FORWARD LOOKING STATEMENTS OR INFORMATION
Certain statements, other than statements of
historical fact, included in this Annual Report, including, without limitation, the statements under “Current Developments”,
“Business” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” are, or may be deemed
to be, forward looking statements that involve significant risks and uncertainties, and accordingly, there is no assurance that these expectations will
be correct. These expectations are based upon many assumptions that the registrant believes to be reasonable, but such assumptions ultimately may prove
to be materially inaccurate or incomplete, in whole or in part and, therefore, undue reliance should not be placed on them. Several factors which could
cause actual results to differ materially from those discussed in such forward-looking statements include, but are not limited to: availability and
pricing of goods purchased from international suppliers, increased port and inbound transportation congestion which could delay receipt of goods and
increase the cost of imported goods, unusual weather patterns which could affect domestic demand for the registrant’s products and curtail
imprinting operations, pricing policies of competitors, the ability to attract and retain employees in key positions, growth trends in the advertising
specialties industry and uncertainties and changes in general economic conditions. The words “believe,” “expect”,
“anticipate”, “should”, “could” and other expressions that indicate future events and trends identify forward-looking
statements. All subsequent forward-looking statements attributable to the registrant or persons acting on its behalf are expressly qualified in their
entirety.
PART I
Item 1. Business
As used in this report, the terms “Boss”
and “Company” refer to Boss Holdings, Inc. (the Registrant), a Delaware corporation, and its operating subsidiaries. The Company’s
primary operating subsidiary is Boss Manufacturing Company, a Delaware corporation (“BMC”), originally established in 1893.
The Company operates primarily in the work gloves
and protective wear business segment. In addition, the Company conducts operations in the pet supplies business segment and completed the acquisition
of Galaxy Balloons, Inc. (“Galaxy”) during 2004, expanding the Company’s operations into the promotional and specialty products
segment.
Work Gloves and Protective Wear
Through BMC, the Company imports, markets and
distributes gloves, boots and rainwear products serving two primary markets — consumer and industrial. The consumer market represents
approximately 57% of BMC domestic sales and consists of retailers ranging from convenience stores to mass merchandisers as well as hardware, and
grocery stores. The industrial market, which accounts for the balance of sales in this segment, includes various commercial users of gloves and
protective wear. These end-users include companies in the agricultural, automotive, energy, lumber and construction industries.
BMC primarily markets its products through
distributors and manufacturer representatives. In addition, the Company sells directly through its own sales force to certain major retail customers.
BMC products are sold predominantly to customers in the United States, with the Company’s Boss Canada subsidiary generating approximately 5% of
the sales in this segment.
The markets served by the work gloves and protective
wear segment are intensely competitive with a high degree of price competition. In addition, many retailers have begun to import products directly in
recent years. BMC competes on the basis of distribution service capabilities, selection, quality and price. Having participated in this segment for
over 100 years, BMC and the Boss trade name are well known in the industry. The market for work gloves and protective wear is highly fragmented and
served by a large number of domestic and foreign competitors ranging in size from small sole proprietorships to several companies substantially larger
than BMC.
Sales in the work gloves and protective wear segment
have historically exhibited seasonal fluctuations. Cold weather months generally provide increased sales while warm weather historically results in
reduced sales activity. Because of this seasonality, glove and protective wear sales tend to be higher in the Company’s first and fourth quarters
and lower during the second and third quarters.
1
BMC sells to a broad customer base approximating two
thousand active accounts. Accordingly, BMC has relatively little dependence on any one customer. At the end of 2004, BMC had an open order backlog of
approximately $1,250,000, down about $225,000 from the previous year.
The Company ceased domestic manufacturing operations
during 2000 and is now primarily an importer and marketer. Finished goods in this segment are generally widely available from a number of suppliers in
various countries. After declining in previous years, the cost of imported goods began to increase during 2004 for certain goods, particularly
split-leather products and goods produced from oil-based materials. The Company has occasionally experienced limitations in the supply of certain
imported products, generally due to raw material shortages. Availability of imported goods is further subject to interruptions in shipping as well as
import/export documentation and clearing. The Company does not anticipate shortages of purchased goods for resale in 2005.
During the fourth quarter of 2002, the Company
entered into a trademark license agreement with Caterpillar, Inc. under which the Company markets work gloves and rainwear under the CAT®
trademark. Management developed a complete new line of CAT® products during 2003. Sales of CAT® products were in line with management
expectations for 2004 and totaled over 5% of sales in the work gloves and protective wear segment for the year. The Company believes that the CAT®
trademark will provide additional sales growth opportunities while allowing the Company to introduce new products which are less sensitive to market
pricing pressures.
The Boss logo is an important trademark of the
Company which it vigorously defends in the market. In addition, BMC has various registered names and trademarks for specific products which the Company
believes add substantial value in the sales and marketing efforts associated with this segment. Additional financial information on the work gloves and
protective wear segment is included in the “Notes to Consolidated Financial Statements” and in “Management’s Discussion and
Analysis of Financial Condition and Results of Operations”.
Pet Supplies
The Company operates in the pet supplies segment
through two subsidiaries. The Warren Pet (“Warren”) division of the Company’s Boss Manufacturing Holdings, Inc. subsidiary imports,
markets and distributes a comprehensive line of non-food pet supplies to various retail outlets. Products in this line include dog and cat toys,
collars and leads, chains and rawhide products. Warren markets its product line primarily to discount and hardware retailers utilizing a network of
regional distributors.
Boss Pet Products, Inc. (“Boss Pet”), a
wholly owned subsidiary of BMC, imports, markets and distributes pet cable restraints, shampoos and other pet chemical products. The Company acquired
this business through the purchase of certain assets from RocCorp, Inc. during the fourth quarter of 2002. Boss Pet markets its products primarily to
pet supply specialty retailers under the Prestige brand name. In addition, Boss Pet sells products to discount retailers under various privately
labeled brand names. Essentially all sales in this segment are within the United States.
The pet supplies industry is extremely competitive.
A small group of companies including Hartz Mountain Corporation and Sergeant’s Pet Care Products, Inc. dominate the industry. The Company competes
primarily in selected market niches by focusing on customer service, specialized marketing, unique products and competitive pricing.
Sales in the pet supplies segment have historically
exhibited seasonal fluctuations. Spring and summer months tend to generate higher sales at retail as consumers spend time outdoors with their pets
during warm weather months. Cold weather months generally produce lower sales at retail. Because of this seasonality, pet supply sales tend to be
higher in the Company’s first and second quarters, with sales declining through the third and fourth quarters.
The Company generally has multiple sources of supply
for substantially all of its product requirements in this segment. Finished goods purchased have generally been readily available in sufficient
quantities. However, the pet supplies segment is subject to the same potential for product interruptions noted in the work gloves and protective wear
segment. Because of the seasonality in this segment, the open order backlog was not material at the end of 2004 or 2003.
Due to the market niches served by Boss Pet and
Warren, these operations serve a smaller customer base with less diversification than the Company’s operations in other segments. Boss Pet’s
largest customer accounted for 41% of sales in this segment during 2004 while Warren’s largest customer accounted for 16%.
2
Additional financial information on the pet supplies
segment is included in the “Notes to Consolidated Financial Statements” and in “Management’s Discussion and Analysis of Financial
Condition and Results of Operations”.
Promotional and Specialty Products
During the third quarter of 2004, the Company
acquired Galaxy, a Cleveland, Ohio based company operating in the promotional and specialty products segment. Galaxy provides custom imprinted
balloons, balls and other inflatable products that are sold primarily into the advertising specialties industry through approximately 4,000
distributors. In addition, Galaxy has broadened its product line to include various non-inflatable imprinted items including candles, yo-yos and
Christmas ornaments.
A broad based group of end-users, from banks to
hotels to schools, purchase Galaxy’s custom imprinted products for advertising and promotional purposes. Examples include miniature footballs and
basketballs thrown into the crowds at sporting events and helium filled balloons given to children at restaurants. These items are imprinted with the
school or company name for maximum effect.
The advertising specialties industry includes over
20,000 distributors serving a $16 billion market which has experienced substantial growth over the past decade. This market is very competitive and
Galaxy competes against companies offering similar products as well as companies offering other custom imprinted goods such as pens, t-shirts and caps.
Galaxy competes on the basis of quality, both in terms of the products offered and the printing process, service, with Galaxy offering quick
turn-around times as well as small minimums, and price. The products offered by Galaxy provide end-users with the opportunity to get their name in
front of many potential customers for a relatively small advertising cost.
Based on its review of results from prior years,
management expects seasonal sales fluctuations in the promotional and specialty products segment. Historically, sales in this segment reach a low point
during the holiday season through January, then build to a peak in late summer. To reduce this seasonality, Galaxy has increased its product line to
include Christmas ornaments and candles.
Due to its broad customer base, Galaxy has little
dependence on any one customer. Galaxy’s open order backlog was not material at year-end due to the seasonal nature of sales in this segment.
Galaxy purchases the finished goods on which it custom imprints products from a number of sources, both domestic and international. Though suppliers
are limited in certain product areas, Galaxy has experienced no product shortages in recent years and anticipates an adequate supply of goods in the
coming year.
Additional financial information on the promotional
and specialty products segment is included in the “Notes to Consolidated Financial Statements” and in “Management’s Discussion and
Analysis of Financial Condition and Results of Operations”.
Environmental Matters
The Company is subject to various federal, state and
local regulations concerning the environment. Efforts to maintain compliance with such regulations have not required expenditures material to the
Company’s overall operating performance or financial condition.
Employees
As of December 25, 2004, Boss employed approximately
213 full-time associates, up about 89 from the previous year due to the purchase of Galaxy. The Company employed no union employees at the end of 2004.
Approximately 206 associates were located in the United States with 7 located in Canada at year-end.
The Company believes its employee relations are
excellent with relatively low turnover rates in key positions. However, the Company’s past success in attracting and retaining employees cannot
assure attainment of future employment objectives.
Available Information
Information concerning the Company and its products
can be obtained from its primary internet website at www.bossgloves.com. The Company’s public financial reports and insider trading reports
can be accessed under the “Boss Holdings, Inc.” subsection of the website area titled “Company Information”. In addition,
information
3
about products available from subsidiary
operations is available at the following websites, www.galaxyballoon.com and www.roccorp.com.
The following table shows the location, general
character, square footage, approximate annual rent and lease expiration date of the principal operating facilities owned or leased by the Company as of
December 25, 2004. The principal executive offices are located in Kewanee, Illinois.
Location
|
|
|
|
City
|
|
General Character
|
|
Square
Feet
|
|
Annual
Rent
|
|
Lease
Expiration
|
Br. Columbia,
Canada |
|
|
|
Vancouver |
|
Distribution |
|
|
5,600 |
|
|
$ |
9,000 |
|
|
Month-to-month |
Illinois |
|
|
|
Kewanee |
|
Administrative
Office |
|
|
10,200 |
|
|
$ |
0 |
|
|
Owned |
Illinois |
|
|
|
Kewanee |
|
Distribution
& Administration |
|
|
147,000 |
|
|
$ |
0 |
|
|
Owned |
Illinois |
|
|
|
Kewanee |
|
Distribution |
|
|
70,000 |
|
|
$ |
0 |
|
|
Owned |
Illinois |
|
|
|
Kewanee |
|
Distribution
— Pet Supplies |
|
|
19,000 |
|
|
$ |
0 |
|
|
Owned |
Illinois |
|
|
|
Springfield |
|
Distribution |
|
|
25,000 |
|
|
$ |
62,500 |
|
|
11/11/2005 |
Ontario,
Canada |
|
|
|
Concord |
|
Distribution
& Administration |
|
|
11,150 |
|
|
$ |
48,000 |
|
|
3/31/2006 |
Ohio |
|
|
|
Lakewood |
|
Printing,
Distribution &
Administration |
|
|
65,000 |
|
|
$ |
144,000 |
|
|
12/31/2009 |
Ohio |
|
|
|
Brunswick |
|
Manufacturing,
Distribution &
Admin — Pet Supplies |
|
|
30,000 |
|
|
$ |
90,000 |
|
|
Month-to-month |
The Company sold its Springfield, Illinois building
in the fourth quarter of 2004 and leased back 25,000 square feet for one year to provide temporary storage. In connection with the Galaxy acquisition,
the Company assumed the lease of a portion of a building in Lakewood, Ohio. The above properties not designated as used in the pet supplies segment or
printing (promotional and specialty products segment) are predominantly used in the work gloves and protective wear segment.
Due to the addition of the CAT® product line,
various new industrial products, increased volume of industrial shipments and planned product expansion into certain outdoor products, the
Company’s facilities in the work gloves and protective wear segment are currently at capacity. Management may obtain additional temporary storage
to meet anticipated space requirements during the coming year.
| Item 3. |
|
Legal Proceedings |
The Company is a party to various legal actions
incident to the normal operations of its business. These lawsuits primarily involve claims for damages arising out of commercial disputes. The Company
has been named as a defendant in several lawsuits alleging past exposure to asbestos contained in gloves sold by one of the
Company’s predecessors-in-interest, all of which actions are being defended by one or more of the Company’s general liability or products
liability insurers. Management believes the ultimate disposition of these matters should not materially impair the Company’s consolidated
financial position or liquidity.
| Item 4. |
|
Submission of Matters to a Vote of Security
Holders |
The Company submitted no matters for security holder
voting during the fourth quarter of 2004.
4
PART II
| Item 5. |
|
Market for Registrant’s Common Equity and Related
Stockholder Matters |
The Company’s common stock (symbol: BSHI)
currently is listed on the Over-the-Counter (OTC) Bulletin Board. The Company’s common stock is not listed on any national stock exchange or on
NASDAQ. The OTC Bulletin Board is a regulated quotation service that displays real-time quotes, last-sale prices and volume information for non-listed
(over-the-counter) equity securities. The OTC Bulletin Board is a reporting system for participating market makers, not an issuer listing service, and
should not be confused with the NASDAQ Stock Market. Participating market makers in the bulletin board system enter quotes and trade reports on a
closed computer network and the information is made publicly available through numerous websites and other locations. The OTC Bulletin Board is
distinct from the “pink sheets” published by the National Quotation Bureau which also report on transactions in non-listed equity securities.
OTC Bulletin Board quotations reflect interdealer prices, without retail mark-up, mark-down or commission and may not represent actual
transactions.
Stockholders of record at February 28, 2005 numbered
approximately 1,479. The Company has not paid cash dividends on its Common Stock in the past and currently plans to retain earnings, if any, for
business development and expansion.
| |
|
|
|
Quarterly Stock Prices
|
|
| |
|
|
|
First
Quarter
|
|
Second
Quarter
|
|
Third
Quarter
|
|
Fourth
Quarter
|
2004 — High
bid |
|
|
|
$ |
7.00 |
|
|
$ |
7.12 |
|
|
$ |
6.80 |
|
|
$ |
7.05 |
|
2004 — Low
bid |
|
|
|
$ |
5.06 |
|
|
$ |
6.40 |
|
|
$ |
5.80 |
|
|
$ |
6.65 |
|
2003 — High
bid |
|
|
|
$ |
3.90 |
|
|
$ |
4.80 |
|
|
$ |
5.00 |
|
|
$ |
5.26 |
|
2003 — Low
bid |
|
|
|
$ |
3.20 |
|
|
$ |
3.45 |
|
|
$ |
4.15 |
|
|
$ |
4.81 |
|
There were no repurchases of common stock during the
three months ended December 25, 2004.
5
| Item 6. |
|
Selected Financial Data |
The following table contains selected consolidated
financial data for the five year period ended December 25, 2004 as derived from the consolidated financial statements of the Company. This table should
be read in conjunction with “Management’s Discussion and Analysis of Results of Operations and Financial Condition” and the
Company’s audited Consolidated Financial Statements and Notes thereto appearing elsewhere herein.
Consolidated Balance Sheet Data
| |
|
|
|
As of
|
|
| |
|
|
|
12/25/04
|
|
12/27/03
|
|
12/28/02
|
|
12/29/01
|
|
12/30/00
|
| |
|
|
|
(Amounts in thousands, except per share data)
|
|
Working
capital |
|
|
|
$ |
20,039 |
|
|
$ |
18,890 |
|
|
$ |
18,167 |
|
|
$ |
17,486 |
|
|
$ |
18,434 |
|
Total
assets |
|
|
|
|
32,179 |
|
|
|
26,798 |
|
|
|
24,531 |
|
|
|
23,164 |
|
|
|
25,462 |
|
Long-term
debt, including current portion |
|
|
|
|
4,020 |
|
|
|
3,183 |
|
|
|
1,462 |
|
|
|
2,377 |
|
|
|
4,608 |
|
Stockholders’ equity |
|
|
|
|
24,605 |
|
|
|
20,856 |
|
|
|
20,220 |
|
|
|
18,591 |
|
|
|
17,715 |
|
Consolidated Statement of Operations Data
| |
|
|
|
Year Ended
|
|
| |
|
|
|
12/25/04
|
|
12/27/03
|
|
12/28/02
|
|
12/29/01
|
|
12/30/00
|
Net
sales |
|
|
|
$ |
43,474 |
|
|
$ |
36,271 |
|
|
$ |
33,808 |
|
|
$ |
33,737 |
|
|
$ |
36,429 |
|
Cost of
sales |
|
|
|
|
29,624 |
|
|
|
24,284 |
|
|
|
22,899 |
|
|
|
23,384 |
|
|
|
26,191 |
|
Gross
profit |
|
|
|
|
13,850 |
|
|
|
11,987 |
|
|
|
10,909 |
|
|
|
10,353 |
|
|
|
10,238 |
|
Operating
expenses |
|
|
|
|
12,623 |
|
|
|
11,630 |
|
|
|
10,064 |
|
|
|
10,080 |
|
|
|
10,255 |
|
Operating
income (loss) |
|
|
|
|
1,227 |
|
|
|
357 |
|
|
|
845 |
|
|
|
273 |
|
|
|
(17 |
) |
Interest
income |
|
|
|
|
28 |
|
|
|
62 |
|
|
|
97 |
|
|
|
77 |
|
|
|
166 |
|
Interest
expense |
|
|
|
|
(267 |
) |
|
|
(149 |
) |
|
|
(113 |
) |
|
|
(298 |
) |
|
|
(351 |
) |
Other
income |
|
|
|
|
47 |
|
|
|
305 |
|
|
|
847 |
|
|
|
588 |
|
|
|
217 |
|
Net income (loss)
before income taxes |
|
|
|
|
1,035 |
|
|
|
575 |
|
|
|
1,676 |
|
|
|
640 |
|
|
|
15 |
|
Income tax
benefit (expense) |
|
|
|
|
2,688 |
|
|
|
(7 |
) |
|
|
(40 |
) |
|
|
89 |
|
|
|
(42 |
) |
Net
income (loss) |
|
|
|
$ |
3,723 |
|
|
$ |
568 |
|
|
$ |
1,636 |
|
|
$ |
729 |
|
|
$ |
(27 |
) |
Basic
earnings (loss) per share |
|
|
|
$ |
1.93 |
|
|
$ |
.29 |
|
|
$ |
.84 |
|
|
$ |
.38 |
|
|
$ |
(.01 |
) |
Diluted
earnings (loss) per share |
|
|
|
$ |
1.72 |
|
|
$ |
.27 |
|
|
$ |
.79 |
|
|
$ |
.38 |
|
|
$ |
(.01 |
) |
In the third quarter of 2004, the Company reduced
its valuation allowance on the deferred tax asset related to net operating loss carryforwards, resulting in a $2,688,000 net tax non-cash benefit for
the year. This change materially affects the comparability of 2004 net earnings with prior periods. Please refer to Management’s Discussion and
Analysis of Results of Operations and Financial Condition — Income Tax Expense below.
| Item 7. |
|
Management’s Discussion and Analysis of Financial
Condition and Results of Operations |
Contents
This item of the annual report on Form 10K is
divided into the following sections:
• |
|
Executive Summary — Provides a brief overview of the
year’s results and known uncertainties expected to have an effect on future results. |
• |
|
Critical Accounting Policies — Discusses the accounting
policies which management believes are the most essential to aid in understanding the Company’s financial results. |
• |
|
Results of Operations — Analyzes the Company’s
financial results comparing sales, operating margins and expenses to prior periods including management’s expectation of trends and uncertainties
on future results. |
• |
|
Liquidity and Capital Resources — Analyzes the
Company’s cash flow from operating, investing and financing activities and further discusses the Company’s current and projected
liquidity. |
6
• |
|
Inflation — Reviews the impact of inflation on the
Company’s reported results. |
• |
|
Market Risk — Discusses the Company’s exposure to
market risk sensitive instruments commonly referred to as derivatives. |
Executive Summary
Boss expanded its family of companies with the
acquisition of Galaxy Balloons, Inc. during the third quarter of 2004. The Company generated sales of over $43 million, up about 20% from 2003, on the
strength of sales from this acquisition and revenue growth in the Company’s traditional operating segments. Boss also improved its profitability
producing operating income for the year of $1,227,000, up $870,000 from 2003.
Due to the recent trend of improved earnings in the
Company’s traditional operating segments and projected earnings from the Galaxy acquisition, management concluded during the third quarter of 2004
that the Company should recognize a portion of the tax benefit associated with its net operating loss (“NOL”) carryforwards. Accordingly, the
Company recorded a non-cash tax benefit of $3,127,000. With improved operating income and the recognition of a significant tax benefit, the Company
recorded net earnings of $3,723,000 for 2004. Excluding the tax benefit of $3,127,000, net income after tax at a normal rate of 39% would total
approximately $600,000, or basic earnings per share of $0.31.
While the Galaxy acquisition accounted for one half
of sales growth in 2004, the Company continued its favorable sales trend from 2003 in other segments. During 2004, Boss revenues in the work gloves and
protective wear segment increased on the strength of positive initial year sales of the recently developed CAT® product line of gloves and
rainwear as well as expansion of its domestic industrial customer base. In an effort to enhance sales growth for 2005, the Company developed an
expanded line of sports and outdoor products for the work gloves and protective wear segment during 2004. In the pet supplies segment, the Company
continued to expand its customer base, resulting in favorable revenue growth for this segment.
Due to product cost increases on certain items,
particularly in the work gloves and protective wear segment, the Company increased selling prices on a selected basis during 2004. These selling price
increases favorably impacted sales. However, margins trended slightly lower in 2004 because of higher product costs. Management believes import costs
on many items in this segment will increase further during the coming year.
Operating expenses increased 9% during 2004 compared
to the prior year due primarily to the Galaxy acquisition. In addition, operating expenses increased in the Company’s other segments due in large
part to commissions and other expenses which fluctuate with sales.
Several factors significantly influenced the
Company’s liquidity during 2004. First, the net cash price paid for Galaxy totaled $3,418,000, with the Company financing $1,750,000 from its
primary lender under a new term loan. A second significant factor occurred in the fourth quarter when the Company sold its Springfield, Illinois
building for $1,850,000. The selling price net of expenses essentially equaled the carrying cost of this facility. The Springfield sale enabled the
Company to retire a $1,120,000 mortgage and reduce its revolving line of credit by approximately $600,000. Third, the Company significantly increased
inventory during the year, particularly in its work gloves and protective wear segment, in large part to support CAT® product sales. Primarily as
a result of these factors, the Company’s cash position declined by $3,423,000 and long-term debt, including the current portion, increased by
$837,000. Management believes the sales and profitability growth from its activities in 2004 will improve the Company’s future liquidity and
financial position.
In the year ahead, several key factors are likely to
affect the Company’s results. These factors include the impact of Galaxy operations on a full year basis, the cost of imported finished goods,
market acceptance of new CAT® products, customer retention and expansion efforts, particularly in the consumer market of the work gloves and
protective wear segment, and the upward trend in operating expenses. Each of these will be further discussed in the following sections. To summarize,
management anticipates sales growth for 2005 on full year sales from Galaxy, customer growth in the pet supplies segment and industrial market for work
gloves and protective wear and sales of outdoor and sporting gloves. However, margins are likely to be negatively impacted by higher import costs.
Further, management expects operating costs to increase due to the higher governance costs associated with public companies in the current environment
as well as sales related expenses such as commissions which should increase
7
with higher sales. Increased costs and lower margins may offset
a significant portion of the benefit from higher sales during 2005.
Critical Accounting Policies
The discussion and analysis of financial condition
and results of operations are based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting
principles generally accepted in the United States. Preparation of these financial statements requires management to make estimates and judgments that
affect the reported amount of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of
the financial statements. Actual results may differ from these estimates under different assumptions or conditions.
Significant accounting policies which management
believes are the most critical to aid in fully understanding and evaluating the Company’s reported financial results include the
following:
Revenue Recognition
The Company recognizes revenue from product sales at
the time of shipment and passage of title. Management records estimated reductions to revenue for customer programs and incentive offerings including
special pricing agreements, promotions and other volume-based incentives. Management periodically reviews the balance in the associated accrued
promotional liability in relation to amounts charged and the current accrual rate. In addition, the Company maintains a schedule of allowances earned
for all major customers to ensure accrued allowances are materially accurate.
Accounts Receivable
Management performs ongoing customer credit
evaluations and adjusts credit limits based upon payment history and the customer’s current credit worthiness, as determined by review of
available credit information. The Company’s estimate for its allowance for doubtful accounts related to trade receivables is based on two methods.
The amounts calculated from each of these methods are evaluated to determine the total amount reserved. First, the Company evaluates specific accounts
on which available information indicates that the customer may have an inability to meet its financial obligations. In these cases, based on the best
available facts and circumstances, the Company records a specific reserve for that customer against amounts due to reduce the receivable to the amount
that is expected to be collected. Second, a general reserve is established for all customers based on a range of percentages applied to aging
categories. The Company has consistently applied these percentages for a number of years and management believes the results adequately provide for
expected unrecoverable accounts. However, should circumstances change, for example an unexpected material adverse change in a major customer’s
ability to meet its financial obligation to the Company, management’s estimate of the recoverability of amounts due the Company could be reduced
by a material amount.
Inventories
Inventories are stated at the lower of cost or
market value. Cost is principally determined by the first-in, first-out method using a standard cost system. To facilitate up-to-date costing in the
current rapidly changing environment, standards are updated upon receipt of goods when the cost of the goods received represents a material change from
the current standard. Inventory gains and losses associated with these standard cost changes are amortized in an effort to match the impact of such
gains and losses with the associated impact on margin recorded in the statement of income. Management periodically reviews inventory quantities on hand
and records a provision for excess, slow-moving and obsolete inventory based primarily on forecasted product demand. As of December 25, 2004, the
inventory valuation allowance totaled approximately $799,000. Should forecasted product demand prove inaccurate, the Company may be unable to realize
the recorded value of certain products included in inventory.
8
Deferred Taxes
The Company recognizes deferred tax assets and
liabilities based on the differences between the financial statement carrying amounts and the tax bases of assets and liabilities. Because of
substantial losses in prior years, primarily during the years 1995 through 1997, the Company has available NOL carryforwards of approximately
$31,325,000 as of December 25, 2004.
Accounting principles generally accepted in the
United States require the recording of a valuation allowance against the net deferred tax asset associated with this NOL and other timing differences
if it is “more likely than not” that the Company will not be able to utilize the NOL to offset future taxes. Due to the size of the NOL
carryforward in relation to the Company’s taxable income and to potential uncertainties surrounding expected future earnings, management did not
recognize any of its net deferred tax asset prior to the third quarter of 2004.
Because of the Company’s recent profitability
trend from traditional operating segments and projected profitability from the Galaxy acquisition, management concluded during the third quarter of
2004 that the Company would likely utilize approximately 25% of its available NOL carryforwards. Accordingly, the Company reduced its valuation
allowance by $3,127,000 and recognized a commensurate tax benefit. In all subsequent periods, for book purposes the Company will record income tax
expense on earnings at normal rates, approximately 39% currently, and reduce the related deferred tax asset. The tax benefit and tax expenses recorded
for book purposes have no effect on the Company’s actual tax liability.
Subsequent revisions to the estimated net realizable
value of the deferred tax asset could cause the provision for income taxes to vary significantly from