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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED MARCH 31, 2004
COMMISSION FILE NO. 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)
Registrant's telephone number, including area code: (407) 855-5500
Securities registered under Section 12(b) of the Exchange Act: NONE
Securities registered under Section 12(g) of the Exchange Act:
COMMON STOCK, PAR VALUE $.01 PER SHARE AMERICAN STOCK EXCHANGE
(Title of Class) (Name of exchange on which registered)
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 if a disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes No X
The aggregate market value of the voting common equity held by non-affiliates as
of September 30, 2003 (the last business day of the registrant's most recently
completed second fiscal quarter) was $18,284,935 based on the closing price of
such common equity of $2.90 per share on such date.
As of June 25, 2004, the number of shares outstanding of registrant's common
stock, $0.01 par value per share, was 15,724,073.
DOCUMENTS INCORPORATED BY REFERENCE: NONE
1
PART I
FORWARD LOOKING STATEMENTS
THIS FORM 10-K CONTAINS FORWARD-LOOKING STATEMENTS. THESE STATEMENTS RELATE TO
FUTURE EVENTS OR THE COMPANY'S FUTURE FINANCIAL PERFORMANCE. THESE
FORWARD-LOOKING STATEMENTS ARE BASED ON THE COMPANY'S CURRENT EXPECTATIONS,
ESTIMATES AND PROJECTIONS ABOUT ITS INDUSTRY, MANAGEMENT'S BELIEFS AND CERTAIN
ASSUMPTIONS MADE BY THE COMPANY. WORDS SUCH AS "ANTICIPATES," "EXPECTS,"
"INTENDS," "PLANS," "BELIEVES," "SEEKS," "ESTIMATES" AND VARIATIONS OF THESE
WORDS OR SIMILAR EXPRESSIONS ARE INTENDED TO IDENTIFY FORWARD-LOOKING
STATEMENTS. THESE STATEMENTS ARE NOT GUARANTEES OF FUTURE PERFORMANCE AND ARE
SUBJECT TO CERTAIN RISKS, UNCERTAINTIES AND ASSUMPTIONS THAT ARE DIFFICULT TO
PREDICT. THEREFORE, ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE EXPRESSED
OR FORECASTED IN ANY FORWARD-LOOKING STATEMENTS AS A RESULT OF A VARIETY OF
FACTORS, INCLUDING THOSE SET FORTH IN "RISK FACTORS" AND ELSEWHERE IN, OR
INCORPORATED BY REFERENCE INTO, THIS FORM 10-K. 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.
ITEM 1. BUSINESS.
GENERAL
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 dairy alternative products made with soy. The Company was founded by
Angelo S. Morini in 1972 under the original name of Fiesta Foods & Galaxy Foods.
In June 1991, the Company relocated from New Castle, Pennsylvania to Orlando,
Florida and began production and shipment of its products directly from its
Orlando plant to customers in each of the Company's two principal
markets--retail stores, such as supermarket chains and health food stores; and
food service operations, such as restaurant chains, cafeterias, hospitals and
schools.
The Company's sales effort is primarily directed to retailers, to take advantage
of what it perceives to be an increased consumer emphasis on nutrition, by
offering a diverse line of low and no fat, no saturated fat, no trans-fats, low
and no cholesterol, no lactose cheese and dairy-related products. These include
individually wrapped cheese slices, shredded cheeses, grated toppings, cheese
crumbles, butter, milk, yogurt, smoothies, chunk cheeses, deli cheeses, string
cheese and soft cheeses like sour cream, cream cheese and cheese sauces.
The Company also manufactures and markets non-branded and private label process
and blended cheese products, as well as branded, organic soy-based, rice-based
and non-dairy cheese products. Most of these products are made using the
Company's formulas and processes, which are believed to be proprietary, and the
Company's state-of-the-art manufacturing equipment.
The Company's strategy for the future is to continue its marketing efforts
primarily in the retail market to capitalize on the continuing interest among
consumers in eating more nutritious natural foods, which will help reduce their
cholesterol levels and saturated fat intake. The Company believes that one of
the leading contributors of cholesterol and saturated fat in the American diet
is conventional cheese. By providing good tasting cheese alternatives in diverse
forms and flavors, the Company believes it will be able to attract an increasing
number of worldwide consumers interested in improving their health and changing
to more nutritious eating habits. The Company intends to broaden this strategy
for the future by creating a more widely accepted and broader appealing line of
great tasting, healthy dairy related products.
2
DEVELOPMENT OF BUSINESS
In the past eight years, the Company has developed several new marketing
strategies and product lines for the retail and foodservice markets. In retail,
the Company developed a unique marketing strategy for its complete product line
of plant-based dairy alternatives, called Veggie(TM). While most companies sell
dairy products through supermarket dairy cases, the Company adopted a marketing
strategy whereby its Veggie(TM) plant-based dairy alternatives are sold mostly
in produce cases of supermarkets nationwide. In produce, the products are sold
next to other nutritious natural products, which allows targeted consumers to
locate the products much more easily instead of being sold in the dairy cases of
supermarkets where targeted consumers may not look.
In health food stores, the Company significantly expanded its existing product
lines and introduced several new line extensions over the past few years. These
product line extensions also are plant-based dairy alternatives and are made
from either soy or rice. The Company believes its vegan (non-dairy) product line
is the most extensive in the world. With the addition of natural food sections
to most supermarkets, the Company also markets these products to the mass
market. In the past, these products were only sold to the health food industry.
In the past few years, the Company began offering these plant-based dairy
alternatives to the foodservice market so that consumers could also enjoy the
taste and health benefits of these products while eating away from home. Prior
to doing this, the Company primarily sold only conventional-type products to
foodservice.
PRODUCTS AND SERVICES
The Company's healthy cheese and dairy related products, sold under the
Company's brand names such as Veggie(TM), Veggie Nature's Alternative to
Milk(R), Veggie Slices(R), Veggie Milk(TM), Soyco(R), Soymage(R), Wholesome
Valley(R), Rice Slice(TM), Veggy Singles(R), Lite Bakery(R), and Veggie Lite
Bakery(TM), are low or no fat, low or no cholesterol, no saturated fat, and
lactose (milk sugar) free, vitamin and mineral enriched, and contain one-third
fewer calories and typically more calcium than conventional cheese. These
healthy cheese and dairy related products mirror the flavor, appearance, aroma,
texture, and melt of conventional cheeses and products that use conventional
cheeses, and are nutritionally equal or superior to such cheeses and products.
Some of the Company's cheese alternatives, which are marketed for their lower
price points and not for their nutritious components, are not nutritionally
equivalent or superior to conventional cheeses.
VEGGIE(TM)- COMPLETE LINE OF HEALTHY DAIRY ALTERNATIVES - The Company's flagship
brand has a complete line of nutritious dairy alternative products made with
soy. All Veggie(TM) products are reduced or low in fat, contain less calories,
and are saturated fat, trans fat, cholesterol and lactose free. The Veggie(TM)
product line includes Veggie Slices(R), Veggie Chunks, Veggie Shreds, Veggie
Cream Cheese, Veggie Sour Cream, Veggie Butter, Veggie Honey Butter, Veggie
Grated Toppings, Veggie Milk, Veggie Milk Bars, Veggie Ice Cream, Veggie Yogurt,
Veggie String Cheese, and Veggie Deli Products.
DAIRY FREE - SOYMAGE(R) VEGAN DAIRY ALTERNATIVES - Soymage(R) products were
developed for health food and specialty stores. These products are intended for
consumers who are allergic to dairy products, such as milk protein, or who are
practicing a Vegan lifestyle. The Soymage(R) Vegan line is completely dairy
free, contains no animal fats and has no casein (skim milk protein). The
Soymage(R) Vegan product line includes: cheese slices, grated toppings, chunk
cheeses, sour cream, cream cheese and cheese sauce alternatives. The Company
believes that its Soymage(R) line is the largest and most comprehensive vegan
line in the world.
3
SOY FREE - SOY FREE DAIRY ALTERNATIVES MADE WITH RICE -- The Company has
developed a dairy free alternative product line made with organic brown rice.
This product is reduced or low in fat, cholesterol free, lactose free, soy free
and is fortified with essential vitamins and minerals. Additionally, this
product is formulated for people with soy allergy or who are just looking for
alternatives for conventional dairy products. The Rice product line includes
individual slices, shreds, chunks, grated toppings, cream cheese, sour cream,
butter and yogurt.
VEGGY(TM) - SOY NUTRITIOUS - SOY DAIRY ALTERNATIVES - These Veggy(TM) products
offer the taste of cheese, are available in many forms, and are made from soy.
They are low in fat or fat free, and are lactose, cholesterol and saturated fat
free. The Veggy product line comes in several flavors and is available in
individual slices (Veggy Singles(R)), grated toppings and chunks. These products
are distributed to natural foods stores and produced specifically to meet the
discriminating taste and nutritional demands of the specialized nutritional
foods market.
WHOLESOME VALLEY(R) ORGANIC - PRODUCTS MADE FROM ORGANIC MILK - These products
are processed cheese foods made from organic milk, contain up to 50% less fat
than regular processed cheese food, contain no artificial ingredients, no rBST
hormone or antibiotics and are an excellent source of calcium and protein. The
farmland, cows and feed are free from pesticides, antibiotics, growth hormones
and chemicals.
PROCESSED CHEESE PRODUCTS - GALAXY SANDWICH SLICES(TM) AND TOPPINGS - These
products are low in cholesterol and serve as an alternative to conventional
dairy cheeses. They are not nutritionally equivalent or superior to conventional
cheeses and may have more cholesterol than the Company's branded cheeses. These
products include a variety of sandwich slices and shredded cheeses, including
shredded taco and pizza toppings, and a cheddar cheese sauce. They are marketed
as a lower cost alternative to conventional dairy cheeses.
LITE BAKERY(R) - VEGGIE LITE BAKERY(R) - The Company has developed a collection
of over 50 recipes using the Company's soy based bakery ingredients. The
Company's soy based bakery powder can be used to develop finished products or
can be sold as an ingredient to be used in other foods. The Company's Lite
Bakery(R) mix is fat free, low or reduced fat, cholesterol free and lactose
free.
The Company's only branded product line, which accounts for more than 10% of the
Company's gross sales for the fiscal year ended March 31, 2004, is the
Veggie(TM) line of products. This line of products contributed approximately
sixty percent (60%), sixty-one percent (61%), and fifty-six percent (56%) of
gross sales for the fiscal years ended March 31, 2004, 2003 and 2002,
respectively. The Company's non-branded imitation, private label and sandwich
slice business contributed approximately twenty-four percent (24%), twenty-one
percent (21%), and twenty-nine percent (29%) of gross sales for the fiscal years
ended March 31, 2004, 2003 and 2002, respectively.
The characteristics of the Company's products vary according to the specific
requirements of individual customers within each market. In the retail market,
the Company's products are formulated to meet the health concerns of today's
consumers. In the food service markets, the Company's products are made
according to the customer's specifications as to color, texture, shred, melt,
cohesiveness, stretch, browning, fat retention, protein, vitamin and mineral
content, and cost parameters. The Company's products are manufactured in various
forms, such as individual slices, grated, shredded, salad toppings, deli loaves,
and multi-pound blocks and are available in several flavors, including, but not
limited to mozzarella, pepper-jack, cheddar, American, parmesan and Swiss.
4
MARKETS
The Company's products are sold primarily to two commercial markets: retail
(conventional grocery stores, mass merchandisers, natural foods and club stores)
and food service (restaurants, cafeterias, hospitals and schools).
In the retail market, where the Company believes taste and nutrition generally
outweighs price considerations, the Company markets its Veggie(TM) and Soyco(R)
products at prices generally comparable to or higher than the prices of
conventional cheeses. In this market, the Company sells directly to retail
establishments, including national and regional supermarket chains, and to
distributors that sell and deliver to retail establishments.
In the food service market, the Company markets its more expensive premium
products to customers who place importance on taste and nutrition and its less
expensive branded, non-branded and private label substitute and
conventional-type cheese products to customers whose primary consideration is
cost. The food service products are primarily sold to distributors who supply
food to restaurants, cafeterias, hospitals, correctional institutions, and
schools. The Company also markets its products directly to franchisees of large
national restaurant chains.
The following chart sets forth the percentage of gross sales that the retail and
food service markets represented for the fiscal years ended March 31, 2004, 2003
and 2002:
PERCENTAGE OF SALES
FISCAL YEARS ENDED MARCH 31,
CATEGORY 2004 2003 2002
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Retail sales 88% 87% 83%
Food service sales 12% 13% 17%
DISTRIBUTION CHANNELS AND METHODS
The Company currently distributes all of its products by common carrier and
customer pick-up. The Company ships all its products from its shipping,
warehouse and cooler facilities in Orlando, Florida. In order to distribute to
its Canadian customers quickly and efficiently, the Company stores and
distributes products through a public storage facility in Canada. The Company
maintains a certain stock level at this facility and pays the Canadian facility
a processing fee for its services.
MANUFACTURING PROCESS
Most of the Company's products are made using the Company's formulas, processes
and manufacturing equipment, from five principal ingredients: casein (a pure
skim milk protein) instead of liquid milk which is used to make conventional
cheeses; soybean and canola oils; water; soy proteins; and natural flavorings.
The Company's Soymage(R) products are also made using the Company's formulas,
processes and manufacturing equipment from these principal ingredients, except
that Soymage(R) does not contain casein. All of these products are produced at a
temperature above that required for pasteurization. The Company's original
formulas and processes were designed and developed by the Company's Founder,
Angelo S. Morini. Mr. Morini has assigned the rights to these formulas,
processes and equipment to the Company. Unlike the conventional cheese
manufacturing process, the production of the Company's products does not require
the costly and time-consuming use of bacteria to curdle milk, nor does it
require removal of whey or product curing.
5
QUALITY CONTROL
Throughout the production process, the Company subjects its products to
stringent quality control inspections in order to satisfy federal and state
regulations for good manufacturing procedures, meet customer specifications, and
assure consistent product quality. A sample of each production run is tested for
various characteristics including taste, color, acidity (Ph), melt, stretch,
percentage fat, and microorganisms, such as pathogens, total bacterial count,
yeast, mold, and coliform. Random samples are also regularly sent to an
independent laboratory to test for bacteria and other microorganisms.
CAPITAL EXPENDITURES
During the fiscal years ended March 31, 2004, 2003 and 2002, the Company's
capital expenditures, including capitalized leases, were approximately $277,000,
$309,000, $1,705,000, respectively. The substantial capital expenditures for the
fiscal year ended March 31, 2002 were the result of the final installation costs
on several new production lines at its manufacturing facility in Orlando,
Florida. These new lines included two new slice lines, a new chunk cheese line,
a cup line, a string cheese line and a shred line.
SALES AND MARKETING
In the retail market, the Company markets its healthy products to grocery
stores, mass merchandisers, natural food stores and club stores. The Company
believes its healthy products appeal to a wide range of consumers interested in
lower fat, lower cholesterol, lactose free products and other health-promoting
aspects of these products and that the retail market for its products will
continue to expand. These products are sold through distributors and directly to
customers by in-house and territory sales managers and a nationwide network of
non-exclusive commission brokers. The Company uses conventional marketing and
public relations techniques for market introductions such as promotional
allowances, coupons, in-store consumer sampling, print advertising and
television.
In the food service market, the Company promotes its healthy Veggie(TM) cheese
products as well as lower cost cheese alternatives. In marketing its Veggie(TM)
line of products to food service customers, the Company emphasizes that its
products taste like conventional cheese and have no, low or reduced fat, low or
no cholesterol, no lactose and typically more calcium than conventional cheeses.
The Company also promotes its food service products on the basis of their
considerably longer shelf life and microbiologically safer profile than
conventional cheeses. The Company sells directly to food distributors and other
customers in the food service market, as well as utilizing its in-house staff,
territory managers and nationwide network of non-exclusive commission brokers to
sell the Company's products.
PRODUCT DEVELOPMENT
The Company conducts ongoing research to improve product quality on key
strategic product lines, develop new varieties of cheese, dessert products and
dairy related products, in addition to developing new flavors and customized
formulations for existing products. For the fiscal years ended March 31, 2004,
2003 and 2002, expenditures for product development were $260,410, $232,552, and
$261,972, respectively. None of the research and development costs are directly
borne by any particular customer or group of customers, instead they are
considered part of operating expenses.
6
In May 2001, the Company entered into a licensing arrangement with Tropicana(R)
that enabled the Company to manufacture, distribute (in limited distribution
channels and countries) and market its Ultra Smoothie(TM) product in a
co-branding relationship and use Tropicana's logo "made with Tropicana(R)
Juices" on the package. After review of actual sales related to its Ultra
Smoothie(TM) product and in a mutual agreement with Tropicana(R), the Company
canceled the licensing agreement effective June 1, 2004. The Company noted a
lack of sufficient sales revenue primarily resulting from agreement restrictions
on distribution channels in which the product could be sold and a packaging
design (i.e. beverage in a yogurt cup) that was not optimal for the intended
consumer usage occasion. The parties agreed that neither party should have any
further obligation to the other with respect to the agreement. The Company plans
to reformulate, redesign, and consider for re-introduction into more mainstream
retail grocery distribution a new smoothie product at a future date.
SUPPLIERS
The Company purchases the ingredients used in its manufacturing operations,
i.e., casein, vegetable proteins and oils, enzymes and other ingredients, from
several sources, and it believes that all of these ingredients are readily
available from numerous suppliers. Due to more cost effective conditions in
other countries, suppliers from such countries are often able to supply casein
at prices lower than domestic suppliers. Accordingly, the Company currently
purchases its major ingredient, casein, from foreign suppliers. Because casein
purchased by the Company is imported, its availability is subject to a variety
of factors, including federal import regulations. During the fiscal year ended
March 31, 2002, casein prices were significantly higher as a result of "Mad Cow"
and "foot and mouth" disease epidemics in Europe. The Company's increased costs
for casein throughout the fiscal year ended March 31, 2002 had an adverse impact
on the Company's results of operations for such fiscal year. In the fiscal year
ended March 31, 2003, the cost of casein returned to levels comparable to those
prior to the occurrence of the above events. The Company is anticipating
substantial price increases during fiscal 2005 compared fiscal 2004 as further
discussed in Item 7 under "Cost of Goods Sold".
For the fiscal years ended March 31, 2004, 2003 and 2002, the Company purchased
approximately $6,133,967, $7,911,000, $8,975,000, respectively, of casein, the
principal raw material used to manufacture the Company's products. The following
table sets forth the name of each supplier along with the percentage they
supplied of casein which either alone, or together with their affiliates,
provided 5% or more casein to the Company, based on dollar volume purchased.
PERCENT OF CASEIN PURCHASES
FISCAL YEAR ENDED MARCH 31,
TYPE OF RAW MATERIAL NAME OF SUPPLIER 2004 2003 2002
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Casein Lactalis f/n/a Besnier-Scerma U.S.A. 20% 24% 36%
Glanbia f/n/a Avonmore Food Products 29% 36% 18%
Irish Dairy Board 24% 22% 20%
Eurial Poitouraine/Euro Proteins 20% 18% 10%
Kerry Ingredients 7% -- --
JLS Foods International -- -- 7%
TRADEMARKS AND OTHER INTELLECTUAL PROPERTY
The Company owns several registered and unregistered trademarks, which are used
in the marketing and sale of the Company's products. Its material product
trademarks are those mentioned above under Products and Services. The
registrations of these trademarks in the United States and foreign jurisdictions
are effective for varying periods of time, and may be renewed periodically,
provided that the Company, as the registered owner of the trademarks, complies
with all pertinent renewal requirements.
7
Trademarks include registered brand names, logos, symbols, or copyright used to
identify the Company's products or services. As such, this prevents other
manufacturers from using any words or symbols for which the Company holds the
trademark. This is important as it helps provide competitive insulation around
the Company's products in the marketplace and enables consumers to identify with
one particular brand or another. The Company will continue to market its
trademarks in order to increase brand awareness for its products in order to
improve demand and margin.
Although the Company believes that its formulas and processes are proprietary,
the Company has not sought and does not intend to seek patent protection for
such technology. In not seeking patent protection, the Company is instead
relying on the complexity of its technology, on trade secrecy laws, and on
employee confidentiality agreements. The Company believes that its technology
has been independently developed and does not infringe on the patents or trade
secrets of others.
INVENTORY SUPPLY
During the fiscal year ended March 31, 2002, the Company reduced the number of
items it manufactures on a regular basis from 400 to 200. During the fiscal year
ended March 31, 2003, the Company further reduced its core item base to 135
items that are in line with the Company's strategy of higher margin or higher
volume products. As a result of this change in production policy and the desire
to create more inventory turns during the year, the Company reduced its net
inventory levels from $5,748,652 at March 31, 2002 to $5,294,500 at March 31,
2003 and then to $4,632,843 at March 31, 2004. The Company anticipates that
inventory will begin to increase in the future as sales volume and larger
accounts increase.
CUSTOMERS
The Company sells to customers throughout the United States and direct to 16
other countries. Revenues derived from foreign countries were approximately
$2,500,000, $3,800,000 and $1,800,000 with sales to Canada and Puerto Rico
accounting for approximately 75% of these sales for the fiscal years ended March
31, 2004, 2003 and 2002, respectively. Revenues are attributed to individual
countries based on the customer address. The Company has no long-term assets
located outside of the United States.
For the fiscal years ended March 31, 2004, 2003 and 2002, the Company had net
sales of $36,176,961, $40,008,769, and $42,927,104, respectively. The following
table sets forth the name of each customer of the Company, which either alone,
or together with its affiliates, accounted for 5% or more of the Company's gross
sales for the fiscal years ended March 31, 2004, 2003, and 2002:
PERCENTAGE OF SALES
FISCAL YEAR ENDED MARCH 31,
CUSTOMER NAME 2004 2003 2002
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DPI Food Products 8.2% 9.5% 6.1%
Kroger 5.6% 5.8% 5.9%
Publix 6.8% 6.6% 5.0%
United Natural Foods 9.2% 9.9% 5.7%
*Less than 5% of sales for the stated fiscal year.
The majority of the Company's customers are required to make payment on goods
within 30 days of invoicing. The Company's credit department makes calls on
payments that are 10 to 15 days past due and then puts accounts on credit hold
if they have not made arrangements for those payments that are 30 to 45 days
past due. After all efforts have been exhausted to contact the customer and
collect the past due balances, the credit manager will provide authorization to
write off the past due balance. The Company typically averages less than 1% of
gross sales in credits related to bad debt.
The Company provides a guarantee of sale to many of its retail customers in
natural food stores, conventional grocery stores and mass merchandising
industry. If the product is not sold during its shelf life, the Company will
allow a credit for the unsold merchandise. Since the shelf life of the Company's
products range from 6 months to one year, the Company historically averages less
than 2% of gross sales in credits for unsold product.
8
COMPETITION
The food industry is highly competitive, and the Company faces substantial
competition in the manufacturing, marketing and sale of its products. In the
retail cheese market, the Company competes with conventional cheeses, including
"Lite" and "low fat", and low or no cholesterol or lactose products produced by
manufacturers of conventional cheeses. "Lite" cheese generally has lower fat
content than regular cheese but still contains cholesterol and lactose, unlike
the Company's Veggie(TM) and Soyco(R) brand product lines, which are soy
nutritious, contain no cholesterol and are lactose free. In the food service
markets, the Company's substitute and imitation cheese products compete with
other substitute and imitation cheese products, as well as with conventional
cheeses.
The Company believes that its primary competition in its niche market are small
companies such as Tree of Life, White Wave, Tofutti Brands, Inc. ("Tofutti"),
Yves, a subsidiary of Hain Celestial Group, and Melissa's. Tree of Life is a
wholly owned subsidiary of Koninklijke Wessanen, NV, a multinational
manufacturer of dairy, natural and specialty foods and cereals. Like the
Company's products, Tree of Life's Soya Kaas, Yves and Melissa's dairy
alternatives are sold in mainstream supermarkets. White Wave is a private
company that primarily markets soy milk to the retail markets (grocery and
natural foods stores). Tofutti (AMEX:TOF) is a public company that offers a wide
range of soy based products including alternative cheese slices, sour creams,
cream cheese and frozen pizza made with alternative cheeses to the retail
markets (primarily grocery). These parties are considered competitors as they
offer similar product lines in terms of product form, consumer benefits, and are
distributed or positioned in the same retail shelf space as the Company's
products.
The Company also competes with larger national and regional manufacturers of
conventional and imitation cheeses, such as Kraft (which produces products under
the Kraft Free(R) label), Borden's, and ConAgra (which produces products under
the Healthy Choice(R) label). Each of these competitors is well established and
has substantially greater marketing, financial and human resources than the
Company. However, management believes its products are nutritionally superior,
strategically marketed, and positioned to a slightly different consumer base
versus the healthy cheese items offered by larger cheese manufacturers.
The Company believes that it has the most complete line of alternative dairy
products in the industry and that its competitors' current products do not have
all of the same healthy characteristics. Further, the Company's branded products
are fortified and possess soy-based ingredients, reduced, low and no fat, low or
no cholesterol, no saturated fat, no transfat, no lactose, no artificial
colorings or flavorings. The Company further believes that it is superior to the
competition in its niche in the most important competitive factors, which are
taste, nutritional value, product appearance, breadth and depth of product line,
and overall consumer purchase interest.
The Company also believes that its vertically integrated operations provide it
with a cost advantage over its smaller competitors because it has the ability to
maintain quality and efficiency at every level, from purchasing to manufacturing
to shipping to merchandising. Furthermore, the Company believes the breadth and
depth of its product line has made it difficult for its smaller competitors to
have a significant impact on the Company's market share in the alternative
cheese category.
9
GOVERNMENT REGULATION
As a manufacturer of food products for human consumption, the Company is subject
to extensive regulation by federal, state and local governmental authorities
regarding the quality, purity, manufacturing, distribution and labeling of food
products.
The Company's United States product labels are subject to regulation by the
United States Food and Drug Administration ("FDA"). Such regulation includes
standards for product descriptions, nutritional claims, label format, minimum
type sizes, content and location of nutritional information panels, nutritional
comparisons, and ingredient content panels. The Company's labels, ingredients,
and manufacturing techniques and facilities are subject to inspection by the
FDA. Labeling regulations require specific details of ingredients and their
components along with nutritional information on labels and also impose
restrictions on product claims that can be included on labels. The Company
believes the labeling regulations have enhanced the marketability of the
Company's products and has resulted in increased sales of the Company's products
because product labels make it easier for consumers to recognize the nutritional
benefits of the Company's products compared to other products.
The Company's facility and manufacturing processes are subject to inspection by
the Florida Department of Agriculture and Consumer Services. The Company
received its Annual Food Permit from that bureau for 2004.
The Company has a team of individuals from its marketing, quality assurance, and
research and development departments who review all new labels for compliance
with Company standards and current laws and regulations. The Company believes
that it is in material compliance with all applicable governmental regulations
regarding its current products and has obtained the necessary government
permits, licenses, qualifications, and approvals, which are required for its
operations.
ENVIRONMENTAL REGULATION
The Company is required to comply with environmental regulations in connection
with the development of its products and the operation of its business. At the
present time, the Company believes that it is in material compliance with the
federal, state and local environmental laws and regulations applicable to it.
The Company believes that continued compliance with any current or reasonably
foreseeable future environmental laws and regulations will not have a material
adverse effect on the capital expenditures, earnings, financial condition or
competitive position of the Company.
EMPLOYEES
As of June 25, 2004, the Company had a total of 141 full-time employees and 4
temporary employees. All personnel are employed directly by the Company. The
Company is an affirmative action employer providing equal employment opportunity
to all applicants. The Company considers its relations with employees to be
satisfactory. No employee is a member of a trade union.
ITEM 2. PROPERTIES.
The Company occupies two facilities, close in proximity, approximating a total
of 119,000 square feet of industrial property in Orlando, Florida. The Company's
corporate headquarters occupies approximately 55,000 square feet and is
comprised of approximately 8,500 square feet in office space, approximately
31,500 square feet of dock-height, air-conditioned manufacturing space and
coolers of approximately 15,000 square feet, which are situated on 2.4 acres of
a 5.2 acre site in an industrial park. The Company entered into a lease
agreement for the corporate headquarters with Anco Company, a Florida general
partnership, on November 13, 1991. The lease was renewed for a 5-year period in
November 1996 and again in November 2001. The lease expires in November 2006,
unless renewed pursuant to terms mutually agreeable to the Company and the
landlord. The Company has a right of first refusal to purchase or lease the
remaining 2.8 acres upon 20 days notice to the landlord in the event that the
landlord elects to sell or lease such remaining land. The lease is a "triple
net" lease, which means that the Company is responsible for all taxes,
insurance, maintenance and repair of the facilities, in addition to rental
payments. The monthly base rent through the stated expiration of the lease is
$28,173.
10
The Company produces all of its products at its Orlando manufacturing facility.
The Company maintains production equipment for mixing, blending, cooking and
heating ingredients, and for production, shredding, dicing, slicing, chopping,
grating, packaging and labeling of its products. The Company also maintains cold
storage areas for cooling finished products and warehouse areas for storing
supplies and finished goods.
The Company's second facility includes additional office space, shipping and
receiving, warehouse and cooler space totaling approximately 64,000 square feet.
The Company entered into a lease agreement with Cabot Industrial Properties, a
Florida limited partnership, on July 28, 1999 for this second facility. In May
2004, the Company renegotiated and renewed the lease from August 1, 2004 to July
31, 2009. The term of the lease is for five years and provides for escalating
rental payments ranging from $18,225 to $22,942 per month through the end of the
lease period. The lease is a "triple net lease", which means the Company is
responsible for all taxes, insurance, maintenance, and repair of the facility,
in addition to rental payments.
Management believes that the Company's properties are adequately covered by
casualty insurance. The Company believes that its facilities and production
equipment are adequate to meet current requirements and its anticipated growth
through the end of fiscal 2006. The Company further believes that suitable
additional space and equipment will be available as needed to accommodate any
further physical expansion of its operations.
ITEM 3. 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 alleged 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 was seeking a preliminary
and permanent injunction prohibiting the Company from further infringing acts
and was also seeking damages in the nature of either lost profits or reasonable
royalties.
On May 6, 2004, Schreiber Foods and the Company executed a settlement agreement
pursuant to which all claims in the patent infringement lawsuit were dismissed.
Pursuant to this settlement agreement, the Company procured a worldwide, fully
paid-up, nonexclusive license to own and use all of the Company's individually
wrapped slice equipment, which Schreiber alleged infringed on Schreiber's
patents. The Company was not obligated to make any cash payment in connection
with the settlement of the lawsuit or the license granted in the settlement
agreement. The settlement agreement restricts the Company from using the slicing
equipment to co-pack product for certain specified manufacturers, however, the
Company is not currently engaged in any co-packing business with any of the
specified parties, and does not contemplate engaging in the future in any
co-packing business with the specified parties.
11
Pursuant to the settlement agreement, if, during the term of the license, the
Company receives an offer to purchase the Company or its business, the Company
must notify Schreiber of the offer and Schreiber will have the option to match
the offer or make a better offer to purchase the Company or its business.
Acceptance of the Schreiber offer is subject to the approval by the Company's
Board of Directors, however, if the Board of Directors determines that the
Schreiber offer is equal to or better than the other offer, the Board of
Directors must take all permitted actions to accept the offer and recommend it
to the Company's shareholders for approval.
The term of the license extends through the life of all patents named in the
lawsuit (and all related patents) and is assignable by the Company in connection
with the sale of its business. In the event the assignee uses the applicable
equipment to manufacture private label product, and such private label product
accounts for more than 50% of the total product manufactured on the applicable
equipment, the assignee will be required to pay Schreiber a royalty in an amount
to be agreed upon by Schreiber and the assignee, but in any event not more than
$.20 per pound of product for each pound of private label product manufactured
by the assignee in any year that exceeds the amount of private label product
manufactured by the Company in the year preceding the sale of the Company or its
business. In the event that the parties cannot agree upon a royalty rate, the
assignee retains the license rights but private label production must be
maintained at a level less than 50% of the total product manufactured on the
applicable equipment.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
There were no matters submitted to a vote of security holders during the fourth
quarter of the fiscal year ended March 31, 2004.
12
PART II
ITEM 5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES.
Market Information
Since August 1999, the Company's common stock, $.01 par value per share, has
been traded on the American Stock Exchange ("AMEX") under the symbol "GXY".
There is no established public trading market for the Company's Series A
Convertible Preferred Stock, $0.01 par value per share. The following table sets
forth the high and low closing sales prices for each quarter for the Company's
common stock as reported on AMEX during the fiscal years ended March 31, 2004
and 2003:
Period High Closing Sales Price Low Closing Sales Price
- -----------------------------------------------------------------------------------------------------------
2004 Fiscal Year, quarter ended:
June 30, 2003 $2.85 $1.65
September 30, 2003 $3.10 $2.55
December 31, 2003 $4.00 $2.36
March 31, 2004 $3.18 $1.90
2003 Fiscal Year, quarter ended:
June 30, 2002 $5.48 $4.74
September 30, 2002 $4.70 $2.90
December 31, 2002 $2.90 $1.50
March 31, 2003 $2.15 $1.55
Holders
On June 25, 2004, there were 665 shareholders of the Company's common stock of
record and 2 holders of the Company's Series A convertible preferred stock of
record.
Dividends
The Company has not paid any dividends with respect to the Company's common
stock and does not expect to pay dividends on its common stock in the
foreseeable future. It is the present policy of the Company's Board of Directors
to retain future earnings to finance the growth and development of the Company's
business. Any future dividends will be declared at the discretion of the Board
of Directors and will depend upon, among other things, the financial condition,
capital requirements, earnings and liquidity of the Company. The Company's
Restated Certificate of Incorporation provides that before any dividend is
declared or paid, the Company must secure the consent of the holders of at least
60% of the then-outstanding shares of the Series A convertible preferred stock.
Additionally, the Company's credit facilities with Textron Financial Corporation
and SouthTrust Bank require the Company to obtain the approval of such financial
institutions prior to declaring or paying any dividends. See Management's
Discussion and Analysis of Financial Condition and Results of Operations for a
discussion of the Company's current capital position.
Securities Authorized for Issuance under Equity Compensation Plans
Please see the section titled "Equity Compensation Plan Information" in Item 12
in Part III of this Form 10-K.
Recent Sales of Unregistered Securities
There were no sales of unregistered securities in the quarter ended March 31,
2004.
13
ITEM 6. SELECTED FINANCIAL DATA.
FISCAL YEAR ENDED MARCH 31,
2004 2003 2002 2001 2000
Net sales $ 36,176,961 $ 40,008,769 $ 42,927,104 $ 45,085,937 $ 41,911,295
Non-cash compensation (income)/expense (1) 651,273 (2,906,762) 2,373,662 1,116,444 18,583
Income (loss) before taxes (2,962,173) 1,034,128 (15,499,152) (5,939,334) 2,420,560
Income (loss) before cumulative effect of
change in accounting policy (2,962,173) 1,034,128 (17,059,152) (5,699,334) 3,629,891
Net income (loss) available to common
shareholders (4,504,907) (601,077) (19,147,995) (6,485,763) 3,629,891
Net income (loss) per common share before
cumulative effect of change in accounting
policy - basic (0.30) (0.05) (1.81) (0.61) 0.40
Net income (loss) per common share - basic (0.30) (0.05) (1.81) (0.69) 0.40
Net income (loss) per common share before
cumulative effect of change in accounting
policy - diluted (0.30) (0.05) (1.81) (0.61) 0.39
Net income (loss) per common share - diluted (0.30) (0.05) (1.81) (0.69) 0.39
Total assets 29,887,087 33,255,842 36,115,051 48,083,126 36,450,393
Long-term debt 8,446,952 10,170,195 12,511,461 14,720,875 7,261,706
Redeemable Convertible Preferred Stock 2,573,581 2,324,671 2,156,311 -- --
(1) Non-cash compensation is calculated based on fluctuations in the Company's
stock price, which are outside the Company's control and typically do not
reflect the Company's operations. 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. Large swings in the Company's stock
price could result in material changes to the Company's Financial Statements as
demonstrated in prior years. See "Valuation of Non-Cash Compensation" in Item 7
below for further information.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION.
Statements other than historical information contained in this report are
considered forward looking and involve a number of risks and uncertainties.
Factors that could cause such statements not to be accurate include, but are not
limited to, increased competition for the Company's products, improvements in
alternative technologies, a lack of market acceptance for new products
introduced by the Company and the failure of the Company to successfully market
its products.
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 income and expense during the
reporting periods presented. The Company's significant estimates include the
allowance for doubtful accounts receivable, provision for obsolete inventory,
and valuation of deferred taxes and warrants. Although the Company believes that
these estimates are reasonable, actual results could differ from those estimates
given a change in conditions or assumptions that have been consistently applied.
14
The critical accounting policies used by the Company, and the methodology for
estimates and assumptions are as follows:
Valuation of Accounts Receivable and Chargebacks
The Company records revenue upon shipment of products to its customers and
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 Company's accounts receivable
reserve estimate is based on a specific identification and a general reserve
methodology over the remaining items.
Based on the age of the receivable, cash collection history and past dilution in
the receivables, the Company makes an estimate of its anticipated bad debt,
anticipated future authorized deductions due to current period activity and
anticipated collections on non-authorized amounts that customers have currently
deducted on past invoices. Based on this analysis, the Company reserved $633,000
and $633,221 for known and anticipated future credits and doubtful accounts at
March 31, 2004 and 2003, respectively. We believe that this estimate is
reasonable, but there can be no assurance that the Company's estimate will not
change given a change in economic conditions or business conditions within the
food industry or the Company.
Inventory
Inventories are valued at the lower of cost or market. Cost is determined using
a weighted average, first-in, first out method. The Company reviews its
inventory valuation each month and writes down the inventory for potential
obsolete and damaged inventory. In addition, the finished goods inventory value
is reduced to market value when the known sales price is less than the cost of
the inventory.
Deferred Taxes
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.
Valuation of Non-Cash 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", furnishes the pro forma disclosures required
under Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting
for Stock-Based Compensation", and applies SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure" on a prospective basis for
options granted after March 31, 2003.
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. 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.
15
Several management estimates are needed to compute the fair value of the options
including anticipated life of the options, risk free interest rates, and
volatility of the Company's stock price. Currently, the Company estimates the
life of all options granted assuming that the option will remain outstanding and
not be exercised until the end of its term. This results in the highest possible
value of the option. If the Company were to change its estimate of the option
lives to something less than the maximum term, then the fair value expense per
share would decrease by approximately $.01 to $.02 per month. If the Company
changes its estimate of the volatility percentage, the fair value expense per
share would change by approximately $.02 per percentage change in the
volatility. If the Company changes its estimate of the interest rate, the fair
value expense per share would change by approximately $.04 per percentage change
in the interest rate.
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
the grant date by using a Black-Scholes option-pricing model. The following
assumptions were used for options issued during the periods:
Year Ended March 31, 2004 March 31, 2003 March 31, 2002
- ---------- -------------- -------------- --------------
Dividend Yield None None None
Volatility 41% to 45% 37% to 44% 38%
Risk Free Interest Rate 2.01% to 4.28% 1.71% to 5.03% 4.75%
Expected Lives in Months 36 to 120 60 to 120 120
In addition to non-cash compensation expense related to new option issuances,
the Company also records non-cash compensation expense or income in accordance
with the Financial Accounting Standards Board Interpretation No. 44 ("FIN 44").
FIN 44 states that when an option is repriced or there is an outstanding loan
related to the exercise of an option, 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 option 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. Each period the Company records
non-cash compensation expense or income related to its analysis on approximately
6.8 million option shares. Assuming that the stock price exceeds the Floor on
all the variable option shares, a $0.01 increase or decrease in the Company's
common stock price results in an expense or income, respectively, of $68,000.
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.
NEW ACCOUNTING PRONOUNCEMENTS
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. On November 7, 2003, the FASB deferred the
classification and measurement provisions of SFAS No. 150 as they apply to
certain mandatorily redeemable non-controlling interests. This deferral is
expected to remain in effect while these provisions are further evaluated by the
FASB. The application of the requirements of SFAS 150 did not have any impact on
the Company's financial position or result of operations as the Company's Series
A convertible preferred stock is not mandatorily redeemable.
16
In December 2003, the FASB issued a revised FASB Interpretation No. 46,
"Consolidation of Variable Interest Entities"(FIN 46R), which clarifies how a
business enterprise should evaluate whether it has a controlling interest in an
entity through means other than voting rights and accordingly should consolidate
the entity. FIN46R replaces FASB Interpretation No. 46, "Consolidation of
Variable Interest Entities" which was issued in January 2003. The application of
the requirements of FIN 46R did not have any impact on the Company's financial
position or result of operations as the Company does not have any variable
interests in variable interest entities.
MATERIAL FUTURE EVENTS
On April 6, 2005, the Series A Preferred Holders have the right to require the
Company to redeem the outstanding shares of Series A convertible preferred
stock. The redemption price is payable 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 aggregate market price on the date of
redemption of the common stock that would be then issuable upon conversion of
the Series A convertible preferred stock. 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.
As of June 25, 2004, there are 41,994 shares of Series A convertible preferred
stock outstanding. Assuming that no further conversions were made and the
conversion price remained at $1.75, the redemption price of the outstanding
Series A convertible preferred stock would be the greater of (a) $2,711,116
(100% of the preference amount plus accrued dividends through April 6, 2005 -
$64.56 per share) or (b) the value of 1,549,209 shares of common stock
multiplied by the market price on the date of redemption (currently estimated at
$3,364,882 using the average of the closing market price of the Company's common
stock from June 21, 2004 - June 25, 2004).
The Company is considering a number of alternatives related to the redemption of
the Series A convertible preferred stock which, individually or in combination,
could resolve the Series A redemption obligations. These alternatives include
procuring the necessary funds from operating activities and existing credit
facilities, or from additional equity financing, or identifying one or more
investors to buy out the Series A Preferred Holders directly and, in connection
therewith, extending the date by which the Series A convertible preferred stock
must be redeemed, or negotiating an extension of such date with the current
Series A Preferred Holders. However, there are no assurances that any of such
alternatives will be viable or available to the Company on terms that are
acceptable to the Company, or that, even if viable, that the Company will be
successful in implementing any of such alternatives. If the Company is required
to redeem the outstanding Series A convertible preferred stock and does not have
the funds to do so, the Company will be in default of its obligations and the
Series A Preferred Holders will be entitled to pursue their remedies against the
Company. In addition, any unpaid redemption amount owed to the Series A
Preferred Holders shall bear interest at the rate of 3% per month until paid in
full.
A default by the Company in its obligations to redeem the Series A convertible
preferred stock will also result in a default by the Company under the Textron
Loan, which, in turn, will result in a default by the Company under the
SouthTrust Loan. In the cases of the Textron Loan and the SouthTrust Loan, the
lenders thereunder could exercise their respective rights under their loan
documents to, among other things, declare a default under the loans, accelerate
the outstanding indebtedness such that it would become immediately due and
payable, and pursue foreclosure of the Company's assets which are pledged as
collateral for such loans. In such event, it is unlikely that the Company would
be able to continue as a going concern.
17
BUSINESS ENVIRONMENT
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 dairy alternative products made with
soy. For the year ended March 31, 2004 ("fiscal 2004"), 71% of the Company's
sales were derived from sales of sliced cheese products. However, due to the
change in consumers' eating habits toward low-carbohydrate meal preparation, the
Company is in the process of diversifying, strengthening and balancing the
Company's product segmentation between various forms of cheese such as slices,
shreds, and chunks, and in its other non-cheese related products. This
diversification will help the Company extend consumer usage occasions beyond
lunchtime cheese slices for sandwich usage. For example, the Company may add new
products that appeal to younger consumers and have portable functionality (that
is, "on-the-go" users).
Management focuses on several items in order to measure the Company's
performance. In the short term (1 to 3 years), management is working towards
obtaining positive trends in the following areas:
o Operating cash flow
o Gross margin in dollars and % of gross sales
o Operating income excluding certain employment contract expenses and
non-cash compensation related to options and warrants
o EBITDA excluding certain employment contract expenses and non-cash
compensation related to options and warrants
o Liquidity
o Key financial ratios (AR/AP/Inventory turnover)
o Net sales trends (as it relates to consumer demand)
In the long term (over 3 years), management is striving to generate consistent
and predictable net sales growth while incrementally enhancing net cash flow
from operations.
The principal raw material used by the Company is casein, which accounts for
approximately 41% of the Company's raw material purchases. As casein is a
significant component of the Company's product formulation, the Company is
vulnerable to changes in casein pricing over time, which, at times has been
volatile. Management will pursue new business models that create less of a
dependency on casein and trying to incorporate alternative sources of protein
that maintain the integrity of the Company's product benefits, as well as the
cost base of producing the Company's products.
Management believes that since the Company has procured a reasonable level of
funding and has the working capital and production capacity required to meet
consumer demand, it will be able to maintain and improve upon the operating cash
flow performance demonstrated in the results during fiscal 2004. To accelerate
top line growth and better utilize existing assets, the Company is again
pursuing strategic co-pack, private label, and imitation cheese sales in
addition to our branded sales focus. Although the Company's expansion of its
private label and imitation business may result in a decrease in the Company's
overall gross margin percentage, it should contribute incremental gross margin
dollars through increased net sales. Management will balance the additional
private label and imitation business growth by reinvesting the gross margin
obtained from these sales into further developing its core brands. Management
plans to build the business by leveraging a "superior" premium brand approach
that begins with superior product quality over most of the direct alternative
cheese competition. Improved quality versus conventional cheese competition
leads to better than expected consumer experiences and thus better market share.
This market share leads to an ability to charge premium prices for the Company's
branded products and thus deliver enhanced margins. The enhanced margins will be
reinvested into the core brands and new products to produce additional earnings.
18
RESULTS OF OPERATIONS
As a result of the large cash outlays related to a large plant expansion, delays
in new product shipment, and a sales mix skewed toward lower margin imitation
and private label items in the fiscal year ended March 31, 2001 ("fiscal 2001"),
the Company experienced shortfalls in cash that affected nearly every aspect of
its operations in the fiscal year ended March 31, 2002 ("fiscal 2002"). This
cash constraint on purchasing ingredients forced the Company to eliminate
significant amounts of business at the key account level in order to achieve
sustainable and adequate case fill and order fill levels. During the year ended
March 31, 2003 ("fiscal 2003"), the Company achieved positive cash flow levels
through efficiencies in production, purchase discounts, realignment of the sales
mix toward branded items, reduction in overall number of items being sold and
inventoried, improved customer fulfillment levels, new terms of sale, new
customer invoice promotion settlement processes, new trade spending strategies
and additional cost reductions through rigorous management. During fiscal 2004,
the Company refinanced or paid in full all of its credit facilities, which
improved the Company's financial position and reduced interest expense over $1.6
million during fiscal 2004. All excess cash has been used for working capital
purposes to improve the Company's operations and financial position.
FISCAL 2004 AS COMPARED TO FISCAL 2003
NET SALES were $36,176,961 and $40,008,769 during fiscal 2004 and fiscal 2003,
respectively, a decrease of approximately $3.8 million or 9.6%.
The Company's management has identified several market factors that it believes
have had a negative affect on the Company's business. First, consumers' eating
habits are changing with the publicly recognized trend toward low-carbohydrate
meal preparation during all meals (breakfast, lunch, snack, and dinner). This
has led to decreased consumption of items such as bread and the Company's
primary complementary product of cheese slices. Second, the number of consumers
shopping in the retail grocery and natural food stores is down versus the prior
year due to the further national emergence and presence of Wal*Mart superstores
and other similar superstores which include extensive grocery operations. The
Company's product selection is growing but is still limited at Wal*Mart.
Therefore, the Company's sales growth with this account has not been able to
fully counter the decline in retail grocery trends. In response to this change
in consumer shopping, the Company is redesigning its products and packaging
formats to specifically target growth opportunities in the superstore, warehouse
club and mass merchandiser markets (such as Wal*Mart, Costco, Kmart, Target, and
Sam's Club). Third, the Veggie(TM) brand sales were down due to the Southern
California retail grocery labor strike that occurred during fiscal 2004, but has
since been resolved.
Management uses several internal and external reports to monitor sales by brand,
segment, form and channel of sale to determine the outside factors affecting the
sales levels. These reports provide management information on which brand,
segments, forms and/or channel sales are increasing or decreasing both in units
sold and price per unit. By reviewing these reports along with industry data
from publications, syndicated retail consumption reports, and conversations with
major retailers, other manufacturers in the food and beverage industry, and
ingredient and service suppliers, management makes decisions on which brands to
promote and analyzes trends in the consumer marketplace.
19
Through March 28, 2004, IRI (Information Resources Incorporated) scanner data,
which measures retail grocery consumption, indicates that many of the major
competitors in the conventional cheese slice, private label cheese slice and
imitation cheese slice cheese segments have all experienced declining
consumption versus the same period a year ago in terms of dollar sales. The
range in declines is from 1% to 17% depending on the brand and consumer support
(that is, advertising, promotion, and brand building efforts). Consumption in
dollars of Veggie slices, the Company's major product line, was down
approximately 10% in fiscal 2004 compared to fiscal 2003. Alternatively, Veggie
consumption in dollars increased approximately 2% in shred form and 5% in chunk
form during fiscal 2004 compared fiscal 2003. Management believes this data
demonstrates that pressure on Veggie slice consumption is a function of usage
occasion and not a result of overall consumer dissatisfaction with the Company's
brand.
Additionally, management regularly reviews statistics such as case fill rates
and order fill rates. These rates show of every case/item ordered, what
percentage was shipped complete and of every order placed, what percentage was
shipped 100% complete, respectively. The case fill rate was 99.9% and 97.2% in
fiscal 2004 and fiscal 2003, respectively, and the order fill rate was 98.7% and
74.1%, respectively. The high levels of completion on the fill rates indicate
that the reduction in sales is a function of external consumer demand and
behavior versus internal operational constraints.
Certain key initiatives and tactical actions implemented by the Company's
management during the year have helped counter some of the market factors (noted
above), which negatively impacted the business. Such key initiatives and
tactical actions include but are not limited to:
1) Created and communicated a new more meaningful brand position for
the Company's flagship Veggie(TM) Brand and new products. The recent
focus is to highlight the good levels of carbohydrates and protein
in the Company's products and to target a broader universe of
consumers. The Company is attempting to attract incremental users by
convincing prior users and light users of conventional cheese that
the Veggie(TM) brand items can satisfy their needs with great
tasting nutrition. This is a departure from the Company's past
product positioning where physiological and medical requirements
were a key driver in why consumers should buy the "healthy
alternatives."
2) Added approximately 15,000 points of new distribution with a focus
on slices, shreds, and chunk cheese. During fiscal 2004, it has
proved much more difficult than expected to gain points of
distribution on the three core items noted above; however, the
Company achieved much greater success on new product distribution
through crumbles and string cheese. It should be noted that,
typically, crumbles and string cheese velocity (sales per point of
distribution) is significantly lower than that of the slices,
shreds, and chunks, and therefore the Company's new points of
distribution were not as productive overall as was anticipated by
the Company under its original plan.
3) Created and tested regionally a consumer driven marketing campaign
that provided valuable insights into sales growth opportunities
relative to its overall marketing strategy (trade/retailer
incentives versus consumer advertising/promotion) going forward.
These insights led to better consumer marketing, which helped stem
consumer sales decline in the regions where testing was performed.
4) Improved gross margin through purchase savings, product mix, and
efficiencies in price related promotions.
5) Improved product quality in terms of taste, color, aroma, and
texture on the Company's Veggie(TM)and Rice slices product line.
The Company anticipates that the annual net sales for fiscal 2005 will increase
compared to annual net sales for fiscal 2004 based on its plan to take on
additional private label and imitation business, while simultaneously initiating
marketing programs for the core brands.
In order to positively impact sales volume throughout fiscal 2005, the Company
is focusing on three primary areas:
o The Company is shifting the emphasis and resource allocation of its
marketing strategy from vendor promotions (retailer
publications/flyers featuring price reductions and on-shelf
temporary price reductions) to increase sales through consumer
advertising (magazine, radio, event sponsorship, etc.) and consumer
promotions (for example, on-pack "cents off" coupons, "cents off"
coupons delivered via newspapers, in-store product sampling, product
benefit communication at the point of purchase/shelf) while
highlighting and communicating the benefits of the Company's
products to meet the consumer demand for low carbohydrate and high
protein products. This is a significant strategy shift and is based
upon retail consumption data purchased from IRI (Information
Resources Incorporated) that indicates increased sales potential
from consumer focused marketing efforts versus similar dollars being
spent toward price related vendor advertising and promotions.
20
o The Company will also focus its efforts toward generating consumer
awareness, conducting product trials, and generating more repeat
purchases for its brands.
o Due to the completion of the financial restructuring in the first
quarter of fiscal 2004, the Company has begun to pursue certain
private label opportunities, which it previously turned away or did
not pursue earlier due to cash constraints. This will enable the
Company to better utilize some of its excess production capacity.
These efforts should result in greater operating cash flow and a
higher return on invested capital in future periods. As the Company
adds certain private label business to its product mix, the
Company's gross margin percentage may decrease. However, the overall
gross margin dollars should increase due to higher net sales volume.
The Company does not believe that inflation or changing prices had a significant
impact on its results of operations for the periods presented.
COST OF GOODS SOLD ("COGS") was $24,864,289 (69% of net sales) and $28,080,188
(70% of net sales) during fiscal 2004 and fiscal 2003, respectively, a decrease
of approximately $3.2 million or 11.5%. Approximately $1.8 million of the
decrease is the result of lower variable expenses such as direct materials,
direct labor and direct overhead required as a function the decrease in sales as
discussed above. Approximately $1 million is the result of lower raw material
costs due to a change in product mix and lower prices in the Company's key
ingredients. The Company saw an 8% decrease in the price of casein, the
Company's primary ingredient in a majority of its products, in fiscal 2004
compared to fiscal 2003, resulting in a savings in excess of $500,000. Based on
current pricing trends with its suppliers, management expects to see substantial
increases in its casein prices in the first half of fiscal 2005. A 5% increase
in casein prices would result in an annual cost increase of approximately
$307,000 assuming the same amount of pounds purchased as in fiscal 2004.
Management is striving to offset these cost increases with efficiencies in
production and cost savings in the purchase of other raw materials, along with
substituting additional sources of protein into its products. Additionally,
management plans to pass some of the cost increases down to the consumer through
increases in the sales price of certain products. Management monitors its costs
and production efficiencies through various ratios including pounds produced per
hour and cost per pound sold and uses these ratios to make decisions in
purchasing, production and setting sales prices. Due to certain production
efficiencies gained during fiscal 2004, the Company reduced direct labor costs
by nearly $300,000.
SELLING EXPENSE was $4,981,996 (14% of net sales) and $4,958,272 (12% of net
sales) during fiscal 2004 and fiscal 2003, respectively, an increase of $23,724
or 0.5%. The Company recorded an increase of approximately $414,000 in
advertising costs. These costs were limited in fiscal 2003 due to the prior
financial constraints of the Company, but increased in fiscal 2004 with renewed
emphasis on print, radio and television advertisement. The Company noted a
decrease of approximately $298,000 in brokerage costs and $117,000 in
promotional costs, which correspond to the decrease in sales in fiscal 2004. The
Company expects that selling expenses should increase in fiscal 2005 as a
function of the anticipated increase in net sales.
DELIVERY expense was $1,877,682 (5% of net sales) and $2,008,638 (5% of net
sales) during fiscal 2004 and fiscal 2003, respectively, a decrease of $130,956
or 6.5%. Since delivery expense is primarily a function of sales, nearly all of
the decrease is a result of the decrease in sales as discussed above.
Historically, delivery expenses approximate 5% of net sales each period. Unless
offset by price savings from shipping larger loads, the Company anticipates that
delivery costs will increase as a percentage of sales in the future periods due
to higher fuel prices and rate changes in anticipation of the new laws regarding
limitation of driver hours. The Company anticipates an increase from the current
5% to 6% of net sales.
21
NON-CASH COMPENSATION RELATED TO OPTIONS AND WARRANTS
YEARS ENDED MARCH 31,
2004 2003
------------- --------------
Notes Receivable for Common Stock $ -- $ (3,060,000)
Option and Warrant Repricing 8,001 --
Option and Warrant Issuances 643,272 153,238
------------- --------------
Total Non-Cash Compensation (Income)/Expense $ 651,273 $ (2,906,762)
============= ==============
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 the
Company's founder, Angelo S. Morini, are treated as variable due to the
nature of the note being non-interest bearing and non-recourse. The Floor
for the underlying shares is $4.38 per share. There was no non-cash
compensation expense or income related to these shares recorded during
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 $3,060,000 for fiscal 2003 based on the decrease in
the market price of the Company's common stock from $5.43 at March 31,
2002 to $1.87 at March 31, 2003. The Company did not record any further
non-cash compensation income once the stock price fell below the Floor of
$4.38. 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. If the Company's stock price is above the Floor of
$4.38, a $0.01 increase or decrease in the Company's common stock price
results in an expense or income, respectively, of $29,143.
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 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 (as
discussed under Notes Receivable for Common Stock above) 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 founder, Angelo S. Morini, 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 in accordance with variable accounting
standards each period.
22
The Company recorded non-cash compensation expense of $8,001 related to
these variable options and warrants for the year ended March 31, 2004.
There was no compensation expense recorded for the year ended March 31,
2003, as the market price of the Company's stock was less than the $2.05
Floor. The remaining outstanding variable options and warrants as of March
31, 2004 were 3,882,092. Assuming no further options or warrants are
exercised or cancelled and all are vested and the Company's stock price is
above the lowest Floor of $2.05, a $0.01 increase or decrease in the
Company's common stock price results in an expense or income,
respectively, up to $38,821.
c. Option and Warrant Issuances
During fiscal 2004, 2003, and 2002, the Company recorded $643,272,
$153,238, and $413,662, respectively, as non-cash compensation expense
related to stock, options and warrants that were issued to and vested by
employees, officers, directors and consultants. This expense is included
in non-cash compensation in the Company's Statements of Operations.
EMPLOYMENT CONTRACT EXPENSE - In October 2003, the Company and Angelo S. Morini
created a Second Amended and Restated Employment Agreement, which agreement is
described under Item 11 of Part III, "Executive Compensation". The Company
accrued and expensed the five-year cost of this agreement in the quarter ended
December 31, 2003. The total estimated costs expensed under this agreement are
$1,830,329 of which $170,882 was paid during fiscal 2004 and $1,659,447 remained
unpaid but accrued ($366,305 as short-term accrued liabilities and $1,293,142 as
long-term liabilities) as of March 31, 2004. The long-term portion will be paid
out in nearly equal monthly installments ending in October 2008.
GENERAL AND ADMINISTRATIVE expenses were $3,303,030 and $3,570,889 during fiscal
2004 and fiscal 2003, respectively, a decrease of $267,859 or 7.5%. During
fiscal 2004, there was an increase of approximately $132,000 in legal fees due
to the Schreiber lawsuit, refinancing activities and additional reporting
requirements during the fiscal 2004. Additionally, the Company had an increase
of approximately $183,000 in director and related insurance expenses due to the
expanded Board of Directors and their activity in the fiscal 2004. These
increases were offset by decreases of approximately $115,000 in consulting fees,
$106,000 in personnel costs, $67,000 in bad debt write-offs, $50,000 in bank
charges, $44,000 in audit fees, and general allocation costs such as rent,
depreciation and telephone charges of approximately $200,000. Management is
anticipating further declines in general and administrative expenses in fiscal
2005 due to continued reductions in general overhead costs for rent and
depreciation along with a decrease in personnel expenses based on the amended
employment agreement with Angelo S. Morini as described above. Additionally,
management believes that legal fees should decrease significantly now that the
Schreiber lawsuit has been fully resolved.
RESEARCH AND DEVELOPMENT expenses were $260,410 and $232,552 during fiscal 2004
and fiscal 2003, respectively, an increase of $27,858 or 12.0%. These increases
are primarily the result of an increase in quality control testing as required
by the Company and its customers in addition to salary and benefit cost
increases. The Company anticipates minimal increases to research and development
in future periods mainly related to increasing personnel costs.
INTEREST EXPENSE was $1,361,606 and $2,923,215 during fiscal 2004 and fiscal
2003, respectively, a decrease of $1,561,609 or 53.4%. During fiscal 2003, the
Company amortized to interest expense $614,230 related to debt discounts on its
prior mezzanine loan from FINOVA Mezzanine Capital, Inc. ("FINOVA Mezzanine").
This non-cash amortization ended in September 2002 and did not occur during
fiscal 2004. The Company also noted a decrease in loan costs of approximately
$413,722 in fiscal 2004 due to the lower fees charged under the Textron credit
facility compared to the FINOVA credit facility. The remaining decrease in
interest expense was the result of lower debt balances, and lower interest rates
on the outstanding debt balances partly due to a reduction in the average prime
rate during fiscal 2004 compared to fiscal 2003. See "Debt Financing" below for
further detail on the Company's outstanding debts and interest rates thereon.
23
FISCAL 2003 AS COMPARED TO FISCAL 2002
SALES for fiscal 2003 decreased by 7% from fiscal 2002, reflecting the reduction
of lower margin business during fiscal 2003. Sales in the fourth quarter of
fiscal 2003 were $10,213,005 reflecting a 3% increase over fourth quarter sales
in fiscal 2002 and a 5% increase from the sales in the third quarter of fiscal
2003. While the Company has experienced positive cash flows in fiscal 2003, it
has used this cash to improve the balance sheet by paying down debt and payables
rather than increasing inventory for sale. As a result of the constraints put on
ingredient, packaging and finished goods availability, the Company made a
strategic decision to downsize sales volume in an effort to increase its
margins. The product mix shift to focus on higher-margin brand name products
under the Veggie(TM) and Soyco(R) brands, required the Company to turn away
certain private label and other lower margin, non-branded business. While both
the customer and consumer demand (as measured by IRI Scan Data for Grocery
stores and SPINS Scan Data for Natural Food stores) for the Company's products
and private label business remained strong, sales growth was maintained at lower
levels so that the Company could improve margins on its core items and grow
profitably. The Company does not believe that inflation or changing prices had a
significant impact on its results of operations for the periods presented.
COST OF GOODS SOLD ("COGS") was $28,080,188 representing 70% of net sales for
fiscal 2003, compared with $35,276,362 or 82% of net sales for fiscal 2002.
There was an overall decrease in costs of $7,196,174 in fiscal 2003 compared to
fiscal 2002. This decrease in cost is primarily the result of several factors,
including: (a) a 7% decrease in raw materials required for operations from the
previous fiscal year (a decrease of $3 million) due to the 7% decrease in sales
described above; (b) the completed installation of the new equipment which
resulted in a substantial decrease in the number of production personnel late in
fiscal 2002 and caused labor-related expenses to decrease by approximately
$900,000 in fiscal 2003 as compared to fiscal 2002; (c) the non-recurrence of a
$600,000 inventory write-off which occurred in fiscal 2002 due to the Company's
decision to decrease its product mix to 200 core items that constituted nearly
98% of sales; and (d) a decrease in raw material costs due to improved vendor
relations, lower raw material costs and purchase discounts.
By fiscal 2003, the equipment was fully operational, the labor crews were
trained, ingredient and packaging supply was consistent, and fewer number of
core items were being produced, based on specific sales forecasting. Therefore,
the Company experienced longer production runs, and improved run rates with
more, high-quality product produced per hour. This resulted in the Company's
gross margin increasing from 18% in fiscal 2002 to 30% in fiscal 2003.
SELLING expenses decreased by $3,615,685 (42%) for fiscal 2003 compared to
fiscal 2002. The Company decreased advertising and promotional expenses by
approximately $155,000 and $2,101,000, respectively, in fiscal 2003 as compared
to fiscal 2002. In fiscal 2002, more effort was directed to provide incentives
to our direct customers for brand item purchases, in addition to discounts
offered to maintain current relationships with brokers and customers. The
Company also experienced a decrease of approximately $933,000 in brokerage and
salary costs directly attributable to deployment of more focused, productive key
account selling strategies and tactics and to the reduction in sales. The
remainder of the decrease was caused by improved administrative efficiencies and
a reduction in travel expenses.
DELIVERY expenses decreased 19% during fiscal 2003 compared to fiscal 2002. The
decrease in delivery costs is due as result of the decrease in net sales and due
to a diversification in shipping carriers resulting in lower prices per
shipment.
24
NON-CASH COMPENSATION RELATED TO OPTIONS AND WARRANTS
YEARS ENDED MARCH 31,
2003 2002
---------------- ---------------
Notes Receivable for Common Stock $ (3,060,000) $ 1,960,000
Option and Warrant Issuances 153,238 413,662
---------------- ---------------
Total Non-Cash Compensation (Income)/Expense $ (2,906,762) $ 2,373,662
================ ===============
Non-cash compensation related to options and warrants showed income of
$2,906,762 and an expense of $2,373,662 for fiscal 2003 and 2002, respectively.
The Financial Accounting Standards Board issued Interpretation No. 44 ("FIN
44"), which clarifies the application of APB Opinion 25 relating to the
accounting consequences of various modifications to fixed stock options. FIN 44
states that when an option is repriced, it is treated as a variable option and
is marked to market each quarter. 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 benefit. Compensation benefit is limited to the original base
exercise price of the options. During fiscal 2003, the market price of the
Company's common stock decreased from $5.43 at March 31, 2002 to $1.87 at March
31, 2003. In accordance with FIN 44, the underlying shares related to the
$12,772,200 note receivable from Angelo S. Morini, the Company's Founder, are
treated as variable due to the nature of the note being non-interest bearing and
non-recourse. Therefore, the Company recorded a $3,060,000 decrease in the
non-cash compensation based on the change in the market price of the Company's
common stock from $5.43 to the floor of $4.38 (the average base exercise price
of the shares). The Company also recorded a $153,238 expense related to the fair
value of warrants issued for consulting services.
On October 11, 2002 through unanimous consent of the Board of Directors, the
Company repriced all outstanding options granted to employees prior to this date
(4,284,108 shares at former prices ranging from $2.84 to $10.28) to the market
price of $2.05 per share. In addition, the Company repriced the outstanding
warrants held by current consultants prior to this date (291,429 shares at
former prices ranging from $3.31 to $5.50) to the market price of $2.05 per
share. This stock option repricing resulted in variable accounting treatment for
these stock options beginning with the quarter ended December 31, 2002 until the
related options have been cancelled, expired or exercised. On December 4, 2002,
as a result of discussions and negotiations with certain major shareholders, the
Company's Founder 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 any new
options issued to the Company's Founder prior to June 4, 2003 in accordance with
variable accounting standards each quarter.
The remaining variable options and warrants as of March 31, 2003 were 3,612,770
of which none were vested and "in-the-money" based on the Company's closing
stock price of $1.87 on March 31, 2003. Therefore, there is no non-cash
compensation expense recorded in fiscal 2003 related to these variable options
and warrants.
GENERAL AND ADMINISTRATIVE expenses decreased $1,777,624 (33%) during fiscal
2003, as compared to fiscal 2002. The decrease was due to a $798,000 decrease in
bad debt expense and a $162,000 decrease in personnel costs along with a general
reduction in standard administrative expenses due to cost cutting measures
implemented at the end of fiscal 2002. Additionally, fiscal 2002 expenses were
higher than fiscal 2003 due to $547,000 in unused advertising trade credits that
the Company wrote off in the fourth quarter of fiscal 2002.
25
RESEARCH AND DEVELOPMENT expenses decreased 11% during fiscal 2003 compared to
fiscal 2002. The decrease resulted primarily from a reduction in personnel costs
during fiscal 2003.
INTEREST EXPENSE decreased $670,876 (19%) from $3,594,091 in fiscal 2002 to
$2,923,215 in fiscal 2003. On September 30, 1999, the Company entered into a
$4,000,000 subordinated note payable with FINOVA Mezzanine. During fiscal 2003,
this debt bore interest at a rate of 15.5% and included an original issuance
discount of $786,900, which was amortized as interest expense over the term of
the debt until September 30, 2002. In connection with FINOVA Mezzanine's warrant
exercise and transfer of 815,000 shares of the Company's common stock, the
Company agreed to guarantee the price at which the shares were sold to the
public at $4.41 per share. The actual price received by FINOVA Mezzanine was
$3.25 per share and the difference of $945,400 was recorded as a debt discount
and was amortized over the term until September 30, 2002. During the year ended
March 31, 2003, interest expense decreased $205,000 because the above debt
discounts were fully amortized. Additionally, interest expense decreased
approximately $520,000 as a result of lower debt balances during fiscal 2003
compared to fiscal 2002. Loan fees amortized to interest expense increased
approximately $54,000 during the year ended March 31, 2003 due to additional
loan costs and the shortened loan periods. See "Debt Financing" below for
further detail on the Company's outstanding debts and interest rates thereon.
INCOME TAX EXPENSE for the year ended March 31, 2002 was $1,560,000 compared to
zero income tax for fiscal 2003. At March 31, 2001, the Company had recorded a
deferred tax asset of $1,560,000, derived mainly from tax net operating losses
incurred in prior years, which was expected to be realized in the future. This
asset was written off during the fiscal year 2002 due to the uncertainty of the
Company's ability to take advantage of the net operating loss carryforwards
before they expire. As of March 31, 2003, the Company has approximately $36
million of net operating loss carryforwards that it may be able to use to offset
future taxable income.
LIQUIDITY AND CAPITAL RESOURCES
YEARS ENDED MARCH 31,
---------------------------------------------------------------------
2004 2003 CHANGE %
---------------------------------------------------------------------
CASH PROVIDED BY OPERATING 2,236,350 1,175,875 1,060,475 90.2%
ACTIVITIES
-------------------------------------------------------
CASH USED IN INVESTING ACTIVITIES (231,778) (100,026) (131,752) (131.7%)
=======================================================
CASH USED IN FINANCING
ACTIVITIES (1,556,491) (1,074,419) (482,072) (44.9%)
=======================================================
26
OPERATING ACTIVITIES - During fiscal 2004, the Company received cash from
operating activities of $2,236,350, which is an increase in cash of $1,060,475
over the previous fiscal year. The increase in cash from operations is primarily
attributable to continued reductions in accounts receivable and inventory levels
in fiscal 2004 compared to fiscal 2003. Management is continually reviewing its
collection practices and inventory levels to maximize its cash flow from
operations. The Company expects to maintain positive cash flows from operations
during fiscal 2005.
INVESTING ACTIVITIES - Net cash used in investing activities totaled $231,778
for in fiscal 2004 compared to $100,026 in fiscal 2003. The Company used cash of
$221,585 and $214,003 to purchase equipment in fiscal 2004 and 2003,
respectively. Additionally, the Company received $113,977 in cash due to a
decrease in its deposits and other assets during fiscal 2003. The Company does
not anticipate any large capital expenditures during fiscal 2005 that would
exceed the levels shown in fiscal 2004.
FINANCING ACTIVITIES - Net cash flows used in financing activities were
$1,556,491 and $1,074,419 for fiscal 2004 and 2003. During the first quarter of
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 used to further
reduce the Company's book overdrafts, accounts payable and debt balances.
Additionally, the Company obtained from Textron Financial Corporation a
revolving credit facility that 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 further described below.
27
During the first quarter of fiscal 2003, the Company received loan proceeds from
Excalibur Limited Partnership in the amount of $500,000 in cash. The proceeds of
which were used to pay down a portion of the Company's outstanding debt under
its term loan from SouthTrust Bank. In addition, the Company raised $1,500,000
through the issuance of common stock to Stonestreet Limited Partnership (as
further discussed below). These proceeds were used to pay off its term loan from
Excalibur Limited Partnership and for working capital purposes. The Company used
its cash from operating activities to reduce the balance of the Company's
outstanding debt under its line of credit from FINOVA Capital and to pay down
its term debt with SouthTrust Bank.
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 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. 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) eighty-five percent (85%) of the net amount of its
eligible accounts receivable plus (ii) 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
(5.75% at March 31, 2004) 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. As of March 31, 2004, the outstanding principal balance on
the Textron Loan was $4,605,277.
28
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.
Due to the $1.8 million charge to operations related to the Amended and Restated
Employment Agreement for Angelo Morini, the Company fell below the requirement
for the adjusted tangible net worth and the fixed charge coverage ratio
covenants for the quarter ended December 31, 2003. Pursuant to a Second
Amendment to the Loan Agreement dated June 25, 2004, which is effective as of
December 31, 2003, Textron changed the definitions on the covenants to exclude
accrued but unpaid costs related to the above mentioned Employment Agreement.
Based on the revised definitions, the Company was in compliance with all
covenants under the Loan Agreement for the quarter ended December 31, 2003 and
the year ended March 31, 2004. The Company anticipates that it will be in
compliance with these ratios, as amended, through the remainder of the loan
period.
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 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 dated 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 March 31, 2004), 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 May 2004 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, 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 March 31, 2004 was $9,381,985.
The SouthTrust term loan described above contains certain financial and
operating covenants. Due to the $1.8 million charge to operations related to the
Amended and Restated Employment Agreement for Angelo Morini, the Company fell
below the requirement for the tangible net worth covenant for the quarter ended
December 31, 2003. Pursuant to a Loan Modification letter dated May 21, 2004,
SouthTrust changed the definitions in its loan covenants to exclude accrued but
unpaid costs related to the above mentioned Employment Agreement. Additionally,
SouthTrust waived the Company's need to comply with the Maximum Funded Debt to
EBITDA ratio for the year ended March 31, 2004. Based on the revised definitions
and the waiver, the Company was in compliance with all covenants under the Loan
Agreement for the quarter ended December 31, 2003 and the year ended March 31,
2004. The Company anticipates that it will be in compliance with these ratios,
as amended, through the remainder of the loan period. Additionally, the Loan
Modification letter dated May 21, 2004 established a pricing matrix which will
tie the interest rate charged on the term loan to the Company's performance
related to its funded debt to EBITDA ratio. Beginning October 1, 2004, the
interest rate may be adjusted quarterly depending on the Company's ratio at the
end of the prior quarter. Interest will be assessed in the range of prime to
prime plus 1.25% according to the Company's performance. SouthTrust charged a
fee of $50,000 to make the all of the above modifications to the term loan. The
Company's management believes that it will be able to offset a substantial
portion of this fee in future periods by securing lower interest rates related
to improved ratios. The fee is payable in four installments between June and
December 2004.
29
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 founder, and
secured by the pledge of one million shares of the Company's common stock owned
by him. Interest on this note was at the prime rate. This loan was paid in full
in February 2004 and the collateral shares were released by SouthTrust to the
Company.
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. In accordance with SFAS 123, the fair value of this warrant was estimated
at $101,000 and will be amortized as non-cash compensation over 72 months
beginning in May 2003.
In March 2002, Angelo S. Morini, the Company's founder, loaned $330,000 to the
Company in order for it to pay down certain notes payable that were coming due.
This loan bore interest at the prime rate and was due on or before June 15,
2006. In connection with a Second Amended and Restated Employment Agreement
effective October 13, 2003 between Mr. Morini and the Company, the Company
offset $167,603 of unreimbursed advances owed to it by Mr. Morini prior to June
2002 and certain family members against the balance of the loan and issued an
aggregate of 55,087 shares of the Company's common stock (valued at
approximately $2.95 per share) as payment in full.
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 bore interest at 7% per annum and was due in twelve equal
monthly installments of $30,066. This note was paid in full by September 30,
2003.
In January 2003, Ruggieri of Windermere Family Limited Partnership, an affiliate
of Mr. John Ruggieri, the Company's former Vice President of Manufacturing,
entered into a credit arrangement with the Company pursuant to which the
partnership purchased 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 Mr.
Deluca purchased raw materials for the Company in an aggregate amount that did
not 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. In accordance with SFAS 123, the fair value of this
warrant was estimated at $63,000 and was recorded as non-cash compensation
expense in the first quarter of fiscal 2004. 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) of the number of shares of common stock for
each share of Series A convertible preferred stock equal to the quotient of:
30
$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,
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.
As of March 31, 2004, the Series A Preferred Holders had converted 28,752 shares
of the Series A convertible preferred stock plus accrued dividends, into
1,084,844 shares of common stock. The conversion prices ranged from $1.3633 to
$1.75 and were based on the lower of (a) 95% of the average of the two lowest
closing bid prices on the AMEX for the fifteen trading days immediately prior to
conversion or (b) $1.75. From April 1, 2004 through June 25, 2004, the Series A
Preferred Holders converted 1,900 shares of the Series A convertible preferred
stock, plus accrued dividends, into 66,752 shares of common stock at a
conversion price of $1.75.
The Series A Preferred Holders have the right to require the Company to redeem
their shares of Series A convertible preferred stock on April 6, 2005. 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 aggregate market price on the date of redemption
of common stock that would be then issuable upon conversion of the Series A
convertible preferred stock. 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. As of June 25, 2004, there are still 41,994 shares of the Series A
convertible preferred stock outstanding. Assuming that no further conversions
were made and the conversion price remained at $1.75, the redemption price of
the outstanding Series A convertible preferred stock would be the greater of (a)
$2,711,116 (100% of the preference amount plus accrued dividends through April
6, 2005 - $64.56 per share) or (b) the value of 1,549,209 shares of common stock
multiplied by the market price on the date of redemption (currently estimated at
$3,364,882 using the average of the closing market price of the Company's common
stock from June 21, 2004 - June 25, 2004). Any unpaid amount after April 6, 2005
shall bear interest at the rate of 3% per month until paid in full.
On November 7, 2002, the Series A Preferred Holders exercised their right under
the Series A Preferred Stock and Warrants Purchase Agreement the "Series A
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. The Company was required to hold a
shareholders meeting to solicit such approval on or before February 5, 2003. In
accordance with the Stock Purchase Option Agreement described below, the Series
A Preferred Holders agreed, among other things, to extend the deadline to
September 30, 2003. On September 30, 2003, the Company's shareholders, by
majority vote, approved the issuance by the Company of all required common stock
in the event of a conversion of the Company's Series A convertible preferred
stock and upon the exercise of certain warrants held by the Series A Preferred
Holders.
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. The option expired on September 30, 2003. Pursuant
to such agreement, the Series A Preferred Holders also agreed to extend the
Company's required date 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 warrants to purchase 250,000 shares of the Company's common stock
to each BH Capital Investments, L.P. and Excalibur Limited Partnership. 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. These warrants were included on a Registration
Statement on Form S-3, SEC File No. 333-109649, which was filed on October 10,
2003 and declared effective on November 18, 2003. In accordance with SFAS 123,
the fair value of these warrants was estimated at $230,000 and was recorded as
non-cash compensation expense in the first quarter of fiscal 2004.
31
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. These securities were
included on a Registration Statement on Form S-3, SEC File No. 333-109649, which
was filed on October 10, 2003 and declared effective on November 18, 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 former 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. 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.
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 for general operations through March 31, 2005.
On April 6, 2005, the Series A Preferred Holders have the right to require the
Company to redeem the outstanding shares of Series A convertible preferred stock
for cash. Assuming that no further conversions of the Series A convertible
preferred stock are made after the date hereof, the cost to the Company to
redeem the outstanding Series A convertible preferred stock could be in excess
of $3,500,000.
The Company is considering a number of alternatives related to the redemption of
the Series A convertible preferred stock which, individually or in combination,
could resolve the Series A redemption obligations. These alternatives include
procuring the necessary funds from operating activities and existing credit
facilities, or from additional equity financing, or identifying one or more
investors to buy out the Series A Preferred Holders directly and, in connection
therewith, extending the date by which the Series A convertible preferred stock
must be redeemed, or negotiating an extension of such date with the current
Series A Preferred Holders.
32
If the Company is required to redeem the outstanding Series A convertible
preferred stock and does not have the funds to do so, the Company will be in
default of its obligations and the Series A Preferred Holders will be entitled
to pursue their remedies against the Company. In addition, any unpaid redemption
amount owed to the Series A Preferred Holders shall bear interest at the rate of
3% per month until paid in full.
A default by the Company in its obligations to redeem the Series A convertible
preferred stock will also result in a default by the Company under the Textron
Loan, which, in turn, will result in a default by the Company under the
SouthTrust Loan. In the cases of the Textron Loan and the SouthTrust Loan, the
lenders thereunder could exercise their respective rights under their loan
documents to, among other things, declare a default under the loans, accelerate
the outstanding indebtedness such that it would become immediately due and
payable, and pursue foreclosure of the Company's assets which are pledged as
collateral for such loans. In such event, it is unlikely that the Company would
be able to continue as a going concern. The issue related to the Series A
convertible preferred stock is a key item on the agenda of the Company's Board
of Directors and substantial attention is being focused on resolving this issue
during fiscal 2005.
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
The Company leases its operating facilities and certain equipment under
operating and capital leases, expiring at various dates through fiscal year
2010. In addition, the Company has several loan obligations as described in
detail above. The table below summarizes the principal balances of the Company's
obligations for indebtedness and lease obligations as of March 31, 2004 in
accordance with their required payment terms:
Payments due by period
--------------------------------------------------------------------------
Contractual Obligations Total 2005 2006-2007 2008-2009 Thereafter
- ------------------------------------------------------------------------------------------------------------------
Textron credit facility (1) $ 4,605,277 $ 4,605,277 $ -- $ -- $ --
SouthTrust Bank term loan 9,381,985 1,140,000 3,821,250 3,990,000 430,735
Series A convertible preferred stock(2) -- -- -- -- --
Capital Lease Obligations 436,399 231,432 183,893 21,074 --
Operating Lease Obligations 2,349,094 746,608 928,960 581,757 91,769
-------------------------------------------------------------------------
Total $ 16,772,755 $ 6,723,317 $ 4,934,103 $ 4,592,831 $ 522,504
=========================================================================
(1) In accordance with EITF 95-22, "Balance Sheet Classification of Borrowings
Outstanding under Revolving Credit Agreements that involve both a
Subjective Acceleration Clause and a Lock-Box Arrangement," the $4,605,277
balance owed to Textron is reflected as current on the balance sheet and
in the above schedule. However, per the Textron Loan Agreement, the
balance is not due until May 26, 2006.
(2) In fiscal 2006, the Company may be required to redeem the outstanding
Series A convertible preferred stock on April 6, 2005 in accordance with
the terms discussed above.
33
On May 22, 2003, the Company entered into a Master Distribution and Licensing
Agreement with Fromageries Bel S.A., a leading branded cheese company in Europe
who is a greater than 5% shareholder in the Company. The agreement became
effective upon the closing of the Textron Loan, the new $2 million loan from
SouthTrust Bank and the private placements described above. Under the agreement,
the Company has granted Fromageries Bel S.A. exclusive distribution rights for
the Company's 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 Fromageries Bel S.A. the exclusive option during the
term of the agreement to elect to manufacture the products designated by
Fromageries Bel S.A. 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.
RISK FACTORS
In addition to the other information in this Form 10-K, the following factors
should be considered carefully in evaluating the Company's business and
prospects. If any of the following risks actually occur, they could seriously
harm the Company's business, financial condition, results of operations or cash
flows. This could cause the trading price of the Company's common stock to
decline and you could lose all or part of your investment. For the purposes of
this "RISK FACTORS" section, the terms "we," "us," "our" and similar terms refer
to the Company.
WE HAVE AN OBLIGATION TO REDEEM OUR OUTSTANDING SERIES A PREFERRED STOCK ON
APRIL 6, 2005 AND WE MAY NOT HAVE THE FUNDS TO DO SO.
On April 6, 2005, the Series A Preferred Holders have the right to require that
we redeem the outstanding shares of Series A convertible preferred stock. The
redemption price is payable 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 aggregate market price on the date of redemption of
the common stock that would be then issuable upon conversion of the Series A
convertible preferred stock. 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.
,
As of June 25, 2004, there are 41,994 shares of Series A convertible preferred
stock outstanding. Assuming that no further conversions were made and the
conversion price remained at $1.75, the redemption price of the outstanding
Series A convertible preferred stock would be the greater of (a) $2,711,116
(100% of the preference amount plus accrued dividends through April 6, 2005 -
$64.56 per share) or (b) the value of 1,549,209 shares of common stock
multiplied by the market price on the date of redemption (currently estimated at
$3,364,882 using the average of the closing market price of our common stock
from June 21, 2004 - June 25, 2004).
We are considering a number of alternatives related to the redemption of the
Series A convertible preferred stock which, individually or in combination,
could resolve the Series A redemption obligations. These alternatives include
procuring the necessary funds from operating activities and existing credit
facilities, or from additional equity financing, or identifying one or more
investors to buy out the Series A Preferred Holders directly and, in connection
therewith, extending the date by which the Series A convertible preferred stock
must be redeemed, or negotiating an extension of such date with the current
Series A Preferred Holders. However, there are no assurances that any of such
alternatives will be viable or available to us on acceptable terms, or, even if
a viable alternative is available, that we will be successful in implementing
any such alternative. If we are required to redeem the outstanding Series A
convertible preferred stock and do not have the funds to do so, we will be in
default of our obligations and the Series A Preferred Holders will be entitled
to pursue their remedies against us. In addition, any unpaid redemption amount
owed to the Series A Preferred Holders shall bear interest at the rate of 3% per
month until paid in full.
34
A default by us in our obligations to redeem the Series A convertible preferred
stock will also result in our default under the Textron Loan, which, in turn,
will result in a default under the SouthTrust Loan. In the cases of the Textron
Loan and the SouthTrust Loan, the lenders thereunder could exercise their
respective rights under their loan documents to, among other things, declare a
default under the loans, accelerate the outstanding indebtedness such that it
would become immediately due and payable, and pursue foreclosure of our assets,
which are pledged as collateral for such loans. In such event, it is unlikely
that we would be able to continue as a going concern.
WE MAY ISSUE SECURITIES WITH RIGHTS SUPERIOR TO THOSE OF THE COMMON STOCK, WHICH
COULD MATERIALLY LIMIT THE OWNERSHIP RIGHTS OF EXISTING STOCKHOLDERS.
We may offer debt or equity securities in private and/or public offerings in
order to raise working capital and to refinance our debt. The board of directors
has the right to determine the terms and rights of any debt securities and
preferred stock without obtaining further approval of the stockholders. It is
likely that any debt securities or preferred stock that we sell would have terms
and rights superior to those of the common stock and may be convertible into
common stock. Any sale of securities could adversely affect the interests or
voting rights of the holders of common stock, result in substantial dilution to
existing stockholders, or adversely affect the market price of our common stock.
WE CANNOT CONTROL THE TIMING OR VOLUME OF SALES OF A SUBSTANTIAL NUMBER OF
SHARES OF OUR COMMON STOCK.
As of June 25, 2004, approximately 7,000,000 shares of the 15,724,073 shares of
our issued and outstanding common stock were freely tradable (unless acquired by
one of our "affiliates") under the Securities Act of 1933. All of the shares
which are not freely tradable are "restricted securities" within the meaning of
Rule 144 promulgated by the Securities and Exchange Commission under the
Securities Act, and may be sold in open market transactions after the holding
period under Rule 144 with respect to such transaction has been met. As to
shares subject to outstanding options and warrants, the one-year holding period
generally will not begin until the shares underlying such options or warrants
actually have been acquired. After the one-year holding period has been met,
each holder generally may sell, every three months in brokerage transactions, an
amount equal to the greater of one percent of our outstanding common stock or
the amount of the average weekly trading volume during the four weeks preceding
the sale. After two years, unless any such holder is one of our "affiliates,"
such sales can be made without restriction.
As of June 25, 2004, 41,994 shares of our Series A convertible preferred stock
were issued and outstanding. The Series A convertible preferred stock is subject
to certain designations, preferences and rights set forth in our Restated
Certificate of Incorporation, including the right to convert such shares into
shares of common stock at any time. We registered 1,557,895 shares of our common
stock to cover the number of shares required to be issued upon conversion of the
Series A convertible preferred stock assuming the conversion price were to fall
50% below the conversion price on April 6, 2001.
Because the sales of registered common stock, including common stock underlying
the Series A convertible preferred stock and the resale of any additional shares
which may be attempted under Rule 144 may not be effected through an underwriter
pursuant to a firm commitment agreement, there will be a substantial number of
additional shares which may be available for sale on the market at one time
without any control over the timing or volume of sales thereof by us or any
third party. We cannot foresee the impact of such potential sales on the market,
but it is possible that if a significant percentage of such available shares are
attempted to be sold within a short period of time, the effect on the market may
be negative. It is also unclear as to whether or not the market for our common
stock could absorb a large number of attempted sales in a short period of time,
regardless of the price at which the same might be offered. It is noted that
even if a substantial number of sales does not occur within a short period of
time, the mere existence of this "market overhang" could have a negative effect
on the market for our common stock and our ability to raise additional capital
or refinance our indebtedness.
35
OUR FOUNDER OWNS A LARGE PERCENTAGE OF THE OUTSTANDING SHARES, WHICH COULD
MATERIALLY LIMIT THE OWNERSHIP RIGHTS OF EXISTING STOCKHOLDERS.
As of June 25, 2004, Angelo S. Morini, our founder, beneficially owned
approximately 22% of our current outstanding common stock and held options
which, if exercised and assuming the exercise of no other outstanding options or
warrants, would give him approximately 34% of our issued and outstanding common
stock. Shareholders may be unable to elect any members of the board of directors
or exercise significant control over us or our business as a result of Mr.
Morini's ownership.
SHAREHOLDERS MAY EXPERIENCE FURTHER DILUTION.
We have a substantial number of outstanding options and warrants to acquire
shares of common stock. A total of 5,985,057 shares have been reserved for
issuance upon exercise of options and warrants that we have granted or may grant
in the future. A total of 2,704,596 of these options and warrants are "in the
money" and are currently exercisable as of June 25, 2004. "In the money"
generally means that the current market price of the common stock is above the
exercise price of the shares subject to the warrant or option. The issuance of
common stock upon the exercise of these options and warrants could adversely
affect the market price of the common stock or result in substantial dilution to
our existing stockholders.
IF WE LOSE KEY FOREIGN SUPPLIERS ON WHOM WE DEPEND, WE MAY BE UNABLE TO OBTAIN
ADEQUATE SUPPLIES TO MANUFACTURE OUR PRODUCTS.
Currently, we purchase our major ingredient, a milk protein called casein, from
a limited number of foreign suppliers. We purchase casein from foreign suppliers
because they have lower prices than domestic suppliers. However, their lower
prices are generally the result of governmental export supports or subsidies. We
do not have any contractual arrangements with our principal suppliers, except
for short-term agreements for periods of less than six months. Because we
purchase casein from foreign suppliers, its availability is subject to a variety
of factors, including federal import regulations. If the export supports or
subsidies are reduced or eliminated or the United States takes retaliatory
action or otherwise establishes trade barriers with any of the countries in
which our casein suppliers are located, our business and results of operations
would be negatively affected. Moreover, exchange rate fluctuations or the
imposition of import quotas or tariffs could have an adverse effect on our
business and our ability to compete with competitors that do not rely on foreign
suppliers. We cannot assure you that we could obtain casein from U.S. sources if
a foreign supply of casein were reduced or terminated. Even if we could obtain
casein from U.S. sources, our production may be reduced during the period that
it takes us to change suppliers and the prices for the casein would likely be
significantly higher than we are paying now. Either event would negatively
affect our business, results of operations and cash flows.
Based on current pricing trends with its suppliers, we expect to see substantial
increases in our casein prices in the first half of fiscal 2005. A 5% increase
in casein prices would result in an annual cost increase of approximately
$307,000 assuming the same amount of pounds purchased as in fiscal 2004. We are
striving to offset these cost increases with efficiencies in production and cost
savings in the purchase of other raw materials, along with substituting
additional sources of protein into its products. Additionally, we plan to pass
some of the cost increases down to the consumer through increases in the sales
price of certain products.
BECAUSE WE ARE DEPENDENT UPON A SINGLE MANUFACTURING FACILITY, THE LOSS OF THE
FACILITY WOULD RESULT IN A WORK STOPPAGE, WHICH WOULD NEGATIVELY IMPACT OUR
BUSINESS.
We manufacture all of our products at a single manufacturing facility in
Orlando, Florida, and our revenues are dependent upon the continued operation of
this facility. This facility is subject to a lease that expires in November
2006, unless renewed pursuant to terms mutually agreeable to our landlord and
us. We do not have a backup facility or contractual arrangements with any other
manufacturers in the event of a casualty to or destruction of the facility or if
the facility ceases to be available to us for any other reason. If we are
required to rebuild or relocate our manufacturing facility, a substantial
investment in improvements and equipment would be necessary. Any rebuilding or
relocation also would likely result in a significant delay or reduction in
manufacturing and production capability which, in turn, could lead to
substantially reduced sales and loss of market share.
36
COMPETITION IN OUR INDUSTRY IS INTENSE.
Competition in our segment of the food industry is intense. We believe that as
consumers become more interested in healthy food alternatives the competition in
our markets will increase substantially. Our primary competition consists of
equally sized companies such as Tree of Life, White Wave, Yves and Tofutti
Brands that manufacture soy-based products, such as alternative cheese slices,
sour creams, cream cheese and related products. In addition, we compete with
major companies such as Kraft, which produces products under the Kraft Free(R)
label, Borden's, and ConAgra, which produces products under the Healthy
Choice(R) label. Each of these companies has substantially greater name
recognition and greater research and development, marketing, financial and human
resources than we have. These advantages have led to a substantially greater
market penetration and product acceptance than we have developed. In addition,
our competitors may succeed in developing new or enhanced products, which are
better than our products. These companies may also prove to be more successful
than us in marketing and selling these products. We cannot assure you that we
will be able to compete successfully with any of these companies or achieve a
greater market share than we currently possess. Increased competition as to any
of our products or services could result in price reductions, reduced margins,
and loss of market share, which could negatively affect our business, prospects,
results of operations and financial condition.
CONSUMER EATING HABITS AND SHOPPING TRENDS MAY CHANGE AND NEGATIVELY IMPACT
DEMAND FOR OUR PRODUCTS.
There could be downward pressure on demand for our products as consumers tastes,
preferences, shopping behavior, and overall evaluation of health benefits change
over time. This is demonstrated in the current year 9.6% decrease in sales which
is due in part to a change in consumers' eating habits with the publicly
recognized trend toward low-carbohydrate meal preparation during all meals
(breakfast, lunch, snack, and dinner). This has led to decreased consumption of
items such as bread and our primary complementary product of cheese slices.
Additionally, the number of consumers shopping in the retail grocery and natural
food stores is down due to the further national emergence and presence of
Wal*Mart superstores and other similar superstores which include extensive
grocery operations. Our product selection is growing but is still limited at
Wal*Mart. Therefore, our sales growth with this account may not be able to fully
counter the decline in retail grocery trends. In response to this change in
consumer shopping, we are redesigning its products and packaging formats to
specifically target growth opportunities in the superstore, warehouse club and
mass merchandiser markets (such as Wal*Mart, Costco, Kmart, Target, and Sam's
Club). With the growth in the aging population of U.S. consumers, there could be
price pressure on our products due to the fixed income nature of this population
segment.
DEMAND FOR OUR PRODUCTS COULD BE HINDERED DUE TO CHANGING CONDITIONS WITHIN THE
DISTRIBUTION CHANNELS WE SELL PRODUCTS IN.
Our sales could suffer based upon market place abnormalities such as retailer,
distributor, and/or food service operator labor strikes. Further, consolidation
within the industry could result in store closings, store layouts, and operating
strategies that are incompatible with our product requirements.
WE RELY ON THE PROTECTION OF OUR TRADEMARKS, AND THE LOSS OF A TRADEMARK WOULD
NEGATIVELY IMPACT THE PRODUCTS ASSOCIATED WITH THE TRADEMARK, WHICH COULD
MATERIALLY ADVERSELY AFFECT OUR BUSINESS.
We own several registered and unregistered trademarks, which are used in the
marketing and sale of our products. We have invested a substantial amount of
money in promoting our trademarked brands. However, the degree of protection
that these trademarks afford us is unknown. Further, we may not have the money
necessary to engage in actions to prevent infringement of our trademarks. A loss
of a material trademark would negatively impact the products associated with it,
and could negatively affect our business, prospects, results of operations,
financial condition and cash flows.
37
WE DO NOT HAVE PATENT PROTECTION FOR OUR FORMULAS AND PROCESSES, AND A LOSS OF
OWNERSHIP OF ANY OF OUR FORMULAS AND PROCESSES WOULD NEGATIVELY IMPACT OUR
BUSINESS.
We believe that we own our formulas and processes. However, we have not sought,
and do not intend to seek, patent protection for our formulas and processes.
Instead, we rely on the complexity of our formulas and processes, trade secrecy
laws, and employee confidentiality agreements. However, we cannot assure you
that other companies will not acquire our confidential information or trade
secrets or will not independently develop equivalent or superior products or
technology and obtain patent or similar rights. Although we believe that our
formulas and processes have been independently developed and do not infringe the
patents or rights of others, a variety of components of our processes could
infringe existing or future patents, in which event we may be required to modify
our processes or obtain a license. We cannot assure you that we will be able to
do so in a timely manner or upon acceptable terms and conditions and the failure
to do either of the foregoing would negatively affect our business, results of
operations, financial condition and cash flows.
BECAUSE WE SELL FOOD PRODUCTS, WE FACE THE RISK OF EXPOSURE TO PRODUCT LIABILITY
CLAIMS.
We, like any other seller of food, face the risk of exposure to product
liability claims in the event that our quality control procedures fail and the
consumption of our products causes injury or illness. With respect to product
liability claims, our insurance may not continue to be available at a reasonable
cost, or, if available, may not be adequate to cover liabilities. We generally
seek contractual indemnification and insurance coverage from parties supplying
us products, but this indemnification or insurance coverage is limited, as a
practical matter, to the creditworthiness of the indemnifying party, and their
carriers, if any, as well as the insured limits of any insurance provided by
suppliers. If we do not have adequate insurance or contractual indemnification
available, product liability claims relating to defective products could have a
material adverse effect on our financial condition, results of operations and
cash flows.
GOVERNMENT REGULATION COULD INCREASE OUR COSTS OF PRODUCTION AND INCREASE OUR
LEGAL AND REGULATORY EXPENSES.
We are subject to extensive regulation by federal, state, and local governmental
authorities regarding the quality, purity, manufacturing, distribution, and
labeling of food products. We cannot assure that you that we will be able to
continue to comply with these regulations, or comply with future regulations,
without inordinate cost or interruption of our operations. Failure to comply
with applicable laws and regulations could subject us to civil remedies,
including fines, injunctions, recalls or seizures, as well as possible criminal
sanctions, which could have a material adverse effect on our business.
THE LOW VOLUME OF TRADING OF OUR SHARES MAY NEGATIVELY IMPACT THE LIQUIDITY OF
OUR SHARES.
Although our shares are publicly traded on the American Stock Exchange, the
trading market for our shares is limited. During the calendar quarter prior to
June 25, 2004, the trading volume for our shares averaged 15,000 shares per
trading day. We do not anticipate any material increase in the trading volume
for our shares. The lack of an active trading market for our shares could
negatively impact stockholders' ability to sell their shares when they desire
and the price which could be obtained upon a sale of shares.
RISING INTEREST RATES COULD NEGATIVELY AFFECT OUR RESULTS OF OPERATIONS.
The interest rates of most of the Company's outstanding debts fluctuate based
upon changes in our lenders' prime rate. Increases in the prime rate will result
in an increase in our cost of funds, and could negatively affect our results of
operations. The Company is anticipating future increases in interest rates
during fiscal 2005. We have not entered into any derivative instruments such as
interest rate swap or hedge agreements to manage our exposure to rising interest
rates.
THE MARKET PRICE OF OUR STOCK COULD BE SUBJECT TO FLUCTUATION.
The market price of our common stock could be subject to fluctuations in
response to factors such as the following, some of which are beyond our control:
38
o quarterly variations in our operating results;
o operating results that vary from the expectations of securities
analysts and investors;
o changes in expectations as to our future financial performance,
including financial estimates by securities analysts and investors;
o announcements by us or our competitors of major business
developments, such as new products, services or technologies or
significant contracts, acquisitions, strategic partnerships, joint
ventures or capital commitments;
o announcements by third parties of significant claims or proceedings
against us;
o future sales of our common stock;
o and general market conditions.
ITEM 7A. 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 the Company's outstanding debts to
SouthTrust Bank and Textron 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 March 31, 2004
with respect to the Company's debt as of such date would increase or decrease
interest expense and hence reduce or increase net income of the Company by
approximately $140,000 per year or $35,000 per quarter.
The Company's sales which were denominated in a currency other than U.S. dollars
during the fiscal years ended March 31, 2004, 2003 and 2002 were less than 2% of
gross sales and no net assets were maintained in a functional currency other
than U. S. dollars such fiscal years. Therefore, the effects of changes in
foreign currency exchange rates have not historically been significant to the
Company's operations or net assets.
39
ITEM 8. FINANCIAL STATEMENTS.
Report of Registered Public Accounting Firm
To the Board of Directors and Stockholders
Galaxy Nutritional Foods, Inc.
Orlando, Florida
We have audited the accompanying balance sheets of Galaxy Nutritional Foods,
Inc. as of March 31, 2004 and 2003 and the related statements of operations,
stockholders' equity and cash flows for each of the three years in the period
ended March 31, 2004. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Galaxy Nutritional Foods, Inc.
as of March 31, 2004 and 2003 and the results of its operations and its cash
flows for each of the three years in the period ended March 31, 2004 in
conformity with accounting principles generally accepted in the United States of
America.
/s/ BDO Seidman, LLP
Atlanta, Georgia
June 16, 2004
40
GALAXY NUTRITIONAL FOODS, INC.
BALANCE SHEETS
MARCH 31, MARCH 31,
Notes 2004 2003
-------- --------------- ---------------
ASSETS
CURRENT ASSETS:
Cash $ 449,679 $ 1,598
Trade receivables, net of allowance for
doubtful accounts of $633,000 and $633,221 15 3,964,198 4,963,026
Inventories, net 2 4,632,843 5,294,500
Prepaid expenses and other 3 191,572 553,396
--------------- ---------------
Total current assets 9,238,292 10,812,520
PROPERTY AND EQUIPMENT, NET 4 20,232,089 22,168,404
OTHER ASSETS 416,706 274,918
--------------- ---------------
TOTAL $ 29,887,087 $ 33,255,842
=============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Book overdrafts $ -- $ 1,151,276
Line of credit 5 4,605,277 4,939,894
Accounts payable 1,191,617 2,622,996
Accrued liabilities 1,812,300 1,745,552
Current portion of accrued employment contract 6 366,305 --
Current portion of term notes payable 5 1,140,000 1,497,760
Current portion of subordinated note payable 5 -- 2,000,000
Current portion of obligations under capital leases 6 231,432 363,152
--------------- ---------------
Total current liabilities 9,346,931 14,320,630
ACCRUED EMPLOYMENT CONTRACT, less current portion 6 1,293,142 --
TERM NOTES PAYABLE, less current portion 5 8,241,985 7,786,985
SUBORDINATED NOTE PAYABLE 5 -- 2,000,000
OBLIGATIONS UNDER CAPITAL LEASES, less current portion 6 204,967 383,210
--------------- ---------------
Total liabilities 19,087,025 24,490,825
--------------- ---------------
COMMITMENTS AND CONTINGENCIES 6 -- --
REDEEMABLE CONVERTIBLE PREFERRED STOCK 7 2,573,581 2,324,671
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value, authorized 85,000,000
shares; 15,657,321 and 12,761,685 shares issued 156,573 127,617
Additional paid-in capital 64,520,084 59,800,732
Accumulated deficit (43,557,515 (40,595,342)
--------------- ---------------
21,119,142 19,333,007
Less: Notes receivable arising from the exercise of
stock options and sale of common stock (12,772,200 (12,772,200)
Treasury stock, 26,843 shares, at cost (120,461 (120,461)
--------------- ---------------
Total stockholders' equity 8,226,481 6,440,346
--------------- ---------------
TOTAL $ 29,887,087 $ 33,255,842
=============== ===============
See accompanying notes to financial statements
41
GALAXY NUTRITIONAL FOODS, INC.
STATEMENTS OF OPERATIONS
YEARS ENDED MARCH 31, 2004 2003 2002
--------------- ---------------- ---------------
NET SALES $ 36,176,961 $ 40,008,769 $ 42,927,104
COST OF GOODS SOLD 24,864,289 28,080,188 35,276,362
--------------- ---------------- ---------------
Gross margin 11,312,672 11,928,581 7,650,742
--------------- ---------------- ---------------
OPERATING EXPENSES:
Selling 4,981,996 4,958,272 8,573,957
Delivery 1,877,682 2,008,638 2,475,989
Non-cash compensation related to options & warrants
(Note 7) 651,273 (2,906,762) 2,373,662
Employment contract expense (Note 6) 1,830,329 -- --
General and administrative 3,303,030 3,570,889 5,348,513
Research and development 260,410 232,552 261,972
--------------- ---------------- ---------------
Total operating expenses 12,904,720 7,863,589 19,034,093
--------------- ---------------- ---------------
INCOME (LOSS) FROM OPERATIONS (1,592,048) 4,064,992 (11,383,351)
--------------- ---------------- ---------------
OTHER INCOME (EXPENSE):
Interest expense (1,361,606) (2,923,215) (3,594,091)
Loss on disposal of assets (8,519) (47,649) (464,190)
Other expense -- (60,000) (57,520)
--------------- ---------------- ---------------
(1,370,125) (3,030,864) (4,115,801)
--------------- ---------------- ---------------
INCOME (LOSS) BEFORE INCOME TAXES (2,962,173) 1,034,128 (15,499,152)
INCOME TAX BENEFIT (EXPENSE) (Note 8) -- -- (1,560,000)
--------------- ---------------- ---------------
NET INCOME (LOSS) $ (2,962,173) $ 1,034,128 $ (17,059,152)
Preferred Stock Dividends (Note 7) 201,791 264,314 709,400
Preferred Stock Accretion to Redemption Value (Note 7) 1,340,943 1,370,891 1,379,443
--------------- ---------------- ---------------
NET LOSS AVAILABLE TO COMMON SHAREHOLDERS $ (4,504,907) $ (601,077) $ (19,147,995)
=============== ================ ===============
BASIC NET LOSS PER COMMON SHARE (Note 13) $ (0.30) $ (0.05) $ (1.81)
=============== ================ ===============
DILUTED NET LOSS PER COMMON SHARE (Note 13) $ (0.30) $ (0.05) $ (1.81)
=============== ================ ===============
See accompanying notes to financial statements
42
GALAXY NUTRITIONAL FOODS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
Common Stock Notes
------------------------- Additional Accumulated Receivable for Treasury
Share Par Value Paid-In Capital Deficit Common Stock Stock Total
--------------------------------------------------------------------------------------------------------------
Balance at March 31, 10,017,612 $ 100,176 $ 51,902,100 $ (24,570,318) $ (12,772,200) $ (120,461) $ 14,539,297
2001
Exercise of options 4,143 41 19,480 -- -- -- 19,521
Exercise of warrants 753,625 7,537 2,252,549 -- -- -- 2,260,086
Issuance of common
stock under
employee stock
purchase plan 11,648 116 32,163 -- -- -- 32,279
Issuance of common
stock 753,013 7,530 3,801,282 -- -- -- 3,808,812
Fair value of
warrants issued -- -- 355,692 -- -- -- 355,692
Non-cash compensation
related to variable
securities -- -- 1,960,000 -- -- -- 1,960,000
Dividends on
preferred stock -- -- (350,000) -- -- -- (350,000)
Discount on preferred
stock -- -- 2,003,770 -- -- -- 2,003,770
Accretion of discount
on preferred stock (1,259,122) -- -- -- (1,259,122)
Net loss -- -- -- (17,059,152) -- -- (17,059,152)
--------------------------------------------------------------------------------------------------------------
Balance at March 31,
2002 11,540,041 $ 115,400 $ 60,717,914 $ (41,629,470) $ (12,772,200) $ (120,461) $ 6,311,183
Exercise of options 1,000 10 4,240 -- -- -- 4,250
Issuance of common
stock under
employee stock
purchase plan 9,880 99 19,564 -- -- -- 19,663
Issuance of common
stock 585,828 5,859 2,295,269 -- -- -- 2,301,128
Conversion of
preferred stock 624,936 6,249 845,726 -- -- -- 851,975
Fair value of
warrants issued -- -- 146,000 -- -- -- 146,000
Non-cash compensation
related to variable
securities -- -- (3,060,000) -- -- -- (3,060,000)
Dividends on
preferred stock -- -- (264,314) -- -- -- (264,314)
Accretion of discount
on preferred stock (903,667) -- -- -- (903,667)
Net income -- -- -- 1,034,128 -- -- 1,034,128
--------------------------------------------------------------------------------------------------------------
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 options 7,911 79 16,138 -- -- -- 16,217
Exercise of warrants 200,000 2,000 358,000 -- -- -- 360,000
Issuance of common
stock under
employee stock
purchase plan 16,339 163 28,364 -- -- -- 28,527
Issuance of common
stock 2,211,478 22,115 3,929,242 -- -- -- 3,951,357
Conversion of
preferred stock 459,908 4,599 794,921 -- -- -- 799,520
Fair value of
warrants and
employee options
issued -- -- 685,308 -- -- -- 685,308
Non-cash compensation
related to variable
securities -- -- 8,001 -- -- -- 8,001
Dividends on
preferred stock -- -- (201,791) -- -- -- (201,791)
Accretion of discount
on preferred stock -- -- (898,831) -- -- -- (898,831)
Net income -- -- -- (2,962,173) -- -- (2,962,173)
--------------------------------------------------------------------------------------------------------------
Balance at March 31,
2004 15,657,321 $ 156,573 $ 64,520,084 $ (43,557,515) $ (12,772,200) $ (120,461) $ 8,226,481
==============================================================================================================
See accompanying notes to financial statements
43
GALAXY NUTRITIONAL FOODS, INC.
STATEMENTS OF CASH FLOWS
Years Ended March 31, 2004 2003 2002
-------------- -------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES: (Note 12)
Net Income (Loss) $ (2,962,173) $ 1,034,128 $ (17,059,152)
Adjustments to reconcile net income (loss) to net cash from (used
in) operating activities:
Depreciation and amortization 2,205,053 2,273,349 2,362,900
Amortization of debt discount and financing costs 236,321 1,264,273 1,069,522
Deferred tax expense (benefit) -- -- 1,560,000
Provision for losses on trade receivables (221) (177,245) 1,058,335
Non-cash compensation related to options and warrants (Note 7) 651,273 (2,906,762) 2,373,662
Loss on disposal of assets 8,519 47,649 464,190
(Increase) decrease in:
Trade receivables 999,049 364,907 1,844,538
Inventories 661,657 454,152 5,025,888
Prepaid expenses and other 194,248 2,124 1,260,490
Increase (decrease) in:
Accounts payable (1,431,379) (1,589,514) (4,056,922)
Accrued liabilities 1,674,003 408,814 368,060
-------------- -------------- --------------
NET CASH FROM (USED IN) OPERATING ACTIVITIES 2,236,350 1,175,875 (3,728,489)
-------------- -------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (221,585) (214,003) (140,277)
(Increase) decrease in other assets (10,193) 113,977 1,801
-------------- -------------- --------------
NET CASH FROM (USED IN) INVESTING ACTIVITIES (231,778) (100,026) (138,476)
-------------- -------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase (decrease) in book overdrafts (1,151,276) (41,580) 746,027
Net borrowings (payments) on line of credit (334,617) (583,981) (3,252,403)
Borrowings on term notes payable 2,000,000 500,000 330,000
Repayments on term notes payable (1,572,760) (1,763,265) (1,409,964)
Repayments on subordinated note payable (4,000,000) -- (815,000)
Financing costs for long term debt (288,230) (239,539) (25,000)
Principal payments on capital lease obligations (365,635) (431,937) (539,399)
Proceeds from exercise of common stock options 16,217 4,250 19,521
Proceeds from exercise of common stock warrants, net of costs 360,000 -- 2,070,801
Proceeds from issuance of common stock under employee stock
purchase plan 28,527 19,663 32,279
Proceeds from issuance of common stock, net of offering costs 3,751,283 1,461,970 3,808,812
Proceeds from issuance of preferred stock, net of costs -- -- 2,900,959
-------------- -------------- --------------
NET CASH FROM (USED IN) FINANCING ACTIVITIES (1,556,491) (1,074,419) 3,866,633
-------------- -------------- --------------
NET INCREASE (DECREASE) IN CASH 448,081 1,430 (332)
CASH, BEGINNING OF YEAR 1,598 168 500
-------------- -------------- --------------
CASH, END OF YEAR $ 449,679 $ 1,598 $ 168
============== ============== ==============
See accompanying notes to financial statements.
44
GALAXY NUTRITIONAL FOODS, INC.
NOTES TO FINANCIAL STATEMENTS
(1) Summary of Significant Accounting Policies
------------------------------------------
Business
--------
Galaxy Nutritional Foods, Inc. (the "Company") is principally engaged in
the development, manufacturing and marketing of a variety of healthy cheese
and dairy related products, as well as other cheese alternatives. These
healthy cheese and dairy related products include low, reduced 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, food service and industrial markets. The Company's headquarters and
manufacturing facilities are located in Orlando, Florida.
Accounts Receivable
-------------------
Accounts receivable are customer obligations due under normal trade terms.
The Company evaluates the collectibility of its accounts receivable on a
combination of factors. In circumstances where it is aware of a specific
customer's inability to meet its financial obligations, it records a
specific allowance to reduce the amounts recorded to what it believes will
be collected. In addition to reserving for potential uncollectible
accounts, the Company uses its allowance for trade receivables account to
estimate future credits that will be issued to customers for items such as
rebates, sales promotions, coupons, and spoils that relate to current
period sales. The Company also records these additional reserves for
potential uncollectible amounts and future credits based on certain
percentages, which are determined based on historical experience and its
assessment of the general financial conditions affecting its customer base.
After all attempts to collect a receivable have been exhausted and failed,
the receivable is written off against the allowance.
Inventories
-----------
Inventories are valued at the lower of cost (weighted average, which
approximates FIFO) or market.
Property and Equipment
----------------------
Property and equipment are stated at cost. Depreciation is computed over
the estimated useful lives of the assets by the straight-line method for
financial reporting and by accelerated methods for income tax purposes.
Capital leases are recorded at the lower of fair market value or the
present value of future minimum lease payments. Assets under capital leases
are amortized by the straight-line method over their useful lives.
Revenue Recognition
-------------------
Sales are recognized upon shipment of products to customers. The Company
offers a right of return policy to certain retail customers in the
conventional grocery stores and mass merchandising industry. If the product
is not sold during its shelf life, the Company will allow a credit for the
unsold merchandise. Since the shelf life of the Company's products range
from 6 months to one year, the Company historically averages less than 2%
in credits for unsold product. The Company's reserve on accounts receivable
takes these potential future credits into consideration. Certain expenses
such as slotting fees, rebates, coupons and other discounts are accounted
for as a reduction to Revenues.
Shipping and Handling Costs
---------------------------
The Company accounts for certain shipping and handling costs related to the
acquisition of goods from its vendors as Cost of Goods Sold. However,
shipping and handling costs related to the shipment of goods to its
customers is classified as Delivery expense.
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", furnishes the pro forma
disclosures required under Statement of Financial Accounting Standards
("SFAS") No. 123, "Accounting for Stock-Based Compensation", and applies
SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure" on a prospective basis for options granted after March 31,
2003.
In December 2002, the Financial Accounting Standards Board ("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
45
GALAXY NUTRITIONAL FOODS, INC.
NOTES TO FINANCIAL STATEMENTS
(Continued)
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. 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 was approximately $0.03.
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:
Year Ended March 31, 2004 March 31, 2003 March 31, 2002
-------------- -------------- --------------
Dividend Yield None None None
Volatility 41% to 45% 37% to 44% 38%
Risk Free Interest Rate 2.01% to 4.28% 1.71% to 5.03% 4.75%
Expected Lives in Months 36 to 120 60 to 120 120
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:
Year Ended March 31, 2004 March 31, 2003 March 31, 2002
----------------- ------------------ -----------------
Net income (loss) available to common $ (4,504,907) $ $ (19,147,995)
shareholders as reported (601,077)
Add: Stock-based compensation expense included
in reported net income 651,273 (2,906,762) 2,373,662
Deduct: Stock-based compensation expense
determined under fair value based method for
all awards (1,070,997) (3,728,592) (2,918,802)
----------------- ------------------ -----------------
Pro forma net income (loss) available to common $ (4,924,631) $ (7,236,431) $ (19,693,135)
shareholders
================= ================== =================
Net income (loss) per common share:
Basic - as reported $ (0.30) $ (0.05) $ (1.81)
================= ================== =================
Basic - pro forma $ (0.33) $ (0.60) $ (1.87)
================= ================== =================
Diluted - as reported $ (0.30) $ (0.05) $ (1.81)
================= ================== =================
Diluted - pro forma $ (0.33) $ (0.60) $ (1.87)
================= ================== =================
Income Taxes
------------
Deferred income taxes are recognized for the tax consequences of temporary
differences between the financial reporting bases and the tax bases of the
Company's assets and liabilities in accordance with SFAS No. 109. 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.
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
46
GALAXY NUTRITIONAL FOODS, INC.
NOTES TO FINANCIAL STATEMENTS
(Continued)
outstanding plus potential common shares which would arise from the
exercise of stock options, warrants and conversion of the Series A
convertible preferred stock.
Financial Instruments
---------------------
Statement of Financial Accounting Standards No. 107, "Disclosures about
Fair Value of Financial Instruments," requires disclosure of fair value
information about financial instruments. Fair value estimates discussed
herein are based upon certain market assumptions and pertinent information
available to management as of March 31, 2004.
The respective carrying value of certain on-balance-sheet financial
instruments approximated their fair values. These financial instruments
include cash, trade receivables, book overdrafts, accounts payable and
accrued liabilities. Fair values were assumed to approximate carrying
values for these financial instruments since they are short term in nature
and their carrying amounts approximate fair values or they are receivable
or payable on demand. The fair value of the Company's long-term debt,
subordinated debt, and capital leases is estimated based upon the quoted
market prices for the same or similar issues or on the current rates
offered to the Company for debt of the same remaining maturities.
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, which is
made up of reserves for promotions, discounts and bad debts, provision for
inventory obsolescence, valuation of deferred taxes, and valuation of stock
options and warrants. Actual results could differ from those estimates.
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.
Reclassifications
-----------------
Certain items in the financial statements of prior periods have been
reclassified to conform to current period presentation.
Recent Accounting Pronouncements
--------------------------------
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. On November 7, 2003, the FASB
deferred the classification and measurement provisions of SFAS No. 150 as
they apply to certain mandatorily redeemable non-controlling interests.
This deferral is expected to remain in effect while these provisions are
further evaluated by the FASB. The application of the requirements of SFAS
150 did not have any impact on the Company's financial position or result
of operations as the Company's Series A convertible preferred stock is not
mandatorily redeemable.
In December 2003, the FASB issued a revised FASB Interpretation No. 46,
"Consolidation of Variable Interest Entities"(FIN 46R), which clarifies how
a business enterprise should evaluate whether it has a controlling interest
in an entity through means other than voting rights and accordingly should
consolidate the entity. FIN46R replaces FASB Interpretation No. 46,
"Consolidation of Variable Interest Entities" which was issued in January
47
GALAXY NUTRITIONAL FOODS, INC.
NOTES TO FINANCIAL STATEMENTS
(Continued)
2003. The application of the requirements of FIN 46R did not have any
impact on the Company's financial position or result of operations as the
Company does not have any variable interests in variable interest entities.
(2) Inventories
-----------
Inventories are summarized as follows:
March 31, 2004 March 31, 2003
-------------- --------------
Raw materials $ 1,786,586 $ 2,216,558
Finished goods 2,846,257 3,077,942
-------------- --------------
Total $ 4,632,843 $ 5,294,500
============== ==============
(3) Prepaid Expenses and Other
--------------------------
Prepaid expenses are summarized as follows:
March 31, 2004 March 31, 2003
-------------- --------------
Employee advances $ 10,195 $ 231,918
Prepaid commissions 47,322 110,416
Prepaid insurance 49,786 70,888
Other 84,269 140,174
-------------- --------------
Total $ 191,572 $ 553,396
============== ==============
The Company expenses the production costs of advertising the first time the
advertising takes place. During fiscal 2001, the Company changed its
accounting policy with regards to slotting fees and direct response
advertising costs to expense these costs as incurred.
Advertising expense was approximately $910,000, $224,000, and $762,000
during fiscal 2004, 2003, and 2002, respectively.
(4) Property and Equipment
----------------------
Property and equipment are summarized as follows:
Useful Lives March 31, 2004 March 31, 2003
------------ -------------- --------------
Leasehold improvements 10-25 years $ 3,215,596 $ 3,187,596
Machinery and equipment 5-20 years 27,112,809 27,049,817
Equipment under capital leases 7-15 years 1,808,810 1,753,138
Construction in progress 112,649 --
------------ -------------- --------------
32,249,864 31,990,551
Less accumulated depreciation and amortization 12,017,775 9,822,147
-------------- --------------
Property and equipment, net $20,232,089 $22,168,404
============== ==============
(5) 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 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. 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) eighty-five percent (85%) of the net amount of its eligible
accounts receivable
48
GALAXY NUTRITIONAL FOODS, INC.
NOTES TO FINANCIAL STATEMENTS
(Continued)
plus (ii) 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 (5.75% at
March 31, 2004) 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. However, in accordance with EITF 95-22, "Balance Sheet
Classification of Borrowings Outstanding under Revolving Credit Agreements
that involve both a Subjective Acceleration Clause and a Lock-Box
Arrangement," the balance is reflected as current on the balance sheet. As
of March 31, 2004, the outstanding principal balance on the Textron Loan
was $4,605,277.
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 would be measured and tested on a
quarterly rather than monthly basis. Due to the $1.8 million charge to
operations related to the Amended and Restated Employment Agreement for
Angelo Morini (See Note 6), the Company fell below the requirement for the
adjusted tangible net worth and the fixed charge coverage ratio covenants
for the quarter ended December 31, 2003. Pursuant to a Second Amendment to
the Loan Agreement dated June 25, 2004, which is effective as of December
31, 2003, Textron changed the definitions on the covenants to exclude
accrued but unpaid costs related to the above mentioned Employment
Agreement. Based on the revised definitions, the Company was in compliance
with all covenants under the Loan Agreement for the quarters ended December
31, 2003 and year ended March 31, 2004. The Company anticipates that it
will be in compliance with these ratios, as amended, through the remainder
of the loan period.
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 7. In accordance with a warrant agreement dated 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 March 31, 2004), 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 May 2004 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 7), 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 March 31, 2004 was $9,381,985.
The SouthTrust term loan described above contains certain financial and
operating covenants. Due to the $1.8 million charge to operations related
to the Amended and Restated Employment Agreement for Angelo Morini, the
Company fell below the requirement for the tangible net worth covenant for
the quarter ended December 31, 2003. Pursuant to a Loan Modification letter
dated May 21, 2004, SouthTrust changed the definitions in its loan
covenants to exclude accrued but unpaid costs related to the above
mentioned Employment Agreement. Additionally, SouthTrust waived the
Company's need to comply with the Maximum Funded Debt to EBITDA ratio for
the year ended March 31, 2004. Based on the revised definitions and the
waiver, the Company was in
49
GALAXY NUTRITIONAL FOODS, INC.
NOTES TO FINANCIAL STATEMENTS
(Continued)
compliance with all covenants under the Loan Agreement for the quarter
ended December 31, 2003 and the year ended March 31, 2004. The Company
anticipates that it will be in compliance with these ratios, as amended,
through the remainder of the loan period. Additionally, the Loan
Modification letter dated May 21, 2004 established a pricing matrix which
will tie the interest rate charged on the term loan to the Company's
performance related to its funded debt to EBITDA ratio. Beginning October
1, 2004, the interest rate may be adjusted quarterly depending on the
Company's ratio at the end of the prior quarter. Interest will be assessed
in the range of prime to prime plus 1.25% according to the Company's
performance. SouthTrust charged a fee of $50,000 to make the all of the
above modifications to the term loan. The Company's management believes
that it will be able to offset a substantial portion of this fee in future
periods by securing lower interest rates related to improved ratios. The
fee is payable in four installments between June and December 2004.
In October 2000, the Company obtained a $1.5 million bridge loan from
SouthTrust Bank, which was guaranteed by Angelo S. Morini, the Company's
founder, and secured by the pledge of one million shares of the Company's
common stock owned by him. Interest on this note was at the prime rate. The
loan was paid in full in February 2004 and the collateral shares were
returned to the Company.
In March 2002, Angelo S. Morini, the Company's founder, loaned $330,000 to
the Company in order for it to pay down certain notes payable that were
coming due. This loan bore interest at the prime rate and was due on or
before June 15, 2006. In connection with a Second Amended and Restated
Employment Agreement effective October 13, 2003 between Mr. Morini and the
Company, the Company offset $167,603 of unreimbursed advances owed to it by
Mr. Morini and certain family members against the balance of the loan and
issued an aggregate of 55,087 shares of the Company's common stock (valued
at approximately $2.95 per share) as payment in full.
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 bore interest at 7% per annum and was
due in twelve equal monthly installments of $30,066. This note was paid in
full by September 30, 2003.
On June 26, 2002, the Company signed a $550,000 promissory note with
Excalibur Limited Partnership, one of the holders of the Company's Series A
convertible preferred stock. In consideration of the note, the Company
issued Excalibur Limited Partnership a warrant to purchase 30,000 shares of
the Company's common stock, which are exercisable until June 26, 2007 at a
price equal to $5.50 per share. This note was non-interest bearing assuming
that it was repaid on or before July 26, 2002. This note was secured by
250,000 shares of the Company's common stock owned by the Angelo S. Morini,
the Company's Founder. In consideration of his pledge, the Company granted
Mr. Morini stock options to acquire 289,940 shares of common stock at an
exercise price of $5.17 (110% of market) per share. These options expire on
July 1, 2007. On June 26, 2002, the Company received loan proceeds in the
amount of $500,000 in cash from Excalibur Limited Partnership. The
additional $50,000 was retained by Excalibur Limited Partnership as payment
for consulting fees due to Excalibur Limited Partnership in accordance with
a consulting agreement entered into on June 26, 2002, which expired
December 31, 2002. This note was paid in full on June 28, 2002 from
proceeds derived from the issuance of common stock to Stonestreet Limited
Partnership as discussed in Note 7.
Aggregate maturities of the SouthTrust term loan payable over future years
are as follows: 2005 - $1,140,000; 2006 - $1,826,250; 2007 - $1,995,000;
2008 - $1,995,000; 2009 - $1,995,000; and 2010 - $430,735
(6) Commitments and Contingencies
-----------------------------
Leases
------
The Company leases its operating facilities and certain equipment under
operating and capital leases, expiring at various dates through its fiscal
year 2009. The following is a schedule by years as of March 31, 2004, of
(1) future minimum lease payments under capital leases, together with the
present value of the net minimum lease payments and (2) future minimum
rental payments required under operating leases that have initial or
remaining terms in excess of one year:
50
GALAXY NUTRITIONAL FOODS, INC.
NOTES TO FINANCIAL STATEMENTS
(Continued)
Capital Operating
Leases Leases
---------- ----------
2005 $ 239,772 $ 746,608
2006 175,720 570,763
2007 12,211 358,197
2008 12,211 309,023
2009 9,646 272,734
2010 -- 91,769
---------- ----------
Total net minimum lease payments 449,560 $2,349,094
==========
Less amount representing interest 13,161
----------
Present value of the net minimum lease payments 436,399
Less current portion (231,432
----------
Long-term obligations under capital leases $ 204,967
==========
The total capitalized cost for equipment under capital lease is $1,808,810
with accumulated depreciation of $634,383 as of March 31, 2004.
Rental expense was approximately, $1,088,000 $1,190,000, and $1,102,000 for
the fiscal years ended March 31, 2004, 2003, 2002, respectively.
Employment Agreements
---------------------
In a Second Amended and Restated Employment Agreement effective October 13,
2003, Angelo S. Morini the Company's Founder, Vice-Chairman and President
resigned from his positions with the Company as Vice Chairman and President
and will no longer be involved in the daily operations of the Company. He
will retain the title of Founder and has been named Chairman Emeritus. Mr.
Morini will continue as an employee and as a member of the Company's Board
of Directors. Additionally, he may carry out special assignments designated
to him by the Chairman of the Board. The agreement is for a five-year
period beginning October 13, 2003 and provides for an annual base salary of
$300,000 plus standard health insurance benefits, club dues and an auto
allowance. Other material provisions of the agreement are as follows:
1. For the term of Mr. Morini's employment, the Company shall cause Mr.
Morini to be nominated for election to the Company's Board of Directors as
a member of the slate of directors proposed by the Company in its proxy
statement for any meeting of the Company's stockholders whereby directors
shall be elected. Notwithstanding the foregoing, in the event Mr. Morini is
not elected to the Board of Directors by the stockholders at any meeting of
the Company's stockholders for which the proxy statement indicates Mr.
Morini is nominated for election as a member of the slate of directors
proposed by the Company, such obligations shall immediately cease.
2. The Company will obtain, and maintain in effect during the term of Mr.
Morini's employment, for the benefit of Mr. Morini (or reimburse Mr. Morini
for the cost of) a Two Million Dollar ($2,000,000) term life insurance
policy insuring Mr. Morini's life, the beneficiaries of which shall be
designated by Mr. Morini.
3. Mr. Morini and the Company agreed that Mr. Morini and certain family
members received advances from the Company of which $167,603 was
unreimbursed as of October 13, 2003, and (ii) the Company owed $330,000 to
Mr. Morini pursuant to a loan on March 28, 2002 to the Company. Mr. Morini
and the Company agreed to offset the unreimbursed advances against the
amounts owed by the Company, and, in repayment of the remainder of the
amounts owed by the Company, the Company issued an aggregate of 55,087
shares of the Company's common stock to Mr. Morini (valued at approximately
$2.95 per share based on the average of the closing prices for the five
trading days preceding the effective date of the Agreement).
51
GALAXY NUTRITIONAL FOODS, INC.
NOTES TO FINANCIAL STATEMENTS
(Continued)
4. Mr. Morini has agreed that during the term of his employment, and for a
period of one (1) year following his termination of employment for any
reason other than pursuant to termination without cause, a material breach
of the agreement, or a change of control (as defined in the agreement) in
the Company for which he did not vote, he will not, directly or indirectly,
either as an employee, employer, consultant, agent, principal, partner,
stockholder (other than owning fewer than one percent (1%) of the
outstanding shares of a public corporation), corporate officer, director,
or any other individual or representative capacity, engage or participate
in any business that directly competes with the Company within those areas
in the United States in which the Company is doing business as of the date
of termination.
5. If the agreement is terminated by the Company without cause, Mr. Morini
shall: (a) be entitled to continued payment of his annual compensation,
health insurance benefits, club dues, auto allowance and life insurance
benefits for the remainder of the term of the agreement, (b) become fully
"vested" under the terms of any stock option agreements executed and
delivered prior to, along with, or after the agreement and (c) be released
from the terms of the $12,772,200 Loan Agreement dated June 15, 1999 and
all monies outstanding thereunder will be forgiven by the Company. The
provisions of the agreement related to the forgiveness of the $12,772,200
loan remain unchanged from the first Amended and Restated Employment
Agreement. Mr. Morini acknowledges that his change in role does not
constitute a termination of Mr. Morini by the Company, under the First
Amended and Restated Employment Agreement.
6. If Mr. Morini terminates his employment in any manner other than in
connection with a material breach of the agreement by the Company, he shall
not be entitled to receive any further compensation or benefits, except
that if he terminates his employment in connection with a change of control
(as defined in the Agreement) in the Company for which he did not vote, he
will be released from the terms of the $12,772,200 Loan Agreement dated
June 15, 1999 and all monies outstanding thereunder will be forgiven by the
Company. The provisions of the Agreement related to the forgiveness of the
$12,772,200 loan remain unchanged from the first Amended and Restated
Employment Agreement.
The Company accrued and expensed the five-year cost of this agreement in
the quarter ended December 31, 2003. The total estimated costs expensed
under this agreement are $1,830,329 of which $1,659,447 remained unpaid but
accrued ($366,305 as short-term liabilities and $1,293,142 as long-term
liabilities) as of March 31, 2004. The long-term portion will be paid out
in nearly equal monthly installments ending in October 2008.
The Company currently has employment agreements with several of its key
employees that provide for up to five-year severance in the event they are
terminated without cause.
Litigation
----------
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 alleged 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 was seeking a preliminary and
permanent injunction prohibiting the Company from further infringing acts
and was also seeking damages in the nature of either lost profits or
reasonable royalties.
On May 6, 2004, Schreiber Foods and the Company executed a settlement
agreement pursuant to which all claims in the patent infringement lawsuit
were dismissed. Pursuant to this settlement agreement, the Company procured
a worldwide, fully paid-up, nonexclusive license to own and use all of the
Company's individually wrapped slice equipment, which Schreiber alleged
infringed on Schreiber's patents. The Company was not obligated to make any
cash payment in connection with the settlement of the lawsuit or the
license granted in the settlement agreement. The settlement agreement
restricts the Company from using the slicing equipment to co-pack product
for certain specified manufacturers, however, the Company is not currently
engaged in any co-packing business with any of the specified parties, and
does not contemplate engaging in the future in any co-packing business with
the specified parties.
52
GALAXY NUTRITIONAL FOODS, INC.
NOTES TO FINANCIAL STATEMENTS
(Continued)
Pursuant to the settlement agreement, if, during the term of the license,
the Company receives an offer to purchase the Company or its business, the
Company must notify Schreiber of the offer and Schreiber will have the
option to match the offer or make a better offer to purchase the Company or
its business. Acceptance of the Schreiber offer is subject to the approval
by the Company's Board of Directors, however, if the Board of Directors
determines that the Schreiber offer is equal to or better than the other
offer, the Board of Directors must take all permitted actions to accept the
offer and recommend it to the Company's shareholders for approval.
The term of the license extends through the life of all patents named in
the lawsuit (and all related patents) and is assignable by the Company in
connection with the sale of its business. In the event the assignee uses
the applicable equipment to manufacture private label product, and such
private label product accounts for more than 50% of the total product
manufactured on the applicable equipment, the assignee will be required to
pay Schreiber a royalty in an amount to be agreed upon by Schreiber and the
assignee, but in any event not more than $.20 per pound of product for each
pound of private label product manufactured by the assignee in any year
that exceeds the amount of private label product manufactured by the
Company in the year preceding the sale of the Company or its business. In
the event that the parties cannot agree upon a royalty rate, the assignee
retains the license rights but private label production must be maintained
at a level less than 50% of the total product manufactured on the
applicable equipment.
(7) Capital Stock
-------------
Employee Stock Purchase Plan
----------------------------
In January 1992, the Company's stockholders approved the 1991 Employee
Stock Purchase Plan (the "1991 Purchase Plan"). The 1991 Purchase Plan
provides for the sale of up to an aggregate of 85,714 shares of common
stock to eligible employees. Up to 500 shares may be purchased by each
eligible employee at the lesser of 85% of the fair market value of the
shares on the first or last business day of the six-month purchase periods
ending August 31 and February 28. Substantially all full-time employees are
eligible to participate in the plan. During the year ended March 31, 2004,
16,339 shares were issued under this plan at prices of $1.49 and $1.96 per
share. During the year ended March 31, 2003, 9,880 shares were issued under
this plan at prices of $1.55 and $2.80 per share. During the year ended
March 31, 2002, 11,648 shares were issued under this plan at prices of
$4.63 and $4.80 per share. The weighted average fair value of the shares
issued were $1.75, $1.99, and $4.78 per share for the fiscal years ended
March 31, 2004, 2003 and 2002, respectively. As of March 31, 2004, there
were 29,795 shares available for purchase under the Plan.
Stock Warrants
--------------
At March 31, 2004, the Company had common stock warrants outstanding, which
were issued in connection with sales consulting, financial consulting, and
financing arrangements. Information relating to these warrants is
summarized as follows:
Expiration Date Number of Warrants Exercise Price
--------------- ------------------ -----------------
September 2004 7,500 $ 4.25
August 2005 7,143 2.05
December 2005 81,500 3.90
January 2006 33,571 2.05
April 2006 100,000 1.70
July 2006 500,000 2.00
July 2006 10,000 5.00
January 2007 42,592 5.74
June 2007 30,000 2.05
June 2007 122,549 5.52
May 2008 50,000 2.05
August 2008 1,429 2.05
January 2009 1,429 2.05
June 2009 100,000 1.97
June 2009 153,000 2.05
June 2012 2,143 2.05
-----------------
1,242,856
=================
On April 10, 2003, the Company entered into a credit arrangement with one
of its greater than 5% shareholders pursuant to which the shareholder
purchased raw materials for the Company in an aggregate amount that did not
exceed $500,000. 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. This warrant is
exercisable until April 10, 2006. The fair value of this warrant was
estimated at $63,000 and was recorded as non-cash compensation expense in
the quarter ended June 30, 2003.
On April 24, 2003, the Company and the Series A Preferred Holders entered
into a 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. The option expired on September 30, 2003.
Pursuant to such Agreement, the holders of the Series A convertible
preferred stock also agreed to extend the Company's required date to hold a
shareholders meeting, pursuant to an exercised right under the Series A
Purchase Agreement as discussed under "Series A Convertible Preferred
Stock" below, from February 5, 2003 to September 30, 2003. In exchange for
the option and the extension of the annual meeting date, the Company issued
warrants to purchase 250,000 shares of the Company's common stock to each
BH Capital Investments, L.P. and Excalibur Limited Partnership. These
warrants are exercisable until July 15, 2006 at an exercise price equal to
$2.00 per share. The fair value of these warrants was estimated at $230,000
and was recorded as non-cash compensation expense in the quarter ended June
30, 2003.
53
GALAXY NUTRITIONAL FOODS, INC.
NOTES TO FINANCIAL STATEMENTS
(Continued)
In connection with the consolidations and extensions of the SouthTrust Bank
loans as described in Note 5, 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
and will be amortized as non-cash compensation over 72 months beginning in
May 2003.
Stock Options
-------------
At March 31, 2004, the Company has three employee stock option plans, which
were adopted in 1987, 1991, and 1996 and has granted additional non-plan
stock options. Under the Company's stock option plans, qualified and
nonqualified stock options to purchase up to 200,500 shares of the
Company's common stock may be granted to employees and members of the Board
of Directors. The maximum and typical term of options granted under the
plans is ten years. Generally, options vest from zero to three years. The
following table summarizes information about plan stock option activity:
Weighted-Average Weighted-Average
Exercise Price Fair Value of
Shares per Share Options Granted
---------- -------------- -----------------
133,684 $ 4.60 --
Balance, March 31, 2001
Granted - at market 6,858 5.52 $3.19
Exercised (4,143) 4.71 --
Cancelled (32,855) 5.00 --
---------- --------------
103,544 4.54 --
Balance, March 31, 2002
Granted - at market 25,858 4.37 $2.51
Exercised (1,000) 4.25 --
Cancelled (23,096) 2.43 --
---------- --------------
105,306 2.66 --
Balance, March 31, 2003
Granted - at market 914 2.90 $1.65
Exercised (7,911) 2.05 --
Cancelled (2,948) 4.96 --
---------- --------------
95,361 $ 2.64 --
Balance, March 31, 2004
========== ==============
At March 31, 2004, 2003 and 2002, a total of 82,027, 85,306, and 84,955 of
the outstanding plan options were exercisable with a weighted-average
exercise price of $2.74, $2.80, and $4.69 per share, respectively.
54
GALAXY NUTRITIONAL FOODS, INC.
NOTES TO FINANCIAL STATEMENTS
(Continued)
The following table summarizes information about non-plan stock option
activity:
Weighted-Average Weighted-Average
Exercise Price Fair Value of
Shares per Share Options Granted
---------- ---------------- ----------------
Balance, March 31, 2001 1,887,983 $ 3.66 --
Granted - at market 830,000 4.54 $2.63
Cancelled (12,143) 6.59 --
---------- ----------------
Balance, March 31, 2002 2,705,840 3.93 --
Granted - at market 3,907,041 3.51 $1.72
Cancelled 2,066,041) 2.06 --
---------- ----------------
Balance, March 31, 2003 4,546,840 3.17 --
Granted - at market 400,000 2.73 $0.77
Cancelled (300,000) 2.24 --
---------- ----------------
Balance, March 31, 2004 4,646,840 $ 3.19 --
========== ================
At March 31, 2004, 2003, and 2002, a total of 4,452,006, 4,002,507, and
2,068,340 of the outstanding non-plan options were exercisable with a
weighted-average exercise price of $3.16, $3.19, and $3.73 per share,
respectively.
The following table summarizes information about plan and non-plan stock
options outstanding and exercisable at March 31, 2004:
Weighted- Weighted- Weignted-
Average Average Average Weighted-
Range of Options Remaining Exercise Options Remaining Average
Exercise Prices Outstanding Life Price Exercisable Life Exercise Price
--------------------- ------------------ ------------- ------------ ------------- -------------- ----------------
$1.60 - 1.99 132,143 8.7 years $ 1.79 132,143 8.7 years $ 1.79
2.00 - 2.99 1,676,726 4.7 years 2.11 1,618,558 4.5 years 2.11
3.00 - 3.99 1,921,198 5.4 years 3.41 1,921,198 5.4 years 3.41
4.00 - 4.99 576,716 5.9 years 4.29 426,716 5.5 years 4.25
5.00 - 5.99 432,797 3.3 years 5.20 432,797 3.3 years 5.20
6.00 -19.25 2,621 3.6 years 10.17 2,621 3.6 years 10.17
------------------ -------------
4,742,201 4,534,033
================== =============
Reserved
--------
At March 31, 2004, the Company has reserved common stock for future
issuance under all of the above arrangements totaling 5,985,057 shares.
Non-Cash Compensation Related to Options and Warrants
-----------------------------------------------------
There Company calculates 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
55
GALAXY NUTRITIONAL FOODS, INC.
NOTES TO FINANCIAL STATEMENTS
(Continued)
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 the
Company's founder, Angelo S. Morini, as disclosed in Note 9, are
treated as variable due to the nature of the note being non-interest
bearing and non-recourse. The Floor for the underlying shares is $4.38
per share. There was no non-cash compensation expense or income
related to these shares recorded during the fiscal year ended March
31, 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 $3,060,000 for the year ended March
31, 2003 based on the decrease in the market price of the Company's
common stock from $5.43 at March 31, 2002 to $1.87 at March 31, 2003.
The Company did not record any further non-cash compensation income
once the stock price fell below the Floor of $4.38. The Company
recorded non-cash compensation expense of $1,960,000 for the year
ended March 31, 2002, based on the increase in the market price of the
Company's common stock from the Floor of $4.38 to $5.43 at March 31,
2002.
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 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 (as discussed under Notes Receivable for
Common Stock above) 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 founder,
Angelo S. Morini, 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 in accordance with variable accounting
standards each period.
The Company recorded non-cash compensation expense of $8,001 related
to these variable options and warrants for the year ended March 31,
2004. There was no compensation expense recorded for the year ended
March 31, 2003, as the market price of the Company's stock was less
than the $2.05 Floor. The remaining outstanding variable options and
warrants as of March 31, 2004 were 3,882,092.
c. Option and Warrant Issuances
During the fiscal years ended March 31, 2004, 2003, and 2002, the
Company recorded $643,272, $153,238, and $413,662, respectively, as
non-cash compensation expense related to stock, options and warrants
that were issued to and vested by employees, officers, directors and
consultants. This expense is included in non-cash compensation in the
Company's Statements of Operations.
Series A Convertible Preferred Stock
------------------------------------
On April 6, 2001, 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 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 equal
to the quotient of $48.18, plus all accrued and unpaid dividends for each
share of the Series A convertible preferred stock, ($60.71 at March 31,
2004), 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.
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 events, as defined. The redemption price shall be paid in cash at
a price per preferred share equal to the greater of (a) 100% of the
preference amount ($48.18 plus accrued dividends) or (b) an amount equal to
the aggregate market price on the date of redemption of the common stock
that would be then issuable upon conversion of the preferred stock and
multiplied by 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. Should there be no additional
conversions on the Series A convertible preferred stock before April 6,
2005, the Company may be required to redeem the shares at a minimum price
in excess of $2.7 million.
56
GALAXY NUTRITIONAL FOODS, INC.
NOTES TO FINANCIAL STATEMENTS
(Continued)
The Series A Preferred Holders converted 13,490 and 15,262 shares of the
Series A convertible preferred stock plus accrued dividends, into 459,908
and 624,936 shares of common stock, respectively, during the years ended
March 31, 2004 and 2003, respectively. The conversion prices ranged from
$1.3633 to $1.75 and were based on the lower of (a) 95% of the average of
the two lowest closing bid prices on the AMEX for the fifteen trading days
immediately prior to conversion or (b) $1.75.
The Series A Preferred Holders have the right to receive on any outstanding
Series A convertible preferred stock a ten percent dividend on the shares,
payable one year after the issuance of such preferred stock, and an eight
percent dividend for the subsequent three years thereafter, payable in
either cash or shares of preferred stock. For the years ended March 31,
2004, 2003 and 2002, the Company recorded preferred dividends of $201,791,
$264,314, and $709,400, respectively, on the outstanding shares of the
Series A convertible preferred stock.
On April 6, 2001, the Company recorded the initial carrying value of the
preferred stock as $521,848. Each quarter the Company calculates an
estimated redemption value of the remaining preferred stock and then
calculates the difference between the initial carrying value and this
estimated redemption value. The difference 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 years
ended March 31, 2004, 2003 and 2002, the Company recorded $1,340,943,
$1,370,891, and $1,379,443, respectively, related to the accretion of the
redemption value of preferred stock and the beneficial conversion feature
of accrued dividends. As of March 31, 2004, the value of the remaining
43,894 shares of redeemable convertible preferred stock is $2,573,581.
On November 7, 2002, the Series A Preferred Holders exercised their right
under the Series A 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 and the exercise of their warrants. On
September 30, 2003, the Company's shareholders, by majority vote, approved
the issuance by the Company of all required common stock in the event of a
conversion of the Company's Series A Convertible Preferred Stock and upon
the exercise of certain warrants held by the Series A Preferred Holders.
Common Stock Issuances
----------------------
In October 2003, pursuant to an employment contract, the Company issued
17,500 shares of its common stock with a total value of $37,650 to a former
employee for his services from January 2003 to July 2003.
In March 2002, Angelo S. Morini, the Company's founder, loaned $330,000 to
the Company in order for it to pay down certain notes payable that were
coming due. This loan bore interest at the prime rate and was due on or
before June 15, 2006. In connection with a Second Amended and Restated
Employment Agreement effective October 13, 2003 between Mr. Morini and the
Company, the Company offset $167,603 of unreimbursed advances owed to it by
Mr. Morini and certain family members against the balance of the loan and
issued an aggregate of 55,087 shares of the Company's common stock (valued
at approximately $2.95 per share) as payment in full.
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. 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 former 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
57
GALAXY NUTRITIONAL FOODS, INC.
NOTES TO FINANCIAL STATEMENTS
(Continued)
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 in Note 5, 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.
In accordance with Section 4(2) of the Securities Act of 1933, as amended,
and pursuant to a Securities Purchase Agreement dated August 27, 2002, the
Company issued 65,404 shares of common stock for $4.08 per share in
settlement of an outstanding payable to Hart Design and Manufacturing, Inc.
in the amount of $266,848.
In accordance with Regulation D and pursuant to a certain common stock and
Warrants Purchase Agreement dated June 28, 2002, the Company sold 367,647
shares of common stock on June 28, 2002 for $4.08 (85% of an average market
price) and issued warrants to purchase 122,549 shares of common stock at a
price equal to $5.52 per share to Stonestreet Limited Partnership. In
connection with such sale, the Company issued 7,812 shares of common stock
to Stonestreet Corporation and 4,687 shares of common stock to H&H
Securities Limited in exchange for their services as finders. Per the terms
of the agreement, the Company received net proceeds of $930,000, after the
repayment of a $550,000 promissory note dated June 26, 2002 in favor of
Excalibur Limited Partnership and payment of $20,000 for Stonestreet
Limited Partnership's costs and expenses related to the purchase of these
shares of common stock.
In accordance with Section 4(2) of the Securities Act of 1933, as amended,
and pursuant to a Food Service Brokerage Agreement dated June 25, 2002, the
Company issued 140,273 shares of common stock for $4.08 per share on
September 9, 2002 to certain food brokers in consideration for prior
services rendered valued at $572,310.
58
GALAXY NUTRITIONAL FOODS, INC.
NOTES TO FINANCIAL STATEMENTS
(Continued)
(8) Income Taxes
------------
The components of the net deferred tax assets consist of the following:
March 31, 2004 2003
-----------------------------------------------------------------------------------------------------------
Deferred tax assets:
Net operating loss carry forwards $14,207,000 $13,391,000
Non-deductible reserves 198,000 401,000
Investment, alternative minimum and general business tax credits 86,000 139,000
Accrued employment contract 596,000 --
Other 635,000 442,000
-----------------------------------------------------------------------------------------------------------
Gross deferred income tax assets 15,722,000 14,373,000
Valuation allowance (11,816,000) (11,029,000)
-----------------------------------------------------------------------------------------------------------
Total deferred income tax assets 3,906,000 3,344,000
Deferred income tax liabilities:
Depreciation and amortization (3,906,000) (3,344,000)
-----------------------------------------------------------------------------------------------------------
Net deferred income tax assets -- --
Less current portion -- --
-----------------------------------------------------------------------------------------------------------
Long-term deferred income tax asset -- --
===========================================================================================================
The valuation allowance increased by $787,000, $1,037,000, and $6,451,000
for the years ended March 31, 2004, 2003, and 2002, respectively. The
Company has recorded a valuation allowance to state its deferred tax assets
at estimated net realizable value due to the uncertainty related to
realization of these assets through future taxable income.
Significant components of income tax (expense) benefit are as follows:
Years ended March 31, 2004 2003 2002
-----------------------------------------------------------------------------------------------------------
Current:
Federal $ -- $ -- $ --
State -- -- --
-----------------------------------------------------------------------------------------------------------
-- -- --
-----------------------------------------------------------------------------------------------------------
Deferred:
Federal -- -- (1,353,900)
State -- -- (206,100)
-----------------------------------------------------------------------------------------------------------
-- -- (1,560,000)
-----------------------------------------------------------------------------------------------------------
$ -- $ -- $ (1,560,000)
===========================================================================================================
Tax expense for the year ended March 31, 2000 for the Company's
liability for alternative minimum tax was $110,669. The alternative
minimum tax system limits the amount of alternative minimum NOL carry
forward that can be applied against current year alternative minimum
income, thus creating alternative minimum taxable income. Alternative
minimum tax paid is carried forward as a tax credit to offset federal
tax if incurred in the future. This credit does not expire.
59
GALAXY NUTRITIONAL FOODS, INC.
NOTES TO FINANCIAL STATEMENTS
(Continued)
The following summary reconciles differences from taxes at the federal
statutory rate with the effective rate:
--------------------------------------------------------------------------------------------------------
Years ended March 31, 2004 2003 2002
--------------------------------------------------------------------------------------------------------
Federal income taxes at statutory rates (34.0%) (34.0%) (34.0%)
Change in deferred tax asset valuation allowance 26.6% (93.4%) 41.8%
Alternative minimum tax -- -- --
Non deductible expenses:
Non deductible compensation -- 93.7% 4.3%
Imputed interest on note receivable 7.0% (18.8%) 1.5%
Other 0.4% 52.5% (3.5%)
Utilization of net operating loss carry forward -- -- --
-------------------------------------------------
Income taxes (benefit) at effective rates -- -- 10.1%
=================================================
Unused net operating losses for income tax purposes, expiring in various
amounts from 2008 through 2024, of approximately $37,800,000 are available
at March 31, 2004 for carry forward against future years' taxable income.
Under Section 382 of the Internal Revenue Code, the annual utilization of
this loss may be limited in the event there are changes in ownership.
(9) Related Party Transactions
--------------------------
Additional Morini Transactions
------------------------------
On October 24, 2002, the Company entered into a special services agreement
with Angelo S. Morini, authorizing him to author and promote "Veggiesizing,
the stealth/health diet" book, which promotes the Company's products. In
consideration of these services and for his continued personal pledges, the
Company granted him 900,000 shares at the market price of $2.05 on October
24, 2002. On December 4, 2002, as a result of discussions and negotiations
with certain major shareholders, Mr. Morini cancelled these options with
the Company and accepted new options to acquire 510,060 shares of common
stock - 200,000 options were granted at an exercise price of $4.08 per
share and 310,060 were granted at an exercise price of $2.05 per share.
These options expire on December 4, 2007. As a result of the cancellation
and reissuance of options, the Company will account for these options in
accordance with variable accounting standards.
On July 1, 2002, in consideration of his pledge of 250,000 shares of the
Company's common stock to secure a $550,000 promissory note by the Company
in favor of Excalibur Limited Partnership (See Note 5), the Company granted
Mr. Morini stock options to acquire 289,940 shares of common stock at an
exercise price of $5.17 (110% of market) per share. These options expire on
July 1, 2007.
In June 1999, in connection with an amended and restated employment
agreement for Angelo S. Morini, the Company's Founder, 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 the Company's common stock. Per the June
1999 employment agreement and the October 2003 Second Amended and Restated
Employment Agreement, 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 (as discussed in Note 5), which was guaranteed by Angelo S.
Morini and secured by one million of his above mentioned 2,914,286 shares
of the Company's common stock. These one million shares were returned to
the Company when the loan was paid in full during February 2004.
60
GALAXY NUTRITIONAL FOODS, INC.
NOTES TO FINANCIAL STATEMENTS
(Continued)
Other Related Party Transactions
--------------------------------
Beginning January 13, 2003, the Company entered into a vendor arrangement
with one of its employees pursuant to which the employee purchased 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
purchased raw materials for the Company in an aggregate amount that did not
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 and 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 with Fromageries Bel S.A. ("Bel"), a leading branded
cheese company in Europe who is a greater than 5% shareholder in the
Company. The agreement became effective upon the closing of the Textron
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 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.
A director of the Company was paid consulting fees totaling $32,300,
$77,520, and $79,600 for introductions into several large foodservice
companies during the fiscal years ended March 31, 2004, 2003, and 2002,
respectively. Another director of the Company was paid $59,000 for his
consulting services on marketing issues.
(10) Economic Dependence
-------------------
For the fiscal years ended March 31, 2004, 2003 and 2002, the Company did
not have any customer that comprised more than 10% of net sales.
For the fiscal year ended March 31, 2004, the Company did not have any
supplier that comprised more than 10% of raw material purchases. For the
fiscal year ended March 31, 2003, the Company purchased approximately
$2,23899,000 from one supplier totaling approximately 13% of raw material
purchases for the fiscal year. For the fiscal year ended March 31, 2002,
the Company purchased approximately $3,374,000 from one supplier totaling
approximately 19% of raw material purchases for the fiscal year.
(11) Employee Benefit Plan
---------------------
The Company has a 401(k) defined contribution plan covering all employees
meeting certain minimum age and service requirements. The Company's
contributions to the plan are determined by the Board of Directors and are
limited to a maximum of 50% of the employee's contribution and 6% of the
employee's compensation. Company contributions to the plan amounted to
$35,807, $21,820, and $38,911 for the fiscal years ended March 31, 2004,
2003 and 2002, respectively.
61
(12) Supplemental Cash Flow Information
----------------------------------
Years ended March 31, 2004 2003 2002
----------------------------------------------------------------------------------------------------------------
Non-cash financing and investing activities:
Purchase of equipment through capital lease obligations and term
notes payable $ 55,672 $ 94,763 $1,564,355
Amortization of consulting and directors fees paid through
issuance of common stock warrants 643,272 153,238 413,662
Reduction in accounts payable through issuance of notes payable -- 347,475 --
Reduction in accounts payable through issuance of common stock 37,650 839,158 --
Reduction in notes payable through issuance of common stock 162,424 -- --
Preferred dividends recorded for preferred
shareholder waiver received in exchange for
issuance of common stock
-- -- 359,400
Accrued preferred stock dividends 201,791 264,314 350,000
Beneficial conversion feature related to preferred stock dividends 84,923 62,035 120,321
Accretion of discount on preferred stock 1,256,020 1,308,856 1,259,122
Discount related to preferred stock -- -- 2,003,770
Cash paid for:
Interest (expensed and capitalized) 1,396,419 2,349,002 3,579,953
Income taxes -- 51,037 --
(13) Earnings Per Share
-------------------
The following is a reconciliation of basic net earnings (loss) per share to
diluted net earnings (loss) per share:
Years ended March 31, 2004 2003 2002
----------------------------------------------------------------------------------------------------------------
Net loss available to common shareholders $(4,504,907) $(601,077) $(19,147,995)
================= ================ =================
Weighted average shares outstanding - basic 14,937,005 12,110,349 10,556,203
"In-the-money" shares under stock option agreements -- -- --
"In-the-money" shares under stock warrant agreements -- -- --
Less: Shares assumed repurchased under treasury stock
method -- -- --
----------------- ---------------- -----------------
Weighted average shares outstanding - diluted 14,937,005 12,110,349 10,556,203
================= ================ =================
Basic net loss per common share $ (0.30) $ (0.05) $ (1.81)
================= ================ =================
Diluted net loss per common share $ (0.30) $ (0.05) $ (1.81)
================= ================ =================
Potential conversion of the Series A convertible preferred stock for
1,522,658 shares, options for 4,742,201 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 year ended March 31, 2004 as their effects
were antidilutive. Potential conversion of the Series A convertible
preferred stock for 2,013,831 shares, options for 4,652,146 shares and
warrants for 742,856 shares have not been included in the computation of
diluted net income (loss) per common share for the year ended March 31,
2003 as their effects were antidilutive. Potential conversion of the Series
A convertible preferred
62
GALAXY NUTRITIONAL FOODS, INC.
NOTES TO FINANCIAL STATEMENTS
(Continued)
stock for 769,034 shares, options for 2,809,384 shares and warrants for
490,878 shares have not been included in the computation of diluted net
income (loss) per common share for the year ended March 31, 2002 as their
effects were antidilutive.
(14) Fourth Quarter Adjustments
--------------------------
There were no significant or unusual adjustments in the fourth quarter of
fiscal 2004 and 2003.
During the fourth quarter of fiscal 2002, the Company recorded the
following adjustments:
Credits and reserves issued on accounts receivable $3,474,242
Deferred tax valuation reserve 1,560,000
Inventory write-offs 581,201
Write-off of unused advertising credits 547,386
Disposal of fixed assets 464,190
Due to the nature of the above adjustments, it is impractical to apply
their effects to prior quarters.
(15) Schedule of Valuation Account
-----------------------------
Balance at Charged to Write-Offs,
Beginning of Costs and Retirements and Balance at
Year Expenses Collections End of Year
-------------------------------------------------------------------------------------------------------------------
Year Ended March 31, 2002:
Allowance for trade receivables $375,000 $6,364,871 ($5,929,405) $810,466
Year Ended March 31, 2003:
Allowance for trade receivables $810,466 $2,159,891 ($2,337,136) $633,221
Year Ended March 31, 2004:
Allowance for trade receivables $633,221 2,433,458 ($2,433,679) $633,000
In addition to reserving for potential uncollectible accounts, the Company
uses its allowance for trade receivables account to estimate future credits
that will be issued to customers for items such as discounts, rebates,
sales promotions, coupons, slotting fees and spoils that relate to current
period sales. For the years ended March 31, 2004, 2003 and 2002, the
Company recorded an expense of $59,908, $127,389 and $925,836, respectively
related to bad debt. For the years ended March 31, 2004 and 2003, this
amounted to less than 0.5% of gross sales and for the year ended March 31,
2002 it was approximately 2% of gross sales.
63
GALAXY NUTRITIONAL FOODS, INC.
NOTES TO FINANCIAL STATEMENTS
(Continued)
(16) Quarterly Operating Results (Unaudited)
---------------------------------------
Unaudited quarterly operating results are summarized as follows:
Three Months Ended (Unaudited)
-----------------------------------------------------------------------
2004 March 31 December 31 September 30 June 30
----
------------- ---------------- ----------- -------------
Net sales $ 8,512,702 $ 9,638,571 $ 9,329,907 $ 8,695,781
Gross margin 2,745,256 2,922,821 2,999,930 2,644,665
Net income (loss) 614,430 (1,378,354) (228,145) (1,970,104)
Net income (loss) for common shareholders 906,277 (1,557,986) (933,385) (2,919,813)
Basic net income (loss) per common share 0.06 (0.10) (0.06) (0.21)
Diluted net income (loss) per common share 0.06 (0.10) (0.06) (0.21)
Stockholders' equity 8,226,481 7,497,656 8,404,579 9,191,983
Three Months Ended (Unaudited)
-----------------------------------------------------------------------
2003 March 31 December 31 September 30 June 30
----
------------- ---------------- ----------- -------------
Net sales $ 10,213,005 $ 9,755,729 $10,062,331 $ 9,977,704
Gross margin 3,222,414 2,949,866 3,015,101 2,741,200
Net income (loss) (241,059) (476,568) 732,245 1,019,510
Net income (loss) for common shareholders 70,755 (1,823,610) 541,545 610,233
Basic net income (loss) per common share 0.01 (0.15) 0.05 0.05
Diluted net income (loss) per common share 0.01 (0.15) 0.04 0.05
Stockholders' equity 6,440,346 6,470,626 7,111,328 7,062,553
64
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not Applicable.
ITEM 9A. CONTROLS AND PROCEDURES.
As of March 31, 2004, an evaluation was performed under the supervision and with
the participation of the Company's management, including the Chief Executive
Officer ("CEO"), and the Chief Financial Officer ("CFO"), of the effectiveness
of the design and operation of the Company's disclosure controls and procedures
to insure that the Company records, processes, summarizes and reports in a
timely and effective manner the information required to be disclosed in reports
filed with or submitted to the Securities and Exchange Commission. Based on that
evaluation, the Company's management, including the CEO and CFO, concluded that
the Company's disclosure controls and procedures were effective in timely
bringing to their attention material information related to the Company required
to be included in the Company's periodic Securities and Exchange Commission
filings. Since the date of this evaluation, there have been no significant
changes in the Company's internal controls or in other factors that could
significantly affect those controls.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
The following table sets forth the current directors and executive officers of
the Company as of June 25, 2004, as well as their respective ages and positions
with the Company:
NAME AGE POSITIONS
- ---------------------------------------------------------------------------------------------------------------
David H. Lipka 74 Director, Chairman of the Board of Directors
Michael E. Broll (1) 55 Director
Thomas R. Dyckman (1) (2) 72 Director, Chairman of the Audit Committee
Charles L. Jarvie (2) 67 Director, Chairman of the Compensation Committee
Joseph J. Juliano (2) 53 Director
Angelo S. Morini 61 Director
Christopher J. New 43 Director and Chief Executive Officer
Patrice M.A. Videlier (1) 61 Director
Salvatore J. Furnari 39 Chief Financial Officer
John W. Jackson 46 Vice President of Sales
Christopher E. Morini 48 Vice President of New Business Development and Key Accounts
Thomas J. Perno 49 Vice President of Operations
Kulbir Sabharwal 61 Vice President of Technical Services
(1) Audit Committee Member
(2) Compensation Committee Member
65
The Board of Directors is currently comprised of the eight directors, including
the Chairman of the Board, of which six are non-employee directors. The Chairman
of the Board and the directors hold office until the next annual meeting of
stockholders and until their successors have been duly elected and qualified.
The executive officers of the Company are elected annually at the first Board of
Directors meeting following the annual meeting of shareholders, and hold office
until their respective successors are duly elected and qualified, unless sooner
displaced.
Directors
- ---------
David H. Lipka spent forty years (1955-1995) with DCA Food Industries Inc., an
international manufacturer of food ingredients and equipment with combined sales
in excess of $1 billion per annum, holding positions of president, chief
executive officer, and chief operating officer. Since 2001, Mr. Lipka has served
on the board of directors of Doctor's Associates Inc. (Subway Stores) and has
served on numerous boards including Dunkin Donuts Inc. (1989-1994), Allied-Lyons
Inc. (1988-1994), and Kerry Group PLC (1995-1996). Mr. Lipka has also been
chairman and chief executive officer of Pennant Foods and Leons Baking Company.
He obtained a B.S. degree from Brooklyn College and attended the Graduate School
of Business at New York University. Mr. Lipka has agreed to serve as a director
of the Company at the request of Frederick A. DeLuca, a beneficial owner of more
than five percent (5%) of the Company's common stock. Both Messrs. Lipka and
DeLuca are members of the Board of Directors of Doctor's Associates Inc.
Michael E. Broll is a private investor and consultant in the food industry, and
most recently was President and CEO, from 1999 to 2002, of Chef Solutions Inc.,
a subsidiary of LSG Lufthansa, a business specializing in providing convenient
baked foods and prepared meals to food service and retail segments of the food
industry. Mr. Broll's career includes major executive assignments with
Allied-Domecq Retailing as the head of its total supply chain for North America
from 1997 to 1999, Nestle USA as the head of all supply chains for the chilled
food group in North America from 1993 to 1995, and Pillsbury Company as its Vice
President of Operations for the bakery group supply chain from 1991 to 1993. Mr.
Broll received his BS in Economics from the University of Illinois in 1978.
Thomas R. Dyckman is currently the Ann Whitney Olin Professor of Accounting at
the S.C. Johnson Graduate School of Management at Cornell University, Ithaca,
New York, and has been a professor at Cornell University since 1964. Mr. Dyckman
also served as Acting Vice President of the University for Information
Technology (1998-1999) at Cornell University. He has conducted management
executive programs for Goodyear, IBM, Gould Pump, New England Telephone, Ocean
Spray, Columbia University, G.T.E. and Sylvania. Mr. Dyckman served as a
consultant on research issues to the Financial Accounting Standards Board (FASB)
from 1977 to 1988. During the mid 1990's he was acting dean of the S.C. Johnson
Graduate School of Management at Cornell University. He is a member of the
American Accounting Association and the Accounting Researchers International
Association, and completed terms with the Financial Accounting Standards
Advisory Committee (1984-1987) and the Financial Accounting Foundation
(1989-1993). Mr. Dyckman has more than sixty published articles and is the
author of ten books. He received his B.A., M.B.A. and Ph.D. from the University
of Michigan.
Charles L. Jarvie, a partner with Beta Capital Group, LLC, has had an
illustrious business career. After twenty years with the Procter and Gamble
Company (1959-1979), he was president of Dr. Pepper Company (1980-1983), and
Fidelity Investments Marketing Corp. (1983-1984), and Chief Executive Officer of
Schenley Industries, Inc. (1984-1988). He has also served as a director of
Guinness America, Inc. (1988-1992), chief executive officer of New Era Beverage
Company (1990-1992), chairman of Universal Sports America (1995-2000), president
of Host Communications, Inc. (1992-2000), chairman of Streetball Partners, Inc.
(1990-2000) and chairman of J/P Management Associates, Inc. (1990-present). His
accomplishments include the acquisition of Canada Dry Corporation, and the sale
of Schenley Industries, Host Communications and New Era Beverage Company. Mr.
Jarvie has helped generate and implement and still enforces strategic plans for
many successful turnarounds. Mr. Jarvie has numerous civic and business
associations serving as a director or member of many prestigious organizations
and companies. He is a graduate of Cornell University where he received both his
B.S. and M.B.A.
66
Joseph J. Juliano was elected to the Board of Directors on June 16, 1999. From
1973 to 1988, Mr. Juliano served in various management positions for Pepsi-Cola
Company. In 1988, Mr. Juliano managed Pepsi Cola Company Bottling Operations
where he achieved record sales and profits during his three-year tenure in this
position. From 1991 to 1998, he served as Vice President of Prestige, Sports and
Gaming for Pepsi Cola North America. In 1998, he was promoted to Vice President
of Entertainment Sales, with expanded domestic and international account
responsibilities encompassing movie theaters, theme parks, sports venues, golf
management companies, theme restaurants, hotels, and casinos. Mr. Juliano
currently serves on the board of Nevada Gold & Casinos, Inc, a developer of
gaming properties. Mr. Juliano received his B.S. in marketing and Masters in
Business Administration from St. John's University in New York City.
Angelo S. Morini was the Founder and inventor of the Company's healthier dairy
alternative formula and was President of the Company since its inception until
October 2003.. In December 2002, he was elected as the Vice-Chairman of the
Board of Directors and President. On December 17, 2002, Mr. Morini resigned from
his positions as Chief Executive Officer and Chairman of the Board. Effective
October 13, 2003, Angelo S. Morini the Company's Founder, Vice-Chairman and
President resigned from his positions with the Company as Vice-Chairman and
President and will no longer be involved in the daily operations of the Company.
He will retain the title of Founder and has been named Chairman Emeritus. From
1987 to December 2002, he served as Chairman of the Board of Directors,
President, and Chief Executive Officer. Between 1972 and 1980, Mr. Morini was
the general manager of Galaxy Cheese Company, which operated as a sole
proprietorship until its incorporation in May 1980. Prior to 1974, he was
associated with the Food Service Division of Pillsbury Company and the Post
Division of General Foods Company. In addition, he worked in Morini Markets, his
family-owned and operated chain of retail grocery stores in the New Castle,
Pennsylvania area. Mr. Morini received a B.S. degree in Business Administration
from Youngstown State University in 1968. Mr. Morini's brother, Christopher E.
Morini, works for the Company as Vice President of New Business Development and
Key Accounts. Prior to November 2003, Angelo S. Morini's wife, Julie Morini, was
employed by the Company in the marketing and public relations departments. Mr.
Morini's brother, Ronald Morini, worked for the Company until October 31, 2003
as an engineering consultant and was paid $61,310 in consulting fees and
benefits during the fiscal year ended March 31, 2004.
Christopher J. New was appointed the Company's Chief Marketing Officer and Vice
President of Strategy on September 4, 2001. On December 14, 2001, the Board
appointed Mr. New as Chief Operating Officer and on December 17, 2002 the Board
appointed him as Chief Executive Officer. From 1993 through 2001, Mr. New was
the Vice President of Commercial Strategies & Services for Tropicana Products of
Bradenton, Florida. At Tropicana, Mr. New's responsibilities included direction
and leadership of strategic planning, marketing, business development, sales
planning, e-commerce, customer service and category management. Prior to his
employment at Tropicana, Mr. New served as Senior Marketing Manager of Mott's
USA, a division of Cadbury Schweppes, for four years. Mr. New received his M.S.
in marketing and economics from Cornell University in 1986.
Patrice M.A. Videlier currently serves as Senior Vice President of Marketing -
World for Fromageries Bel S.A. a company organized under the laws of France. Mr.
Videlier has held numerous Sales and Marketing vice presidential positions over
divisions such as the Natural Cheese Division, the European Division, and the
International Worldwide Division; and he has served as a director for
Fromageries Bel S.A. since 1990. From 1969 to 1989, Mr. Videlier was a senior
marketing executive with Unilever Co. Mr. Videlier received his Masters in
Business Administration from Indiana University. Mr. Videlier has agreed to
serve as a director of the Company at the request of Fromageries Bel S.A., a
beneficial owner of more than five percent (5%) of the Company's common stock.
Mr. Videlier received his Masters in Business Administration from Indiana
University in 1968.
67
Executive Officers
- ------------------
Salvatore J. Furnari, CPA was appointed the Company's Chief Financial Officer on
July 8, 2002. From November 11, 2001 until July 8, 2002, Mr. Furnari served as
the Company's Controller. Prior to joining the Company, Mr. Furnari was
Corporate Controller and Treasurer of Pritchard Industries, Inc. From 1998
through 1999, he served as Chief Financial Officer and Vice President of Finance
for Garage Management Corporation; and from 1993 until 1998, he was Chief
Financial Officer of American Asset Corporation. Mr. Furnari received his B.S.
in accounting from Queens College in New York City in May 1987.
John W. Jackson has been Vice President of Sales for the Company since 1993.
From 1985 through 1992, Mr. Jackson was director of sales for H.J. Heinz
Company. Mr. Jackson received his B.S. in business administration and accounting
from Mars Hill College in 1980.
Christopher E. Morini has been the Vice President of New Business Development
and Key Accounts since September 2001, having formerly served as Vice President
of Marketing and International Sales for the Company since 1993. From 1986
through 1993, Mr. Morini was a Vice President of the Company, where he has been
responsible for various sales and marketing divisions of the Company, including
the Food Service, International Sales and Retail Sales divisions. Mr. Morini
started with the Company as an area salesman in 1983 and became sales manager in
1984. Mr. Morini received a B.S. in economics from Slippery Rock University in
1978. Christopher E. Morini's brother, Angelo S. Morini, is the Founder of the
Company.
Thomas J. Perno has worked for the Company since 1983. He began as a Shipping
and Receiving Supervisor, then he was promoted to Plant Manager and then to Vice
President of Operations. Mr. Perno received his M.S in Electrical Engineering
from Penn State University in 1976.
Kulbir Sabharwal has been Vice President of Technical Services for the Company
since 1991. Dr. Sabharwal worked as the Director of Research and Quality Control
for Gilardies Frozen Foods from 1987 to 1990 and for Fisher Cheese Company from
1972 to 1986. Dr. Sabharwal received his Ph.D. from the Ohio State University in
1972.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires the
Company's executive officers and directors, and persons who own more than 10% of
a registered class of the Company's equity securities, to file reports of
ownership and changes in ownership with the Securities and Exchange Commission
and the American Stock Exchange. Officers, directors and stockholders owning
more than 10% of the Company's common stock are required by SEC regulations to
provide the Company with copies of all the reports they file pursuant to Section
16(a).
Based solely upon the Company's review of those reports required by Section
16(a) and filed by or on behalf of the Company's officers, directors and
stockholders owning greater than 10% of the Company's common stock, or written
representations that no such reports were required which were submitted by such
persons, the Company believes that during the fiscal year ended March 31, 2004,
all of the officers and directors and stockholders owning greater than 10% of
the Company's common stock complied with all applicable Section 16(a) filing
requirements except for Michael E. Broll, Charles L. Jarvie and John W. Jackson.
Each of the named individuals filed one report containing one transaction
related to the acquisition of stock options after the required two or ten day
reporting period, as applicable.
68
Other
- -----
The Company has adopted a code of ethics as defined in Item 406 of Regulation
S-K, which code applies to all of its employees, including its principal
executive officer, principal financial officer, principal accounting officer and
persons performing similar functions. This code of ethics is available free of
charge on the Company's website at www.galaxyfoods.com.
Additionally, the Company has adopted corporate governance guidelines and
charters for its Audit and Compensation Committees and will adopt a code of
business conduct and ethics that applies to the members of its Board of
Directors. All of these materials may be acquired free of charge by requesting a
copy by writing to: Corporate Secretary, Galaxy Nutritional Foods, Inc. 2441
Viscount Row, Orlando, FL 32809.
Audit Committee
- ---------------
The Company maintains a separately designated standing audit committee in
accordance with Section 3(a)(14)(A) of the Securities Exchange Act of 1934, as
amended. The audit committee members are Thomas R. Dyckman, Michael E. Broll and
Patrice M.A. Videlier.
The Board of Directors has determined that all members of the audit committee
are financially capable and that Thomas R. Dyckman, the audit committee
chairman, is an "audit committee financial expert" within the meaning of the
regulations of the Securities and Exchange Commission. Mr. Dyckman is considered
an audit committee financial expert related to his significant and relevant
accounting and financial experience disclosed above. The Company has determined
that all audit committee members are "independent" as that term is defined in
Item 7(d)(3)(iv) of Schedule MA promulgated under the Exchange Act. No member of
the audit committee received any payments from the Company other than
compensation received as a director of the Company. Mr. Dyckman has declined all
cash compensation for his director services to the Company.
Nominating Committee
- --------------------
The Company does not have a standing nominating committee as of the date of this
report, but the Board of Directors intends to establish a nominating committee
prior to the filing of the Company's proxy statement for its next annual
meeting.
ITEM 11. EXECUTIVE COMPENSATION
Summary Compensation Table
- --------------------------
The following table sets forth the compensation during the fiscal years ended
March 31, 2004, 2003 and 2002 paid to the following individuals (each, a "Named
Executive Officer"): the Company's Chief Executive Officer and (i) its four
other most highly compensated executive officers, and (ii) up to two additional
individuals for whom disclosure would have been provided but for the fact that
the individual was not serving as an executive officer at the end of the last
completed fiscal year; provided, in the cases of (i) and (ii) above, that no
disclosure is provided for any individual whose total annual salary and bonus
does not exceed $100,000:
69
SUMMARY COMPENSATION TABLE
Long-Term Compensation
Annual Compensation Awards Payouts
(a) (b) (c) (d) (e) (f) (g) (h) (i)
Other
Annual Restricted All Other
Compen- Stock Securities LTIP Compen-
Names and Fiscal Salary Bonus sation Award(s) Underlying Payouts sation
Principal Position Year ($) ($) ($) ($) Options/SARs (#) ($) ($) (34)
- -----------------------------------------------------------------------------------------------------------------------------------
Christopher J. New 2004 188,539 - 26,601 (2) - - - 5,106
Chief Executive Officer (1) 2003 165,673 - 16,564 (3) - 125,000(5) - 2,855
2002 89,693 - 7,583 (4) - 100,000(6) - -
Salvatore J. Furnari 2004 134,577 - 25,600 (8) - - - 5,106
Chief Financial Officer (7) 2003 116,923 - (33) - 30,000(9) - 4,680
2002 28,077 - (33) - 10,000(10) - 700
John W. Jackson 2004 138,000 - 11,510 (12) - - - 6,302
Vice President of Sales (11) 2003 138,000 - 10,250 (13) - 96,429(15) - 4,591
2002 138,000 38,300 10,296 (14) - 75,000(16) - 1,200
Angelo S. Morini 2004 300,000 - 38,512 (19) - - - 14,086
Founder and Director (17) 2003 300,000 53,706 (18) 33,349 (20) - 800,000(22) - 4,556
2002 300,000 - 31,407 (21) - 375,000(23) - 3,450
Christopher E. Morini 2004 155,000 - 18,135 (25) - - - 5,106
Vice President of Int'l 2003 155,000 - 17,626 (26) - 97,143(28) - 4,829
Sales (24) 2002 155,000 23,000 18,865 (27) - 75,000(29) - 3,450
Kulbir Sabharwal 2004 132,500 - (33) - - - 7,438
Vice President of Technical
Services (30) 2003 130,000 - (33) - 63,143(31) - 6,343
2002 118,000 - (33) - 45,000(32) - 3,450
(1) On September 4, 2001, Christopher J. New was appointed Chief
Marketing Officer and Vice President of Strategy. In December 2001,
the Board appointed Mr. New as Chief Operating Officer and on
December 17, 2002, the Board appointed Mr. New as Chief Executive
Officer. Effective January 1, 2004, the Board approved an increase
in his annual compensation from $180,000 to $210,000.
(2) For the fiscal year ended March 31, 2004, the Company paid $26,601
for an auto allowance for Mr. New.
(3) For the fiscal year ended March 31, 2003, the Company paid $14,835
for an auto allowance and $1,729 for auto insurance for Mr. New.
(4) For the fiscal year ended March 31, 2002, the Company paid $7,583 to
Mr. New for an auto allowance.
(5) In December 2002, the Company granted options to acquire 25,000
shares of the Company's common stock at an exercise price equal to
the market price on the date of grant of $1.67 per share to Mr. New
in consideration for his continued employment with the Company. Such
options are fully exercisable and expire December 5, 2012. In
October 2002, the Company repriced 100,000 options, which were
previously granted (as described below in footnote 6) and therefore
are included.
(6) Under the terms of his employment agreement, Mr. New received an
option to purchase up to 100,000 shares of the Company's common
stock at an exercise price equal to the market price on the date of
grant of $4.98 per share. On October 11, 2002, the Company repriced
the options to purchase 100,000 shares from $4.98 per share to the
then-market price of $2.05 per share. One-third of such options
shall become exercisable in September each year until all such
options are exercisable. In the event of a change in control, all
such options shall immediately become exercisable. Such options
expire July 16, 2011.
(7) On July 8, 2002, Salvatore Furnari was appointed Chief Financial
Officer of the Company. From November 2002 to July 8, 2002, he
worked as the Company's Controller. Effective January 1, 2004, the
Board approved an increase in his annual compensation from $130,000
to $145,000.
(8) For the fiscal year ended March 31, 2004, the Company paid $25,600
for a car allowance for Mr. Furnari.
(9) On July 8, 2002, the Company granted options to acquire 20,000
shares of the Company's common stock at an exercise price equal to
the market price on the date of grant of $4.55 per share to Mr.
Furnari in consideration for his continued employment with the
Company. On October 11, 2002, the Company repriced the options to
purchase 20,000 shares from $4.55 per share to the then-market price
of $2.05 per share. One-third of such options shall become
exercisable each year in July 2003, 2004 and 2005 until all such
options are exercisable. In the event of a change in control, all
such options shall immediately become exercisable. Such options
expire July 8, 2012. In October 2002, the Company repriced 10,000
options, which were previously granted (as described below in
footnote 10) and therefore are included.
70
(10) Under the terms of his employment agreement, Mr. Furnari received an
option to purchase up to 10,000 shares of the Company's common stock
at an exercise price equal to the market price on the date of grant
of $5.60 per share. On October 11, 2002, the Company repriced the
options to purchase 10,000 shares from $5.60 per share to the
then-market price of $2.05 per share. One-fourth of the options
became exercisable February 12, 2002 and one-fourth shall become
exercisable on each of the following December 12, 2002, 2003 and
2004. Such options expire November 12, 2011.
(11) Effective April 1, 2004, Mr. Jackson's employment agreement provides
for an annual base salary of $144,900. Prior to this, the annual
base salary was $138,000. In March 2002, Mr. Jackson received
$38,300 in bonuses related to fiscal 2000.
(12) For the fiscal year ended March 31, 2004, the Company paid $10,943
in auto lease and auto allowance payments and $567 for automobile
insurance.
(13) For the fiscal year ended March 31, 2003, the Company paid $8,871 in
auto lease payments and $1,379 for automobile insurance.
(14) For the fiscal year ended March 31, 2002, the Company paid $8,917 in
auto lease payments and $1,379 for automobile insurance.
(15) On October 11, 2002, the Company repriced all 96,429 outstanding
options held by Mr. Jackson from their original exercise price to
the then-market price of $2.05 per share. The original exercise
prices of the options were equal to the market price on the date of
grant as follows: 14,286 options at $2.84; 75,000 options (as
further described below in footnote 16) at $4.40 and 7,143 options
at $8.47.
(16) In April 2001, Mr. Jackson was granted an incentive stock option to
purchase up to 75,000 shares of common stock at an exercise price
equal to the market price on the date of grant of $4.40 per share.
On October 11, 2002, the Company repriced the options to purchase
75,000 shares from $4.40 per share to the then-market price of $2.05
per share. One-third of such options shall become exercisable on
each anniversary of the grant date until all such options are
exercisable. Such options expire April 19, 2011.
(17) In a Second Amended and Restated Employment Agreement effective
October 13, 2003, Angelo S. Morini the Company's Founder,
Vice-Chairman and President resigned from his positions with the
Company as Vice-Chairman and President and will no longer be
involved in the daily operations of the Company. He will retain the
title of Founder and has been named Chairman Emeritus. Mr. Morini
will continue as an employee and as a member of the Company's Board
of Directors. Additionally, he may carry out special assignments
designated to him by the Chairman of the Board. The Agreement is for
a five-year period beginning October 13, 2003 and provides for an
annual base salary of $300,000 plus standard health insurance
benefits, club dues and an auto allowance.
(18) For the fiscal year ended March 31, 2003, the Company accrued
bonuses of $53,706 to Mr. Morini. These bonuses were used to pay
down the employee advances due from Mr. Morini at the end of fiscal
2003.
(19) For the fiscal year ended March 31, 2004, the Company paid $24,584
in auto lease and auto allowance payments and $13,928 for club dues
for Mr. Morini.
(20) For the fiscal year ended March 31, 2003, the Company paid $21,081
in auto lease payments, $1,670 for automobile insurance, and $10,598
for club dues for Mr. Morini.
(21) For the fiscal year ended March 31, 2002, the Company paid $20,833
in auto lease payments, $1,670 for automobile insurance, and $8,904
in club dues for Mr. Morini.
(22) On July 1, 2002, the Board of Directors granted Mr. Morini options
to acquire 289,940 shares of common stock at an exercise price of
$5.17 per share (110% of market) in consideration of Mr. Morini's
pledge of 250,000 shares of the Company's common stock to secure a
$550,000 bridge loan to the Company from Excalibur Limited
Partnership. Such options are fully exercisable and shall expire on
July 1, 2007. Effective as of December 4, 2002, the Board of
Directors granted Mr. Morini options to acquire 510,060 shares of
common stock in accordance with the terms of a special services
agreement between the Company and Mr. Morini for writing a
comprehensive diet and recipe book about the Company and its
products and for the potential distribution of this book worldwide.
Of these 510,060 options, 200,000 have an exercise price of $4.08
per share and 310,060 have an exercise price of $2.05 per share.
Such options are fully exercisable and shall expire on December 4,
2007. The market price on the date of grant was $1.67.
71
(23) In April 2001, Angelo S. Morini was granted incentive stock options
to acquire 375,000 shares of common stock at an exercise price equal
to the market price on the date of grant of $4.40 per share.
One-fifth of such options shall become exercisable on each
anniversary of the grant date until all such options are
exercisable. Such options shall expire on April 19, 2011.
(24) Mr. C. Morini's annual base salary was $155,000. In March 2002, Mr.
Morini received $23,000 in bonuses related to fiscal 2000.
(25) For the fiscal year ended March 31, 2004, the Company paid $12,595
for auto lease payments, $1,368 for automobile insurance, and $4,172
for club dues for Mr. C. Morini.
(26) For the fiscal year ended March 31, 2003, the Company paid $12,595
for auto lease payments, $1,368 for automobile insurance, and $3,663
for club dues for Mr. C. Morini.
(27) For the fiscal year ended March 31, 2002, the Company paid $12,536
in auto lease payments, $1,368 for automobile insurance, and $4,961
for club dues for Mr. C. Morini.
(28) On October 11, 2002, the Company repriced all 97,143 outstanding
options held by Mr. C. Morini from their original exercise price to
the then-market price of $2.05 per share. The original exercise
prices of the options were equal to the market price on the date of
grant as follows: 14,286 options at $2.84, 714 options at $3.50;
75,000 options (as further described below in footnote 29) at $4.40
and 7,43 options at $8.47.
(29) In April 2001, Mr. C. Morini was granted an incentive stock option
to purchase up to 75,000 shares of common stock at an exercise price
equal to the market price on the date of grant of $4.40 per share.
On October 11, 2002, the Company repriced the options to purchase
75,000 shares from $4.40 per share to the then-market price of $2.05
per share. One-third of such options shall become exercisable on
each anniversary of the grant date until all such options are
exercisable. Such options expire April 19, 2011.
(30) Effective April 1, 2004, Mr. Sabharwal will receive an annual base
salary of $135,200. Prior to this, the annual base salary was
$130,000 during fiscal 2004 and $118,000 during fiscal 2003.
(31) On September 20, 2002, Mr. Sabharwal was granted an incentive stock
option to purchase up to 11,000 shares of common stock at an
exercise price equal to the market price on the date of grant of
$3.12 per share. Two thousand (2,000) such options shall become
exercisable one year from the grant date and then 3,000 per year
thereafter on each anniversary of the grant date until all such
options are exercisable. Such options expire September 20, 2012. On
October 11, 2002, the Company repriced all 63,143 outstanding
options held by Mr. Sabharwal from their original exercise price to
the then-market price of $2.05 per share. The original exercise
prices of the options were equal to the market price on the date of
grant as follows: 7,143 options at $8.47, 45,000 options (as further
described below in footnote 32) at $4.40 and 11,000 options at
$3.12.
(32) In April 2001, Mr. Sabharwal was granted an incentive stock option
to purchase up to 45,000 shares of common stock at an exercise price
equal to the market price on the date of grant of $4.40 per share.
On October 11, 2002, the Company repriced the options to purchase
75,000 shares from $4.40 per share to the then-market price of $2.05
per share. One-third of such options shall become exercisable on
each anniversary of the grant date until all such options are
exercisable. Such options expire April 19, 2011.
(33) Other than the options described in the footnotes above, there were
no other annual compensation, perquisites or other personal
benefits, securities or property equal to the lesser of $50,000 or
10% of the total annual salary and bonus reported for such Named
Executive Officer.
(34) "All Other Compensation" represents the health insurance premiums
and employer matching 401k contributions paid by the Company on
behalf of the indicated Named Executive Officer.
72
Aggregate Option Exercises and Fiscal Year-End Option Value Table
- -----------------------------------------------------------------
The following table summarizes for each Named Executive Officer each exercise of
stock options during the fiscal year ended March 31, 2004 and the fiscal
year-end value of unexercised options. The value of unexercised in-the-money
options at March 31, 2004 is based on a value of $1.93 per share, the closing
price of the Company's common stock on the American Stock Exchange on March 31,
2004:
AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR AND YEAR-END OPTION VALUES
- ------------------------------------------------------------------------------------------------------------------------------------
Shares Number of Securities Value of
Acquired on Value Underlying Unexercised Options/SARS at Unexercised
Exercise Realized ($) Fiscal Year-End (#) In-the-Money Options/SARS
Name (#) at Fiscal Year-End ($)
- ------------------------------------------------------------------------------------------------------------------------------------
Exercisable Unexercisable Exercisable Unexercisable
----------------- --------------------- ----------------- ---------------------
Christopher J. New -- -- 92,984 33,334 $6,500 --
Salvatore J. Furnari -- -- 14,166 15,834 -- --
John W. Jackson -- -- 96,429 -- -- --
Angelo S. Morini -- -- 2,888,447 150,000 -- --
Christopher E. Morini -- -- 96,429 -- -- --
Kulbir Sabharwal -- -- 55,393 9,000 -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Compensation of Directors
- -------------------------
Standard Arrangements. Each non-employee director who served on the Board of
Directors during the fiscal year ended March 31, 2004 was entitled to receive a
fee of $2,500 plus expenses for each Board of Directors meeting in which they
attended in person on or before September 30, 2003. After September 30, 2003,
the Board agreed to reduce this fee to $1,500 per meeting. Additionally, each
non-employee director of the Company is entitled to receive, on October 1 of
each year, options to purchase a number of shares of common stock equal to (i)
286 shares, if such director served for a full year prior to the October 1
anniversary date, or (ii) a pro rated amount equal to 24 shares for each full
month served during the year prior to such anniversary date, if such director
did not serve for a full year prior to the anniversary date. Such options are
granted pursuant to the Company's 1991 Non-Employee Director Stock Option Plan,
which was adopted by the Board of Directors on October 1, 1991, and approved by
the shareholders of the Company on January 31, 1992, as the same was amended by
that certain 1996 Amendment and Restatement of the 1991 Non-Employee Director
Stock Option Plan (as amended, the "Director Plan").
Other Arrangements. During each of the fiscal years ended March 31, 2004, 2003
and 2002, Joseph J. Juliano, a director of the Company, received cash or
benefits totaling $32,300, $77,520, and $79,600, respectively, in return for
developing and maintaining business relationships with prospective and existing
customers and suppliers on behalf of the Company. During the fiscal year ended
March 31, 2004, C. Anthony Wainwright was granted options to acquire 200,000
shares of common stock at an exercise price of $2.17 per share (123% of the
closing price of the common stock as reported by AMEX) in consideration of his
acceptance of the position as a member of the Board of Directors. On December
17, 2003, Michael E. Broll, was granted options to acquire 200,000 shares of
common stock at an exercise price of $3.29 per share (130% of the closing price
of the common stock as reported by AMEX) in consideration of his acceptance of
position as a member of the Board of Directors. During the fiscal year ended
March 31, 2004, Charles L. Jarvie received total compensation of $59,000 for his
services as Chairman of the Board prior to August 22, 2003 and for his
consulting services to the Company. David H. Lipka received $34,417 for his
services as Chairman of the Board from September 22, 2003 to March 31, 2004.
73
Employment Agreements
- ---------------------
Angelo S. Morini. In a Second Amended and Restated Employment Agreement
effective October 13, 2003, Angelo S. Morini the Company's Founder,
Vice-Chairman and President resigned from his positions with the Company as
Vice-Chairman and President and will no longer be involved in the daily
operations of the Company. He will retain the title of Founder and has been
named Chairman Emeritus. Mr. Morini will continue as an employee and as a member
of the Company's Board of Directors. Additionally, he may carry out special
assignments designated to him by the Chairman of the Board. The agreement is for
a five-year period beginning October 13, 2003 and provides for an annual base
salary of $300,000 plus standard health insurance benefits, club dues and an
auto allowance. Other material provisions of the Agreement are as follows:
1. For the term of Mr. Morini's employment, the Company shall cause Mr.
Morini to be nominated for election to the Company's Board of
Directors as a member of the slate of directors proposed by the
Company in its proxy statement for any meeting of the Company's
stockholders whereby directors shall be elected. Notwithstanding the
foregoing, in the event Mr. Morini is not elected to the Board of
Directors by the stockholders at any meeting of the Company's
stockholders for which the proxy statement indicates Mr. Morini is
nominated for election as a member of the slate of directors
proposed by the Company, such obligations shall immediately cease.
2. The Company will obtain, and maintain in effect during the term of
Mr. Morini's employment, for the benefit of Mr. Morini (or reimburse
Mr. Morini for the cost of) a Two Million Dollar ($2,000,000) term
life insurance policy insuring Mr. Morini's life, the beneficiaries
of which shall be designated by Mr. Morini.
3. Mr. Morini and the Company agreed that Mr. Morini and certain family
members received advances from the Company of which $167,603 was
unreimbursed as of October 13, 2003, and (ii) the Company owed
$330,000 to Mr. Morini pursuant to a loan on March 28, 2002 to the
Company. Mr. Morini and the Company agreed to offset the
unreimbursed advances against the amounts owed by the Company, and,
in repayment of the remainder of the amounts owed by the Company,
the Company issued an aggregate of 55,087 shares of the Company's
common stock to Mr. Morini (valued at approximately $2.95 per share
based on the average of the closing prices for the five trading days
preceding the effective date of the agreement).
4. Mr. Morini has agreed that during the term of his employment, and
for a period of one (1) year following his termination of employment
for any reason other than pursuant to termination without cause, a
material breach of the agreement, or a change of control (as defined
in the agreement) in the Company for which he did not vote, he will
not, directly or indirectly, either as an employee, employer,
consultant, agent, principal, partner, stockholder (other than
owning fewer than one percent (1%) of the outstanding shares of a
public corporation), corporate officer, director, or any other
individual or representative capacity, engage or participate in any
business that directly competes with the Company within those areas
in the United States in which the Company is doing business as of
the date of termination.
5. If the agreement is terminated by the Company without cause, Mr.
Morini shall: (a) be entitled to continued payment of his annual
compensation, health insurance benefits, club dues, auto allowance
and life insurance benefits for the remainder of the term of the
Agreement, (b) become fully "vested" under the terms of any stock
option agreements executed and delivered prior to, along with, or
after the agreement and (c) be released from the terms of the
$12,772,200 Loan Agreement dated June 15, 1999 and all monies
outstanding thereunder will be forgiven by the Company. The
provisions of the agreement related to the forgiveness of the
$12,772,200 loan remain unchanged from the first Amended and
Restated Employment Agreement. Mr. Morini acknowledges that his
change in role does not constitute a termination of Mr. Morini by
the Company, under the First Amended and Restated Employment
Agreement.
74
6. If Mr. Morini terminates his employment in any manner other than in
connection with a material breach of the agreement by the Company,
he shall not be entitled to receive any further compensation or
benefits, except that if he terminates his employment in connection
with a change of control (as defined in the agreement) in the
Company for which he did not vote, he will be released from the
terms of the $12,772,200 Loan Agreement dated June 15, 1999 and all
monies outstanding thereunder will be forgiven by the Company. The
provisions of the agreement related to the forgiveness of the
$12,772,200 loan remain unchanged from the first Amended and
Restated Employment Agreement.
The Company accrued and expensed the five-year cost of this agreement in the
quarter ended December 31, 2003. The total estimated costs expensed under this
agreement are $1,830,329 of which $1,659,447 remained unpaid but accrued
($366,305 as short-term liabilities and $1,293,142 as long-term liabilities) as
of March 31, 2004. The long-term portion will be paid out in nearly equal
monthly installments ending in October 2008.
Christopher J. New. On September 4, 2001, Christopher J. New was appointed Chief
Marketing Officer and Vice President of Strategy. In December 2001, the Board
appointed him to Chief Operating Officer and in December 2002, the Board
appointed him to Chief Executive Officer. Mr. New's current employment agreement
provides for a base salary of $210,000. Mr. New will also be entitled to receive
a bonus of up to 40% of his base salary at fiscal year end with the
qualification of such bonus to be determined by the Board of Directors. The
agreement also provides for an automobile allowance up to $2,700 per month. In
the event of a change in ownership of the Company which results in his
termination, Mr. New will be entitled to receive three years of his base salary
as severance. In the event Mr. New's employment is terminated after September 4,
2003, but prior to September 4, 2004, he will be entitled to receive two years
of his base salary as severance. In the event Mr. New's employment is terminated
after September 4, 2004, he will be entitled to receive three years of his base
salary as severance. In the event of a change in control of the majority
ownership of the Company or he is terminated without cause, all prior granted
but unvested stock options will immediately vest.
Salvatore J. Furnari. On November 11, 2001, Mr. Furnari was appointed as
Controller and on July 8, 2002, he was appointed as the Company's Chief
Financial Officer. Under the terms of his current employment agreement, he will
receive an annual base salary of $145,000. In the event of a change in control
of the majority ownership of the Company or he is terminated without cause, all
prior granted but unvested stock options will immediately vest. In the event Mr.
Furnari's employment is terminated, he will be entitled to receive one year of
his base salary, auto allowance and health benefits as severance.
John W. Jackson. In August of 1993, Mr. Jackson was appointed as Vice President
of Sales. Mr. Jackson's current employment agreement provides for a base salary
of $144,900 and an auto allowance of $1,000 per month. Mr. Jackson will also be
entitled to a bonus that shall not exceed 40% of his base salary based on
certain personal and Company goals as established by the Company's Chief
Executive Officer. In the event of a change in ownership of the Company which
results in his termination, Mr. Jackson will be entitled to receive three years
of his base salary as severance. In the event Mr. Jackson's employment is
otherwise terminated, he is entitled to receive one year of his base salary as
severance, the payment of which shall be made at the Company's discretion.
Christopher E. Morini. Angelo S. Morini's brother, Christopher E. Morini, works
for the Company as Vice President of New Business Development and Key Accounts.
From February of 1993 until October 2001, Mr. C. Morini served as Vice President
of Marketing. Mr. C. Morini's current employment agreement provides for a base
salary of $155,000 per year, an automobile lease with insurance, which together
shall not exceed $1,100 per month, and monthly country club dues. Mr. C. Morini
will also be entitled to a bonus that shall not exceed 40% of his base salary
based on certain personal and Company goals as established by the Company's
Chief Executive Officer. In the event Mr. C. Morini's employment is terminated,
Mr. C. Morini will be entitled to receive five years of his base salary as
severance.
75
Additional Information with Respect to Insider Participation in Compensation
- --------------------------------------------------------------------------------
Committee
- ---------
From April 1, 2003 until August 22, 2003, the committee members consisted of
David H. Lipka (chairman), Thomas R. Dyckman, Joseph J. Juliano and C. Anthony
Wainwright. On August 22, 2003, Charles L. Jarvie replaced Mr. Lipka as the
Chairman and in October 2003, upon the death of Mr. Wainwright, the committee
was reduced to three members.
None of the current or former members of the Compensation Committee is or has
been an officer or employee of the Company. All current members are independent
within the meaning of the listing standards of the AMEX except for Mr. Juliano
who, prior to September 2003, received compensation for his services in
developing and maintaining business relationships with prospective and existing
customers and suppliers on behalf of the Company. During each of the fiscal
years ended March 31, 2004, 2003 and 2002, Mr. Juliano, received cash or
benefits totaling $32,300, $77,520, $79,600, respectively. From April 2002 to
August 31, 2003, the Company leased an apartment in New York from 400 East 84th
Street Associates, LP at $6,460 per month and allowed Mr. Juliano use of this
apartment in lieu of direct cash payments for his services.
Board Report on Executive Compensation
- --------------------------------------
The following report describes the compensation policies applicable to the
Company's executive officers' compensation for the fiscal year ended March 31,
2004:
ROLE OF THE COMPENSATION COMMITTEE
- ----------------------------------
In accordance with the charter of the Compensation Committee (the "Committee"),
the Committee is appointed by the Board to oversee the overall Company
compensation policies and their specific application to executive officers
elected by the Board and to members of the Board.
In order to carry out this purpose, the Committee has the following duties and
responsibilities with respect to setting the compensation of the Chief Executive
Officer and other executive officers of the Company who are elected by the
Board:
o To periodically review compensation policies and strategies that apply
generally to all or groups of Company employees;
o To regularly review and evaluate compensation of executive officers of
the Company;
o To approve compensation of executive officers of the Company as
designated by the Board or for which it cannot be delegated to the
Company's Chief Executive Officer;
o To review and approve corporate goals and objectives relevant to the
compensation of the Company's Chief Executive Officer and President;
o To evaluate the performance of the Chief Executive Officer and
President in light of the approved corporate goals and objectives;
o To set the base salary and short-term incentive compensation of the
Chief Executive Officer and President based on the Committee's
evaluation of competitive compensation practices and their performance
in achieving the corporate goals established for the position as set
by the Committee;
76
o To set the long-term incentive compensation of the Chief Executive
Officer and President considering the Company's performance and
relative shareholder return, along with the value of incentive awards
to chief executives at other companies;
o To make recommendations to the Board with respect to incentive
compensation plans and equity based plans;
o To regularly review and evaluate the compensation program for
Directors and, as appropriate, recommend changes to the Board;
o To administer and otherwise exercise the various authorities
prescribed for the Committee by the Company's Stock Plans including
the Non-Employee Directors Stock Plan
The Committee has the authority to retain a compensation consultant to assist in
the evaluation of Director, CEO or principal officer compensation, as well as
such other experts as the Committee deems necessary in the performance of its
duties.
COMPENSATION OF EXECUTIVE OFFICERS
- ----------------------------------
In reviewing and approving the base salaries of executive officers, other than
the Chief Executive Officer and President as discussed below, the Committee
considered the terms of any existing employment contract with the executive, the
recommendation of the Chief Executive Officer, responsibility levels and the
salary norms for other individuals in comparable positions. The salaries for the
most highly compensated executive officers of the Company are disclosed in the
Executive Compensation Summary Table.
For salary increases to its Chief Financial Officer during fiscal 2004 and for
salary increases that became effective on the first day of fiscal 2005 for other
Named Executive Officers, the Committee approved them based on the above stated
factors.
COMPENSATION OF THE COMPANY'S FOUNDER (FORMERLY ITS PRESIDENT)
- --------------------------------------------------------------
During fiscal 2004, the Committee along with the Board of Directors entered into
a Second Amended and Restated Employment Agreement effective October 13, 2003
with Angelo S. Morini, the Company's Founder. In accordance with the agreement,
which is more fully disclosed above under "Employment Agreements - Angelo S.
Morini," Mr. Morini resigned from his positions with the Company as
Vice-Chairman and President and will no longer be involved in the daily
operations of the Company. He will retain the title of Founder and has been
named Chairman Emeritus. Mr. Morini will continue as an employee and as a member
of the Company's Board of Directors. Additionally, he may carry out special
assignments designated to him by the Chairman of the Board. The agreement is for
a five-year period beginning October 13, 2003 and provides for an annual base
salary of $300,000 plus standard health insurance benefits, club dues and an
auto allowance.
COMPENSATION OF THE COMPANY'S CHIEF EXECUTIVE OFFICER
- -----------------------------------------------------
During the year ended March 31, 2004, the Committee recommended and it was
approved by the Board of Directors to increase the base salary for Christopher
J. New, the Company's Chief Executive Officer from $180,000 to $210,000
effective January 1, 2004, based on his performance in completing the corporate
restructuring and refinancing in May 2003 and to increase him to a salary level
more comparable to other executives in this role.
BONUS, STOCK AWARDS AND PERFORMANCE-BASED COMPENSATION
- ------------------------------------------------------
There were no bonuses, stock awards, or performance based compensation paid to
any Named Executive Officer during the year ended March 31, 2004 as the
Compensation Committee is in the process of developing a more formal plan and
evaluation criteria against which to measure the performance of the executive
officers.
Respectively submitted by the Compensation Committee: Charles L. Jarvie
Thomas R. Dyckman
Joseph J. Juliano
77
Stock Performance Graph
- -----------------------
The following graph provides a comparison of the Company's cumulative total
shareholder return on the Company's common stock with the cumulative total
return of the Standard & Poor's SmallCap Index and a peer group index for the
five-year period beginning April 1, 1999:
COMPARATIVE OF FIVE YEAR (1) CUMULATIVE TOTAL RETURNS OF (2)
GALAXY NUTRITIONAL FOODS COMMON STOCK, THE S&P
SMALLCAP INDEX (3) AND A PEER GROUP INDEX (4)
[CHART]
COMPARATIVE OF FIVE YEAR (1) CUMULATIVE TOTAL RETURNS OF (2)
GALAXY NUTRITIONAL FOODS COMMON STOCK, THE S&P
SMALLCAP INDEX (3) AND A PEER GROUP INDEX (4)
2000 2001 2002 2003 2004
------- ------- ------- ------- -------
Galaxy Nutritional Foods $ 95.17 $127.48 $140.13 $ 48.26 $ 49.81
S&P Small Cap $129.73 $127.14 $153.92 $114.72 $177.97
Peer Group $ 87.49 $ 70.04 $ 71.28 $ 52.87 $ 40.49
(1) Compares fiscal years ending on or about March 31st of the years
indicated.
(2) The comparison of total return on investment assumes $100 invested on
April 1, 1999 in Galaxy Nutritional Foods common stock and in each S&P
Small Cap Index and the Peer Group.
(3) The S&P Small Cap Index is composed of public companies with market
capitalizations between zero and $1 billion. As of June 25, 2004, the
Company had a market capitalization of approximately $37 million.
(4) Companies in the Peer Group Index are food manufacturing and distribution
companies within the S&P Food Group Indexes. The companies included are
Hain Celestial Group, Conagra Foods, International Multifoods, Lance, and
Tofutti Brands.
78
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
EQUITY COMPENSATION PLAN INFORMATION
- ------------------------------------
The following table describes the Company's compensation plans under which the
Company's common stock are authorized for issuance as of March 31, 2004:
EQUITY COMPENSATION PLAN INFORMATION TABLE
(a) (b) (c)
Plan Category Number of Securities to be Weighted-average exercise Number of securities remaining
issued upon exercise of price of outstanding options, available for future issuance
outstanding options, warrants warrants and rights under equity compensation
and rights plans (excluding securities
reflected in column (a))
Equity compensation plans
approved by security holders 4,370,772 $ 3.11 107,932
Equity compensation plans
not approved by security
holders (1) 371,429 $ 3.95 N/A
------------------ -------------------------------
Total 4,742,201 $ 3.18
================== ===============================
(1) These securities were issued pursuant to individual compensation
arrangements prior to July 2, 1997 or after September 30, 2003 and have
not been approved by security holders.
Security Ownership of Certain Beneficial Owners
- -----------------------------------------------
The following tables describe the beneficial ownership of the Company's common
stock and the Company's Series A convertible preferred stock by each person or
entity known to the Company to be the beneficial owner of more than 5% of the
outstanding shares of the Company's capital stock outstanding as of June 25,
2004. The tables show beneficial ownership in accordance with the rules of the
Securities and Exchange Commission to include securities that a named person or
entity has the right to acquire within 60 days.
79
COMMON STOCK OWNERSHIP OF 5% OR MORE STOCKHOLDERS
Amount and Nature of
Name and Address of Beneficial Owner Beneficial Ownership (1) Percent of Class (2)
- ------------------------------------------------------------------------------------------
Angelo S. Morini
2441 Viscount Row
Orlando, Florida 32809 6,387,806 (3) 34.3%
John Hancock Advisors, Inc.
101 Huntington Avenue
Boston, Massachusetts 02117 1,451,348 (4) 9.2%
BH Capital Investments, L.P.
175 Bloor Street East
South Tower, 7th Floor
Toronto, Ontario, Canada M4W 3R8 981,413 (5) 5.6%
Excalibur Limited Partnership
33 Prince Arthur Avenue
Toronto, Ontario, Canada M5R IB2 1,051,314 (6) 6.0%
Royce & Associates LLC
1414 Avenue of the Americas
New York, NY 10019 1,227,000 (7) 7.8%
Frederick A. DeLuca
c/o Doctor's Associates, Inc.
325 Bic Drive
Milford, Connecticut 06460 1,269,842 8.1%
Fromageries Bel S.A
16, Bd Malesherbes 75008
Paris, France 1,111,112 (8) 7.1%
(1) The inclusion herein of any shares deemed beneficially owned does
not constitute an admission of beneficial ownership of these shares.
(2) The total number of shares outstanding as of June 25, 2004 is
15,724,073. The percentages are calculated on the basis of the
amount of shares outstanding plus shares which may be acquired
through the exercise of options, warrants, rights or conversion
privileges by such holder within sixty (60) days of June 25, 2004.
(3) Includes options to acquire 2,888,197 shares of the Company's common
stock, which are currently exercisable at prices ranging from $2.05
to $5.25 per share. Options expire as to 13,072 shares on October 1,
2006, as to 432,797 on July 1, 2007, as to 517,203 shares on
December 4, 2007, as to 1,357,000 shares on June 15, 2009, as to
343,125 on December 15, 2010, and as to 225,000 on April 19, 2011.
Also includes a warrant to purchase 250 shares at an exercise price
of $5.744 per share, which expires on January 17, 2007. With the
exception of the options, 10,500 shares held in a nominee name, 286
shares held in joint tenancy and 714 shares held individually, all
of Mr. Morini's shares and warrant are held by Morini Investments
Limited Partnership, a Delaware limited liability partnership, of
which Angelo Morini is the sole Limited Partner and Morini
Investments LLC is the sole General Partner. Mr. Morini is the sole
member of Morini Investments LLC.
(4) The information is based solely on a Schedule 13G filed with the SEC
on February 6, 2004 by each of the reporting persons listed below.
John Hancock Advisers, LLC has direct beneficial ownership of, and
sole voting power and sole dispositive power to, the reported shares
pursuant to Advisory Agreements for the following: John Hancock
Small Cap Value Fund, John Hancock Small Cap Equity Fund, John
Hancock Small Cap Value Fund, John Hancock Focused Relative Value
Fund, and John Hancock Small Cap Value Fund. Each of The Berkeley
Financial Group, LLC, John Hancock Subsidiaries, LLC, John Hancock
Life Insurance Company, and John Hancock Financial Services, Inc.
report that they do not beneficially own any of the reported shares
except through their indirect, wholly owned subsidiary, John Hancock
Advisers, LLC.
(5) Includes a warrant to purchase 250,000 shares of the Company's
common stock, which is exercisable until July 15, 2006 at $2.00 per
share. BH Capital Investments, L.P. ("BH Capital) informed the
Company that it owned 12,597 shares of the Company's common stock as
of June 25, 2004. Additionally, BH Capital still holds 20,430 shares
of the Series A convertible preferred stock, which are presently
convertible with accrued dividends into 718,816 shares of common
stock. Combined BH Capital has potential beneficial ownership in
981,413 shares of the Company's common stock.
80
However, BH Capital, together with its affiliates (which includes
Excalibur Limited Partnership), may not convert the Series A
convertible preferred stock into an amount that, upon giving effect
to such conversion, would cause the aggregate number of shares of
common stock beneficially owned by BH Capital and its affiliates to
exceed 9.99% of the outstanding shares of the Company's common stock
following such conversion. BH Capital has the right to waive such
restriction upon not less than 61 days prior notice to the Company.
As of June 25, 2004, the Company has not received any such notice.
Because BH Capital and Excalibur Limited Partnership cannot
collectively own more than 1,742,382 common shares (9.99% of the
Company's outstanding shares excluding 25,196 shares currently owned
by the Series A Preferred Holders), BH Capital may only convert its
Series A convertible preferred stock into 428,471 shares of common
stock as of June 25, 2004 on the assumption that Excalibur Limited
Partnership will convert all of its outstanding warrants and Series
A preferred stock into a total ownership of 1,051,314 common shares.
The information is based solely on a Schedule 13G, filed with the
SEC on February 10, 2004: Each of the following reporting persons
are deemed to beneficially own a pro rata share of the maximum 9.9%
of the Company's common stock beneficially owned by the group, which
pro rata share does not exceed 4.99% of the class: BH Capital
Investments, L.P., HB and Co., Inc., Henry Brachfeld, Excalibur
Limited Partnership, Excalibur Capital Management, Inc. and William
S. Hechter. Lillian Brachfeld is the sole stockholder of HB and Co,
Inc. and the wife of Henry Brachfeld. Lillian Brachfeld has
disclaimed pursuant to Rule 13d-4 of the Securities Exchange Act of
1934, as amended, beneficial ownership of all shares she may be
deemed to beneficially own by reason of such status. The address of
the principal business office of BH Capital Investments, L.P., HB
and Co., Inc., Henry Brachfeld and Lillian Brachfeld is 175 Bloor
Street East, South Tower, Suite 705, Ontario Canada M4W 3R8. The
address of the principal business office of Excalibur Limited
Partnership, Excalibur Capital Management, Inc. and William S.
Hechter is 33 Prince Arthur Avenue, Toronto, Ontario, Canada M5R
1B2.
(6) Includes a warrant to purchase 250,000 shares of the Company's
common stock, which is exercisable until July 15, 2006 at $2.00 per
share, and a warrant to purchase 30,000 shares of the Company's
common stock, which is exercisable until June 26, 2007 at $2.05 per
share. Excalibur Limited Partnership ("Excalibur") informed the
Company that it owned 12,599 shares of the Company's common stock as
of June 25, 2004. Additionally, Excalibur still holds 21,564 shares
of the Series A convertible preferred stock, which are presently
convertible with accrued dividends into 758,715 shares of common
stock. Combined Excalibur has potential beneficial ownership
1,051,314 shares of the Company's common stock.
However, Excalibur, together with its affiliates (which includes BH
Capital), may not convert the Series A convertible preferred stock
into an amount that, upon giving effect to such conversion, would
cause the aggregate number of shares of common stock beneficially
owned by Excalibur and its affiliates to exceed 9.99% of the
outstanding shares of the Company's common stock following such
conversion. Excalibur has the right to waive such restriction upon
not less than 61 days prior notice to the Company. As of June 25,
2004, the Company has not received any such notice.
Because BH Capital and Excalibur cannot collectively own more than
1,742,382 common shares (9.99% of the Company's outstanding shares
excluding 25,196 shares currently owned by the Series A Preferred
Holders), Excalibur may only convert its Series A convertible
preferred stock into 468,370 shares of common stock as of June 25,
2004 on the assumption that BH Capital will convert all of its
outstanding warrants and Series A preferred stock into a total
ownership of 981,413 common shares.
The information is based solely on a Schedule 13G filed with the SEC
on February 10, 2004: Each of the following reporting persons are
deemed to beneficially own a pro rata share of the maximum 9.9% of
the Company's common stock beneficially owned by the group, which
pro rata share does not exceed 4.99% of the class: BH Capital
Investments, L.P., HB and Co., Inc., Henry Brachfeld, Excalibur
Limited Partnership, Excalibur Capital Management, Inc. and William
S. Hechter. Lillian Brachfeld is the sole stockholder of HB and Co,
Inc. and the wife of Henry Brachfeld. Lillian Brachfeld has
disclaimed pursuant to Rule 13d-4 of the Securities Exchange Act of
1934, as amended, beneficial ownership of all shares she may be
deemed to beneficially own by reason of such status. The address of
the principal business office of BH Capital Investments, L.P., HB
and Co., Inc., Henry Brachfeld and Lillian Brachfeld is 175 Bloor
Street East, South Tower, Suite 705, Ontario Canada M4W 3R8. The
address of the principal business office of Excalibur Limited
Partnership, Excalibur Capital Management, Inc. and William S.
Hechter is 33 Prince Arthur Avenue, Toronto, Ontario, Canada M5R
1B2.
81
(7) The information is based solely on a Schedule 13G filed with the SEC
on February 3, 2004 by Royce and Associates, LLC. Royce and
Associates, LLC has the sole voting power and sole dispositive power
of all of the shares reported.
(8) The information is based solely on a Schedule 13D filed with the SEC
on June 9, 2003, by Fromageries Bel S.A. Fromageries Bel S.A. owns
directly and beneficially all of the reported shares. Unibel, a
French limited partnership, is deemed to beneficially own the
reported shares by reason of the provisions of Rule 13d-3 of the
Securities Exchange Act of 1934, as amended. Each of Fromageries Bel
S.A. and Unibel, a French limited partnership, has shared voting
power and shared dispositive power of all of the reported shares of
the Company's common stock. The address of the principal office of
Fromageries Bel S.A. and Unibel is 4 rue d Anjou 75008, Paris,
France.
SERIES A CONVERTIBLE PREFERRED STOCK OWNERSHIP OF 5% OR MORE STOCKHOLDERS
Amount and Nature of
Name and Address of Beneficial Owner Beneficial Ownership (1) Percent of Class
- -----------------------------------------------------------------------------------------------------------
BH Capital Investments, L.P. (2)
175 Bloor Street East
South Tower, 7th Floor
Toronto, Ontario, Canada M4W 3R8 20,430 Series A 48.6%
Excalibur Limited Partnership (2)
33 Prince Arthur Avenue
Toronto, Ontario, Canada M5R IB2 21,564 Series A 51.4%
(1) The inclusion herein of any shares deemed beneficially owned does not
constitute an admission of beneficial ownership of these shares.
(2) Pursuant to a certain Series A Preferred Stock and Warrants Purchase
Agreement dated as of April 6, 2001, BH Capital Investments, L.P. and
Excalibur Limited Partnership each purchased 36,323 shares of the
Company's Series A convertible preferred stock and warrants to purchase
60,000 shares of common stock, at an aggregate sales price of
approximately $3,082,000. BH Capital Investments, L.P. and Excalibur
Limited Partnership exercised their warrants and the Company has been
informed that they have sold all of the shares received upon the exercise
of the warrants. From April 2001 through June 25, 2004, the Series A
Preferred Shareholders have converted a total of 30,652 Series A preferred
shares into 1,151,596 shares of common stock. As of June 25, 2004, the
holders of the Series A convertible preferred stock were each entitled to
an additional $13.39 per outstanding preferred share, or 11,674 total
additional shares of the Series A convertible preferred stock, for
dividends accrued on their initial purchase of the Series A convertible
preferred stock. This dividend is payable in cash or shares of the Series
A convertible preferred stock at the Company's discretion. However, in
accordance with the terms of the asset-based loan from Textron Financial
Corporation, the Company is prohibited from paying dividends in cash
without Textron's consent.
Security Ownership of Management
- --------------------------------
The following table describes the beneficial ownership of the Company's common
stock by (i) each Named Executive Officer, (ii) each director, and (iii) all of
the Company's directors and executive officers as a group, outstanding as of
June 25, 2004. The tables show beneficial ownership in accordance with the rules
of the Securities and Exchange Commission to include securities that a named
person or entity has the right to acquire within 60 days:
82
Amount and Nature of
Name and Address of Beneficial Owner Beneficial Ownership (1) Percent of Class (2)
- ----------------------------------------------------------------------------------------------------------
David H. Lipka 255,781 (3) 1.6%
Michael E. Broll 200,000 (4) 1.3%
Thomas R. Dyckman 200,225 (3) 1.3%
Charles L. Jarvie 200,225 (3) 1.3%
Joseph J. Juliano 185,283 (5) 1.2%
Angelo S. Morini 6,387,806 (6) 34.3%
Christopher J. New 98,254 (7) *
Patrice M.A. Videlier 96 (8) *
Salvatore J. Furnari 22,832 (9) *
Christopher E. Morini 96,429 (10) *
John W. Jackson 100,631 (10) *
Kulbir Sabharwal 55,393 (11) *
---------
All executive officers and
directors as a group 7,802,955 39.1%
========= ====
* Less than 1%.
(1) The inclusion herein of any shares deemed beneficially owned does not
constitute an admission of beneficial ownership of these shares.
(2) The total number of shares outstanding as of June 25, 2004 is 15,724,073.
The percentages are calculated on the basis of the amount of shares
outstanding plus shares which may be acquired through the exercise of
options, warrants, rights or conversion privileges by such holder within
sixty (60) days of June 25, 2004.
(3) Includes currently exercisable options to acquire 200,000 shares of the
Company's common stock at $2.17 per share, which expire on December 17,
2007. Also, includes currently exercisable options to acquire 225 shares
of the Company's common stock at $2.90 per share, which expire on October
1, 2013.
(4) Includes currently exercisable options to acquire 200,000 shares of the
Company's common stock at $3.29 per share, which expire on December 17,
2008.
(5) Mr. Juliano, a current member of the Company's Board of Directors, is the
beneficial owner of 33,571 shares of common stock issuable upon the
exercise of warrants held by JCII Corporation, of which Catherine Juliano,
Mr. Juliano's wife, is the sole shareholder. Additionally, there is a
warrant for 143,000 shares of common stock issuable to V&R corporation,
which is owned by Mr. Juliano's parents. The exercise price of the
warrants is $2.05 per share and they expire on January 31, 2006 and June
15, 2009, respectively. These warrants had an original exercise price of
$4.81 and $3.31 per share, respectively, but were repriced to $2.05 on
October 11, 2002. These warrants were granted as compensation for
introductions of key accounts to the Company. Mr. Juliano also
beneficially owns 7,143 shares of common stock, held of record by JCII
Corporation. Additionally, Mr. Juliano was granted an option to acquire
2,143 shares of the Company's common stock. This option was issued at the
closing bid price as quoted on the American Stock Exchange on the date of
the grant, is currently exercisable at $2.05 per share and expires on May
27, 2009. All of JCII Corporation's, V&R Corporation's and Mr. Juliano's
options and warrants currently are exercisable.
83
(6) Includes options to acquire 2,888,197 shares of the Company's common
stock, which are currently exercisable at prices ranging from $2.05 to
$5.25 per share. Options expire as to 13,072 shares on October 1, 2006, as
to 432,797 on July 1, 2007, as to 517,203 shares on December 4, 2007, as
to 1,357,000 shares on June 15, 2009, as to 343,125 on December 15, 2010,
as to 225,000 on April 19, 2011. Also includes a warrant to purchase 250
shares at an exercise price of $5.744 per share, which expires on January
17, 2007. With the exception of the options, 10,500 shares held in a
nominee name, 286 shares held in joint tenancy and 714 shares held
individually, all of Mr. Morini's shares and warrant are held by Morini
Investments Limited Partnership, a Delaware limited liability partnership,
of which Angelo Morini is the sole Limited Partner and Morini Investments
LLC is the sole General Partner. Mr. Morini is the sole member of Morini
Investments LLC.
(7) Includes currently exercisable options to acquire 66,666 shares of the
Company's common stock at $2.05 per share, which expire on July 16, 2011.
These options had an original exercise price of $4.98 per share, but were
repriced to $2.05 on October 11, 2002. Also, includes currently
exercisable options to acquire 25,000 shares of the Company's common stock
at $1.67 per share, which expire on December 5, 2012. Includes a warrant
to purchase 1,318 shares of the Company's common stock at an exercise
price of $5.744 per share, which expires on January 17, 2007.
(8) Includes currently exercisable options to acquire 96 shares of the
Company's common stock at $2.90 per share, which expire on October 1,
2013.
(9) Includes currently exercisable options to acquire 7,500 and 13,332 shares
of the Company's common stock at $2.05 per share, which expire on November
12, 2011 and July 8, 2012, respectively. These options had an original
exercise price of $5.60 and $4.55 per share, respectively, but were
repriced to $2.05 on October 11, 2002.
(10) Includes currently exercisable options to acquire 96,429 shares of the
Company's common stock at $2.05 per share. These options had an original
exercise prices ranging from $2.84 to $8.47 per share, but were repriced
to $2.05 on October 11, 2002. Options expire as to 7,143 shares on May 16,
2006, as to 14,286 shares on September 24, 2008, and as to 75,000 shares
on April 19, 2011.
(11) Includes currently exercisable options to acquire 54,143 shares of the
Company's common stock at $2.05 per share. These options had an original
exercise prices ranging from $3.12 to $8.47 per share, but were repriced
to $2.05 on October 11, 2002. Options expire as to 7,143 shares on May 16,
2006, as to 45,000 shares on April 19, 2011, and as to 2,000 on September
20, 2012. Also includes a warrant to purchase 1,250 shares at an exercise
price of $5.744 per share, which expires on January 17, 2007.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Transactions with Management and Others
- ---------------------------------------
Employment Agreements
Please see "ITEM 11. EXECUTIVE COMPENSATION - Employment Agreements."
Other Transactions
- ------------------
Angelo S. Morini, Founder
In a Second Amended and Restated Employment Agreement effective October 13,
2003, Angelo S. Morini the Company's Founder, Vice-Chairman and President
resigned from his positions with the Company as Vice-Chairman and President and
will no longer be involved in the daily operations of the Company. He will
retain the title of Founder and has been named Chairman Emeritus. Mr. Morini
will continue as an employee and as a member of the Company's Board of
Directors. Additionally, he may carry out special assignments designated to him
by the Chairman of the Board. The agreement is for a five-year period beginning
October 13, 2003 and provides for an annual base salary of $300,000 plus
standard health insurance benefits, club dues and an auto allowance.
84
In March 2002, Angelo S. Morini, the Company's founder, loaned $330,000 to the
Company in order for it to pay down certain notes payable that were coming due.
This loan bore interest at the prime rate and was due on or before June 15,
2006. In connection with the Second Amended and Restated Employment Agreement
above, the Company offset $167,603 of unreimbursed advances owed to it by Mr.
Morini and certain family members against the balance of the loan and issued an
aggregate of 55,087 shares of the Company's common stock (valued at
approximately $2.95 per share) as payment in full.
In June 1999, in connection with an amended and restated employment agreement
for Angelo S. Morini, the Company's Founder, 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 the Company's common
stock. Per the June 1999 employment agreement and continued in the October 2003
Second Amended and Restated Employment Agreement, 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.
Mr. Morini's brother, Christopher E. Morini, is employed by the Company as Vice
President of New Business Development and Key Accounts and received total
compensation of $178,241 during the fiscal year ended March 31, 2004 (which
includes salary, bonuses, 401k employer contributions, auto allowance and health
benefits). Mr. Morini's brother-in-law, Robert Peterson, is employed by the
Company as a sales representative. Mr. Peterson's total compensation for the
fiscal year ended March 31, 2004 was $111,292 (which includes salary, bonuses,
401k employer contributions, auto allowance and health benefits). Mr. Morini's
brother, Ronald Morini, worked for the Company until October 31, 2003 as an
engineering consultant and was paid $61,310 in consulting fees and benefits
during the fiscal year ended March 31, 2004.
Patrice M.A. Videlier, Director
Effective May 22, 2003, the Company entered into a Master Distribution and
Licensing Agreement with Fromageries Bel S.A., a leading branded cheese company
in Europe, of which Mr. Videlier is the Senior Vice President of Marketing -
World. Under the agreement, the Company has granted Fromageries Bel S.A.
exclusive distribution rights for the Company's products in a territory
comprised of the European Union States and to more than 21 other European
countries and territories, as well as the exclusive option during the term of
the agreement to elect to manufacture the products designated by Fromageries Bel
S.A. for distribution in the territory. Fromageries Bel S.A. also purchased
1,111,112 the Company's common stock at a purchase price of $1.80 per share for
a total investment of $2,000,000 pursuant to a Securities Purchase Agreement
dated as of May 21, 2003 between the Company and Fromageries Bel S.A. These
shares were included on a Registration Statement on Form S-3, SEC File No.
333-109649, which was filed on October 10, 2003 and declared effective on
November 18, 2003.
BH Capital Investments, L.P., and Excalibur Limited Partnership, the Series A
Preferred Stockholders
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. As of June 25,
2004, the Series A Preferred Holders had converted 30,652 shares of the Series A
convertible preferred stock plus accrued dividends, into 1,151,596 shares of
common stock. The conversion prices ranged from $1.3633 to $1.75 and were based
on the lower of (a) 95% of the average of the two lowest closing bid prices on
the AMEX for the fifteen trading days immediately prior to conversion or (b)
$1.75.
85
On November 7, 2002, the Series A Preferred Holders exercised their right under
the Series A 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. The Company was required to
hold a shareholders meeting to solicit such approval on or before February 5,
2003. Pursuant to the Stock Purchase Option Agreement described below, the
Series A Preferred Holders agreed, among other things, to extend the deadline to
September 30, 2003. On September 30, 2003, the Company's shareholders, by
majority vote, approved the issuance by the Company of all required common stock
in the event of a conversion of the Company's Series A convertible preferred
stock and upon the exercise of certain warrants held by the Series A Preferred
Holders.
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. The option expired on September 30, 2003. Pursuant
to such agreement, the Series A Preferred Holders also agreed to extend the
Company's required date 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 warrants to purchase 250,000 shares of the Company's common stock
to each BH Capital Investments, L.P. and Excalibur Limited Partnership. 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. These warrants were included on a Registration
Statement on Form S-3, SEC File No. 333-109649, which was filed on October 10,
2003 and declared effective on November 18, 2003. In accordance with SFAS 123,
the fair value of these warrants was estimated at $230,000 and was recorded as
non-cash compensation expense in the first quarter of fiscal 2004.
Frederick A. DeLuca, 5% Common Stockholder
On April 10, 2003, Mr. DeLuca entered into a credit arrangement with the Company
pursuant to which Mr. DeLuca would purchase for the Company raw materials 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, were paid
in full and the credit arrangement terminated as of June 27, 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. In accordance with SFAS 123, the fair value of this warrant was
estimated at $63,000 and was recorded as non-cash compensation expense in the
first quarter of fiscal 2004.
Pursuant to a Securities Purchase Agreement dated as of May 21, 2003, Mr. DeLuca
purchased 555,556 shares of common stock, respectively, at an aggregate sales
price of $1,000,000. These shares were included on a Registration Statement on
Form S-3, SEC File No. 333-109649, which was filed on October 10, 2003 and
declared effective on November 18, 2003.
David H. Lipka, Director
Pursuant to a Securities Purchase Agreement dated as of May 21, 2003, David H.
Lipka purchased 55,556 shares of common stock, respectively, at an aggregate
sales price of $100,000. These shares were included on a Registration Statement
on Form S-3, SEC File No. 333-109649, which was filed on October 10, 2003 and
declared effective on November 18, 2003.
86
Indebtedness of Management and Others
- -------------------------------------
On June 15, 1999, in conjunction with the entry into a new employment agreement,
the Company agreed to a consolidation of Mr. Morini's two existing promissory
notes in favor of the Company into a single note payable in the amount of
$12,772,200 due and payable on June 15, 2006. This note is non-interest bearing,
non-recourse to Mr. Morini, and is secured by 2,914,286 shares of the Company's
common stock beneficially owned by Mr. Morini. In the event of certain
circumstances, the loan may be forgiven in full. The Company has a security
interest in the pledged shares. The current outstanding balance of the
obligation is $12,772,200.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
Audit Fees
- ----------
With respect to the fiscal years ended March 31, 2004 and 2003, the aggregate
fees (including expenses) charged the Company by BDO Seidman, LLP for auditing
the annual financial statements and reviewing interim financial statements were
$138,458 and $144,961, respectively. Audit fees consist of those fees incurred
in connection with statutory and regulatory filings or engagements; fees
necessary to perform an audit or review in accordance with GAAS; and services
that generally only an independent accountant reasonably can provide, such as
comfort letters, statutory audits, attest services, consents and assistance with
and review of documents filed with the Commission.
Approximately 74% and 75% of the total hours spent by the auditors in carrying
out the audit of the Company's financial statements for the year ended March 31,
2004 and 2003, respectively were spent by members of the BDO Alliance network of
firms. Such members are not full-time, permanent employees of BDO Seidman, LLP.
Audit-Related Fees
- ------------------
During the fiscal year ended March 31, 2004 and 2003, BDO Seidman, LLP charged
the Company $16,805 and $32,577 for audit-related fees. These fees related to
accounting research and audit committee meeting attendance.
Tax Fees
- --------
BDO Seidman, LLP did not render any tax services during the fiscal years ended
March 31, 2004 and 2003.
All Other Fees
- --------------
There were no fees for other services charged to the Company by BDO Seidman, LLP
during the fiscal years ended March 31, 2004 and 2003. The Audit Committee has
considered and determined that BDO Seidman, LLP's provision of non-audit
services to the Company during the fiscal years ended March 31, 2004 and 2003 is
compatible with maintaining their independence.
Audit Committee Pre-Approval Policies and Procedures.
- -----------------------------------------------------
The Audit Committee's pre-approval policy is as follows:
o The Audit Committee will review and pre-approve on an annual basis any
known audit, audit-related, tax and all other services, along with
acceptable cost levels, to be performed by any audit firm. The Audit
Committee may revise the pre-approved services during the period based
on subsequent determinations. Pre-approved services typically include:
statutory audits, quarterly reviews, regulatory filing requirements,
consultation on new accounting and disclosure standards, employee
benefit plan audits, reviews and reporting on management's internal
controls and specified tax matters.
o Any proposed service that is not pre-approved on the annual basis
requires a specific pre-approval by the Audit Committee, including
cost level approval.
o The Audit Committee may delegate pre-approval authority to the Audit
Committee chairman. The chairman must report to the Audit Committee,
at the next Audit Committee meeting, any pre-approval decisions made.
The Audit Committee is responsible for approving all engagements to perform
audit or non-audit services prior to Company engaging BDO Seidman, LLP or
Gallogly, Fernandez and Riley, LLP, a member of the BDO Alliance network of
firms. All of the services under the headings Audit Fees, Audit-Related Fees,
Tax Fees, and All Other Fees were 100% approved by the Audit Committee pursuant
to Rule 2-01 paragraph (c)(7)(i)(C) of Regulation S-X of the Exchange Act.
87
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
Financial Statements
- --------------------
Balance Sheets at March 31, 2004 and 2003
Statements of Operations for the years ended March 31, 2004, 2003 and 2002
Statement of Stockholders' Equity for the years ended March 31, 2004, 2003
and 2002
Statements of Cash Flows for the years ended March 31, 2004, 2003 and 2002
Notes to Financial Statements
Exhibits
- --------
The following Exhibits are filed as part of this Form 10-K.
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.)
* 4.1 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 as Exhibit 10.52 on Form 10-Q for the
fiscal quarter ended June 30, 2003.)
* 4.2 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.)
* 4.3 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.)
* 4.4 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.)
* 4.5 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.)
* 4.6 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.)
* 4.7 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.)
* 4.8 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.)
* 4.9 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.)
88
EXHIBIT NO EXHIBIT DESCRIPTION
- ---------- -------------------
* 4.10 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.)
* 4.11 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.)
* 4.12 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.)
* 4.13 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.)
* 4.14 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.)
* 4.15 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.)
* 4.16 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.)
* 4.17 Stockholder Agreement dated as of October 13, 2003 between
Galaxy Nutritional Foods, Inc. and Angelo S. Morini (Filed as
Exhibit 10.55 on Form 10-Q for the fiscal quarter ended
September 30, 2003.)
* 10.1 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.)
* 10.2 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.)
* 10.3 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.)
* 10.4 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 10.3
on Form 8-K filed June 2, 2003.)
* 10.5 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 10.4 on Form 8-K
filed June 2, 2003.)
* 10.6 Amendment of Loan Agreement dated as of May 28, 2003 between
Galaxy Nutritional Foods, Inc. and SouthTrust Bank (Filed as
Exhibit 10.5 on Form 8-K filed June 2, 2003.)
* 10.7 Amendment of Security Agreement dated as of May 28, 2003
between Galaxy Nutritional Foods, Inc. and SouthTrust Bank
(Filed as Exhibit 10.6 on Form 8-K filed June 2, 2003.)
* 10.8 Waiver Letter from Textron Financial Corporation to the
Company dated August 13, 2003 (Filed as Exhibit 10.53 on Form
10-Q for the fiscal quarter ended June 30, 2003.)
* 10.9 Second Amended and Restated Employment Agreement dated as of
October 13, 2003 between Galaxy Nutritional Foods, Inc. and
Angelo S. Morini (Filed as Exhibit 10.1 on Form 8-K filed
October 20, 2003.)
* 10.10 Settlement Agreement dated May 6, 2004 between Galaxy
Nutritional Foods, Inc. and Schreiber Foods, Inc. (Filed as
Exhibit 10.1 on Form 8-K filed May 11, 2004.)
10.11 Modification Letter on the Security Agreement dated as of May
21, 2004 between Galaxy Nutritional Foods, Inc. and SouthTrust
Bank (Filed herewith.)
89
EXHIBIT NO EXHIBIT DESCRIPTION
- ---------- -------------------
10.12 Second Amendment to Loan and Security Agreement dated June 25,
2004 between Galaxy Nutritional Foods, Inc. and Textron
Financial Corporation (Filed herewith.)
10.13 Third Amendment to Lease Agreement dated June 10, 2004 between
Galaxy Nutritional Foods, Inc. and Cabot Industrial
Properties, L.P. (Filed herewith.)
* 20.1 Audit Committee Charter (Filed as Exhibit 20.1 on Form 10-Q
for the fiscal quarter ended September 30, 2003.)
* 20.2 Compensation Committee Charter (Filed as Exhibit 20.2 on Form
10-Q for the fiscal quarter ended September 30, 2003.)
23.1 BDO Seidman, LLP Consent Letter (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
- -------------------
On February 18, 2004, the Company filed a Current Report on Form 8-K to disclose
the press release announcing the Company's financial results for its third
fiscal quarter ended December 31, 2003. There was one report on Form 8-K filed
on May 11, 2004 announcing the settlement of the litigation suit between the
Company and Schreiber Foods, Inc.
90
SIGNATURES
----------
Pursuant to the requirements of Section 13 or 15(d) 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: June 29, 2004 /s/ Christopher J. New
-----------------------------------------
Christopher J. New
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dated indicated.
Date: June 29, 2004 /s/ Christopher J. New
-----------------------------------------
Christopher J. New
Chief Executive Officer & Director
(Principal Executive Officer)
Date: June 29, 2004 /s/ Salvatore J. Furnari
-----------------------------------------
Salvatore J. Furnari
Chief Financial Officer
(Principal Financial & Accounting Officer)
Date: June 29, 2004 /s/ David H. Lipka
-----------------------------------------
David H. Lipka
Chairman of the Board
Date: June 29, 2004 /s/ Michael E. Broll
-----------------------------------------
Michael E. Broll
Director
Date: June 29, 2004 /s/ Thomas R. Dyckman
-----------------------------------------
Thomas R. Dyckman
Director
Date: June 29, 2004 /s/ Charles L. Jarvie
-----------------------------------------
Charles L. Jarvie
Director
Date: June 29, 2004 /s/ Joseph J. Juliano
-----------------------------------------
Joseph J. Juliano
Director
Date: June 29, 2004 /s/ Angelo S. Morini
-----------------------------------------
Angelo S. Morini
Director
Date: June 29, 2004 /s/ Patrice M.A. Videlier
-----------------------------------------
Patrice M.A. Videlier
Director
91