SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
------------------------------------------------------------------
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For The Quarterly Period Ended September 30, 2004
-----------------------------
Commission File Number 1-15345
GALAXY NUTRITIONAL FOODS, INC.
(Exact name of registrant as specified in its charter)
Delaware 25-1391475
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2441 Viscount Row
Orlando, Florida 32809
(Address of principal executive offices) (Zip Code)
(407) 855-5500
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). YES [ ] NO [X]
On November 12, 2004, there were 18,388,214 shares of Common Stock, $.01
par value per share, outstanding.
1
GALAXY NUTRITIONAL FOODS, INC.
Index to Form 10-Q
For Quarter Ended September 30, 2004
PAGE NO.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Balance Sheets 3
Statements of Operations 4
Statement of Stockholders' Equity 5
Statements of Cash Flows 6
Notes to Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operation 14
Item 3. Quantitative and Qualitative Disclosures About Market Risk 24
Item 4. Controls and Procedures 24
PART II. OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 25
Item 3. Defaults upon Senior Securities 25
Item 4. Submission of Matters to a Vote of Security Holders 25
Item 5. Other Information 26
Item 6. Exhibits 27
SIGNATURES 30
2
PART I. FINANCIAL INFORMATION
-----------------------------
GALAXY NUTRITIONAL FOODS, INC.
Balance Sheets
SEPTEMBER 30, MARCH 31,
Notes 2004 2004
------ ------------ ------------
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash $ 423,480 $ 449,679
Trade receivables, net 8 5,819,826 3,964,198
Inventories 4,972,097 4,632,843
Prepaid expenses and other 314,103 266,301
------------ ------------
Total current assets 11,529,506 9,313,021
PROPERTY AND EQUIPMENT, NET 19,251,686 20,232,089
OTHER ASSETS 336,192 416,706
------------ ------------
TOTAL $ 31,117,384 $ 29,961,816
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Line of credit 2 $ 5,881,762 $ 4,605,277
Accounts payable 2,439,586 1,266,346
Accrued liabilities 1,538,510 1,812,300
Preferred stock redemption liability 3 2,484,688 --
Current portion of accrued employment contracts 7 589,254 366,305
Current portion of term notes payable 2 1,488,750 1,140,000
Current portion of obligations under capital leases 186,595 231,432
------------ ------------
Total current liabilities 14,609,145 9,421,660
ACCRUED EMPLOYMENT CONTRACTS, less current portion 7 1,286,721 1,293,142
TERM NOTES PAYABLE, less current portion 2 7,413,235 8,241,985
OBLIGATIONS UNDER CAPITAL LEASES, less current portion 150,549 204,967
------------ ------------
Total liabilities 23,459,650 19,161,754
------------ ------------
COMMITMENTS AND CONTINGENCIES -- --
CONVERTIBLE PREFERRED STOCK 3 495,183 2,573,581
STOCKHOLDERS' EQUITY:
Common stock 157,882 156,573
Additional paid-in capital 64,536,203 64,520,084
Accumulated deficit (44,638,873) (43,557,515)
------------ ------------
20,055,212 21,119,142
Less: Notes receivable arising from the exercise of
stock options and sale of common stock (12,772,200) (12,772,200)
Treasury stock, 26,843 shares, at cost (120,461) (120,461)
------------ ------------
Total stockholders' equity 7,162,551 8,226,481
------------ ------------
TOTAL $ 31,117,384 $ 29,961,816
============ ============
See accompanying notes to financial statements.
3
GALAXY NUTRITIONAL FOODS, INC.
Statements of Operations
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2004 2003 2004 2003
------------ ------------ ------------ ------------
NET SALES $ 11,900,553 $ 9,329,907 $ 23,092,231 $ 18,025,688
COST OF GOODS SOLD 9,319,969 6,329,977 17,571,299 12,381,093
------------ ------------ ------------ ------------
Gross margin 2,580,584 2,999,930 5,520,932 5,644,595
------------ ------------ ------------ ------------
OPERATING EXPENSES:
Selling 1,572,470 1,446,859 3,032,870 2,760,732
Delivery 615,257 433,959 1,208,583 885,776
Non-cash compensation related to
options & warrants (Note 1 and
Note 4) (121,172) 128,258 41,202 1,435,389
Employment contract expense
(Note 7) 444,883 -- 444,883 --
General and administrative 565,968 886,019 1,199,310 1,869,498
Research and development 78,932 62,908 151,618 125,992
------------ ------------ ------------ ------------
Total operating expenses 3,156,338 2,958,003 6,078,466 7,077,387
------------ ------------ ------------ ------------
INCOME (LOSS) FROM OPERATIONS (575,754) 41,927 (557,534) (1,432,792)
Interest expense (264,008) (270,072) (523,824) (765,457)
------------ ------------ ------------ ------------
NET INCOME (LOSS) $ (839,762) $ (228,145) $ (1,081,358) $ (2,198,249)
Preferred Stock Dividends
(Note 3) 40,180 53,836 82,572 108,616
Preferred Stock Accretion to
Redemption Value (Note 3) (308,570) 651,404 203,605 1,546,333
------------ ------------ ------------ ------------
NET LOSS AVAILABLE TO COMMON
SHAREHOLDERS $ (571,372) $ (933,385) $ (1,367,535) $ (3,853,198)
============ ============ ============ ============
BASIC and DILUTED NET LOSS PER
COMMON SHARE (Note 5) $ (0.04) $ (0.06) $ (0.09) $ (0.27)
============ ============ ============ ============
See accompanying notes to financial statements.
4
GALAXY NUTRITIONAL FOODS, INC.
Statements Of Stockholders' Equity
(UNAUDITED)
Common Stock Notes
--------------------------- Additional Accumulated Receivable for Treasury
Shares Par Value Paid-In Capital Deficit Common Stock Stock Total
-----------------------------------------------------------------------------------------------------------
Balance at March 31,
2004 15,657,321 $ 156,573 $ 64,520,084 $(43,557,515) $(12,772,200) $ (120,461) $ 8,226,481
Costs associated with
equity raise -- -- (22,500) -- -- -- (22,500)
Issuance of common
stock 9,527 95 12,385 -- -- -- 12,480
Conversion of
preferred stock 121,396 1,214 202,147 -- -- -- 203,361
Fair value of
warrants and
employee options
issued -- -- 32,785 -- -- -- 32,785
Dividends on
preferred stock -- -- (82,572) -- -- -- (82,572)
Accretion of discount
on preferred stock -- -- (126,126) -- -- -- (126,126)
Net loss -- -- -- (1,081,358) -- -- (1,081,358)
-----------------------------------------------------------------------------------------------------------
Balance at September
30, 2004 15,788,244 $ 157,882 $ 64,536,203 $(44,638,873) $(12,772,200) $ (120,461) $ 7,162,551
==========================================================================================================
See accompanying notes to financial statements.
5
GALAXY NUTRITIONAL FOODS, INC.
Statements of Cash Flows
(UNAUDITED)
Six Months Ended September 30, Notes 2004 2003
----- ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income (Loss) $ (1,081,358) $ (2,198,249)
Adjustments to reconcile net income (loss) to net cash from (used
in) operating activities:
Depreciation and amortization 1,092,086 1,108,799
Amortization of debt discount and financing costs 49,615 152,022
Provision for losses on trade receivables 164,000 (5,000)
Non-cash compensation related to options and warrants 1,4 41,202 1,435,389
(Increase) decrease in:
Trade receivables (2,019,628) 746,596
Inventories (339,254) 803,444
Prepaid expenses and other (47,802) 27,978
Increase (decrease) in:
Accounts payable 1,173,240 (1,021,513)
Accrued liabilities 7 343,691 (238,762)
------------ ------------
NET CASH FROM (USED IN) OPERATING ACTIVITIES (624,208) 810,704
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (77,207) (100,087)
Decrease in other assets 22,482 1,807
------------ ------------
NET CASH FROM (USED IN) INVESTING ACTIVITIES (54,725) (98,280)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Book overdrafts -- (1,151,276)
Net borrowings (payments) on lines of credit 1,276,485 (208,802)
Repayments on subordinated note payable -- (4,000,000)
Borrowings on term note payable -- 2,000,000
Repayments on term notes payable (480,000) (871,760)
Principal payments on capital lease obligations (133,731) (189,542)
Financing costs for long term debt -- (231,578)
Proceeds from issuance of common stock, net of offering costs (10,020) 3,796,868
Proceeds from exercise of common stock warrants -- 360,000
------------ ------------
NET CASH FROM (USED IN) FINANCING ACTIVITIES 652,734 (496,090)
------------ ------------
NET INCREASE (DECREASE) IN CASH (26,199) 216,334
CASH, BEGINNING OF PERIOD 449,679 1,598
------------ ------------
CASH, END OF PERIOD 6 $ 423,480 $ 217,932
============ ============
See accompanying notes to financial statements.
6
GALAXY NUTRITIONAL FOODS, INC.
Notes To Financial Statements
(UNAUDITED)
(1) Summary of Significant Accounting Policies
------------------------------------------
The unaudited financial statements have been prepared by the Company,
under the rules and regulations of the Securities and Exchange Commission.
The accompanying financial statements contain all normal recurring
adjustments which are, in the opinion of management, necessary for the
fair presentation of such financial statements. Certain information and
disclosures normally included in the financial statements prepared in
accordance with generally accepted accounting principles have been omitted
under such rules and regulations although the Company believes that the
disclosures are adequate to make the information presented not misleading.
The March 31, 2004 balance sheet data was derived from the audited
financial statements, but does not include all disclosures required by
accounting principles generally accepted in the United States of America.
These unaudited financial statements should be read in conjunction with
the financial statements and notes included on Form 10-K for the fiscal
year ended March 31, 2004. Interim results of operations for the six-month
period ended September 30, 2004 may not necessarily be indicative of the
results to be expected for the full year.
Stock Based Compensation
------------------------
The Company accounts for its stock-based employee compensation plans under
the accounting provisions of Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees", 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 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
during the six months ended September 30, 2004 and 2003 were approximately
$0.01 and $0.03, respectively.
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:
September September 30,
Six Months Ended 30, 2004 2003
---------- --------------
Dividend Yield None None
Volatility 45% 41% to 42%
Risk Free Interest Rate 3.96% 2.01% to 3.77%
Expected Lives in Months 120 36 to 120
7
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:
THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------- ----------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
Net loss to common shareholders as
reported $ (571,372) $ (933,385) $ (1,367,535) $ (3,853,198)
Add: Stock-based compensation
expense included in reported net loss (121,172) 128,258 41,202 1,435,389
Deduct: Stock-based compensation
expense determined under fair value
based method for all awards 91,263 (207,629) (101,317) (1,707,756)
------------ ------------ ------------ ------------
Pro forma net loss to common
shareholders $ (601,281) $ (1,012,756) $ (1,427,650) $ (4,125,565)
============ ============ ============ ============
Net loss per common share:
Basic & Diluted - as reported $ (0.04) $ (0.06) $ (0.09) $ (0.27)
Basic & Diluted - pro forma $ (0.04) $ (0.07) $ (0.09) $ (0.29)
Net Income (Loss) per Common Share
----------------------------------
Net income (loss) per common share is computed by dividing net income or
loss by the weighted average shares outstanding. Diluted income (loss) per
common share is computed on the basis of weighted average shares
outstanding plus potential common shares which would arise from the
exercise of stock options, warrants and conversion of the Series A
convertible preferred stock.
Use of Estimates
----------------
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and reported amounts
of revenues and expense during the reporting period. The Company's
significant estimates include the allowance for doubtful accounts
receivable, 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.
Reclassifications
-----------------
Certain items in the financial statements of the prior period have been
reclassified to conform to current period presentation.
Segment Information
-------------------
The Company does not identify separate operating segments for management
reporting purposes. The results of operations are the basis on which
management evaluates operations and makes business decisions. The
Company's sales are generated primarily within the United States of
America.
(2) Line of Credit and Notes Payable
--------------------------------
On May 27, 2003, the Company obtained from Textron Financial Corporation
("Textron") a revolving credit facility (the "Textron Loan") with a
maximum principal amount of $7,500,000 pursuant to the terms and
conditions of a Loan and Security Agreement dated May 27, 2003 (the
"Textron Loan Agreement"). The Textron Loan is secured by the Company's
inventory, accounts receivable and all other assets. Generally, subject to
the maximum principal amount, which can be borrowed under the Textron Loan
and certain reserves that must be maintained during the term of the
Textron Loan, the amount available under the Textron Loan for borrowing by
the Company from time to time is equal to the sum of (i) 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 (6.50% at
September 30, 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
8
involve both a Subjective Acceleration Clause and a Lock-Box Arrangement,"
the balance is reflected as current on the balance sheet. As of September
30, 2004, the outstanding principal balance on the Textron Loan was
$5,881,762.
The Textron Loan Agreement contains certain financial and operating
covenants. Due to the $444,883 charge to operations related to the
Separation and Settlement Agreement between the Company and Christopher J.
New, its former Chief Executive Officer, the Company fell below the
requirement for the adjusted tangible net worth and the fixed charge
coverage ratio covenants for the quarter ended September 30, 2004.
Pursuant to discussions and a written confirmation, , Textron has agreed
in principle to amend the loan covenants effective as of September 30,
2004, the effect of which would bring the Company into compliance with
both ratios as of that date. The Company anticipates that it will be in
compliance with these ratios, as amended, for the foreseeable future based
on current forecasts.
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% (5.75% at September 30, 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: $110,000 from
October 2004 to June 2005, and $166,250 from July 2005 until maturity in
June 2009. In a Loan Modification letter dated May 21, 2004, beginning in
October 2004, interest may be adjusted quarterly from prime to prime plus
1.25% according to the Company's performance in its Maximum Funded Debt to
EBITDA ratio in prior quarters. This note is secured by all of the
Company's equipment and certain related assets. The balance outstanding on
the term loan as of September 30, 2004 was $8,901,985.
(3) Capital Stock
-------------
Preferred Stock & Subsequent Period Redemption
-----------------------------------------------
On October 6, 2004, the Company's Series A Preferred Holders (BH Capital
Investments, LP and Excalibur Limited Partnership) converted 10,278 Series
A convertible preferred shares into approximately 600,000 shares of common
stock. The value of these converted Series A convertible preferred shares
including accrued dividends was $644,068. Simultaneously, the remaining
30,316 Series A convertible preferred shares held by the Series A
Preferred Holders were acquired by the Company for a total price of
$2,279,688. The entire class of Series A convertible preferred stock of
the Company has now been cancelled. As part of the transaction, the former
Series A Preferred Holders also received warrants to purchase up to
500,000 shares of common stock at an exercise price of $2.00 per share for
a period of five (5) years. The fair value of the warrants is $205,000.
According to Statement of Financial Standard No. 150, once it is
determined that a convertible security will be redeemed, the redemption
value of the convertible security should be considered a liability.
Therefore, the $2,279,688 value of the redeemed shares and the $205,000
value of the warrants are classified as a current liability. The principal
value of $495,183 of the 10,278 converted shares is classified as
preferred stock in the mezzanine and the accrued dividend value of
$148,885 is classified in accrued liabilities.
On April 6, 2001, the Company received from 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 were 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 was equal to the quotient of $48.18, plus all accrued and unpaid
dividends for each share of the Series A convertible preferred stock,
($62.61 at September 30, 2004), divided by the lesser of (x) $1.75 or (y)
95% of the average of the two lowest closing bid prices of the Company's
common stock on the American Stock Exchange ("AMEX") out of the fifteen
trading days immediately prior to conversion.
The Series A Preferred Holders converted 3,300 and 1,800 shares of the
Series A convertible preferred stock plus accrued dividends, into 121,396
and 62,364 shares of common stock, respectively, during the six months
ended September 30, 2004 and 2003, respectively. The conversion prices
ranged from $1.28 to $1.75 based on the above formula.
The Series A Preferred Holders had 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 three and
9
six months ended September 30, 2004, the Company recorded preferred
dividends of $40,180 and $82,572, respectively, on the outstanding shares
of the Series A convertible preferred stock. For the three and six months
ended September 30, 2003, the Company recorded preferred dividends of
$53,836 and $108,616, 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 calculated 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 was then accreted over the
redemption period (48 months beginning April 2001) using the straight-line
method, which approximates the effective interest method. For the three
and six months ended September 30, 2004, the Company recorded ($308,570)
and $203,605, respectively, related to the accretion of the redemption
value of preferred stock and the beneficial conversion feature of accrued
dividends. For the three and six months ended September 30, 2003, the
Company recorded $651,404 and $1,546,333, respectively, related to the
accretion of the redemption value of preferred stock and the beneficial
conversion feature of accrued dividends.
Common Stock Issuance
---------------------
On October 6, 2004, the Company completed a private placement of its
Common Stock, $.01 par value, issuing a total of two million shares to an
existing shareholder of the Company for aggregate gross proceeds to the
Company of $2,300,000. These proceeds were used to redeem the Company's
Series A convertible preferred stock as discussed above. The purchase
price of the shares was $1.15 per share. The shareholder also received a
warrant to purchase up to 500,000 shares of common stock of the Company at
an exercise price of $1.15 per share for a period of five (5) years. The
fair value of the warrants is $315,000. The closing sale price of the
common stock on the AMEX Stock Exchange on October 6, 2004 was $1.30. The
shares are restricted securities that have not been registered under the
Act and may not be offered or sold in the United States absent
registration or applicable exemptions and registration requirements. The
Company has undertaken the obligation to file a registration statement
with the Securities and Exchange Commission within 180 days of closing to
register the shares issued in the private placement and to include the
shares underlying the warrants described herein.
(4) Non-Cash Compensation Related to Options and Warrants
-----------------------------------------------------
The Company calculates non-cash compensation related to its securities in
the Company's Statements of Operations 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 the
three and six months ended September 30, 2004 and 2003 as the price of the
Company's common stock at the beginning and end of the periods was below
the Floor.
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 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,
10
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 income of $158,166 and non-cash
compensation expense of $86,399 related to these variable options and
warrants in the three months ended September 30, 2004 and 2003,
respectively. For the six months ended September 30, 2004, the Company did
not record any income or expense related to these variable options and
warrants as the stock price was below $2.05 at the beginning and end of
the period. The Company recorded non-cash compensation expense of $920,041
related to the variable options and warrants in the six months ended
September 30, 2003. The remaining outstanding variable options and
warrants as of September 30, 2004 were 3,882,092.
c. Option and Warrant Issuances
During the three months ended September 30, 2004 and 2003, the Company
recorded $36,994 and $41,859, respectively as non-cash compensation
expense related to stock, options and warrants that were issued to and
vested by officers, directors and consultants. During the six months ended
September 30, 2004 and 2003, the Company recorded $41,202 and $515,348,
respectively as non-cash compensation expense related to stock, options
and warrants that were issued to and vested by officers, directors and
consultants.
(5) Earnings Per Share
------------------
The following is a reconciliation of basic net earnings (loss) per share
to diluted net earnings (loss) per share:
THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------------------------------------
2004 2003 2004 2003
Net loss per common share $ (571,372) $ (933,385) $ (1,367,535) $ (3,853,198)
============ ============ ============ ============
Average shares outstanding - basic and
diluted 15,767,924 15,156,722 15,717,439 14,378,079
============ ============ ============ ============
Basic and diluted net income (loss)
per common share $ (0.04) $ (0.06) $ (0.09) $ (0.27)
Potential conversion of Series A convertible preferred stock for 2,148,829
shares, options for 4,783,701 shares and warrants for 1,235,356 shares
have not been included in the computation of diluted net loss per common
share for the three and six months ended September 30, 2004, respectively,
as their effect would be antidilutive. Potential conversion of Series A
convertible preferred stock for 1,866,286 shares, options for 4,648,680
shares and warrants for 1,242,856 shares have not been included in the
computation of diluted net income (loss) per common share for the three
and six months ended September 30, 2003, as their effect would be
antidilutive.
(6) Supplemental Cash Flow Information
----------------------------------
For purposes of the statement of cash flows, all highly liquid investments
with a maturity date of three months or less are considered to be cash
equivalents.
Six months ended September 30, 2004 2003
--------------------------------------------------------------------------------------------
Non-cash financing and investing activities:
Fair value of stock, options and warrants issued $ -- $ 565,800
Accrued preferred stock dividends 82,572 108,616
Beneficial conversion feature related to preferred stock dividends 14,491 57,653
Accretion of discount on preferred stock 189,114 1,488,680
11
Purchase of equipment through capital lease 34,476 --
Cash paid for:
Interest 483,006 800,270
Income taxes -- --
(7) Related Party Transactions
--------------------------
Angelo S. Morini
----------------
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 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. 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 $1,476,627 remained unpaid but accrued ($366,305
in short-term liabilities and $1,110,322 in long-term liabilities) as of
September 30, 2004. The long-term portion will be paid out in nearly equal
monthly installments ending in October 2008.
In July 2004, the Company entered into a brokerage contract with Mr.
Morini's brother. The contract has been cancelled effective December 1,
2004. Total amounts to be paid in accordance with this brokerage contract
are deemed to be immaterial.
Christopher J. New
------------------
On July 8, 2004, Christopher J. New resigned from his position as Chief
Executive Officer in order to pursue other opportunities. In accordance
with the Separation and Settlement Agreement between the Company and Mr.
New, the Company recorded $444,883 related to the employment contract
expense in July 2004. This settlement will be paid out in nearly equal
installments over two years payable on the Company's regular payroll
dates. In addition to the compensation, the Company agreed that Mr. New's
stock option rights under that certain Non-Qualified Stock Option
Agreement dated December 5, 2002 (for 25,000 shares at $1.67) and that
certain Non-Qualified Stock Option Agreement dated July 16, 2001 (for
100,000 shares at $2.05) will continue in full force and effect as if he
was employed by the Company. The remaining balance accrued as of September
30, 2004 was $399,348 ($222,949 in short-term liabilities and $176,399 in
long-term liabilities).
Michael E. Broll
----------------
On July 8, 2004, Michael E. Broll, a member of the Company's Board of
Directors, was appointed as the new Chief Executive Officer upon the
resignation of Mr. New. The Company entered into a one-year employment
agreement whereby Mr. Broll is entitled to receive an annual base salary
of $200,000 plus a performance bonus at the discretion of the Board,
standard health benefits, a housing allowance of up to $500 per week for
one year and an auto allowance of $1,500 per month. The employment
agreement renews automatically for one-year periods unless cancelled by
either party ninety days prior to the end of the term. In the event Mr.
Broll's employment is terminated without cause, he will be entitled to
receive one year of his base salary as severance.
12
(8) Economic Dependence
-------------------
The Company had one customer that accounted for approximately 11% and 13%
of sales in the three and six months ended September 30, 2004. As of
September 30, 2004, the amount due from this customer is approximately 12%
of the balance of accounts receivable. There were no customers that
accounted for greater than 10% of sales or of the accounts receivable
balance as of September 30, 2003.
13
GALAXY NUTRITIONAL FOODS, INC.
ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operation
The following discussion and analysis should be read in conjunction with the
Financial Statements and Notes thereto appearing elsewhere in this report. The
following discussion contains certain forward-looking statements, within the
meaning of the "safe-harbor" provisions of the Private Securities Reform Act of
1995, the attainment of which involves various risks and uncertainties. These
forward-looking statements are based on the Company's current expectations,
estimates and projections about the Company's industry, management's beliefs and
certain assumptions made by us. Forward-looking statements may be identified by
the use of forward-looking terminology such as "may", "will", "expect",
"believe", "estimate", "anticipate", "continue", or similar terms, variations of
these terms or the negative of those terms. These statements are not guarantees
of future performance and are subject to certain risks, uncertainties and
assumptions that are difficult to predict. Therefore, the Company's actual
results may differ materially from those described in these forward-looking
statements due to among other factors, competition in the Company's product
markets, dependence on suppliers, the Company's manufacturing experience, and
production delays or inefficiencies. The Company undertakes no obligation to
update publicly any forward-looking statements for any reason, even if new
information becomes available or other events occur in the future.
Galaxy Nutritional Foods, Inc. (the "Company") is principally engaged in
developing, manufacturing and marketing a variety of healthy cheese and dairy
related products, as well as other cheese alternatives, and is a leading
producer of dairy alternative products made with soy. These healthy cheese and
dairy related products include low or no fat, no saturated fat, no trans-fat,
low or no cholesterol and lactose-free varieties. These products are sold
throughout the United States and internationally to customers in the retail and
food service markets. The Company's headquarters and manufacturing facilities
are located in Orlando, Florida.
MATERIAL EVENTS
On October 6, 2004, the Company's Series A Preferred Holders (BH Capital
Investments, LP and Excalibur Limited Partnership) converted 10,278 Series A
convertible preferred shares into approximately 600,000 shares of common stock.
Simultaneously, the remaining 30,316 Series A convertible preferred shares held
by the Series A Preferred Holders were redeemed by the Company for a total price
of $2,279,688. The entire class of Series A convertible preferred stock of the
Company has now been cancelled. As part of the transaction, the former Series A
Preferred Holders also received warrants to purchase up to 500,000 shares of
common stock at an exercise price of $2.00 per share for a period of five (5)
years. The fair value of the warrants is $205,000. The cash for the redemption
was provided to the Company through a private placement of two million shares of
its common stock with an existing shareholder of the Company for aggregate gross
proceeds to the Company of $2,300,000. See "Equity Financing" below for further
details.
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 six months ended September 30, 2004, 66% 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 net 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)
14
o Other operating ratios and statistics
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 45% of the Company's raw material purchases. As casein is a
significant component of the Company's product formulation, the Company is
vulnerable to short and long-term changes in casein pricing, which, at times has
been volatile. During the first six months of fiscal 2005, the Company has seen
a 19% increase in casein prices compared to the first six months of fiscal 2004
which resulted in excess cost of goods of approximately one million dollars.
Every 5% increase in casein prices will result in an annual cost increase of
approximately $300,000 assuming the same amount of pounds purchased as in fiscal
2004. Costs are rising mainly due to a worldwide shortage of casein. The Company
anticipates that the price of casein will continue to rise during the remainder
of fiscal 2005, resulting in an annual increase of approximately 35% over fiscal
2004. Based on discussions with its primary suppliers, the Company expects that
the price of casein will moderate in the fourth quarter of fiscal 2005. In order
to offset the rising costs, management is pursuing tactics that minimize the
effects of the volatility of casein pricing on the Company, as well as trying to
incorporate alternative sources of protein that maintain the integrity of the
Company's product benefits. Additionally, management is passing along some of
the increased costs to its customers during the remainder of fiscal 2005.
To accelerate top line growth and better utilize existing assets, the Company is
pursuing strategic contract manufacturing business in addition to our branded
sales focus. Although the Company's expansion of its contract manufacturing
business has resulted, and will likely to continue to 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 contract manufacturing growth by reinvesting additional gross margin
dollars generated from these sales into increased marketing spending against its
core brands. Management plans to build the core branded business by leveraging a
premium brand approach that begins with superior product quality over most of
the direct alternative cheese competition. Management believes that combining
"healthy" product attributes, improved taste and product functionality will lead
to better than expected consumer experiences with our brands. Management's focus
is to transfer those improved consumer experiences into enhanced market share
and higher margins.
RESULTS OF OPERATIONS
Three Months Ended September 30, 2004 ("second quarter of fiscal 2005") Compared
to Three Months Ended September 30, 2003 ("second quarter of fiscal 2004") and
Six Months Ended September 30, 2004 ("first six months of fiscal 2005" Compared
to Six Months Ended September 30, 2003 ("first six months of fiscal 2004")
Three Months Ended September 30, Six Months Ended September 30,
---------------------------------------------- -----------------------------------------------
2004 2003 Change % 2004 2003 Change %
---------------------------------------------- -----------------------------------------------
Net Sales 11,900,553 9,329,907 2,570,646 27.6% 23,092,231 18,025,688 5,066,543 28.1%
Cost of Goods Sold 9,319,969 6,329,977 2,989,992 47.2% 17,571,299 12,381,093 5,190,206 41.9%
---------------------------------------------- -----------------------------------------------
Gross Margin 2,580,584 2,999,930 (419,346) (14.0%) 5,520,932 5,644,595 (123,663) (2.2%)
============================================== ===============================================
Gross Profit % 22% 32% 24% 31%
======================== =========================
Net Sales increased approximately 28% in the second quarter and the first six
months of fiscal 2005 compared to the same periods in fiscal 2004. This increase
is primarily due to increased sales in contract manufacturing, the food service
business and Wholesome Valley Organic products. During the first six months of
fiscal 2005, the Company had one new contract manufacturing customer that
accounted for approximately 13% of sales. This customer accounted for nearly 60%
of the increase in fiscal 2005 sales during the first six months. Contract
manufacturing sales consist primarily of products that generate high sales
volumes but lower gross margins.
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.
15
The Company's internal data indicates that our overall branded sales were
slightly higher in the first six months of fiscal 2005 versus the first six
months of fiscal 2004. Additionally, the data from several external sources
indicates that sales in the overall alternative cheese category has decreased
during the first six months of fiscal 2005.
In order to positively impact sales volume throughout fiscal 2005, the Company
continues to focus on three primary areas:
o The Company has shifted 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 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). The Company has seen
an increase in sales through its consumer advertising and
promotions, which highlight and communicate 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.
o The Company will also focus its efforts toward generating consumer
awareness, conducting product trials, and generating more repeat
purchases for its brands.
o The Company has secured certain contract manufacturing
opportunities, which it previously turned away or did not pursue
earlier in prior years due to cash constraints. This will enable the
Company to better utilize some of its excess production capacity.
These efforts should result in a higher return on invested capital
in future periods. The Company's contract manufacturing activities
relate primarily to products that generate lower margins. As the
Company adds additional contract manufacturing business to its
product mix, the Company's gross margin percentage will likely
decrease. However, the overall gross margin dollars should increase
due to higher net sales volume.
Cost of Goods Sold increased from 68% of net sales in the second quarter of
fiscal 2004 to 78% of net sales in the second quarter of fiscal 2005. Of the ten
percent change, four percent was due to rising key commodity costs (primarily in
casein), two percent was due to higher overhead costs as a result of the rapid
growth in manufacturing volume, and the remaining four percent was due to the
shift in sales mix resulting from the addition of certain contract manufacturing
items that were sold at a lower margin. Cost of goods sold increased seven
percent during the first six months of fiscal 2005 compared to the first six
months of 2004 for the same reasons as stated above. Based on current pricing
trends with its suppliers, management expects to see continued substantial
increases in its casein prices during fiscal 2005. Every 5% increase in casein
prices will result in an annual cost increase of approximately $300,000 assuming
the same amount of pounds purchased as in fiscal 2004. Costs are rising mainly
due to a worldwide shortage of casein. The Company anticipates that the price of
casein will continue to rise during the remainder of fiscal 2005, resulting in
an annual increase of approximately 35% over fiscal 2004. Based on discussions
with its primary suppliers, the Company expects that the price of casein will
moderate in the fourth quarter of fiscal 2005. Management is striving to offset
these cost increases by implementing projects to improve production efficiency
and to reduce costs of other raw materials. Additionally, management is passing
along some of these costs to its customers through sales price increases on
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.
In fiscal 2005, the gross profit percentage is expected to remain lower than the
levels in fiscal 2004 due to the sharp increase in raw material costs and the
change in the product mix as noted above. In spite of the increase in net sales
during fiscal 2005, gross margin for fiscal 2005 is expected to be comparable or
slightly lower than the gross margin for fiscal 2004 due to a large portion of
raw material cost increases that cannot been passed on completely to existing
customers.
Three Months Ended September 30, Six Months Ended September 30,
-----------------------------------------------------------------------------------------------
2004 2003 Change % 2004 2003 Change %
-----------------------------------------------------------------------------------------------
Gross Margin 2,580,584 2,999,930 (419,346) (14.0%) 5,520,932 5,644,595 (123,663) (2.2%)
Operating Expenses:
Selling 1,572,470 1,446,859 125,611 8.7% 3,032,870 2,760,732 272,138 9.9%
Delivery 615,257 433,959 181,298 41.8% 1,208,583 885,776 322,807 36.4%
Non-cash compensation
related to options and
warrants (121,172) 128,258 (249,430) (194.5%) 41,202 1,435,389 (1,394,187) (97.1%)
Employment contract 444,883 -- 444,883 -- 444,883 -- 444,883 --
General & administrative 565,968 886,019 (320,051) (36.1%) 1,199,310 1,869,498 (670,188) (35.8%)
Research & development 78,932 62,908 16,024 25.5% 151,618 125,992 25,626 20.3%
-----------------------------------------------------------------------------------------------
Total Operating Expenses 3,156,338 2,958,003 198,335 6.7% 6,078,466 7,077,387 (998,921) (14.1%)
-----------------------------------------------------------------------------------------------
16
Income (Loss) From
Operations (575,754) 41,927 (617,681) (1473.2%) (557,534) (1,432,792) 875,258 (61.1%)
Non-cash compensation
related to options and
warrants (2) (121,172) 128,258 (249,430) (194.5%) 41,202 1,435,389 (1,394,187) (97.1%)
Employment contract (3) 444,883 -- 444,883 -- 444,883 -- 444,883 --
-----------------------------------------------------------------------------------------------
Operating Income (Loss), As
Adjusted (1) (a non-GAAP
measure) (252,043) 170,185 (422,228) 248.1% (71,449) 2,597 (74,046) (2851.2%)
===============================================================================================
(1) Management utilizes certain non-GAAP measures such as Operating Income, as
adjusted, Net Income, as adjusted and EBITDA, as adjusted, because they
provide useful information to management, lenders and investors in order
to accurately review the Company's current on-going operations and
business trends related to its financial condition and results of
operations. Additionally, these measure are key factors upon which the
Company prepares its budgets and forecasts, calculates bonuses, and
evaluates loan covenants. These non-GAAP measures are not in accordance
with, or an alternative for, generally accepted accounting principles and
may be different from non-GAAP measures reported by other companies.
(2) In its determination of non-GAAP measures, management excludes the
non-cash compensation related to options and warrants because it believes
that this item does not accurately reflect the Company's current on-going
operations. Non-cash compensation is calculated based on fluctuations in
the Company's stock price, which can skew the financial results
dramatically up and down. The price of the Company's common shares as
traded on AMEX are outside the Company's control and typically do not
reflect the Company's current operations.
(3) In its determination of non-GAAP measures, management excludes the
employment contract expenses related to Angelo S. Morini and Christopher
J. New because it believes that these items do not reflect expenses
related to the Company's current on-going operations. Additionally, these
items are excluded by the Company's lenders when calculating compliance
with loan covenants.
The decrease in Operating Income, as adjusted, during the second quarter of
fiscal 2005 compared to the second quarter of fiscal 2004 is primarily due to
the decrease in gross margin as a result of the sharp increase in cost of goods
sold as described above.
Selling expenses were 13% of net sales in the second quarter of fiscal 2005
compared to 16% in the second quarter of fiscal 2004. The $125,611 increase in
selling expenses was due to the shift in marketing efforts from vendor
promotions to consumer advertising. In the second quarter of fiscal 2005, the
Company increased consumer advertising by approximately $364,000 and decreased
vendor promotions by nearly $257,000 compared to the second quarter of fiscal
2004. The large consumer advertising costs were related to a strategic
television campaign, which was undertaken to promote the Company's Veggie brand
products during the second quarter of fiscal 2005. Although selling expenses are
increasing, they are becoming a smaller percentage of sales in the second
quarter of fiscal 2005, as the fixed components of selling expenses are
remaining comparable to the second quarter of fiscal 2004. The Company expects
that fiscal 2005 selling expenses will increase compared to fiscal 2004 expenses
as a result of the higher sales volume and based on the Company's current plan
for marketing strategic products.
Delivery expenses increased $181,298 in the second quarter of fiscal 2005
compared to the second quarter of fiscal 2004 in proportion to the increase in
net sales. 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 due to the new laws regarding limitation
of driver hours. The Company anticipates that during fiscal 2005 delivery
expenses will increase from 5% of net sales to 6% of net sales based on the
above factors.
17
Non-Cash Compensation Related to Options and Warrants
Three Months Ended September 30, Six Months Ended September 30,
----------------------------------------------------------------------------------------------
2004 2003 Change % 2004 2003 Change %
----------------------------------------------------------------------------------------------
Notes Receivable for Common
Stock -- -- -- -- -- -- -- --
Option and Warrant Repricing (158,166) 86,399 (244,565) (283.1%) -- 920,041 (920,041) --
Option and Warrant Issuances 36,994 41,859 (4,865) (11.6%) 41,202 515,348 (474,146) (92.0%)
----------------------------------------------------------------------------------------------
Total Non-Cash
Compensation
(Income)/Expense (121,172) 128,258 (249,430) (194.5%) 41,202 1,435,389 (1,394,187) (97.1%)
==============================================================================================
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 the
three and six months ended September 30, 2004 and 2003 as the price of the
Company's common stock at the beginning and end of the periods was below
the Floor. 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 approximately $29,000.
b. Option and Warrant Repricing
----------------------------
On October 11, 2002, the Company repriced all outstanding options granted
to employees prior to October 11, 2002 (4,284,108 shares at former prices
ranging from $2.84 to $10.28) to the market price of $2.05 per share. In
addition, the Company repriced the outstanding warrants held by current
consultants as of October 11, 2002 (291,429 shares at former prices
ranging from $3.31 to $5.50) to the market price of $2.05 per share. This
stock option repricing resulted in variable accounting treatment for these
stock options beginning with the quarter ended December 31, 2002 and such
variable accounting treatment will continue until the related options have
been cancelled, expired or exercised. On December 4, 2002, as a result of
discussions and negotiations with certain major shareholders, the
Company's 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 income of $158,166 and non-cash
compensation expense of $86,399 related to these variable options and
warrants in the three months ended September 30, 2004 and 2003,
respectively. For the six months ended September 30, 2004, the Company did
not record any income or expense related to these variable options and
warrants as the stock price was below $2.05 at the beginning and end of
the period. The Company recorded non-cash compensation expense of $920,041
related to the variable options and warrants in the six months ended
September 30, 2003. The remaining outstanding variable options and
warrants as of September 30, 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 $39,000.
18
c. Option and Warrant Issuances
----------------------------
During the three months ended September 30, 2004 and 2003, the Company
recorded $36,994 and $41,859, respectively as non-cash compensation
expense related to stock, options and warrants that were issued to and
vested by officers, directors and consultants. During the six months ended
September 30, 2004 and 2003, the Company recorded $41,202 and $515,348,
respectively as non-cash compensation expense related to stock, options
and warrants that were issued to and vested by officers, directors and
consultants.
Employment Contract Expense - On July 8, 2004, Christopher J. New resigned from
his position as Chief Executive Officer in order to pursue other opportunities.
In accordance with the Separation and Settlement Agreement between the Company
and Mr. New, Mr. New will receive (1) a one-time settlement of $1,000; (2) two
years of his base salary, payable over two years on the Company's regular
payroll dates; (3) coverage of health care costs for six months; and (4)
extension of the time for which he can exercise his employee stock options under
that certain Non-Qualified Stock Option Agreement dated December 5, 2002 (for
25,000 shares at $1.67) and that certain Non-Qualified Stock Option Agreement
dated July 16, 2001 (for 100,000 shares at $2.05) from 60 days after leaving
employment to the end of the option terms. The Company recorded $444,883 in
costs related to this separation agreement as employment contract expense in
July 2004. This charge is reflected in the results for the Company's second
quarter of fiscal 2005.
General and administrative expenses decreased by 36% in the second quarter and
the first six months of fiscal 2005 compared to the second quarter and first six
months of fiscal 2004. This decrease results primarily from a decrease in
personnel costs and legal fees. Personnel costs declined due to the change in
the employment status of Angelo S. Morini per the amended employment agreement
in October 2003. Legal fees were higher in the second quarter of fiscal 2004 due
to the equity raise and corporate refinancing that was completed in May 2003.
Additionally, legal fees decreased in fiscal 2005 due to the settlement of the
Schreiber lawsuit in May 2004. Management is anticipating further declines in
general and administrative expenses in fiscal 2005 compared to fiscal 2004 due
to continued reductions in general overhead costs such as rent along with a
decrease in personnel expenses based on the amended employment agreement with
Angelo S. Morini. Additionally, management believes that legal fees should
continue to decrease significantly now that the Schreiber lawsuit has been fully
resolved.
Research and development expenses increased by $16,024 in the second quarter of
fiscal 2005 compared to the second quarter of fiscal 2004 and by $25,626 in the
first six months of fiscal 2005 compared to the first six months of fiscal 2004
primarily as a result of an increase in personnel costs. The Company anticipates
increases in research and development expenses in fiscal 2005 compared to fiscal
2004 primarily due to additional personnel costs associated with new product
development.
Three Months Ended September 30, Six Months Ended September 30,
----------------------------------------------- -----------------------------------------------
2004 2003 Change % 2004 2003 Change %
----------------------------------------------- -----------------------------------------------
Income (Loss) from
Operations (575,754) 41,927 (617,681) (1473.2%) (557,534) (1,432,792) 875,258 (61.1%)
Interest Expense (264,008) (270,072) 6,064 2.3% (523,824) (765,457) 241,633 31.6%
----------------------------------------------- -----------------------------------------------
Net Income (Loss) (839,762) (228,145) (611,617) (268.1%) (1,081,358) (2,198,249) 1,116,891 (50.8%)
Non-cash compensation
related to options and
warrants (2) (121,172) 128,258 (249,430) (194.5%) 41,202 1,435,389 (1,394,187) (97.1%)
Employment contract (3) 444,883 -- 444,883 -- 444,883 -- 444,883 --
----------------------------------------------- -----------------------------------------------
NET INCOME (LOSS), AS
ADJUSTED (1) (a non-GAAP
measure) (516,051) (99,887) (416,164) (416.6%) (595,273) (762,860) 167,587 22.0%
Interest Expense 264,008 270,072 (6,064) (2.3%) 523,824 765,457 (241,633) (31.6%)
Depreciation 546,045 550,674 (4,629) (0.8%) 1,092,086 1,108,799 (16,713) (1.5%)
----------------------------------------------- -----------------------------------------------
EBITDA, AS ADJUSTED (1)
(a non-GAAP measure) 294,002 720,859 (426,857) (59.2%) 1,020,637 1,111,396 (90,759) (8.2%)
=============================================== ===============================================
EBITDA % of Net Sales 2.5% 7.7% 4.4% 6.2%
======================== =========================
19
(1) Management utilizes certain non-GAAP measures such as Operating
Income, as adjusted, Net Income, as adjusted and EBITDA, as
adjusted, because they provide useful information to management,
lenders and investors in order to accurately review the Company's
current on-going operations and business trends related to its
financial condition and results of operations. Additionally, these
measure are key factors upon which the Company prepares its budgets
and forecasts, calculates bonuses, and evaluates loan covenants.
These non-GAAP measures are not in accordance with, or an
alternative for, generally accepted accounting principles and may be
different from non-GAAP measures reported by other companies.
(2) In its determination of non-GAAP measures, management excludes the
non-cash compensation related to options and warrants because it
believes that this item does not accurately reflect the Company's
current on-going operations. Non-cash compensation is calculated
based on fluctuations in the Company's stock price, which can skew
the financial results dramatically up and down. The price of the
Company's common shares as traded on AMEX are outside the Company's
control and typically do not reflect the Company's current
operations.
(3) In its determination of non-GAAP measures, management excludes the
employment contract expenses related to Angelo S. Morini and
Christopher J. New because it believes that these items do not
reflect expenses related to the Company's current on-going
operations. Additionally, these items are excluded by the Company's
lenders when calculating compliance with loan covenants.
The decrease in net income, as adjusted, is primarily the result of the decrease
in gross margin as a result of the sharp increase in cost of goods sold as
described above.
Interest expense decreased slightly in the second quarter of fiscal 2005
compared to the second quarter of fiscal 2004 due to lower principal balances on
the Company's term loan with Southtrust Bank being offset by higher floating
interest rates. As well, the Textron loan carried a higher average outstanding
balance as well as higher floating interest rates versus the prior year second
quarter. The increase in floating interest rates was due to higher prevailing
market interest rates upon which our lenders' floating rates are based. Interest
expense decreased $241,633 or 32% in the first six months of fiscal 2005
compared to the first six months of fiscal 2004 due a reduction of its total
outstanding debt through the refinancing in May 2003. Additionally, the FINOVA
asset based line of credit was replaced by a comparable line of credit with more
favorable terms from Textron through the refinancing. See "Debt Financing"
below for further detail on the Company's outstanding debts and interest rates
thereon.
LIQUIDITY AND CAPITAL RESOURCES
Six Months Ended September 30, 2004 2003 Change %
------------ ------------ ------------ ------------
Cash provided by (used in) operating
activities $ (624,208) $ 810,704 $ (1,434,912) (177.0%)
Cash used in investing activities (54,725) (98,280) 43,555 44.3%
Cash provided by (used in) financing
activities 652,734 (496,090) 1,148,824 231.6%
------------ ------------ ------------ ------------
Net increase (decrease) in cash $ (26,199) $ 216,334 $ (242,533) (112.1%)
============ ============ ============ ============
Operating Activities -The decrease in cash provided by operations in the first
six months of fiscal 2005 compared to the first six months of fiscal 2004 is
primarily attributable to higher accounts receivable and inventory levels offset
by higher accounts payable balances reflective of the higher sales volume in the
current year. Accounts receivable, inventory and accounts payable levels are
rising due to the higher sales volumes during the first six months of fiscal
2005. Accounts receivable collection periods are fairly consistent with prior
periods and inventory turnover is increasing. The Company anticipates that
annual operating activities should continue to provide positive cash for
operations. Additionally, the Company anticipates that accounts receivable,
inventories and accounts payable balances will continue to increase during
fiscal 2005 as sales continue to increase over fiscal 2004 levels.
20
Investing Activities -The decrease in cash used for investing activities during
the first six months of fiscal 2005 as compared to the first six months fiscal
of 2004 primarily resulted from less purchases of fixed assets during the
period. The Company currently has no plans for any major capital additions. Most
current period purchases of assets are for normal recurring asset upgrades and
replacements.
Financing Activities - During the first six months of fiscal 2005, the Company
increased its line of credit with Textron Financial Corporation to fund its
increases in accounts receivable and inventory levels. During the first six
months 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. 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 for operations and to
further reduce the Company's accounts payable and debt balances.
Debt Financing
- --------------
On May 27, 2003, the Company obtained from Textron Financial Corporation
("Textron") a revolving credit facility (the "Textron Loan") with a maximum
principal amount of $7,500,000 pursuant to the terms and conditions of a Loan
and Security Agreement dated May 27, 2003 (the "Textron Loan Agreement"). The
Textron Loan is secured by the Company's inventory, accounts receivable and all
other assets. Generally, subject to the maximum principal amount, which can be
borrowed under the Textron Loan and certain reserves that must be maintained
during the term of the Textron Loan, the amount available under the Textron Loan
for borrowing by the Company from time to time is equal to the sum of (i)
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 (6.50% at September 30, 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
September 30, 2004, the outstanding principal balance on the Textron Loan was
$5,881,762.
The Textron Loan Agreement contains certain financial and operating covenants.
Due to the $444,883 charge to operations related to the Separation and
Settlement Agreement between the Company and Christopher J. New, its former
Chief Executive Officer, the Company fell below the requirement for the adjusted
tangible net worth and the fixed charge coverage ratio covenants for the quarter
ended September 30, 2004. Pursuant to discussions and a written confirmation,
Textron has agreed in principle to amend the loan covenants effective as of
September 30, 2004, the effect of which would bring the Company into compliance
with both ratios as of that date. The Company anticipates that it will be in
compliance with these ratios, as amended, for the foreseeable future based on
current forecasts.
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% (5.75% at September 30, 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: $110,000 from October 2004 to June 2005, and $166,250 from July 2005
until maturity in June 2009. In a Loan Modification letter dated May 21, 2004,
beginning in October 2004, interest may be adjusted quarterly from prime to
prime plus 1.25% according to the Company's performance ratios in prior
quarters. This note is secured by all of the Company's equipment and certain
related assets. The balance outstanding on the term loan as of September 30,
2004 was $8,901,985.
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 had 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
$48.18, plus all accrued dividends that are then unpaid for each share of the
Series A
21
convertible preferred stock divided by the lesser of (x) $1.75 or (y) 95% of the
average of the two lowest closing bid prices of the Company's common stock on
the American Stock Exchange out of the fifteen trading days immediately prior to
conversion.
As of September 30, 2004, the Series A Preferred Holders had converted 32,052
shares of the Series A convertible preferred stock plus accrued dividends, into
1,206,240 shares of common stock. The conversion prices ranged from $1.28 to
$1.75 based on the above formula.
On October 6, 2004, the Company's Series A Preferred Holders (BH Capital
Investments, LP and Excalibur Limited Partnership) converted 10,278 Series A
convertible preferred shares into approximately 600,000 shares of common stock.
Simultaneously, the remaining 30,316 Series A convertible preferred shares held
by the Series A Preferred Holders were acquired by the Company for a total price
of $2,279,688. The entire class of Series A convertible preferred stock of the
Company has now been cancelled. As part of the transaction, the former Series A
Preferred Holders also received warrants to purchase up to 500,000 shares of
common stock at an exercise price of $2.00 per share for a period of five (5)
years. The fair value of the warrants is $205,000.
On October 6, 2004, the Company completed a private placement of its common
stock, $.01 par value, issuing a total of two million shares to Mr. Fredrick
DeLuca (an existing shareholder of the Company) for aggregate gross proceeds to
the Company of $2,300,000. The purchase price of the shares was $1.15 per share.
Mr. DeLuca also received a warrant to purchase up to 500,000 shares of common
stock of the Company at an exercise price of $1.15 per share for a period of
five (5) years. The fair value of the warrants is $315,000. The closing sale
price of the common stock on the AMEX Stock Exchange on October 6, 2004 was
$1.30. The shares are restricted securities that have not been registered under
the Act and may not be offered or sold in the United States absent registration
or applicable exemptions and registration requirements. The Company has
undertaken the obligation to file a registration statement with the Securities
and Exchange Commission within 180 days of closing to register the shares issued
in the private placement and to include the shares underlying the warrants
described herein.
Summary
- -------
Management believes that with the proceeds available with its Textron credit
facilities 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.
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.
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 $797,000
and $751,393 for known and anticipated future credits and doubtful accounts at
September 30, 2004 and 2003, respectively. Actual bad debt expense during the
periods is less than 1% of gross sales. We believe that
22
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.
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:
Six Months Ended September 30, September 30,
2004 2003
---------- --------------
Dividend Yield None None
Volatility 45% 41% to 42%
Risk Free Interest Rate 3.96% 2.01% to 3.77%
Expected Lives in Months 120 36 to 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
23
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.
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
The Company's exposure to market risk results primarily from fluctuations in
interest rates. The interest rates on 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 September 30,
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 $148,000 per year or $37,000 per quarter.
The Company's sales during the six months ended September 30, 2004 and 2003
which were denominated in a currency other than U.S. dollars were less than 5%
of gross sales and no net assets were maintained in a functional currency other
than U. S. dollars during such periods. Therefore, the effects of changes in
foreign currency exchange rates have not historically been, and are not
currently, significant to the Company's operations or net assets.
ITEM 4. Controls and Procedures
As of the end of the fiscal quarter ended September 30, 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 material changes in the Company's internal
controls or in other factors that are reasonably likely to materially affect
those controls.
24
PART II. OTHER INFORMATION
--------------------------
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
In accordance with an exemption from registration under Regulation D promulgated
under the Securities Act of 1933, as amended, on October 6, 2004, the Company
completed a private placement of its Common Stock, $.01 par value, issuing a
total of two million shares to Mr. Fredrick DeLuca (an existing shareholder of
the Company) for aggregate gross proceeds to the Company of $2,300,000. The
purchase price of the shares was $1.15 per share. Mr. DeLuca also received a
warrant to purchase up to 500,000 shares of common stock of the Company at an
exercise price of $1.15 per share for a period of five (5) years. The fair value
of the warrants is $315,000. The closing sale price of the common stock on the
AMEX Stock Exchange on October 6, 2004 was $1.30. The shares are restricted
securities that have not been registered under the Act and may not be offered or
sold in the United States absent registration or applicable exemptions and
registration requirements. The Company has undertaken the obligation to file a
registration statement with the Securities and Exchange Commission within 180
days of closing to register the shares issued in the private placement and to
include the shares underlying the warrants described herein.
The proceeds from the sale were used to redeem the remaining 30,316 Series A
convertible preferred shares held by the Series A Preferred Holders on October
6, 2004 and to pay the legal fees associated with the transaction. The Company
redeemed these Series A convertible preferred shares for a total purchase price
of $2,279,688 ($75.20 per share). This constitutes all of the Company's
outstanding Series A convertible preferred shares.
ITEM 3. Defaults Upon Senior Securities
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 contains certain financial and operating covenants. Due to the $444,883
charge to operations related to the Separation and Settlement Agreement between
the Company and Christopher J. New, its former Chief Executive Officer, the
Company fell below the requirement for the adjusted tangible net worth and the
fixed charge coverage ratio covenants for the quarter ended September 30, 2004.
Pursuant to discussions and a written confirmation, Textron has agreed in
principle to amend the loan covenants effective as of September 30, 2004, the
effect of which would bring the Company into compliance with both ratios as of
that date. The Company anticipates that it will be in compliance with these
ratios, as amended, for the foreseeable future based on current forecasts.
ITEM 4. Submission of Matters to a Vote of Security Holders
The Company held its annual shareholders meeting on September 24, 2004. As of
the record date on August 6, 2004, there were 15,759,287 shares of common stock
issued, outstanding and eligible to vote. In this meeting, the shareholders
voted on and approved the following proposals:
1. To fix the number of directors at eight and to elect a Board of
Directors for the ensuing year. The board members were voted in with
the following number of votes for their election:
Votes Cast Votes Cast
Director FOR AGAINST
-----------------------------------------------------------
David H. Lipka 13,777,742 67,884
Michael E. Broll 13,761,344 84,282
Thomas R. Dyckman 13,782,017 63,609
Charles L. Jarvie 13,781,169 64,457
Joseph J. Juliano 13,760,802 84,824
Angelo S. Morini 13,739,101 106,525
Patrice M.A. Videlier 13,761,844 83,762
25
2. To ratify the retention of BDO Seidman, L.L.P. as the independent
auditors of the Company for the fiscal year ending March 31, 2005.
The vote tabulation for this proposal was as follows: VOTES CAST FOR
- 13,787,845; VOTES CAST AGAINST - 29,300; ABSTENTIONS - 28,481;
BROKER NON-VOTES - none.
ITEM 5. Other Information
On July 8, 2004, Christopher J. New resigned from his position as Chief
Executive Officer in order to pursue other opportunities. In accordance with the
Separation and Settlement Agreement between the Company and Mr. New, Mr. New
will receive (1) a one-time settlement of $1,000; (2) two years of his base
salary, payable over two years on the Company's regular payroll dates; (3)
coverage of health care costs for six months; and (4) extension of the time for
which he can exercise his employee stock options under that certain
Non-Qualified Stock Option Agreement dated December 5, 2002 (for 25,000 shares
at $1.67) and that certain Non-Qualified Stock Option Agreement dated July 16,
2001 (for 100,000 shares at $2.05) from 60 days after leaving employment to the
end of the option terms. The Company recorded approximately $445,000 in costs
related to this separation agreement as employment contract expense in July
2004. This charge is reflected in the results for the Company's second quarter
of fiscal 2005 ended September 30, 2004.
On July 8, 2004, Michael E. Broll was appointed as the new Chief Executive
Officer upon the resignation of Mr. New. The Company entered into a one-year
employment agreement whereby Mr. Broll is entitled to receive an annual base
salary of $200,000 plus a performance bonus at the discretion of the Board,
standard health benefits, a housing allowance of up to $500 per week for one
year and an auto allowance of $1,500 per month. The employment agreement renews
automatically for one-year periods unless cancelled by either party ninety days
prior to the end of the term. In the event Mr. Broll's employment is terminated
without cause, he will be entitled to receive one year of his base salary as
severance.
26
ITEM 6. Exhibits
The following exhibits are filed as part of this Form 10-Q.
Exhibit No Exhibit Description
- ---------- -------------------
* 3.1 Restated Certificate of Incorporation of the Company as filed
with the Secretary of State of the State of Delaware on December
23, 2002 (Filed as Exhibit 3.2 on Form 10-Q for the fiscal quarter
ended December 31, 2002.)
* 3.2 By-laws of the Company, as amended (Filed as Exhibit 3.2 to
Registration Statement on Form S-18, No. 33-15893-NY.)
* 4.1 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.)
* 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.)
27
* 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.)
* 4.18 Securities Purchase Agreement dated as of October 6, 2004 between
Galaxy Nutritional Foods, Inc. and Frederick A. DeLuca (Filed as
Exhibit 4.18 on Form 8-K filed October 8, 2004.)
* 4.19 Registration Rights Agreement dated as of October 6, 2004 between
Galaxy Nutritional Foods, Inc. and Frederick A. DeLuca (Filed as
Exhibit 4.19 on Form 8-K filed October 8, 2004.)
* 4.20 Warrant to Purchase Securities of Galaxy Nutritional Foods, Inc.
dated as of October 6, 2004 in favor of Frederick A. DeLuca (Filed
as Exhibit 4.20 on Form 8-K filed October 8, 2004.)
* 4.21 Stock Repurchase Agreement dated as of October 6, 2004 by and
among Galaxy Nutritional Foods, Inc., BH Capital Investments L.P.
and Excalibur Limited Partnership (Filed as Exhibit 4.21 on Form
8-K filed October 8, 2004.)
* 4.22 Registration Rights Agreement dated as of October 6, 2004 by and
among Galaxy Nutritional Foods, Inc., BH Capital Investments L.P.
and Excalibur Limited Partnership (Filed as Exhibit 4.22 on Form
8-K filed October 8, 2004.)
* 4.23 Warrant to Purchase Securities of Galaxy Nutritional Foods, Inc.
dated as of October 6, 2004 in favor of BH Capital Investments
L.P. (Filed as Exhibit 4.23 on Form 8-K filed October 8, 2004.)
* 4.24 Warrant to Purchase Securities of Galaxy Nutritional Foods, Inc.
dated as of October 6, 2004 in favor of Excalibur Limited
Partnership (Filed as Exhibit 4.24 on Form 8-K filed October 8,
2004.)
* 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.)
28
* 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 as Exhibit 10.11 on Form 10-K for the fiscal year ended
March 31, 2004.)
* 10.12 Second Amendment to Loan and Security Agreement dated June 25,
2004 between Galaxy Nutritional Foods, Inc. and Textron Financial
Corporation (Filed as Exhibit 10.12 on Form 10-K for the fiscal
year ended March 31, 2004.)
* 10.13 Third Amendment to Lease Agreement dated June 10, 2004 between
Galaxy Nutritional Foods, Inc. and Cabot Industrial Properties,
L.P. (Filed as Exhibit 10.13 on Form 10-K for the fiscal year
ended March 31, 2004.)
* 10.14 Separation and Settlement Agreement dated July 8, 2004 between
Galaxy Nutritional Foods, Inc. and Christopher J. New (Filed as
Exhibit 10.14 on Form 8-K filed July 13, 2004.)
* 10.15 Employment Agreement dated July 8, 2004 between Galaxy Nutritional
Foods, Inc. and Michael E. Broll (Filed as Exhibit 10.15 on Form
8-K filed July 13, 2004.)
* 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.)
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.
29
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
GALAXY NUTRITIONAL FOODS, INC.
Date: November 15, 2004 /s/ Michael E. Broll
--------------------------------------------
Michael E. Broll
Chief Executive Officer
(Principal Executive Officer)
Date: November 15, 2004 /s/ Salvatore J. Furnari
--------------------------------------------
Salvatore J. Furnari
Chief Financial Officer
(Principal Accounting and Financial Officer)
30