VERMONT TEDDY BEAR CO INC - 10-Q Quarterly Report

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U.S. Securities and Exchange Commission

Washington, D.C. 20549

Form 10-Q

(Mark One)

[ X ] Quarterly report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended March 31, 2005 .

[ ] 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

(State or other jurisdiction (I.R.S. Employer

of incorporation or organization) Identification No.)

6655 Shelburne Road, Post Office Box 965

Shelburne, Vermont 05482

(Address of principal executive offices)

(802) 985-3001

(Issuer's telephone number)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes X ; No .

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes__; No X.

APPLICABLE ONLY TO CORPORATE ISSUERS

As of May 13, 2005, there were 5,039,098 shares of the registrant's common stock (par value $.05 per share) outstanding.

The Vermont Teddy Bear Co., Inc.

Index to Form 10-Q

March 31, 2005

PART I. FINANCIAL INFORMATION

Item 1. Unaudited Condensed Consolidated Financial Statements

THE VERMONT TEDDY BEAR CO., INC AND SUBSIDIARIES

Unaudited Condensed Consolidated Balance Sheets

	Page No.
Part I - Financial Information
Item 1. Unaudited Condensed Consolidated Financial Statements
Unaudited Condensed Consolidated Balance Sheets as of March 31, 2005 and June 30, 2004 (as restated)	3
Unaudited Condensed Consolidated Statements of Income for the three and nine months ended March 31, 2005 and 2004 (as restated)	4
Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended March 31, 2005 and 2004 (as restated)	5
Notes to Unaudited Condensed Consolidated Financial Statements	6

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations	13
Item 3. Quantitative and Qualitative Disclosure About Market Risk	22
Item 4. Controls and Procedures	23

Part II - Other Information
Item 1. Legal Proceedings	23
Item 5. Other Information	23
Item 6. Exhibits	23
Signatures	24

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

THE VERMONT TEDDY BEAR CO., INC. AND SUBSIDIARIES

Unaudited Condensed Consolidated Statements of Income

Three Months Ended Nine Months Ended

	March 31, 2005	June 30, 2004
ASSETS
Cash and cash equivalents	$8,376,395	$ 6,586,571
Accounts receivable, trade (net of allowance for doubtful accounts of $17,000 and $13,000 as of March 31, 2005 and June 30, 2004, respectively)	84,162	181,658
Inventories	6,087,791	4,090,936
Prepaid expenses and other current assets	1,865,028	1,471,355
Deferred income taxes	659,264	659,264
Total Current Assets	17,072,640	12,989,784

Restricted cash	473,770	470,835
Property and equipment, net	6,169,226	6,238,670
Goodwill	4,163,260	4,163,260
Indefinite lived intangibles	1,220,000	1,220,000
Deposits and other assets	1,130,755	1,223,967
Other intangibles, net	146,389	223,889
Total Assets	$ 30,376,040	$ 26,530,405

LIABILITIES AND STOCKHOLDERS' EQUITY

Accounts payable	$ 4,105,506	$ 3,805,939
Accrued expenses	5,598,429	1,854,892
Deferred revenue	1,388,686	1,272,766
Current portion of long-term debt	663,900	763,600
Current portion of capital lease obligations	190,217	175,495
Total Current Liabilities	11,946,738	7,872,692

Long-term debt, net of current portion	1,280,975	1,781,400
Capital lease obligations, net of current portion	4,656,515	4,801,073
Total Liabilities	17,884,228	14,455,165

Commitments and Contingencies (Note 11)

Series C convertible redeemable preferred stock Authorized 110 shares; issued 69.0 shares; outstanding 9.3 shares, $93,042 liquidation value as of March 31, 2005 and June 30, 2004	93,042	93,042

Series D convertible redeemable preferred stock Authorized 260 shares; issued 250 shares, outstanding 250 shares, $2,510,616 and $2,510,274 liquidation value at March 31, 2005 and June 30, 2004, respectively	2,510,616	2,510,274

Stockholders' Equity:
Preferred stock, $.05 par value: Authorized 1,000,000 shares Series A; issued and outstanding; 90 shares at March 31, 2005 and June 30, 2004; $1,530,000 and $1,476,000 liquidation value at March 31, 2005 and June 30, 2004, respectively	1,530,000	1,476,000
Authorized 375,000 shares Series B; issued 204,912 shares; 0 shares outstanding at March 31, 2005 and June 30, 2004	--	--
Common stock, $.05 par value: Authorized 20,000,000 shares; issued 8,211,184 and 8,176,435 shares; outstanding 5,038,898 and 5,004,149 shares as of March 31, 2005 and June 30, 2004, respectively	410,559	408,822
Additional paid-in capital	13,884,780	13,780,275
Retained earnings	5,326,443	5,070,455
Treasury stock at cost: 3,172,286 shares at March 31, 2005 and June 30, 2004	(11,263,628)	(11,263,628)
Total Stockholders' Equity	9,888,154	9,471,924
Total Liabilities and Stockholders' Equity	$ 30,376,040	$ 26,530,405

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

THE VERMONT TEDDY BEAR CO., INC. AND SUBSIDIARIES

Unaudited Condensed Consolidated Statements of Cash Flows

For the Nine Months Ended March 31, 2005 and 2004

	March 31,	March 31,	March 31,	March 31,
	2005	2004	2005	2004
		(as restated, see Note 2)		(as restated, see Note 2)
Net revenues	$ 25,573,767	$ 20,078,040	$ 47,839,754	$ 38,468,011
Cost of goods sold	10,878,855	8,196,650	21,113,190	16,180,911
Gross Profit	14,694,912	11,881,390	26,726,564	22,287,100

Operating expenses:
Marketing and selling expenses	8,721,041	7,524,196	17,269,921	14,563,948
General and administrative expenses	2,399,340	1,761,760	5,334,648	4,326,771
Legal settlement	2,150,000	--	2,150,000	--
	13,270,381	9,285,956	24,754,569	18,891,719
Operating Income	1,424,531	2,595,434	1,971,995	3,396,381
Interest income	21,651	10,348	32,355	28,108
Interest expense	(156,774)	(168,819)	(488,773)	(509,376)
Other (expense) income	(715)	251	5,262	2,493
Income before income taxes	1,288,693	2,437,214	1,520,839	2,917,606
Income tax provision	(1,017,875)	(998,283)	(1,112,823)	(1,195,051)
Net Income	270,818	1,438,931	408,016	1,722,555
Series A preferred stock dividends	(18,000)	(18,000)	(54,000)	(54,000)
Series C preferred stock dividends	(1,378)	(1,392)	(4,192)	(6,471)
Series D preferred stock dividends	(30,824)	(30,822)	(93,836)	(72,602)
Accretion of original issue discount	--	--	--	(18,153)
Net Income available to common stockholders	$ 220,616	$ 1,388,717	$ 255,988	$ 1,571,329

Basic net income per common share	$0.04	$0.27	$0.05	$0.31

Diluted net income per common share	$0.04	$0.22	$0.05	$0.27

Weighted average number of common shares outstanding	5,116,471	5,062,525	5,103,938	5,049,872

Weighted average number of diluted common shares outstanding	6,424,231	6,323,312	5,650,253	6,093,384

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

THE VERMONT TEDDY BEAR CO., INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS

(1) Basis of Presentation

The unaudited condensed consolidated financial statements of The Vermont Teddy Bear Co., Inc. and subsidiaries (the "Company") included herein have been prepared, pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC") and, in the opinion of management, reflect all adjustments necessary to present fairly the financial condition and results of operations for such interim periods. Certain information and footnote disclosures normally included in the financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. Certain prior period amounts have been reclassified to conform to the current period financial statement presentation. It is suggested that these financial statements be read in conjunction with the audited consolidated financial statements and notes thereto for the fiscal year ended June 30, 2004, included in the Company'
s filing with the SEC on Amendment No. 2 of Form 10-K/A. The Company's sales are seasonal in nature and, therefore, the results for these interim periods are not necessarily indicative of the results expected for the respective full year.

(2) Restatement of Consolidated Financial Statements

Subsequent to the issuance of the 2004 consolidated financial statements, the Company has determined that amortization of a building and the related costs financed under a sales-leaseback arrangement should have been amortized over the financing period of twenty years rather than the estimated useful life of the building of thirty-seven years. Additionally, the Company restated its basic weighted average common shares outstanding and earnings per share calculation to include the effect of the Series C Convertible Preferred Stock as it meets the definition of a participating security. As a result, the accompanying balance sheet as of June 30, 2004, the related consolidated statements of income for the three and nine months ended March 31, 2004, and the related statement of cash flows for the nine months ended March 31, 2004 have been restated to correct these errors. The following tables summarize the effect of such restatements:

Consolidated Statement of Income for the three months ended March 31, 2004:

	2005	2004
		(as restated, see Note 2)
Cash flows from operating activities:
Net income	$ 408,016	$ 1,722,555
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization	758,030	724,143
Deferred income taxes	--	64,450
Unrecognized gain on disposal of fixed assets	(119,689)	--
Changes in assets and liabilities net of assets acquired and liabilities assumed:
Accounts receivable, trade	97,496	(110,820)
Inventories	(1,996,855)	98,542
Prepaid and other current assets	(393,673)	175,136
Deposits and other assets	67,768	46,864
Accounts payable	299,567	376,765
Accrued expenses	3,743,538	913,412
Deferred revenue	115,920	517,496
Net cash provided by operating activities	2,980,118	4,528,543
Cash flows from investing activities:
Purchases of property and equipment	(721,837)	(122,813)
Proceeds from sale of property and equipment	255,882	--
Cash paid for business acquired	--	(1,373,206)
Increase in restricted cash	(2,935)	(7,173)
Net cash used in investing activities	(468,890)	(1,503,192)
Cash flows from financing activities:
Borrowings of short-term debt	1,850,000	500,000
Borrowings of long-term debt	--	1,000,000
Repayments of short-term debt	(1,850,000)	(500,000)
Repayments of long-term debt	(600,125)	(687,250)
Principal payments on capital lease obligations	(129,836)	(118,020)
Issuance of common stock, exercise of stock options	106,242	35,042
Payment of preferred stock dividends	(97,685)	(68,800)
Net cash (used in) provided by financing activities	(721,404)	160,972

Net increase in cash and cash equivalents	1,789,824	3,186,323

Cash and cash equivalents, beginning of period	6,586,571	5,168,177

Cash and cash equivalents, end of period	$ 8,376,395	$ 8,354,500

Supplemental Disclosures of Cash Flow Information:
Cash paid for interest	485,552	504,667
Cash paid for income taxes	52,000	20,000

Supplemental Disclosures of Non-cash Investing and Financing Activities:
Conversion of Series C Preferred Stock to Common Stock	--	90,000
Series A Preferred Stock dividends	54,000	54,000
Issuance of Series D Preferred Stock for business acquired	--	2,500,000
Accretion of original issue discount	--	18,153

Consolidated Statement of Income for the nine months ended March 31, 2004


	As Reported	As Restated
Cost of goods sold	$ 8,186,536	$ 8,196,650
Gross profit	11,891,504	11,881,390
Marketing & selling expenses	7,504,129	7,524,196
General and administrative expenses	1,757,745	1,761,760
Operating income	2,629,630	2,595,434
Interest expense	(167,193)	(168,819)
Income before income taxes	2,473,036	2,437,214
Income tax provision	(1,034,890)	(998,283)
Net income	1,438,146	1,438,931
Net income available to common stockholders	1,387,932	1,388,717
Basic net income per common share	$0.28	$0.27
Diluted net income per common share	$0.22	$0.22

Consolidated Statements of Cash Flows for the nine months ended March 31, 2004


	As Reported	As Restated
Cost of goods sold	$ 16,150,569	$ 16,180,911
Gross profit	22,317,442	22,287,100
Marketing & selling expenses	14,503,747	14,563,948
General and administrative expenses	4,314,726	4,326,771
Operating income	3,498,969	3,396,381
Interest expense	(504,498)	(509,376)
Income before income taxes	3,025,072	2,917,606
Income tax provision	(1,296,563)	(1,195,051)
Net income	1,728,509	1,722,555
Net income available to common stockholders	1,577,283	1,571,329
Basic net income per common share	$0.32	$0.31
Diluted net income per common share	$0.27	$0.27

(3) Basis of Consolidation

The consolidated financial statements include the accounts of The Vermont Teddy Bear Co., Inc. and its wholly owned subsidiaries, SendAMERICA, Inc. and Calyx & Corolla, Inc. All material inter-company balances and transactions have been eliminated in consolidation.

(4) Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The primary estimates underlying the Company's financial statements include inventory valuation, returns and allowances, the income tax provision, impairment of goodwill and other intangible assets. Actual results could differ from those estimates. Management bases its estimates on historical experience and on various assumptions, which are believed to be reasonable under the circumstances.

(5) Earnings Per Share

The following tables reconcile the net income and the weighted average common shares outstanding to the diluted net income and shares used in the computation of basic and diluted earnings per share:

Three Months Ended Nine Months Ended


	As Reported	As Restated
Net cash from operating activities	$ 4,533,422	$ 4,528,543
Net cash flow financing activities	156,093	160,972

Three Months Ended Nine Months Ended

	March 31, 2005	March 31, 2004	March 31, 2005	March 31, 2004
Net income available to common stockholders used in basic EPS calculation	$220,616	$1,388,717	$255,988	$1,571,329
Add: Dividends on Series C Preferred Stock	1,378	1,392	4,192	6,471
Accretion of original issue discount attributable to Series C Preferred Stock	--	--	--	18,153
Dividends on Series D Preferred Stock	30,824	30,822	--	72,602
Net income available to common stockholders used in diluted EPS calculation	$252,818	$1,420,931	$260,180	$1,668,555

Diluted weighted average shares outstanding for the three months ended March 31, 2005 have no excluded potential common shares because the price of the potential common shares was not greater than the average market price for the common stock for that period. Diluted weighted average shares outstanding for the nine months ended March 31, 2005 exclude 13,250 potential common shares because the price of the potential common shares was greater than the average market price of the common stock for that period.

Diluted weighted average shares outstanding for the three and nine months ended March 31, 2004 exclude 6,000 and 27,500 potential common shares, respectively, because the price of the potential common shares was greater than the average market price of the common stock for that period.

For the nine month period ended March 31, 2005, the diluted net income per share calculation does not include the effect of the conversion of Series D preferred because the conversion of those shares would have an antidilutive effect. Dividends on the Series D preferred were $93,836 for the nine months ended March 31, 2005. Diluted weighted average shares outstanding for the nine month periods ended March 31, 2005 excluded 708,215 potential shares.

(6) Stock-Based Compensation

Stock-based compensation cost is accounted for using the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25 Accounting for Stock Issued to Employees. Accordingly, no accounting recognition is given to stock options granted to employees at fair market value until they are exercised. Upon exercise, net proceeds, including the tax benefits realized, are credited to stockholders' equity.

Pro-forma disclosure - Had the Company recognized compensation costs for its stock option plans based on fair market value for awards under those plans, in accordance with Statements of Financial Accounting Standards ("SFAS") No. 123 Accounting for Stock Based Compensation, as amended by SFAS No. 148, pro forma net income and pro forma net income per share would have been as follows:

Nine Months Ended

	March 31, 2005	March 31, 2004	March 31, 2005	March 31, 2004
Weighted average basic number of shares	5,027,852	4,973,906	5,015,319	4,913,569
Effect of conversion of Preferred Series C	88,619	88,619	88,619	136,303
Weighted average number of shares used in basic EPS calculation	5,116,471	5,062,525	5,103,938	5,049,872

Add: Common shares issuable upon exercise of:
Stock options	952,405	976,340	949,664	958,143
Warrants	193,111	193,111	193,111	193,111
Convertible redeemable Series D preferred stock	708,215	708,215	--	556,271
Total Common shares issuable	1,853,731	1,877,666	1,142,775	1,707,525

Less: Shares assumed to be repurchased under treasury stock method	(545,971)	(616,879)	(596,460)	(664,013)
Weighted average number of shares used in diluted EPS calculation	6,424,231	6,323,312	5,650,253	6,093,384

The fair values used to compute pro forma net income and net income per share were estimated at their fair value at grant date using the Black-Scholes option-pricing model with the following weighted average assumptions:

	March 31, 2005		March 31, 2004
Net income available to common stockholders		$ 255,988		$ 1,571,329
Deduct: Total stock-based employee compensation expense determined under fair market value method for awards, net of related tax effects		(124,381)		(61,198)
Pro forma net income available to common stockholders		$ 131,607		$1,510,131

Basic EPS - as reported		$0.05		$0.31
Basic EPS - pro forma		$0.03		$0.30
Diluted EPS - as reported		$0.05		$0.27
Diluted EPS - pro forma		$0.02		$0.26

(7) Recent Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board ("FASB") issued SFAS No.123R, Share-Based Payment. SFAS No. 123R is a revision of SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance. SFAS No. 123R focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. SFAS No. 123R requires entities to recognize stock compensation expense for awards of equity instruments to employees based on the grant-date fair value of those awards (with limited exemptions). SFAS No. 123R is effective for the first annual reporting period that begins after June 15, 2005. The Company is evaluating the two methods of adoption allowed by SFAS No. 123R; the modified-prospective transition method and the modified-retrospective transition method and does not believe adopti
on of SFAS No. 123R will have a material effect on its consolidated financial position, results of operations or cash flows.

On November 29, 2004, the FASB issued SFAS No. 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4. SFAS No. 151 clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs and waste material. SFAS No. 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company does not believe adoption of SFAS No. 151 will have a material effect on its consolidated financial position, results of operations or cash flows.

(8) Inventories

Inventories consist of the following at March 31, 2005 and June 30, 2004:

	2005	2004
Risk-free interest rate	4.50%	3.86%
Expected dividend yield	0%	0%
Expected volatility	71.2%	46.0%
Expected lives	6.0 years	6.7 years

(9) Indebtedness

The following is a summary of the Company's long-term debt obligations as of March 31, 2005:

	March 31, 2005	June 30, 2004
Raw materials	$ 436,900	$ 451,179
Work-in-process	93,881	192,670
Finished goods	5,557,010	3,447,087
	$6,087,791	$4,090,936

(10) Segment Information

Operating segments represent components of the Company's business that are evaluated regularly by the Chief Executive Officer in assessing performance and resource allocation. The Company has determined that its reportable segments consist of Gift Delivery Services, Retail Operations, and Corporate/Wholesale (including licensing). The Gift Delivery Services segment is comprised of the BearGram, PajamaGram, Calyx & Corolla floral, and TastyGram delivery services.

The BearGram delivery service involves sending personalized teddy bears directly to recipients for special occasions such as birthdays, get well, and new births, as well as holidays such as Valentine's Day, Christmas, and Mother's Day. BearGram orders are placed through the toll free number, on-line at vermontteddybear.com , or through the catalog.

The PajamaGram delivery service involves sending pajamas and related loungewear and spa products to recipients as gifts for similar special occasions and holidays. PajamaGram orders are placed via a toll free number or online at pajamagram.com.

The Calyx & Corolla, Inc. segment was acquired on August 29, 2003 for the purpose of extending the Company's product offerings in the gift delivery service industry to include floral delivery service. The Calyx & Corolla delivery service involves sending premium flowers and plants with unique up-scale arrangements and containers to recipients, direct from the growers, as gifts for special occasions and holidays. Calyx & Corolla orders are placed through a catalog, via a toll free number or online at calyxandcorolla.com.

The TastyGram delivery service business operates through SendAMERICA, Inc., a wholly owned subsidiary of the Company, to extend the Company's product offerings in the gift delivery service industry to include food related gift products delivered to recipients for special occasions and holidays. TastyGram orders are placed via a toll free number or online at tastygram.com.

The Retail Operation segment involves a retail location and family tours of its teddy bear factory in Shelburne, located ten miles south of Burlington, Vermont. The Company also has a retail store located on Route 100 in Waterbury, Vermont. In an effort to make a visit to the stores more entertaining and draw additional traffic, the Company has implemented Make-A-Friend-For-Life bear assembly areas at both stores, where visitors can participate in the creation of their own teddy bear.

The Corporate/Wholesale segment develops opportunities in the corporate affinity market and certain wholesale markets.

The reporting segments follow the same accounting policies used for the Company's consolidated financial statements as described in the summary of significant accounting policies. Management evaluates a segment's performance based upon gross margin and gross margin percentage.

Fiscal Year	Long-Term Debt Obligations
2005	$ 186,574
2006	742,158
2007	733,203
2008	377,085
2009	50,409
Sub total	2,089,429
Less amounts representing interest and dividends	(144,554)
Total	$ 1,944,875

		"Gift Delivery	Services"
Three Months Ended 3/31/05	BearGram Service	PajamaGram Service	Calyx & Corolla Service	TastyGram Service	Retail Operations	Corporate/ Wholesale	Totals
Net Revenues	$ 15,076,980	$ 5,624,143	$ 4,299,088	$ 106,826	$ 375,349	$ 91,381	$ 25,573,767
Cost of Goods Sold	5,699,897	2,459,679	2,441,849	76,053	147,288	54,089	10,878,855
Gross Margin	$ 9,377,083	$ 3,164,464	$ 1,857,239	$ 30,773	$ 228,061	$ 37,292	$ 14,694,912
Gross Margin %	62.2%	56.3%	43.2%	28.8%	60.8%	40.8%	57.5%

		"Gift Delivery	Services"
Three Months Ended 3/31/04	BearGram Service	PajamaGram Service	Calyx & Corolla Service	TastyGram Service	Retail Operations	Corporate/ Wholesale	Totals
Net Revenues	$ 13,050,137	$ 2,611,070	$ 3,619,427	$ 107,241	$ 392,964	$ 297,201	$ 20,078,040
Cost of Goods Sold	4,909,287	995,891	1,937,564	87,676	132,716	133,516	8,196,650
Gross Margin	$ 8,140,850	$ 1,615,179	$ 1,681,863	$ 19,565	$ 260,248	$ 163,685	$ 11,881,390
Gross Margin %	62.4%	61.9%	46.5%	18.2%	66.2%	55.1%	59.2%

The Company believes that there is no discernable basis to identify assets and net income by segment. Revenues from any single customer, revenues between business segments, and revenues, operating profit and identifiable assets of foreign operations are not significant.

(11) Commitments and Contingencies

The Company has been a party in a suit against 538 Madison Realty Company pending in the Supreme Court of the State of New York, County of New York, seeking a declaration that a lease with 538 Madison Realty Company is terminated.

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 be
lieved it was not obligated 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 judgment on its claims and dismissal of the landlord's claims. That motion was granted by order dated July 25, 2001 and judgment 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 judgment and, as settlement discussions were unsuccessful,
posted a bond to stay enforcement of the judgment pending its appeal, which was argued on November 1, 2002. That judgment was affirmed by a 3-2 vote of New York's Appellate Division, First Department. Based on the two dissenting votes, the landlord had a right of appeal to New York's Court of Appeals. That appeal was fully briefed and then argued on February 10, 2004. On March 25, 2004, the New York Court of Appeals issued a decision reversing the Appellate Division, and denying the Company's summary judgment motion. This decision returned the case to the New York Supreme Court for a determination as to whether the Company's lease was terminated or continued in effect following the December 7, 1997 incident. The Company continued to pursue all of its legal remedies to resolve the litigation favorably by decision or settlement. The Company accrued management's estimated cost of $220,000 to settle this contingency, but no assurance could be given that this dispute could be settled for that amount. In the
event that no settlement could be reached and the Company was not successful in its suit against 538 Madison Realty Company, the remaining amount owed under the lease over its remaining term at face value was $2,825,000. The landlord also claimed damages, pursuant to the lease for interest, attorneys fees and its costs incurred in connection with re-letting the space. In the event there was a determination that the lease continued in effect, the Company would assert offsets to the damages claimed, based on other settlements reached by the landlord in connection with the December 7, 1997 incident and the current re-letting of the space. Nevertheless there was no assurance that this dispute could be resolved for less than the full amount claimed by the landlord. Discovery was scheduled to be completed in March 2005 and no trial date had been set. The Company had agreed to enter into mediation with the landlord and a mediation date, after prior cancellations, occurred on March 3, 2005. On March 18, 2005, f
ollowing mediation that occurred on March 3, 2005, and continuing settlement discussions, the Company increased the amount of its reserve for the litigation by $1,780,000 to reflect management's then current estimated cost of $2,000,000 to settle this contingency. On April 28, 2005, the Company executed a Settlement and Release Agreement (the "Settlement Agreement") with 538 Madison Realty Company. Under the Settlement Agreement, the Company agreed to pay 538 Madison Realty Company a settlement amount of $2.35 million and the parties exchanged releases. Of this settlement amount, $1.15 million was paid by the Company upon execution of the Settlement Agreement, including the release of a security deposit previously held by 538 Madison Realty Company in the amount of $150,000. The remaining $1.2 million will be paid by the Company on or before March 15, 2006, without interest. The Company recorded an additional $2,150,000 as a liability at March 31, 2005.

On April 29, 2005, in conjunction with the Settlement Agreement, the Company evaluated financial covenants and received consents from its lender, Banknorth, N.A. and W.P. Carey & Co. LLC, the Company's landlord in a sale-leaseback financing transaction relating to its retail/manufacturing facility in Shelburne, Vermont, to amend certain financial covenants in regards to the one-time charge of $2.35 million attributable to payments made to 538 Madison Realty Company LLC pursuant to the Settlement Agreement.

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.

On July 29, 2004, the Company entered into a new ten year lease for its Shelburne warehouse and fulfillment center to incorporate a 60,400 square foot addition to its existing facility that is contiguous to the property on which the Company's factory headquarters are located. The addition replaces 25,000 square feet of month-to-month leased space in Williston, Vermont. The new consolidated lease for 120,800 square feet replacing the July 19, 2000 lease began in October 2004. The consolidated lease is for ten years with three five-year renewal options.

On May 16, 2005, the Company entered into a definitive Agreement and Plan of Merger (the "Merger Agreement") with Hibernation Holding Company, Inc., a Delaware Corporation, and Hibernation Company, Inc., a Delaware Corporation and wholly-owned subsidiary of Hibernation Holding Company, Inc. Pursuant to the Merger Agreement, with the exception of certain stockholders who will exchange their existing stock and warrants for stock and warrants of Hibernation Holding Co., Inc., the Company's common and preferred stockholders would receive $6.50 per share of common stock, on an as converted basis, in cash, upon the closing of the transaction. The consummation of the merger is subject to certain terms and conditions customary for transactions of this type, including stockholder approval and completion of committed debt and equity financing.

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

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 report filed on Form 10-Q. This 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 forward-looking statements. The Company undertakes no obligation to pu
blicly 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.

Restatement

Subsequent to the issuance of the 2004 consolidated financial statements, the Company has determined that amortization of a building and the related costs financed under a sales-leaseback arrangement should have been amortized over the financing period of twenty years rather than the estimated useful life of the building of thirty-seven years. As a result, the accompanying unaudited condensed consolidated balance sheet as of June 30, 2004 and the related unaudited condensed consolidated statements of income for the three and nine months ended March 31, 2004 and the related unaudited condensed consolidated statement of cash flows for the nine months period ended March 31, 2004 have been restated to correct these errors.

Additionally, the Company has determined that it should restate the basic weighted average common shares outstanding and basic per share calculations to include the effect of the Series C convertible preferred stock. Because the Series C Preferred is deemed to be participating, the shares assumed to be converted into common shares are included in the calculation of basic earnings per share. Basic earnings per common share have been restated accordingly. See Note 2 to the unaudited condensed consolidated financial statements for additional information.

The following Management's Discussion and Analysis gives effect to the restatement.

Other Matters

On April 28, 2005, the Company executed a Settlement and Release Agreement (the "Settlement Agreement") with 538 Madison Realty Company LLC ("538 Madison"). Under the Settlement Agreement, the Company agreed to pay 538 Madison a settlement amount of $2.35 million and the parties exchanged mutual releases. Of this settlement amount, $1.15 million was paid by the Company upon e

		"Gift Delivery	Services"
Nine Months Ended 3/31/05	BearGram Service	PajamaGram Service	Calyx & Corolla Service	TastyGram Service	Retail Operations	Corporate/ Wholesale	Totals
Net Revenues	$ 22,918,697	$ 9,776,561	$ 12,326,651	$ 293,503	$ 2,284,547	$ 239,795	$ 47,839,754
Cost of Goods Sold	8,976,297	4,165,349	6,763,618	211,924	860,154	135,848	21,113,190
Gross Margin	$ 13,942,400	$ 5,611,212	$ 5,563,033	$ 81,579	$ 1,424,393	$ 103,947	$ 26,726,564
Gross Margin %	60.8%	57.4%	45.1%	27.8%	62.3%	43.3%	55.9%

		"Gift Delivery	Services"
Nine Months Ended 3/31/04	BearGram Service	PajamaGram Service	Calyx & Corolla Service	TastyGram Service	Retail Operations	Corporate/ Wholesale	Totals
Net Revenues	$ 20,895,460	$ 4,560,637	$ 9,787,635	$ 248,433	$ 2,470,028	$ 505,818	$ 38,468,011
Cost of Goods Sold	8,028,237	1,820,198	5,039,121	174,366	876,438	242,551	16,180,911
Gross Margin	$ 12,867,223	$ 2,740,439	$ 4,748,514	$ 74,067	$ 1,593,590	$ 263,267	$ 22,287,100
Gross Margin %	61.6%	60.1%	48.5%	29.8%	64.5%	52.0%	57.9%