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KID > SEC Filings for KID > Form 10-Q on 20-Nov-2012All Recent SEC Filings

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Form 10-Q for KID BRANDS, INC


20-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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 Reports on Form 10-Q for the quarters ended March 31, 2012 (the "Q1 10-Q") and June 30, 2012 (the "Q2 10-Q"), 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, including the recently acquired Kokopax® line of baby gear products as described in "Recent Developments" below (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 $60.9 million and $171.6 million for the three and nine months ended September 30, 2012. International sales, defined as sales outside of the United States, including export sales, constituted 10.4% and 7.9% of our net sales for the nine months ended September 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. Also see "Recent Developments" below for a discussion of the initiation of the wind-down of the Kid Line's U.K. operations.


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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 $5.0 million for the three and nine months ended September 30, 2012, respectively, and $1.8 million and $5.7 million for the three and nine months ended September 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 (or have been paid) 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 September 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

Hurricane Sandy

Hurricane Sandy resulted in the temporary closure of the New Jersey corporate offices of the Company, and the Company's LaJobi subsidiary (also based in New Jersey). LaJobi was unable to ship products to its retailers from October 29, 2012 until November 5, 2012. The Company is in the early stages of assessing the financial and operational impacts of the storm on the Company and its customers, and is therefore currently unable to estimate such impacts.

Amended Credit Agreement

On November 15, 2012, the Company's current credit agreement was amended, among other things, to revise the financial covenants contained therein for future periods, to extend the deadline to implement specified cash management arrangements required thereby, to give the Administrative Agent thereunder the discretion to extend the dates required for the Company to (i) provide a commitment letter for funding sufficient to satisfy the Company's current term loan and (ii) satisfy the term loan (in each case in order to avoid a requirement to retain the Retained Executive (defined below)), and to extend the trigger date pertaining to the waiver or payment of specified fees and PIK interest to the extent the consent of all the Lenders is obtained. Details with respect to the rationale for and the terms of such amendment are described in Note 4 of the Notes to Unaudited Consolidated Financial Statements under the caption "2012 Credit Agreement", and in "Liquidity and Capital Resources-Debt Financings" below. The Company was in compliance with all financial covenants contained in its credit agreement as of September 30, 2012.


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Valuation Allowance for Deferred Tax Assets

The valuation allowance for deferred tax assets as of September 30, 2012 and December 31, 2011 was $68.5 million and $23.5 million, respectively. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion, or all, of the deferred tax asset will not be realized. In assessing the realization of deferred tax assets, management evaluates all available positive and negative evidence, including the Company's past operating results, the existence of cumulative losses and near-term forecasts of future taxable income that is consistent with the plans and estimates management is using to manage its underlying businesses, the amount of taxes paid in available carry-back years, and tax planning strategies. This analysis is updated quarterly. Based on this analysis, the Company determined that an increase in its valuation allowance of $45.0 million was required as of September 30, 2012 as a result of the Company's reduced estimates of current and future taxable income during the carry forward period, and the fact that it is in a three-year cumulative loss position. The weight of these negative factors and level of economic uncertainty in our current business out weighed the positive factors considered by the Company and supported its conclusion. Management will continue to periodically reevaluate the valuation allowance and, to the extent that conditions change, a portion of such valuation allowance could be reversed in future periods. The valuation allowance at December 31, 2011 was associated with foreign tax credit, capital loss, foreign NOL, and state NOL carry forwards that, in the opinion of management, were not more likely than not to be realized. See Note 8 of the Notes to Unaudited Consolidated Financial Statements.

Management Changes

Effective at the close of business on September 11, 2012, David C. Sabin resigned as President of Kids Line and CoCaLo. In connection therewith, Renee Pepys Lowe was appointed to the position of President of Kids Line and CoCaLo, effective as of September 12, 2012. Ms. Lowe founded CoCaLo and served as its President from its acquisition by the Company in April 2008 until August 2010, and prior thereto, since its inception in 1998.

In addition, Ms. Kerry Carr, a former executive of Avon Products, Inc., a New York Stock Exchange listed global beauty products company, was appointed to the position of Executive Vice President and Chief Operating Officer of the Company, effective as of September 12, 2012.

For details with respect to these management changes, please see the Current Report on Form 8-K filed by the Company on September 12, 2012.

Intangible Assets

Due to continued softness in the business during the third quarter of 2012, the Company determined that indicators of impairment of its indefinite-lived intangible assets (consisting of trade names) existed, and conducted testing of the Company's trade names as of September 30, 2012 in connection therewith. Testing of 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 September 30, 2012 analysis, it used a five-year projection period, which has been its prior practice. For the interim testing the Company concluded that it was appropriate to retain the long-term growth rates and assumed royalty rates used for its 2011 annual testing. Such interim testing demonstrated that the fair market value of the Company's trade names exceeded their carrying values, and as a result, the Company determined that no trade names were impaired in for the quarter ended September 30, 2012. See Note 6 to the Notes to Unaudited Consolidated Financial Statements.

Kokopax Purchase

In late September of 2012, Sassy acquired substantially all of the operating assets of Kokopax, LLC, a developer and marketer of framed infant back carriers and related accessories, including sun hats and totes. Such assets consist primarily of inventory and intellectual property rights. The Company believes that the Kokopax ® infant carriers and related products are a natural fit for Sassy's growing baby gear product line, and the Company anticipates bringing its design and distribution capabilities to bear to expand the reach of these products.


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Wind-Down of Kids Line's U.K. Operations

In light of the unprofitability of Kids Line's U.K. operations, the Company has initiated the wind-down of such operations which is intended to be complete by the end of 2012 in a manner designed to minimize negative financial impacts to the Company.

Dismissal with Prejudice of Putative Class Action Litigation and Appeal Therefrom

On October 16, 2012, the United States District Court for the District of New Jersey granted the defendants' motion to dismiss the current complaint (naming the Company, Bruce G. Crain, Guy A. Paglinco, and Raphael Benaroya as defendants) in the Putative Class Action (as defined and described in Part II, Item I - Legal Proceedings), with prejudice. On November 14, 2012, plaintiff filed a Notice of Appeal to the U.S. Court of Appeals for the Third Circuit from the judgement of the U.S. District Court.

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 nine months ended September 30, 2011 presented in this Quarterly Report on Form 10-Q for the quarter ended September 30, 2012 (the "Q3 10-Q").

U.S. Customs Settlement Submissions

See Note 9 of the Notes to Unaudited Consolidated Financial Statements for a discussion of submissions made by the Company to U.S. Customs in the fourth quarter of 2012, which included the Company's final determination of amounts it believes are owed, as well as proposed settlement amounts and/or proposed payment terms with respect to anti-dumping duties owed by LaJobi, as well as customs duties owed by the Company's other operating subsidiaries, including payments made in respect of Kids Line and CoCaLo, such payments to be credited against the amounts that U.S. Customs determines is to be paid in satisfaction of such matters.

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;


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• pursuing organic growth opportunities to capture additional market share, including:

(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 have stabilized and 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.


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THREE MONTHS ENDED SEPTEMBER 30, 2012 AND 2011

Net sales for the three months ended September 30, 2012 decreased 12.3% to $60.9 million, compared to $69.5 million for the three months ended September 30, 2011. This decrease was primarily the result of sales declines of 20.9% at Kids Line, 17.1% at LaJobi and 4.1% at CoCaLo, in each case primarily due to significantly lower sales volume at certain large customers. These declines were partially offset by an increase in sales of 16.5% at Sassy, primarily due to increases at two major retailers and the success of Carter's® branded products.

Gross profit was $13.4 million, or 22.0% of net sales, for the three months ended September 30, 2012, as compared to $18.5 million, or 26.6% of net sales, for the three months ended September 30, 2011. In absolute terms, gross profit decreased as a result of lower sales and lower gross profit margins. Gross profit margins decreased primarily as a result of: (i) lower sales ($2.1 million) (ii) higher markdowns and allowances ($1.3 million); (iii) higher inventory reserves as a result of closeout and promotional sales and the wind down of the Kids Line U.K. operations ($1.2 million); (iv) the impact of voluntary product recall costs ($0.6 million); and (v) product mix changes and increased product costs ($0.6 million). This decline was partially offset by:
(i) a reduction in the aggregate accrual for Customs duties ($0.4 million) as a result of the completion of the Company's prior disclosures and settlement . . .

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