U.S. Securities and Exchange Commission

Washington, D.C. 20549

______________

Form 10-K

(Mark one)

[ X ] Annual report under Section 13 or 15(d) of the Securities Exchange Act of 1934

For the fiscal year ended June 30, 2002.

[ ] Transition report under Section 13 or 15(d) of the Exchange Act

For the transition period from _______________ to _______________.

Commission file number 1-12580.

THE VERMONT TEDDY BEAR CO., INC.

(Exact Name of Registrant as Specified in its Charter)

New York 03-0291679

of incorporation or organization) Identification No.)

6655 Shelburne Road, Post Office Box 965

Shelburne, Vermont 05482

(Address of principal executive offices)

Registrant's telephone number, including area code: (802) 985-3001

Securities registered under Section 12(b) of the Exchange Act:

Title of each class: Name of each exchange on which registered

Common Stock, par value $.05 per share NASDAQ Smallcap Market

Securities registered under Section 12(g) of the Exchange Act:

Common Stock, per value $.05 per share

(Title of class)

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 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X ; No .

Indicate by check mark if disclosure of delinquent filers in response to Item 405 of Regulation S-K contained is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ]

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant, based on the average high and low prices of such stock on September 23, 2002, as reported on NASDAQ, was $13,946,853.

As of September 23, 2002, there were 6,867,021 shares of the issuer's common stock issued and 6,844,001 shares outstanding.

Documents Incorporated By Reference

The following documents, in whole or in part, are specifically incorporated by reference in the indicated part of this Annual Report on Form 10-K:

Proxy Statement for 2002 Annual Meeting of the issuer's stockholders: Part III, Items 9, 10, 11 and 12.

The Vermont Teddy Bear Co., Inc.

2002 Form 10-K Annual Report

Founded in 1981 and incorporated in 1984, The Vermont Teddy Bear Co., Inc. (the "Company"), with its principal offices located at 6655 Shelburne Road, Shelburne, Vermont, is a direct marketer in the gift delivery industry competing primarily against companies that deliver flowers and other specialty gifts. Its principal product line is the Bear-Gram gift, a Vermont Teddy Bear customized to suit a special occasion or a life event, personalized with a greeting card and optional embroidery, and delivered in a colorful gift box with a candy treat. Recently, the Company extended its product offering in the gift delivery business under the service marks "SendAMERICA" and "Pajamagram". In December 2000, SendAMERICA, Inc., which is a wholly owned subsidiary of the Company, was introduced to offer a variety of American handcrafted gift products including food, jewelry, home décor and craft items. The Pajamagram gift delivery service, launched in April 2002, offers a variety of pajamas and related sleepwear and spa products packaged with lavender tub tea and a personalized card in a keepsake organza hat-box, and delivered in a colorful gift box. In July 2002, the Company decided to focus the activities of SendAMERICA, Inc. exclusively on food related gift products under the service mark "Tastygram". The Tastygram gift delivery service includes regional food specialties such as NY Carnegie Deli Cheesecake and Gino's Chicago Deep Dish Pizza. A Tastygram gift is also delivered in a colorful gift box complete with a personalized greeting card and signature mints.

Principal Business Segments and Distribution Methods

The Company also distributes its teddy bear products through Retail Store Operations and through its Corporate/Wholesale segments. The Company's Retail Store Operations represented 8.4 percent of net revenues, and the Corporate/Wholesale programs were 1.6 percent of net revenues for the fiscal year ended June 30, 2002. Revenues from sales of Pajamagram and SendAMERICA gifts in the Retail and Corporate/Wholesale segments were negligible for the fiscal year ended June 30, 2002. It is possible the Company will distribute its Pajamagram and Tastygram products in these segments in the future.

Primary Business Segments

(12 months ended June 30)

* Excludes Bear-Gram revenues from retail operations.

The Company uses primarily direct response radio advertising, supported visually by the Internet, to market its Bear-Gram gift delivery service. The combination of direct response radio and the Internet represent 91.6 percent of net revenues in the Bear-Gram segment for the fiscal year ended June 30, 2002. The Company includes the sales from orders placed on its vermontteddybear.com Internet website with sales generated by direct response radio as the Company believes the majority of traffic to the website is generated by radio advertising. All radio advertisements are tagged once with the website address in addition to three mentions of its toll-free number. Other avenues of marketing the Bear-Gram delivery service are direct mail catalogs and print advertisements primarily in magazines which together represent 8.4 percent of Bear-Gram net revenues for the same twelve-month period. The Company introduced its first catalog for Christmas of 1992, and currently has an in-house mailing list in excess of 2,221,000 unique names. During the twelve months ended June 30, 2002, more than 47.8 million circulated pages were mailed to prospective customers.

Primary Distribution Methods for the Bear-Gram Segment

(12 months ended June 30)

In July 2002, the Company decided to focus the activities of SendAMERICA, Inc. exclusively on food-related gift products as this was generally the most successful category of SendAMERICA gift products. In October 2002, SendAMERICA, which will remain a wholly owned subsidiary of the Company, will begin doing business as the Tastygram gift delivery service selling a variety of regional food specialties such as NY Carnegie Deli Cheesecake and Gino's Chicago Deep Dish Pizza. Orders will be placed at tastygram.com or by calling toll free 1-800-82-Tasty.

Sales generated from the combination of catalog and Internet represent 100% of net revenues in the SendAMERICA segment for the fiscal year ended June 30, 2002. Beginning in October 2002, SendAMERICA, doing business as the Tastygram gift delivery service, will be marketed via direct response radio and Internet in a manner similar to the Bear-Gram and Pajamagram services.

Net revenues for the Pajamagram service were generated from the combination of direct response radio and the Internet during the fiscal year ended June 30, 2002.

Retail Store Operations. The retail operations business segment was second only to the Bear-Gram delivery service segment in its contribution to the Company's net revenues in the fiscal year ended June 30, 2002, at 8.4 percent of net revenues. The Company's factory retail store actively promotes family tours of its teddy bear factory and store at the factory location in Shelburne, located ten miles south of Burlington, Vermont. In June 2002, the Company opened a second retail store in Waterbury, Vermont. Both stores feature a variety of Vermont Teddy Bears, the Company's new line of imported teddy bears including the Make-A-Friend-For-Life products, and other teddy bear related items, including apparel, many of which feature the Company's logo.

The Company sold a negligible amount of SendAMERICA products through its Shelburne retail store and its corporate/wholesale segment during the year ended June 30, 2002. The Company does not currently sell any of its Pajamagram products through its retail or corporate/wholesale business segments. Beginning in fiscal 2003, the Company will explore opportunities to sell both Pajamagram and Tastygram products in the retail and corporate/wholesale segments.

Development of the Business.

The Bear-Gram delivery service was first introduced on a small scale in 1985. Throughout the 1980's, however, the Company's marketing efforts focused primarily on wholesaling teddy bears to specialty stores and direct retail through its own outlets. Shortly before Valentine's Day in 1990, the Company introduced radio advertising of its Bear-Gram delivery service on radio station WHTZ ("Z-100") in New York City, positioning it as a novel gift for Valentine's Day, and offering listeners a toll-free number for customers to order from the Company's facility in Vermont. This test proved to be successful, and the service was expanded to other major radio markets across the country. Primarily through the Bear-Gram delivery service, the Company has increased its net revenues from approximately $351,000 in 1989 (the year prior to the initial New York City Bear-Gram campaign) to a peak of approximately $38,994,000 in 2002. Expansion of its radio marketing principally in the Northeast f ueled rapid growth through 1995. After a brief period of retail expansion with the addition of three stores in New York, Maine and New Hampshire that were subsequently closed, the Company refocused its marketing efforts in fiscal 1998 on direct response radio and experienced another period of growth. The Company continues to expand its radio advertising campaign nationally complemented by an Internet website and certain online marketing and direct mail programs. Retail Operations include the Company's Shelburne factory store and a recently opened satellite store in Waterbury, Vermont.

Since 1990, the Company has expanded the radio advertising of its Bear-Gram delivery service beyond New York City, to include other metropolitan areas and syndicated radio programs carried by stations across the United States, with significant expansion occurring in the past five years. During its fiscal year ended June 30, 2002, the Company regularly placed advertising on 356 radio stations in ninety radio market areas in the United States. For Valentine's Day in fiscal year ended June 30, 2002, the Company advertised on approximately 707 radio stations in 128 different markets as well as 11 syndicated programs, as compared to 580 radio stations in 125 different markets and 10 syndicated programs in the year ended June 30, 2001.

The Company began taking Bear-Gram orders on its website in March of 1997 recognizing that the website provided visual support to the Company's radio advertising campaign across the country and a convenient way for customers to place orders. In December 1997, online orders represented seven percent of total Bear-Gram orders. The percentage has trended upward reaching fifty-two percent of total Bear-Gram orders in June 2002. A total of 5,224,027 unique visitors to vermontteddybear.com were recorded during the twelve months ended June 30, 2002, up forty-eight percent from the 3,540,338 unique visitors recorded during the twelve months ended June 30, 2001. The total number of unique visitors received by sendamerica.com in its first full year of operation, the fiscal year ended June 30, 2002 was approximately 220,000. Unique visitors to pajamagram.com in the period from its launch in mid-April 2002 to June 30, 2002 totaled approximately 203,000.

Each of the "Gram" services segments, Bear-Gram, Pajamagram and SendAMERICA (soon to be Tastygram) has its own website with its own branded graphical identity to reinforce the appeal of its product line to its target customer. The websites of all three "Gram" services are linked together as "sister companies". A significant amount of traffic and orders for the Pajamagram and SendAMERICA segments were received through their links to the vermontteddybear.com website in the year ended June 30, 2002. The Company plans to dedicate each radio advertisement to only one of the gift services but will support the introduction of both Pajamagram and Tastygram services in existing Bear-Gram markets with a mention that each is a "sister company of The Vermont Teddy Bear Company." Approximately sixty percent of SendAMERICA orders were received from customers online. Online Pajamagram orders were approximately eighty and eighty-six percent of the total orders in May and June 2002, respectively.

After conducting market research, the Company decided to introduce SendAMERICA (soon to be Tastygram) and Pajamagram as separate brands with separate advertising and separate websites and toll free numbers in order to more effectively target specific customers for each new product line. By referring to them as "sister companies of The Vermont Teddy Bear Company", the Company intends to impart on each new venture the credibility of The Vermont Teddy Bear Company as an established company in the gift delivery business. Using this brand endorsement strategy, the Company also hopes to minimize confusion when the Company, with the name Vermont Teddy Bear Company, sells gift products unrelated to teddy bears.

In recent years, the Company has begun to diversify its marketing channels.

In the fiscal year ended June 30, 2002, the Company expanded its Fall/Holiday Vermont Teddy Bear Bear-Gram catalog from 24 to 32 pages and its Valentine's Day and Mother's Day catalogs from 16 to 24 pages to promote its expanded line of Vermont Teddy Bear Bear-Gram products. By mailing larger catalogs to an increased number of Bear-Gram customers, the Company increased the number of circulated pages from 31.8 million in the fiscal year ended June 30, 2001 to more than 47.8 million in the fiscal year ended June 30, 2002. The Company intends to increase the number of circulated pages in the year ahead by mailing catalogs to the increasing number of customers on its in-house mailing list and to certain lists rented from or received an exchange with other companies selling gift related products. The Company does not plan to circulate a catalog for SendAMERICA in fiscal 2003, but will explore alternatives to market both Pajamagram and Tastygram services via direct mail. In addition, the Ve rmont Teddy Bear Bear-Gram catalog includes a half page promotional advertisement for the Pajamagram and Tastygram services.

In May 2000, the Company launched a new online PreFUR'd Member program to stimulate loyalty among its existing Bear-Gram customers, increase repeat purchases and average down its advertising costs. The PreFUR'd Member program offers customers special promotions, previews of new teddy bears and a newsletter via e-mail. In June 2000, the Company had approximately 188,000 PreFUR'd Members. By June 2002, the number of PreFUR'd Members was approximately 520,000. The Company will seek to expand this program as new Members are added either by placing Bear-Gram orders online and deciding not to opt out of the program or by opting in to the program over the phone, via email, or in the retail store. In the year ahead, the Company will offer similar benefits to its offline Bear-Gram customers in addition to online customers. The Company also plans to develop a loyalty marketing program similar to the PreFUR'd Member program for each of the Pajamagram and the Tastygram services tailored specifi cally to each customer group. Additionally, customers of each service will periodically receive emails from the other "sister companies" cross-promoting their alternative gift products.

In February 2001, the Company also initiated an online affiliate marketing program for its Bear-Gram gift delivery service. The Company has worked with affiliate partners, including opt-in list aggregators, news and entertainment websites, existing radio stations and charities, to advertise to new prospects via e-mail and paid these partners a percentage of sales generated. In the year ahead, the Company will seek to expand this program for the Bear-Gram service and will explore opportunities to promote the Pajamagram and Tastygram services through affiliate marketing programs

In May of 2001 the Company completed expansion of its retail store from 3,000 square feet to 5,000 square feet. The factory tour drew over 114,000 visitors in the twelve-month period ended June 30, 2002, and has drawn more than 841,000 tour visitors since moving to its new location in July 1995. The Company believes its factory tour is now the second most popular factory tour attraction, based on number of tours taken, in Vermont. In June of 2002, the company also opened a 2,000 square foot retail store on Route 100 in Waterbury, Vermont. This retail space is part of small retail complex with five other retail outlets located approximately 1.5 miles from the Ben and Jerry's factory tour location. In an effort to make a visit to both stores more entertaining and draw additional traffic, the Company has implemented the Make-A-Friend-For-Life bear assembly area at both locations, where visitors can participate in the creation of their own teddy bear. Customers made 38,500 Make-A-Friend- For-Life bears during fiscal 2002.

As the Company expands its radio advertising campaign, its catalog circulation and its Internet marketing initiatives nationally, it is increasingly diversifying its geographic markets and becoming less dependent on a few metropolitan locations. The following table shows the Company's largest Bear-Gram markets and most frequent reasons given by customers for purchasing the Company's Bear-Gram gifts:

Percentage of Bear-Gram revenues

(12 months ended June 30)

Percentage of Bear-Gram orders

(12 months ended June 30)

The Company's Bear-Gram segment sales are heavily seasonal, with Valentine's Day, Mother's Day, and Christmas as the Company's largest sales seasons. While the Company also expects sales from the Pajamagram and Tastygram services to be seasonal, the Company anticipates that revenues from these new services will be greater at Christmas and less at Valentine's Day as a percentage of their annual revenues than for the Bear-Gram service.

Competitive Business Conditions

The Company's Bear-Gram delivery service competes with a number of sellers of flowers, balloons, candy, cakes, and other gift items, which can be ordered by telephone for special occasions and delivered by express service in a manner similar to Bear-Gram gifts, including but not limited to FTD and 1-800-Flowers. The Company positions its Bear-Gram gifts as a "creative alternative" to these products and competes in this gift delivery industry by providing last minute shoppers with convenient customer service, options to personalize their gift with embroidery or artwork and a greeting card, and reliable expedited delivery options. The Company also competes to a lesser degree with a number of companies that sell teddy bears in the United States, including but not limited to Steiff of Germany, Dakin, North American Bear, Gund and Build-A-Bear Workshop. The Company also competes with businesses that market and sell teddy bears and other stuffed animals in a manner similar to Bear- Grams, including "Pooh-Grams" marketed by certain subsidiaries of Disney Enterprises, Inc.

Many small companies have developed web-sites that allow customers to order bears and have them delivered in a manner similar to Bear-Gram gifts. The Company vigorously defends trademark infringement when it appears on these web-sites, and continues to police the Internet for such infringement. However, the Company anticipates that there will continue to be other companies that compete directly with the Company's Bear-Gram gift business, including those with greater financial resources than the Company.

With its Pajamagram gift delivery service the Company competes against virtually all apparel retailers selling pajamas and related sleepwear and spa products including Lands End, L.L. Bean, GAP and Victoria's Secret, that can deliver their products via express service. The Company competes by providing its customers convenient service and reliable expedited delivery options. The Company also competes by providing its customer a "complete" gift with the added value of a free personalized greeting card and a free add-on such as lavender tub tea, packaged in a decorative box and delivered in a colorful shipping container.

With its Tastygram service, the Company will compete with other specialty retailers that sell food items and deliver them via express service, including Harry and David, Omaha Steaks and Hickory Farms. Again, the Company plans to compete by providing convenient customer service and offering a gift presentation of the item with a free personalized card and free mints in a colorful gift box.

The Company also competes with other retailers with all of its gift services by marketing each as a unique, singular idea via direct response radio directly to a busy person who needs a gift idea at the last minute. The Company's factory retail store also competes with a wide variety of other retail destinations and tourist attractions and venues in Vermont and surrounding areas.

Many of its competitors sell similar products at lower price points and have greater financial, and selling and marketing resources than the Company. The Company believes that its brand strength, its customer relationships and its last minute personalization and fulfillment capabilities position it to compete effectively with its current and future competitors in each of the gift service categories. Barriers to entry into the Company's markets are low, however, and increased competition based on price or other considerations could result in decreased revenues, increased marketing and selling expenditures and lower profit margins. These and other competitive factors may adversely impact the Company's business and results of operations.

The Company is making material new investments in radio advertising to promote its new Pajamagram and Tastygram gift delivery services in fiscal 2003 in an attempt to gain market share in the gift delivery industry. The Company's decision to make these investments is based on the results of market research and test marketing during the year ended June 30, 2002. If sales do not materialize from the additional advertising expenditures, the Company's profits could be reduced which may adversely impact the Company's business and results of operations.

Principal Products

From its inception, the Company's has sought to design, manufacture and market the best teddy bears made in America. For many years the Company manufactured its bears exclusively in the United States. Beginning in its fiscal year 1998, the Company began importing certain of its products from Asia for its retail and corporate/wholesale business segments. However, convinced that its identity as an American manufacturer of teddy bears is a key element of its brand positioning, the Company remains committed to preserving and growing its Vermont based manufacturing operations to make the classic Vermont Teddy Bear brand bear for the Bear-Gram gift delivery service. In addition to the Shelburne, Vermont manufacturing facility, on November 1, 1999, the Company opened a manufacturing facility in Newport, Vermont, which on June 30, 2002 employed 69 people in all aspects of teddy bear manufacturing. The Company sources plush fabric and other materials from China and other countries in Asia and South America for its Vermont-based teddy bear manufacturing operations, in an effort to lower the Company's cost of goods sold and to broaden its available sources of supply. Previously, the Company had relied on a single domestic source of supply for plush fabric.

The move offshore represents a significant departure from the Company's historical position as an American manufacturer using almost exclusively American materials. The Company's strategic repositioning involves a commitment to ensuring that our partners adhere to stringent quality standards and provide decent, lawful working environments for their employees. The Company obtains a written statement to that effect from each offshore vendor prior to any transaction. Company management has visited the factories of its established partners in China and will continue to visit its offshore partners periodically. With this repositioning, the Company also commits to differentiate imported product from its Vermont-made bears to preserve the Company's Vermont Teddy Bear brand identity and to clearly label its imported products so as not to deceive or confuse customers. During the year ended June 30, 2002, the company consolidated all of its imported teddy bears under a new brand label "Friend fo r Life" to further differentiate this product from the authentic Vermont Teddy Bear. Previously imported teddy bears were identified with a co-branded label and a tagline "vtbc design! An import division of The Vermont Teddy Bear Company."

The Company produces many different sizes of its Vermont Teddy Bear brand bears, ranging from 11" to 36" tall, in six standard colors. In addition, the Company produces certain limited edition bears that vary in size. Virtually all of the Company's Vermont Teddy Bear brand bears have moveable joints and faux-suede paw pads, which are features associated with traditional, high-quality teddy bears.

Approximately 140 different bear outfits are manufactured, including ballerina bears, birthday bears, bride and groom bears, business bears, nurse bears, and sports bears. Ninety-four percent of the outfits were outsourced to overseas contractors during the twelve months ended June 30, 2002.

In addition to its own manufactured teddy bear products, the Company sells items related to teddy bears, as well as merchandise from other manufacturers, featuring the logo of The Vermont Teddy Bear Company. These items are available primarily in the Company's retail stores.

The Company's wholly owned subsidiary, SendAMERICA, Inc., during the year ended June 30, 2002 offered a variety of products, in categories including home décor, artwork or crafts, jewelry and traditional American gourmet foods. Each product incorporates the tradition of excellence associated with American craftsmanship and is positioned with the unique story of its maker. Through drop ship arrangements with its artisan suppliers, SendAMERICA takes title to each product at the point when Federal Express manifests the packaged item for delivery. All SendAMERICA products are accompanied by a guarantee of 100% satisfaction.

The Company plans to focus the activities of SendAMERICA exclusively on food related gift products under the new service mark "Tastygram" beginning in fiscal 2003. Many of the food products previously sold under the mark SendAMERICA will by sold by the new Tastygram service mark. Regional food specialties include NY Carnegie Deli Cheesecake and Gino's Chicago Deep Dish Pizza. All Tastygram food products will be shipped fresh and direct from the kitchen, farm, bakery or packer. Many of its products can only be shipped via overnight or second-day services and are delivered in dry ice or other special packaging to maintain freshness. Tastygram also will take title to each product at the point when Federal Express picks up the packaged item at the supplier's location on the Company's account and will guarantee its customers 100% satisfaction.

The Pajamagram gift delivery service sells a variety of pajamas and related sleepwear and spa products. The assortment for the 2002 Fall/Holiday season includes approximately 100 different styles of pajamas, gowns and robes, and approximately 70 related sleepwear and spa items sold as add-ons. Many of the styles have well-known brand labels such as Natori, Nick & Nora and Crabtree & Evelyn. Others are labeled with lesser-known brands and a few are purchased at wholesale and private labeled with the Pajamagram mark.

Sources and Availability of Materials, Supplies, and Production

Raw materials for the Company's bears and outfits are obtained from several suppliers. The Company presently purchases certain of its raw materials from single suppliers, but believes that alternate sources of supply are available at competitive prices, should conditions warrant. In addition, virtually all of the Company's teddy bear outfits and accessories are imported from countries in Asia and South America. If supplies of these items were interrupted production output and sales could be negatively impacted which may adversely affect the Company's business and results of operations.

Fabric for all teddy bears is cut at the Company's Shelburne and Newport factories prior to being sewn. Bear parts, including arms, legs, bodies, and heads are sewn by employees in both locations, and by home-workers and other domestic subcontractors. Once individual parts are sewn, they are returned to the factory for mechanical stuffing. The bears are assembled by attaching the stuffed parts to the bears with plastic joints, mechanically stuffing the bodies, and hand-stitching the backs. Each bear is finally outfitted and accessorized in Shelburne by the Company's Bear Dressers to meet customer requests.

The Company does not currently manufacture any of its Pajamagram or Tastygram products. All of these products are purchased wholesale for resale. It is possible that the Company will in the future manufacture under contract with other manufacturers in the U.S. and China and other countries its own line of pajama products.

Inventory management is critical to the Company's success due to the highly seasonal nature of the Company's sales. The Company has in the past achieved appropriate levels of inventory in relation to its sales as it has adjusted to varying growth rates. However, if the Company failed to maintain sufficient inventory to support seasonal sales, revenues could be reduced which may adversely affect the Company's business and results of operations. Conversely, if the Company accumulates inventory and sales do not materialize, the available cash resources of the Company may be reduced which may adversely affect the Company's business and results of operations.

Fulfillment Operations

The Company receives approximately half of total orders via telephone. The other half of orders are placed online at the Company's websites. During most of the year the Company answers all telephone calls at its call center in Shelburne, Vermont. During Valentine's Day and Mother's Day when call volume increases significantly, the Company contracts with third party call center service providers in various locations around the country and calls are distributed to the Company's internal call center and to the call center facilities of its partners by the Company's long distance carrier.

All Bear-Gram and Pajamagram orders are processed, fulfilled and shipped out of the Company's Shelburne warehouse, except on February 13 when a portion of Bear-Gram orders are processed in Shelburne but fulfilled and shipped from a remote location near a central hub of Federal Express. SendAMERICA orders are processed in Shelburne but drop shipped from each supplier's location. Again, the volume of orders is significantly greater during the Valentine's Day and Mother's Day seasons.

The Company believes it has developed redundant systems and contingency plans to mitigate the risk of service interruption by its service providers or the possible malfunction of its operating systems at the holidays. There can be no assurance, however, that services, including but not limited to long distance call service, call center services, website hosting services, common carrier services or electrical services, will not be interrupted. It is also possible that one or more of the Company's operating systems could malfunction limiting the Company's ability to process orders. If one or more of the Company's outside operating services were interrupted or one or more of the Company's operating systems malfunctioned during a peak holiday selling season, the loss of orders and revenue may adversely affect the Company's business and results of operations.

Patents, Trademarks, and Licenses

The Company regards its trademarks and service marks and other intellectual property as critical to its success. The Company's name and its various logos, are in combination registered trademarks and service marks in the United States. In addition, the Company also owns the registered trademarks in the United States for "The Vermont Teddy Bear Company," "Make-A-Friend-For-Life," "Teddy Grams," "Racer Ted," "BearAnimal," "The All-American Teddy Bear," And "Coffee Cub". The Company also owns the registered service marks "Bear-Gram", "Bear Counselor," "Vermont Bear-Gram", "Teddy Bear-Gram," "Bears Say it Best," "Bears to Business," "Love is in the Bear," and "The Creative Alternative to Flowers." The Company also has applications pending to register "The Great American Teddy Bear," "Ted Ex," "Teddy Express," "Love is in the Bear," "Making the world a better place one bear at a time," "Nothing says you care like a bear," "Bears to Business," "Huffin' Puffin'," "PreFUR'd Member," "Show You Care, Send a Bear," "Vermont Teddy Bear," "SendAMERICA," "SendVERMONT," and "Send(all 49 other states)", "Pajamagram," and "Tastygram". The Company also owns the registered trademark "Vermont Teddy Bear" in Japan and "Bear-Gram" and "Teddy Bear-Gram" in Great Britain.

The Company also claims copyright, service mark or trademark protection for its teddy bear designs, its marketing slogans, and its advertising copy, website pages and promotional literature.

The Company vigorously defends trademark and service mark infringement and monitors the Internet and other advertising channels for such infringement. However, third parties have in the past infringed or misappropriated the Company's intellectual property, and the Company anticipates infringements and misappropriations will occur in the future. There can be no assurance that the Company will be able to enforce its rights and enjoin infringers from use of confusingly similar marks, telephone numbers or website domain names.

Third parties may also assert infringement claims against the Company. While the Company currently is not aware of any material infringement claims against it, the Company can not be certain that such claims will not be made against it in the future.

Legal proceedings related to matters of intellectual property can be costly and time consuming and therefore may, if material, have an adverse effect on the Company's business and results of operations.

Employees

As of June 30, 2002, the Company employed 311 individuals, of whom 138 were employed in production-related functions, 140 were employed in sales and marketing positions, and 33 were employed in general and administrative positions. As of June 30, 2002, 233 of the Company's employees were full time. During peak periods, the company substantially increases its workforce with temporary employees in the third and fourth quarters of each fiscal year to service increased customer demand at the Valentine's Day and Mother's Day periods. No employees are members of a union, and the Company believes it enjoys favorable relations with its employees.

The Company supplements its regular in-house work force with homeworkers who perform production functions at their homes. The level of outsourced work fluctuates with Company production targets; at June 30, 2002, there were 6 homeworkers producing products for the Company. Homeworkers are treated by the Company as independent contractors for all purposes, except for withholding of Social Security and Medicare taxes. As independent contractors, homeworkers are free to accept or reject work offered by the Company. This working relationship allows the Company to adapt to short term fluctuations in production requirements.

In July 1995, to consolidate the Company's disparate locations and improve manufacturing flow, the Company moved its principal offices, along with its factory retail store, manufacturing, sales, and fulfillment operations, to a newly-constructed 62,000 square foot building, located on a 57-acre site along U.S. Route 7 in Shelburne, Vermont. The site is ten miles south of Burlington, Vermont. The Company purchased the site for approximately $817,000, and the cost of improving the site and constructing the new facility totaled approximately $7.1 million. On September 26, 1995, the Company entered into a $3.5 million commercial loan with the Vermont National Bank, secured by a first mortgage on the new facility, as well as general business assets. Repayment of the mortgage loan was based on a thirty-year fixed principal payment schedule, with a balloon payment due on September 26, 1997.

On July 18, 1997, the Company completed a sale-leaseback transaction involving its factory headquarters and a portion of its property located in Shelburne, Vermont. This financing replaced the Company's mortgage and line of credit agreement with the Vermont National Bank. The Company received approximately $5.9 million in cash, of which approximately $3.3 million was used to pay off the existing mortgage with the Vermont National Bank. The balance, approximately $2.6 million, was used for general working capital purposes, to pay down a $600,000 balance on the Company's line of credit (which was retired as the result of the termination of the original mortgage loan), and for associated transaction costs of $679,000, which have been capitalized and recorded as a component of other assets as of June 30, 2002. The lease obligation, secured by the business assets of the Company, is payable on a twenty-year amortization schedule through July 2017 with three additional five-year renewa l options at the Company's discretion.

On September 29, 1999 the Company entered into a one-year lease with four one-year renewal options for a new manufacturing facility in Newport, Vermont, for 12,000 square feet. In April 2001 the Company expanded its Newport operation to occupy an additional 12,000 square feet in an adjacent facility owned by the same landlord. A three-year lease with two three-year renewal options effective October 1, 2001 combined the two facilities. Annual lease payments under the combined Newport lease total $96,316. On November 1, 1999, the Company began operation of the facility with 25 skilled sewers stitching teddy bear parts. As of June 30, 2002 there were 69 full time employees in the Newport facility manufacturing complete teddy bears, from cutting to stitching, to stuffing, pinning and assembly, and back sealing. The bears are then shipped back to the Shelburne plant for order fulfillment. The Company is accounting for this lease as an operating lease in its financial statements.

On July 19, 2000, to consolidate remote warehouse locations, the Company entered into a ten-year lease with three five-year renewal options for a new 60,400 square foot warehouse and fulfillment center in Shelburne, Vermont. This facility is on property that is contiguous to the property on which the Company's factory headquarters are located. Annual lease payments are $400,577. The lease began on September 1, 2000 and replaced a lease for 20,000 square feet of off-site space in Williston, Vermont and a lease for 4,000

square feet in Shelburne, Vermont. The Company is accounting for this lease as an operating lease in its financial statements.

On March 19, 2002, the company entered into a three-year lease agreement with two three-year renewal options for 2,000 square feet of retail space on Route 100 in Waterbury, Vermont. This retail space is part of a small retail complex with five other retail outlets located approximately 1.5 miles from the Ben and Jerry's factory tour location. The annual amount due under the lease is $24,000 for the first year and increases two percent annually thereafter. The company is accounting for this lease as an operating lease in its financial statements.

On October 24, 1996, the company entered into a ten-year lease for 2,600 square feet on Madison Avenue in New York City. On December 7, 1997, the Company's 538 Madison Avenue location was closed due to structural problems at neighboring 540 Madison Avenue. On December 16, the Company announced that it was permanently closing that retail location. The City of New York deemed the 538 Madison Avenue building uninhabitable from December 8, 1997 to April 9, 1998, and the Company has not made any rent payments on the lease since December, 1997. On December 24, 1998, the Company received a notice from its landlord of 538 Madison Avenue alleging that it was in default under the lease for failure to resume occupancy, and demand for back rent for the period July 8, 1998 to December 31, 1998 in the amount of $144,355. Further on January 4, 1999 the Company received a demand to resume rent payments beginning January 1999. The Company disputed the landlord's position and believed it was not ob ligated to resume occupancy or pay rent under the lease. As a result, on May 25, 1999, the Company commenced action in the Supreme Court of the State of New York, County of New York against 538 Madison Realty Company. The action sought breach of contract damages and a declaration that the contract at issue, the former lease between the parties, has been terminated. The landlord moved to dismiss the action based on purported documentary evidence, being the lease itself. That motion was denied by order entered April 12, 2000. After having unsuccessfully attempted to resolve the disputes and after engaging in document discovery, the Company moved for summary judgement on its claims and dismissal of the landlord's claims. That motion was granted by order dated July 25, 2001 and judgement was entered in favor of the Company and against the landlord in the amount of $211,146 on August 10, 2001. The landlord filed an appeal of that judgement and, as settlement discussions have been unsuccessful, has posted a bond to stay enforcement of the judgement pending its appeal, which will be argued in October of 2002. The Company has accrued management's estimated cost of $220,000 to settle this contingency, but no assurance can be given that this dispute can be settled for this amount. In the event that no settlement is reached and the judgement is ultimately reversed on appeal and the Company is not successful in its suit against 538 Madison Realty Company, the remaining amount owed under the lease over its remaining term at face value is $2,825,000.

There are various other claims, lawsuits, and pending actions against the Company incident to the operations of its businesses. It is the opinion of management, after consultation with counsel, that the ultimate resolution of such claims, lawsuits and pending actions will not have a material adverse effect on the Company's consolidated financial position, results of operations or liquidity. There can be no assurance, however, that claims will not be made against the Company in the future. Such claims, if material, may adversely affect the Company's businesses and results of operations.

No matter was submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report.

Market Information

At the time of the initial public offering of 1,172,500 shares of the Company's Common Stock in November 1993, the Company's Common Stock had been approved for quotation on NASDAQ and the Pacific Stock Exchange under the symbols "BEAR" and "VTB," respectively. On July 31, 1996, the Company voluntarily de-listed from the Pacific Stock Exchange as a result of minimal trading volume. Between July 1, 1999 and June 30, 2002, the high and low closing bid and closing sales prices for a share of the Company's Common Stock as quoted on NASDAQ were as follows:

Description of Securities

Immediately prior to the Company's initial public offering, there were 4,000,000 shares of the Company's Common Stock outstanding, held of record by nine shareholders. As a result of the 1,000,000 share initial public offering and the Underwriters' purchase of 172,500 additional shares to cover over-allotments in connection therewith, there were 5,172,500 shares of the Company's Common Stock outstanding immediately following the

offering. On March 8, 1995, the Company purchased 12,000 common shares in the open market and continues to hold these shares as treasury stock. On November 4, 1998, the company purchased 11,020 additional common shares from dissenting shareholders and continues to hold these shares as treasury stock. From March 1, 1996 to June 30, 2002, 523,721 shares of the Company's Common Stock were issued pursuant to the exercise of employee Incentive Stock Options. On February 3, 1999, 10 holders of Series B Preferred Stock exercised conversion rights of 176,970 preferred shares into 474,989 shares of common

There are 90 shares of non-voting Series A Preferred Stock, held of record by one shareholder, with a liquidation value of $10,000 per share plus cumulative dividends of eight percent per annum. There has been no change in the number of Series A Preferred shares and the original shareholder remains the sole shareholder of Series A Preferred Stock. There were $72,000 in dividends accrued in respect of the Series A preferred Stock during each of the fiscal years between July, 1 1996 and June 30, 2002.

On July 12, 1996, the Company privately placed $550,000 of Series B convertible Preferred Stock. The 204,912 shares, $.05 par value, of Series B Convertible Preferred Stock were issued to twelve individuals. Series B stockholders are not entitled to any dividends or voting rights, but each share was originally convertible into one share of the Company's Common Stock at any time on or after July 14, 1997, subject to certain anti-dilution rights. As the result of subsequent financing transactions, the anti-dilution provisions of the Series B agreement were activated, and on February 3, 1999, 176,970 shares of Series B Convertible Preferred Stock was converted into 474,989 shares of the Company's Common Stock. On July 19, 1999, the remaining 27,942 shares of Series B Preferred Convertible Stock were converted into 74,996 shares of the Company's Common Stock.

On November 3, 1998, the Company closed on a private placement of $600,000 of its Series C Convertible Redeemable Preferred Stock ("Series C Preferred Stock") to an investor group lead by TSG Equity Partners (formerly The Shepherd Group LLC). Accompanying the Series C Preferred Stock were warrants to purchase 495,868 shares of the Company's Common Stock at an exercise price of $1.05 per share, which will expire seven years from the date of issuance. In connection with the issuance of the Series C Preferred Stock, a warrant to purchase 42,500 shares of the Company's Common Stock was issued at an exercise price of $1.05 to the Company's lessor in the sale-leaseback transaction. Because of the mandatory redemption provision, the Series C Preferred Stock net of the value of the warrants has been classified as long term debt in the accompanying balance sheet. The Company has valued the warrants using the Black-Scholes valuation model. The aggregate value of $272,449 was applied as a discount to the face value of the Series C Preferred Stock on the Company's balance sheet. The Company will accrete this discount with charges to retained earnings over a five-year period.

Each of the shares of Series C Preferred Stock has a liquidation value of $10,000 per share, and is convertible into 9,523 shares of the Company's Common Stock. The Series C Preferred Stock requires redemption upon the tenth anniversary of its issuance, with the Company and the Series C Preferred stockholders having call and put rights, respectively, beginning on the fifth anniversary of issuance. The Series C Preferred stock carries voting rights on an as-converted basis, and, as a class, has the right to elect two members to the Company's Board of Directors. Both the Series C Preferred Stock and the accompanying warrants carry certain anti-dilution provisions. The Series C Preferred Stock has a cumulative preferred dividend of six percent per annum, payable quarterly. The dividends were required to be paid in additional shares of Series C Preferred Stock for the first two and one-half years after issuance. As of April 30, 2001, the Company was no longer required to pay the divi dends in stock and exercised its option to pay them in cash. For the fiscal year ended June 30, 2002 $36,002 of dividends were paid in cash. For the fiscal year ended June 30, 2001 $30,000 of dividends were paid in the form of additional shares of Series C Preferred Stock and $6,017 were paid in cash. For fiscal year ended June 30, 2000 $36,000 of dividends were paid in the form of additional shares of Series C Preferred Stock. There were 69.0, 69.0 and 66.0 shares of Series C Preferred Stock issued and outstanding at June 30, 2002, 2001, and 2000 respectively.

On January 15, 2002, the Company executed a Warrant Repurchase Agreement with TSG Equity Partners to repurchase 495,868 of the outstanding Warrants TSG Equity Partners were issued in connection with the Series C Preferred Stock for a total purchase price of $768,595, representing a net cash amount of $1.55 for each share issuable on the exercise of the Warrants, or $2.60 per share less the $1.05 exercise price of the Warrants. The transaction closed on January 15, 2002, and the warrants were terminated on that date. The transaction was recorded as an equity transaction in the quarter ended March 31, 2002. The original issue discount of $272,449 will continue to accrete through charges to retained earnings until October 2003.

Dividends

The Company has never paid cash dividends on any shares of its Common Stock, and the Company's Board of Directors intends to continue this policy for the foreseeable future. Earnings, if any, will be used to finance the development and expansion of the Company's business. The Company's ability to pay dividends on its Common Stock is limited by the preferences of certain classes of Preferred Stock, as well as certain indebtedness, and may be further limited by the terms of Preferred Stock issued or other indebtedness incurred by the Company in the future. Future dividend policy will depend upon the Company's earnings, capital requirements, financial condition and other factors considered relevant by the Company's Board of Directors.

The Series A Preferred Stock is entitled to receive cumulative dividends of eight percent per annum, which are payable before any dividend may be paid upon, or set apart for, the Common Stock outstanding. The Series B Preferred Stock was not entitled to receive dividends. The Series C Preferred Stock is entitled to a six percent dividend, to be paid in additional shares of Series C Preferred Stock for the first two and one-half years and thereafter either in cash or Series C Preferred Stock, at the Company's discretion. As of April 30, 2001 the Company elected to pay remaining Series C dividends in cash.

Equity Compensation Plan Information

The following table shows the number of securities to be issued upon exercise of outstanding stock options under all equity compensation plans of the Company, the weighted average exercise price of the outstanding options and the number of securties remaining for future issuance under the plans.

The selected consolidated statement of operations data for the years ended June 30, 2002, June 30, 2001, and June 30, 2000 and the consolidated balance sheet data as of June 30, 2002 and June 30, 2001, have been derived from the Company's audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K. The selected consolidated statement of operations data for the years ended June 30, 1999 and June 30, 1998 and the selected consolidated balance sheet data as of June 30, 2000, June 30, 1999, and June 30, 1998 are derived from the Company's audited consolidated financial statements which are not included in this Annual Report on Form 10-K.

The following table summarizes the Company's consolidated statement of operations and balance sheet data. You should read this information together with the discussion in "Management's Discussion and Analysis of Financial Condition and Result of Operations" and the Company's consolidated financial statements and notes to those statements included elsewhere in this Annual Report on Form 10-K.

Consolidated Statement of Operations Data

Years Ended

(in thousands, except per share data)

As of

(in thousands)

The following discussion and analysis provides information that the Company's management believes is relevant to an assessment and understanding of the Company's results of operations and financial condition. The discussion should be read in conjunction with the financial statements and footnotes that appear elsewhere in this Annual Report filed on Form 10-K. This Annual Report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1993 and Section 21E of the Securities Exchange Act of 1934. The words "believe," "expect," "anticipate," "intend," "estimate," and other expressions that predict or indicate future events and trends, and that do not relate to historical matters, identify forward-looking statements. Such statements involve risks and uncertainties that could cause actual results to differ materially from those set forth in such for ward-looking statements. The Company undertakes no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise, except as required by applicable laws and regulations.

Results of Operations

The following table provides unaudited quarterly consolidated results of operations for each quarter of fiscal years 2002 and 2001. The company believes this unaudited information has been prepared substantially on the same basis as the annual audited consolidated financial statements and all necessary adjustments have been included in the amounts stated below to present fairly the Company's results of operations. The operating results for any quarter are not necessarily indicative of the operating results for any future period.

(in thousands, except per share data)