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| KID > SEC Filings for KID > Form 10-Q on 13-Aug-2012 | All Recent SEC Filings |
13-Aug-2012
Quarterly Report
The financial and business analysis below provides information which we believe is relevant to an assessment and understanding of our consolidated financial condition, changes in financial condition and results of operations. This financial and business analysis should be read in conjunction with our Unaudited Consolidated Financial Statements and accompanying Notes to Unaudited Consolidated Financial Statements set forth in Part I, Financial Information, Item 1, "Financial Statements" of this Quarterly Report on Form 10-Q, our Quarterly Report on Form 10-Q for the quarter ended March 31, 2012 and our Annual Report on Form 10-K for the year ended December 31, 2011, as amended (the "2011 10-K"), including the audited consolidated financial statements and notes thereto.
OVERVIEW
We are a leading designer, importer, marketer and distributor of branded infant and juvenile consumer products. Through our four wholly-owned operating subsidiaries - Kids Line, LLC ("Kids Line"); LaJobi, Inc. ("LaJobi"); Sassy, Inc. ("Sassy"); and CoCaLo, Inc. ("CoCaLo") - we design, manufacture through third parties, and market branded infant and juvenile products in a number of complementary categories including, among others: infant bedding and related nursery accessories and décor, kitchen and nursery appliances and food preparation products, bath/spa products and diaper bags (Kids Line ® and CoCaLo®); nursery furniture and related products (LaJobi®); and developmental toys and feeding, bath and baby care items with features that address the various stages of an infant's early years (Sassy®). In addition to our branded products, we also market certain categories of products under various licenses, including Carter's®, Disney ®, Graco® and Serta®. Our products are sold primarily to retailers in North America, the United Kingdom ("U.K.") and Australia, including large, national retail accounts and independent retailers (including toy, specialty, food, drug, apparel and other retailers). We maintain a direct sales force and distribution network to serve our customers in the United States, the U. K. and Australia. We also maintain relationships with several independent representatives to service select domestic and foreign retail customers, as well as international distributors to service certain retail customers in several foreign countries.
We generated net sales of approximately $55.5 million and $110.7 million for the three and six months ended June 30, 2012. International sales, defined as sales outside of the United States, including export sales, constituted 11.2% and 9.0% of our net sales for the six months ended June 30, 2012 and 2011, respectively.
We operate in one segment: the infant and juvenile business. Our senior corporate management, together with senior management of our subsidiaries, coordinates the operations of all of our businesses and seeks to identify cross-marketing, procurement and other complementary business opportunities, while maintaining the separate brand identities of each subsidiary.
Aside from funds provided by our senior credit facility, revenues from the sale of products have historically been the major source of cash for the Company, and cost of goods sold and payroll expenses have been the largest uses of cash. As a result, operating cash flows primarily depend on the amount of revenue generated and the timing of collections, as well as the quality of customer accounts receivable. The timing and level of the payments to suppliers and other vendors also significantly affect operating cash flows. Management views operating cash flows as a good indicator of financial strength. Strong operating cash flows provide opportunities for growth both internally and through acquisitions, and also enable us to pay down debt.
We do not ordinarily sell our products on consignment, although we may do so in limited circumstances. We ordinarily accept returns only for defective merchandise, although we may in certain cases accept returns as an accommodation to retailers. In the normal course of business, we grant certain accommodations and allowances to certain customers in order to assist these customers with inventory clearance or promotions. Such amounts, together with discounts, are deducted from gross sales in determining net sales.
Our products are manufactured by third parties, principally located in the PRC and other Eastern Asian countries. Our purchases of finished products from these manufacturers are primarily denominated in U.S. dollars. Expenses for these manufacturers are primarily denominated in Chinese Yuan. As a result, any material increase in the value of the Yuan relative to the U.S. dollar, as occurred in past periods, or higher rates of inflation in the country of origin, would increase our expenses, and therefore, adversely affect our profitability. Conversely, a small portion of our revenues are generated by our subsidiaries in Australia and the U.K. and are denominated primarily in their local currencies. Any material increase in the value of the U.S. dollar relative to the value of the Australian dollar or British pound would result in a decrease in the amount of these revenues upon their translation into U.S. dollars for reporting purposes. See Item 1A, Risk Factors - "Currency exchange rate fluctuations could increase our expenses", of the 2011 10-K.
Our gross profit may not be comparable to those of other entities, since some entities include the costs of warehousing, outbound handling costs and outbound shipping costs in their costs of sales. We account for the above expenses as operating expenses
and classify them under selling, general and administrative expenses. The costs of warehousing, outbound handling costs and outbound shipping costs were $1.7 million and $3.4 million for the three and six months ended June 30, 2012, respectively, and $1.8 million and $3.9 million for the three and six months ended June 30, 2011, respectively. In addition, the majority of outbound shipping costs are paid by our customers, as many of our customers pick up their goods at our distribution centers.
If our suppliers experience increased raw materials, labor or other costs, and pass along such cost increases to us through higher prices for finished goods, our cost of sales would increase. Many of our suppliers are currently experiencing significant cost pressures related to labor rates, raw material costs and currency inflation, which has and, we believe, will continue to put pressure on our gross margins, at least for the foreseeable future. To the extent we are unable to pass such price increases along to our customers or otherwise reduce our cost of goods, our gross profit margins would decrease. Our gross profit margins have also been impacted in recent periods by: (i) an increasing shift in product mix toward lower margin products, including increased sales of licensed products, which typically generate lower margins as a result of required royalty payments (which are recorded in cost of goods sold); (ii) increased pressure from major retailers, largely as a result of prevailing economic conditions, to offer additional mark downs and other pricing accommodations to clear existing inventory, secure new product placements and/or to improve the gross margins of such retailers; and (iii) other increased costs of goods. We believe that our future gross margins will continue to be under pressure as a result of the items listed above, and such pressures may be more acute over the next several quarters as a result of anticipated product cost increases. In addition, charges pertaining to anti-dumping duties that we anticipate will be owed by our LaJobi subsidiary to U.S. Customs, and charges pertaining to customs duties we anticipate will be owed by our Kids Line and CoCaLo subsidiaries to U.S. Customs have adversely affected gross margins and net income for specified periods (See Notes 9 and 12 to the Notes to Unaudited Consolidated Financial Statements). The restatement of the Prior Financial Statements, as described in Note 12 to Notes to Unaudited Consolidated Financial Statements, however, had a positive impact on previously-reported results of operations for the period ended June 30, 2011. As the customs matters have not been concluded, however, it is possible that the actual amount of duty owed for the relevant periods will be higher than currently accrued amounts, and in any event, additional interest will continue to accrue until payment is made. In addition, we may be assessed by U.S. Customs a penalty of up to 100% of any customs duty owed, as well as possibly being subject to fines, penalties or other measures from U.S. Customs or other governmental authorities. Any amounts owed in excess of the accruals recorded will adversely affect our gross margin and net income for the period(s) in which such amounts are recorded and could have a material adverse affect on our results of operations. See Note 9 of Notes to the Unaudited Consolidated Financial Statements for a discussion of the LaJobi anti-dumping duty matters and the Kids Line/CoCaLo customs duty matters. We have discontinued the practices that resulted in the charge for anticipated anti-dumping duties, and have established alternate vendor arrangements for the relevant products in countries that are not subject to such anti-dumping duties. We believe that our ability to procure the affected categories of furniture has not been materially adversely affected. We have also discontinued the practices that resulted in the charge for anticipated Kids Line and CoCaLo customs duties.
We continue to seek to mitigate margin pressure through the development of new products that can command higher pricing, the identification of alternative, lower-cost sources of supply, re-engineering of certain existing products to reduce manufacturing cost, where possible, price increases, and more aggressive inventory management. Particularly in the mass market, our ability to increase prices or resist requests for mark-downs and/or other allowances is limited by market and competitive factors, and, while we have implemented selective price increases and will likely continue to seek to do so, we have not been able to increase prices commensurate with our cost increases and have generally focused on maintaining (or increasing) shelf space at retailers and, as a result, our market share.
Recent Developments
Amended Credit Agreement
As of June 30, 2012, the Company was not in compliance with the consolidated leverage ratio covenant (the "Covenant Default") under its then-existing credit agreement. As a result, such credit agreement was amended as of August 13, 2012 via a Waiver and First Amendment to Credit Agreement and First Amendment to Security Agreement to, among other things, waive such Covenant Default, amend the financial covenants applicable to the Company for future periods, and in consideration therefor, amend the terms of the facility. See "Liquidity and Capital Resources - Debt Financings" below for a more detailed description of the terms of such amendment.
CPSC Staff Investigation
See Part II, Item I - Legal Proceedings, for a discussion of a letter received by the Company from the staff of the Consumer Product Safety Commission regarding alleged violations by LaJobi of the reporting requirements of the Consumer Product Safety Act.
Restatement of Financial Statements
See Note 12 of the Notes to Unaudited Consolidated Financial Statements for a description of: (i) a restatement in the 2011 10-K of the Company's financial statements previously included in its Annual Report on Form 10-K for the year ended December 31, 2010 to reflect the recording of specified anticipated anti-dumping and customs duty (and related interest) payment requirements of LaJobi, Kids Line and CoCaLo in the respective periods to which such liabilities relate; and (ii) the impact of such restatement on the applicable unaudited quarterly financial information for the three and six months ended June 30, 2011 presented in this Quarterly Report on Form 10-Q for the quarter ended June 30, 2012 (the "Q2 10-Q"). The Company's Quarterly Report on Form 10-Q for the third quarter of 2012 will restate applicable 2011 comparable prior quarter and year to date periods.
Goodwill and Intangible Assets
Because the restatement of the Prior Financial Statements results in the technical satisfaction of the formulaic provisions for the payment of a portion of the LaJobi earnout under the agreement governing the purchase of the LaJobi assets, applicable accounting standards required that the Company record a liability in the approximate amount of $11.7 million for the year ended December 31, 2010 ($10.6 million in respect of the LaJobi earnout and $1.1 million in respect of the related finder's fee), which also required an offset in equal amount to goodwill, all of which goodwill was impaired as of December 31, 2011.
With respect to such goodwill, we performed our annual goodwill assessment as of December 31, 2011. The goodwill impairment test is accomplished using a two-step process. The first step compares the fair value of a reporting unit that has goodwill to its carrying value. The fair value of a reporting unit is estimated using a discounted cash flow analysis. If the fair value of the reporting unit is determined to be less than its carrying value, a second step is performed to compute the amount of goodwill impairment, if any. Step two allocates the fair value of the reporting unit to the reporting unit's net assets other than goodwill. The excess of the fair value of the reporting unit (using fair-value based tests) over the amounts assigned to its net assets other than goodwill is considered the implied fair value of the reporting unit's goodwill. The implied fair value of the reporting unit's goodwill is then compared to the carrying value of its goodwill. Any shortfall represents the amount of goodwill impairment.
As of December 31, 2011, after completing the first step of the impairment test, there was indication of impairment because our carrying value exceeded our market capitalization (as a result of the substantial decline of the Company's stock price during 2011).
Management's determination of the fair value of the goodwill for the second step
in the analysis was performed with the assistance of a public accounting firm,
other than the Company's auditors. The analysis used a variety of testing
methods that are judgmental in nature and involve the use of significant
estimates and assumptions, including: (i) the Company's operating forecasts;
(ii) revenue growth rates; (iii) risk-commensurate discount rates and costs of
capital; and (iv) price or market multiples. The Company's estimates of revenues
and costs are based on historical data, various internal estimates and a variety
of external sources, and are developed by the Company's routine long-range
planning process.
In addition to the stock price decline, during the year ended December 31, 2011, net sales and gross margins for LaJobi declined substantially from the previous year, and the margins for Kids Line and CoCaLo declined from the previous year. These adverse conditions led the Company to revise its estimates with respect to net sales and gross margins, which in turn negatively impacted our cash flow forecasts for LaJobi, Kids Line and CoCaLo. These revised cash flows forecasts resulted in the conclusion in the second step of the analysis that the Company's goodwill was fully impaired (it was determined to have no implied value), and as a result, the Company recorded a goodwill impairment charge in the amount of $11.7 million for the year ended December 31, 2011, representing the shortfall between the fair value of its operations for which goodwill had been allocated and its carrying value.
In addition, in connection with our annual assessment of indefinite-lived and definite-lived intangible assets (discussed in Note 4 to the Notes to Consolidated Financial Statements of the 2011 10-K), we recorded, in our consolidated financial statements for the fourth quarter and fiscal year ended December 31, 2011, non-cash impairment charges: (i) to our LaJobi trade name in the amount of $9.9 million; and (ii) to our Kids Line customer relationships in the amount of $19.0 million.
Testing for impairment of indefinite-lived trade names is based on whether the fair value of such trade names exceeds their carrying value. The Company determines fair value by performing a projected discounted cash flow analysis based on the Relief-From-Royalty Method for all indefinite-lived trade names. In the Company's analysis for 2011, it used a five-year projection period, which has been its prior practice, and projected for each business unit the long-term growth rate of each business, as well as the assumed royalty rate that could be obtained by each such business by licensing out each intangible. For 2011, the Company kept its long-term growth rate at 2.5% for all of its business units, but used assumed royalty rates of 3%, 2.6%, 2.5% and 4% for Kids Line, Sassy, LaJobi and CoCaLo, respectively. Assumed royalty rates decreased with respect to Kids Line and LaJobi from the 2010 rates of 5% and 4%, respectively, as a result of reduced profitability for each such business unit in 2011. With respect to LaJobi, the difference ,between fair value and the carrying value of the relevant trade names resulted in an impairment charge in the amount of $9.9 million. No other trade names were impaired during 2011.
The Company's other intangible assets with definite lives (consisting primarily of customer lists) are amortized over their estimated useful lives and are tested if events or changes in circumstances indicate that an asset may be impaired. In testing for impairment, the Company compares the carrying value of such assets to the estimated undiscounted future cash flows anticipated from the use of the assets and their eventual disposition. When the estimated undiscounted future cash flows are less than their carrying amount, an impairment charge is recognized in an amount equal to the difference between the asset's fair value and its carrying value. The fair value of the Kids Line customer relationships was lower than the carrying value due to revised undiscounted future cash flow projections resulting from meaningfully lower sales to one of its major customers and reduced profitability in 2011. This resulted in a $19.0 million impairment which was recorded in cost of sales. While LaJobi sales also decreased during 2011, the fair value of its customer lists continued to exceed its carrying value as of December 31, 2011.
There was no impairment of the Company's other intangible assets (either definite-lived or indefinite-lived) during 2011. In accordance with applicable accounting standards, there were no triggering events warranting interim testing of intangible assets in the first or second quarter of 2012, and no impairments of intangible assets (either definite-lived or indefinite-lived) were recorded during either such period.
Interim Executive Chairman
Effective September 12, 2011, Bruce G. Crain resigned as President and Chief
Executive Officer of the Company. In connection therewith, Mr. Crain also
resigned his position as a member of the Board and all other positions with the
Company and its subsidiaries. In addition, as of September 12, 2011, Raphael
Benaroya was appointed by the Board to the position of interim Executive
Chairman, to serve as the chief executive of the Company during the pendency of
the Board's search for a new chief executive officer until the earlier of:
(i) December 31, 2011; and (ii) the appointment of a new chief executive officer
or written notice from the Company. On February 14, 2012, this agreement was
modified and extended on a month-to-month basis, effective as of January 1,
2012, subject to termination by either the Company or RB, Inc. at any time upon
ten days written notice to the other party.
The Board's Search Committee is continuing to oversee the process for the selection of a new chief executive officer with the assistance of the executive search firm retained by the Board for such purpose.
Details with respect to these events are set forth in the Company's Current Report on Form 8-K filed on February 17, 2012.
Inventory
Inventory, which consists of finished goods, is carried on our balance sheet at the lower of cost or market. Cost is determined using the weighted average cost method and includes all costs necessary to bring inventory to its existing condition and location. Market represents the lower of replacement cost or estimated net realizable value of such inventory. Inventory reserves are recorded for damaged, obsolete, excess and slow-moving inventory if management determines that the ultimate expected proceeds from the disposal of such inventory will be less than its carrying cost as described above. Management uses estimates to determine the necessity of recording these reserves based on periodic reviews of each product category based primarily on the following factors: length of time on hand, historical sales, sales projections (including expected sales prices), order bookings, anticipated demand, market trends, product obsolescence, the effect new products may have on the sale of existing products and other factors. Risks and exposures in making these estimates include changes in public and consumer preferences and demand for products, changes in customer buying patterns, competitor activities, our effectiveness in inventory management, as well as discontinuance of products or product lines. In addition, estimating sales prices, establishing markdown percentages and evaluating the condition of our inventories all require judgments and estimates, which may also impact the inventory valuation. However, we believe that, based on our prior experience of managing and evaluating the recoverability of our slow moving, excess, damaged and obsolete inventory in response to market conditions, including decreased sales in specific product lines, our established reserves are materially adequate. If actual market conditions and product sales were less favorable than we have projected, however, additional inventory reserves may be necessary in future periods.
Company Outlook
The principal elements of our current global business strategy include:
• focusing on design-led and branded product development at each of our subsidiaries to enable us to continue to introduce compelling new products;
(i) expanding our product offerings into related categories;
(ii) increasing our existing product penetration (selling more products to existing customer locations);
(iii) increasing our existing store or online penetration (selling to more store locations within each large, national retail customer or their associated websites); and
(iv) expanding and diversifying our distribution channels, with particular emphasis on sales into international markets and non-traditional infant and juvenile retailers;
• growing through licensing, distribution or other strategic alliances, including pursuing acquisition opportunities in businesses complementary to ours;
• implementing strategies to further capture synergies within and between our confederation of businesses, through cross-marketing opportunities, consolidation of certain operational activities and other collaborative activities; and
• continuing efforts to manage costs within and across each of our businesses, including continued efforts to manage working capital, especially by improving inventory turns.
General Economic Conditions as they Impact Our Business
Our business, financial condition and results of operations have and may continue to be affected by various economic factors. Periods of economic uncertainty can lead to reduced consumer and business spending, including by our customers, and the purchasers of their products, as well as reduced consumer confidence, which we believe has resulted in lower birth rates (although recent third party forecasts have suggested declining birth trends are likely to reverse with modest improvements in the economy). In addition, there has been a continuing shift in the channels from which consumers purchase goods, including from brick-and-mortar stores to online venues, and our business will be affected by our ability to adapt to such changes in an efficient manner. Reduced access to credit has and may continue to adversely affect the ability of consumers to purchase our products from retailers, as well as the ability of our customers to pay us. If such conditions are experienced in future periods, our industry, business and results of operations may be negatively impacted. Continuing adverse global economic conditions in our markets may result in, among other things: (i) reduced demand for our products; (ii) increased price competition for our products; (iii) increased risk in the collectibility of cash from our customers and/or (iv) increased pressure from major retailers to offer additional mark downs and other pricing accommodations. See Item 1A, "Risk Factors-The state of the economy may impact our business" of the 2011 10-K.
In addition, if internal funds are not available from our operations, we may be required to rely on the banking and credit markets to meet our financial commitments and short-term liquidity needs. Continued disruptions in the capital and credit markets, could adversely affect our ability to draw on our bank revolving credit facility (to the extent we have sufficient availability thereunder). Our access to funds under our credit facility is dependent on the ability of the banks that are parties to such facility to meet their funding commitments. Those banks may not be able to meet their funding commitments to us if they experience shortages of capital and liquidity or if they experience excessive volumes of borrowing requests from us and other borrowers within a short period of time. Such disruptions could require us to take measures to conserve cash until the markets stabilize or until alternative credit arrangements or other funding for our business needs can be arranged. See Item 1A, "Risk Factors-Further potential disruptions in the credit markets may adversely affect the availability and cost of short-term funds for liquidity requirements and our ability to meet long-term commitments, which could adversely affect our results of operations, cash flows, and financial condition" of the 2011 10-K.
SEGMENTS
The Company operates in one segment: the infant and juvenile business.
RESULTS OF OPERATIONS
The Results of Operations set forth below reflects the impact of the restatement of the Prior Financial Statements described in Note 12 of the Notes to Unaudited Consolidated Financial Statements.
THREE MONTHS ENDED JUNE 30, 2012 AND 2011
Net sales for the three months ended June 30, 2012 decreased 8% to $55.5 million, compared to $60.3 million for the three months ended June 30, 2011. This decrease was primarily the result of sales declines of 25.5% at Kids Line and 37.9% at CoCaLo, in each case primarily due to significantly lower sales volume at certain large customers. These declines were partially offset by increases in sales of 18.0% at Sassy, primarily due to the expansion of Carter's®branded products, and 5.3% at LaJobi, primarily due to the continued success of Graco® branded products.
Gross profit was $13.1 million, or 23.6% of net sales, for the three months ended June 30, 2012, as compared to $16.3 million, or 27.1% of net sales, for . . .
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