnings (loss) per share:
Three months ended Nine months ended
December 31, December 31,
--------------------------------- ---------------------------------
2002 2001 2002 2001
-------------- -------------- -------------- --------------
Net income (loss) available to common
shareholders $ (744,437) $ (181,653) $ 792,621 $ (8,642,238)
============== ============== ============== ==============
Weighted average shares outstanding - basic 12,139,619 10,750,790 11,898,580 10,273,538
"In-the-money" shares under stock option
agreements -- -- 3,198,046 --
"In-the-money" shares under stock warrant
agreements -- -- 380,715 --
Less: Shares assumed repurchased under treasury
stock method -- -- (2,618,772) --
-------------- -------------- -------------- --------------
Weighted average shares outstanding - diluted 12,139,619 10,750,790 12,858,569 10,273,538
============== ============== ============== ==============
Basic net income (loss) per common share $ (0.06) $ (0.02) $ 0.07 $ (0.84)
============== ============== ============== ==============
Diluted net income (loss) per common share $ (0.06) $ (0.02) $ 0.06 $ (0.84)
============== ============== ============== ==============
Potential conversion of Series A preferred stock for 2,123,168 shares,
options for 4,554,771 and 1,356,725 shares and warrants for 644,856 and
264,141 shares have not been included in the computation of diluted net
income (loss) per common share for the three and nine months ended December
31, 2002, respectively, as their effect would be antidilutive. Potential
conversion of Series A preferred stock for 747,269 shares, options for
3,254,700 shares, and warrants for 518,286 shares have not been included in
the computation of diluted net income (loss) per common share for the three
and nine months ended December 31, 2001, as their effect would be
antidilutive.
(8) SUPPLEMENTAL CASH FLOW INFORMATION
----------------------------------
For purposes of the statement of cash flows, all highly liquid investments
with a maturity date of three months or less are considered to be cash
equivalents.
Nine months ended December 31, 2002 2001
-----------------------------------------------------------------------------------
Non-cash financing and investing activities:
Amortization of consulting and directors fees
paid through issuance of common stock warrants $ 76,975 $ 343,386
Purchase of equipment through capital lease
obligations and term notes payable 94,763 785,000
Reduction in accounts payable through issuance of
notes payable 347,475 --
Reduction in accounts payable through issuance of
common stock 839,158 --
Discount related to preferred stock -- 2,020,734
Accrued preferred stock dividends 209,017 262,500
Beneficial conversion feature related to preferred
stock dividends (18,416) 68,100
Accretion of discount on preferred stock 291,965 843,538
Preferred dividends recorded for preferred
shareholder waiver received in exchange for
issuance of common stock -- 359,400
12
Cash paid for:
Interest 1,832,018 1,703,121
Income taxes 51,037 --
(9) OPTION AND WARRANT REPRICING
----------------------------
On October 11, 2002 through unanimous consent of the Board of Directors,
the Company repriced all outstanding options granted to employees prior to
this date (4,284,108 shares at former prices ranging from $2.84 to $10.28)
to the market price of $2.05 per share. In addition, the Company repriced
the outstanding warrants held by current consultants prior to this date
(291,429 shares at former prices ranging from $3.31 to $5.50) to the market
price of $2.05 per share. This stock option repricing resulted in variable
accounting treatment for these stock options beginning with the quarter
ended December 31, 2002 until the related options have been cancelled,
expired or exercised. On December 4, 2002, as a result of discussions and
negotiations with certain major shareholders, the Company's President
reversed the repricing of his options for the purpose of improving
shareholder value and lessening potential financial statement expense.
Although the exercise prices of the options were reversed back to their
original amounts, the Company is still required to account for these
options and all new options issued to the Company's President prior to June
4, 2003 in accordance with variable accounting standards.
Variable accounting treatment will result in unpredictable stock-based
compensation expense or income depending on fluctuations in quoted prices
for the Company's common stock. The remaining variable options and warrants
as of December 31, 2002 was 3,901,110 of which 1,017,441 were vested and
"in-the-money" based on the Company's closing stock price of $2.28 on
December 31, 2002. This resulted in a non-cash compensation expense of
$188,395. Assuming no further options or warrants are exercised or canceled
and all are vested, a $0.01 increase in the Company's stock price will
result in a non-cash compensation expense of approximately $39,000.
13
GALAXY NUTRITIONAL FOODS, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction with the
Financial Statements and Notes thereto appearing elsewhere in this report. The
following discussion contains certain forward-looking statements, within the
meaning of the "safe-harbor" provisions of the Private Securities Reform Act of
1995, the attainment of which involves various risks and uncertainties. These
forward-looking statements are based on our current expectations, estimates and
projections about our industry, management's beliefs and certain assumptions
made by us. Forward-looking statements may be identified by the use of
forward-looking terminology such as "may", "will", "expect", "believe",
"estimate", "anticipate", "continue", or similar terms, variations of these
terms or the negative of those terms. These statements are not guarantees of
future performance and are subject to certain risks, uncertainties and
assumptions that are difficult to predict. Therefore, our actual results may
differ materially from those described in these forward-looking statements due
to among other factors, competition in our product markets, dependence on
suppliers, our manufacturing experience, and production delays or
inefficiencies. We undertake no obligation to update publicly any
forward-looking statements for any reason, even if new information becomes
available or other events occur in the future.
Galaxy Nutritional Foods, Inc. (the "Company") is principally engaged in
developing, manufacturing and marketing a variety of healthy cheese and dairy
related products, as well as other cheese alternatives, and is a leading
producer of soy-based alternative dairy products. These healthy cheese and dairy
related products include low or no fat, low or no cholesterol and lactose-free
varieties. These products are sold throughout the United States and
internationally to customers in the retail and food service markets. The
Company's headquarters and manufacturing facilities are located in Orlando,
Florida.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and reported amounts of revenues and expense during the
reporting period. The Company's significant estimates include the allowance for
doubtful accounts receivable, provision for obsolete inventory, and valuation of
deferred taxes and warrants. Actual results could differ from those estimates.
The Company records revenue upon shipment of products to its customers and there
is reasonable assurance of collection on the sale. It provides credit terms to
customers usually based on net 30 days. The Company performs ongoing credit
evaluations of its accounts receivable and makes reserves for anticipated future
credits that will be issued to its customers for promotions, discounts, spoils,
etc., based on historical experience. In addition, the Company evaluates the
accounts for potential uncollectible amounts. The reserve for accounts
receivable is then adjusted to reflect these estimates. At December 31, 2002 and
March 31, 2002, the Company had reserved approximately $815,000 and $678,000 for
known and anticipated future credits and doubtful accounts. During the nine
months ended December 31, 2002 and 2001, the Company recorded income of $136,700
and expense of $425,000, respectively, related to anticipated future credits and
doubtful accounts. The Company utilizes a detailed customer invoice promotion
settlement process to methodically predict, track, manage, and resolve invoicing
issues.
Inventories are valued at the lower of cost (weighted average, which
approximates FIFO) or market. The Company reviews its inventory valuation each
month and writes down the inventory for potential obsolete and damaged
inventory. In addition, the inventory value is reduced to market value when the
known sales price is less than the cost of the inventory.
Valuation allowances are established when necessary to reduce deferred tax
assets to the amount expected to be realized. Income tax expense is the tax
payable or refundable for the period plus or minus the change during the period
in deferred tax assets and liabilities.
Statement of Financial Accounting Standards No. 123 ("FAS 123"), Accounting for
Stock Based Compensation, requires the Company to report compensation expense on
warrants issued to non-employees for services rendered, in accordance with the
fair value based method prescribed in FAS 123. The Company estimates the fair
value of each warrant based on the expected vesting due to performance
requirements set forth in the warrant or service agreement and life of the
warrant by using a Black-Scholes option-pricing model with the following
assumptions used in the fiscal 2003 option-pricing model: no dividend yield,
43.2% volatility, risk-free interest rate of 4.25%, and expected lives of ten
years. Assumptions used for
14
grants in fiscal 2002: no dividend yield, 38% volatility, risk-free interest
rate ranging from 4.75%, and expected lives of ten years.
NEW ACCOUNTING PRONOUNCEMENTS
In December 2002, the FASB issued Statement of Financial Accounting Standards
No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure-an
amendment of FAS 123" ("SFAS 148"). This statement amends Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS
123"), to provide alternative methods of transition for a voluntary change to
the fair value based method of accounting for stock-based employee compensation
and amends the disclosure requirements to SFAS 123 to require prominent
disclosures in both annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results. The transition and annual disclosure provisions of
SFAS 148 are effective for fiscal years ending after December 15, 2002. The
Company will adopt SFAS 148 during its fourth quarter ending March 31, 2003.
RECENT DEVELOPMENTS
After discussions with certain major shareholders concerning ways to improve
shareholder value and improve financial statement results, Angelo S. Morini and
the Company conducted following in December 2002:
On December 4, 2002, Mr. Morini canceled options to acquire 1,163,898 shares of
the Company's common stock at an exercise price of $5.72 (110% of market) per
share which he had been granted on May 24, 2002, in consideration of his
personal loan to the Company and his continued pledge of one million of his
shares of the Company's common stock for the loan with SouthTrust Bank, N.A.
On December 4, 2002, Mr. Morini canceled options to acquire 900,000 shares of
the Company's common stock at an exercise price of $2.05 (100% of market). These
options were granted to him on October 24, 2002 in connection with a special
services agreement between the Company and Angelo S. Morini, authorizing him to
author and promote "Veggiesizing, the stealth/health diet" book, which promotes
the Company's products. On December 4, 2002, the Company then issued him new
options to acquire 510,060 shares of common stock - 200,000 options were granted
at an exercise price of $4.08 per share and 310,060 were granted at an exercise
price of $2.05 per share. These options expire on December 4, 2012.
On December 4, 2002, Mr. Morini reversed the repricing of his remaining options
granted prior to October 11, 2002 when through unanimous consent of the Board of
Directors, the Company repriced all outstanding options granted to employees
prior to this date to $2.05. Thus, all of his options are subject to their
original exercise prices.
On December 17, 2002, Angelo S. Morini resigned from his positions as Chief
Executive Officer and Chairman of the Board. Mr. Morini retained his position as
President and accepted an appointment as Vice-Chairman of the Board in order to
focus his attention on expanding the Company's brand awareness and marketing
relationships. Christopher J. New, formerly the Company's Chief Operating
Officer, was then appointed as the Company's Chief Executive Officer.
Additionally, on December 17, 2002, the Board of Directors voted to expand the
number of Board members to six and appointed Charles L. Jarvie as the Company's
Chairman of the Board, Angelo S. Morini as Vice-Chairman of the Board, Thomas R.
Dyckman as Chairman of the Audit Committee, and Michael H. Jordan, Joseph J.
Juliano and David H. Lipka as additional directors. Former directors Dr. Douglas
Walsh and Marshall Luther resigned from the Board of Directors effective as of
December 17, 2002, in order to pursue other opportunities. On December 18, 2002,
the Board of Directors again voted to expand the number of Board members to
seven and appointed Christopher J. New, the Company's Chief Executive Officer,
as a director. The new independent directors, Charles L. Jarvie, Thomas R.
Dyckman, Michael H. Jordan and David H. Lipka, were each granted options to
acquire 200,000 shares of common stock at an exercise price of $2.17 per share
(130% of the closing price of the common stock as reported by AMEX on December
4, 2002 which was the date they agreed to become a director of the Company) in
consideration of their acceptance of positions as members of the Board of
Directors.
15
RESULTS OF OPERATIONS
As a result of the large cash outlays related to a large plant expansion, delays
in new product shipment, and a sales mix skewed toward lower margin imitation
and private label items in fiscal 2001, the Company experienced shortfalls in
cash that affected nearly every aspect of its operations in fiscal 2002. This
cash constraint on purchasing ingredients forced the Company to eliminate
significant amounts of business at the key account level in order to achieve
sustainable and adequate case fill and order fill levels. In fiscal 2003, the
Company has returned to positive cash flow levels through efficiencies in
production, purchase discounts, realignment of the sales mix toward branded
items, reduction in overall number of items ("SKU's") being sold and
inventoried, improved customer fulfillment levels, new terms of sale, new
customer invoice promotion settlement processes, and additional cost reductions.
All excess cash has been put back into operations to improve the Company's
operations and financial position.
NET SALES were $9,829,420 in the three months ended December 31, 2002, compared
to net sales of $10,325,699 for the three months ended December 31, 2001, a
decrease of 5%. The Company experienced an overall decrease of 10% for the first
nine months of fiscal 2003 compared to the same period in fiscal 2002,
reflecting the continued elimination of lower margin business. Although sales
for the three and nine months of fiscal 2003 is a decrease from the sales for
the three and nine months of fiscal 2002, the sales are at the same level
(approx. $10 million) as they were for the fourth quarter ended fiscal 2002
where customer fulfillment levels peaked against the Company's core business
items. While the Company has experienced positive cash flows in fiscal 2003, it
has used this cash to improve the balance sheet by paying down debt and payables
rather than increasing inventory for sale. As a result of the constraints put on
ingredient, packaging and finished goods availability, the Company made a
strategic decision to downsize sales volume in an effort to upsize its margins.
The product mix shift to focus on higher-margin brand name products under the
Veggie brand, required the Company to turn away certain private label and other
less desirable business. While both the customer and consumer demand for the
Company's products and private label business remains strong, sales growth was
maintained at lower levels so that the Company can improve margins on its core
items and grow profitably.
COSTS OF GOODS SOLD were $6,805,863 representing 69% of net sales for the three
months ended December 31, 2002, compared with $7,355,250 or 71% of net sales for
the same period ended December 31, 2001. These costs represented 70% and 76% of
net sales for the nine months ended December 2002 and 2001, respectively. There
was an overall decrease in costs of $4,435,287 in the nine months of fiscal 2003
compared to fiscal 2002. This decrease in cost is primarily the result of
several factors: (a) a 10% decrease in raw materials required for operations in
the first nine months of fiscal 2003 as compared to fiscal 2002 (a decrease of
$2.6 million) which resulted from the 10% decrease in sales described above; (b)
the completed installation of the new equipment which resulted in a substantial
decrease in the number of production personnel late in fiscal 2002 and caused
labor-related expenses to decrease by approximately $1.5 million in the first
nine months of fiscal 2003 as compared to fiscal 2002; (c) a decrease of
$600,000 in inventory write-offs in the first nine months of fiscal 2003 as
compared to fiscal 2002 which resulted from the Company's change in production
focus in the second quarter of fiscal 2002 by decreasing its product mix to 200
core items that constituted nearly 98% of sales; and (d) a decrease in raw
material costs due to improved vendor relations, lower raw material costs and
purchase discounts.
Now that the equipment is fully operational, the labor crews are trained,
ingredient and packaging supply is consistent, and fewer number of SKU items are
being produced based on specific sales forecasting, the Company is seeing longer
production runs, improved run rates with more, high-quality product produced per
hour. This resulted in gross margin increasing from the annual rate of 19% in
fiscal 2002 to 30% in the first nine months of fiscal 2003. The Company expects
that with its increased efficiencies in labor, production and purchasing along
with continued monitoring of items being offered and tight controls on product
mix, it will continue to sustain its improved margins in fiscal 2003.
SELLING expenses were $1,314,235 and $3,773,908 for the three and nine months
ended December 31, 2002, respectively, compared with $1,983,565 and $5,499,661
for the three and nine months ended December 31, 2001, respectively, a decrease
of 34% and 31% in the respective periods. The decrease in expenses is due to
further efficiencies in advertising and promotional expenses of approximately
$1.1 million in the first nine months of fiscal 2003 compared to the same period
in fiscal 2002. In 2002, more promotions were directed to provide incentives to
the Company's direct customers for merchandising and brand item purchases. In
addition, the Company experienced a decrease (approximately $500,000) in
brokerage and salary costs and a decrease in travel costs in excess of
approximately $100,000 directly attributable to deployment of more focused,
productive key account selling strategies and tactics. The Company expects that
fiscal 2003 selling expenses will continue to remain at levels below that of
fiscal 2002 expenses based on the Company's current plan
16
for advertising and promotional allowances that are focused against key accounts
and granted on volume purchases rather than on individual item discounts.
DELIVERY expenses were $478,331 and $1,561,847 for the three and nine months
ended December 31, 2002, respectively, compared with $595,162 and $1,807,783 for
the same periods ended December 31, 2001. Delivery expenses approximate 5% of
net sales each period. The decrease in delivery costs is primarily in proportion
to the decrease in net sales.
NON-CASH COMPENSATION RELATED TO OPTIONS AND WARRANTS showed an expense of
$190,720 and income of $2,794,630 for the three and nine months ended December
31, 2002, respectively, compared to an income of $1,559,024 and expense of
$2,070,243 for the three and nine months ended December 31, 2001, respectively.
The Financial Accounting Standards Board issued Interpretation No. 44 ("FIN
44"), which clarifies the application of APB Opinion 25 relating to the
accounting consequences of various modifications to fixed stock options. FIN 44
states that when an option is repriced, it is treated as a variable option and
is marked to market each quarter. In accordance with FIN 44, the underlying
options related to the $12,772,200 note receivable from Angelo S. Morini, the
Company's President, are treated as variable due to the nature of the note being
a non-interest bearing and non-recourse note. Accordingly, any differences
between the exercise price of the options ($4.38) and the market price of the
Company's common stock is recorded as compensation income or expense at each
reporting period. During the nine months ended December 31, 2002, the market
value of the Company's stock decreased from $5.43 at March 31, 2002 to $2.28 at
December 31, 2002. Therefore, the Company recorded a $3,060,000 decrease in the
compensation related to this decrease in stock value to the floor of $4.38.
Additionally, the Company recorded a $76,975 expense related to the fair value
of warrants issued for consulting services. During the nine months ended
December 31, 2001, the market value of the Company's stock increased from $4.76
at March 31, 2001 to $5.35 at December 31, 2001. Therefore, the Company recorded
a $1,726,857 increase in the compensation related to this increase in stock
value. Additionally, the Company recorded a $343,386 expense related to the fair
value of warrants issued for consulting services. Due to the volatility of the
market price of the Company's common stock, it is incapable of predicting
whether this expense will increase or decrease in the future. A $0.01 increase
or decrease in the Company's common stock price results in an expense or income,
respectively, of $29,143.
On October 11, 2002 through unanimous consent of the Board of Directors, the
Company repriced all outstanding options granted to employees prior to this date
(4,284,108 shares at former prices ranging from $2.84 to $10.28) to the market
price of $2.05 per share. In addition, the Company repriced the outstanding
warrants held by current consultants prior to this date (291,429 shares at
former prices ranging from $3.31 to $5.50) to the market price of $2.05 per
share. This stock option repricing resulted in variable accounting treatment for
these stock options beginning with the quarter ended December 31,2002 until the
related options have been cancelled, expired or exercised. On December 4, 2002,
as a result of discussions and negotiations with certain major shareholders, the
Company's President reversed the repricing of his options for the purpose of
improving shareholder value and lessening potential financial statement expense.
Although the exercise prices of the options were reversed back to their original
amounts, the Company is still required to account for these options and any new
options issued to the Company's President prior to June 4, 2003 in accordance
with variable accounting standards.
Variable accounting treatment will result in unpredictable stock-based
compensation expense or income depending on fluctuations in quoted prices for
the Company's common stock. The remaining variable options and warrants as of
December 31, 2002 was 3,901,110 of which 1,017,441 were vested and
"in-the-money" based on the Company's closing stock price of $2.28 on December
31, 2002. This resulted in a non-cash compensation expense of $188,395. Assuming
no further options or warrants are exercised or canceled and all are vested, a
$0.01 increase in the Company's stock price will result in a non-cash
compensation expense of approximately $39,000.
GENERAL AND ADMINISTRATIVE expenses were $864,399 and $786,634 for the three
months ended December 31, 2002 and 2001, respectively (a 10% increase). For the
three months ended December 31, 2001, the Company reversed $75,000 of its bad
debt reserve due to a change in its reserve estimates creating income
recognition for the fiscal 2002 quarter. Without this reversal, the fiscal 2003
and 2002 quarterly expenses were nearly the same. For the nine months ended
December 31, 2002 and 2001, general and administrative expenses were $2,453,148
and $3,197,175, respectively (a 23% decrease). The decrease was primarily due to
a decrease in bad debt expense and personnel costs in fiscal 2003 along with a
general reduction in standard administrative expenses due to cost cutting
measures implemented at the end of fiscal 2002.
RESEARCH AND DEVELOPMENT expenses were $60,674 and $43,075 for the three months
ended December 31, 2002 and 2001, respectively (a 41% increase). For the nine
months ended December 31, 2002 and 2001, expenses were $174,888 and $140,931 (a
24% increase). This increase is primarily the result of a change in the
allocation of general overhead costs to
17
this department. The Company expects that these expenses will remain at this
level throughout the remainder of fiscal 2003 and fiscal 2004.
INTEREST expense was $536,766 and $913,523 for the three months ended December
31, 2002 and 2001, respectively (a 41% or $376,757 decrease). For the nine
months ended December 31, 2002 and 2001, interest expense was $2,404,868 and
$2,310,635 (a 4% increase). On September 30, 1999, the Company entered into a
$4,000,000 subordinated note payable with FINOVA Mezzanine Capital, Inc.
("FINOVA Mezzanine"). This debt currently bears interest at a rate of 15.5% and
included an original issuance discount of $786,900, which was amortized as
interest expense over the term of the debt until September 30, 2002. In
connection with FINOVA Mezzanine's warrant exercise and transfer of 815,000
shares of the Company's Common Stock, the Company agreed to guarantee the price
at which the shares were sold to the public at $4.41 per share. The actual price
received by FINOVA Mezzanine was $3.25 per share and the difference of $945,400
was recorded as a debt discount and was amortized over the term until September
30, 2002. During the three months ended December 31, 2002, interest expense
decreased $307,115 because the above debt discounts were fully amortized. The
remaining decrease resulted from a lower note payable to FINOVA Mezzanine
($4,000,000 in fiscal 2003 compared to $4,815,000 in fiscal 2002) during the
three months ended December 31, 2002. During the nine months ended December 31,
2002 and 2001, $614,230 and $511,859, respectively, of the total debt discount
of $1,732,300 was amortized to interest expense. In addition, the loan fees
amortized to interest expense increased approximately $397,000 during the nine
months ended December 31, 2002 due to additional loan costs and the shortened
loan periods. The increase in the above mentioned fees was offset by a decrease
of approximately $405,000 in interest expense as a result of lower debt balances
during fiscal 2003 compared to fiscal 2002; thus resulting in an overall
increase of $94,233 for the nine months ended December 31, 2002 compared to
2001. See "Debt Financing" below for further detail on the Company's outstanding
debts and interest rates thereon.
LIQUIDITY AND CAPITAL RESOURCES
OPERATING ACTIVITIES - Net cash provided by operating activities was $1,901,996
for the nine months ended December 31, 2002 compared to net cash used of
$1,504,597 for the same period ended December 31, 2001. The increase in cash
from operations is primarily attributable to a net income of $1,275,187
evidencing the improved gross margins and reduction in cash operating
expenditures in fiscal 2003 along with further collections on accounts
receivable and reductions in inventory levels. In fiscal 2002, the Company used
a significant portion of its cash to decrease its amounts payable to vendors and
to fund operating losses.
INVESTING ACTIVITIES - Net cash used in investing activities totaled $231,742
for the nine months ended December 31, 2002 compared to net cash used of
$565,110 for the same period ended December 31, 2001. The cash used for
investing activities during fiscal 2003 resulted from the increase in deferred
loan costs related to the FINOVA Capital and FINOVA Mezzanine loans as further
discussed below and the purchase of equipment. These deferred loan costs are
capitalized and expensed to interest over the life of the loans. The cash used
in fiscal 2002 was all used to purchase equipment.
FINANCING ACTIVITIES - Net cash flows used in financing activities were
$1,668,794 for the nine months ended December 31, 2002 compared to cash flows
provided by financing activities of $2,151,616 for the same period ended
December 31, 2001. During the first quarter of fiscal 2003, the Company received
loan proceeds from Excalibur Limited Partnership in the amount of $500,000 in
cash. The proceeds of which were used to pay down a portion of the Company's
outstanding debt under its term loan from SouthTrust Bank, N.A. In addition, the
Company raised $1,500,000 through the issuance of common stock (as further
discussed below). These proceeds were used to pay off its term loan from
Excalibur Limited Partnership and for working capital purposes. The Company used
its cash from operating activities to reduce the balance of the Company's
outstanding debt under its line of credit from FINOVA Capital and to pay down
its term debt with SouthTrust Bank, N.A. The large cash flows from financing
activities during the nine months ended December 31, 2001 were primarily the
result of the issuance of common and preferred stock. The majority of these
proceeds were used to pay down the line of credit from FINOVA Capital and to
finance the Company's operating activities in fiscal 2002.
Debt Financing
As of December 31, 2002, the Company had a line of credit with a maximum
principal amount of $7.5 million from FINOVA Capital Corporation, the proceeds
of which are for working capital purposes. The amount that the Company can
borrow under the line of credit is based on a formula of up to 80% of eligible
accounts receivable plus a certain percentage of eligible inventories not to
exceed $3 million, as defined in the agreement. Pursuant to a certain Amendment
and Limited Waiver to Security Agreement dated June 26, 2002, the inventory
advance rate decreases by 1% per month beginning July 1, 2002 from a level of
50% at June 30, 2002 to 37% by the maturity date (44% at December 31, 2002). The
line of credit is secured by all accounts receivable, inventory, machinery,
equipment, trademarks and patents owned by the Company.
18
Interest is payable monthly on the outstanding draws on the line of credit at a
rate of prime plus four percent (8.25% at December 31, 2002). The line of credit
expires on July 1, 2003, at which time the entire outstanding principal amount
of the line of credit, and all accrued but unpaid interest thereon, is due and
payable in full. As of December 31, 2002, the Company had an outstanding balance
of $4,166,084 under this line.
On September 30, 1999, the Company obtained a $4 million subordinated loan from
FINOVA Mezzanine to finance additional working capital and capital improvement
needs. The Company received loan proceeds in the amount of $3,620,000 after
paying loan costs of $380,000. Amounts outstanding under the loan are secured by
a subordinated lien on substantially all of the Company's assets. A balloon
payment of the entire principal amount of the loan, and all accrued but unpaid
interest thereon, is due upon maturity in July 2003. The interest rate
applicable to the loan was increased from 11.5% to 13.5% in July 2001. In
February 2002, the interest rate increased to 15.5%. In consideration of the
loan, the Company issued to FINOVA Mezzanine a warrant to purchase 915,000
shares of the Company's common stock at an exercise price of $3.41 per share
which represented 80% of the fair value of the Company's stock on the date the
warrant was issued. The warrant, valued at $786,900, was recorded as a debt
discount was amortized to interest expense from the date of issuance of the note
to an original earlier maturity date of the note until September 30, 2002. As of
December 31, 2002, the discount has been fully amortized to interest expense and
the Company has an outstanding principal balance of $4,000,000 under this loan.
On December 26, 2000, the FINOVA Mezzanine exercised a portion of the warrant to
purchase 815,000 shares of Common Stock at a price of $3.41 per share. The
Company received from the exercise of the warrant net proceeds of $2,452,329,
after paying transaction costs of $326,822. In connection with this transaction,
the Company agreed to reimburse FINOVA Mezzanine for brokerage commission and
other expenses incurred by it, in connection with the sale of the 815,000 shares
to the public, which were sold at a price of $3.25 per share. These costs and
expenses were recorded as a reduction in the proceeds received from the exercise
of the warrants. In addition, the Company agreed to guarantee the price ($4.41
per share) at which the shares would be sold to the public. The difference
between the actual price received by FINOVA Mezzanine ($3.25) and the guaranteed
price ($4.41) of $945,400 was recorded as a debt discount and was being
amortized over the term of the subordinated note until September 30, 2002. The
consideration for the difference between the exercise price of $3.41 and the
guaranteed price of $4.41 was $815,000. FINOVA Mezzanine agreed to finance such
amount under an additional subordinated term loan which was payable in full on
December 29, 2001. However, the Company obtained an extension for a fee of
$55,000 and made payments of $30,000 per business day through February 28, 2002,
at which time the additional loan was paid in full. During the nine months ended
December 31, 2002 and 2001, $614,230 and $204,743, respectively, of the total
debt discounts of $1,732,300 were amortized to interest expense. At December 31,
2002, there were no remaining unamortized debt discounts and the remaining
principal balance due on the notes was $4,000,000.
The line of credit and subordinated loans described above contain certain
financial and operating covenants. In June 2002, the Company notified FINOVA
Capital and FINOVA Mezzanine that it had failed to comply with the minimum
operational cash flow to contractual debt service ratio and the funded debt to
EBITDA ratio. FINOVA Capital agreed to waive those violations for the fiscal
year ended March 31, 2002 and the fiscal quarter ended June 30, 2002 and to
amend such covenants for the fiscal quarters beginning July 1, 2002, pursuant to
a certain Amendment and Limited Waiver to Security Agreement dated June 26,
2002. FINOVA Capital extended the maturity date from October 15, 2002 to July 1,
2003, removed any prepayment penalties, reduced the credit line from $13 million
to $7.5 million, reduced the inventory limit from $6 million to $3 million, and
will reduce the inventory advance rate by 1% per month beginning July 1, 2002
(from a level of 50% at June 30, 2002 to 37% by the maturity date). FINOVA
Mezzanine also agreed to waive the violations of its covenants for the fiscal
year ended March 31, 2002 and the fiscal quarter ended June 30, 2002, and to
amend those covenants for future fiscal quarters pursuant to a letter agreement
dated June 26, 2002 and amendments to the subordinated notes. In consideration
of the waivers and covenant amendments, the Company agreed to pay a facility fee
of $413,500, which was deemed fully earned on June 26, 2002. The facility fee is
payable as follows: $172,500 is due and payable on the earliest of (a) $28,750
per month beginning January 2003, (b) the occurrence of an event of default, or
(c) the date on which the Company repays either all of the obligations to FINOVA
Capital under the Loan Agreement or any portion of the principal obligations to
FINOVA Mezzanine under the FINOVA Mezzanine loan documents, with the balance of
$241,000 due and payable only upon FINOVA Mezzanine's exercise of its remaining
100,000 warrants. The Company was in compliance with all amended covenants for
the quarter ended December 31, 2002. The Company believes that it will remain in
compliance with the new FINOVA loan covenants established in the June 26, 2002
waiver and amendment documents.
In March 2000, the Company obtained a $10 million term loan from SouthTrust
Bank, N.A. This note bears interest at prime rate (4.25% at December 31, 2002)
and is due in monthly principal installments of $93,000 plus interest. In a
letter agreement dated September 27, 2002, the bank deferred the four principal
payments, due in June 2002 through September 2002, until the maturity of the
note. The note matures in March 2005. The balance outstanding on this note as of
December
19
31, 2002 was $8,397,313. This note was used to pay off a prior term loan and to
finance approximately $7.5 million in new equipment purchases to expand the
Company's production capacity, including the new production equipment purchased
and installed throughout fiscal 2001 and the beginning of fiscal 2002. This term
loan is secured by certain machinery and equipment, including the Company's new
production equipment.
In October 2000, the Company obtained a $1.5 million short-term bridge loan from
SouthTrust Bank, N.A. which is secured by the pledge of one million shares of
the Company's common stock owned by the Company's President. Interest on this
note is at the prime rate (4.25% at December 31, 2002). The loan is being paid
down by monthly principal payments of $50,000 plus interest. In a letter
agreement dated September 27, 2002, the bank deferred the four principal
payments, due in June 2002 through September 2002, until the maturity of the
note. The note matures in October 2003. The balance outstanding on this note as
of December 31, 2002 was $750,000. In consideration of his pledge, the Company
granted Mr. Morini stock options to acquire 343,125 shares of Common Stock at an
exercise price of $3.88 per share. These options expire on December 15, 2010.
The term loan and the short-term bridge loan from SouthTrust Bank, N.A. contain
certain financial and operating covenants. The Company was in violation of all
financial covenants at March 31, 2002. On June 27, 2002, the Company received a
waiver for the year ended March 31, 2002 and for all future periods through July
1, 2003. On February 13, 2003, the Company received a waiver for all future
periods through March 31, 2004.
In March 2002, Angelo Morini, the Company's President, loaned $330,000 to the
Company in order for it to pay down certain notes payable that were coming due.
This loan bears interest at prime (4.25% at December 31, 2002) and is due on or
before June 15, 2006.
On June 26, 2002, the Company signed a $550,000 promissory note with Excalibur
Limited Partnership, one of the holders of the Company's Series A Preferred
Stock. In consideration of the note, the Company issued Excalibur Limited
Partnership a warrant to purchase 30,000 shares of Common Stock, which are
exercisable until June 26, 2007 at a price equal to $5.50 per share. This note
was non-interest bearing assuming that it was repaid on or before July 26, 2002.
This note was secured by 250,000 shares of Common Stock owned by the Angelo S.
Morini, the Company's President. In consideration of his pledge, the Company
granted Mr. Morini stock options to acquire 289,940 shares of Common Stock at an
exercise price of $5.17 (110% of market) per share. These options expire on July
1, 2007. On June 26, 2002, the Company received loan proceeds in the amount of
$500,000 in cash from Excalibur Limited Partnership. The additional $50,000 was
retained by Excalibur Limited Partnership as payment for consulting fees due to
Excalibur Limited Partnership in accordance with a consulting agreement entered
into on June 26, 2002, which expired December 31, 2002. This note was paid in
full on June 28, 2002 from proceeds derived from the issuance of common stock to
Stonestreet Limited Partnership as discussed below.
On August 15, 2002, the Company signed a $347,475 promissory note with Target
Container, Inc. in satisfaction of its accounts payable obligation to this
vendor. This note bears interest at 7% per annum and is due in twelve equal
monthly installments of $30,066. The balance outstanding on this note as of
December 31, 2002 was $234,334.
Equity Financing
On April 6, 2001, the Company issued to BH Capital Investments, L.P. and
Excalibur Limited Partnership, in accordance with an exemption from registration
under Regulation D promulgated under the Securities Act of 1933, as amended
("Regulation D"), (i) an aggregate of 72,646 shares of the Company's Series A
convertible preferred stock, $0.01 par value (the "Series A Preferred Stock"),
and (ii) warrants to purchase shares of the Common Stock, at an aggregate sales
price of approximately $3,082,000. The Series A Preferred Stock is subject to
certain designations, preferences and rights set forth in the Company's
Certificate of Designations, Preferences and Rights of Series A Convertible
Preferred Stock, including the right to convert such shares into shares of
Common Stock at any time, at a current conversion rate (subject to appropriate
adjustment for stock splits, stock dividends, recapitalizations and other
events) equal to the quotient of:
o $48.18, plus all accrued dividends that are then unpaid for each share
of Series A Preferred Stock then held by the holder,
divided by,
20
o the lesser of (x) $4.08 or (y) 95% of the average of the two lowest
closing bid prices on the American Stock Exchange of the Common Stock
out of the fifteen trading days immediately prior to conversion.
In no case, however, shall any holder of Series A Preferred Stock be permitted
to convert Series A Preferred Stock in an amount that would cause such holder to
beneficially own at any given time, in the aggregate, such number of shares of
common stock which would exceed 9.99% of the aggregate outstanding shares of
common stock, unless such holder waives such restriction upon not less than 61
days prior notice to the Company. The number of shares issuable upon conversion
of the Series A Preferred Stock will vary depending upon the closing bid prices
of the Company's common stock on the AMEX.
On December 26, 2002, Excalibur Limited Partnership and BH Capital Investments,
L.P. converted 10,378 and 4,884 shares of Series A Preferred Stock,
respectively, plus accrued dividends, into 424,950 and 199,986 shares of common
stock, respectively. The conversion rate was $1.3633 based on 95% of the average
of the two lowest closing bid prices on AMEX for the fifteen trading days
immediately prior to conversion.
In connection with the issuance of the Series A Preferred Stock, the Company
also granted to BH Capital Investments, L.P. and Excalibur Limited Partnership
warrants to purchase an aggregate of 120,000 shares of common stock. The initial
warrants were exercisable for a period of five years from April 6, 2001, at a
per share exercise price of $5.30. Pursuant to a letter agreement dated October
5, 2001, the Company agreed to issue additional warrants to acquire 60,000
shares of its Common Stock at an exercise price of $5.86 per share to each of BH
Capital Investments, L.P. and Excalibur Limited Partnership. In exchange for the
warrants, BH Capital Investments, L.P. and Excalibur Limited Partnership agreed
to provide us certain consulting services, including the introduction of
potential customers in Canada. Subsequently, the Company agreed to reduce the
per share exercise price on all the warrants to $2.67 in order to induce BH
Capital Investments, L.P. and Excalibur Limited Partnership to exercise their
warrants and to gain their required approval for a private placement. On January
17, 2002, BH Capital Investments, L.P. and Excalibur Limited Partnership
exercised all 240,000 for a total of $640,800.
In accordance with Regulation D and pursuant to a Securities Purchase Agreement
dated as of September 24, 2001, Hare & Co. f/b/o John Hancock Small Cap Value
Fund, an affiliate of John Hancock Advisors, Inc., purchased 522,648 shares of
Common Stock and warrants to purchase 140,000 shares of Common Stock, at an
aggregate sales price of $3,000,000. The warrants held by Hare & Co. f/b/o John
Hancock Small Cap Value Fund were exercisable at a price per share equal to
$6.74 until September 25, 2006. Subsequently, the Company agreed to reduce the
per share exercise price on all the warrants to $4.50 in order to induce Hare &
Co. f/b/o John Hancock Small Cap Value Fund to exercise their warrants. All of
the warrants were exercised in January 2002 at a price of $4.50 per share for a
total of $630,000.
In accordance with Regulation D and pursuant to certain Securities Purchase
Agreements dated January 17, 2002 with FNY Millenium Partners, LP, Millenium
Global Offshore Ltd., Potomac Capital Partners, LP, and Potomac Capital
International Ltd., the Company sold 158,095 shares of Common Stock for $4.74
(95% of an average market price) and issued warrants to purchase 39,524 shares
of Common Stock at a price equal to $5.74 per share. Pursuant to the same
Securities Purchase Agreements dated January 17, 2002, the Company sold 12,270
shares of Common Stock for $4.74 (95% of an average market price) and issued
warrants to purchase 3,068 shares of Common Stock at a price equal to $5.74 per
share to its officers Angelo S. Morini, Christopher New, LeAnn Hitchcock and
Kulbir Sabharwal. All of the warrants are exercisable until January 17, 2007.
The Company received total proceeds of $808,212 related to the sale of these
shares of Common Stock.
In accordance with Regulation D and pursuant to a certain Common Stock and
Warrants Purchase Agreement dated June 28, 2002, the Company sold 367,647 shares
of Common Stock for $4.08 (85% of an average market price) and issued warrants
to purchase 122,549 shares of Common Stock at a price equal to $5.52 per share
to Stonestreet Limited Partnership. In connection with such sale, the Company
issued 7,812 shares of Common Stock to Stonestreet Corporation and 4,687 shares
of Common Stock to H&H Securities Limited in exchange for their services as
finders. Per the terms of the agreement, the Company received net proceeds of
$930,000, after the repayment of a $550,000 promissory note dated June 26, 2002
in favor of Excalibur Limited Partnership and payment of $20,000 for Stonestreet
Limited Partnership's costs and expenses related to the purchase of these shares
of Common Stock.
In accordance with Section 4(2) of the Securities Act of 1933, as amended, and
pursuant to a Food Service Brokerage Agreement dated June 25, 2002, the Company
issued 140,273 shares of Common Stock for $4.08 per share on September 9, 2002
to certain food brokers in consideration for prior services rendered valued at
$572,310.
21
In accordance with Section 4(2) of the Securities Act of 1933, as amended, and
pursuant to a Securities Purchase Agreement dated August 27, 2002, the Company
issued 65,404 shares of Common Stock for $4.08 per share in settlement of an
outstanding payable to Hart Design and Manufacturing, Inc. in the amount of
$266,848.
The Company's ability to continue as a going concern depends upon successfully
obtaining sufficient financing to pay down or replace the FINOVA debts due in
July 2003. In the event the Company cannot extend the loans, or raise the
capital to pay off or replace the debt in July 2003, FINOVA Capital and FINOVA
Mezzanine could exercise their respective rights under their loan documents to,
among other things, declare a default under the loans and pursue foreclosure of
the Company's assets which are pledged as collateral for such loans. In the
event that FINOVA exercises their right to pursue foreclosure, then SouthTrust
has the ability to do the same based on a cross-default provision in their loan
agreement. The Company is seeking to obtain the necessary funds through its
positive cash flows from operating activities, equity financing, and/or
refinancing with FINOVA or a substitute lender. There are no assurances,
however, that such financing, if available will be at a price that will not
cause substantial dilution to the Company's shareholders. If the Company is not
able to generate sufficient cash through its operating and financing activities
in fiscal 2003, it will not be able to pay its debts in a timely manner.
However, the Company, with direct involvement from key new board and management
members, is currently discussing terms with several independent parties to
provide the funds required to replace FINOVA Capital as the Company's primary
asset-based lender and to pay off the debt to FINOVA Mezzanine.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The interest on the Company's debt to FINOVA Capital Corporation and SouthTrust
Bank N.A. is floating and based on the prevailing market interest rates. For
market-based debt, interest rate changes generally do not affect the market
value of the debt but do impact future interest expense and hence earnings and
cash flows, assuming other factors remain unchanged. A theoretical 1% change in
market rates in effect on December 31, 2002 with respect to the Company's
anticipated debt as of such date would increase interest expense and hence
reduce net income of the Company by approximately $34,000 per quarter.
The Company's fiscal 2002 and 2001 sales denominated in a currency other than
U.S. dollars were less than 5% of total sales and no net assets were maintained
in a functional currency other than U. S. dollars at December 31, 2002 and 2001.
The effects of changes in foreign currency exchange rates has not historically
been significant to the Company's operations or net assets.
ITEM 4. CONTROLS AND PROCEDURES
Within ninety (90) days prior to the filing of this report, an evaluation was
performed under the supervision and with the participation of the Company's
management, including the Chief Executive Officer ("CEO"), and the Chief
Financial Officer ("CFO"), of the effectiveness of the design and operation of
the Company's disclosure controls and procedures to insure that the Company
records, processes, summarizes and reports in a timely and effective manner the
information required to be disclosed in reports filed with or submitted to the
Securities and Exchange Commission. Based on that evaluation, the Company's
management, including the CEO and CFO, concluded that the Company's disclosure
controls and procedures were effective in timely bringing to their attention
material information related to the Company required to be included in the
Company's periodic Securities and Exchange Commission filings. Since the date of
this evaluation, there have been no significant changes in the Company's
internal controls or in other factors that could significantly affect those
controls.
22
PART II. OTHER INFORMATION
GALAXY NUTRITIONAL FOODS, INC.
ITEM 1. LEGAL PROCEEDINGS
On May 17, 2002, Schreiber Foods, Inc. of Green Bay Wisconsin filed a lawsuit
against the Company in the federal district court for the Eastern District of
Wisconsin ("Wisconsin lawsuit"), being Case No. 02-C-0498, alleging various acts
of patent infringement. The Complaint alleges that the Company's machines for
wrapping of individual cheese slices, manufactured by Kustner Industries, S.A.
of Switzerland, known as models KE and KD, and the Company's machines for
producing individually wrapped slices manufactured by Hart Design Mfg., Inc. of
Green Bay, Wisconsin, infringe unspecified claims of U.S. Patents Nos.
5,440,860, 5,701,724 and 6,085,680. Additionally, the Complaint refers to U.S.
Patent No. 5,112,632, but it does not explicitly allege infringement of that
patent. Because the case is in the earliest stages, there has not yet been an
opportunity to determine whether Schreiber Foods intends to pursue allegations
of infringement of the 5,112,632 Patent against the Company. Schreiber Foods is
seeking a preliminary and permanent injunction prohibiting the Company from
further infringing acts and is also seeking damages in the nature of either lost
profits or reasonable royalties. The Company initially challenged Schreiber's
claim that it had sufficient rights in the patents in suit to permit it to bring
the lawsuit in Wisconsin. After preliminary investigation of the matter, the
Company has chosen to withdraw its challenge and to await the discovery of
additional information on the subject.
The '860 and '724 Patents--and the Kustner machines for producing individually
wrapped slices--were the subject of a lawsuit commenced by Schreiber in 1997
against Beatrice Foods and others in the Eastern District of Wisconsin, being
Case No. 97-CV-11. Schreiber alleges that the machines that were at issue in
that case are similar to the Kustner machines in use by the Company. In the 1997
lawsuit, the matter was tried to a jury, which found the Kustner machines to
infringe and awarded Schreiber $26 million in a verdict of August 25, 1998. On
March 30, 2000, however, the judge reversed that verdict, entered a finding of
no infringement on the part of Beatrice, and dismissed the case. Schreiber
appealed that order to the Court of Appeals for the Federal Circuit, which
entered its judgment on appeal on February 27, 2002. The appeals court reversed
the action of the trial court, found that substantial evidence supported the
jury's finding of infringement, and ordered the jury verdict reinstated. Kustner
Industries has informed the Company that a petition for certiorari is currently
before the Supreme Court and that it is considering additional judicial options.
Schreiber has also commenced a similar action against Borden, Inc., and others,
in March 2002, but no result has yet been reached in that case.
Several years prior to the filing of the lawsuit against the Company, the
Company modified the seals on its Kustner machines to make them more
technologically safe and superior. The seals on the two Hart Design machines
were modified by the manufacturer from the standard Hart Design configuration at
Galaxy's request and were delivered to the Company as modified.
The Company believes that these modifications are such that the modified
machines do not literally infringe upon any of the identified patents, and the
Company will vigorously defend this position. However, a formal opinion from
patent counsel has not yet been obtained to that regard, given the recent filing
date of the lawsuit. Therefore, the Company is not in a position at this time to
express a view on the likelihood that it will succeed in its position, nor in
the amount of damages that might be awarded against it should it be unsuccessful
in that regard.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
In accordance with Section 4(2) of the Securities Act of 1933, as amended, and
pursuant to a Food Service Brokerage Agreement dated June 25, 2002, the Company
issued 141,221 shares of common stock for $4.08 per share on September 9, 2002
to certain food brokers in consideration for prior services rendered valued at
$576,179. In the quarter ended December 31, 2002, one of the grantees returned
948 shares valued at $3,869 leaving a net amount of 140,273 shares issued at a
value of $572,310.
On December 26, 2002, Excalibur Limited Partnership and BH Capital Investments,
L.P. converted 10,378 and 4,884 shares of Series A Preferred Stock,
respectively, plus accrued dividends, into 424,950 and 199,986 shares of common
stock, respectively. The conversion rate was $1.3633 based on 95% of the average
of the two lowest closing bid prices on AMEX for the fifteen trading days
immediately prior to conversion.
23
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
NONE
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
NONE
ITEM 5. OTHER INFORMATION
NONE
24
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
The following exhibits are filed as part of this Form 10-Q.
EXHIBIT NO EXHIBIT DESCRIPTION
3.1 Certificate of Amendment of Certificate of Incorporation of the
Company, as filed with the Secretary of State of the State of
Delaware on December 23, 2002 (Filed Herewith.)
3.2 Restated Certificate of Incorporation of the Company as filed
with the Secretary of State of the State of Delaware on December
23, 2002 (Filed Herewith.)
*3.3 By-laws of the Company, as amended (Filed as Exhibit 3.2 to the
Company's Registration Statement on Form S-18, No. 33-15893-NY,
incorporated herein by reference.)
*4.3 Stock Purchase Warrant issued to Excalibur Limited Partnership
dated as of June 26, 2002. (Filed as Exhibit 4.3 to Registration
Statement on Form S-3 filed September 30, 2002.)
*4.4 Registration Rights Agreement dated as of June 28, 2002 by and
among the Registrant, Stonestreet Limited Partnership, Excalibur
Limited Partnership, H&H Securities Limited and Stonestreet
Corporation. (Filed as Exhibit 4.4 to Registration Statement on
Form S-3 filed September 30, 2002.)
*4.5 Purchase Agreement dated as of August 27, 2002 by and between the
Registratnt and Hart Design & Mfg, Inc. (Filed as Exhibit 4.5 to
Registration Statement on Form S-3 filed September 30, 2002.)
*4.6 Form of Subscription Agreement by and between the Registrant and
those food brokers named in the selling stockholders section of
this Registration Statement. (Filed as Exhibit 4.6 to
Registration Statement on Form S-3 filed September 30, 2002.)
*4.8 Common Stock and Warrants Purchase Agreement by and between the
Company and Stonestreet Limited Partnership dated June 28, 2002
(Filed as Exhibit 4.8 on Form 10-K for fiscal year ended March
31, 2002, and incorporated herein by reference.)
*4.9 Stock Purchase Warrant issued to Stonestreet Limited Partnership,
dated June 28, 2002 (Filed as Exhibit 4.9 on Form 10-K for fiscal
year ended March 31, 2002, and incorporated herein by reference.)
*10.1 Second Amendment to the Security Agreement with Finova Financial
Services dated June 1998 (Filed as Exhibit 10.1 on Form 10-K for
fiscal year ended March 31, 1999, and incorporated herein by
reference.)
*10.2 Third Amendment to the Security Agreement with Finova Financial
Services dated December 1998 (Filed as Exhibit 10.2 on Form 10-K
for fiscal year ended March 31, 1999, and incorporated herein by
reference.)
*10.3 Term Loan Agreement with Southtrust Bank dated March 2000 (Filed
as Exhibit 10.3 on Form 10-K/A for fiscal year ended March 31,
2000, and incorporated herein by reference.)
*10.4 Cabot Industrial Properties L.P. Lease dated July 1999 (Filed as
Exhibit 10.4 on Form 10-K/A for fiscal year ended March 31, 2000,
and incorporated herein by reference.)
*10.6 Third Amendment to Lease Agreement, dated as of August 14, 2001,
by and between Anco Company and the Company (Filed as Exhibit
10.6 on Form 10-K/A for fiscal year ended March 31, 2001, and
incorporated herein by reference.)
*10.7 Amendment and Limited Waiver to Security Agreement, dated as of
July 13, 2001, by and between the Company and FINOVA Capital
Corporation (Filed as Exhibit 10.7 on Form 10-Q/A for the quarter
ended September 30, 2001, and incorporated herein by reference.)
25
*10.8 Waiver Letter from FINOVA Mezzanine Capital, Inc. to the Company
dated as of July 12, 2001 (Filed as Exhibit 10.8 on Form 10-Q/A
for the quarter ended September 30, 2001, and incorporated herein
by reference.)
*10.9 Amended and Restated Secured Promissory Note in the principal
amount of $815,000, dated as of July 13, 2001, by the Company in
favor of FINOVA Mezzanine Capital, Inc. (Filed as Exhibit 10.9 on
Form 10-Q/A for the quarter ended September 30, 2001, and
incorporated herein by reference.)
*10.10 Second Amended and Restated Secured Promissory Note in the
principal amount of $4,000,000, dated as of July 13, 2001, by the
Company in favor of FINOVA Mezzanine Capital, Inc. (Filed as
Exhibit 10.10 on Form 10-Q/A for the quarter ended September 30,
2001, and incorporated herein by reference.)
*10.11 Amendment and Limited Waiver to Security Agreement, dated as of
November 14, 2001, by and between the Company and FINOVA Capital
Corporation (Filed as Exhibit 10.11 on Form 10-Q/A for the
quarter ended September 30, 2001, and incorporated herein by
reference.)
*10.12 Intellectual Property Security Agreement, dated as of November
14, 2001, by and between the Company and FINOVA Capital
Corporation (Filed as Exhibit 10.12 on Form 10-Q/A for the
quarter ended September 30, 2001, and incorporated herein by
reference.)
*10.13 Waiver Letter from FINOVA Mezzanine Capital, Inc. to the Company
dated as of November 14, 2001 (Filed as Exhibit 10.13 on Form
10-Q/A for the quarter ended September 30, 2001, and incorporated
herein by reference.)
*10.14 Allonge to Second Amended and Restated Secured Promissory Note,
dated as of November 14, 2001, by the Company in favor of FINOVA
Mezzanine Capital, Inc. (Filed as Exhibit 10.14 on Form 10-Q/A
for the quarter ended September 30, 2001, and incorporated herein
by reference.)
*10.15 Amendment and Limited Waiver to Security Agreement, dated as of
February 13, 2002, by and between the Company and FINOVA Capital
Corporation (Filed as Exhibit 10.15 of Form 10-Q for the quarter
ended December 31, 2001, and incorporated herein by reference.)
*10.16 Waiver Letter from FINOVA Mezzanine Capital, Inc. to the Company
dated as of February 13, 2002 (Filed as Exhibit 10.16 of Form
10-Q for the quarter ended December 31, 2001, and incorporated
herein by reference.)
*10.17 Allonge to Second Amended and Restated Secured Promissory Note
dated as of February 13, 2002, by the Company in favor of FINOVA
Mezzanine Capital, Inc. (Filed as Exhibit 10.17 of Form 10-Q for
the quarter ended December 31, 2001, and incorporated herein by
reference.)
*10.18 Amendment and Limited Waiver to Security Agreement, dated as of
June 26, 2002, by and between the Company and FINOVA Capital
Corporation (Filed as Exhibit 10.18 on Form 10-K for fiscal year
ended March 31, 2002, and incorporated herein by reference.)
*10.19 Amendment and Limited Waiver to Loan Agreement dated as of June
26, 2002, by and between the Company and FINOVA Mezzanine
Capital, Inc. (Filed as Exhibit 10.19 on Form 10-K for fiscal
year ended March 31, 2002, and incorporated herein by reference.)
*10.20 Allonge to Second Amended and Restated Secured Promissory Note
dated as of June 26, 2002, by the Company in favor of FINOVA
Mezzanine (Filed as Exhibit 10.20 on Form 10-K for fiscal year
ended March 31, 2002, and incorporated herein by reference.)
*10.25 Letter from SouthTrust Bank, N.A. dated September 27, 2002
regarding principal deferment on $10,000,000 Promissory Note
(Filed as Exhibit 10.25 on Form 10-Q for the fiscal quarter ended
September 30, 2002, and incorporated herein by reference.)
26
*10.26 Letter from SouthTrust Bank, N.A. dated September 27, 2002
regarding principal deferment on $1,500,000 Promissory Note
(Filed as Exhibit 10.26 on Form 10-Q for the fiscal quarter ended
September 30, 2002, and incorporated herein by reference.)
10.27 Waiver Letter from SouthTrust Bank, N.A. dated February 13, 2003
(Filed herewith.)
*10.30 Promissory Note payable to Angelo S. Morini dated March 28, 2002
(Filed as Exhibit 10.30 on Form 10-Q for the fiscal quarter ended
September 30, 2002, and incorporated herein by reference.)
*10.31 Promissory Note payable to Target Container, Inc. dated August
15, 2002 (Filed as Exhibit 10.31 on Form 10-Q for the fiscal
quarter ended September 30, 2002, and incorporated herein by
reference.)
*10.40 Non-qualified stock option agreement between the Company and
Angelo S. Morini dated May 24, 2002 (Filed as Exhibit 10.40 on
Form 10-Q for the fiscal quarter ended June 30, 2002, and
incorporated herein by reference.)
*10.41 Stock purchase warrant issued to Douglas Walsh dated June 11,
2002 (Filed as Exhibit 10.41 on Form 10-Q for the fiscal quarter
ended June 30, 2002, and incorporated herein by reference.)
*10.42 Incentive stock option agreement between the Company and
Salvatore J. Furnari dated July 8, 2002 (Filed as Exhibit 10.42
on Form 10-Q for the fiscal quarter ended June 30, 2002, and
incorporated herein by reference.)
*10.43 Non-qualified stock option agreement between the Company and
Angelo S. Morini dated July 1, 2002 (Filed as Exhibit 10.43 on
Form 10-Q for the fiscal quarter ended June 30, 2002, and
incorporated herein by reference.)
10.44 Amended and Restated employment agreement between the Company and
Angelo S. Morini dated June 15, 1999 (Filed herewith.)
10.45 Loan Agreement between the Company and Angelo S. Morini dated
June 15, 1999 (Filed herewith.)
10.46 Promissory Note from Angelo S. Morini dated June 15, 1999 (Filed
herewith.)
10.47 Stock Pledge Agreement between the Company and Angelo S. Morini
dated June 15, 1999 (Filed herewith.)
10.48 First Amendment to Loan Agreement and Stock Pledge Agreement
between the Company and Angelo S. Morini dated December 16, 2002
(Filed herewith.)
10.49 Stock Option Agreement between the Company and Angelo S. Morini
dated June 15, 1999 (Filed herewith.)
10.50 Special Services Agreement between the Company and Angelo S.
Morini dated December 4, 2002 (Filed herewith.)
99.1 Certification of the Company's Chief Executive Officer dated
February 14, 2003 (Filed herewith.)
99.2 Certification of the Company's Chief Financial Officer dated
February 14, 2003 (Filed herewith.)
* Previously Filed
27
REPORTS ON FORM 8-K
- -------------------
There was one report on Form 8-K dated December 17, 2002 whereby the Company
disclosed that Angelo S. Morini resigned from his position with Galaxy
Nutritional Foods ("the Company") as Chief Executive Officer, but will continue
to remain as President of the Company. Christopher J. New, the Company's Chief
Operating Officer, then assumed the role and responsibilities of the Company's
Chief Executive Officer. In addition, the Company disclosed that it increased
the number of Board members to six and then elected four new members, including
Charles L. Jarvie, Michael H. Jordan, Thomas R. Dykman, and David H. Lipka, and
simultaneously accepted the resignations of Marshall K. Luther and Douglas
A.Walsh, who resigned in order to pursue other opportunities. Charles L. Jarvie
assumed the role as the Chairman of the Board, Angelo S. Morini assumed the role
as Vice-Chairman of the Board, and Thomas R. Dykman assumed the role as Chairman
of the Audit Committee. On December 18, 2002, the Board increased the size to
seven and appointed Christopher J. New as a director. There were no other
reports on Form 8-K filed during the three months ended December 31, 2002.
28
SIGNATURES
----------
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
GALAXY NUTRITIONAL FOODS, INC.
Date: February 14, 2003 /s/ Christopher J. New
-----------------------------
Christopher J. New
Chief Executive Officer
(Principal Executive Officer)
Date: February 14, 2003 /s/ Salvatore J. Furnari
-----------------------------
Salvatore J. Furnari
Chief Financial Officer
(Principal Financial Officer)
29
I, Christopher J. New, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Galaxy Nutritional
Foods, Inc.("the registrant");
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, 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. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we 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 us 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 our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation to the registrant's auditors and the audit
committee of registrant's board of directors:
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 and material weaknesses 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
6. The registrant's other certifying officers and 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 our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
/s/ Christopher J. New
----------------------------
Christopher J. New
Chief Executive Officer
February 14, 2003
30
I, Salvatore J. Furnari, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Galaxy Nutritional
Foods, Inc.("the registrant");
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, 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. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we 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 us 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 our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation to the registrant's auditors and the audit
committee of registrant's board of directors:
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 and material weaknesses 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
6. The registrant's other certifying officers and 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 our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
/s/ Salvatore J. Furnari
----------------------------
Salvatore J. Furnari
Chief Financial Officer
February 14, 2003
31