SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
__________________________________________________________________
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003
_____________________________
COMMISSION FILE NUMBER 1-15345
GALAXY NUTRITIONAL FOODS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 25-1391475
(State or other jurisdiction of (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 August 14, 2003, there were 15,153,932 shares of Common Stock, $.01 par
value per share, outstanding.
1
GALAXY NUTRITIONAL FOODS, INC.
INDEX TO FORM 10-Q
FOR QUARTER ENDED JUNE 30, 2003
PAGE NO.
--------
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Balance Sheets 4
Statements of Operations 5
Statement of Stockholders' Equity 6
Statements of Cash Flows 7
Notes to Financial Statements 8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION 16
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 22
ITEM 4. CONTROLS AND PROCEDURES 22
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 24
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS 24
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 25
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 26
SIGNATURES 31
2
PART I. FINANCIAL INFORMATION
GALAXY NUTRITIONAL FOODS, INC.
BALANCE SHEETS
JUNE 30, MARCH 31,
NOTES 2003 2003
----- ------------ ------------
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash $ -- $ 1,598
Trade receivables, net 4,220,674 5,109,247
Inventories 5,161,497 5,294,500
Prepaid expenses and other 613,001 553,396
------------ ------------
Total current assets 9,995,172 10,958,741
PROPERTY AND EQUIPMENT, NET 21,701,667 22,168,404
OTHER ASSETS 454,343 274,918
------------ ------------
TOTAL $ 32,151,182 $ 33,402,063
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Book overdrafts $ 193,880 $ 1,151,276
Line of credit 2 4,690,218 4,939,894
Accounts payable 1,844,186 2,622,996
Accrued liabilities 1,616,483 1,891,773
Current portion of term notes payable 2 1,285,610 1,497,760
Current portion of subordinated note payable 2 -- 2,000,000
Current portion of obligations under capital leases 334,201 363,152
------------ ------------
Total current liabilities 9,964,578 14,466,851
TERM NOTES PAYABLE, less current portion 2 9,561,742 7,786,985
SUBORDINATED NOTE PAYABLE 2 -- 2,000,000
OBLIGATIONS UNDER CAPITAL LEASES, less current portion 318,227 383,210
------------ ------------
Total liabilities 19,844,547 24,637,046
------------ ------------
COMMITMENTS AND CONTINGENCIES 3 -- --
REDEEMABLE CONVERTIBLE PREFERRED STOCK 4 3,114,652 2,324,671
STOCKHOLDERS' EQUITY: 4
Common stock 151,529 127,617
Additional paid-in capital 64,498,561 59,800,732
Accumulated deficit (42,565,446) (40,595,342)
------------ ------------
22,084,644 19,333,007
Less: Notes receivable arising from the exercise of 5,8
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 9,191,983 6,440,346
------------ ------------
TOTAL $ 32,151,182 $ 33,402,063
============ ============
See accompanying notes to financial statements.
1
GALAXY NUTRITIONAL FOODS, INC.
STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED JUNE 30, NOTES 2003 2002
----- ------------ ------------
NET SALES $ 8,695,781 $ 9,977,704
COST OF GOODS SOLD 6,051,116 7,236,504
------------ ------------
Gross margin 2,644,665 2,741,200
------------ ------------
OPERATING EXPENSES:
Selling 1,313,873 989,637
Delivery 451,817 571,562
Non-cash compensation related to options and warrants 1,5 1,307,131 (1,637,261)
General and administrative 983,479 841,506
Research and development 63,084 57,774
------------ ------------
Total operating expenses 4,119,384 823,218
------------ ------------
INCOME (LOSS) FROM OPERATIONS (1,474,719) 1,917,982
Interest expense 495,385 898,472
------------ ------------
NET INCOME (LOSS) $ (1,970,104) $ 1,019,510
Preferred Stock Dividends 4 54,780 70,000
Preferred Stock Accretion to Redemption Value 4 894,929 339,277
------------ ------------
NET INCOME (LOSS) TO COMMON SHAREHOLDERS $ (2,919,813) $ 610,233
============ ============
BASIC NET INCOME (LOSS) PER COMMON SHARE 6 $ (0.21) $ 0.05
============ ============
DILUTED NET INCOME (LOSS) PER COMMON SHARE 6 $ (0.21) $ 0.05
============ ============
See accompanying notes to financial statements.
2
GALAXY NUTRITIONAL FOODS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
(UNAUDITED)
Common Stock Notes
---------------------- Additional Accumulated Receivable for Treasury
Shares Par Value Paid-In Capital Deficit Common Stock Stock Total
--------------------------------------------------------------------------------------------------
Balance at March 31, 2003 12,761,685 $ 127,617 $59,800,732 $(40,595,342) $(12,772,200) $(120,461) $ 6,440,346
Exercise of warrants 200,000 2,000 358,000 -- -- -- 360,000
Issuance of common stock 2,138,891 21,389 3,771,731 -- -- -- 3,793,120
Conversion of preferred stock 52,302 523 85,686 -- -- -- 86,209
Fair value of warrants and
employee options issued -- -- 565,800 -- -- -- 565,800
Non-cash compensation related
to variable securities -- -- 833,642 -- -- -- 833,642
Dividends on preferred stock -- -- (54,780) -- -- -- (54,780)
Accretion of discount on
preferred stock -- -- (862,250) -- -- -- (862,250)
Net loss -- -- -- (1,970,104) -- -- (1,970,104)
--------------------------------------------------------------------------------------------------
Balance at June 30, 2003 15,152,878 $ 151,529 $64,498,561 $(42,565,446) $(12,772,200) $(120,461) $ 9,191,983
==================================================================================================
See accompanying notes to financial statements.
3
GALAXY NUTRITIONAL FOODS, INC.
STATEMENTS OF CASH FLOWS
(UNAUDITED)
THREE MONTHS ENDED JUNE 30, NOTES 2003 2002
----- ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income (Loss) $ (1,970,104) $ 1,019,510
Adjustments to reconcile net income (loss) to net cash
from (used in) operating activities:
Depreciation and amortization 558,125 568,770
Amortization of debt discount and financing costs 99,440 439,272
Provision for losses on trade receivables (91,000) (179,037)
Non-cash compensation related to options and warrants 1,5 1,307,131 (1,637,261)
(Increase) decrease in:
Trade receivables 979,573 155,610
Inventories 133,003 793,019
Prepaid expenses and other (59,605) (21,636)
Increase (decrease) in:
Accounts payable (778,810) (559,571)
Accrued liabilities (316,130) 144,863
------------ ------------
NET CASH FROM (USED IN) OPERATING ACTIVITIES (138,377) 723,539
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (91,388) (126,623)
Increase in other assets 1,807 --
------------ ------------
NET CASH FROM (USED IN) INVESTING ACTIVITIES (89,581) (126,623)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Book overdrafts (957,396) (493,285)
Net payments on lines of credit (249,676) (1,021,456)
Repayments on subordinated note payable 2 (4,000,000) --
Borrowings on term note payable 2 2,000,000 500,000
Repayments on term notes payable (437,393) (876,802)
Principal payments on capital lease obligations (93,934) (91,715)
Financing costs for long term debt (188,361) (83,289)
Proceeds from issuance of common stock,
net of offering costs 4 3,793,120 1,467,000
Proceeds from exercise of common stock options -- 4,250
Proceeds from exercise of common stock warrants 2 360,000 --
------------ ------------
NET CASH FROM (USED IN) FINANCING ACTIVITIES 226,360 (595,297)
------------ ------------
NET INCREASE (DECREASE) IN CASH (1,598) 1,619
CASH, BEGINNING OF PERIOD 1,598 168
------------ ------------
CASH, END OF PERIOD 7 $ -- $ 1,787
============ ============
See accompanying notes to financial statements.
4
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, 2003 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 31,2003. Interim results of operations for the three-month
period ended June 30, 2003 may not necessarily be indicative of the results
to be expected for the full year.
Stock Based Compensation
------------------------
The Company accounts for its stock-based employee compensation plans under
the accounting provisions of Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees", and has furnished the pro forma
disclosures required under Statement of Financial Accounting Standards
("SFAS") No. 123, "Accounting for Stock-Based Compensation", and SFAS No.
148, "Accounting for Stock-Based Compensation - Transition and Disclosure".
SFAS No. 123, "Accounting for Stock Based Compensation", requires the
Company to provide pro forma information regarding net income (loss) and
earnings (loss) per share amounts as if compensation cost for the Company's
employee and director stock options had been determined in accordance with
the fair market value-based method prescribed in SFAS No. 123. The Company
estimates the fair value of each stock option at the grant date by using a
Black-Scholes option-pricing model. The following assumptions were used for
options issued during the periods:
Quarter Ended June 30, 2003 June 30, 2002
------------- -------------
Dividend Yield None None
Volatility 41% to 42% 37% to 44%
Risk Free Interest Rate 2.01% to 3.77% 1.71% to 5.03%
Expected Lives in Months 36 to 120 60 to 120
Under the accounting provisions of SFAS No. 123, the Company's net income
(loss) and net income (loss) per basic and diluted share would have been
reduced to the pro forma amounts indicated below:
Quarter Ended June 30, 2003 June 30, 2002
-------------- --------------
Net income (loss) to common shareholders as $ (2,919,813) $ 610,233
reported
Add: Stock-based compensation expense included
in reported net income 1,307,131 (1,637,261)
Deduct: Stock-based compensation expense
determined under fair value based method for all
awards (1,500,127) (2,404,346)
-------------- --------------
Pro forma net income (loss) to common shareholders $ (3,112,809) $ (3,431,374)
============== ==============
Net income (loss) per common share:
Basic - as reported $ (0.21) $ 0.05
============== ==============
Basic - pro forma $ (0.23) $ (0.30)
============== ==============
Diluted - as reported $ (0.21) $ 0.05
============== ==============
Diluted - pro forma $ (0.23) $ (0.30)
============== ==============
7
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
convertible 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 inventory obsolescence, and valuation of deferred taxes, employee
options and warrants. Actual results could differ from those estimates.
New Accounting Pronouncements
-----------------------------
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock Based
Compensation--Transition and Disclosure--an Amendment to SFAS 123." SFAS
148 provides two additional transition methods for entities that adopt the
preferable method of accounting for stock based compensation. Further, the
statement requires disclosure of comparable information for all companies
regardless of whether, when, or how an entity adopts the preferable, fair
value based method of accounting. These disclosures are now required for
interim periods in addition to the traditional annual disclosure. The
amendments to SFAS 123, which provides for additional transition methods,
are effective for fiscal years ending after December 15, 2002, although
earlier application is permitted. The amendments to the disclosure
requirements are required for financial reports containing condensed
financial statements for interim periods beginning after December 15, 2002.
Effective April 1, 2003, the Company adopted the fair value method of
recording compensation expense related to all stock options granted after
March 31, 2003, in accordance with SFAS 123 and SFAS 148 (the prospective
method, as defined by SFAS 148). Accordingly, the fair value of stock
options as determined on the date of grant using the Black-Scholes
option-pricing model, will be expensed over the vesting period of the
related stock options. The negative impact on diluted earnings per share
related to the issuance of employee stock options in fiscal 2004 is
estimated to be approximately $0.01. The actual impact may differ from this
estimate as this estimate is based upon a number of factors including, but
not limited to, the number of stock options granted and the fair value of
the stock options on the date of grant.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity."
The Statement establishes standards for how an issuer classifies and
measures in its statement of financial position certain financial
instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its
scope as a liability (or an asset in some circumstances) because that
financial instrument embodies an obligation of the issuer. Many of such
instruments were previously classified as equity. The statement is
effective for financial instruments entered into or modified after May 31,
2003, and otherwise is effective at the beginning of the first interim
period beginning after June 15, 2003, except for mandatory redeemable
financial instruments of nonpublic entities. The application of the
requirements of SFAS 150 did not have any impact on the Company's financial
position or result of operations.
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.
(2) LINE OF CREDIT AND NOTES PAYABLE
--------------------------------
Effective May 30, 2003, the Company obtained from Textron Financial
Corporation ("Textron") a revolving credit facility (the "Textron Loan") in
the maximum principal amount of $7,500,000 pursuant to the terms and
conditions of a Loan and Security Agreement dated May 27, 2003 (the "Loan
Agreement"). The Textron Loan is secured by the Company's inventory,
accounts receivable and all other assets. Generally, subject to the maximum
principal amount, which can be borrowed under the Textron Loan and certain
reserves that must be maintained during the term of the Textron Loan, the
amount available under the Textron Loan for borrowing by the Company from
time to time is equal to the sum of (i) up to eight-five percent (85%) of
the net amount of its eligible accounts receivable plus (ii) up to sixty
8
percent (60%) of the Company's eligible inventory not to exceed $3,500,000.
Advances under the Textron Loan bear interest at a variable rate, adjusted
on the first (1st) day of each month, equal to the prime rate plus one and
three-quarter percent (1.75%) per annum (6% at June 30, 2003) calculated on
the average cash borrowings for the preceding month. The Textron Loan
matures and all amounts are due and payable in full on May 26, 2006. The
Textron Loan replaced the Company's asset-based credit facility with FINOVA
Capital Corporation on May 30, 2003, which had an outstanding principal
balance of $4,254,667 at the time of replacement. As of June 30, 2003, the
outstanding principal balance on the Textron Loan was $4,690,218.
The Textron Loan described above contains certain financial and operating
covenants. In August 2003, the Company notified Textron that it had failed
to comply with the fixed charge coverage ratio in June 2003. Pursuant to a
certain Waiver Letter dated August 13, 2003, Textron agreed to waive the
requirement to meet the fixed charge coverage ratio for each monthly period
through September 30, 2003. Additionally, Textron agreed that after August
13, 2003, all of the financial covenants required of the Company under
Section 7.6 of the Loan Agreement will be measured and tested on a
quarterly rather than monthly basis.
On September 30, 1999, the Company obtained a $4 million subordinated loan
from FINOVA Mezzanine to finance additional working capital and capital
improvement needs. This loan was paid in full as of May 30, 2003 by the
proceeds from a new loan from SouthTrust Bank as discussed below and from
the equity proceeds raised in the private placements in May 2003, as
discussed in Note 4. In accordance with a warrant agreement from September
30, 1999, the exercise price on 200,000 warrants still held by FINOVA
Mezzanine on May 30, 2003, was reduced from $3.41 to $1.80 per share based
on the sales price of the Company's common stock in May 2003. FINOVA
Mezzanine exercised these warrants to purchase 200,000 shares of the
Company's common stock on June 2, 2003. The Company received net proceeds
of $119,000 after a deduction of $241,000 due to FINOVA Capital Corporation
for waiver fees pursuant to a certain Amendment and Limited Waiver to
Security Agreement dated June 26, 2002.
Simultaneous with the closing of the Textron Loan in May 2003, SouthTrust
Bank extended the Company a new term loan in the principal amount of
$2,000,000. This loan was consolidated with the Company's March 2000 term
loan with SouthTrust Bank, which had a then outstanding principal balance
of $8,131,985 for a total term loan amount of $10,131,985. The revised term
loan bears interest at SouthTrust Bank's prime rate of interest plus 1% (5%
at June 30, 2003), and is due in increasing principal installments by June
2009. Each month, the Company will pay the accrued interest on the loan
plus principal amounts as follows: $75,000 from July 2003 to June 2004,
$110,000 from July 2004 to June 2005, and $166,250 from July 2005 until
maturity in June 2009. This note is secured by all of the Company's
equipment and certain related assets. The proceeds of the new term loan,
together with the proceeds from certain sales of the Company's common stock
conducted in May 2003 (as discussed in Note 4), were used to repay the
Company's $4,000,000 mezzanine loan from FINOVA Mezzanine. The balance
outstanding on the new term loan as of June 30, 2003 was $10,056,742.
In October 2000, the Company obtained a $1.5 million bridge loan from
SouthTrust Bank, which is guaranteed by Angelo S. Morini, the Company's
President, and secured by the pledge of one million shares of the Company's
common stock owned by him. Interest on this note is at the prime rate (4%
at June 30, 2003). The loan is being paid down by monthly principal
payments of $50,000 plus interest. In May 2003, SouthTrust Bank amended
this loan to extend the maturity date from October 2003 to April 2004.
Principal payments of $50,000 are due each month beginning June 1, 2003
until maturity. The balance outstanding on this note as of June 30, 2003
was $401,000. In consideration of his guarantee and stock pledge in respect
to this loan, the Company issued an option to acquire 343,125 shares of
common stock to Mr. Morini on December 15, 2000. The option has an exercise
price of $3.88 per share, which is equal to the fair value of the Company's
common stock at the date of the grant. Such options shall expire on
December 15, 2010.
In connection with the consolidations and extensions of the SouthTrust Bank
loans as described above, the Company issued a warrant to purchase 100,000
shares of the Company's common stock to SouthTrust Bank on May 29, 2003.
The warrant is exercisable until June 1, 2009 at an exercise price of $1.97
per share. The fair value of this warrant was estimated at $101,000, which
will be amortized as non-cash compensation over 72 months beginning in May
2003.
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 the prime rate (4% at June 30,
2003) and is due on or before June 15, 2006.
9
On August 15, 2002, the Company executed and delivered to Target Container,
Inc. a $347,475 promissory note in satisfaction of its accounts payable
obligation to this vendor. This note 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 June 30, 2003 was $59,610.
(3) 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 certain claims of U.S. Patents Nos. 5,112,632, 5,440,860,
5,701,724 and 6,085,680. 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. Schreiber Foods has not specified the amount of money
damages it plans to seek at the time of trial; however, preliminary
discussions between the parties lead the Company to conclude that the
amount requested will be at least several million dollars, and will be
based roughly on a cents-per-pound of product formula.
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. However, the
Company understands that a motion to rescind the verdict and judgment is
currently pending. 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 its Kustner machines. The two Hart Design machines were
modified by the manufacturer from the standard Hart Design configuration
and were delivered to the Company as modified. The Company believes that
the modifications to the machines take them even further outside the ambit
of the Schreiber patents at issue.
As well, the Company has, through legal counsel, advised the Court of the
scope it believes should be given to the claims at issue in the lawsuit (as
part of the so-called Markman briefing process). Schreiber has taken a
different view of the claims. The Court conducted a hearing on the issue on
August 4, 2003, and the Company received the Court's ruling on August 13,
2003. The Court adopted Schreiber's view on many of the claim terms at
issue. The Company, through legal and patent counsel, is still reviewing
the ruling.
The Company and Schreiber recently participated in a Court-sponsored
mediation of claims that did not result in a settlement agreement. Based
upon the failure of that mediation process to resolve the matter, the
Company requested the formal opinion of patent counsel with regard to the
merits of Schreiber's patent and Schreiber's claims of infringement. Patent
counsel has advised that, in his opinion, the patent claim interpretation
being asserted by the Company in the Markman briefing process is the
correct one, and that the Company's machines do not infringe the patent
claims if that claim interpretation is adopted by the Court. The Company
has requested patent counsel to review his opinion in light of the Court's
ruling.
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.
(4) CAPITAL STOCK
-------------
Preferred and Common Stock Issuances
------------------------------------
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 from BH Capital Investments, L.P. and Excalibur Limited
Partnership (the "Series A Preferred Holders") proceeds of approximately
$3,082,000 less costs of $181,041 for the
10
issuance of 72,646 shares of the Company's Series A convertible preferred
stock with a face value of $3,500,000 and warrants to purchase shares of
the Company's common stock. The shares are subject to certain designations,
preferences and rights including the right to convert such shares into
shares of common stock at any time. The per share conversion price is now
equal the quotient of $48.18, plus all accrued dividends that are then
unpaid for each share of the Series A convertible preferred stock then held
by the holder, ($57.81 at June 30, 2003), divided by the lower of (x) $1.75
or (y) 95% of the average of the two lowest closing bid prices of the
Company's common stock on the American Stock Exchange ("AMEX") out of the
fifteen trading days immediately prior to conversion.
In no case, however, shall any Series A Preferred Holder be permitted to
convert the Series A convertible 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 convertible
preferred stock will vary depending upon the closing bid prices of the
Company's common stock on the AMEX.
The Series A Preferred Holders have the right to require the Company to
redeem their shares of preferred stock on April 6, 2005 or upon occurrence
of other specified events. 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 number of shares of common stock that would be then issuable upon
conversion of the preferred stock and times the market price on the date of
redemption. The market price is based on a five-day average of the closing
bid prices for the five trading days prior to 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 the Series A
convertible preferred stock, respectively, plus accrued dividends, into
424,950 and 199,986 shares of common stock, respectively. The conversion
price was $1.3633 based on 95% of the average of the two lowest closing bid
prices on the AMEX for the fifteen trading days immediately prior to
conversion. On June 3, 2003, BH Capital Investments, L.P. converted 1,500
shares of the Series A convertible preferred stock into 52,302 shares of
common stock. The conversion price was $1.6483 based on 95% of the average
of the two lowest closing bid prices on the AMEX for the fifteen trading
days immediately prior to conversion.
The Series A Preferred Holders have the right to receive on any outstanding
Series A convertible preferred stock a ten percent stock dividend on the
shares, payable one year after the issuance of such preferred stock, and an
eight percent stock dividend for the subsequent three years thereafter,
payable in either cash or shares of preferred stock. For the three months
ended June 30, 2003 and 2002, the Company recorded preferred dividends of
$54,780 and $70,000, respectively, in connection with the issuance of the
preferred stock on April 6, 2001. On April 6, 2001, the Company recorded
the initial carrying value of the preferred stock as $521,848, which
included adjustment for the estimated fair value of the initial warrants
($277,200) and redemption warrants ($277,200). Each quarter the Company
calculates the estimated redemption value based on the formulas stated
above and the difference between the initial carrying value and the
estimated redemption value is then accreted over the redemption period (48
months beginning April 2001) using the straight line method, which
approximates the effective interest method. For the three months ended June
30, 2003 and 2002, the Company recorded $894,929 and $339,277,
respectively, related to the accretion of the redemption value of preferred
stock and the beneficial conversion feature of accrued dividends. As of
June 30, 2003, the value of the remaining 55,884 shares of redeemable
convertible preferred stock is $3,114,652.
On November 7, 2002, BH Capital Investments, L.P. and Excalibur Limited
Partnership, as holders of a majority of the shares of the Series A
convertible preferred stock, exercised their right under the Purchase
Agreement to require the Company to solicit the approval of its
shareholders for the Company's issuance of all of the shares of common
stock potentially issuable upon conversion of the Series A convertible
preferred stock in full and the exercise of their warrants. This right
arose when the number of shares of common stock they are entitled to
receive, assuming conversion of the all of the Series A convertible
preferred stock and the exercise of their warrants, exceeded 15% of the
Company's then-outstanding shares of common stock. The Company was required
to hold a shareholders meeting to solicit such approval on or before
February 5, 2003. Pursuant to a letter agreement in January 2003, the
holders of the Series A convertible preferred stock agreed to extend the
deadline to hold a meeting to March 31, 2003. Subsequently, pursuant to the
Stock Purchase Option Agreement described below, the holders of the Series
A convertible preferred stock agreed, among other things, to extend the
deadline to September 30, 2003.
On April 24, 2003, the Company and the holders of the Series A convertible
preferred stock entered into that certain Stock Purchase Option Agreement,
whereby the Company was granted the option to purchase all of the shares of
11
the Series A convertible preferred stock owned by such holders at the time
the purchase is consummated. The option may be exercised by the Company or
its assigns at any time until the earlier of five days after the date of
the Company's next annual shareholders meeting or September 30, 2003.
Pursuant to such agreement, the holders of the Series A convertible
preferred stock also agreed to extend the deadline to hold a shareholders
meeting to September 30, 2003. In exchange for the option and the extension
of the annual meeting date, the Company issued to each of BH Capital
Investments, L.P. and Excalibur Limited Partnership warrants to purchase
250,000 shares of the Company's common stock. These warrants are
exercisable until July 15, 2006 at an exercise price equal to $2.00 per
share, which price was greater than the market value of the Company's
common stock on April 24, 2003. The Company agreed to register the shares
underlying the warrants by no later than December 31, 2003. The fair value
of these warrant was estimated at $230,000, which was recorded as non-cash
compensation expense in the quarter ended June 30, 2003.
On April 10, 2003, the Company entered into a credit arrangement with one
of its greater than 5% shareholders pursuant to which the shareholder would
purchase raw materials for the Company in an aggregate amount not to exceed
$500,000. The amounts paid for the purchased materials, plus interest at
the rate of 15% per annum on such amounts, was due and payable in full on
July 9, 2003. In consideration of the credit arrangement, the Company
issued to the shareholder a warrant to purchase 100,000 shares of the
Company's common stock at an exercise price of $1.70. The fair value of
this warrant was estimated at $63,000, which was recorded as non-cash
compensation expense in the quarter ended June 30, 2003. All amounts owed
under the credit arrangement were repaid in full and such credit
arrangement was terminated on June 27, 2003.
Pursuant to the Company's Restated Certificate of Incorporation, the
warrant issued to the above shareholder caused the maximum conversion price
of the Series A convertible preferred stock to decrease to $1.75, such that
the conversion rate of the Series A convertible preferred stock to common
stock is currently equal to the quotient of (i) $48.18, plus all accrued
dividends that are then unpaid for each share of the Series A convertible
preferred stock then held by the holder, divided by (ii) the lesser of (x)
$1.75 or (y) 95% of the average of the two lowest closing bid prices of the
Company's common stock on AMEX out of the fifteen trading days immediately
prior to conversion.
Pursuant to seven Securities Purchase Agreements dated May 21, 2003, the
Company issued a total of 2,138,891 shares of its common stock at a price
per share equal to $1.80 for aggregate gross proceeds to the Company of
$3,850,000. Pursuant to a Registration Rights Agreement dated May 21, 2003,
the Company has agreed to register the shares of common stock purchased by
the investors with the Securities and Exchange Commission no later than
November 24, 2003. Sales to related parties under the Securities Purchase
Agreements include: 555,556 shares of common stock sold at an aggregate
sales price of $1,000,000 to Frederick DeLuca, a greater than 5%
shareholder; 55,556 shares of common stock sold at an aggregate sales price
of $100,000 to David H. Lipka, a Director of the Company; 83,333 and 55,556
shares of common stock sold at an aggregate sales price of $150,000 and
$100,000, respectively, to Ruggieri of Windermere Family Limited
Partnership and Ruggieri Financial Pension Plan, respectively, each an
affiliate of John Ruggieri, the Company's Vice President of Manufacturing;
1,111,112 shares of common stock sold at an aggregate sales price of
$2,000,000 to Fromageries Bel S.A., a leading branded cheese company in
Europe which signed a Master Distribution and Licensing Agreement effective
May 22, 2003 with the Company. Sales to non-related parties under the
Securities Purchase Agreements include: 138,889 shares of common stock sold
at an aggregate sales price of $250,000 Apollo Capital Management Group;
and 138,889 shares of common stock sold at an aggregate sales price of
$250,000 Apollo MicroCap Partners, L.P.
The Company used $2,000,000 of the proceeds generated from these May 2003
private placements to pay down the balance of the Company's mezzanine loan
from FINOVA Mezzanine Capital, Inc. The Company then applied the additional
proceeds from the new loan from SouthTrust Bank, as discussed above, to pay
the remaining $2,000,000 on the FINOVA Mezzanine loan. The Company utilized
the remainder of the private placement proceeds for working capital and
general corporate purposes.
(5) NON-CASH COMPENSATION RELATED TO OPTIONS AND WARRANTS
-----------------------------------------------------
Notes Receivable for Common Stock
---------------------------------
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 covers specific events that occurred after December 15, 1998 and was
effective as of July 2, 2000. FIN 44 clarified that when an option is
repriced, it is treated as a variable option and is marked to market each
quarter. Accordingly, any increase in the market price of the Company's
common stock over the exercise price of the options that was not previously
recorded is recorded as compensation expense at each reporting period. If
there is a decrease in the market
12
price of the Company's common stock compared to the prior reporting period,
the reduction is recorded as compensation income. Compensation income is
limited to the original base exercise price (the "Floor") of the options.
In accordance with FIN 44, the underlying shares related to the $12,772,200
note receivable from Angelo S. Morini, as disclosed in Note 8, are treated
as variable due to the nature of the note being non-interest bearing and
non-recourse. There was no non-cash compensation expense or income related
to these shares recorded in the three months ended June 30, 2003 as the
price of the Company's common stock at the beginning and end of the period
was below the Floor. The Company recorded non-cash compensation income of
$1,690,286 for the three months ended June 30, 2002 based on the decrease
in the market price of the Company's common stock from $5.43 at March 31,
2002 to $4.85 at June 30, 2002.
Option and Warrant Repricing
----------------------------
On October 11, 2002, the Company repriced all outstanding options granted
to employees prior to October 11, 2002 (4,284,108 shares at former prices
ranging from $2.84 to $10.28) to the market price of $2.05 per share. In
addition, the Company repriced the outstanding warrants held by current
consultants as of October 11, 2002 (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 and such
variable accounting treatment will continue 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 agreed to reverse the repricing of his 3,692,035 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 any outstanding options related to these reversed-repriced
options and all new options issued to the Company's President prior to June
4, 2003 in accordance with variable accounting standards each quarter.
The Company recorded $833,642 as non-cash compensation expense related to
these variable options and warrants in the three months ended June 30,
2003. The remaining outstanding variable options and warrants as of June
30, 2003 were 3,890,860.
Option and Warrant Issuances
----------------------------
The Company recorded $485,806 and $50,700 as non-cash compensation expense
related to employee options and warrants that it issued during the three
months ended June 30, 2003 and 2002, respectively. Additionally, it
recorded non-cash compensation income of $12,317 and non-cash compensation
expense of $2,325 related to the amortization of the fair value of warrants
it issued in periods prior to June 30, 2003 and 2002, respectively.
(6) 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 June 30, 2003 2002
- --------------------------------------------------------------------------------------------
Net income (loss) per common share $ (2,919,813) $ 610,233
Basic net income (loss) per common share $ (0.21) $ 0.05
------------ ------------
Average shares outstanding - basic 13,590,879 11,548,929
"In-the-money" shares under stock option agreements -- 2,570,504
"In-the-money" shares under stock warrant agreements -- 460,429
Less: Shares assumed repurchased under treasury stock method -- (2,246,511)
------------ ------------
Average shares outstanding - diluted 13,590,879 12,333,351
------------ ------------
Diluted income (loss) per common share $ (0.21) $ 0.05
============ ============
Potential conversion of Series A convertible preferred stock for 1,815,502
shares, options for 4,651,521 shares and warrants for 1,242,856 shares have
not been included in the computation of diluted net income (loss) per
common share for the three months ended June 30, 2003, as their effect
would be antidilutive. Potential conversion of Series A convertible
preferred stock for 943,648 shares, options for 1,401,296 shares and
warrants for 195,141 shares have not
13
been included in the computation of diluted net income (loss) per common
share for the three months ended June 30, 2002, as their effect would be
antidilutive.
(7) 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.
Three months ended June 30, 2003 2002
--------------------------------------------------------------------------------------
Non-cash financing and investing activities:
Fair value of options and warrants issued $565,800 $ 50,700
Accrued preferred stock
dividends 54,780 70,000
Beneficial conversion feature related to preferred
stock dividends 25,105 12,971
Accretion of discount on preferred stock 869,824 326,306
Cash paid for:
Interest 530,198 451,766
Income taxes -- 24,000
(8) 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. 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 bridge loan from SouthTrust Bank, which is guaranteed by Mr. Angelo
S. Morini, the Company's President, and secured by one million of his above
mentioned 2,914,286 shares of the Company's common stock. These one million
shares are expected to be released to the Company upon full payment of the
bridge loan.
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% at June 30, 2002) and is
due on or before June 15, 2006.
Included in the Balance Sheet as prepaid and other at June 30, 2003 and
2002 is $140,288 and $259,761 in advances to the Company's President.
Beginning January 13, 2003, the Company entered into a vendor arrangement
with one of its employees pursuant to which the employee would purchase raw
materials for the Company approximating $500,000. The amounts paid for the
purchased materials, plus interest at the rate of 15% per annum on such
amounts, was due and paid in full by May 31, 2003.
On April 10, 2003, the Company entered into a credit arrangement with one
of its greater than 5% shareholders pursuant to which the shareholder would
purchase raw materials for the Company in an aggregate amount not to exceed
$500,000. The amounts paid for the purchased materials, plus interest at
the rate of 15% per annum on such amounts, was due and payable in full on
July 9, 2003. In consideration of the credit arrangement, the Company
issued to the shareholder a warrant to purchase 100,000 shares of the
Company's common stock at an exercise price of $1.70. The fair value of
this warrant was estimated at $63,000, which was recorded as non-cash
compensation expense in the quarter ended June 30, 2003. All amounts owed
under the credit arrangement were repaid in full and such credit
arrangement was terminated on June 27, 2003.
On May 22, 2003, the Company entered into a Master Distribution and
Licensing Agreement (the "Agreement") with Fromageries Bel S.A. ("Bel"), a
leading branded cheese company in Europe. The Agreement became effective
upon
14
the closing of the Textron Financial Corporation asset based loan, the new
$2 million loan from SouthTrust Bank and the private placements described
above. Under the Agreement, the Company has granted Bel exclusive
distribution rights for the Company's products (the "Products") in a
territory comprised of the European Union States and to more than 21 other
European countries and territories (the "Territory"). The Company has also
granted Bel the exclusive option during the term of the Agreement to elect
to manufacture the Products designated by Bel for distribution in the
Territory. The term of the Agreement is ten years, provided that either of
the parties may elect to terminate the Agreement by delivery of notice to
the other between March 24, 2007 and May 22, 2007, which termination shall
be effective as of first anniversary of the date of the notice of
termination. Alternatively, the parties may mutually agree to continue
operating under the Agreement, to convert the Agreement to a manufacturing
and license agreement, or to terminate the Agreement.
15
GALAXY NUTRITIONAL FOODS, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
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 the Company's current expectations,
estimates and projections about the Company's 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, the Company's actual
results may differ materially from those described in these forward-looking
statements due to among other factors, competition in the Company's product
markets, dependence on suppliers, the Company's manufacturing experience, and
production delays or inefficiencies. The Company undertakes 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 inventory obsolescence, and
valuation of deferred taxes, employee options 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 June 30, 2003 and
March 31, 2003, the Company had reserved $396,000 and $487,000, respectively,
for known and anticipated future promotional credits and doubtful accounts. The
Company utilizes a detailed customer invoice promotion settlement process to
methodically predict, track, manage, and resolve invoicing issues. Actual bad
debt expense during the three months ended June 30, 2003 was approximately
$7,000. There was no bad debt expense recorded during the three months ended
June 30, 2002.
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 ("SFAS 123"), "Accounting
for Stock Based Compensation", requires the Company to provide pro-forma
information regarding net income (loss) and earnings (loss) per share amounts as
if compensation cost for the Company's employee and director stock options had
been determined in accordance with the fair market value-based method prescribed
in SFAS No. 123. The Company estimates the fair value of each stock option at
16
the grant date by using a Black-Scholes option-pricing model. The following
assumptions were used for options issued during the periods:
Quarter Ended June 30, 2003 June 30, 2002
------------- -------------
Dividend Yield None None
Volatility 41% to 42% 37% to 44%
Risk Free Interest Rate 2.01% to 3.77% 1.71% to 5.03%
Expected Lives in Months 36 to 120 60 to 120
RESULTS OF OPERATIONS
Three Months Ended June 30, 2003 ("first quarter fiscal 2004") Compared to Three
- --------------------------------------------------------------------------------
Months Ended June 30, 2002 ("first quarter fiscal 2003")
- --------------------------------------------------------
NET SALES were $8,695,781 in first quarter fiscal 2004 compared to net sales of
$9,977,704 in first quarter fiscal 2003, a decrease of $1,281,923 or 13%. This
decrease is primarily due to a reduction in retail grocery sales from the prior
year mainly as a result of management's decision to turn away lower margin
private label and sandwich slice business in order to reallocate the Company's
limited cash resources for production of higher margin "branded" items. Another
factor in the sales decrease was the reduction in the number of core items
produced in order to eliminate lower volume and lower margin items. While the
effect of these decisions caused top line sales to diminish initially, this
approach enabled the Company's gross margin to increase from 27% in first
quarter fiscal 2003 to 30% in first quarter fiscal 2004. Additionally, the
reduction in the number of items produced by the Company will enable it to
rebuild its top-line sales by focusing on a smaller base of core items which
generate higher production volumes and margins.
COST OF GOODS SOLD were $6,051,116 representing 70% of net sales for first
quarter fiscal 2004, compared with $7,236,504 or 73% of net sales for first
quarter fiscal 2003. The three percent improvement primarily resulted from a
price decrease in raw material costs. The Company expects that it will continue
to control costs throughout fiscal 2004 by virtue of its increased efficiencies
in production and purchasing along with tight controls on product mix and
individual item margins.
SELLING expenses were $1,313,873 in first quarter fiscal 2004 compared to
$989,637 in first quarter fiscal 2003, an increase of $324,236 or 33%. In first
quarter fiscal 2004, the Company recorded increases of approximately $338,000 in
promotional costs and $115,000 in advertising costs. These costs were limited in
the prior year due to the prior financial constraints of the Company. The
Company noted a decrease of approximately $110,000 in brokerage costs
corresponding with the decrease in sales and additional decreases in personnel
expenses in first quarter fiscal 2004 compared to first quarter fiscal 2003. The
Company expects that fiscal 2004 selling expenses will increase compared to
fiscal 2003 expenses based on the Company's current plan for expanding
distribution of strategic products, and advertising and promotional allowances
that are focused towards specific regions and customers.
DELIVERY expenses were $451,817 in first quarter fiscal 2004 compared to
$571,562 in first quarter fiscal 2003, a decrease of $119,745 or 21%. Delivery
expenses approximate 5% of net sales each period. The decrease in delivery costs
is in direct proportion to the decrease in net sales.
NON-CASH COMPENSATION RELATED TO OPTIONS AND WARRANTS was an expense of
$1,307,131 in first quarter fiscal 2004 compared to an income of $1,637,261 for
first quarter fiscal 2003. The Company values the non-cash compensation related
to its securities on three primary items:
a. Notes Receivable for Common Stock
--------------------------------------
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 covers specific events that occurred after December 15, 1998 and was
effective as of July 2, 2000. FIN 44 clarified that when an option is
repriced, it is treated as a variable option and is marked to market each
quarter. Accordingly, any increase in the market price of the Company's
common stock over the exercise price of the options that was not previously
recorded is recorded as compensation expense at each reporting period. If
there is a decrease in the market price of the Company's common stock
compared to the prior reporting period, the reduction is recorded as
compensation income. Compensation income is limited to the original base
exercise price (the "Floor") of the options. In accordance with FIN 44, the
underlying shares related to the $12,772,200 note receivable from Angelo S.
Morini are treated as variable due to the nature of the note being
non-interest bearing and non-recourse. There was no non-cash
17
compensation expense or income related to these shares recorded in first
quarter fiscal 2004 as the price of the Company's common stock at the
beginning and end of the period was below the Floor. The Company recorded
non-cash compensation income of $1,690,286 in first quarter fiscal 2003
based on the decrease in the market price of the Company's common stock
from $5.43 at March 31, 2002 to $4.85 at June 30, 2002. Due to the
volatility of the market price of its common stock, the Company 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 approximately
$29,000.
b. Option and Warrant Repricing
---------------------------------
On October 11, 2002, the Company repriced all outstanding options granted
to employees prior to October 11, 2002 (4,284,108 shares at former prices
ranging from $2.84 to $10.28) to the market price of $2.05 per share. In
addition, the Company repriced the outstanding warrants held by current
consultants prior to October 11, 2002 (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 and such
variable accounting treatment will continue 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 agreed to reverse the repricing of his 3,692,035 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 any outstanding options related to these reversed-repriced
options and all new options issued to the Company's President prior to June
4, 2003 in accordance with variable accounting standards each quarter.
The Company recorded $833,642 as non-cash compensation expense related to
these variable options and warrants in first quarter fiscal 2004. 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. Assuming no further options or warrants are
exercised or cancelled and all are vested, a $0.01 increase or decrease in
the Company's stock price results in a non-cash compensation expense or
income, respectively, of approximately $39,000.
c. Option and Warrant Issuances
---------------------------------
The Company recorded $485,806 and $50,700 as non-cash compensation expense
related to employee options and warrants that it issued during its first
quarter fiscal 2004 and its first quarter fiscal 2003, respectively.
Additionally, it recorded non-cash compensation income of $12,317 and
non-cash compensation expense of $2,325 related to the amortization of the
fair value of warrants it issued in periods prior to first quarter fiscal
2004 and first quarter fiscal 2003, respectively.
GENERAL AND ADMINISTRATIVE expenses were $983,479 in first quarter fiscal 2004
compared to $841,506 in first quarter fiscal 2003, a $141,973 or 17% increase
due primarily to an increase in personnel, legal, insurance and director
expenses. The increase in personnel costs in first quarter fiscal 2004 compared
to first quarter fiscal 2003 related to the addition of several new employees, a
change in classification of wages from selling to general and administrative
expense due to a change in the job functions of Mr. Christopher J. New when he
became Chief Executive Officer, and an increase in wages paid to existing
administrative personnel.
RESEARCH AND DEVELOPMENT expenses were $63,084 in first quarter fiscal 2004
compared to $57,774 in first quarter fiscal 2003, a $5,310 or 9% increase. This
increase is primarily the result of an increase in the allocation of general
overhead costs to this department.
INTEREST expense was $495,385 in first quarter fiscal 2004 compared to $898,472
in first quarter fiscal 2003, a $403,087 or 45% decrease. During first quarter
fiscal 2003, the Company amortized to interest expense $307,115 related to debt
discounts on its prior mezzanine loan from FINOVA Mezzanine Capital, Inc.
("FINOVA Mezzanine"). Additionally, interest expense decreased as a result of
lower debt balances and a reduction in the prime rate by one-half of a percent
(0.5%) during first quarter fiscal 2004 compared to first quarter fiscal 2003.
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 used in operating activities was $138,377 in
first quarter fiscal 2004 compared to net cash provided by operating activities
of $723,539 in first quarter fiscal 2003. The increase in cash used in
operations in first quarter fiscal 2004 is primarily attributable to reductions
in accounts payable and accrued liabilities offset by substantial
18
collections on trade receivables. In first quarter fiscal 2003, the Company
received a significant portion of its cash from operations by decreasing its
inventory levels.
INVESTING ACTIVITIES - Net cash used in investing activities totaled $89,581 and
$126,623 in first quarter fiscal 2004 and 2003, respectively. The decrease in
cash used for investing activities during first quarter fiscal 2004 as compared
to first quarter fiscal 2003 primarily resulted from less purchases of fixed
assets during the period.
FINANCING ACTIVITIES - Net cash provided by financing activities was $226,360 in
first quarter fiscal 2004 compared to net cash used in financing activities of
$595,297 in first quarter fiscal 2003. During first quarter fiscal 2004, the
Company raised $3,850,000 through the issuance of common stock and $2,000,000
from a new term loan with SouthTrust Bank, as described below. The Company used
$4,000,000 of these proceeds to pay in full the principal balance owed to FINOVA
Mezzanine. The remaining proceeds were for used operations and to further reduce
the Company's accounts payable and debt balances. During first quarter 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. In addition in first quarter fiscal 2003, the Company raised $1,500,000
through the issuance of common stock. These proceeds were used to pay off the
Company's 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 Corporation ("FINOVA Capital").
Debt Financing
- --------------
Effective May 30, 2003, the Company obtained from Textron Financial Corporation
("Textron") a revolving credit facility (the "Textron Loan") in the maximum
principal amount of $7,500,000 pursuant to the terms and conditions of a Loan
and Security Agreement dated May 27, 2003 (the "Loan Agreement"). The Textron
Loan is secured by the Company's inventory, accounts receivable and all other
assets. Generally, subject to the maximum principal amount, which can be
borrowed under the Textron Loan and certain reserves that must be maintained
during the term of the Textron Loan, the amount available under the Textron Loan
for borrowing by the Company from time to time is equal to the sum of (i) up to
eight-five percent (85%) of the net amount of its eligible accounts receivable
plus (ii) up to sixty percent (60%) of the Company's eligible inventory not to
exceed $3,500,000. Advances under the Textron Loan bear interest at a variable
rate, adjusted on the first (1st) day of each month, equal to the prime rate
plus one and three-quarter percent (1.75%) per annum (6% at June 30, 2003)
calculated on the average cash borrowings for the preceding month. The Textron
Loan matures and all amounts are due and payable in full on May 26, 2006. The
Textron Loan replaced the Company's asset-based credit facility with FINOVA
Capital on May 30, 2003, which had an outstanding principal balance of
$4,254,667 at the time of replacement. As of June 30, 2003, the outstanding
principal balance on the Textron Loan was $4,690,218.
The Textron Loan described above contains certain financial and operating
covenants. In August 2003, the Company notified Textron that it had failed to
comply with the fixed charge coverage ratio in June 2003. Pursuant to a certain
Waiver Letter dated August 13, 2003, Textron agreed to waive the requirement to
meet the fixed charge coverage ratio for each monthly period through September
30, 2003. Additionally, Textron agreed that after August 13, 2003, all of the
financial covenants required of the Company under Section 7.6 of the Loan
Agreement will be measured and tested on a quarterly rather than monthly basis.
On September 30, 1999, the Company obtained a $4 million subordinated loan from
FINOVA Mezzanine to finance additional working capital and capital improvement
needs. This loan was paid in full as of May 30, 2003 by the proceeds from the a
loan from SouthTrust Bank and from the equity proceeds raised in the private
placements in May 2003, as discussed below. In accordance with a warrant
agreement from September 30, 1999, the exercise price on 200,000 warrants still
held by FINOVA Mezzanine on May 30, 2003, was reduced from $3.41 to $1.80 per
share based on the sales price of the Company's common stock in May 2003. FINOVA
Mezzanine exercised these warrants to purchase 200,000 shares of the Company's
common stock on June 2, 2003. The Company received net proceeds of $119,000
after a deduction of $241,000 due to FINOVA Capital Corporation for waiver fees
pursuant to a certain Amendment and Limited Waiver to Security Agreement dated
June 26, 2002.
Simultaneous with the closing of the Textron Loan in May 2003, SouthTrust Bank
extended the Company a new term loan in the principal amount of $2,000,000. This
loan was consolidated with the Company's March 2000 term loan with SouthTrust
Bank, which had a then outstanding principal balance of $8,131,985 for a total
term loan amount of $10,131,985. The revised term loan bears interest at
SouthTrust Bank's prime rate of interest plus 1% (5% at June 30, 2003), and is
due in increasing principal installments by June 2009. Each month, the Company
will pay the accrued interest on the loan plus principal amounts as follows:
$75,000 from July 2003 to June 2004, $110,000 from July 2004 to June 2005, and
$166,250 from July 2005 until maturity in June 2009. This note is secured by all
of the Company's equipment
19
and certain related assets. The proceeds of the new term loan, together with the
proceeds from certain sales of the Company's common stock conducted in May 2003,
were used to repay the Company's $4,000,000 mezzanine loan from FINOVA
Mezzanine. The balance outstanding on this new term loan as of June 30, 2003 was
$10,056,742.
In October 2000, the Company obtained a $1.5 million bridge loan from SouthTrust
Bank, which is guaranteed by Angelo S. Morini, the Company's President, and
secured by the pledge of one million shares of the Company's common stock owned
by him. Interest on this note is at the prime rate (4% at June 30, 2003). The
loan is being paid down by monthly principal payments of $50,000 plus interest.
In May 2003, SouthTrust Bank amended this loan to extend the maturity date from
October 2003 to April 2004. Principal payments of $50,000 are due each month
beginning June 1, 2003 until maturity. The balance outstanding on this note as
of June 30, 2003 was $401,000. In consideration of his guarantee and stock
pledge in respect to this loan, the Company issued an option to acquire 343,125
shares of common stock to Mr. Morini on December 15, 2000. The option has an
exercise price of $3.88 per share, which is equal to the fair value of the
Company's common stock at the date of the grant. Such options shall expire on
December 15, 2010.
In connection with the consolidations and extensions of the SouthTrust Bank
loans as described above, the Company issued a warrant to purchase 100,000
shares of the Company's common stock to SouthTrust Bank on May 29, 2003. The
warrant is exercisable until June 1, 2009 at an exercise price of $1.97 per
share. The fair value of this warrant was estimated at $101,000, which will be
amortized as non-cash compensation over 72 months beginning in May 2003.
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 the prime rate (4% at June 30, 2003) and is due on
or before June 15, 2006.
On August 15, 2002, the Company executed and delivered to Target Container, Inc.
a $347,475 promissory note in satisfaction of its accounts payable obligation to
this vendor. This note 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 June
30, 2003 was $59,610.
In January 2003, Ruggieri of Windermere Family Limited Partnership, an affiliate
of Mr. John Ruggieri, the Company's Vice President of Manufacturing, entered
into a credit arrangement with the Company pursuant to which the partnership
would purchase for the Company raw materials approximating $500,000. The amounts
paid for the purchased materials, plus interest at the rate of 15% per annum on
such amounts, was due and paid in full by May 31, 2003.
On April 10, 2003, the Company entered into a credit arrangement with Mr.
Frederick Deluca, one of its greater than 5% shareholders, pursuant to which the
shareholder would purchase raw materials for the Company in an aggregate amount
not to exceed $500,000. The amounts paid for the purchased materials, plus
interest at the rate of 15% per annum on such amounts, was due and payable in
full on July 9, 2003. All amounts owed under the credit arrangement were repaid
in full and such credit arrangement was terminated on June 27, 2003.
Equity Financing
- ----------------
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 from BH Capital Investments, L.P. and Excalibur Limited
Partnership (the "Series A Preferred Holders") proceeds of approximately
$3,082,000 less costs of $181,041 for the issuance of 72,646 shares of the
Company's Series A convertible preferred stock with a face value of $3,500,000
and warrants to purchase shares of the Company's common stock. The Series A
Preferred Holders have the right to receive on any outstanding Series A
convertible preferred stock a ten percent stock dividend on the shares, payable
one year after the issuance of such preferred stock, and an eight percent stock
dividend for the subsequent three years thereafter, payable in either cash or
shares of preferred stock. The Series A convertible preferred stock is subject
to certain designations, preferences and rights set forth in the Company's
Restated Certificate of Incorporation, 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:
$48.18, plus all accrued dividends that are then unpaid for each share of the
Series A convertible preferred stock then held by the holder,
divided by,
20
the lesser of (x) $1.75 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 Series A Preferred Holder be permitted to convert
the Series A convertible 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 convertible preferred stock will vary depending upon
the closing bid prices of the Company's common stock on the AMEX.
The Series A Preferred Holders have the right to require the Company to redeem
their shares of preferred stock on April 6, 2005 or upon occurrence of other
specified events. 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 number of shares
of common stock that would be then issuable upon conversion of the preferred
stock and times the market price on the date of redemption. The market price is
based on a five-day average of the closing bid prices for the five trading days
prior to 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 the Series A convertible preferred
stock, respectively, plus accrued dividends, into 424,950 and 199,986 shares of
common stock, respectively. The conversion price was $1.3633 based on 95% of the
average of the two lowest closing bid prices on the AMEX for the fifteen trading
days immediately prior to conversion. On June 3, 2003, BH Capital Investments,
L.P. converted 1,500 shares of the Series A convertible preferred stock into
52,302 shares of common stock. The conversion price was $1.6483 based on 95% of
the average of the two lowest closing bid prices on the AMEX for the fifteen
trading days immediately prior to conversion.
On November 7, 2002, BH Capital Investments, L.P. and Excalibur Limited
Partnership, as holders of a majority of the shares of the Series A convertible
preferred stock, exercised their right under the Purchase Agreement to require
the Company to solicit the approval of its shareholders for the Company's
issuance of all of the shares of common stock potentially issuable upon
conversion of the Series A convertible preferred stock in full and the exercise
of their warrants. This right arose when the number of shares of common stock
they are entitled to receive, assuming conversion of the all of the Series A
convertible preferred stock and the exercise of their warrants, exceeded 15% of
the Company's then-outstanding shares of common stock. The Company was required
to hold a shareholders meeting to solicit such approval on or before February 5,
2003. Pursuant to a letter agreement in January 2003, the holders of the Series
A convertible preferred stock agreed to extend the deadline to hold a meeting to
March 31, 2003. Subsequently, pursuant to the Stock Purchase Option Agreement
described below, the holders of the Series A convertible preferred stock agreed,
among other things, to extend the deadline to September 30, 2003.
On April 24, 2003, the Company and the Series A Preferred Holders entered into
that certain Stock Purchase Option Agreement, whereby the Company was granted
the option to purchase all of the shares of the Series A convertible preferred
stock owned by such holders at the time the purchase is consummated. The option
may be exercised by the Company or its assigns at any time until the earlier of
five days after the date of the Company's next annual shareholders meeting or
September 30, 2003. Pursuant to such agreement, the Series A Preferred Holders
also agreed to extend the deadline to hold a shareholders meeting to September
30, 2003. In exchange for the option and the extension of the annual meeting
date, the Company issued to each of BH Capital Investments, L.P. and Excalibur
Limited Partnership warrants to purchase 250,000 shares of the Company's common
stock. These warrants are exercisable until July 15, 2006 at an exercise price
equal to $2.00 per share, which price was greater than the market value of the
Company's common stock on April 24, 2003. The Company agreed to register the
shares underlying the warrants by no later than December 31, 2003. The fair
value of these warrant was estimated at $230,000, which was recorded as non-cash
compensation expense in first quarter fiscal 2004.
On April 10, 2003, the Company entered into a credit arrangement with Mr.
Frederick Deluca, one of its greater than 5% shareholders, pursuant to which the
shareholder would purchase raw materials for the Company in an aggregate amount
not to exceed $500,000. The amounts paid for the purchased materials, plus
interest at the rate of 15% per annum on such amounts, was due and payable in
full on July 9, 2003. In consideration of the credit arrangement, the Company
issued to Mr. Deluca a warrant to purchase 100,000 shares of the Company's
common stock at an exercise price of $1.70. The fair value of this warrant was
estimated at $63,000, which was recorded as non-cash compensation expense in
first quarter fiscal 2004. All amounts owed under the credit arrangement were
repaid in full and such credit arrangement was terminated on June 27, 2003.
21
Pursuant to the Company's Restated Certificate of Incorporation, the warrant
issued to Mr. Deluca caused the maximum conversion price of the Series A
convertible preferred stock to decrease to $1.75, such that the conversion rate
of the Series A convertible preferred stock to common stock is currently equal
to the quotient of (i) $48.18, plus all accrued dividends that are then unpaid
for each share of the Series A convertible preferred stock then held by the
holder, divided by (ii) the lesser of (x) $1.75 or (y) 95% of the average of the
two lowest closing bid prices of the Company's common stock on AMEX out of the
fifteen trading days immediately prior to conversion.
In accordance with an exemption from registration under Regulation D promulgated
under the Securities Act of 1933, as amended, and pursuant to seven Securities
Purchase Agreements dated May 21, 2003, the Company sold and issued a total of
2,138,891 shares of its common stock at a price per share equal to $1.80 for
aggregate gross proceeds to the Company of $3,850,000. Pursuant to a
Registration Rights Agreement dated May 21, 2003, the Company has agreed to
register the shares of common stock purchased by the investors with the
Securities and Exchange Commission no later than November 24, 2003. Sales to
related parties under the Securities Purchase Agreements include: 555,556 shares
of common stock sold at an aggregate sales price of $1,000,000 to Frederick
DeLuca, a greater than 5% shareholder; 55,556 shares of common stock sold at an
aggregate sales price of $100,000 to David H. Lipka, a Director of the Company;
83,333 and 55,556 shares of common stock sold at an aggregate sales price of
$150,000 and $100,000, respectively, to Ruggieri of Windermere Family Limited
Partnership and Ruggieri Financial Pension Plan, respectively, each an affiliate
of John Ruggieri, the Company's Vice President of Manufacturing; 1,111,112
shares of common stock sold at an aggregate sales price of $2,000,000 to
Fromageries Bel S.A., a leading branded cheese company in Europe which signed a
Master Distribution and Licensing Agreement effective May 22, 2003 with the
Company. Sales to non-related parties under the Securities Purchase Agreements
include: 138,889 shares of common stock sold at an aggregate sales price of
$250,000 Apollo Capital Management Group; and 138,889 shares of common stock
sold at an aggregate sales price of $250,000 Apollo MicroCap Partners, L.P.
The Company used $2,000,000 of the proceeds generated from these May 2003
private placements to pay down the balance of the Company's mezzanine loan from
FINOVA Mezzanine Capital, Inc. The Company then applied the additional proceeds
from the new loan from SouthTrust Bank, as discussed above, to pay the remaining
$2,000,000 on the FINOVA Mezzanine loan. The Company utilized the remainder of
the private placement proceeds for working capital and general corporate
purposes.
Summary
- -------
Management believes that with the proceeds received in connection with its
revised credit facilities and equity financings together with cash flow from
current operations, the Company will have enough cash to meet its current
liquidity needs based on current operation levels.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's exposure to market risk results primarily from fluctuations in
interest rates. The interest rates on most of the Company's outstanding debts,
including its debt to SouthTrust Bank, Textron and Angelo S. Morini, are
floating and based on the prevailing market interest rates. For market-based
debt, interest rate changes generally do not affect the market value of the debt
but do impact future interest expense and hence earnings and cash flows,
assuming other factors remain unchanged. A theoretical 1% increase or decrease
in market rates in effect on June 30, 2003 with respect to the Company's
anticipated debt as of such date would increase or decrease interest expense and
hence reduce or increase net income of the Company by approximately $39,000 per
quarter.
The Company's sales during the three-month periods ended June 30, 2003 and 2002
which were denominated in a currency other than U.S. dollars were less than 5%
of gross sales and no net assets were maintained in a functional currency other
than U. S. dollars during such periods. Therefore, the effects of changes in
foreign currency exchange rates have not historically been significant to the
Company's operations or net assets.
ITEM 4. CONTROLS AND PROCEDURES
As of the end of the fiscal quarter ended June 30, 2003, 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 ensure that the information
required to be disclosed by the Company in the reports that it files or submits
under the
22
Securities Exchange Act of 1934, as amended, is recorded, processed, summarized
and reported within the time periods specified in the Securities and Exchange
Commission's rules and forms. Based on that evaluation, the Company's
management, including the CEO and CFO, concluded that the Company's disclosure
controls and procedures were effective as of the end of the period covered by
this report.
There was no change in the Company's internal control over financial reporting
that occurred during the fiscal quarter ended June 30, 2003 that has materially
affected, or is reasonably likely to materially affect, internal control over
financial reporting.
23
PART II. OTHER INFORMATION
--------------------------
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 certain claims of U.S. Patents Nos. 5,112,632,
5,440,860, 5,701,724 and 6,085,680. 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. Schreiber Foods has not specified the amount of money damages it
plans to seek at the time of trial; however, preliminary discussions between the
parties lead the Company to conclude that the amount requested will be at least
several million dollars, and will be based roughly on a cents-per-pound of
product formula.
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.
However, the Company understands that a motion to rescind the verdict and
judgment is currently pending. 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 its Kustner machines. The two Hart Design machines were
modified by the manufacturer from the standard Hart Design configuration and
were delivered to the Company as modified. The Company believes that the
modifications to the machines take them even further outside the ambit of the
Schreiber patents at issue.
As well, the Company has, through legal counsel, advised the Court of the scope
it believes should be given to the claims at issue in the lawsuit (as part of
the so-called Markman briefing process). Schreiber has taken a different view of
the claims. The Court conducted a hearing on the issue on August 4, 2003, and
the Company received the Court's ruling on August 13, 2003. The Court adopted
Schreiber's view on many of the claim terms at issue. The Company, through legal
and patent counsel, is still reviewing the ruling.
The Company and Schreiber recently participated in a Court-sponsored mediation
of claims that did not result in a settlement agreement. Based upon the failure
of that mediation process to resolve the matter, the Company requested the
formal opinion of patent counsel with regard to the merits of Schreiber's patent
and Schreiber's claims of infringement. Patent counsel has advised that, in his
opinion, the patent claim interpretation being asserted by the Company in the
Markman briefing process is the correct one, and that the Company's machines do
not infringe the patent claims if that claim interpretation is adopted by the
Court. The Company has requested patent counsel to review his opinion in light
of the Court's ruling.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
In accordance with an exemption from registration under Regulation D promulgated
under the Securities Act of 1933, as amended, and pursuant to seven Securities
Purchase Agreements dated May 21, 2003, the Company sold and issued a total of
2,138,891 shares of its common stock at a price per share equal to $1.80 for
aggregate gross proceeds to the Company of $3,850,000. Pursuant to a
Registration Rights Agreement dated May 21, 2003, the Company has agreed to
register the shares of common stock purchased by the investors with the
Securities and Exchange Commission no later than November 24, 2003. Sales to
individual investors were as follows:
24
Investor Shares Purchased Total Purchase Price
- -------- ---------------- --------------------
Frederick A. DeLuca 555,556 $ 1,000,000
David H. Lipka 55,556 $ 100,000
Ruggieri of Windermere Family
Limited Partnership 83,333 $ 150,000
Ruggieri Financial Pension Plan 55,556 $ 100,000
Fromageries Bel S.A. 1,111,112 $ 2,000,000
Apollo Capital Management Group 138,889 $ 250,000
Apollo MicroCap Partners, L.P. 138,889 $ 250,000
----------- ---------------
Total 2,138,891 $ 3,850,000
=========== ===============
The Company used $2,000,000 of the proceeds generated from the May 2003 private
placements to pay down the balance of the Company's mezzanine loan from FINOVA
Mezzanine Capital, Inc. The Company then applied the additional proceeds from
the new loan from SouthTrust Bank, as discussed above, to pay the remaining
$2,000,000 on the FINOVA Mezzanine loan. The Company utilized the remainder of
the private placement proceeds for working capital and general corporate
purposes.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
The Textron Loan described above contains certain financial and operating
covenants. In August 2003, the Company notified Textron that it had failed to
comply with the fixed charge coverage ratio in June 2003. Pursuant to a certain
Waiver Letter dated August 13, 2003, Textron agreed to waive the requirement to
meet the fixed charge coverage ratio for each monthly period through September
30, 2003. Additionally, Textron agreed that after August 13, 2003, all of the
financial covenants required of the Company under Section 7.6 of the Loan
Agreement will be measured and tested on a quarterly rather than monthly basis.
25
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 Restated Certificate of Incorporation of the Company as filed
with the Secretary of State of the State of Delaware on December
23, 2002 (Filed as Exhibit 3.2 on Form 10-Q for the fiscal
quarter ended December 31, 2002.)
*3.2 By-laws of the Company, as amended (Filed as Exhibit 3.2 to
Registration Statement on Form S-18, No. 33-15893-NY.)
*4.3 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.)
*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.)
*4.10 Loan and Security Agreement dated as of May 27, 2003 between
Galaxy Nutritional Foods, Inc. and Textron Financial Corporation
(Filed as Exhibit 10.1 on Form 8-K filed June 2, 2003.)
*4.11 Patent, Copyright and Trademark Collateral Security Agreement
dated as of May 27, 2003 between Galaxy Nutritional Foods, Inc.
and Textron Financial Corporation (Filed as Exhibit 10.1 on Form
8-K filed June 2, 2003.)
*4.12 Renewal Promissory Note in the principal amount of $10.131,984.85
dated as of May 28, 2003 by Galaxy Nutritional Foods, Inc. in
favor of SouthTrust Bank (Filed as Exhibit 10.1 on Form 8-K filed
June 2, 2003.)
*4.13 Renewal Promissory Note in the principal amount of $501,000.00
dated as of May 28, 2003 by Galaxy Nutritional Foods, Inc. in
favor of SouthTrust Bank (Filed as Exhibit 10.1 on Form 8-K filed
June 2, 2003.)
*4.14 Amendment of Loan Agreement dated as of May 28, 2003 between
Galaxy Nutritional Foods, Inc. and SouthTrust Bank (Filed as
Exhibit 10.1 on Form 8-K filed June 2, 2003.)
*4.15 Amendment of Security Agreement dated as of May 28, 2003 between
Galaxy Nutritional Foods, Inc. and SouthTrust Bank (Filed as
Exhibit 10.1 on Form 8-K filed June 2, 2003.)
*4.16 Warrant to Purchase Securities of Galaxy Nutritional Foods, Inc.
dated as of May 29, 2003 in favor of SouthTrust Bank (Filed as
Exhibit 10.1 on Form 8-K filed June 2, 2003.)
26
*4.17 Securities Purchase Agreement dated as of May 21, 2003 between
Galaxy Nutritional Foods, Inc. and Fromageries Bel S.A. (Filed as
Exhibit 10.8 on Form 8-K filed June 2, 2003.)
*4.18 Registration Rights Agreement dated as of May 21, 2003 between
Galaxy Nutritional Foods, Inc. and Fromageries Bel S.A. (Filed as
Exhibit 10.9 on Form 8-K filed June 2, 2003.)
*4.19 Securities Purchase Agreement dated as of May 21, 2003 between
Galaxy Nutritional Foods, Inc. and Frederick A. DeLuca (Filed as
Exhibit 10.10 on Form 8-K filed June 2, 2003.)
*4.20 Registration Rights Agreement dated as of May 21, 2003 between
Galaxy Nutritional Foods, Inc. and Frederick A. DeLuca (Filed as
Exhibit 10.11 on Form 8-K filed June 2, 2003.)
*4.21 Securities Purchase Agreement dated as of May 21, 2003 between
Galaxy Nutritional Foods, Inc. and Apollo Capital Management
Group, L.P. (Filed as Exhibit 10.12 on Form 8-K filed June 2,
2003.)
*4.22 Registration Rights Agreement dated as of May 21, 2003 between
Galaxy Nutritional Foods, Inc. and Apollo Capital Management
Group, L.P. (Filed as Exhibit 10.13 on Form 8-K filed June 2,
2003.)
*4.23 Securities Purchase Agreement dated as of May 21, 2003 between
Galaxy Nutritional Foods, Inc. and Apollo MicroCap Partners, L.P.
(Filed as Exhibit 10.14 on Form 8-K filed June 2, 2003.)
*4.24 Registration Rights Agreement dated as of May 21, 2003 between
Galaxy Nutritional Foods, Inc. and Apollo MicroCap Partners, L.P.
(Filed as Exhibit 10.15 on Form 8-K filed June 2, 2003.)
*4.25 Securities Purchase Agreement dated as of May 21, 2003 between
Galaxy Nutritional Foods, Inc. and Ruggieri of Windermere Family
Limited Partnership (Filed as Exhibit 10.16 on Form 8-K filed
June 2, 2003.)
*4.26 Registration Rights Agreement dated as of May 21, 2003 between
Galaxy Nutritional Foods, Inc. and Ruggieri of Windermere Family
Limited Partnership (Filed as Exhibit 10.17 on Form 8-K filed
June 2, 2003.)
*4.27 Securities Purchase Agreement dated as of May 21, 2003 between
Galaxy Nutritional Foods, Inc. and Ruggieri Financial Pension
Plan (Filed as Exhibit 10.18 on Form 8-K filed June 2, 2003.)
*4.28 Registration Rights Agreement dated as of May 21, 2003 between
Galaxy Nutritional Foods, Inc. and Ruggieri Financial Pension
Plan (Filed as Exhibit 10.19 on Form 8-K filed June 2, 2003.)
*4.29 Securities Purchase Agreement dated as of May 21, 2003 between
Galaxy Nutritional Foods, Inc. and David Lipka (Filed as Exhibit
10.20 on Form 8-K filed June 2, 2003.)
*4.30 Registration Rights Agreement dated as of May 21, 2003 between
Galaxy Nutritional Foods, Inc. and David Lipka (Filed as Exhibit
10.21 on Form 8-K filed June 2, 2003.)
*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.)
*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.)
*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.)
*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.)
*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.)
*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.)
27
*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.)
*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.)
*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.)
*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.)
*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.)
*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.)
*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.)
*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.)
*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.)
*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.)
*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.)
*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.)
*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.)
*10.25 Letter from SouthTrust Bank. 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.)
28
*10.26 Letter from SouthTrust Bank 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.)
*10.27 Waiver Letter from SouthTrust Bank dated February 13, 2003 (Filed
as Exhibit 10.27 on Form 10-Q for the fiscal quarter ended
December 31, 2002.)
*10.28 Renewal Promissory Note in the principal amount of $10,131,984.85
in favor of SouthTrust Bank dated May 28, 2003 (Filed as Exhibit
10.3 on Form 8-K filed June 2, 2003.)
*10.29 Renewal Promissory Note in the principal amount of $501,000 in
favor of SouthTrust Bank dated May 28, 2003 (Filed as Exhibit
10.4 on Form 8-K filed June 2, 2003.)
*10.30 Amendment of Loan Agreement dated May 28, 2003 between Galaxy
Nutritional Foods, Inc. and SouthTrust Bank (Filed as Exhibit
10.5 on Form 8-K filed June 2, 2003.)
*10.31 Amendment of Security Agreement dated May 28, 2003 between Galaxy
Nutritional Foods, Inc. and SouthTrust Bank (Filed as Exhibit
10.6 on Form 8-K filed June 2, 2003.)
*10.32 Warrant to Purchase Securities of Galaxy Nutritional Foods, Inc.
dated as of May 29, 2003 in favor of SouthTrust Bank (Filed as
Exhibit 10.7 on Form 8-K filed June 2, 2003.)
*10.33 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.)
*10.34 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.)
*10.35 Loan and Security Agreement dated as of May 27, 2003 between
Galaxy Nutritional Foods, Inc. and Textron Financial Corporation
(Filed as Exhibit 10.1 on Form 8-K filed June 2, 2003.)
*10.36 Patent, Copyright and Trademark Collateral Security Agreement
dated as of May 27, 2003 between Galaxy Nutritional Foods, Inc.
and Textron Financial Corporation (Filed as Exhibit 10.2 on Form
8-K filed June 2, 2003.)
*10.40 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.)
*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.)
*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.)
*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.)
*10.44 Amended and Restated employment agreement between the Company and
Angelo S. Morini dated June 15, 1999 (Filed as Exhibit 10.44 on
Form 10-Q for the fiscal quarter ended December 31, 2002.)
*10.45 Loan Agreement between the Company and Angelo S. Morini dated
June 15, 1999 (Filed as Exhibit 10.45 on Form 10-Q for the fiscal
quarter ended December 31, 2002.)
*10.46 Promissory Note from Angelo S. Morini dated June 15, 1999 (Filed
as Exhibit 10.46 on Form 10-Q for the fiscal quarter ended
December 31, 2002.)
*10.47 Stock Pledge Agreement between the Company and Angelo S. Morini
dated June 15, 1999 (Filed as Exhibit 10.47 on Form 10-Q for the
fiscal quarter ended December 31, 2002.)
29
*10.48 First Amendment to Loan Agreement and Stock Pledge Agreement
between the Company and Angelo S. Morini dated December 16, 2002
(Filed as Exhibit 10.48 on Form 10-Q for the fiscal quarter ended
December 31, 2002.)
*10.49 Stock Option Agreement between the Company and Angelo S. Morini
dated June 15, 1999 (Filed as Exhibit 10.49 on Form 10-Q for the
fiscal quarter ended December 31, 2002.)
*10.50 Special Services Agreement between the Company and Angelo S.
Morini dated December 4, 2002 (Filed as Exhibit 10.50 on Form
10-Q for the fiscal quarter ended December 31, 2002.)
*10.51 Master Distribution and License Agreement dated as of May 22,
2003 between Galaxy Nutritional Foods, Inc. and Fromageries Bel
S.A. (Filed as Exhibit 10.22 on Form 8-K filed June 2, 2003.)
10.52 Stock Purchase Option Agreement and Stock Purchase Warrant by and
between Excalibur Limited Partnership and BH Capital Investments,
L.P. and Galaxy Nutritional Foods dated as of April 24, 2003
(Filed herewith.)
10.53 Waiver Letter from Textron Financial Corporation to the Company
dated August 13, 2003 (Filed herewith.)
31.1 Section 302 Certification of the Company's Chief Executive
Officer (Filed herewith.)
31.2 Section 302 Certification of the Company's Chief Financial
Officer (Filed herewith.)
32.1 Section 906 Certification of the Company's Chief Executive
Officer (Filed herewith.)
32.2 Section 906 Certification of the Company's Chief Financial
Officer (Filed herewith.)
* Previously filed and incorporated herein by reference.
REPORTS ON FORM 8-K
- -------------------
During the fiscal quarter ended June 30, 2003, the Company filed one
Current Report on Form 8-K, dated May 30, 2003 and filed on June 2, 2003,
to disclose the Company's financial restructuring and other significant
contracts including its new asset based credit facility with Textron
Financial Corporation, its new term loan and modification of existing term
loans with SouthTrust Bank, its private placement of 2,138,891 shares of
common stock, and its master distribution and licensing agreement with
Fromageries Bel, S.A. Additionally, the Company reported the payment of the
amounts owed to FINOVA Capital Corporation under its asset-based line of
credit and to FINOVA Mezzanine Capital, Inc. under its mezzanine loan.
30
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
GALAXY NUTRITIONAL FOODS, INC.
Date: August 14, 2003 /s/ Christopher J. New
---------------------------------
Christopher J. New
Chief Executive Officer
(Principal Executive Officer)
Date: August 14, 2003 /s/ Salvatore J. Furnari
---------------------------------
Salvatore J. Furnari
Chief Financial Officer
(Principal Accounting and
Financial Officer)
31