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 March 31, 2004
	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)
Oregon		93-0886359
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
15615 Alton Parkway, Suite 350, Irvine, California		92618
(Address of principal executive offices)		(Zip Code)
Registrant’s telephone number, including area code:  949-255-2000

 

 

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 by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  Yes  o  No  ý

 

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 May 14, 2004)

 

 

GARDENBURGER, INC.

FORM 10-Q

INDEX

 

PART I - FINANCIAL INFORMATION
Item 1.	Financial Statements (unaudited)
	Balance Sheets – March 31, 2004 and September 30, 2003
	Statements of Operations – Three-Month and Six-Month Periods Ended March 31, 2004 and 2003
	Statements of Cash Flows – Six-Month Periods Ended March 31, 2004 and 2003
	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
Item 4.	Controls and Procedures
PART II - OTHER INFORMATION
Item 4.	Submission of Matters to a Vote of Security Holders
Item 6.	Exhibits and Reports on Form 8-K
Signatures

 

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PART I - FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

GARDENBURGER, INC.
BALANCE SHEETS
(In thousands, except share amounts)
(Unaudited)

 

		March 31, 2004			September 30, 2003
Assets
Current Assets:
Cash and cash equivalents		$	698		$	1,262
Accounts receivable, net of allowances of $204 and $193 at March 31, 2004 and September 30, 2003, respectively		3,246			2,960
Inventories, net		10,677			9,191
Prepaid expenses		1,692			2,089
Total current assets		16,313			15,502
Property, plant and equipment, net of accumulated depreciation of $11,992 and $10,588 at March 31, 2004 and September 30, 2003, respectively		11,426			11,969
Other assets, net of accumulated amortization of $1,620 and $1,397 at March 31, 2004 and September 30, 2003, respectively		814			757
Total assets		$	28,553		$	28,228
Liabilities and Shareholders’ Equity (Deficit)
Current Liabilities:
Short-term note payable		$	4,248		$	2,183
Current portion of long-term debt		1,720			1,833
Accounts payable		3,167			2,546
Accrued payroll and employee benefits		1,084			704
Other current liabilities		2,596			2,299
Total current liabilities		12,815			9,565
Long-term debt, less current maturities		4,471			4,979
Convertible note payable		19,210			18,672
Convertible redeemable preferred stock, liquidation preference of $56,154 and $54,204 at March 31, 2004 and September 30, 2003, respectively, and 650,000 shares outstanding		53,600			51,012
Shareholders’ Equity (Deficit):
Preferred stock, no par value, 5,000,000 shares authorized		—			—
Common stock, no par value, 25,000,000 shares authorized; 9,002,101 shares issued and outstanding: at March 31, 2004 and September 30, 2003		11,189			11,189
Additional paid-in capital		12,500			12,500
Accumulated deficit		(85,232		)	(79,689		)
Total shareholders’ deficit		(61,543		)	(56,000		)
Total liabilities and shareholders’ deficit		$	28,553		$	28,228

 

See accompanying notes to financial statements.

 

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GARDENBURGER, INC.
STATEMENTS OF OPERATIONS
(In thousands, except share and per share amounts)
(Unaudited)

 

		Three months ended March 31,						Six months ended March 31,
		2004			2003			2004			2003
Net sales		$	12,584		$	12,408		$	23,345		$	21,397
Cost of goods sold		8,122			8,041			14,686			13,666
Gross margin		4,462			4,367			8,659			7,731
Operating expenses:
Sales and marketing		3,527			3,440			6,634			6,638
General and administrative		909			996			2,510			1,980
Other operating expense (income)		—			3			(17		)	4
		4,436			4,439			9,127			8,622
Operating income (loss)		26			(72		)	(468		)	(891		)
Other income (expense):
Interest income		1			3			2			7
Interest expense		(1,252		)	(1,113		)	(2,489		)	(2,219		)
		(1,251		)	(1,110		)	(2,487		)	(2,212		)
Loss before cumulative effect of a change in accounting principle and preferred dividends		(1,225		)	(1,182		)	(2,955		)	(3,103		)
Cumulative effect of a change in accounting for goodwill		—			—			—			411
Net loss		(1,225		)	(1,182		)	(2,955		)	(3,514		)
Preferred dividends		1,294			1,294			2,588			2,588
Net loss applicable to common shareholders		$	(2,519	)	$	(2,476	)	$	(5,543	)	$	(6,102	)
Basic and diluted loss per share before cumulative effect of a change in accounting principle		$	(0.28	)	$	(0.28	)	$	(0.62	)	$	(0.63	)
Basic and diluted loss per share for cumulative effect of a change in accounting principle		$	—		$	—		$	—		$	(0.05	)
Basic and diluted net loss per share applicable to common shareholders		$	(0.28	)	$	(0.28	)	$	(0.62	)	$	(0.68	)
Shares used in per share calculations		9,002,101			9,002,101			9,002,101			9,002,101

 

See accompanying notes to financial statements.

 

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GARDENBURGER, INC.
STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)

 

		Six Months Ended March 31,
		2004			2003
Cash flows from operating activities:
Net loss		$	(2,955	)	$	(3,514	)
Adjustments to reconcile net loss to net cash flows used in operating activities:
Depreciation and amortization		1,626			1,629
Cumulative effect of a change in accounting for goodwill		—			411
Accretion related to exit fees		652			681
Loss (gain) on sale of property, plant and equipment		(17		)	4
(Increase) decrease in:
Accounts receivable, net		(286		)	(173		)
Inventories, net		(1,486		)	(1,248		)
Prepaid expenses		397			(726		)
Increase (decrease) in:
Accounts payable		621			(479		)
Accrued payroll and employee benefits		380			25
Other current liabilities		297			686
Net cash used in operating activities		(771		)	(2,704		)
Cash flows from investing activities:
Payments for purchase of property, plant and equipment		(908		)	(1,073		)
Proceeds from sale of property, plant and equipment		113			—
Net cash used in investing activities		(795		)	(1,073		)
Cash flows from financing activities:
Proceeds from line of credit, net		2,065			3,426
Payments on long-term debt		(735		)	(1,151		)
Capitalized financing fees		(328		)	—
Net cash provided by financing activities		1,002			2,275
Decrease in cash and cash equivalents		(564		)	(1,502		)
Cash and cash equivalents:
Beginning of period		1,262			2,760
End of period		$	698		$	1,258

 

See accompanying notes to financial statements.

 

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GARDENBURGER, INC.

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

 

Note 1. Basis of Presentation

 

The financial information included herein for the quarterly periods ended March 31, 2004 and 2003 and the financial information as of March 31, 2004, 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, 2003, is derived from our 2003 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 our 2003 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.

 

We anticipate funding our cash commitments for the next twelve-month period ending March 31, 2005 out of operating cash flows and line of credit borrowings.  At March 31, 2004, we had $698,000 of cash and cash equivalents and $2.8 million available on our line of credit. Cash required to meet our interest and principal payments on our debt outstanding at March 31, 2004 totals approximately $2.5 million in the next twelve months as follows (in thousands):

 

Principal payments due on long-term debt		$	1,720
Interest on long-term debt		472
Estimated interest on short-term note payable		250
Estimated unused line of credit fee related to short term note payable		39
Total		$	2,481

 

 

Note 2.  Inventories

 

Inventories are valued at the lower of cost (using the first-in, first-out (FIFO) method) or market, and include materials, labor and manufacturing overhead.  Inventories consisted of the following (in thousands):

 

		March 31, 2004			September 30, 2003
Raw materials		$	1,718		$	1,222
Packaging and supplies		408			330
Finished goods		8,551			7,639
		$	10,677		$	9,191

 

Note 3. Supplemental Cash Flow Information and Non-Cash Activity

 

Supplemental disclosure of cash flow information and non-cash activity is as follows (in thousands):

 

		Six months ended March 31,
		2004			2003
Cash paid during the period for income taxes		$	2		$	7
Cash paid during the period for interest		469			1,033
Non-cash preferred dividends		2,588			2,588

 

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Note 4. Stock-Based Compensation

 

We account for stock options issued to employees using the intrinsic value method as prescribed by Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees.”  Pursuant to Statement of Financial Accounting Standards (“SFAS”) No. 123 “Accounting for Stock-Based Compensation,” as amended, we have computed, for pro forma disclosure purposes, the impact on net loss and net loss per share as if we had accounted for our stock-based compensation plans in accordance with the fair value method prescribed by SFAS No. 123 as follows (in thousands, except per share amounts):

 

		Three Months Ended March 31,						Six Months Ended March 31,
		2004			2003			2004			2003
Net loss applicable to common shareholders, as reported		$	(2,519	)	$	(2,476	)	$	(5,543	)	$	(6,102	)
Deduct - total stock-based employee compensation expense determined under the fair value based method for all awards		(50		)	(112		)	(100		)	(225		)
Net loss applicable to common shareholders, pro forma		$	(2,569	)	$	(2,588	)	$	(5,643	)	$	(6,327	)
Basic and diluted net loss per share:
As reported		$	(0.28	)	$	(0.28	)	$	(0.62	)	$	(0.68	)
Pro forma		$	(0.29	)	$	(0.29	)	$	(0.63	)	$	(0.70	)

 

There were no options granted during the three or six-month periods ended March 31, 2004 and 2003.

 

Note 5. Earnings Per Share

 

Basic earnings per share (“EPS”) and diluted EPS are the same for the three and six-month periods ended March 31, 2004 and 2003 since we were in a loss position.

 

Potentially dilutive securities that are not included in the diluted EPS calculations because they would be antidilutive are as follows (in thousands):

 

		March 31,
		2004		2003
Stock options		3,360		4,443
Stock warrants		1,116		1,116
Convertible Notes		1,730		1,730
Convertible preferred stock		4,062		4,062
Total		10,268		11,351

 

Note 6.  Amendments to Debt Agreements and Preferred Stock

 

In order to address issues relating to our ability to meet our financial obligations and to address non-compliance with certain of our financial covenants, we entered into amendments to our Revolving Credit and Term Loan Agreement (the “Loan Agreement”) with CapitalSource Finance LLC (“CapitalSource”) and our Amended and Restated Convertible Senior Subordinated Note (the “Convertible Note”) held by Dresdner Kleinwort Benson Private Equity Partners, L.P. (“Dresdner”) in late December 2003.  The amendments, which extend the maturity of the Loan Agreement from December 15, 2004 to January 31, 2007, and of the Convertible Note from March 31, 2005 to June 15, 2007, were approved by our shareholders at our Annual Shareholder Meeting in March 2004.

 

We also negotiated amendments to our financial covenants in the Loan Agreement and the Convertible Note to levels that we expected to be able to achieve for the foreseeable future.  These amendments were not subject to shareholder approval. Beginning December 31, 2003, we are required under the Loan Agreement to maintain compliance with the following financial covenants, measured quarterly unless otherwise noted:

 

•                  a maximum ratio of long-term indebtedness to earnings (as defined below) ranging from a high of 3.60:1.00 for the quarter ended March 31, 2004,  to a low of 2.50:1.00 for each quarter ending after June 30, 2004;

 

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•                  minimum earnings for a rolling 12-month period, as adjusted to exclude certain expenses and non-cash charges, ranging from a low of $3,000,000 for the quarter ending June 30, 2004, to a high of $6,000,000 for the quarter ending September 30, 2005, and thereafter (“minimum adjusted EBITDA”);

•                  a minimum senior fixed charge coverage ratio (which excludes from fixed charges both interest expense and accrued premium on the Convertible Note) ranging from a low of 0.90:1.00 for the quarter ending June 30, 2004, to a high of 1.57:1.00 for the quarter ending June 30, 2005;

•                  a minimum fixed charge coverage ratio of 1.10:1.00 for the quarter ending September 30, 2005 and 1.25:1.00 thereafter; and

•                  capital expenditures in an amount per fiscal year not exceeding $1,200,000 for the fiscal year ending September 30, 2004, and $1,100,000 for fiscal years ending thereafter.

 

The financial covenants applicable to the Convertible Note are similar, but in each case slightly less restrictive.

 

We were in compliance with all of our financial covenants at March 31, 2004.

 

In consideration of the maturity date extensions, the financial covenant amendments and the waivers received for prior violations, we paid a loan amendment fee to CapitalSource of approximately $130,000 and agreed to pay interest on the unpaid principal and accrued interest on the Convertible Note at the annual rate of 13% rather than 10%, which is the default interest rate provided in the note, beginning October 1, 2003, and continuing until our interest payments to Dresdner are brought current. The Loan Agreement, as amended, prohibits us from paying accrued interest on the Convertible Note to Dresdner prior to September 30, 2004, and permits us to pay interest to Dresdner on or after September 30, 2004, only if, and to the extent that, we comply with specified financial covenants and levels of capital availability.  Accrued interest due Dresdner at March 31, 2004 totaled approximately $2.0 million and is included in other current liabilities on our balance sheet.

 

We also received an agreement from Dresdner that future failures to pay interest on the Convertible Note when due will not be deemed, under specified conditions, to be an event of default under the Convertible Note.

 

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

 

This Quarterly Report on Form 10-Q contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 and we intend that such forward-looking statements be subject to the safe harbors created thereby. Words such as “may,” “will,” “expect,” “believe,” “anticipate,” “intend,” “could,” “estimate,” “should,” or “continue” or the negative or other variations thereof or comparable terminology are intended to identify forward-looking statements. In addition, any statements that refer to projections of our future financial performance, trends in our businesses, or other characterizations of future events or circumstances are forward-looking statements.  The forward-looking statements included herein are based on current expectations and involve a number of risks and uncertainties, all of which are difficult or impossible to predict accurately and many of which are beyond our control.  As such, our actual results may differ significantly from those expressed in any forward-looking statements.  Factors that may cause or contribute to such differences include, but are not limited to: (i) consumers’ concerns or adverse publicity regarding our products; (ii) effectiveness of operating initiatives and advertising and promotional efforts; (iii) changes in consumer preferences; (iv) the availability and pricing of competitive products; (v) changes in our suppliers’ ability to provide quality and timely products to us; (vi) availability of financing; (vii) new legislation or government regulation concerning packaging or our ability to produce or sell our products; (viii) the availability of distributors, such as retail grocery stores, food services outlets, such as restaurants, club stores and natural food stores to carry our products;

 

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(ix) the success of our research and development activities to develop new meat alternative products; (x) the availability of our manufacturing facilities; and (xi) the costs to protect our intellectual property rights.  Readers should carefully consider these risks, as well as the additional risks described in our Annual Report on Form 10-K for the fiscal year ended September 30, 2003 and in other documents we file from time to time with the Securities and Exchange Commission.  We undertake no obligation to revise the forward-looking statements contained herein to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

 

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the unaudited financial statements contained herein and our audited financial statements and notes to financial statements contained in our Annual Report on Form 10-K for the fiscal year ended September 30, 2003.

 

General

 

Approximately 66% of our gross sales are attributable to the Gardenburger® veggie burger and soy burger products, with the remaining 34% of our gross sales attributable to our newer meat alternative products. Consumers are quickly moving to the wider range of meat alternative products rapidly becoming available in the marketplace.  In response to this development in consumer tastes, we expanded our product line in fiscal 2002 to include a breakfast sausage alternative, our Herb Crusted Cutlet™ and Crispy Nuggets™.  In addition, in fiscal 2003 we added five new products, including BBQ Chik’n and Meatless Meatloaf. These additions join our meat alternative products released in fiscal 2000 and 2001, Riblets, Meatless Meatballs, and Chik’n Grill.

 

Our results have been, and continue to be, adversely affected by consumer trends favoring a low-carbohydrate diet.  This shift in consumer demand led to an 11% decrease and a 4% decrease, respectively, in sales of our veggie burger products in fiscal 2003 compared to fiscal 2002 and in the first six months of fiscal 2004 compared to the first six months of fiscal 2003.  Demand for veggie burgers may continue to decrease in the remainder of fiscal 2004 and beyond.  In addition, effective the second quarter of fiscal 2004, the Costco club stores ceased to require system-wide distribution of The Original Gardenburger® product, which may have a significant adverse impact on our club store sales for the remainder of fiscal 2004 and beyond.  Beginning in fiscal 2002, we launched a variety of new soy-based, meat alternative product offerings, which accounted for a net sales increase of approximately $4.0 million in fiscal 2003.  Sales of meat alternative products launched since the second quarter of fiscal 2003 contributed approximately $2.0 million to our net sales in the first two quarters of fiscal 2004.  We expect sales of our meat alternative products, including reformulated meatless burgers, to continue to increase throughout the remainder of fiscal 2004.

 

Results of Operations

 

(Dollars in thousands)		Three Months Ended March 31, 2004					Three Months Ended March 31, 2003
		Dollars			% of net sales(1)		Dollars			% of net sales(1)
Net sales		$	12,584		100.0	%	$	12,408		100.0	%
Cost of goods sold		8,122			64.5		8,041			64.8
Gross margin		4,462			35.5		4,367			35.2
Sales and marketing expense		3,527			28.0		3,440			27.7
General and administrative expense		909			7.2		996			8.0
Other operating expense		—			—		3			—
		4,436			35.3		4,439			35.8
Operating income (loss)		26			0.2	%	(72		)	(0.6	)%
Other expense, net		(1,251		)			(1,110		)
Net loss		(1,225		)			(1,182		)
Preferred dividends		1,294					1,294
Net loss applicable to common shareholders		$	(2,519	)			$	(2,476	)

 

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		Six Months Ended March 31, 2004					Six Months Ended March 31, 2003
		Dollars			% of net sales(1)		Dollars			% of net sales(1)
Net sales		$	23,345		100.0	%	$	21,397		100.0	%
Cost of goods sold		14,686			62.9		13,666			63.9
Gross margin		8,659			37.1		7,731			36.1
Sales and marketing expense		6,634			28.4		6,638			31.0
General and administrative expense		2,510			10.8		1,980			9.3
Other operating expense (income)		(17		)	(0.1	)	4			—
		9,127			39.1		8,622			40.3
Operating loss		(468		)	(2.0	)%	(891		)	(4.2	)%
Other expense, net		(2,487		)			(2,212		)
Loss before cumulative effect of a change in accounting principle and preferred dividends		(2,955		)			(3,103		)
Cumulative effect of a change in accounting principle		—					411
Net loss		(2,955		)			(3,514		)
Preferred dividends		2,588					2,588
Net loss applicable to common shareholders		$	(5,543	)			$	(6,102	)

 

(1) Percentages may not add due to rounding.

 

Net Sales

 

The increases in net sales in the three and six-month periods ended March 31, 2004 compared to the three and six month periods ended March 31, 2003 are a result of continuing growth in meat alternative products, offset in part by a decrease in sales to Costco.

 

Sales of products launched after the second quarter of fiscal 2003, which are all meat alternative products, contributed $1.1 million and $2.0 million, respectively, to our net sales in the three and six month periods ended March 31, 2004. We expect sales of our meat alternative products, including reformulated meatless burgers, to continue to increase for fiscal 2004.  We also expect our new packaging, which started shipping at the end of the first quarter of fiscal 2004, to increase consumers’ awareness of how our products can fit into their diet choices and lifestyles, including low carbohydrate choices.

 

Net sales to Costco decreased by $532,000, or 30%, and $1.1 million, or 32%, respectively, in the three and six month periods ended March 31, 2004 compared to the same periods of fiscal 2003 as a result of Costco’s decision to remove the Kirkland Signature co-branding label from our Gardenburger original packaging, effective the second quarter of fiscal 2004, which means that our product is no longer required to be carried by all Costco stores.  Approximately 70% to 80% of the Costco stores have continued to carry our Gardenburger product and approximately 40% to 45% of the Costco stores have begun to sell our Riblets product.

 

Trade spending totaled $2.8 million and $4.7 million, respectively, in the three and six-month periods ended March 31, 2004 compared to $2.8 million and $4.6 million, respectively, in the comparable periods of fiscal 2003. Trade spending includes promotions, discounts, contract origination fees and slotting expenses. Pursuant to EITF No. 01-9 “Accounting for Consideration Given by a Vendor to a Customer or a Reseller of the Vendor’s Products,” such expenses are recorded as a reduction of sales when the sale is recognized or the incentive is offered.

 

Gross Margin

 

The increases in gross margin and gross margin as a percentage of net sales in the three and six-month periods ended March 31, 2004, compared to the comparable periods of fiscal 2003 are due to increased unit sales, which provides a larger sales base over which to spread fixed costs.  There were no material changes to raw material costs or selling prices in the first six months of fiscal 2004 compared to the first six months of fiscal 2003.  We are beginning to experience higher commodity,

 

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primarily cheese, costs as we begin the second half of our fiscal year, but we do not anticipate any material selling price changes for the remainder of fiscal 2004.

 

Sales and Marketing Expense

 

Sales and marketing expense in the three and six-month periods ended March 31, 2004 includes approximately $7,000 and $57,000, respectively, of costs related to our move to Irvine, California from Portland, Oregon.  Sales and marketing expenditures in the three-month period ended March 31, 2004 also includes certain termination and recruitment costs related to changes in certain sales positions.  The increases in moving, termination and recruitment costs were offset by decreases that resulted from focusing our expenditures solely on the re-launch of our retail line.

 

General and Administrative Expense

 

General and administrative expense in the three and six-month periods ended March 31, 2004 includes approximately $32,000 and $587,000, respectively of costs related to our move to Irvine, California from Portland, Oregon.  The decrease in the three month period ended March 31, 2004 compared to the three month period ended March 31, 2003 is due to reduced insurance, depreciation and rent expense.  The increase in the six-month period ended March 31, 2004 compared to the six-month period ended March 31, 2003 was primarily due to relocation expenses.

 

Other Operating Expense (Income)

 

Other operating income in the six month period ended March 31, 2004 includes a $17,000 gain on the sale of assets.

 

Interest Expense

 

In connection with the amendment of our senior and subordinated debt instruments in December 2003, the interest rate on our subordinated debt increased to 13% from 10%, retroactive to October 1, 2003, until our interest payments are current, which is not expected to occur until at least fiscal 2005.  This increase in rate increased our interest expense by approximately $127,000 per quarter in fiscal 2004 compared to fiscal 2003.  In March 2004, we amended our Articles of Incorporation to extend the earliest mandatory redemption date of our Series C and Series D convertible preferred stock to as late as June 30, 2008.  As a result, we also extended the maturity dates under our CapitalSource Loan Agreement and our Convertible Note to January 31, 2007 and June 15, 2007, respectively. The extended maturity dates will decrease our interest expense by approximately $186,000 per quarter to approximately $113,000 per quarter.

 

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.  Accordingly, no benefit has been recorded related to our losses in the first three and six-month periods of fiscal 2004 or fiscal 2003.

 

Cumulative Effect of Change in Accounting for Goodwill

 

In accordance with the adoption provisions of SFAS No. 142, “Goodwill and Other Intangible Assets,” in the first quarter of fiscal 2003, we tested the carrying value of our goodwill utilizing a discounted cash flow analysis and determined that the remaining balance of $411,000 should be written off.  There was no goodwill on our balance sheet at March 31, 2004 or September 30, 2003.

 

Preferred Dividends

 

As approved by our shareholders at our 2004 Annual Shareholder Meeting in March 2004, the terms of our Series C and Series D convertible preferred stock were amended to defer the earliest date on which holders may require redemption of their shares of Series C and Series D convertible preferred stock to as late as June 30, 2008 instead of March 31, 2006.  Accordingly, the amount of the 10% redemption premium not previously accreted will be accreted over a longer period of time, which will reduce our quarterly preferred dividend charge from $1.29 million to approximately $1.16 million beginning in the third quarter of fiscal 2004.

 

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Liquidity and Capital Resources

 

We anticipate funding our cash commitments for the next twelve-month period ending March 31, 2005 out of operating cash flows and line of credit borrowings.

 

At March 31, 2004, working capital was $3.5 million, including $698,000 of cash and cash equivalents.  Working capital decreased by $2.4 million at March 31, 2004 compared to September 30, 2003 and the current ratio decreased to 1.3:1 from 1.6:1.

 

Cash and cash equivalents at March 31, 2004 decreased $564,000 from September 30, 2003, primarily due to $771,000 used in operations, $908,000 used for the purchase of equipment, $735,000 used for payments on long-term debt and $328,000 used to pay financing fees related to our debt amendments, offset by $2.1 million of net proceeds from our line of credit and $113,000 of proceeds from the sale of assets.

 

Accounts receivable increased $286,000 to $3.2 million at March 31, 2004 from $3.0 million at September 30, 2003, due primarily to increased sales in the last month of the quarter ended March 31, 2004 compared to the last month of the quarter ended September 30, 2003.  Days sales outstanding were approximately 19 days at March 31, 2004 compared to approximately 21 days at September 30, 2003.

 

Inventories increased $1.5 million to $10.7 million at March 31, 2004 compared to $9.2 million at September 30, 2003.  Inventory turned approximately 3.2 times on an annualized basis in the second quarter of fiscal 2004 compared to 3.0 times in the corresponding period of fiscal 2003.  The increase in inventory is primarily due to normal seasonal build-up in preparation for the summer grilling season.

 

Capital expenditures of $908,000 during the first six months of fiscal 2004 were primarily used for manufacturing equipment relating to our new product introductions.  Capital expenditures could total up to approximately $1.5 million in fiscal 2004, primarily for manufacturing equipment. At this increased level of full-year capital spending, we would have to seek a waiver of our full-year capital expenditures covenants included in our Loan Agreement and our Convertible Note.  We expect that we will be able to obtain these waivers.

 

Other long-term assets increased $57,000 to $814,000 at March 31, 2004 from $757,000 at September 30, 2003 as a result of the capitalization of $328,000 of financing fees, offset primarily by the related amortization of capitalized financing fees.  Unamortized capitalized financing fees totaled $472,000 at March 31, 2004 and will be amortized at the rate of approximately $41,000 per quarter.

 

Our Loan Agreement with CapitalSource provides for an $8.0 million term loan and a $7.0 million line of credit (together, “the Loans”).  The Loan Agreement permits us to request advances under the $7.0 million line of credit up to the sum of 85% of eligible receivables and 60% of eligible inventory.  At March 31, 2004, there was approximately $2.8 million remaining available on the CapitalSource line of credit, which will be used as needed for working capital.  The balance outstanding of $6.2 million on the term loan includes $0.6 million of accrued exit fees at March 31, 2004.

 

We also have approximately $16.9 million of principal and $2.3 million of accretion related to exit fees due to Dresdner pursuant to the terms of our Convertible Note. The Convertible Note requires payment of a 20% premium on the principal plus accrued but unpaid interest at repayment or maturity. The Convertible Note is convertible into common stock at the election of the holder; the conversion price at March 31, 2004 was $9.78 per share.

 

Pursuant to the CapitalSource Loan Agreement and Convertible Note, as amended, in future quarters, we will record quarterly interest expense of approximately $22,000 and $91,000, respectively, for the accretion related to the exit fees. These amounts are added to the long-term debt and convertible note balances, respectively.

 

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In September 2003, Dresdner agreed to permit the deferral of our September 30, 2003 interest payment, which totaled $845,000, to December 31, 2003.  In December 2003, this interest payment was further deferred to no earlier than September 30, 2004.  In addition $576,000 was accrued in each of the first and second quarters of fiscal 2004.  Accordingly, we included the total of $2.0 million and $845,000, respectively, on our balance sheets as of March 31, 2004 and September 30, 2003 in other current liabilities.

 

In order to address issues relating to our ability to meet our financial obligations and to address non-compliance with certain of our financial covenants, we entered into amendments to our Loan Agreement with CapitalSource and our Convertible Note held by Dresdner in late December 2003.  The amendments were contingent upon amending our Articles of Incorporation to extend the date on which our holders of Series C and Series D convertible preferred stock could redeem their shares of preferred stock, which shareholder approval was obtained at our Annual Shareholder Meeting in March 2004.

 

The amendments extend the maturity of the Loan Agreement from December 15, 2004 to January 31, 2007 and of the Convertible Note from March 31, 2005 to June 15, 2007.

 

We also negotiated amendments to our financial covenants in the Loan Agreement and the Convertible Note to levels that we expected to be able to achieve for the foreseeable future.  Beginning December 31, 2003, we are required under the Loan Agreement to maintain compliance with the following financial covenants, measured quarterly unless otherwise noted:

 

•                  a maximum ratio of long-term indebtedness to earnings (as defined below) ranging from a high of 3.60:1.00 for the quarter ended March 31, 2004,  to a low of 2.50:1.00 for each quarter ending after June 30, 2004;

•                  minimum earnings for a rolling 12-month period, as adjusted to exclude certain expenses and non-cash charges, ranging from a low of $3,000,000 for the quarter ending June 30, 2004, to a high of $6,000,000 for the quarter ending September 30, 2005, and thereafter (“minimum adjusted EBITDA”);

•                  a minimum senior fixed charge coverage ratio (which excludes from fixed charges both interest expense and accrued premium on the Convertible Note) ranging from a low of 0.90:1.00 for the quarter ending June 30, 2004, to a high of 1.57:1.00 for the quarter ending June 30, 2005;

•                  a minimum fixed charge coverage ratio of 1.10:1.00 for the quarter ending September 30, 2005 and 1.25:1.00 thereafter; and

•                  capital expenditures in an amount per fiscal year not exceeding $1,200,000 for the fiscal year ending September 30, 2004, and $1,100,000 for fiscal years ending thereafter.

 

The financial covenants applicable to the Convertible Note are similar, but in each case slightly less restrictive.  At March 31, 2004, we were in compliance with all of the financial covenants.

 

In consideration of the maturity date extensions, the financial covenant amendments, and the waivers received for prior violations, we paid a loan amendment fee to CapitalSource of approximately $130,000 and agreed to pay interest on the unpaid principal and accrued interest on the Convertible Note at the annual rate of 13% rather than 10%, which is the default interest rate provided in the note, beginning October 1, 2003, and continuing until our interest payments to Dresdner are brought current. The Loan Agreement, as amended, prohibits us from paying accrued interest on the Convertible Note to Dresdner prior to September 30, 2004, and permits us to pay interest to Dresdner on or after September 30, 2004, only if and to the extent that we comply with specified financial covenants and levels of capital availability. Interest due Dresdner at March 31, 2004 totaled approximately $2.0 million and is included in other current liabilities on our balance sheet.

 

We also received an agreement from Dresdner that future failures to pay interest on the Convertible Note when due will not be deemed, under specified conditions, to be an event of default under the Convertible Note.

 

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Principal payments under our term loan, our Convertible Note and our operating leases are significant.  A schedule of payments remaining due at March 31, 2004 in the next five fiscal years, including exit fees of $750,000 for the term loan and approximately $3.4 million for the Convertible Note, is as follows:

 

Year Ending September 30,		Term Loan			Convertible Note			Operating Leases			Total
2004		$	720,000		$	—		$	323,046		$	1,043,046
2005		2,000,004			—			655,653			2,655,657
2006		2,000,004			—			668,298			2,668,302
2007		1,583,335			20,286,750			551,728			22,421,813
2008		—			—			132,255			132,255
Thereafter		—			—			—			—
Total		$	6,303,343		$	20,286,750		$	2,330,980		$	28,921,073

 

We have 552,500 shares of Series C Convertible Preferred Stock and 97,500 shares of Series D Convertible Preferred Stock outstanding. The Series C preferred shares are convertible into common stock 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% cumulative annual dividend payable upon redemption of the stock or in the event of a sale or liquidation of Gardenburger.  The terms of the Series C and Series D Stock provide for a 10% premium on any liquidation or redemption.  As approved by our shareholders at our March 2004 Annual Shareholders Meeting, the earliest date on which holders may require redemption of their shares was deferred from March 31, 2006 to as late as June 30, 2008, at which point they may be redeemed at the election of the holders or, under certain conditions, at our discretion. The 10% redemption premium, which totals $4.3 million, is being accreted over the redemption period.  At March 31, 2004, $1.8 million of the redemption premium has been accreted and is included in the preferred stock balance on the balance sheet. The liquidation preference of the Series C and Series D Stock was $56.2 million at March 31, 2004.

 

Seasonality

 

The third and fourth quarters of our fiscal year typically have stronger sales due to the summer grilling season.  We typically build inventories during the first and second quarters of each fiscal year in anticipation of increased sales in the third and fourth fiscal quarters.

 

Critical Accounting Policies and Estimates

 

We reaffirm the critical accounting policies and the use of estimates as reported in our Form 10-K for the fiscal year ended September 30, 2003.

 

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

 

Amounts outstanding under our Loan Agreement with CapitalSource bear interest at rates tied to the prime rate with a minimum rate of 10% on the term loan and 8% on the line of credit.  At March 31, 2004, we had $5.6 million outstanding at an interest rate of 10% on the term loan and $4.2 million outstanding at an interest rate of 8% on the line of credit.  A hypothetical 10% increase in the prime rate would not have any effect on the interest rates currently being charged on these amounts under the Loan Agreement because the prime rate would still be below the minimum rates charged on the term loan and line of credit.

 

Our Convertible Note held by Dresdner is at a fixed interest rate and, therefore, a change in market interest rates would not affect interest expense related to the Convertible Note.

 

We do not currently utilize, nor do we anticipate utilizing, derivative financial instruments.

 

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Item 4.  Controls and Procedures

 

Disclosure Controls and Procedures

 

Our management has evaluated, under the supervision and with the participation of our President and Chief Executive Officer and Senior Vice President and Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934 (the “Exchange Act”). Based on that evaluation, our President and Chief Executive Officer and Senior Vice President and Chief Financial Officer have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures are effective in ensuring that information required to be disclosed in our Exchange Act reports is (1) recorded, processed, summarized and reported in a timely manner, and (2) accumulated and communicated to our management, including our President and Chief Executive Officer and Senior Vice President and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

 

Internal Control Over Financial Reporting

 

There has been no change in our internal control over financial reporting that occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

PART II - OTHER INFORMATION

 

Item 4.  Submission of Matters to a Vote of Security Holders

 

Our annual meeting of shareholders was held on March 18, 2004, at which time the following actions were taken:

 

1.               The five nominees for election by the holders of common stock and preferred stock and the two director nominees for election by the holders of the Series C preferred stock as directors were elected.  The voting results follow:

 

 

2.               The amendment to our Restated Articles of Incorporation to defer the earliest date of mandatory redemption of our Series C and Series D Convertible Preferred Stock to as late as June 30, 2008 was approved.  The voting results follow:

 

Number of Votes For		Number of Votes Against		Number of Shares Abstaining		Number of Broker Non-Votes
6,568,568		106,587		54,269		4,487,914

 

Item 6.  Exhibits and Reports on Form 8-K

 

(a)          Exhibits

 

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

 

Exhibit No.
31.1		Certification of Scott C. Wallace Pursuant to Rule 13a-14(a) of the Sarbanes-Oxley Act of 2002.
31.2		Certification of Robert T. Trebing, Jr. Pursuant to Rule 13a-14(a) of the Sarbanes-Oxley Act of 2002.
32.1		Certification of Scott C. Wallace Pursuant to Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2		Certification of Robert T. Trebing, Jr. Pursuant to Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

(b)          Reports on Form 8-K:

 

We did not file any reports on Form 8-K during the quarter ended March 31, 2004.

 

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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:	May 17, 2004	GARDENBURGER, INC.
		By: /s/ROBERT T. TREBING, JR.
		Robert T. Trebing, Jr.
		Senior Vice President and Chief Financial Officer (Duly Authorized Officer and Principal Financial and Accounting Officer)

 

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