UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

 

FORM 10-Q

 

(Mark One)

ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2002

 

OR

 

o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from      to      

 

Commission file number 0-20330

 

 

GARDENBURGER, INC.

(Exact name of registrant as specified in its charter)

 

 

 

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   ý                No   o

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Common stock without par value		9,002,101
(Class)		(Outstanding at August 6, 2002)

 

 

GARDENBURGER, INC.

FORM 10-Q

INDEX

 

PART I - FINANCIAL INFORMATION
Item 1.	Financial Statements
	Balance Sheets – June 30, 2002 and September 30, 2001
	Statements of Operations - Three Month and Nine Month Periods Ended June 30, 2002 and 2001
	Statements of Cash Flows - Nine Months Ended June 30, 2002 and 2001
	Notes to Financial Statements
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosures About Market Risk
PART II - OTHER INFORMATION
Item 6.	Exhibits and Reports on Form 8-K
Signatures

 

 

 

PART I - FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

GARDENBURGER, INC.

BALANCE SHEETS

(in thousands, except share amounts)

 

		June 30, 2002			September 30, 2001
Assets
Current Assets:
Cash and cash equivalents		$	1,731		$	3,065
Accounts receivable, net of allowances of $277 and $266		4,702			3,513
Inventories, net		8,199			7,331
Prepaid expenses		1,505			1,070
Total Current Assets		16,137			14,979
Property, Plant and Equipment, net of accumulated depreciation of $7,557 and $5,696		13,551			5,520
Other Assets, net of accumulated amortization of $1,853 and $1,612		1,535			1,562
Total Assets		$	31,223		$	22,061
Liabilities and Shareholders’ Equity (Deficit)
Current Liabilities:
Short-term note payable		$	2,121		$	1,689
Current portion of long-term debt		917			—
Accounts payable		2,357			1,959
Payroll and related liabilities payable		524			659
Other current liabilities		813			815
Total Current Liabilities		6,732			5,122
Long-Term Debt, less current maturities		7,025			—
Other Long-Term Liabilities		—			126
Convertible Notes Payable		17,877			17,364
Convertible Redeemable Preferred Stock		44,642			40,880
Shareholders’ Equity (Deficit):
Preferred Stock, no par value, 5,000,000 shares authorized		—			—
Common Stock, no par value, 25,000,000 shares authorized; shares issued and outstanding: 9,002,101 and 9,002,101		11,189			11,189
Additional paid-in capital		12,500			12,405
Retained deficit		(68,742		)	(65,025		)
Total Shareholders’ Equity (Deficit)		(45,053		)	(41,431		)
Total Liabilities and Shareholders’ Equity (Deficit)		$	31,223		$	22,061

 

The accompanying notes are an integral part of these balance sheets.

 

2

 

GARDENBURGER, INC.

STATEMENTS OF OPERATIONS

(in thousands, except share and per share amounts)

 

		Three months ended June 30,						Nine months ended June 30,
		2002			2001			2002			2001
Net sales		$	17,083		$	16,530		$	39,533		$	37,041
Cost of goods sold		9,469			9,625			23,103			23,756
Gross margin		7,614			6,905			16,430			13,285
Operating expenses:
Sales and marketing		4,020			3,868			10,381			10,420
General and administrative		963			1,192			3,135			3,830
Legal settlement		(108		)	—			(108		)	—
		4,875			5,060			13,408			14,250
Operating income (loss)		2,739			1,845			3,022			(965		)
Other income (expense):
Interest income		5			23			27			69
Interest expense		(1,182		)	(450		)	(2,696		)	(1,772		)
Debt restructuring costs		—			—			(613		)	—
Other, net		7			(5		)	305			(55		)
		(1,170		)	(432		)	(2,977		)	(1,758		)
Income (loss) before income taxes		1,569			1,413			45			(2,723		)
(Provision for) benefit from income taxes		—			—			—			—
Net income (loss) before preferred dividends		1,569			1,413			45			(2,723		)
Preferred dividends		1,348			1,091			3,762			3,275
Net income (loss) available for common shareholders		$	221		$	322		$	(3,717	)	$	(5,998	)
Basic net income (loss) per share		$	0.02		$	0.04		$	(0.41	)	$	(0.67	)
Shares used in basic per share calculations		9,002,101			9,002,101			9,002,101			8,999,614
Diluted net income (loss) per share		$	0.02		$	0.04		$	(0.41	)	$	(0.67	)
Shares used in diluted per share calculations		11,080,742			9,011,539			9,002,101			8,999,614

 

The accompanying notes are an integral part of these statements.

 

3

 

GARDENBURGER, INC.

STATEMENT OF CASH FLOWS

(in thousands)

 

		Nine Months Ended June 30,
		2002			2001
Cash flows from operating activities:
Income (loss) before preferred dividends		$	45		$	(2,723	)
Adjustments to reconcile net income (loss) before preferred dividends to net cash flows provided by (used in) operating activities:
Depreciation and amortization		2,459			1,551
Other non-cash expense, net		455			1,013
Loss on sale of property and equipment		7			120
(Increase) decrease in:
Accounts receivable, net		(1,189		)	(560		)
Inventories, net		(868		)	(5		)
Prepaid expenses		(435		)	900
Increase (decrease) in:
Accounts payable		398			246
Payroll and related liabilities payable		(135		)	(668		)
Other current liabilities		(2		)	129
Net cash provided by operating activities		735			3
Cash flows from investing activities:
Payments for purchase of property and equipment		(9,858		)	(509		)
Proceeds from sale of property and equipment		208			674
Other assets, net		—			(4		)
Net cash provided by (used in) investing activities		(9,650		)	161
Cash flows from financing activities:
Proceeds from line of credit, net		432			242
Proceeds from long-term debt		8,000			—
Payments on long-term debt		(208		)	—
Capitalized financing fees		(643		)	—
Other financing activities		—			(75		)
Proceeds from exercise of common stock options		—			36
Net cash provided by financing activities		7,581			203
Increase (decrease) in cash and cash equivalents		(1,334		)	367
Cash and cash equivalents:
Beginning of period		3,065			2,178
End of period		$	1,731		$	2,545

 

The accompanying notes are an integral part of these statements.

 

4

 

GARDENBURGER, INC.

NOTES TO FINANCIAL STATEMENTS

(In thousands, except per share amounts and as otherwise indicated)

(Unaudited)

 

Note 1. Basis of Presentation

The financial information included herein for the quarterly periods ended June 30, 2002 and 2001 and the financial information as of June 30, 2002 is unaudited; however, such information reflects all adjustments, consisting only of normal recurring adjustments, which are, in the opinion of management, necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods.  The financial information as of September 30, 2001 is derived from Gardenburger, Inc.’s (the Company’s) 2001 Annual Report on Form 10-K.  The interim financial statements should be read in conjunction with the financial statements and the notes thereto included in the Company’s 2001 Annual Report on Form 10-K.

 

The results of operations for the interim periods presented are not necessarily indicative of the results to be expected for the full year.

 

Note 2. Inventories

Inventories are valued at standard cost, which approximates the lower of cost (using the first-in, first-out (FIFO) method) or market, and include materials, labor and manufacturing overhead.

 

		June 30,2002			September 30,2001
Raw materials		$	1,661		$	1,243
Packaging and supplies		377			309
Finished goods		6,161			5,779
		$	8,199		$	7,331

 

Note 3. Supplemental Cash Flow Information

Supplemental disclosure of cash flow information is as follows:

 

		Nine months ended June 30,
		2002			2001
Cash paid during the period for income taxes		$	7		$	9
Cash paid during the period for interest		1,226			262
Issuance of additional Convertible Notes in lieu of cash payment of interest expense on Convertible Notes		—			1,538
Non-cash preferred dividends		3,762			3,275

 

5

 

Note 4. Earnings Per Share

Basic earnings per share (“EPS”) and diluted EPS are the same for the nine month periods ended June 30, 2002 and 2001, because the Company was in a loss position in those periods. Following is a reconciliation of basic EPS and diluted EPS for the three month periods ended June 30, 2002 and 2001:

 

Three Months Ended June 30,		2002								2001
		Income			Shares		Per Share Amount			Income			Shares		Per Share Amount
Basic EPS
Net income available to common shareholders		$	221		9,002		$	0.02		$	322		9,002		$	0.04
Diluted EPS
Effect of dilutive stock options and warrants		—			2,079					—			10
Net Income available to common shareholders		$	221		11,081		$	0.02		$	322		9,012		$	0.04

 

Potentially dilutive securities that are not included in the diluted EPS calculation because they would be antidilutive are as follows:

 

		Three Months Ended June 30,				Nine Months Ended June 30,
		2002		2001		2002		2001
Stock options		1,650		3,002		3,037		3,168
Convertible Notes		1,772		1,519		1,772		1,483
Convertible Preferred Stock		4,062		4,062		4,062		4,062
		7,484		8,583		8,871		8,713

 

Note 5. Revolving Credit and Term Loan and Amendments to Subordinated Convertible Notes and Preferred Stock

 

On January 10, 2002, the Company entered into a Revolving Credit and Term Loan Agreement (the “Loan Agreement”) with CapitalSource Finance LLC (“CapitalSource”).  It also completed extensions to the maturity date of its subordinated convertible notes and the earliest mandatory redemption date applicable to its outstanding convertible redeemable preferred stock.

 

The Loan Agreement provides for an $8.0 million term loan and a $7.0 million line of credit (together, “the Loans”).  The $8.0 million proceeds from the term loan and $1.05 million of proceeds from the line of credit were applied to purchase the Company’s food processing, production and other equipment used at its Clearfield, Utah, production facility, which had been leased under operating leases with Bank of America (“BA”) Leasing & Capital Corporation.  An additional $1.85 million of proceeds from the line of credit were used to repay the Company’s existing revolving credit facility, which has been terminated, and certain fees of Wells Fargo Bank. The remaining balance available on the line of credit will be used as needed for working capital.  The Company paid a closing fee of $300,000 to CapitalSource (the “Closing Fee”).

 

As a condition to obtaining the new financing, the Company negotiated extensions to the maturities of its outstanding $17.4 million principal amount of Convertible Senior Subordinated Notes (“Convertible Notes”) held by Dresdner Kleinwort Benson Private Equity Partners LP (“Dresdner”) and its Series A Convertible Preferred Stock (“Series A Stock”) and Series B Convertible Preferred Stock (“Series B Stock”) held by various investors.

 

6

 

In order to obtain the extension of maturity date of its Convertible Notes from April 1, 2003, to March 31, 2005, the Company agreed to increase the interest rate on the notes from 7 to 10 percent, to pay a 20 percent premium at repayment or maturity of such notes, and to issue to Dresdner a warrant to purchase 557,981 shares of the Company’s common stock at an exercise price of $0.28 per share.

 

To achieve the extension of the earliest mandatory redemption date of the Company’s outstanding Series A and Series B preferred stock from December 31, 2004, to March 31, 2006, the Company agreed to pay a 10 percent premium on the accumulated liquidation preference and redemption price applicable to its preferred stock, payable upon redemption or any liquidation or deemed liquidation of the Company.  In addition, the Company issued to preferred shareholders, pro rata in accordance with their holdings of preferred stock, warrants to purchase an aggregate of 557,981 shares of common stock at an exercise price of $0.28 a share.  The Company accomplished the agreed changes to its preferred stock by creating two new series of preferred stock designated as Series C Convertible Preferred Stock (“Series C Stock”) and Series D Convertible Preferred Stock (“Series D Stock”) containing such revised terms and exchanging shares of its outstanding Series A Stock and Series B Stock for such newly created Series C Stock and Series D Stock, respectively, on a five-for-one basis. Other than the modifications mentioned above, there were no substantive changes to the rights and privileges of the Series A and Series B compared to Series C and Series D.

 

Farallon Partners, L.L.C., and its affiliates, which together own approximately 30.8% of the Company’s Series C and Series D Stock, have a substantial equity interest in CapitalSource Holdings LLC, which controls CapitalSource.  An affiliate of Rosewood Capital III, L.P., which also owns approximately 30.8% of the Series C and Series D Stock, has a small (less than 2%) equity interest in CapitalSource Holdings LLC.  Two of the Company’s directors are employed by an affiliate of Rosewood Capital III, L.P.  Jason Fish, a director of the Company until his resignation on January 8, 2002, is President of CapitalSource Holdings LLC and was a managing member of Farallon Partners, L.L.C., until June 2000.

 

Terms of the Loan Agreement

The Loan Agreement permits the Company to request advances under the $7.0 million line of credit up to the sum of 85 percent of eligible receivables and 60 percent of eligible inventory.  The Company must maintain a minimum balance under the line of credit of $1.0 million.  Advances will bear interest at an annual rate of the greater of i) prime plus 2.50 percent, or 7.25 percent at June 30, 2002; or ii) 8 percent.  The line of credit expires December 15, 2004.  At June 30, 2002, the Company had $2.1 million outstanding under the line of credit.

 

The $8.0 million term loan bears interest at an annual rate of prime plus 4.50 percent; however, in no event will the interest rate be less than 10 percent.  Interest under the term loan is payable monthly, and minimum monthly principal payments of $41,667 are required until January 1, 2003.  The minimum monthly principal payment increases to $125,000 for the period from February 1, 2003, through January 1, 2004, and increases to $166,667 for the period from February 1, 2004, through the expiration date of the term loan, December 15, 2004.  Amounts due but not paid under the term loan will be automatically drawn from the line of credit, subject to availability.

 

7

 

The Loans are secured by the Company’s assets, including, without limitation, its accounts receivable, inventory, equipment, intellectual property, and bank deposits.  The Loan Agreement contains cross default provisions with respect to the Company’s other indebtedness, including the Convertible Notes.

 

Under the terms of the Loan Agreement, proceeds from a sale of assets outside the ordinary course of business, from certain insurance recoveries, or from other listed events must be used to prepay the Loans.  Also, the Company must apply a portion of all excess cash flow (as defined) it receives to reduce the outstanding balance of the term loan.  Upon a change of control (as defined) affecting the Company, it must prepay the Loans in full.

 

The Company must pay to CapitalSource and any participating lenders an unused line of credit fee equal to 0.083 percent (per month) of unused amounts under the line of credit.  In addition, it must pay to CapitalSource, as agent under the Loan Agreement, a collateral management fee of $4,167 per month.  Upon the earlier of prepayment in full of the term loan or its expiration date, the Company will pay a $750,000 exit fee.  The Company may not elect to prepay the Loans until July 10, 2003, except in the event of a sale of the Company.  The $750,000 exit fee is being amortized as additional interest expense over the life of the Loans, increasing the effective interest rate on the Loans.

 

Pursuant to the Loan Agreement, the Company is required to maintain compliance with the following financial covenants:

•                  a ratio of long-term indebtedness to earnings (as defined in the Loan Agreement) of not more than 2.75 to 1.00 through June 30, 2002, and not in excess of 2.5 to 1.00 for periods thereafter;

•                  minimum earnings (as defined) of at least $ 5.0 million for the prior twelve months calculated as of each quarterly period through June 30, 2002, and $6.0 million as of quarterly periods thereafter;

•                  a ratio of earnings (as defined) to fixed charges, such as debt service payments, capital expenditures and taxes, of not less than 1.25 to 1.00; and

•                  capital expenditures of less than $1.75 million for the prior twelve months calculated as of each quarterly period through September 30, 2002, and less than $1.1 million as of quarterly periods thereafter.

 

In addition, the Company may not, among other restrictions, (1) incur any additional indebtedness other than accounts payable, except in certain limited circumstances, (2) create any liens on its assets, (3) invest in other entities, (4) pay dividends, redeem its capital stock (including preferred stock), or make unscheduled payments under its Convertible Notes (except as expressly permitted), (5) sell assets other than in the ordinary course, except in certain limited circumstances, (6) engage in any transaction with an affiliate, (7) amend its Articles of Incorporation or Bylaws in a manner that would be adverse to CapitalSource, or (8) enter into any contingent obligations or guarantee the obligations of another.

 

The Company was in compliance with the above covenants and other restrictions as of June 30, 2002.

 

8

 

Amendment to Convertible Notes and Warrant Agreement with Dresdner

The Company and Dresdner entered into a Second Amendment to Note Purchase Agreement, an Amended and Restated Convertible Senior Subordinated Note (the “Restated Convertible Note”), and a Warrant Agreement, each dated January 10, 2002, in connection with the extension of the maturity date under the Convertible Notes from April 1, 2003, to March 31, 2005.  In addition, under the terms of the Restated Convertible Note, the Company agreed to (i) increase the interest rate on the Convertible Notes from 7 to 10 percent and (ii) pay a 20 percent premium on the principal plus accrued but unpaid interest on the Convertible Notes at repayment or maturity.  The Restated Convertible Note remains convertible into common stock at the election of the holder; the conversion price at June 30, 2002 was $10.09 per share, which was not affected by the amendment.  Interest is payable in cash semi-annually to the extent of availability under the CapitalSource line of credit.

 

The Company is required to apply a portion of excess cash flow (as defined) to repay accrued interest and the outstanding principal amount of the Restated Convertible Note, subject to certain specified exceptions.  The Company must at all times pay 50 percent of excess cash flow to pay down indebtedness to CapitalSource and to Dresdner in specified proportions.

 

The Restated Convertible Note contains financial covenants, which are the same as those in the Loan Agreement, but in each case slightly more favorable to the Company.  The Restated Convertible Note also contains subordination provisions with respect to the Loans and cross default provisions with respect to the Company’s other indebtedness, including the Loans.

 

In addition, under the terms of the Warrant Agreement, the Company issued to Dresdner an immediately exercisable warrant with a ten–year term to purchase 557,981 shares of the Company’s common stock at a price of $0.28 per share, subject to anti–dilution adjustments.  The Company granted registration rights to Dresdner with respect to shares issuable upon exercise of its warrant.

 

Series C and Series D Preferred Stock

The Company and the holders of its outstanding Series A Stock and Series B Stock entered into a Preferred Stock Exchange Agreement dated January 10, 2002 (the “Exchange Agreement”), in connection with the extension of the earliest date on which the holders of the Company’s preferred stock could require that their shares be redeemed, and certain other changes.  This extension was a condition to funding under the Loan Agreement and closing of the Second Amendment to Note Purchase Agreement.  Under the terms of the Exchange Agreement, holders of Series A Stock and Series B Stock agreed to exchange all of their outstanding shares of Series A Stock and Series B Stock for newly created Series C Stock and Series D Stock, respectively, at an exchange ratio of five shares of Series A Stock for each share of Series C Stock and five shares of Series B Stock for each share of Series D Stock. In addition, the Company issued to preferred shareholders immediately exercisable warrants with a ten–year term to purchase an aggregate of 557,981 shares of the Company’s common stock, exercisable at a price of $0.28 per share, subject to anti–dilution adjustments. The Company granted holders of its preferred stock registration rights with respect to shares to be issued upon exercise of the warrants, including both demand and piggy-back registration rights.

 

9

 

The terms of each new series of Preferred Stock provide participants in the exchange with identical rights, preferences, and privileges as were applicable to the prior Series A Stock and Series B Stock, except that the terms of Series C Stock and Series D Stock provide for a 10 percent premium on any liquidation or redemption and for an earliest date on which holders may require redemption of their shares of March 31, 2006, instead of December 31, 2004.  As a result of the exchange, the Company has outstanding 552,500 shares of its Series C Stock and 97,500 shares of its Series D Stock, which are convertible into the same number of common shares as the Series A Stock and Series B Stock prior to the exchange.  No shares of Series A Stock and Series B Stock remain outstanding.

 

Accounting for Changes to Convertible Notes and Preferred Stock

The Company is accounting for the term revisions, including the fair value of the common stock warrants and exit fee premiums, in accordance with SFAS No. 15 “Accounting by Debtors and Creditors for Troubled Debt Restructurings.”  Accordingly, the Company is accounting for the effects of the debt restructuring on a prospective basis from the date of restructuring and no gain or loss was recorded on the date of restructuring.  The Company computed an effective interest rate and preferred dividend taking into consideration the imputed value of the revised terms, which is being applied as of the restructuring date through the maturity dates.

 

Definitions

Previously used terms are defined as follows:

•                  Excess Cash Flow – for any fiscal year, this is an amount equal to the sum of i) consolidated net income or loss; ii) depreciation, amortization, accrued non-cash interest expense and all other non-cash charges deducted in arriving at consolidated net income or loss; iii) net cash proceeds from the sale, lease, transfer or other disposition of assets that is not reinvested in other collateralized assets or required to be applied to mandatory prepayments or payments on the Loans; iv) the net loss on the sale, lease, transfer or other disposition of assets; and v) the amount of any tax credits or refunds received less the sum of i) non-financed capital expenditures; ii) payments required by and paid on the Loans and voluntary prepayments made on the Loans; iii) the net gain on the sale, lease, transfer or other disposition of assets, other than sales in the ordinary course of business; and iv) an amount equal to the increase in working capital during the period.

 

•                  Change of Control – the occurrence of any of the following: i) a merger, consolidation, reorganization, recapitalization or share or interest exchange, sale or transfer or any other transaction or series of transactions in which any person or group of affiliated persons or persons acting together, own more than 45% of the combined voting power of the Company’s then outstanding securities, calculated on a fully diluted basis; ii) a direct or indirect sale, transfer or other conveyance or disposition, in any single transaction or series of transactions, of all or substantially all of its assets; iii) any change of control or sale or disposition or similar event as defined in any document governing indebtedness of more than $50,000 of such person which gives the holder of such indebtedness the right to accelerate or otherwise require payment of such indebtedness prior to the maturity date thereof; iv) Rosewood Capital III, L.P. and Farallon Capital Partners, L.P., or their affiliates, acting together, cease to have the voting power to elect two directors to the Board of Directors of the Company; v) Scott C. Wallace ceases to be employed as Chief Executive Officer of the Company or otherwise becomes disabled and is not

 

10

 

replaced within thirty days by an interim Chief Executive Officer, and within one hundred twenty days by a permanent Chief Executive Officer, each to the lender’s satisfaction, or any such replacement Chief Executive Officer ceases such employment or otherwise becomes disabled unless replaced in the same time periods and vi) a sale of the Company.

 

•                  Earnings for the purpose of calculating financial covenants – net income or loss determined in conformity with GAAP, plus i) interest expense; ii) taxes on income, whether paid, payable or accrued; iii) depreciation expense; iv) amortization expense; v) non-cash dividends on preferred stock; vi) all other non-cash, non-recurring charges and expenses, excluding accruals for cash expenses made in the ordinary course of business; and vii) certain agreed upon adjustments, all of the foregoing determined in accordance with GAAP, less all non-cash income.

 

Note 6.  Adoption of EITFs 00-14, 00-25 and 01-9

 

In May 2000, the Emerging Issues Task Force (“EITF”), a subcommittee of the Financial Accounting Standards Board, issued EITF No. 00-14 “Accounting for Certain Sales Incentives.”  EITF 00-14 prescribes guidance regarding timing of recognition and income statement classification of costs incurred for certain sales incentive programs.  This guidance requires certain coupons, rebate offers and free products offered concurrently with a single exchange transaction to be recognized at the later of when the revenue is recognized or when the sales incentive is offered, and reported as a reduction of revenue.

 

In April 2001, the EITF issued EITF No. 00-25 “Vendor Income Statement Characterization of Consideration Paid to a Reseller of the Vendor’s Products.”  EITF No. 00-25 addresses the timing, recognition and classification in the income statement of certain promotional costs paid to a retailer or wholesaler by a vendor in connection with the sale of the vendor’s products or promotion of sales of the vendor’s products by the retailer or wholesaler.  This guidance generally requires these costs to be recognized when incurred and reported as a reduction of revenue.

 

The Company adopted EITF 00-14 and EITF 00-25 in the second quarter of fiscal 2002.  Comparative financial statements for prior periods have been reclassified to comply with the classification guidelines of EITF 00-14 and 00-25.

 

The Company also adopted EITF No. 01-9 “Accounting for Consideration Given by a Vendor to a Customer or a Reseller of the Vendor’s Products” in the second quarter of fiscal 2002, which consolidates and clarifies guidance given under EITF No. 00-14 and EITF No. 00-25, but does not change the accounting prescribed above for the Company.

 

A reconciliation of prior period net revenues is as follows:

 

		Three Months Ended June 30, 2001			Nine Months Ended June 30, 2001
Net revenues as previously reported		$	19,020		$	44,348
Sales incentives		(2,490		)	(7,307		)
Net revenues as adjusted		$	16,530		$	37,041

 

Sales and marketing expense for the three and nine month periods ended June 30, 2001 also decreased by the sales incentive amounts indicated in the above table.

 

11

 

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Results of Operations

 

Net Sales

Net sales increased to $17.1 million in the three months ended June 30, 2002 (the “third quarter of fiscal 2002”) from $16.5 million in the three months ended June 30, 2001 (the “third quarter of fiscal 2001”) and increased to $39.5 million for the nine months ended June 30, 2002 compared to $37.0 million for the nine months ended June 30, 2001.  Sales for the three and nine month periods ended June 30, 2002 included approximately $2.2 million and $4.7 million, respectively, attributable to gross sales of recently introduced products.  These new products are representative of the Company’s offerings of meat alternative products beyond veggie burgers. The Company plans additional expansion into this growing part of the meat alternative market.  Additionally, the Company experienced a disruption of its Canadian distribution in the first quarter of fiscal 2001 due to the financial difficulties of its distributor in that country, which decreased sales in the nine month period ended June 30, 2001 by approximately $340,000.

 

Gross Margin

Gross margin was $7.6 million and $16.4 million, respectively (44.6 percent and 41.6 percent of net sales, respectively), for the three and nine month periods ended June 30, 2002, compared to $6.9 million and $13.3 million, respectively (41.8 percent and 35.9 percent of net sales, respectively), for the comparable periods of fiscal 2001. The increases in gross margin are due to an increase in sales and an increase in the gross margin percentage.  The improved gross margin percentages are attributable to reduced selling discounts, reduced lease expense due to the elimination of the equipment operating leases in early January 2002 and increased operating efficiencies at the Company’s Clearfield, Utah manufacturing facility, offset in part by increased depreciation due to the acquisition of the Clearfield manufacturing equipment.

 

Sales and Marketing Expense

Sales and marketing expense was $4.0 million and $10.4 million, respectively (23.5 percent and 26.3 percent of net sales, respectively), for the three and nine month periods ended June 30, 2002, compared to $3.9 million and $10.4 million, respectively (23.4 percent and  28.1 percent of net sales, respectively), for the three and nine month periods ended June 30, 2001.  Decreases in fixed sales and marketing overhead in fiscal 2002 as a result of planned cost reductions were offset by increased consumer and customer marketing costs.

 

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General and Administrative Expense

General and administrative expense (“g&a”) decreased to $1.0 million and $3.1 million, respectively (5.6 percent and 7.9 percent of net sales, respectively), for the three and nine month periods ended June 30, 2002, compared to $1.2 million and $3.8 million, respectively (7.2 percent and 10.3 percent of net sales, respectively), for the three and nine month periods ended June 30, 2001.  The decreases are primarily due to cost reduction initiatives at the Company’s Portland, Oregon Support Center, which houses the Company’s executive and administrative staff.

 

Legal Settlement

Legal settlement of $108,000 in the three and nine month periods ended June 30, 2002 relates to a settlement received from a raw material supplier due to an August 2001 recall of our Chik’n Grill product due to the omission of sulfites, which are known allergens, from the ingredient label.  The raw material supplier reimbursed us for lost operating profits associated with the recall.  This is a final settlement and no further amounts will be received from this supplier related to this recall.

 

Income (Loss) from Operations

Income (loss) from operations was $2.7 million and $3.0 million, respectively, for the three and nine month periods ended June 30, 2002 compared to $1.8 million and $(1.0) million, respectively, for the comparable periods of fiscal 2001.  The improvements in operating results for the three and nine month periods ended June 30, 2002 compared to the comparable periods of fiscal 2001 are primarily a result of the increased revenue, increased gross margin percentage and decreased expenses discussed above.

 

Interest Expense

Interest expense was $1.2 million and $2.7 million, respectively, for the three and nine month periods ended June 30, 2002, compared to $450,000 and $1.8 million for the comparable periods of fiscal 2001.  The increases are primarily a result of increased outstanding debt balances and increases in the effective interest rates of previously outstanding debt.

 

Debt Restructuring Costs

Debt restructuring costs of $613,000 in the nine month period ended June 30, 2002 include an early termination fee of $175,000 for the Company’s previous line of credit facility, the write-off of $279,000 of unamortized financing fees, $95,000 for the value of common stock warrants issued in connection with the restructuring of the Convertible Notes and preferred stock and $181,000 of legal fees.

 

Other Income (Expense)

Other income was $7,000 for the three months ended June 30, 2002.  Other income of $305,000 for the nine months ended June 30, 2002 includes $303,000 related to the reversal of restructuring reserves, which were established in fiscal 1999 and, in the first quarter of fiscal 2002, were determined to no longer be required.  Other expense was $5,000 and $55,000 for the three and nine month periods ended June 30, 2001.

 

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Income Taxes

A valuation allowance has been recorded for the full amount of deferred tax assets due to the uncertainty regarding the realization of the net deferred tax assets consisting primarily of net operating loss and credit carryforwards.

 

Preferred Dividends

Preferred dividends were $1.3 million and $3.8 million for the three and nine month periods ended June 30, 2002 compared to $1.1 million and $3.3 million for the comparable periods of fiscal 2001.  Due to the addition of a 10 percent exit premium in conjunction with the changes made to the outstanding preferred stock during the second quarter of fiscal 2002, the quarterly dividend charge increased from $1.1 million to $1.3 million.

 

Net Income (Loss) Available for Common Shareholders

Net income (loss) available for common shareholders was $221,000 and $(3.7) million, respectively, for the three and nine month periods ended June 30, 2002 compared to $322,000 and $(6.0) million, respectively, for the comparable periods of fiscal 2001 due to the line item changes discussed above.

 

Liquidity and Capital Resources

 

At June 30, 2002, working capital was $9.4 million, including $1.7 million of cash and cash equivalents.  In the first nine months of fiscal 2002, working capital decreased by $452,000 compared to September 30, 2001 and the current ratio decreased to 2.4:1 from 2.9:1.

 

Cash and cash equivalents decreased $1.3 million from September 30, 2001, primarily due to $9.9 million used for the purchase of property and equipment, offset by $8.2 million of proceeds from short and long-term debt, net of payments made, and $735,000 provided by operations.

 

Accounts receivable increased $1.2 million to $4.7 million at June 30, 2002 from $3.5 million at September 30, 2001, due primarily to the increase in sales in the third quarter of fiscal 2002.  Days sales outstanding were approximately 21 days at June 30, 2002 compared to approximately 26 days at September 30, 2001.

 

Inventories increased $868,000 to $8.2 million at June 30, 2002 from $7.3 million at September 30, 2001, primarily as a result of production timing to ensure adequate product is available during the Company’s higher sales season. Inventory turned 4.7 times on an annualized basis in the third quarter of fiscal 2002 compared to 5.0 times in the corresponding period of fiscal 2001.

 

Accounts payable increased $398,000 to $2.4 million at June 30, 2002 from $2.0 million at September 30, 2001, primarily as a result of increased production and the timing of certain purchases.

 

Capital expenditures of $9.9 million during the first nine months of fiscal 2002 primarily resulted from expenditures for manufacturing equipment that the Company had previously been leasing.  In January 2002, the Company utilized the proceeds of an $8.0 million term loan plus $1.05 million of proceeds from a new line of credit to satisfy all obligations under its lease commitments with BA Leasing & Capital Corporation, including the purchase of the

 

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food processing, production and other equipment used at its Clearfield, Utah production facility.  Capital expenditures are estimated to total approximately $400,000 in the fourth quarter of fiscal 2002, primarily for manufacturing equipment.

 

In January 2002, the Company entered into a Revolving Credit and Term Loan Agreement (the “Loan Agreement”) with CapitalSource Finance LLC (“CapitalSource”).  The Loan Agreement provides for an $8.0 million term loan and a $7.0 million line of credit (together, “the Loans”).  At June 30, 2002, there was $4.9 million remaining available on the CapitalSource line of credit (subject to limitations on the borrowing base described above), which will be used as needed for working capital. The Company paid a closing fee of $300,000 in January 2002 to CapitalSource.

 

Under the terms of the Loan Agreement, the Company is required to make monthly principal payments of $41,667 through January 1, 2003, in addition to its monthly interest payments.  From February 1, 2003 through January 1, 2004, the monthly principal payment will increase to $125,000.  Thereafter, principal payments will be $166,667 per month until the expiration of the term loan.

 

See Note 5 for a discussion of the material terms of the Loan Agreement and of the Convertible Notes and amendments thereto.

 

Pursuant to the CapitalSource loan agreements and Dresdner Convertible Notes, the Company records quarterly interest expense of $75,000 and $269,000, respectively, related to exit fees.  These amounts are added to the long-term debt and convertible note balances, respectively.

 

The Company has 552,500 shares of Series C Preferred Stock and 97,500 shares of Series D Preferred Stock outstanding.  The Series C preferred shares are convertible at a price of $10 per share and the Series D preferred shares are convertible at $3.75 per share (subject to antidilution adjustments), in each case based on a base price of $50.00 per share, at any time at the discretion of the holder.  Both series of preferred stock are entitled to a 12 percent cumulative annual dividend payable upon redemption of the stock or in the event of a sale or liquidation of the Company.  The terms of the Series C Stock and Series D Stock provide for a 10 percent premium on any liquidation or redemption and for an earliest date on which holders may require redemption of their shares of March 31, 2006, at which point they may be redeemed at the election of the holders or, under certain conditions, at the discretion of the Company.  The liquidation preference of the Series C and Series D stock was $49.3 million at June 30, 2002.

 

Seasonality

 

The third and fourth quarters of the Company’s fiscal year typically have stronger sales due to the summer grilling season.  The Company typically builds inventories during the first and second quarters of its fiscal year in anticipation of increased sales in the third and fourth fiscal quarters.

 

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New Accounting Pronouncements

 

See Note 6.  for a discussion of the adoption of EITFs 00-14, 00-25 and 01-9.

 

In July 2001, the FASB issued SFAS No. 141, “Business Combinations,” and SFAS No. 142, “Goodwill and Other Intangible Assets.”   SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001.  SFAS No. 142 changes the accounting for goodwill from an amortization method to an impairment-only approach. Thus, amortization of goodwill, including goodwill recorded in past business combinations, will cease upon adoption of this Statement.  SFAS No. 142 becomes effective for fiscal years beginning after December 15, 2001, with early adoption permitted for entities with fiscal years beginning after March 15, 2001.  The Company expects to adopt SFAS No. 142 in the first quarter of fiscal 2003.  At the beginning of fiscal 2003, it is expected that the Company’s goodwill balance will be approximately $411,000. The Company will evaluate this asset for impairment in accordance with SFAS No. 142 at that time.  Had the Company adopted SFAS No. 142 at the beginning of fiscal 2002, assuming no impairment charge, it would not have recorded amortization expense of $93,000 for the nine months ended June 30, 2002.

 

In October 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This Statement supersedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,” and APB Opinion No. 30, “Reporting the Results of Operations – Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions for the Disposal of a Segment of a Business.”  SFAS No. 144 becomes effective for fiscal years beginning after December 15, 2001.  The Company expects to adopt SFAS No. 144 in the first quarter of fiscal 2003 and is currently analyzing the effects of adopting SFAS No. 144 on its financial position and results of operations.

 

In July 2002, the FASB approved SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.”  SFAS No. 146 addresses the financial accounting and reporting for obligations associated with an exit activity, including restructuring, or with a disposal of long-lived assets.  Exit activities include, but are not limited to, eliminating or reducing product lines, terminating employees and contracts and relocating plant facilities or personnel.  SFAS No. 146 specifies that a company will record a liability for a cost associated with an exit or disposal activity only when that liability is incurred and can be measured at fair value.  Therefore, commitment to an exit plan or a plan of disposal expresses only management’s intended future actions and, therefore, does not meet the requirement for recognizing a liability and the related expense.  SFAS No. 146 is effective prospectively for exit or disposal activities initiated after December 31, 2002, with earlier adoption encouraged.  The Company does not anticipate that the adoption of SFAS No. 146 will have a material effect on its financial position or results of operations.

 

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Item 3.  Quantitative and Qualitative Disclosures About Market Risk

 

As discussed above, in January 2002, the Company entered into a loan agreement with CapitalSource and terminated its existing equipment lease agreements and line of credit facility.  Amounts outstanding under this new loan agreement bear interest at variable rates tied to the prime rate.  At June 30, 2002, the Company had $7.9 million outstanding at an interest rate of 10% and $2.1 million outstanding at an interest rate of 8%.  A hypothetical 10% increase in interest rates would increase interest expense by approximately $24,000 on a quarterly basis assuming the amounts outstanding remained constant.

 

PART II – OTHER INFORMATION

 

Item 6.  Exhibits and Reports on Form 8-K

 

(a)   The exhibits filed as a part of this report are listed below and this list is intended to comprise the exhibit index:

 

Exhibit No.
3.1		Restated Articles of Incorporation, as amended January 9, 2002. (1)
10.1		Employment Agreement dated March 25, 1997, with amendments, between Gardenburger,Inc and James W. Linford (1)
10.2		Change in Control Agreement, dated October 30, 2001, between Gardenburger Inc. and James W. Linford.(1)
10.3		Change in Control Agreement, dated October 30, 2001, between Gardenburger Inc. and Lorraine A.Crawford.(1)
10.4		Amendment No. 1 dated as of January 2, 2002 to Rights Agreement dated as of July 15, 1999 between First Chicago Trust Company of New York and the Company, dated effective as of January 2, 2002.
10.5		Amendment No. 2 dated as of January 10, 2002 to the Amended and Restated Rights Agreement dated as of July 15, 1999, as amended by Amendment No. 1 dated January 2, 2002, between the Company and EquiServe Trust Company, N.A. (successor to First Chicago Trust company of New York),
99.1		Certification of Chief Executive Officer
99.2		Certification of Vice President of Finance

 

(1) Incorporated by reference to the Company’s Quarterly Report on Form 10-Q as filed with the Securities and Exchange Commission on February 13, 2002.

 

(b)          Reports on Form 8-K:

The following reports on Form 8-K were filed during the quarter ended June 30, 2002:

•                  Form 8-K pursuant to Item 4. Changes in Registrant’s Certifying Accountant, dated May 16, 2002 and filed May 23, 2002; and

•                  Form 8-K/A pursuant to Item 4. Changes in Registrant’s Certifying Accountant, dated May 16, 2002 and filed May 30, 2002.

 

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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.

 

Date: August 8, 2002	GARDENBURGER, INC.
	By::	/s/ SCOTT C. WALLACE
	Scott C. Wallace
	Director, President and Chief Executive Officer
	(Principal Executive Officer)
	By::	/s/ LORRAINE CRAWFORD
	Lorraine Crawford
	Vice President of Finance, Corporate Controller, Secretary and Treasurer
	(Principal Accounting Officer)

 

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