Attached files
file | filename |
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EXCEL - IDEA: XBRL DOCUMENT - KID BRANDS, INC | Financial_Report.xls |
EX-32.1 - EXHIBIT 32.1 - KID BRANDS, INC | c24327exv32w1.htm |
EX-31.1 - EXHIBIT 31.1 - KID BRANDS, INC | c24327exv31w1.htm |
EX-31.2 - EXHIBIT 31.2 - KID BRANDS, INC | c24327exv31w2.htm |
EX-32.2 - EXHIBIT 32.2 - KID BRANDS, INC | c24327exv32w2.htm |
EX-10.50 - EXHIBIT 10.50 - KID BRANDS, INC | c24327exv10w50.htm |
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2011
OR
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number: 1-8681
KID BRANDS, INC.
(Exact name of registrant as specified in its charter)
New Jersey | 22-1815337 | |
(State of or other jurisdiction of | (I.R.S. Employer Identification Number) | |
incorporation or organization) | ||
One Meadowlands Plaza, 8th Floor, East Rutherford, New Jersey | 07073 | |
(Address of principal executive offices) | (Zip Code) |
(201) 405-2400
(Registrants Telephone Number, including area code)
(Registrants Telephone Number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
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 þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period
that the registrant was required to submit and post such files). Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated
filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
(Check one):
Large accelerated filer o | Accelerated filer þ | Non-accelerated filer o | Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act). Yes o No þ
The number of shares outstanding of each of the registrants classes of common stock, as of
November 7, 2011 was as follows:
CLASS | SHARES OUTSTANDING | |
Common Stock, $0.10 stated value | 21,655,862 |
KID BRANDS, INC.
INDEX
2
Table of Contents
PART 1 FINANCIAL INFORMATION
ITEM 1. | FINANCIAL STATEMENTS |
KID BRANDS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share and Per Share Data)
(UNAUDITED)
(In Thousands, Except Share and Per Share Data)
(UNAUDITED)
September 30, 2011 | December 31, 2010 | |||||||
Assets |
||||||||
Current assets: |
||||||||
Cash and cash equivalents |
$ | 1,811 | $ | 1,075 | ||||
Accounts receivable- trade, less allowances of $5,869 in 2011 and $6,934 in 2010 |
49,187 | 55,270 | ||||||
Inventories, net |
47,420 | 48,564 | ||||||
Prepaid expenses and other current assets |
2,287 | 3,843 | ||||||
Income tax receivable |
948 | 307 | ||||||
Deferred income taxes, net |
7,002 | 6,372 | ||||||
Total current assets |
108,655 | 115,431 | ||||||
Property, plant and equipment, net |
5,130 | 5,030 | ||||||
Intangible assets |
75,087 | 77,154 | ||||||
Note receivable, net of allowance of $14,955 in 2011 and $16,648 in 2010 |
| | ||||||
Deferred income taxes, net |
36,768 | 41,626 | ||||||
Other assets |
2,994 | 3,255 | ||||||
Total assets |
$ | 228,634 | $ | 242,496 | ||||
Liabilities and Shareholders Equity |
||||||||
Current liabilities: |
||||||||
Current portion of long-term debt |
$ | | $ | 13,526 | ||||
Short-term debt |
| 18,595 | ||||||
Accounts payable |
15,615 | 22,940 | ||||||
Accrued expenses |
19,951 | 16,954 | ||||||
Income taxes payable |
707 | 207 | ||||||
Total current liabilities |
36,273 | 72,222 | ||||||
Income taxes payable non-current |
37 | 37 | ||||||
Deferred income taxes |
320 | 332 | ||||||
Long-term debt |
65,265 | 41,000 | ||||||
Other long-term liabilities |
1,161 | 923 | ||||||
Total liabilities |
103,056 | 114,514 | ||||||
Commitments and contingencies |
||||||||
Shareholders equity: |
||||||||
Common stock: $0.10 stated value; authorized 50,000,000 shares; issued
26,727,780 shares at September 30, 2011 and December 31, 2010 |
2,674 | 2,674 | ||||||
Additional paid-in capital |
90,796 | 90,645 | ||||||
Retained earnings |
130,794 | 135,049 | ||||||
Accumulated other comprehensive income |
488 | 503 | ||||||
Treasury stock, at cost 5,074,578 and 5,162,354 shares at September 30, 2011
and December 31, 2010, respectively |
(99,174 | ) | (100,889 | ) | ||||
Total shareholders equity |
125,578 | 127,982 | ||||||
Total liabilities and shareholders equity |
$ | 228,634 | $ | 242,496 | ||||
The accompanying notes are an integral part of these unaudited consolidated financial statements.
3
Table of Contents
KID BRANDS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Share and Per Share Data)
(UNAUDITED)
(In Thousands, Except Share and Per Share Data)
(UNAUDITED)
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Net sales |
$ | 69,475 | $ | 71,128 | $ | 189,603 | $ | 200,523 | ||||||||
Cost of sales |
50,914 | 50,490 | 140,438 | 140,511 | ||||||||||||
Gross profit |
18,561 | 20,638 | 49,165 | 60,012 | ||||||||||||
Selling, general and administrative expenses |
16,305 | 13,710 | 46,463 | 38,533 | ||||||||||||
TRC valuation reserve |
| | (2,000 | ) | | |||||||||||
Income from operations |
2,256 | 6,928 | 4,702 | 21,479 | ||||||||||||
Other (expense) income: |
||||||||||||||||
Interest expense, including amortization
and write-off of deferred financing
costs |
(1,914 | ) | (887 | ) | (4,210 | ) | (2,951 | ) | ||||||||
Interest and investment income |
4 | 3 | 11 | 10 | ||||||||||||
Other, net |
(180 | ) | 105 | (84 | ) | 370 | ||||||||||
(2,090 | ) | (779 | ) | (4,283 | ) | (2,571 | ) | |||||||||
Income before income tax provision |
166 | 6,149 | 419 | 18,908 | ||||||||||||
Income tax provision |
246 | 2,189 | 4,674 | 7,004 | ||||||||||||
Net (loss) income |
$ | (80 | ) | $ | 3,960 | $ | (4,255 | ) | $ | 11,904 | ||||||
Net (loss) income per share: |
||||||||||||||||
Basic |
$ | (0.00 | ) | $ | 0.18 | $ | (0.20 | ) | $ | 0.55 | ||||||
Diluted |
$ | (0.00 | ) | $ | 0.18 | $ | (0.20 | ) | $ | 0.54 | ||||||
Weighted average shares: |
||||||||||||||||
Basic |
21,653,000 | 21,546,000 | 21,646,000 | 21,545,000 | ||||||||||||
Diluted |
21,653,000 | 21,999,000 | 21,646,000 | 21,951,000 | ||||||||||||
The accompanying notes are an integral part of these unaudited consolidated financial statements.
4
Table of Contents
KID BRANDS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(UNAUDITED)
(In Thousands)
(UNAUDITED)
Nine Months Ended September 30, | ||||||||
2011 | 2010 | |||||||
Cash flows from operating activities: |
||||||||
Net (loss) income |
$ | (4,255 | ) | $ | 11,904 | |||
Adjustments to reconcile net (loss) income to net cash provided by operating activities: |
||||||||
Depreciation and amortization |
2,986 | 2,704 | ||||||
Amortization and write-off of deferred financing costs |
1,610 | 693 | ||||||
Provision for customer allowances |
22,876 | 28,086 | ||||||
Provision for inventory reserve |
1,559 | 129 | ||||||
Share-based compensation expense |
1,757 | 1,668 | ||||||
TRC valuation reserve |
(2,000 | ) | | |||||
Deferred income taxes |
4,216 | 9,868 | ||||||
Change in assets and liabilities: |
||||||||
Accounts receivable |
(16,843 | ) | (32,751 | ) | ||||
Income tax receivable |
(641 | ) | (170 | ) | ||||
Inventories |
(498 | ) | (11,215 | ) | ||||
Prepaid expenses and other current assets |
1,230 | (111 | ) | |||||
Other assets |
453 | (53 | ) | |||||
Accounts payable |
(7,300 | ) | 3,784 | |||||
Accrued expenses |
5,470 | 996 | ||||||
Income taxes payable |
500 | (4,339 | ) | |||||
Net cash provided by operating activities |
11,120 | 11,193 | ||||||
Cash flows from investing activities: |
||||||||
Capital expenditures |
(1,019 | ) | (1,088 | ) | ||||
Net cash used in investing activities |
(1,019 | ) | (1,088 | ) | ||||
Cash flows from financing activities: |
||||||||
Proceeds from issuance of common stock |
243 | 229 | ||||||
Excess tax benefit from stock-based compensation |
(135 | ) | 2 | |||||
Payment of financing fees |
(1,680 | ) | | |||||
Net borrowing (payment) of long-term debt |
10,739 | (10,256 | ) | |||||
Net (payment) borrowing on short-term revolving credit facility |
(18,595 | ) | (130 | ) | ||||
Net cash used in financing activities |
(9,428 | ) | (10,155 | ) | ||||
Effect of exchange rate changes on cash and cash equivalents |
63 | (137 | ) | |||||
Net increase (decrease) in cash and cash equivalents |
736 | (187 | ) | |||||
Cash and cash equivalents at beginning of period |
1,075 | 1,593 | ||||||
Cash and cash equivalents at end of period |
$ | 1,811 | $ | 1,406 | ||||
Cash paid during the period for: |
||||||||
Interest |
$ | 2,021 | $ | 2,936 | ||||
Income taxes |
$ | 649 | $ | 1,862 |
The accompanying notes are an integral part of these unaudited consolidated financial statements.
5
Table of Contents
KID BRANDS, INC AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 INTERIM CONSOLIDATED FINANCIAL STATEMENTS
Kid Brands, Inc. (KID), together with its subsidiaries (collectively with KID, the
Company), is a leading designer, importer, marketer and distributor of infant and juvenile
consumer products. The Company operates in one segment: the infant and juvenile business.
The Companys operations, which currently consist of Kids Line, LLC (Kids Line), Sassy, Inc.
(Sassy), LaJobi, Inc. (LaJobi) and CoCaLo, Inc. (CoCaLo), each direct or indirect
wholly-owned subsidiaries of KID, design, manufacture through third parties and market products in
a number of categories including, among others; infant bedding and related nursery accessories and
décor, food preparation and nursery appliances and products, diaper bags, and bath/spa products
(Kids Line® and CoCaLo®); nursery furniture and related products (LaJobi®); and developmental toys
and feeding, bath and baby care items with features that address the various stages of an infants
early years (Sassy®). In addition to branded products, the Company also markets certain categories
under various licenses, including Carters®, Disney®, Graco® and Serta®. The Companys products are
sold primarily to retailers in North America, the United Kingdom and Australia, including large,
national retail accounts and independent retailers (including toy, specialty, food, drug, apparel
and other retailers).
The accompanying unaudited interim consolidated financial statements have been prepared by the
Company in accordance with accounting principles generally accepted in the United States of America
for interim financial reporting and the instructions to the Quarterly Report on Form 10-Q and Rule
10-01 of Regulation S-X. Accordingly, certain information and footnote disclosures normally
included in financial statements prepared under generally accepted accounting principles have been
condensed or omitted pursuant to such principles and regulations. The information furnished
reflects all adjustments, which are, in the opinion of management, of a normal recurring nature and
necessary for a fair presentation of the Companys consolidated financial position, results of
operations and cash flows for the interim periods presented. Results for interim periods are not
necessarily an indication of results to be expected for the year. This Quarterly Report on Form
10-Q should be read in conjunction with the Companys Quarterly Report on Form 10-Q for the quarter
ended March 31, 2011(the Q1 10-Q) and the Companys Quarterly Report on Form 10-Q for the quarter
ended June 30, 2011, as amended (the Q2 10-Q), and the Companys Annual Report on Form 10-K for
the year ended December 31, 2010, as amended (the 2010 10-K).
The Company evaluates all subsequent events prior to filing.
NOTE 2 SHAREHOLDERS EQUITY
Share-Based Compensation
As of September 30, 2011, the Company maintained (i) its Equity Incentive Plan (the EI
Plan), which is a successor to the Companys 2004 Stock Option, Restricted and Non-Restricted
Stock Plan (the 2004 Option Plan, and together with the EI Plan, the Plans) and (ii) the 2009
Employee Stock Purchase Plan (the 2009 ESPP), which was a successor to the Companys Amended and
Restated 2004 Employee Stock Purchase Plan (the 2004 ESPP). The EI Plan and the 2009 ESPP were
each approved by the Companys shareholders on July 10, 2008. In addition, the Company may issue
equity awards outside of the Plans. As of September 30, 2011, there were 20,000 stock options
outstanding that were granted outside the Plans which if unexercised will expire on December 9,
2011. The exercise or measurement price for equity awards issued under the Plans or otherwise is
generally equal to the closing price of KIDs common stock on the New York Stock Exchange as of the
date the award is granted. Generally, equity awards under the Plans (or otherwise) vest over a
period ranging from three to five years from the grant date as provided in the award agreement
governing the specific grant. Options and stock appreciation rights generally expire 10 years from
the date of grant. Shares in respect of equity awards are issued from authorized shares reserved
for such issuance or treasury shares.
The EI Plan, which became effective July 10, 2008 (at which time no further awards could be
made under the 2004 Option Plan), provides for awards in any one or a combination of: (a) Stock
Options, (b) Stock Appreciation Rights, (c) Restricted Stock, (d) Stock Units, (e) Non-Restricted
Stock, and/or (f) Dividend Equivalent Rights. Any award under the EI Plan may, as determined by the
committee administering the EI Plan (the Plan Committee) in its sole discretion, constitute a
Performance-Based Award (an award that qualifies for the performance-based compensation exemption
of Section 162(m) of the Internal Revenue Code of 1986, as amended). All awards granted under the
EI Plan are evidenced by a written agreement between the Company and each participant (which need
not be identical with respect to each grant or participant) that provides the terms and conditions,
not inconsistent with the requirements of the EI Plan, associated with such awards, as determined
by the Plan Committee in its sole discretion. A total of 1,500,000 shares of Common Stock have been
reserved for issuance under the EI Plan. In the event all or a portion of an award is forfeited,
terminated or cancelled, expires, is settled for cash, or otherwise does not result in the issuance
of all or a portion of the shares of Common Stock subject to the award in connection with the
exercise or settlement of such award (Unissued Shares), such Unissued Shares will in each case
again be available for awards under the EI Plan pursuant to a formula set forth in the EI Plan. The
preceding sentence applies to any awards outstanding on July 10, 2008 under the 2004 Option
Plan, up to a maximum of an additional 1,750,000 shares of Common Stock. At September 30, 2011,
1,102,559 shares were available for issuance under the EI Plan.
6
Table of Contents
KID BRANDS, INC AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The 2009 ESPP became effective on January 1, 2009. A total of 200,000 shares of Common Stock
have been reserved for issuance under the 2009 ESPP. At September 30, 2011, 60,947 shares were
available for issuance under the 2009 ESPP.
Impact on Net (Loss)/Income
The components of share-based compensation expense follows (in thousands):
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Stock option expense |
$ | 459 | $ | 425 | $ | 712 | $ | 743 | ||||||||
Restricted stock expense |
172 | 134 | 340 | 333 | ||||||||||||
Restricted stock unit expense |
35 | 53 | 142 | 120 | ||||||||||||
SAR expense |
127 | 172 | 461 | 373 | ||||||||||||
2009 ESPP expense |
34 | 33 | 102 | 99 | ||||||||||||
Total share-based payment expense |
$ | 827 | $ | 817 | $ | 1,757 | $ | 1,668 | ||||||||
The Company records share-based compensation expense in the statements of operations within
the same categories that payroll expense is recorded in selling general and administrative expense.
No share-based compensation expense was capitalized in inventory or any other assets for the three
and nine months ended September 30, 2011 or 2010. The relevant Financial Accounting Standards Board
(FASB) standard requires the cash flows related to tax benefits resulting from tax deductions in
excess of compensation costs recognized for those equity compensation grants (excess tax benefits)
to be classified as financing cash flows.
The fair value of stock options and stock appreciation rights (SARs) granted under the Plans
or otherwise is estimated on the date of grant using a Black-Scholes-Merton options pricing model
using assumptions with respect to dividend yield, risk-free interest rate, volatility and expected
term, which are included below for SARs only, as there were no stock options issued during the
three and nine months ended September 30, 2011 or 2010. Expected volatilities are calculated based
on the historical volatility of KIDs Common Stock. The expected term of options or SARs granted is
derived from the vesting period of the award, as well as historical exercise behavior, and
represents the period of time that the award is expected to be outstanding. Management monitors
exercises and employee termination patterns to estimate forfeiture rates within the valuation
model. Separate groups of employees, directors and officers that have similar historical exercise
behavior are considered separately for valuation purposes. The risk-free interest rate is based on
the Treasury note interest rate in effect on the date of grant for the expected term of the award.
Stock Options
Stock options are rights to purchase KIDs Common Stock in the future at a predetermined per
share exercise price (generally the closing price for such stock on the New York Stock Exchange on
the date of grant). Stock options may be either: Incentive Stock Options (stock options which
comply with Section 422 of the Code), or Nonqualified Stock Options (stock options which are not
Incentive Stock Options).
As of September 30, 2011, the total remaining unrecognized compensation cost related to
unvested stock options, net of forfeitures, was approximately $0.6 million, and is expected to be
recognized over a weighted-average period of 1.9 years.
Activity regarding outstanding stock options for the nine months ended September 30, 2011 is
as follows:
All Stock Options Outstanding | ||||||||
Weighted Average | ||||||||
Shares | Exercise Price | |||||||
Options Outstanding as of December 31, 2010 |
704,175 | $ | 13.53 | |||||
Options Granted |
| $ | | |||||
Options Forfeited/Cancelled* |
(37,200 | ) | $ | 13.65 | ||||
Options Outstanding as of September 30, 2011 |
666,975 | $ | 13.52 | |||||
Option price range at September 30, 2011 |
$ | 6.63-$34.05 |
* | See disclosure below regarding forfeitures. |
7
Table of Contents
KID BRANDS, INC AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The aggregate intrinsic value of the unvested and vested outstanding stock options was $0 and
$239,250 at September 30, 2011 and December 31, 2010, respectively. The aggregate intrinsic value
is the total pretax value of in-the-money stock options, which is the difference between the fair
value at the measurement date and the exercise price of each stock option. No stock options were
exercised during the three and nine months ended September 30, 2011 or 2010, respectively. 112,000
stock options vested during the three and nine months ended September 30, 2011.
A summary of the Companys unvested stock options at September 30, 2011 and changes during the
nine months ended September 30, 2011 is as follows:
Weighted Average | ||||||||
Grant | ||||||||
Unvested stock options | Options | Date Fair Value | ||||||
Unvested at December 31, 2010 |
278,200 | $ | 5.22 | |||||
Granted |
| $ | | |||||
Vested |
(112,000 | ) | $ | 5.36 | ||||
Forfeited/cancelled* |
(16,800 | ) | $ | 5.21 | ||||
Unvested stock options at September 30, 2011 |
149,400 | $ | 5.12 | |||||
* | See disclosure below regarding forfeitures. |
Restricted Stock
Restricted Stock is Common Stock that is subject to restrictions, including risks of
forfeiture, determined by the Plan Committee in its sole discretion, for so long as such Common
Stock remains subject to any such restrictions. A holder of restricted stock has all rights of a
shareholder with respect to such stock, including the right to vote and to receive dividends
thereon, except as otherwise provided in the award agreement relating to such award. Restricted
Stock Awards are equity classified within the consolidated balance sheets. The fair value of each
restricted stock grant is estimated on the date of grant using the closing price of KIDs Common
Stock on the New York Stock Exchange on the date of grant.
During the three and nine months ended September 30, 2011 and 2010, respectively, there were
no shares of restricted stock issued under the EI Plan or otherwise. At September 30, 2011 and
December 31, 2010, there were 4,940 and 29,270 shares of unvested restricted stock outstanding,
respectively. These restricted stock grants have vesting periods ranging from four to five years,
with fair values (per share) at date of grant ranging from $13.65 to $16.77. Compensation expense
is determined for the issuance of restricted stock by amortizing over the requisite service period,
or the vesting period, the aggregate fair value of the restricted stock awarded based on the
closing price of KIDs Common Stock effective on the date the award is made. 21,750 shares of
restricted stock vested during the three and nine months ended September 30, 2011.
A summary of the Companys unvested restricted stock at September 30, 2011 and changes during
the nine months ended September 30, 2011 is as follows:
Weighted Average | ||||||||
Grant | ||||||||
Unvested Restricted Stock | Restricted Stock | Date Fair Value | ||||||
Unvested at December 31, 2010 |
29,270 | $ | 15.91 | |||||
Granted |
| $ | | |||||
Vested |
(21,750 | ) | $ | 16.02 | ||||
Forfeited/cancelled* |
(2,580 | ) | $ | 13.65 | ||||
Unvested restricted stock at September 30, 2011 |
4,940 | $ | 16.58 | |||||
* | See disclosure below regarding forfeitures. |
As of September 30, 2011, the total remaining unrecognized compensation cost related to
issuances of restricted stock was approximately $0.1 million, and is expected to be recognized over
a weighted-average period of 1.2 years.
Restricted Stock Units
A Restricted Stock Unit (RSU) is a notional account representing a participants conditional
right to receive at a future date one (1) share of Common Stock or its equivalent in value. Shares
of Common Stock issued in settlement of an RSU may be issued with or without other consideration as
determined by the Plan Committee in its sole discretion. RSUs may be settled in the sole discretion
of the Plan Committee: (i) by the distribution of shares of Common Stock equal to the grantees
RSUs, (ii) by a lump sum payment of an amount in cash equal to the fair value of the shares of
Common Stock which would otherwise be distributed to the
grantee, or (iii) by a combination of cash and Common Stock. The RSUs issued under the EI Plan
vest (and will be settled) ratably over a 5-year period commencing from the date of grant and are
equity classified in the consolidated balance sheets. There were 34,000 and 54,000 RSUs issued to
employees of the Company during the three and nine months ended September 30, 2011, respectively.
There were 8,500 and 157,750 RSUs issued to employees of the Company during the three and nine
months ended September 30, 2010, respectively.
8
Table of Contents
KID BRANDS, INC AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The fair value of each RSU grant is estimated on the grant date. The fair value is set using
the closing price of KIDs Common Stock on the New York Stock Exchange on the date of grant.
Compensation expense for RSUs is recognized ratably over the vesting period, based upon the market
price of the shares underlying the awards on the date of grant.
A summary of the Companys unvested RSUs at September 30, 2011 and changes during the nine
months ended September 30, 2011 is as follows:
Weighted | ||||||||
Restricted | Average | |||||||
Stock | Grant-Date | |||||||
Units | Fair Value | |||||||
Unvested at December 31, 2010 |
174,730 | $ | 5.22 | |||||
Granted |
54,000 | $ | 5.80 | |||||
Vested |
(29,350 | ) | $ | 5.22 | ||||
Forfeited/cancelled* |
(42,200 | ) | $ | 5.03 | ||||
Unvested at September 30, 2011 |
157,180 | $ | 5.46 | |||||
* | See disclosure below regarding forfeitures. |
As of September 30, 2011, there was approximately $0.8 million of unrecognized compensation
cost related to unvested RSUs. That cost is expected to be recognized over a weighted-average
period of 3.6 years.
Stock Appreciation Rights
A Stock Appreciation Right (a SAR) is a right to receive a payment in cash, Common Stock or
a combination thereof, as determined by the Plan Committee, in an amount or value equal to the
excess of: (i) the fair value, or other specified valuation (which may not exceed fair value), of a
specified number of shares of Common Stock on the date the right is exercised, over (ii) the fair
value or other specified amount (which may not be less than fair value) of such shares of Common
Stock on the date the right is granted; provided, however, that if a SAR is granted in tandem with
or in substitution for a stock option, the designated fair value for purposes of the foregoing
clause (ii) will be the fair value on the date such stock option was granted. No SARs will be
exercisable later than ten (10) years after the date of grant. The SARs issued under the EI Plan
vest ratably over a period ranging from zero to five years and unless terminated earlier, expire on
the tenth anniversary of the date of grant. SARs are typically granted at an exercise price equal
to the closing price of KIDs Common Stock on the New York Stock Exchange on the date of grant.
There were 97,500 and 182,500 SARs granted during the three and nine months ended September 30,
2011, respectively. There were 107,000 and 536,250 SARs granted during the three and nine months
ended September 30, 2010. SARs are accounted for at fair value at the date of grant in the
consolidated statement of operations, are amortized on a straight line basis over the vesting term,
and are equity-classified in the consolidated balance sheets.
The assumptions used to estimate the weighted average fair value of the SARs granted during
the nine months ended September 30, 2011 and 2010 were as follows:
Nine Months Ended September 30, | ||||||||
2011 | 2010 | |||||||
Dividend yield |
0.0 | % | 0.0 | % | ||||
Risk-free interest rate |
1.39 | % | 2.24 | % | ||||
Volatility |
89.5 | % | 83.2 | % | ||||
Expected term (years) |
4.5 | 5.0 | ||||||
Weighted-average fair value of SARs granted |
$ | 3.98 | $ | 3.78 |
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KID BRANDS, INC AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Activity regarding outstanding SARs for the nine months ended September 30, 2011 is as
follows:
All SARs Outstanding | ||||||||
Weighted Average | ||||||||
Shares | Exercise Price | |||||||
SARs Outstanding as of December 31, 2010 |
1,111,513 | $ | 4.17 | |||||
SARs Granted |
182,500 | $ | 6.08 | |||||
SARs Exercised |
(1,100 | ) | $ | 5.54 | ||||
SARs Forfeited/Cancelled* |
(306,000 | ) | $ | 3.04 | ||||
SARs Outstanding as of September 30, 2011 |
986,913 | $ | 4.87 | |||||
SAR price range at September 30, 2011 |
$ | 1.36-9.86 | ||||||
* | See disclosure below regarding forfeitures. |
The aggregate intrinsic value of the unvested and vested outstanding SARs at September 30,
2011 and December 31, 2010 was $0.3 million and $4.9 million, respectively. The aggregate intrinsic
value is the total pretax value of in-the-money SARs, which is the difference between the fair
value at the measurement date and the exercise price of each SAR. There were 1,100 (all of which
were settled in cash) and 5,180 (all of which were settled in stock) SARs exercised for the nine
months ended September 30, 2011 and 2010, respectively.
A summary of the Companys unvested SARs at September 30, 2011 and changes during the nine
months ended September 30, 2011 is as follows:
Weighted-Average Grant | ||||||||
Shares | Date Fair Value Per Share | |||||||
Unvested at December 31, 2010 |
888,830 | $ | 2.90 | |||||
Granted |
182,500 | $ | 3.98 | |||||
Vested |
(155,150 | ) | $ | 2.78 | ||||
Forfeited* |
(256,600 | ) | $ | 2.06 | ||||
Unvested at September 30, 2011 |
659,580 | $ | 3.55 | |||||
* | See disclosure below regarding forfeitures. |
As of September 30, 2011, there was approximately $2.0 million of unrecognized compensation
cost related to unvested SARs, which is expected to be recognized over a weighted-average period of
3.4 years.
Option/SAR Forfeitures
All of the forfeited options/SARs described in the charts set forth above resulted from the
termination of the employment of the respective grantees and the resulting forfeiture of unvested
and/or vested but unexercised options/SARs. Pursuant to the Plans (unless a relevant award or other
agreement provides otherwise), upon the termination of employment of a grantee, such grantees
outstanding unexercised options/SARs are typically cancelled and deemed terminated as of the date
of termination; provided, that if the termination is not for cause, all vested options/SARs
generally remain outstanding for a period ranging from 30 to 90 days, and then expire to the extent
not exercised.
Restricted Stock/RSU Forfeitures
All of the forfeited Restricted Stock and RSUs described in the charts set forth above
resulted from the termination of the employment of the respective grantees and the resulting
forfeiture of unvested Restricted Stock and RSUs. Pursuant to the award agreements governing the
outstanding Restricted Stock and RSUs, upon a grantees termination of employment, such grantees
outstanding unvested Restricted Stock and RSUs are forfeited, except in the event of disability or
death (or as may otherwise be provided by agreement), in which case all restrictions lapse.
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KID BRANDS, INC AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Employee Stock Purchase Plan
Under the 2009 ESPP, eligible employees are provided the opportunity to purchase KIDs Common
Stock at a discount. Pursuant to the 2009 ESPP, options are granted to participants as of the first
trading day of each plan year, which is the calendar year,
and may be exercised as of the last trading day of each plan year, to purchase from KID the
number of shares of Common Stock that may be purchased at the relevant purchase price with the
aggregate amount contributed by each participant. In each plan year, an eligible employee may elect
to participate in the 2009 ESPP by filing a payroll deduction authorization form for up to 10% (in
whole percentages) of his or her compensation. No employee shall have the right to purchase KIDs
Common Stock under the 2009 ESPP that has a fair value in excess of $25,000 in any plan year or the
right to purchase more than 25,000 shares in any plan year. The purchase price is the lesser of 85%
of the closing market price of KIDs Common Stock on either the first trading day or the last
trading day of the plan year. If an employee does not elect to exercise his or her option, the
total amount credited to his or her account during that plan year is returned to such employee
without interest, and his or her option expires. At September 30, 2011, 60,947 shares were
available for issuance under the 2009 ESPP. At September 30, 2011, there were 108 enrolled
participants in the 2009 ESPP.
The fair value of each option granted under the 2009 ESPP is estimated on the date of grant
using the Black-Scholes-Merton option-pricing model with the following assumptions:
Nine Months Ended September 30, | ||||||||
2011 | 2010 | |||||||
Dividend yield |
0 | % | 0 | % | ||||
Risk-free interest rate |
0.29 | % | 0.45 | % | ||||
Volatility |
73.5 | % | 89.2 | % | ||||
Expected term (years) |
1.0 | 1.0 |
Expected volatilities are calculated based on the historical volatility of KIDs Common Stock.
The risk-free interest rate is based on the U.S. Treasury yield with a term that is consistent with
the expected life of the options. The expected life of options granted under the 2009 ESPP is one
year, or the equivalent of the annual plan year.
NOTE 3 WEIGHTED AVERAGE COMMON SHARES
Earnings per share (EPS) under the two-class method is computed by dividing earnings
allocated to common stockholders by the weighted-average number of common shares outstanding for
the period. In determining EPS, earnings are allocated to both common shares and participating
securities based on the respective number of weighted-average shares outstanding for the period.
Participating securities include unvested restricted stock awards where, like the Companys
restricted stock awards, such awards carry a right to receive non-forfeitable dividends, if
declared. As a result of the foregoing, and in accordance with the applicable accounting standard,
vested and unvested shares of restricted stock are also included in the calculation of basic
earnings per share. With respect to RSUs, as the right to receive dividends or dividend
equivalents is contingent upon vesting, in accordance with the applicable accounting standard, the
Company does not include unvested RSUs in the calculation of basic earnings per share. To the
extent such RSUs are settled in stock, upon settlement, such stock is included in the calculation
of basic earnings per share. With respect to SARs and stock options, as the right to receive
dividends or dividend equivalents is contingent upon vesting and exercise (with respect to SARs, to
the extent they are settled in stock), in accordance with the applicable accounting standard, the
Company does not include unexercised SARs or stock options in the calculation of basic earnings per
share. To the extent such SARs and stock options have vested and are exercised (with respect to
SARs, to the extent they are settled in stock), the stock received upon such exercise is included
in the calculation of basic earnings per share.
The weighted average common shares outstanding included in the computation of basic and
diluted net (loss)/income per share is set forth below (in thousands):
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Weighted average common shares outstanding-Basic |
21,653 | 21,546 | 21,646 | 21,545 | ||||||||||||
Dilutive effect of common shares issuable upon
exercise of stock options, RSUs and SARs |
| 453 | | 406 | ||||||||||||
Weighted average common shares outstanding assuming
dilution |
21,653 | 21,999 | 21,646 | 21,951 | ||||||||||||
The computation of diluted net (loss) per common share for the three and nine months ended
September 30, 2011 did not include stock options and stock appreciation rights to purchase an
aggregate of approximately 1.8 million shares of common stock, respectively, because their
inclusion would have been anti-dilutive due to the loss incurred during each such period. The
computation of diluted net income per common share for the three and nine months ended September
30, 2010 did not include stock options and
stock appreciation rights to purchase an aggregate of approximately 0.5 million shares of
common stock, respectively because their inclusion would have been anti-dilutive as their exercise
price exceeded the average market price of the common stock during each such period.
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KID BRANDS, INC AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4 DEBT
Credit Agreement
As of August 8, 2011, KID and specified domestic subsidiaries (such entities collectively with
KID and such other future created or acquired domestic subsidiaries that are designated as
borrowers from time to time, the Borrowers), and the subsidiaries of the Borrowers identified as
guarantors therein (the Guarantors, and together with the Borrowers, the Loan Parties),
executed a Second Amended and Restated Credit Agreement (the New Credit Agreement) with certain
financial institutions (the Lenders), including Bank of America, N.A., as Administrative Agent,
Swing Line Lender and L/C Issuer, and Merrill Lynch, Pierce, Fenner & Smith Incorporated as Sole
Lead Arranger and Book Manager (ML). RB Trademark Holdco, LLC (Licensor), a limited liability
company wholly-owned by KID which licensed specified intellectual property to the buyer of the
Companys former gift business prior to its bankruptcy, will become a Loan Party when permitted
under its organizational documents (upon termination of the relevant license agreement). The
obligations of the Borrowers under the New Credit Agreement are joint and several.
The New Credit Agreement provides for an aggregate $175.0 million revolving credit facility
(the New Revolver), with a sub-facility for letters of credit in an amount not to exceed $25.0
million, and a sub-facility for swing-line loans in an amount not to exceed $5.0 million. Subject
to conditions to lending set forth in the New Credit Agreement, loans may be made up to the full
amount of the New Revolver (without borrowing base limitations), swing-line loans may be made up to
the full amount of the sublimit for swing-line loans, and letters of credit may be issued up to the
sublimit for letters of credit. KID also has the right (without the consent of any Lender or the
Administrative Agent) to increase the amount of the New Revolver by an additional aggregate amount
not to exceed $35.0 million, provided, among other things, that (i) no event of default or
unmatured event of default shall have occurred and be continuing, and (ii) the Borrowers receive
commitments for such increase. KID may offer such increase to existing Lenders or certain third
party financial institutions as described in the New Credit Agreement, however, no lender is
obligated to increase its commitment.
The New Credit Agreement amended and restated the Borrowers previously existing Amended and
Restated Credit Agreement with the Administrative Agent, as successor by merger to LaSalle Bank
National Association, and the other lenders party thereto, dated April 2, 2008, as amended on each
of August 13, 2008, March 20, 2009, and March 30, 2011 (collectively, the Old Credit Agreement),
which provided for a $50.0 million revolving credit facility (the Old Revolver) based on eligible
receivables and inventory, with a $5.0 million sub-facility for letters of credit, and an $80.0
million term loan facility (the Old Term Loan), which was scheduled to mature on April 1, 2013.
The New Credit Agreement represents a refinancing of the Borrowers senior secured debt under the
Old Credit Agreement. Additional details with respect to the Old Credit Agreement can be found in
Note 4 of the Notes to Unaudited Consolidated Financial Statements of the Q2 10-Q.
Upon the execution of the New Credit Agreement, the Borrowers drew down $47.5 million under
the New Revolver, and utilized the proceeds to repay the Old Term Loan in full. Outstanding
amounts under the Old Revolver (in the approximate amount of an additional $29.4 million) were
reallocated among the continuing Lenders in accordance with their respective commitments under the
New Credit Agreement. Outstanding letters of credit were deemed to have been issued under the New
Credit Agreement.
At September 30, 2011, an aggregate of $65.3 million was borrowed under the New Revolver and
at December 31, 2010, an aggregate of $72.6 million was borrowed under the Old Credit Agreement
(consisting of $54.0 million of long-term debt outstanding under the Old Term Loan and $18.6
million of short-term debt outstanding under the Old Revolver). All amounts outstanding under the
New Credit Agreement at September 30, 2011 are classified as long-term debt as permitted by
applicable accounting standards. At September 30, 2011, revolving loan availability was $12.6
million. At December 31, 2010, revolving loan availability was $28.3 million.
The aggregate amounts outstanding under the New Credit Agreement (other than letters of
credit, which may generally remain outstanding until August 1, 2017) are due and payable on August
8, 2016 (subject to customary early termination provisions).
The New Revolver bears interest, at the Borrowers option, at a specified base rate (the
higher of (x) the Administrative Agents prime rate and (y) the Federal Funds rate plus
0.50%), or a specified Eurodollar rate based on specified British Bankers Association LIBOR, plus
(in each case) applicable margins. Applicable margins range from 1.75% to 2.75% on Eurodollar rate
loans and 0.75% to 1.75% on base rate loans, based on the Companys Consolidated Leverage Ratio (as
defined below) for the most recently ended fiscal quarter. At least until receipt by the
Administrative Agent and the Lenders of the financial statements and
compliance certificates with respect to the quarter ending September 30, 2011, the applicable
margins will be 2.75% for Eurodollar loans and 1.75% for base rate loans. Swing-line loans bear
interest at the base rate plus the applicable margin for base rate loans. Applicable margins under
the Old Credit Agreement ranged from 2.0% to 4.25% for LIBOR loans and from 1.0% to 3.25% for Base
Rate loans, each as defined in the Old Credit Agreement (and base rate borrowings included a floor
of 30 day LIBOR plus 1%). During the continuance of any default under the New Credit Agreement,
the applicable margin shall increase by 2% (subject, in all cases other than a default in the
payment of principal, to the written consent of Lenders holding a majority of the commitments (the
Required Lenders) and prior written notice to KID).
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KID BRANDS, INC AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
As of September 30, 2011, the applicable interest rate margins were: 2.75% for Eurodollar
Loans and 1.75% for Base Rate Loans. The weighted average interest rates for the outstanding loans
as of September 30, 2011was as follows:
At September 30, 2011 | ||||||||
Eurodollar Loans | Base Rate Loans | |||||||
New Revolver |
2.97 | % | 5.00 | % |
The Borrowers may prepay the New Revolver (and swing-line loans) at any time and from time to
time without premium or penalty, and without a corresponding commitment reduction (subject to
reimbursement of the Lenders breakage and redeployment costs in the case of Eurodollar rate
loans). The unutilized portion of the New Revolver may be reduced or terminated by the Borrowers at
any time and from time to time without premium or penalty.
Under the terms of the New Credit Agreement, the Company is required to comply with the
following financial covenants (the Financial Covenants): (a) a quarterly minimum Consolidated
Fixed Charge Coverage Ratio (defined below) of 1.50:1.00; and (b) a quarterly maximum Consolidated
Leverage Ratio (defined below) of 3.25:1.00 (stepping down to 3.00:1.00 for the quarter ending June
30, 2013, provided, that in the event a permitted acquisition is consummated prior to August 8,
2013, such maximum ratio shall remain 3.25:1.00 until the later of June 30, 2013 and the date that
is 18 months after such consummation). The Old Credit Agreement contained a minimum Consolidated
Fixed Charge Coverage Ratio of 1.35:1.00, and a maximum Total Debt to Covenant EBITDA ratio of
2.75:100 (each as defined in the Old Credit Agreement), as well as an annual capital expenditure
limitation.
The Consolidated Fixed Charge Coverage Ratio under the New Credit Agreement is the ratio of:
(a) Covenant EBITDA (as described below) for the most recently completed four quarters
minus the sum of (i) all unfinanced capital expenditures incurred during such period; (ii)
all cash taxes paid during such period; and (iii) all cash dividends paid by KID during such
period, to (b) an amount generally equal to, with respect to the Company, the sum for such period
of all scheduled interest and principal payments of debt, including the principal component of any
capital lease, paid or payable in cash. The Consolidated Leverage Ratio under the New Credit
Agreement is the ratio of the indebtedness of the Company to Covenant EBITDA for the most recently
completed four quarters. Indebtedness, as used in the determination of the maximum Consolidated
Leverage Ratio, generally means the outstanding principal amount of all debt (including obligations
under capital leases plus the face amount of all letters of credit). The Borrowers were in
compliance with all applicable Financial Covenants as of September 30, 2011.
Covenant EBITDA, as defined in the New Credit Agreement, is a non-GAAP financial measure used
to determine relevant interest rate margins and the Borrowers compliance with the Financial
Covenants, as well as the determination of whether certain repurchases of equity securities,
acquisitions, payments of specified Duty Amounts (defined below) and other specified customs duty
underpayments, and payment of LaJobi Earnout Consideration (defined below), if any, can be made if
other specified prerequisites are met, and the determination of the amount of specified fees.
Covenant EBITDA is defined generally as the net income of KID and its consolidated subsidiaries
(excluding extraordinary after-tax or non-recurring gains or losses, non-cash gains or losses from
dispositions other than the write-down of current assets, non-cash restructuring charges, tax
refunds, and net operating losses or other net tax benefits and any after-tax gains and losses from
discontinued operations), as adjusted for interest expense; income tax expense; depreciation;
amortization; other non-cash charges (gains); if expensed, reasonable costs incurred in connection
with the execution of the New Credit Agreement and related documentation; and non-cash transaction
losses (gains) due solely to fluctuations in currency values. Covenant EBITDA is further adjusted
(up to an aggregate maximum of $14.855 million for all periods, less any earnout consideration paid
in respect of KIDs 2008 purchase of LaJobi (LaJobi Earnout Consideration), if any, other than in
accordance with the New Credit Agreement and/or to the extent not deducted in determining
consolidated net income) for: (i) all customs duties, interest, penalties and other related amounts
(Duty Amounts) owed by LaJobi to U.S. Customs and Border Protection (U.S. Customs) to the
extent they relate to the nonpayment or incorrect payment by LaJobi of import duties to U.S.
Customs on certain wooden furniture imported by LaJobi from vendors in China resulting in a
violation prior to March 30, 2011 of anti-dumping regulations, the related misconduct on the part
of certain LaJobi employees, and LaJobis business and staffing practices in Asia prior to March
30, 2011 relating thereto (Duty Events); (ii) fees and expenses incurred in connection with the
internal and U.S. Customs investigation of the Duty Amounts and Duty Events (the
Investigations); and (iii) LaJobi Earnout Consideration, if any, paid in accordance with the
terms of the New Credit Agreement.
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KID BRANDS, INC AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The New Credit Agreement contains customary representations and warranties, as well as various
affirmative and negative covenants in addition to the Financial Covenants, including, without
limitation, financial reporting (including annual delivery of projections) requirements, notice
requirements with respect to specified events and required compliance certificates. In addition,
among other restrictions, the Loan Parties (and their subsidiaries other than the Licensor until
such time as it becomes a Loan Party) are prohibited from consummating a merger or other
fundamental change, paying dividends and making distributions, purchasing or redeeming stock,
incurring additional debt, making acquisitions, disposing of assets and other transactions outside
of the ordinary course of business, making specified payments and investments, engaging in
transactions with affiliates, paying Duty Amounts and other specified customs duty underpayments
(see Note 10 of the Notes to Unaudited Consolidated Financial Statements under paragraph (b)), or
paying any LaJobi Earnout Consideration, subject in each case to specified exceptions, some of
which are described below. The activities of the Licensor are also limited until it becomes
subject to the restrictions set forth above as a Loan Party.
At the time of any accrual in excess of $1.0 million, or proposed payment, of any Duty Amounts
or other specified customs duty underpayments (see Note 10 of the Notes to Unaudited Consolidated
Financial Statements under paragraph (b)): (i) the Consolidated Fixed Charge Coverage Ratio,
calculated on a pro forma basis as of the last day of the most recently ended quarter with respect
to the four most recently ended quarters ending on such date, as if such accrual or payment
occurred during such quarter, must be at least 1:50:1.0; or (ii) the Consolidated Leverage Ratio,
calculated on a pro forma basis as of the last day of the most recently ended quarter with respect
to the four most recently ended quarters ending on such date, as if such accrual or payment
occurred during such quarter, must be equal to or less than 3.25:1:0.
With respect to the payment by KID of dividends, among other things, so long as no event of
default or unmatured event of default then exists or would result therefrom, and no violation of
the Financial Covenants then exists or would result therefrom, KID may pay a regular quarterly
dividend, provided, however, that prior to such time that the focused assessment of U.S. Customs
has been deemed concluded and all Duty Amounts required thereby have been remitted by LaJobi (the
Duty Conclusion Date), such payments, when aggregated with permitted repurchases of KIDs equity
securities as described below, shall be limited to an aggregate amount not to exceed $5.0 million.
With respect to the repurchase by KID of its equity securities, among other things, so long as
no event of default or unmatured event of default then exists or would result therefrom, no
violation of the Financial Covenants then exists or would, on a pro forma basis, result therefrom,
and the Consolidated Leverage Ratio, on a pro forma basis, is at least 0.25x less than the maximum
then permitted, KID may repurchase or redeem its equity securities, provided, however, that prior
to the Duty Conclusion Date, such payments, when aggregated with permitted quarterly dividends as
described above, shall be limited to an aggregate amount not to exceed $5.0 million.
With respect to acquisitions, specified non-hostile acquisitions will be permitted (without a
ceiling on the purchase price therefor), provided that, among other things, immediately before and
after giving effect to such acquisition, no event of default or unmatured event of default exists,
the Loan Parties are in pro forma compliance with the Financial Covenants, the pro forma
Consolidated Leverage Ratio is at least 0.25x less than the maximum level then permitted, and
minimum availability under the New Revolver is at least $15.0 million.
Generally with respect to the payment of LaJobi Earnout Consideration, if any, both before and
immediately after giving effect to any such payment, (i) no event of default or unmatured event of
default may then exist or result therefrom, (ii) no violation of the Financial Covenants or
covenants with respect to Duty Amount accruals or payments may then exist or would, on a pro forma
basis, result therefrom, and (iii) the Consolidated Leverage Ratio (calculated on a pro forma
basis) is at least, if the Duty Conclusion Date has not yet occurred, 0.25 to 1.0 less than the
maximum then permitted.
The New Credit Agreement contains customary events of default (including any failure to remain
in compliance with the Financial Covenants), as well as specified defaults with respect to the
LaJobi Earnout Consideration. If an event of default occurs and is continuing (in addition to
default interest as described above, and other remedies available to the Lenders), with the consent
of the Required Lenders, the Administrative Agent is entitled to, and at the request of such
Lenders, the Administrative Agent is required to, declare commitments under the New Credit
Agreement to be terminated, declare outstanding obligations thereunder to be due and payable,
and/or demand cash collateralization of letters of credit (provided that upon events of bankruptcy,
the commitments will be immediately due and payable, and the Borrowers will be required to cash
collateralize letters of credit). In addition, an event of default under the New Credit Agreement
could result in a cross-default under certain license agreements that KID maintains.
In order to secure the obligations of the Loan Parties under the New Credit Agreement, each
Loan Party has pledged 100% of the equity interests of its domestic subsidiaries, including a
pledge of the capital stock of each Borrower (other than KID) and the Licensor, and 65% of the
equity interests of specified foreign subsidiaries, to the Administrative Agent, and has granted
security interests to the Administrative Agent in substantially all of its personal property (other
than the assets of the Licensor until it becomes a Loan Party), all pursuant to the terms of a
Second Amended and Restated Security and Pledge Agreement dated as of August 8,
2011 (the New Security Agreement), which amends and restates the Amended and Restated
Guaranty and Collateral Agreement dated as of April 2, 2008, as amended, among the Borrowers in
favor of the Administrative Agent (the Old Security Agreement). As additional security for
Sassy, Inc.s obligations under the New Credit Agreement, Sassy, Inc. has continued its grant of a
mortgage for the benefit of the Administrative Agent and the continuing Lenders on the real
property located at 2305 Breton Industrial Park Drive, S.E., Kentwood, Michigan.
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KID BRANDS, INC AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The Borrowers paid an arrangement fee to ML in an aggregate amount of approximately $656,000
and an up-front fee to the Lenders in an aggregate amount of approximately $665,000 in connection
with the execution of the New Credit Agreement and related documentation. The Borrowers are also
required to pay a quarterly commitment fee ranging from 0.30% to 0.45% (based on the Consolidated
Leverage Ratio) on the daily unused portions of the New Revolver (outstanding amounts under letters
of credit are considered utilization for this purpose; outstanding swing-line loans are not so
considered); letter of credit fees ranging from 1.75% to 2.75% (based on the Consolidated Leverage
Ratio) on the maximum daily amount available to be drawn, plus fronting fees and other customary
fees as are set forth in the New Credit Agreement. In connection with the execution of the New
Credit Agreement, the Company also wrote-off $1.0 million of unamortized deferred financing costs
pertaining to the Old Credit Agreement during the three and nine months ended September 30, 2011.
NOTE 5 INTANGIBLE ASSETS
As of September 30, 2011 and December 31, 2010, the components of intangible assets consisted of
the following (in thousands):
Weighted Average | September 30, | December 31, | ||||||||
Amortization Period | 2011 | 2010 | ||||||||
Sassy trade name |
Indefinite life | $ | 5,400 | $ | 5,400 | |||||
Kids Line customer relationships |
20 years | 26,435 | 27,601 | |||||||
Kids Line trade name |
Indefinite life | 5,300 | 5,300 | |||||||
LaJobi trade name |
Indefinite life | 18,600 | 18,600 | |||||||
LaJobi customer relationships |
20 years | 10,477 | 10,954 | |||||||
LaJobi royalty agreements |
5 years | 949 | 1,278 | |||||||
CoCaLo trade name |
Indefinite life | 5,800 | 5,800 | |||||||
CoCaLo customer relationships |
20 years | 2,095 | 2,190 | |||||||
CoCaLo foreign trade name |
Indefinite life | 31 | 31 | |||||||
Total intangible assets |
$ | 75,087 | $ | 77,154 | ||||||
Aggregate amortization expense was approximately $689,000 and $2,067,000 for the three and
nine months ended September 30, 2011, respectively. Aggregate amortization expense was
approximately $690,000 and $2,071,000 for the three and nine months ended September 30, 2010,
respectively.
Indefinite-lived intangible assets are reviewed for impairment at least annually, and more
frequently if a triggering event occurs indicating that an impairment may exist. The Companys
annual impairment testing is performed in the fourth quarter of each year (unless specified
triggering events warrant more frequent testing). All intangible assets, both definite-lived and
indefinite-lived, were tested for impairment in the fourth quarter of 2010. There were no
impairments of intangible assets in 2010. In accordance with applicable accounting standards, the
Company determined that interim testing of intangible assets (indefinite and definite-lived) was
not warranted during the three and nine months ended September 30, 2011, as there were no
applicable triggering events during such periods.
As many of the factors used in assessing fair value are outside the control of management, the
assumptions and estimates used in such assessment may change in future periods, which could require
that the Company record impairment charges to the Companys assets. The Company will continue to
monitor circumstances and events in future periods to determine whether additional asset impairment
testing or recordation is warranted.
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NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6 GEOGRAPHIC INFORMATION AND CONCENTRATION OF RISK
The following tables present net sales and total assets of the Company by geographic area (in
thousands) for the periods shown:
Three Months ended | Nine Months ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
Net sales | 2011 | 2010 | 2011 | 2010 | ||||||||||||
Net domestic sales |
$ | 67,024 | $ | 68,603 | $ | 182,290 | $ | 193,126 | ||||||||
Net foreign sales
(Australia and United
Kingdom)* |
2,451 | 2,525 | 7,313 | 7,397 | ||||||||||||
Total net sales |
$ | 69,475 | $ | 71,128 | $ | 189,603 | $ | 200,523 | ||||||||
September 30, | December 31, | |||||||
Assets | 2011 | 2010 | ||||||
Domestic assets |
$ | 222,478 | $ | 237,982 | ||||
Foreign assets (Australia and United Kingdom) |
6,156 | 4,514 | ||||||
Total assets |
$ | 228,634 | $ | 242,496 | ||||
* | Excludes export sales from the United States. |
The Company currently categorizes its sales in five product categories: Soft Good Basics,
Hard Good Basics, Accessories and Décor, Toys and Entertainment and Other. Soft Good Basics
includes bedding, blankets and mattresses. Hard Good Basics includes cribs and other nursery
furniture, feeding, food preparation and kitchen products, baby gear and organizers. Accessories
and Décor includes hampers, lamps, rugs and décor. Toys and Entertainment includes developmental
toys, bath toys and mobiles. Other includes all other products that do not fit in the above four
categories. The Companys consolidated net sales by product category, as a percentage of total
consolidated net sales, for the three and nine months ended September 30, 2011 and 2010 were as
follows:
Three Months ended | Nine Months ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Soft Good Basics |
38.1 | % | 36.6 | % | 38.6 | % | 38.7 | % | ||||||||
Hard Good Basics |
39.0 | % | 40.8 | % | 36.2 | % | 39.6 | % | ||||||||
Accessories and Décor |
10.1 | % | 10.9 | % | 10.7 | % | 10.3 | % | ||||||||
Toys and Entertainment |
11.9 | % | 10.8 | % | 13.1 | % | 10.6 | % | ||||||||
Other |
0.9 | % | 0.9 | % | 1.4 | % | 0.8 | % | ||||||||
Total |
100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||||||
Customers who account for a significant percentage of the Companys net sales are shown in the
table below:
Three Months ended | Nine Months ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Toys R Us, Inc. and Babies R Us, Inc. |
39.3 | % | 49.2 | % | 39.5 | % | 48.8 | % | ||||||||
Walmart |
11.7 | % | 10.5 | % | 12.4 | % | 8.8 | % | ||||||||
Target |
9.2 | % | 9.0 | % | 9.0 | % | 9.9 | % |
The loss of these customers or any other significant customers, or a significant reduction in
the volume of business conducted with such customers, could have a material adverse impact on the
Company. The Company does not normally require collateral or other security to support credit
sales.
As part of its ongoing risk assessment procedures, the Company monitors concentrations of
credit risk associated with financial institutions with which it conducts business. The Company
seeks to avoid concentration with any single financial institution. The Company also monitors the
creditworthiness of its customers to which it grants credit terms in the normal course of business.
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NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
During each of the nine months ended September 30, 2011 and 2010, respectively, approximately
74% of the Companys dollar volume of purchases was attributable to manufacturing in the Peoples
Republic of China (PRC). The PRC currently enjoys permanent normal trade relations (PNTR)
status under U.S. tariff laws, which provides a favorable category of U.S. import duties. The loss
of such PNTR status would result in a substantial increase in the import duty for products
manufactured for the Company in
the PRC and imported into the United States and would result in increased costs for the
Company. In addition, certain categories of wooden bedroom furniture imported from the PRC by the
Companys LaJobi subsidiary are also subject to anti-dumping duties. For a discussion of charges
taken in each of the first three quarters of 2011 and the quarter and year ended December 31, 2010,
for anticipated anti-dumping duties (and/or related interest) and other actions taken by the
Company in connection with a Focused Assessment of LaJobis import practices, see Note 10. Also
see Note 10 for a discussion of charges taken in each of the second and third quarters of 2011 with
respect to customs practices at the Companys non-LaJobi subsidiaries, and actions taken by the
Company with respect thereto. The Company has discontinued the practices that resulted in these
anticipated charges.
The supplier accounting for the greatest dollar volume of the Companys purchases accounted
for approximately 23% and 19% of such purchases for each of the nine months ended September 30,
2011 and 2010, respectively. The five largest suppliers accounted for approximately 48% and 44% of
the Companys purchases in the aggregate for each of the nine months ended September 30, 2011 and
2010, respectively.
NOTE 7 FINANCIAL INSTRUMENTS
The fair value of assets and liabilities is determined by reference to the estimated price
that would be received to sell an asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date (an exit price). The relevant FASB standard
outlines a valuation framework and creates a fair value hierarchy in order to increase the
consistency and comparability of fair value measurements and related disclosures.
Financial assets and liabilities are measured using inputs from the three levels of the fair
value hierarchy. The three levels are as follows:
Level 1Inputs are unadjusted quoted prices in active markets for identical assets or
liabilities. The Company currently has no Level 1 assets or liabilities that are measured at a
fair value on a recurring basis.
Level 2Inputs include quoted prices for similar assets and liabilities in active markets,
quoted prices for identical or similar assets or liabilities in markets that are not active, inputs
other than quoted prices that are observable for the asset or liability (i.e., interest rates,
yield curves, etc.), and inputs that are derived principally from or corroborated by observable
market data by correlation or other means (market corroborated inputs). Most of the Companys
assets and liabilities fall within Level 2 and include foreign exchange contracts (when applicable)
and an interest rate swap agreement. The fair value of foreign currency and interest rate swap
agreements are based on third-party market maker valuation models that discount cash flows
resulting from the differential between the contract rate and the market-based forward rate or
curve capturing volatility and establishing intrinsic and carrying values.
Level 3Unobservable inputs that reflect the Companys assessment about the assumptions that
market participants would use in pricing the asset or liability. The Company currently has no Level
3 assets or liabilities that are measured at a fair value on a recurring basis.
This hierarchy requires the Company to minimize the use of unobservable inputs and to use
observable market data, if available, when determining fair value. Observable inputs are based on
market data obtained from independent sources, while unobservable inputs are based on the Companys
market assumptions. Unobservable inputs require significant management judgment or estimation. In
some cases, the inputs used to measure an asset or liability may fall into different levels of the
fair value hierarchy. In those instances, the fair value measurement is required to be classified
using the lowest level of input that is significant to the fair value measurement. In accordance
with the applicable standard, the Company is not permitted to adjust quoted market prices in an
active market.
In accordance with the fair value hierarchy described above, the following table shows the
fair value of the Companys current interest rate swap agreement as of September 30, 2011 and
December 31, 2010 (in thousands):
Fair Value Measurements as of September 30, 2011 | ||||||||||||||||
September 30, 2011 | Level 1 | Level 2 | Level 3 | |||||||||||||
Interest Rate Swap Agreement |
$ | (23 | ) | $ | | $ | (23 | ) | $ | |
Fair Value Measurements as of December 31, 2010 | ||||||||||||||||
December 31, 2010 | Level 1 | Level 2 | Level 3 | |||||||||||||
Interest Rate Swap Agreement |
$ | (87 | ) | $ | | $ | (87 | ) | $ | |
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NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The fair values of the Companys interest rate swap agreement of $23,000 and $87,000 at
September 30, 2011 and December 31, 2010, respectively, are included in the Companys accrued
expenses on the balance sheet at the relevant date. Changes between the cost of such agreement and
its fair value resulted in a loss of $23,000 for the three and nine months ended September 30,
2011, which was recorded as interest expense. Unrealized losses of $16,000 and $32,000 for a
previous interest swap agreement were recorded as a component of comprehensive income, for the
three and nine months ended September 30, 2010, respectively.
Cash and cash equivalents, trade accounts receivable, inventory, income tax receivable, trade
accounts payable, accrued expenses and short-term debt (maintained by the Company prior to the
execution of the New Credit Agreement described in Note 4) are reflected in the consolidated
balance sheets at carrying value, which approximates fair value due to the short-term nature of
these instruments.
The carrying value of the Companys long term borrowings including the New Revolver,
approximates fair value because interest rates applicable thereto are variable, based on prevailing
market rates.
There were no material changes to the Companys valuation techniques during the nine months
ended September 30, 2011 compared to those used in prior periods.
Derivative Instruments
The Company was required by its lenders (until the execution of the New Credit Agreement as of
August 8, 2011) to maintain in effect interest rate swap agreements that protected against
potential fluctuations in interest rates with respect to a minimum of 50% of the outstanding amount
of the Old Term Loan (such swap agreement has not been terminated even though it is no longer
required by the New Credit Agreement). The Companys objective was to offset the variability of
cash flows in the interest payments on a portion of the total outstanding variable rate debt. Until
August 8, 2011, the Company applied hedge accounting treatment to such interest rate swap agreement
based upon the criteria established by accounting guidance for derivative instruments and hedging
activities, including designation of its derivatives as fair value hedges or cash flow hedges and
assessment of hedge effectiveness. Following the execution of the New Credit Agreement (as
described in Note 4), as the requirement to maintain hedge agreements was no longer in effect, the
Company discontinued hedge accounting for the interest rate swap agreement and since such date
accounts for such agreement as a non-qualifying derivative instrument. The Company records its
derivatives in its consolidated balance sheets at fair value. The Company does not use derivative
instruments for trading purposes.
Cash Flow Hedges
To comply with a requirement in the Old Credit Agreement to offset variability in cash flows
related to the interest rate payments on the Old Term Loan, the Company used an interest rate swap
designated as a cash flow hedge. The interest rate swap converted the variable rate on a portion of
the Old Term Loan to a specified fixed interest rate by requiring payment of a fixed rate of
interest in exchange for the receipt of a variable rate of interest at the LIBOR U.S. dollar three
month index rate. The duration of the contract is less than twelve months.
The Company assessed hedge effectiveness both at inception of the hedge and at regular
intervals at least quarterly throughout the life of the derivative. These assessments determine
whether derivatives designated as qualifying hedges continue to be highly effective in offsetting
changes in the cash flows of hedged transactions. The Company measured hedge ineffectiveness by
comparing the cumulative change in cash flows of the hedge contract with the cumulative change in
cash flows of the hedged transaction. The Company recognized any ineffective portion of the hedge
in its Consolidated Statement of Operations as a component of interest expense. The impact of hedge
ineffectiveness on earnings was $54,000 during the three and nine months ended September 30, 2011,
primarily as a result of repayment in full of the Old Term Loan.
Cash flow hedge accounting is discontinued when: (i) the hedging relationship is no longer
highly effective; (ii) the forecasted transaction is no longer probable of occurring on the
originally forecasted date or within an additional two months thereafter, (iii) the hedge
relationship is no longer eligible for designation as a hedged transaction; or (iv) the derivative
hedging instrument is sold, terminated, or exercised. Although the interest rate swap agreement was
not terminated upon execution of the New Credit Agreement (and remains in effect), the Company had
determined that the hedging relationship would no longer be highly effective and upon such
execution, therefore discontinued hedge accounting thereon as of August 8, 2011. Subsequent to such
date, all changes in fair value of the interest rate swap agreement have been recorded directly in
earnings.
Accumulated other comprehensive income reflects the difference between the overall change in
fair value of the interest rate swap since inception of the hedge and the amount of ineffectiveness
reclassified into earnings. During the three and nine months ended September 30, 2011, an expense
of $54,000 for the Companys current interest rate swap agreement was reclassified from Accumulated
Other Comprehensive Income to earnings as a component of interest expense.
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NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Non-Qualifying Derivative Instruments
As described above, following the execution of the New Credit Agreement, the Company
discontinued hedge accounting for the interest rate swap agreement and since such date accounts for
such agreement as a non-qualifying derivative instrument. The Company records such derivative
instruments in its consolidated balance sheets at fair value.
Changes between cost and fair value of the interest rate swap resulted in a loss of $23,000
for the three and nine months ended September 30, 2011, respectively, and such amount is included
in interest expense in the unaudited consolidated statements of operations for each such period.
A previous interest rate swap agreement, utilized to offset exposure of the Old Term Loan to
interest rate risk, (as required by the Old Credit Agreement), terminated on April 30, 2010. This
contract converted the variable rate on a portion of the Old Term Loan to a specified fixed
interest rate by requiring payment of a fixed rate of interest in exchange for the receipt of a
variable rate of interest at the LIBOR USD three month index rate. This contract was not designated
as a hedge (in accordance with applicable accounting standards) and was adjusted to fair value at
regular intervals, with any resulting gains or losses recorded immediately in earnings.
Changes between cost and fair value of this previous interest rate swap resulted in income of
$0 and $678,000 for the three and nine months ended September 30, 2010, respectively, and such
amount is included in interest expense in the unaudited consolidated statements of operations for
each such period.
NOTE 8 COMPREHENSIVE (LOSS)/INCOME
Comprehensive (loss)/income, representing all changes in Shareholders Equity during the
period other than changes resulting from the issuance or repurchase of KIDs Common Stock and
payment of dividends, is reconciled to net (loss)/ income for the three and nine months ended
September 30, 2011 and 2010 as follows (in thousands):
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Net (loss) income |
$ | (80 | ) | $ | 3,960 | $ | (4,255 | ) | $ | 11,904 | ||||||
Other comprehensive income: |
||||||||||||||||
Unrealized gain on derivative |
2 | 53 | 33 | 53 | ||||||||||||
Reclassification into (loss) income |
54 | | 54 | | ||||||||||||
Foreign currency translation adjustments |
(39 | ) | (16 | ) | (102 | ) | (32 | ) | ||||||||
Comprehensive (loss) income |
$ | (63 | ) | $ | 3,997 | $ | (4,270 | ) | $ | 11,925 | ||||||
NOTE 9 INCOME TAXES
The Company uses the asset and liability approach for financial accounting and reporting of
income taxes. A valuation allowance is provided for deferred tax assets when it is more likely than
not that some portion or all of the deferred tax asset will not be realized. In assessing the
realizability of deferred tax assets, management considers the scheduled reversals of deferred tax
liabilities, projected future taxable income and tax planning strategies. The Companys ability to
realize its deferred tax assets depends upon the generation of sufficient future taxable income to
allow for the utilization of its deductible temporary differences and loss and credit carry
forwards.
The Company operates in multiple tax jurisdictions, both within the United States and outside
of the United States, and faces audits from various tax authorities regarding the inclusion of
certain items in taxable income, the deductibility of certain expenses, transfer pricing, the
utilization and carryforward of various tax credits, and the utilization of various carryforward
items such as capital losses, and net operating loss carryforwards (NOLs). At September 30,
2011, the amount of liability for unrecognized tax benefits related to federal, state, and foreign
taxes was approximately $737,000 including approximately $151,000 of accrued interest.
Activity regarding the liability for unrecognized tax benefits for the nine months ended
September 30, 2011 is as follows:
(in thousands) | ||||
Balance at December 31, 2010 |
$ | 542 | ||
Increase related to prior year tax positions |
195 | |||
Balance at September 30, 2011 |
$ | 737 | ||
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NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The Company is currently under examination in several tax jurisdictions and remains subject to
examination until the statute of limitations expires for the applicable tax jurisdiction. The
Company is currently under examination by the Internal Revenue Service for its consolidated federal
income tax returns for 2008 and 2009. Based upon the expiration of statutes of limitations and/or
the conclusion of tax examinations in several jurisdictions, the Company believes it is reasonably
possible that the total amount of previously unrecognized tax benefits discussed above may decrease
by up to $700,000 within twelve months of September 30, 2011 and such amount is reflected on the
Companys consolidated balance sheet as current income taxes payable.
The Companys policy is to classify interest and penalties related to unrecognized tax
benefits as income tax expense.
The income tax provision for the three months ended September 30, 2011 was $246,000 on income
before income tax provision of $166,000. The difference between the effective tax rate of 148.5%
for the three months ended September 30, 2011 and the U.S. federal tax rate of 35% primarily
relates to: (1) the true-up of prior year federal and state estimates in the aggregate amount of
$166,000; (2) a provision for state tax, net of federal tax benefit, in the amount of $60,000; (3)
an increase in the liability for unrecognized tax benefits of $7,000 as a result of additional
interest being accrued; and (4) the effect of permanent adjustments of $9,000; offset by foreign
adjustments related to foreign rate differences and unrepatriated foreign earnings in the amount of
$54,000. The income tax provision for the three months ended September 30, 2010 was approximately
$2,189,000 on income before tax provision of approximately $6,149,000. The difference between the
effective tax rate of 36% for the three months ended September 30, 2010 and the U.S. federal tax
rate of 35% primarily relates to: (1) the provision for state taxes, net of federal tax benefit, in
the amount of $282,000; (2) the true-up of prior year federal and state estimates in the aggregate
amount of $39,000; (3) foreign adjustments related to foreign rate differences and withholding
taxes in the amount of $38,000; and (4) the effect of permanent adjustments of $50,000; offset by
(1) state tax credits generated and utilized in the amount of $254,000; and (2) settlement of a
liability for unrecognized tax benefits of $56,000.
The income tax provision for the nine months ended September 30, 2011 was $4.7 million on
income before income tax provision of $0.4 million. The difference between the effective tax rate
of 1,117.9% for the nine months ended September 30, 2011 and the U.S. federal tax rate of 35%
primarily relates to the following discrete items: (1) a change in the valuation allowance against
deferred tax assets associated with the sale of the Companys former gift business in light of the
TRC bankruptcy filing in the amount of $3.6 million; (2) an adjustment to the state deferred tax
asset related to the enactment of a single sales factor in New Jersey in the amount of $0.6
million; (3) an increase for unrecognized tax benefits of $0.2 million; and (4) the true-up of
prior year federal and state estimates in the aggregate amount of $166,000. The difference between
the U.S. federal tax rate of 35% and the estimated effective tax rate for the year (excluding
discrete items) of 42.7% primarily relates to: (1) a provision for state tax, net of federal
benefit, of $22,000; and (2) the effect of permanent adjustments of $10,000. The income tax
provision for the nine months ended September 30, 2010 was $7.0 million on income before income tax
provision of $18.9 million. The difference between the effective tax rate of 37% for the nine
months ended September 30, 2010 and the U.S. federal tax rate of 35% primarily relates to the
provision for state taxes, net of federal tax benefit, in the amount of $964,000; offset by: (1)
state tax credits generated and utilized of $254,000; (2) true-up of prior year tax estimates of
$133,000; and (3) settlement of a liability for unrecognized tax benefits of $42,000.
NOTE 10 LITIGATION, COMMITMENTS AND CONTINGENCIES
(a) LaJobi Customs, LaJobi Earnout and Asia Staffing Matters
In late December 2010, the Companys LaJobi subsidiary was selected by U.S. Customs and Border
Protection (U.S. Customs) for a Focused Assessment of its import practices and procedures,
which Focused Assessment commenced on January 19, 2011. In preparing for the Focused Assessment,
the Company found certain potential issues with respect to LaJobis import practices. As a result,
the Board of Directors initiated an investigation, supervised by a Special Committee of three
non-management members of the Board. The Boards investigation found instances at LaJobi in which
incorrect anti-dumping duties were applied on certain wooden furniture imported from vendors in the
PRC, resulting in a violation of anti-dumping laws. On the basis of the investigation, the Board
concluded that there was misconduct involved on the part of certain LaJobi employees in connection
with the incorrect payment of duties, including misidentifying the manufacturer, shipper and
description of products. As a result, effective March 14, 2011, LaJobis President, Lawrence
Bivona, and LaJobis Managing Director of operations were both terminated from employment.
Promptly upon becoming aware of the issues and related misconduct described above, the Company
voluntarily disclosed its findings to the SEC on an informal basis and is cooperating with the
Staff of the SEC. See SEC Informal Investigation in paragraph (d) below.
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NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The Company expects to complete a voluntary prior disclosure to U.S. Customs identifying
certain underpayments of anti-dumping duty, and remit payment of duty not paid, with interest
thereon. Accordingly, the Company has recorded charges of approximately: (i) $6,860,000 (which
includes approximately $340,000 of interest) for the quarter and year ended December 31, 2010; (ii)
$382,000 (which includes approximately $55,000 of interest) for the quarter ended March 31, 2011;
(iii) $55,000 in related interest
for the quarter ended June 30, 2011; and (iv) $56,000 in related interest expense for the
quarter ended September 30, 2011, in each case for duties (or related interest) the Company
anticipates will be owed to U.S. Customs by LaJobi in respect of the matters discussed above. All
of the foregoing charges were recorded in cost of sales (other than the interest portions, which
were recorded in interest expense), and adversely affected gross margins and net (loss)/income for
the affected periods. As the Focused Assessment is still pending, it is possible that the actual
amount of duty owed for the period covered thereby will be higher upon completion thereof, and in
any event, additional interest will continue to accrue on the amounts the Company currently
anticipates the Company will owe until payment is made. In addition, it is possible that the
Company may be assessed by U.S. Customs a penalty of up to 100% of such duty owed, as well as
possibly being subject to additional fines, penalties or other measures from U.S. Customs or other
governmental authorities. With respect to the actual amount of duty owed, and additional fines,
penalties or other measures, the Company cannot currently estimate the amount of the loss (or range
of loss), if any, in connection therewith. The Company has discontinued the practices that resulted
in the charge for anticipated anti-dumping duty, and the Company believes that its ability to
procure the affected categories of wooden bedroom furniture will not be materially adversely
affected in future periods. The Company is committed to working closely with U.S. Customs to
address issues relating to incorrect duties. The Company has also initiated certain enhancements to
its processes and procedures in areas where underpayments were found, and is reviewing these and
possibly other remedial measures. In addition, there can be no assurance that the Companys
licensors, vendors and/or retail partners will not take adverse action under applicable agreements
with the Company (or otherwise) as a result of the matters described above; however, to date, the
Company is unaware of any such adverse actions.
As a result of the accrual recorded in the fourth quarter and year ended December 31, 2010 for
anticipated duty (and interest thereon) owed by LaJobi to U.S. Customs and the facts and
circumstances discovered in the Companys preparation for the Focused Assessment and in its related
investigation into LaJobis import practices described above (including misconduct on the part of
certain employees at LaJobi), the Company concluded that no LaJobi Earnout Consideration (and
therefore no related finders fee) was payable. Accordingly, the Company did not record any amounts
related thereto in the Companys financial statements for the fourth quarter and year ended
December 31, 2010. The Company had previously disclosed a potential earnout payment of
approximately $12 to $15 million in the aggregate relating to its acquisitions of LaJobi and
CoCaLo, substantially all of which was estimated to relate to LaJobi.
On July 25, 2011, the Company received a letter from counsel to Lawrence Bivona demanding
payment of the LaJobi Earnout Consideration to Mr. Bivona in the amount of $15 million. In
addition, on July 25, 2011, the Company received a letter from counsel to Mr. Bivona alleging that
Mr. Bivonas termination by LaJobi for cause, effective March 14, 2011, violated his employment
agreement and demanding payment to Mr. Bivona of amounts purportedly due under such employment
agreement. The Company does not intend to pay the LaJobi Earnout Consideration to Mr. Bivona and
believes that Mr. Bivona was properly terminated for cause pursuant to his employment agreement,
and the Company has so advised counsel for Mr. Bivona. The Company intends to vigorously defend
any related action that Mr. Bivona may bring. There can be no assurance that the Company will
prevail in any such dispute, although the Company believes that, in any event, it would have
additional claims that it could assert against the LaJobi seller and Mr. Bivona.
Prior to the Companys acquisition of LaJobi, Lawrence Bivona, the former President of LaJobi,
Inc., along with various family members, established L&J Industries in Asia to provide quality
control, compliance and certain other services to LaJobi for goods being shipped by LaJobi from
Asian ports. Pursuant to the terms of a transition services agreement entered into in connection
with the acquisition of LaJobi, commencing in April 2008, the Company utilized the full time
services of approximately 28 individuals who were compensated by L&J Industries for such services.
Beginning February, 2010, the Company paid for the services of some, and later all or substantially
all, of the individuals who had previously been paid by L&J Industries (based in Hong Kong, China,
Vietnam and Thailand), either directly to the individuals or through an individual based in Hong
Kong. Companies retaining the services of individuals in these jurisdictions are subject to a
variety of foreign laws. The Company has completed an internal investigation of its Asia payment
and staffing practices and believes that its payments into Thailand may have violated a criminal
law in that country that requires certain disclosures in connection with wire transfers into that
country, and that its employment practices likely violated a criminal law in Hong Kong, in the
category of a petty violation, that requires registration by foreign companies doing business in
that country. In addition, the Company may have violated certain foreign regulatory,
administrative and civil laws in connection with its payment and employment practices in Asia.
However, the Company currently does not believe that such matters (individually or in the
aggregate) will have a material adverse effect on the Company, and has not accrued any amounts to
date in connection therewith. See SEC Informal Investigation in paragraph (d) below.
LaJobi has since discontinued the above-described manner of paying individuals providing such
services in the PRC, Hong Kong and Thailand, and has taken corrective action by establishing
interim arrangements (i.e., retaining the services of such individuals through a third-party
outsource agency) which it believes are currently in compliance with applicable requirements in
such jurisdictions, and is in the process of establishing subsidiaries in the PRC and Thailand
through which the Company intends to directly employ the quality control individuals in these
jurisdictions in the future. Although the Company believes that once these subsidiaries are fully
established, the Company will be in compliance with applicable laws of the relevant Asian
countries, no assurance can be
given that applicable governmental authorities will concur with such a view and will not
impose taxes or penalties or other measures with respect to staffing practices prior thereto.
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NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(b) Customs Compliance Investigation
Following the discovery of the matters described above with respect to LaJobi, our Board
authorized a review, supervised by the Special Committee and conducted by outside counsel, of
customs compliance practices at the Companys non-LaJobi operating subsidiaries, consisting of Kids
Line, CoCaLo and Sassy (the Customs Review). Although such review is ongoing, based on work to
date involving a sampling of customs filings, the Special Committee has identified instances in
which these subsidiaries filed incorrect entries and invoices with U.S. Customs as a result of, in
the case of Kids Line, incorrect descriptions, classifications and valuations of certain products
imported by Kids Line and, in the case of CoCaLo, incorrect classifications of certain products
imported by CoCaLo. As a result of these findings to date, the Company currently estimates that it
will incur aggregate costs of approximately $2.4 million (pretax) relating to customs duty for the
years ended 2006 through 2010 and the nine months ended September 30, 2011. The impact on prior
periods was deemed to be immaterial to the previously reported financial statements and therefore
the anticipated amounts to such point in time were accrued in the period they were identified (the
quarter ended June 30, 2011). Of the amount accrued, the Company recorded $2.2 million in cost of
sales and $0.2 million in interest expense for the three months ended June 30, 2011 and an
additional $30,000 in interest expense was recorded for the three months ended September 30, 2011.
As the Customs Review is still pending, it is possible that the actual amount of duty owed will be
higher upon its completion and, in any event, additional interest will continue to accrue until
payment is made. In addition, it is possible that the Company may be assessed by U.S. Customs a
penalty of up to 100% of any such duty owed, as well as possibly being subject to additional fines,
penalties or other measures from U.S. Customs or other governmental authorities. With respect to
the actual amount of duties owed, and additional fines, penalties or other measures, the Company
cannot currently estimate the amount of loss (or range of loss), if any, in connection therewith.
Promptly after becoming aware of the foregoing, the Company submitted voluntary prior disclosures
to U.S. Customs identifying such issues. Following the completion of the Customs Review, the
Company intends to remit to U.S. Customs the amount of duties owed and any interest and penalties
thereon. Our Board has also recently authorized an investigation, supervised by the Special
Committee and conducted by a second outside counsel, to more fully review the customs practices at
these operating subsidiaries, including whether there was any misconduct by personnel (the Customs
Investigation). The Company has also voluntarily disclosed to the SEC the existence of the Customs
Review and the Customs Investigation. Because the Customs Review and the Customs Investigation are
ongoing, there can be no assurance as to how the resulting consequences, if any, may impact our
internal controls, business, reputation, results of operations or financial condition.
(c) Putative Class Action and Derivative Litigations
Putative Class Action. On March 22, 2011, a complaint was filed in the United States District
Court, District of New Jersey, encaptioned Shah Rahman v. Kid Brands, et al. (the
Putative Class Action). The Putative Class Action was brought by one plaintiff on behalf of a
putative class of all those who purchased or otherwise acquired the common stock of the Company
between March 26, 2010 and March 15, 2011. In addition to KID, Bruce G. Crain, KIDs then
President, Chief Executive Officer and a member of KIDs board of directors, Guy A. Paglinco, KIDs
Vice President and Chief Financial Officer, Raphael Benaroya, Mario Ciampi, Frederick J. Horowitz,
Salvatore Salibello and Michael Zimmerman, each members of KIDs board of directors, as well as
Lauren Krueger and John Schaefer, each a former member of KIDs board of directors, were named as
defendants.
The Putative Class Action alleges one claim for relief pursuant to Section 10(b) of the
Securities Exchange Act of 1934, as amended (the Exchange Act), and Rule 10b-5 promulgated
thereunder, and a second claim pursuant to the Exchange Act, claiming generally that the Company
and/or the other defendants issued materially false and misleading statements during the relevant
time period regarding compliance with customs laws, the Companys financial reports and internal
controls. The Putative Class Action does not state the size of the putative class. The Putative
Class Action seeks compensatory damages but does not quantify the amount of damages sought. The
Putative Class Action also seeks unspecified extraordinary and injunctive relief, the costs and
disbursements of the lawsuit, including attorneys and experts fees and costs, and such equitable
relief as the court deems just and proper. By order dated July 26, 2011, Shah Rahman was appointed
lead plaintiff pursuant to Section 21D(a)(3)(B) of the Exchange Act.
On September 26, 2011, an amended complaint was filed by the lead plaintiff to expand the
allegations under the claims for relief made in the original complaint, to extend the putative
class to all those who purchased or otherwise acquired KIDs common stock between March 26, 2010
and August 16, 2011 and to eliminate all of the named defendants other than KID, Bruce G. Crain,
Guy A. Paglinco and Raphael Benaroya. The amended complaint was dismissed without prejudice
against Raphael Benaroya by a Notice of Voluntary Dismissal filed by the lead plaintiff on October
21, 2011 and so ordered by the Court on October 25, 2011. Defendants have until November 10, 2011
to respond to the amended complaint.
The Company intends to defend the Putative Class Action vigorously, and has notified its
insurance carriers of the existence of the action; however, no amounts have been accrued in
connection therewith, although legal costs are being expensed as incurred.
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NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Putative Shareholder Derivative Action. On May 20, 2011, a putative shareholder derivative
complaint was filed by the City of Roseville Employees Retirement System in the United States
District Court of the District of New Jersey (the Putative Derivative Action), against Bruce
Crain, KIDs then-CEO, Guy Paglinco, KIDs CFO, Marc Goldfarb, KIDs Senior Vice President and
General Counsel, each member of KIDs current Board of Directors, and John Schaefer, a former
member of KIDs Board of Directors (collectively, the Defendants). In addition, KID has been
named as a nominal defendant.
The Putative Derivative Action alleges, among other things, that the Defendants breached their
fiduciary duties to the Company by allegedly failing to implement an internal controls system for
compliance with US Customs laws for imported goods and applicable local foreign laws, and issuing
false and misleading public statements about the Companys related party transactions with the
former owners of its LaJobi subsidiary and about its internal controls, all in violation of state
law. In addition, the Putative Derivative Action alleges that such failures also constitute gross
mismanagement, abuse of control and commission of corporate waste and resulted in unjust
enrichment. The Putative Derivative Action seeks monetary damages against the individual Defendants
in an unspecified amount together with interest, in addition to exemplary damages, the costs and
disbursements of the lawsuit, including attorneys and experts fees and costs, and such equitable
relief as the court deems just and proper.
On July 25, 2011, the Company filed a motion to dismiss the complaint in this action. On
October 24, 2011, the Court granted Defendants motion to dismiss without prejudice in a decision that cited the complaints failure to meet
applicable pleading standards required to bring a shareholder derivative claim. Plaintiff was granted leave to amend the complaint in a manner consistent with the Courts decision.
The Company notified its insurance carriers of the Putative Derivative Action. While the
Company incurred costs in connection with the defense of this lawsuit, and may incur additional
costs (which costs were or will be expensed as
incurred), the lawsuit did not seek monetary damages against the Company, and no amounts have been
accrued in connection therewith.
(d) SEC Informal Investigation
As noted above, the Company voluntarily disclosed to the SEC the findings of its internal
investigation of LaJobis customs and Asia staffing practices. On June 20, 2011, the Company
received a letter from the SEC indicating that the Staff was conducting an informal investigation
and requesting that the Company provide certain documents on a voluntary basis. More recently, the
Company voluntarily disclosed to the SEC the existence of the Customs Review and the Customs
Investigation. The Company believes that it has fully cooperated, and will continue to fully
cooperate, with the SEC. The Company is currently unable to predict the duration, resources
required or outcome of the investigation or the impact such investigation may have on the Companys
financial condition or results of operations.
(e) U.S. Attorneys Office Investigation
On August 19, 2011, the United States Attorney's Office for the District of New Jersey
(USAO) contacted Company counsel, requesting information relating to LaJobi previously
provided by the Company to U.S. Customs and the SEC, as well as additional documents. The Company
is cooperating with the USAO on a voluntary basis. The Company is currently unable to predict the
duration, the resources required or outcome of the USAO investigation or the impact such
investigation may have.
(f) TRC Landlord Litigation
In connection with the sale of KIDs former gift business in December 2008 (the Gift Sale),
KID and Russ Berrie U.S. Gift, Inc. (U.S. Gift), KIDs subsidiary at the time (and currently a
subsidiary of TRC), sent a notice of termination with respect to the lease (the TRC Lease),
originally entered into by KID (and subsequently assigned to U.S. Gift) of a facility in South
Brunswick, New Jersey. Although the TRC Lease became the obligation of TRC (through its ownership
of U.S. Gift), KID remains potentially obligated for rental and other specified payments due
thereunder (to the extent they are owed but have not been paid by U.S. Gift). On April 27, 2011,
KID received a letter on behalf of the landlord under the TRC Lease (the TRC Landlord) demanding
payment by KID of specified rent and other additional charges allegedly owed by U.S. Gift in an
aggregate amount of approximately $5.9 million (including, among other things, approximately $3.8
million in rent and other charges for periods subsequent to the effective date of the termination
of the TRC Lease (December 23, 2010), for which KID does not believe it is responsible, and
approximately $1.0 million in specified repairs (Repair Charges)).
On July 18, 2011, the TRC Landlord filed a complaint in the Superior Court of New Jersey Law
Division: Middlesex County, alleging that KID, having agreed via an assignment agreement to remain
liable for the obligations of the tenant under the TRC Lease, has breached the TRC Lease and such
assignment by failing to pay rent and other charges due and owing pursuant to the TRC Lease, in an
aggregate amount of approximately $12 million as of June 11, 2011. The complaint also demands
payment of costs in an unspecified amount, including late charges, pre-judgment interest and the
TRC Landlords attorneys fees in connection with the action. The complaint provides no itemization
of the amounts claimed to be due and owing under the TRC Lease; however, KID believes that such
amounts likely reflect amounts specified in the demand letter, plus similar amounts accrued from
the date of such letter through June 11, 2011 (although there can be no assurance that this is the
case). KID believes that any liability it may have under the TRC Lease expired upon the date of its
termination. KID currently estimates that the potential liability for rental and related amounts
under the TRC Lease is approximately $1.1 million and, accordingly, we have accrued such amount for
the nine month period ended September 30, 2011. With respect to the alleged Repair Charges, KID is
currently unable to assess its potential liability
therefor, if any, under the TRC Lease. In addition, KID believes it has potential defenses to
some or all of the amounts claimed. As a result, the aggregate amount of any payments that may
potentially be required to be made by KID with respect to the Lease cannot be ascertained at this
time.
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KID BRANDS, INC AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(g) Share Repurchase Program
On November 8, 2011, the Board approved a share repurchase program. Under the share repurchase
program, the Company is authorized to purchase up to $10.0 million of its outstanding shares of
common stock (and in connection therewith, the Board terminated the repurchase program authorized
in March of 1990). The purchases may be made from time to time on the open market or in negotiated
transactions. The timing and extent to which the Company repurchases its shares will depend on
market conditions and other corporate considerations as may be considered in the Companys sole
discretion, including limitations in the New Credit Agreement, which, in addition to limits on
revolver availability and a stricter consolidated leverage ratio
(0.25x less than the maximum then-permitted), limits the aggregate amount that can be expended on share repurchases and
dividends to $5.0 million until the LaJobi focused assessment has been concluded and all duty
amounts required thereby have been paid. (see Note 4 above). The share repurchase program may be
suspended or discontinued at any time without prior notice. The Company intends to finance the
share repurchase program from available cash and/or proceeds under the New Credit Agreement (to the extent available therefor).
(h) Other
In addition to the proceedings described above, in the ordinary course of its business, the
Company is from time to time party to various copyright, patent and trademark infringement, unfair
competition, breach of contract, customs, employment and other legal actions incidental to the
Companys business, as plaintiff or defendant. In the opinion of management, the amount of
ultimate liability with respect any such actions that are currently pending will not, individually
or in the aggregate, materially adversely affect the Companys consolidated results of operations,
financial condition or cash flows. KID may also remain obligated with respect to certain contracts
and other obligations of its former gift business that were not novated in connection with their
transfer. No payments have been made by KID in connection with the contracts described in the
preceding sentence as of September 30, 2011, nor is KID aware of any remaining potential
obligations (other than the TRC Lease described above), but there can be no assurance that payments
will not be required of KID in the future with respect thereto.
The Company has approximately $50.6 million in outstanding purchase commitments at September
30, 2011, consisting primarily of purchase orders for inventory.
The Company enters into various license and distribution agreements relating to trademarks,
copyrights, designs, and products which enable the Company to market items compatible with its
product line. Most of these agreements are for two- to five-year terms with extensions if agreed
to by both parties. Several of these agreements require pre-payments of certain minimum guaranteed
royalty amounts. The amount of minimum guaranteed royalty payments with respect to all license
agreements pursuant to their original terms aggregates approximately $22.1 million, of which
approximately $11.4 million remained unpaid at September 30, 2011 and is payable over the next
three years. Royalty expense for the three and nine months ended September 30, 2011, was $2.6
million, and $6.4 million, respectively. Royalty expense for the three and nine months ended
September 30, 2010 was $2.2 million, and $5.9 million, respectively.
As of September 30, 2011, the Company had obligations under certain letters of credit that
require the Company to make payments to parties aggregating $0.1 million upon the occurrence of
specified events.
NOTE 11 RECENTLY ISSUED ACCOUNTING STANDARDS
In May 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement (Topic 820) Amendments
to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs (ASU
2011-04), which clarifies the wording and disclosures required in Accounting Standards
Codification (ASC) Topic 820, Fair Value Measurement (ASC 820), to converge with those used (to
be used) in International Financial Reporting Standards (IFRS). The update explains how to
measure and disclose fair value under ASC 820. However, the FASB does not expect the changes in
this standards update to alter the current application of the requirements in ASC 820. The
provisions of ASU 2011-04 are effective for public entities prospectively for interim and annual
periods beginning after December 15, 2011. Early adoption is prohibited. Therefore, ASU 2011-04 is
effective for the Company during the first quarter of fiscal 2012. The Company does not expect ASU
2011-04 to have a material effect on the Companys results of operations, financial condition, and
cash flows.
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KID BRANDS, INC AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
In June 2011, the FASB issued ASU 2011-05, Presentation of Comprehensive Income. This ASU
presents an entity with the option to present the total of comprehensive income, the components of
net income, and the components of other comprehensive income either in a single continuous
statement of comprehensive income or in two separate but consecutive statements. In both
choices, an entity is required to present each component of other comprehensive income along
with a total for other comprehensive income, and a total amount for comprehensive income. This
update eliminates the option to present the components of other comprehensive income as part of the
statement of changes in stockholders equity. The amendments in this update do not change the items
that must be reported in other comprehensive income or when an item of other comprehensive income
must be reclassified to net income. The provisions of ASU 2011-05 are effective for public entities
for interim and annual periods beginning after December 15, 2011. As ASU 2011-05 relates only to
the presentation of Comprehensive Income, the Company does not expect that the adoption of this
update will have a material effect on its consolidated financial statements.
NOTE 12 RELATED PARTY TRANSACTIONS
Lawrence Bivona, the President of LaJobi until March 14, 2011, along with various family
members, established L&J Industries in Asia to provide quality control, compliance and other
services to LaJobi for goods being shipped by LaJobi from Asian ports. Pursuant to the terms of a
transition services agreement entered into in connection with the acquisition of LaJobi, commencing
in April 2008, the Company had used the full-time services of approximately 28 employees of L&J
Industries for such quality control and other services. To the Companys knowledge, L&J Industries
ceased operations in June 2010, thereby terminating the affiliated relationship. However, the
Company continues to utilize the services of all or substantially all of such individuals (see Note
10 for more detail with respect to such arrangements), and is in the process of establishing
subsidiaries in the PRC and Thailand, through which the Company intends to directly employ these
quality control individuals in the future. For the three and nine months ended September 30, 2010,
the Company incurred costs, recorded in cost of goods sold, aggregating approximately $0.3 million
and $0.8 million, respectively related to the services provided, based on the actual, direct costs
incurred (by L&J Industries or otherwise) for the services of such individuals.
CoCaLo contracts for warehousing and distribution services from a company that, until October
15, 2009, had a partner that was the estate of the father of, and is managed by the spouse of,
Renee Pepys Lowe, an employee of the Company until December 31, 2010. As of December 31, 2010,
this company is owned by unrelated parties but the spouse of Renee Pepys Lowe is still a manager of
the business. For the three and nine months ended September 30, 2010, CoCaLo paid approximately
$0.4 million and $1.5 million, respectively, to such company for these services.
TRC and KID entered into a transition services agreement in connection with the sale of KIDs
former gift business to TRC, pursuant to which TRC and KID provided certain specified services to
each other, including, among other things, the sublease of certain office and warehouse space (and
related services) by the Company from TRC and its subsidiaries. As of March 31, 2011, KID
terminated all subleases of space from TRC, and is no longer utilizing TRC services for operational
support. KID had accrued approximately $1.8 million and $1.5 million at March 31, 2011 and December
31, 2010, respectively on its financial statements in connection therewith. See below for a
description of the terms of the settlement agreement entered into in connection with TRCs
voluntary bankruptcy, which include, among other things, the set-off against a note payable by TRC
to KID of all amounts owed by the Company to TRC and its subsidiaries, including the amounts
described above (without the requirement of any cash payment). As a result of such set-off the
Company has reduced the note receivable and the valuation reserve recorded against such note
receivable by $2.0 million (which includes the $1.8 million accrued rent referenced above and $0.2
million of other liabilities to TRC extinguished by the settlement agreement) during the nine
months ended September 30, 2011.
Also see Note 10 for a discussion of potential obligations of KID with respect to the TRC
Lease (and an accrual recorded with respect to amounts anticipated to be owed to the landlord
thereunder), and potential liabilities for which KID may remain obligated under certain contracts
and other obligations that were not novated in connection with their transfer.
As has been previously disclosed, on April 21, 2011, TRC and TRCs domestic subsidiaries
(collectively, the Debtors), filed a voluntary petition under Chapter 7 of the United States
Bankruptcy Code (the Code) in the United States Bankruptcy Court for the District of New Jersey
(the Bankruptcy Court). On June 16, 2011, the Bankruptcy Court entered an order (the Order)
which, among other things, approved a settlement with the secured creditors of the Debtors,
including KID (the Settlement).
Background
On December 23, 2008, KID completed the sales of its former gift business (the Gift Sale) to
TRC. The aggregate purchase price payable by TRC for such gift business was: (i) 199 shares of the
Common Stock of TRC, representing a 19.9% interest in TRC after consummation of the transaction;
and (ii) a subordinated, secured promissory note issued by TRC to KID in the original principal
amount of $19.0 million (the Seller Note). As has been previously disclosed, in the second
quarter of 2009, KID fully impaired or reserved against all such consideration.
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KID BRANDS, INC AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
In connection with the Seller Note: (i) TRC and specified subsidiaries granted a lien (junior
to the lien of Wells Fargo Bank, National Association (WF), TRCs senior lender) to KID on
substantially all of their respective assets, and such subsidiaries
guaranteed the payment (subject to intercreditor arrangements described below) of all
obligations to KID under the Seller Note; and (ii) KID entered into an Intercreditor Agreement with
WF, pursuant to which payment of the Seller Note was fully subordinated to payment of TRCs
obligations under its credit facility with WF.
In addition, in connection with the Gift Sale, a limited liability company wholly-owned by KID
(the Licensor) executed a license agreement (the License Agreement) with TRC permitting TRC to
use specified intellectual property, consisting generally of the Russ and Applause trademarks
and trade names (the Retained IP). Pursuant to the License Agreement, TRC was required to pay the
Licensor a fixed, annual royalty (the Royalty) equal to $1,150,000. The initial annual royalty
payment was due and payable in one lump sum on December 31, 2009. Thereafter, the Royalty was
required to be paid quarterly at the close of each three-month period during the term. TRC did not
pay the initial lump sum Royalty payment. KID received $287,500 in respect of the Royalty payment
due March 23, 2010, which was recorded as other income in the first quarter of 2010, but did not
receive any other payments in respect of the Royalty, and therefore recorded no further income
related to such Royalties.
The Settlement
The Settlement, among other things: (i) includes a release of KID by and on behalf of the
Debtors estates (without the requirement of any cash payment) from all claims, including
fraudulent conveyance and preference claims under the Code, and claims pertaining to KIDs sale of
the gift business to TRC; (ii) confirms that the Seller Note and KIDs security interests therein
are valid, and are junior only to TRCs senior lender; (iii) allows KID to retain ownership of the
Retained IP, provided, that the trustee in the bankruptcy may include such intellectual property as
part of a global sale of TRCs business, if any, as long as KID receives at least $6.0 million
therefor; (iv) includes a set-off against the Seller Note of all amounts owed by KID and its
subsidiaries to TRC and its subsidiaries, for which KID had accrued an aggregate of approximately
$2.0 million, without the requirement of any cash payment; (v) establishes distribution priorities
for any proceeds obtained from the sale of TRCs assets under which KID is generally entitled to
receive, to the extent proceeds are available therefor after the payment of amounts owed to TRCs
senior lender and approximately $1.4 million in specified expenses have been funded, approximately
$1.0 million, and to the extent further proceeds are available subsequent to the payment of
approximately $1.0 million to the Debtors estates for additional specified expenses, 60% of any
remaining proceeds (40% of any such remaining proceeds will go to the Debtors estates for the
benefit of general unsecured creditors, and KID may participate therein as an unsecured creditor to
the extent of 50% of any deficiency claims, including for unpaid royalties). As it is not possible
to determine the amount, if any, that the trustee in the bankruptcy will obtain through the sale of
TRCs assets, KID may obtain only limited recovery on its remaining claims, or may obtain no
recovery at all. In addition, the Settlement provides that the Trustee will cooperate, at KIDs
expense, with KIDs efforts to resolve the claim asserted by the landlord under the TRC Lease
described above (however, the Settlement does not impact amounts potentially owed to the landlord
under such TRC Lease). The Debtors estates rights with respect to the Retained IP will terminate
at the earlier of 6 months from the date of the entry of the Bankruptcy Courts sale order and the
date of liquidation of TRCs operations in the United States, Canada, the United Kingdom and
Australia. Pursuant to the Settlement, KID waives its claims to Royalties as a result of the
liquidation, except that it will be entitled to a 5% royalty on any inventory sold by a third party
liquidator retained by the Trustee as part of the liquidation process. In addition, any bidder for
the stock of the Debtors U.K., Australia or Canada subsidiaries may include a request to use KIDs
Retained IP on a non-exclusive basis in the U.K., Australia or Canada, respectively, for a five
percent (5%) royalty for a period of up to two (2) years. The Trustee has also agreed to
cooperate in the removal of any persons designated by TRC to the board of directors of the
Licensor, and shall waive the right to designate any additional members to such board.
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ITEM 2. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
The financial and business analysis below provides information which we believe is relevant to
an assessment and understanding of our consolidated financial condition, changes in financial
condition and results of operations. This financial and business analysis should be read in
conjunction with our Unaudited Consolidated Financial Statements and accompanying Notes to
Unaudited Consolidated Financial Statements set forth in Part I, Financial Information, Item 1,
Financial Statements of this Quarterly Report on Form 10-Q, our Quarterly Report on Form 10-Q for
the quarter ended March 31, 2011 (the Q1 10-Q) and our Quarterly Report on Form 10-Q for the
quarter ended June 30, 2011, as amended (the Q2 10-Q) and our Annual Report on Form 10-K for the
year ended December 31, 2010, as amended (the 2010 10-K), including the consolidated financial
statements and notes thereto.
OVERVIEW
We are a leading designer, importer, marketer and distributor of branded infant and juvenile
consumer products. Through our four wholly-owned operating subsidiaries Kids Line, LLC (Kids
Line); LaJobi, Inc. (LaJobi); Sassy, Inc. (Sassy); and CoCaLo, Inc. (CoCaLo) we design
and market branded infant and juvenile products in a number of complementary categories including,
among others: infant bedding and related nursery accessories and décor, food preparation and
nursery appliances, bath/spa products and diaper bags (Kids Line® and
CoCaLo®); nursery furniture and related products (LaJobi®); and developmental
toys and feeding, bath and baby care items with features that address the various stages of an
infants early years (Sassy®). In addition to our branded products, we also market
certain categories of products under various licenses, including Carters®,
Disney®, Graco® and Serta®. Our products are sold primarily to
retailers in North America, the United Kingdom (U.K.) and Australia, including large, national
retail accounts and independent retailers (including toy, specialty, food, drug, apparel and other
retailers). We maintain a direct sales force and distribution network to serve our customers in the
United States, the U.K. and Australia. We also maintain relationships with several independent
representatives to service select domestic and foreign retail customers, as well as international
distributors to service certain retail customers in several foreign countries.
We generated net sales of approximately $69.5 million and $189.6 million for the
three and nine months ended September 30, 2011, respectively. International sales, defined as
sales outside of the United States, including export sales, constituted 7.9% and 9.0% of our net
sales for the nine months ended September 30, 2011 and 2010, respectively. One of our long-term
strategies is to increase our international sales, both in absolute terms and as a percentage of
total sales, as we seek to expand our presence outside of the United States.
Consistent with our strategy of building a confederation of complementary businesses, each
subsidiary in our infant and juvenile business is operated substantially independently by a
separate group of managers. Our senior corporate management, together with senior management of our
subsidiaries, coordinates the operations of all of our businesses and seeks to identify
cross-marketing, procurement and other complementary business opportunities.
Aside from funds provided by our senior credit facility, revenues from the sale of products
have historically been the major source of cash for the Company, and cost of goods sold and payroll
expenses have been the largest uses of cash. As a result, operating cash flows primarily depend on
the amount of revenue generated and the timing of collections, as well as the quality of customer
accounts receivable. The timing and level of the payments to suppliers and other vendors also
significantly affect operating cash flows. Management views operating cash flows as a good
indicator of financial strength. Strong operating cash flows provide opportunities for growth both
internally and through acquisitions, and also enable us to pay down debt.
We do not ordinarily sell our products on consignment (although we may do so in limited
circumstances), and we ordinarily accept returns only for defective merchandise. In the normal
course of business, we grant certain accommodations and allowances to certain customers in order to
assist these customers with inventory clearance or promotions. Such amounts, together with
discounts, are deducted from gross sales in determining net sales, and also have significant affect
on operating cash flows.
Our products are manufactured by third parties, principally located in the PRC and other
Eastern Asian countries. Our purchases of finished products from these manufacturers are primarily
denominated in U.S. dollars. Expenses for these manufacturers are primarily denominated in Chinese
Yuan. As a result, any material increase in the value of the Yuan relative to the U.S. dollar, as
occurred in past periods, or higher rates of inflation in the country of origin, would increase our
expenses, and therefore adversely affect our profitability. Conversely, a small portion of our
revenues are generated by our subsidiaries in Australia and the U.K. and are denominated primarily
in their local currencies. Any material increase in the value of the U.S. dollar relative to the
value of the Australian dollar or British pound would result in a decrease in the amount of these
revenues upon their translation into U.S. dollars for reporting purposes. See Item 1A, Risk Factors
Currency exchange rate fluctuations could increase our expenses, of the 2010 10-K.
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Our gross profit may not be comparable to those of other entities, since some entities include
the costs of warehousing, outbound handling costs and outbound shipping costs in their costs of
sales. We account for the above expenses as operating expenses and classify them under selling,
general and administrative expenses. The costs of warehousing, outbound handling costs and
outbound shipping costs were $1.8 million and $1.9 million, for the three months ended September
30, 2011 and 2010, respectively. The costs of warehousing, outbound handling costs and outbound
shipping costs were $5.7 million and $5.3 million, for the nine months ended September 30, 2011 and
2010, respectively. In addition, the majority of outbound shipping costs are paid by our
customers, as many of our customers pick up their goods at our distribution centers.
If our suppliers experience increased raw materials, labor or other costs, and pass along such
cost increases to us through higher prices for finished goods, our cost of sales would increase.
Many of our suppliers are currently experiencing significant cost pressures related to labor rates,
raw material costs and currency inflation, which has and, we believe, will continue to put pressure
on our gross margins, at least for the foreseeable future. To the extent we are unable to pass
such price increases along to our customers or otherwise reduce our cost of goods, our gross profit
margins would decrease. Our gross profit margins have also been impacted in recent periods by: (i)
a shift in product mix toward lower margin products, including increased sales of licensed
products, which typically generate lower margins as a result of required royalty payments (which
are recorded in cost of goods sold); (ii) increased pressure from major retailers, largely as a
result of prevailing economic conditions, to offer additional mark downs and other pricing
accommodations to clear existing inventory and secure new product placements; and (iii) other
increased costs of goods. We believe that our future gross margins will continue to be under
pressure as a result of the items listed above, and such pressures may be more acute over the next
several quarters as a result of anticipated product cost increases. See Note 10 of the Notes to
Unaudited Consolidated Financial Statements for a description of accruals for anticipated customs
duty and interest payment requirements related to (i) certain wooden furniture imported by our
LaJobi subsidiary from the PRC (until January of 2011), which accruals have further adversely
impacted our gross margins and net loss/income for the nine months ended September 30, 2011, and
the quarter and year ended December 31, 2010 and (ii) the findings of our ongoing Customs Review,
which accruals have further adversely impacted our gross margins and net loss for the nine months
ended September 30, 2011.
We continue to seek to mitigate margin pressure through the development of new products that
can command higher pricing; the identification of alternative, lower-cost sources of supply,
re-engineering of certain existing products to reduce manufacturing costs; and, where possible,
price increases. Particularly in the mass market, our ability to increase prices or resist
requests for mark-downs and/or other allowances is limited by market and competitive factors, and,
while we have implemented selective price increases and will likely continue to seek to do so, we
have not been able to increase prices commensurate with our cost increases and have generally
focused on maintaining (or increasing) shelf space at retailers and, as a result, our market share.
Inventory and Intangible Assets
Inventory, which consists of finished goods, is carried on our balance sheet at the lower of
cost or market. Cost is determined using the weighted average cost method and includes all costs
necessary to bring inventory to its existing condition and location. Market represents the lower
of replacement cost or estimated net realizable value of such inventory. Inventory reserves are
recorded for damaged, obsolete, excess and slow-moving inventory if management determines that the
ultimate expected proceeds from the disposal of such inventory will be less than its carrying cost
as described above. Management uses estimates to determine the necessity of recording these
reserves based on periodic reviews of each product category based primarily on the following
factors: length of time on hand, historical sales, sales projections (including expected sales
prices), order bookings, anticipated demand, market trends, product obsolescence, the effect new
products may have on the sale of existing products and other factors. Risks and exposures in
making these estimates include changes in public and consumer preferences and demand for products,
changes in customer buying patterns, competitor activities, our effectiveness in inventory
management, as well as discontinuance of products or product lines. In addition, estimating sales
prices, establishing markdown percentages and evaluating the condition of our inventories all
require judgments and estimates, which may also impact the inventory valuation. However, we believe
that, based on our prior experience of managing and evaluating the recoverability of our slow
moving, excess, damaged and obsolete inventory in response to market conditions, including
decreased sales in specific product lines, our established reserves are materially adequate. If
actual market conditions and product sales were less favorable than we have projected, however,
additional inventory reserves may be necessary in future periods.
Indefinite-lived intangible assets are reviewed for impairment at least annually, and more
frequently if a triggering event occurs indicating that an impairment may exist. The Companys
annual impairment testing is performed in the fourth quarter of each year (unless specified
triggering events warrant more frequent testing). All intangible assets, both definite-lived and
indefinite-lived, were tested for impairment in the fourth quarter of 2010. There were no
impairments of intangible assets in 2010. In accordance with applicable accounting standards, the
Company determined that interim testing of intangible assets (definite and indefinite-lived) was
not warranted for the three and nine months ended September 30, 2011 as no triggering events
occurred during such periods. We will continue to evaluate the carrying amounts of our intangible
assets.
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Recent Developments
Interim Executive Chairman
Effective September 12, 2011, Bruce G. Crain resigned as President and Chief Executive Officer
of the Company. In connection therewith, Mr. Crain also resigned his position as a member of the
Board of Directors (the Board) of the Company and all other positions with the Company and its
subsidiaries. In addition, as of September 12, 2011, Raphael Benaroya was appointed by the Board to
the position of interim Executive Chairman, to serve as the chief executive of the Company during
the pendency of the Boards search for a new chief executive officer. A Search Committee of the
Board has been created to oversee the process for the selection of a new chief executive officer
and an executive search firm has been retained to conduct the search. Details with respect to these
events are set forth in the Companys Current Report on Form 8-K filed on September 14, 2011.
Putative Class Action and Derivative Litigations.
See Part II, Item I, Legal Proceedings, for a discussion of recent developments with respect
to the putative class action proceeding and derivative proceeding instituted against the Company
and various of its officers and directors, including the filing of an amended complaint in the
putative class action eliminating the directors other than Mr. Benaroya as defendants, the
subsequent filing of a voluntary dismissal without prejudice of the class action proceeding against
Mr. Benaroya, and the dismissal without prejudice of the derivative action as to all defendants.
Refinancing of Senior Indebtedness
KID and specified domestic subsidiaries executed a Second Amended and Restated Credit
Agreement as of August 8, 2011, with certain financial institutions, including Bank of America,
N.A., among other things, as Administrative Agent. This amendment and restatement represents a
refinancing of the Companys senior secured debt under the Old Credit Agreement (defined in Debt
Financings below), and provides for an aggregate $175.0 million revolving credit facility (without
borrowing base limitations), with a $25.0 million sub-facility for letters of credit, and a $5.0
million sub-facility for swing-line loans. KID is entitled to increase the amount of this new
revolver by up to an additional $35.0 million, provided that, among other things, no defaults have
occurred and are continuing and commitments are received for such increase (from existing lenders
or certain third party financial institutions). The refinancing, among other things, increases
borrowing capacity previously available under the Old Credit Agreement (which provided for a $50.0
million revolver based on eligible receivables and inventory, with a $5.0 million sub-facility for
letters of credit, and an $80.0 million term loan), lowers minimum and maximum interest rate
margins and is described in detail under Liquidity and Capital Resources below under the section
captioned Debt Financings.
TRC Matters
See Note 12 of the Notes to Unaudited Consolidated Financial Statements for a discussion of
the bankruptcy filing of TRC and its domestic subsidiaries, and a settlement agreement approved by
the Bankruptcy Court with the secure creditors of the debtors, including KID.
See Note 10 of the Notes to Unaudited Consolidated Financial Statements for a discussion of
potential obligations of KID with respect to the TRC Lease (and an accrual recorded with respect to
amounts anticipated to be owed to the landlord thereunder).
LaJobi Matters
See Note 10 of Notes to Unaudited Consolidated Financial Statements for a description of: (i)
the Focused Assessment of our LaJobi subsidiarys import practices and procedures by U.S.
Customs, charges recorded in each of the first three quarters of 2011, and the quarter and year
ended December 31, 2010 in connection therewith, and actions taken by the Company as a result
thereof; and (ii) a discussion of certain payment practices with respect to individuals providing
quality control, compliance and certain other services in the PRC, Hong Kong, Vietnam and Thailand,
and actions taken by the Company in connection therewith, as well as a description of an informal
investigation by the SEC into these matters.
Customs Compliance Investigation
See Note 10 of Notes to Unaudited Consolidated Financial Statements for a description of a
review authorized by the Board of customs compliance practices at the Companys non-LaJobi
subsidiaries, charges recorded in the second and third quarters of 2011 in connection therewith, a
related investigation initiated by the Board with respect to such review and other actions taken by
the Company as a result thereof.
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Company Outlook
The principal elements of our current global business strategy include:
| focusing on design-led and branded product development at each of our
subsidiaries to enable us to continue to introduce compelling new products; |
||
| pursuing organic growth opportunities to capture additional market share,
including: |
(i) | expanding our product offerings into related categories; |
||
(ii) | increasing our existing product penetration (selling more products
to existing customer locations); |
||
(iii) | increasing our existing store or online penetration (selling to
more store locations within each large, national retail customer or their
associated websites); and |
||
(iv) | expanding and diversifying of our distribution channels, with
particular emphasis on sales into international markets and non-traditional
infant and juvenile retailers; |
| growing through licensing, distribution or other strategic alliances, including
pursuing acquisition opportunities in businesses complementary to ours; |
| implementing strategies to further capture synergies within and between our
confederation of businesses, through cross-marketing opportunities, consolidation of
certain operational activities and other collaborative activities; and |
| continuing efforts to manage costs within and across each of our businesses. |
General Economic Conditions as they Impact Our Business
Our business, financial condition and results of operations have and may continue to be
affected by various economic factors. Periods of economic uncertainty, such as the recession
experienced in 2008 and much of 2009, as well as more recent market disruptions, can lead to
reduced consumer and business spending, including by our customers, and the purchasers of their
products, as well as reduced consumer confidence, which we believe has resulted in lower birth
rates, although recent third party forecasts have suggested declining birth trends are likely to
reverse with modest improvements in the economy. Reduced access to credit has and may continue to
adversely affect the ability of consumers to purchase our products from retailers, as well as the
ability of our customers to pay us. If such conditions are experienced in future periods, our
industry, business and results of operations may be negatively impacted. Continuing adverse global
economic conditions in our markets may result in, among other things: (i) reduced demand for our
products; (ii) increased price competition for our products; and/or (iii) increased risk in the
collectibility of cash from our customers. See Item 1A, Risk FactorsThe state of the economy may
impact our business of the 2010 10-K.
In addition, if internal funds are not available from our operations, we may be required to
rely on the banking and credit markets to meet our financial commitments and short-term liquidity
needs. Continued disruptions in the capital and credit markets, could adversely affect our ability
to draw on our bank revolving credit facility. Our access to funds under our credit facility is
dependent on the ability of the banks that are parties to such facility to meet their funding
commitments. Those banks may not be able to meet their funding commitments to us if they experience
shortages of capital and liquidity or if they experience excessive volumes of borrowing requests
from us and other borrowers within a short period of time. Such disruptions could require us to
take measures to conserve cash until the markets stabilize or until alternative credit arrangements
or other funding for our business needs can be arranged. See Item 1A, Risk FactorsFurther
potential disruptions in the credit markets may adversely affect the availability and cost of
short-term funds for liquidity requirements and our ability to meet long-term commitments, which
could adversely affect our results of operations, cash flows, and financial condition of the 2010
10-K.
SEGMENTS
The Company operates in one segment: the infant and juvenile business.
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RESULTS OF OPERATIONSTHREE MONTHS ENDED SEPTEMBER 30, 2011 AND 2010
Net sales for the three months ended September 30, 2011 decreased 2.3% to $69.5 million,
compared to $71.1 million for the three months ended September 30, 2010. This decrease was
primarily the result of lower sales at each of LaJobi (down approximately 12.4% from the prior year
period as a result of lower sales volume due to decreased demand), and Sassy (down approximately
3.3% from the prior year period as a result of lower sales volume). Such decreases were partially
offset by growth at Kids Line (up approximately 10.1% from the prior year period as a result of
reduced markdown allowances and increased sales). Net sales at CoCaLo were flat for the third
quarter of 2011, as compared to the prior year period.
Gross profit was $18.6 million, or 26.7% of net sales, for the three months ended September
30, 2011, as compared to $20.6 million, or 29.0% of net sales, for the three months ended September
30, 2010. Gross profit decreased primarily as a result of: (i) higher product costs at Kids Line
and LaJobi; (ii) additional inventory reserves related to certain underperforming product lines at
Kids Line (approximately $0.2 million); (iii) $0.2 million of additional warehouse expense as a
result of higher inventory levels; and (iv) on an absolute basis, lower net sales, all of which was
partially offset by a reduction in markdown allowances in the approximate amount of $2.3 million.
Selling, general and administrative expense was $16.3 million, or 23.5% of net sales, for the
three months ended September 30, 2011 compared to $13.7 million, or 19.3% of net sales, for the
three months ended September 30, 2010. Selling, general and administrative expense increased
primarily as a result of: (i) professional fees incurred in the aggregate amount of approximately
$1.4 million in connection with the Companys internal investigation of LaJobis import, business
and staffing practices in Asia (the LaJobi Investigation) and Customs compliance investigations
at Kids Line and CoCaLo, as well as related litigation and other costs (collectively, the Customs
Costs); (ii) $0.8 million of transition costs related to the resignation of our former CEO,
consisting primarily of severance and other benefits (of which approximately $0.4 million is a
non-cash charge related to the acceleration of vesting of certain equity awards) (collectively CEO
Transition Costs); (iii) approximately $0.7 million of trade show costs incurred in the third
quarter of 2011, whereas similar costs were incurred in the fourth quarter during 2010; and (iv) on
a percentage basis, a lower sales base.
Other expense was $2.1 million for the three months ended September 30, 2011 as compared to
$0.8 million for the three months ended September 30, 2010. This increase of approximately $1.3
million was primarily due to: (i) a $1.0 million non-cash write-off of deferred financing costs
originally incurred in connection with the Old Credit Agreement (defined in Debt Financings
below); (ii) a $0.2 million foreign exchange loss in the third quarter of 2011 compared to a $0.1
million foreign exchange gain during the comparable 2010 period and (iii) an additional $0.1
million of interest recorded in the third quarter of 2011 associated with anticipated customs duty
payment requirements in connection with the LaJobi Investigation and the Customs Review ($56,000
and $30,000, respectively), all of which was offset by a $0.1 million reduction in interest expense
due to lower borrowings and lower borrowing costs in such period compared to the same period in
2010.
The income tax provision for the three months ended September 30, 2011 was $246,000 on income
before income tax provision of $166,000. The difference between the effective tax rate of 148.5%
for the three months ended September 30, 2011 and the U.S. federal tax rate of 35% primarily
relates to: (1) the true-up of prior year federal and state estimates in the aggregate amount of
$166,000; (2) a provision for state tax, net of federal tax benefit, in the amount of $60,000; (3)
an increase in the liability for unrecognized tax benefits of $7,000 as a result of additional
interest being accrued; and (4) the effect of permanent adjustments of $9,000; offset by foreign
adjustments related to foreign rate differences and unrepatriated foreign earnings in the amount of
$54,000. The income tax provision for the three months ended September 30, 2010 was approximately
$2,189,000 on income before tax provision of approximately $6,149,000. The difference between the
effective tax rate of 36% for the three months ended September 30, 2010 and the U.S. federal tax
rate of 35% primarily relates to: (1) the provision for state taxes, net of federal tax benefit, in
the amount of $282,000; (2) the true-up of prior year federal and state estimates in the aggregate
amount of $39,000; (3) foreign adjustments related to foreign rate differences and withholding
taxes in the amount of $38,000; and (4) the effect of permanent adjustments of $50,000; offset by
(i) state tax credits generated and utilized in the amount of $254,000; and (ii) settlement of a
liability for unrecognized tax benefits of $56,000.
As a result of the foregoing, net loss for the three months ended September 30, 2011 was
$80,000 or ($0.00) per diluted share, compared to net income of $4.0 million, or $0.18 per diluted
share, for the three months ended September 30, 2010.
RESULTS OF OPERATIONSNINE MONTHS ENDED SEPTEMBER 30, 2011 AND 2010
Net sales for the nine months ended September 30, 2011 decreased 5.4% to $189.6 million,
compared to $200.5 million for the nine months ended September 30, 2010. This decrease was
primarily the result of lower sales at LaJobi (down approximately 15.7% from the prior year period
as a result of lower sales volume due to decreased demand). Such decrease was partially offset by
growth at each of CoCaLo (up approximately 8.2% from the prior year period as a result of increased
sales volume resulting from the
strong performance of top-selling collections), Sassy (up approximately 3.3% from the prior
year period as a result of increased sales volume, despite the discontinuation of sales of sleep
positioners that generated $1.1 million of sales in the prior year period), and Kids Line (up
approximately 0.5% from the prior year period primarily as a result of reduced markdown
allowances).
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Gross profit was $49.2 million, or 25.9% of net sales, for the nine months ended September 30,
2011, as compared to $60.0 million, or 29.9% of net sales, for the nine months ended September 30,
2010. Gross profit decreased primarily as a result of: (i) a $2.2 million accrual for anticipated
customs duty payment requirements resulting from the Customs Review; (ii) an accrual aggregating
$0.7 million for remediation activities to bring certain LaJobi cribs into compliance with new
federal crib safety standards that went into effect on June 28, 2011; (iii) additional inventory
reserves related to certain underperforming product lines (approximately $1.2 million primarily
related to a discontinued product program at Kids Line); (iv) $0.3 million in increased warehouse
expense as a result of higher inventory levels; and (v) $0.3 million for anticipated customs duty
payment requirements resulting from the LaJobi Investigation; and (vi) on an absolute basis, lower
net sales, all of which was partially offset by a reduction in markdown allowances in the amount of
$3.3 million.
Selling, general and administrative expense was $46.5 million, or 24.5% of net sales, for the
nine months ended September 30, 2011 compared to $38.5 million, or 19.2% of net sales, for the nine
months ended September 30, 2010. Selling, general and administrative expense increased primarily as a result of: (i) an aggregate of $4.5 million in Customs Costs;
(ii) the $1.1 million accrual in connection with the TRC Lease; (iii) $0.8 million of CEO
Transition Costs; (iv) approximately $0.7 million of trade show costs incurred in the first nine
months ended September 30, 2011, whereas similar trade show costs were incurred in the fourth
quarter of 2010; (v) $0.5 million of increased warehouse, outbound handling and shipping costs as a
result of increased inventory; and (vi) on a percentage basis, a lower sales base.
The TRC valuation reserve adjustment of $2.0 million resulted from the TRC bankruptcy. As a
result of prior ongoing discussions with TRC with respect to the potential restructuring of the
consideration received by KID for the sale of its former gift business to TRC, KID had been
accruing, but not paying (since December 2009), amounts owed to TRC and certain of its subsidiaries
for the sublease of office and warehouse space (and related services) under a transition services
agreement (See Note 12 of the Notes to Unaudited Consolidated Financial Statements). The
Settlement (discussed in Note 12 of Notes to Unaudited Consolidated Financial Statements) includes,
among other things, a set-off against the Seller Note of all amounts owed by the Company to TRC and
its subsidiaries, including the sublease and related amounts discussed above. As a result, the
amounts that had previously been accrued were reversed during the nine months period ended
September 30, 2011 by reducing the valuation allowance previously recorded in June 2009 against the
consideration received in connection with the Gift Sale.
Other expense was $4.3 million for the nine months ended September 30, 2011 as compared to
$2.6 million for the nine months ended September 30, 2010. This increase of approximately $1.7
million was primarily due to: (i) a $1.0 million non-cash write-off of deferred financing costs
originally incurred in connection with the Old Credit Agreement (defined in Debt Financings
below); (ii) $0.3 million in royalty income recorded in 2010 that was not a factor in 2011; (iii) a
favorable change of $0.7 million in the fair market value of an interest rate swap agreement in the
first nine months of 2010, which was not a factor in the first nine months of 2011; (iv) a $0.1
million foreign exchange loss in the first nine months of 2011 compared to a $0.1 million foreign
exchange gain during the comparable 2010 period; (v) $0.1 million in fees for the March 2011
Amendment (defined in Debt Financings below): and (vi) an additional $0.4 million of interest
recorded in the first nine months of 2011 associated with anticipated customs duty payment
requirements in connection with the LaJobi Matters and the Customs Review ($0.2 million and $0.2 million, respectively), all of which was offset
by a reduction ($1.0 million) in interest expense due to lower borrowings and lower borrowing costs
in such period compared to the same period in 2010.
The income tax provision for the nine months ended September 30, 2011 was $4.7 million on
income before income tax provision of $0.4 million. The difference between the effective tax rate
of 1,117.9% for the nine months ended September 30, 2011 and the U.S. federal tax rate of 35%
primarily relates to the following discrete items: (1) a change in the valuation allowance against
deferred tax assets associated with the sale of the Companys former gift business in light of the
TRC bankruptcy filing in the amount of $3.6 million, (2) an adjustment to the state deferred tax
asset related to the enactment of a single sales factor in New Jersey in the amount of $0.6
million, (3) an increase for unrecognized tax benefits of $0.2 million, and (4) the true-up of
prior year federal and state estimates in the aggregate amount of $166,000. The difference between
the U.S. federal tax rate of 35% and the estimated effective tax rate for the year (excluding
discrete items) of 42.7% primarily relates to: (1) a provision for state tax, net of federal
benefit $22,000; and (2) the effect of permanent adjustments of $10,000. The income tax provision
for the nine months ended September 30, 2010 was $7.0 million on income before income tax provision
of $18.9 million. The difference between the effective tax rate of 37% for the nine months ended
September 30, 2010 and the U.S. federal tax rate of 35% primarily relates to the provision for
state taxes, net of federal tax benefit, in the amount of $964,000; offset by: (1) state tax
credits generated and utilized of $254,000, (2) true-up of prior year tax estimates of $133,000,
and (3) settlement of a liability for unrecognized tax benefits of $42,000.
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As a result of the foregoing, net loss for the nine months ended September 30, 2011 was $4.3
million, or ($0.20) per diluted share, compared to net income of $11.9 million, or $0.54 per
diluted share, for the nine months ended September 30, 2010.
Liquidity and Capital Resources
Our principal sources of liquidity are cash and cash equivalents, funds from operations, and
availability under our bank facility. Our operating activities generally provide sufficient cash to
fund our working capital requirements and, together with borrowings under our bank facility, are
expected to be sufficient to fund our operating needs and capital requirements for at least the
next 12 months (including expected customs duty assessments and related interest), based on current
assumptions regarding the timing of such expenditures. Any significant deviation in the timing of
such expenditures from current estimates or significant business or product acquisitions, earnout
payments (if any) or other unanticipated expenses (including additional customs duty assessments
and related interest in excess of current accruals, and/or any related penalties) may require
additional debt or equity financing. As is described in Recent Developments above, and
Liquidity and Capital Resources below under the section captioned Debt Financings, as of August
8, 2011, the Company refinanced its senior secured debt to provide for an aggregate $175.0 million
revolving credit facility, subject to an additional $35.0 million increase in the aggregate
commitment amount under specified circumstances. The Companys previous credit facility provided
for a $50.0 million revolver based on eligible receivables and inventory, and an $80.0 million term
loan. In addition to increased borrowing capacity, anticipated benefits from the refinancing also
include the elimination of borrowing base limitations, reduced debt service requirements (as our
prior term loan was paid in full), lower minimum and maximum interest rate margins, an extended
maturity date, and a generally less restrictive payment and cash utilization structure.
Historically, the proceeds of our bank facility have been used to fund acquisitions, and cash
flows from operations were utilized to pay down our revolving credit facility and required
amortization of our term loan. Accordingly, with the exception of funding short-term working
capital requirements (which were necessitated by our strategy of paying down debt), we typically
did not actively utilize our revolving credit facility to fund operations. As a result of the New
Credit Agreement, our term loan was paid in full, and outstanding amounts under our revolver were
reallocated among the refinancing lenders. The Company anticipates that cash flows from operations
will continue to be used to pay down our new revolving credit facility, as well as to potentially purchase shares under our share repurchase program (in each case to the extent available for
such purposes), and to pay associated interest on amounts outstanding under our revolver. Availability under the refinanced
revolver is intended to continue to be used to fund short-term working capital requirements,
including, expected Customs duty assessments and related interest,
and share repurchases, future acquisitions and/or
unanticipated expenses, if any.
As of September 30, 2011, the Company had cash and cash equivalents of $1.8 million, compared
to $1.1 million at December 31, 2010. Cash and cash equivalents increased by $0.7 million during
the nine months ending September 30, 2011 compared to the balance at December 31, 2010, primarily
reflecting fluctuations in debt repayment. As of September 30, 2011 and December 31, 2010, working
capital was $72.4 million and $43.2 million, respectively. The increase in working capital for the
period ended September 30, 2011 primarily reflects the reclassification of short-term debt to
long-term as a result of the execution of the New Credit Agreement and the reclassification of the
New Revolver thereunder as long-term debt (previously, our revolving credit facility was
characterized as short-term debt), as well as the fluctuations of accounts receivable and inventory
discussed in the following paragraph.
Net cash provided by operating activities was $11.1 million during the nine months ended
September 30, 2011, compared to net cash provided by operating activities of $11.2 million during
the nine months ended September 30, 2010. Cash provided by operating activities in the first nine
months of 2011 reflected (i) the net loss of $4.3 million in the first nine months of 2011, as
compared to net income of $11.9 million in the first nine months of 2010; (ii) a $6.0 million net
decrease in accounts receivable primarily resulting from lower sales during the 2011 period; (iii)
a $5.5 million increase in accrued expenses primarily due to the anticipated timing of payments for Customs
duties accrued; and (iv) a $1.1 million net decrease in inventory partially offset by a $7.3
million decrease in accounts payable due to the timing of inventory payments.
Net cash used in investing activities was $1.0 million and $1.1 million for the nine month
period ended September 30, 2011 and September 30, 2010, respectively. The 2011 expenditures were
primarily used for tooling, ERP system and leasehold improvements, while the 2010 expenditures were
primarily used for ERP system, tooling and office equipment.
Net cash used in financing activities was $9.4 million for the nine months ended September 30,
2011, as compared to net cash used in financing activities of $10.2 million for the nine months
ended September 30, 2010. The cash used during the nine months ended September 30, 2011 primarily
reflects borrowing for working capital needs, and the cash used for the nine months ended September
30, 2010 primarily reflects the repayment of debt under our previous credit agreement.
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Debt Financings
New Credit Agreement
As of August 8, 2011, KID and specified domestic subsidiaries (such entities collectively with
KID and such other future created or acquired domestic subsidiaries that are designated as
borrowers from time to time, the Borrowers), and the subsidiaries of the Borrowers identified as
guarantors therein (the Guarantors, and together with the Borrowers, the Loan Parties),
executed a Second Amended and Restated Credit Agreement (the New Credit Agreement) with certain
financial institutions (the Lenders), including Bank of America, N.A., as Administrative Agent,
Swing Line Lender and L/C Issuer, and Merrill Lynch, Pierce, Fenner & Smith Incorporated as Sole
Lead Arranger and Book Manager (ML). RB Trademark Holdco, LLC (Licensor), a limited liability
company wholly-owned by KID which licensed specified intellectual property to the buyer of the
Companys former gift business prior to its bankruptcy, will become a Loan Party when permitted
under its organizational documents (upon termination of the relevant license agreement). The
obligations of the Borrowers under the New Credit Agreement are joint and several.
The New Credit Agreement provides for an aggregate $175.0 million revolving credit facility
(the New Revolver), with a sub-facility for letters of credit in an amount not to exceed $25.0
million, and a sub-facility for swing-line loans in an amount not to exceed $5.0 million. Subject
to conditions to lending set forth in the New Credit Agreement, loans may be made up to the full
amount of the New Revolver (without borrowing base limitations), swing-line loans may be made up to
the full amount of the sublimit for swing-line loans, and letters of credit may be issued up to the
sublimit for letters of credit. KID also has the right (without the consent of any Lender or the
Administrative Agent) to increase the amount of the New Revolver by an additional aggregate amount
not to exceed $35.0 million, provided, among other things, that (i) no event of default or
unmatured event of default shall have occurred and be continuing, and (ii) the Borrowers receive
commitments for such increase. KID may offer such increase to existing Lenders or certain third
party financial institutions as described in the New Credit Agreement, however, no lender is
obligated to increase its commitment.
The New Credit Agreement amended and restated the Borrowers previously existing Amended and
Restated Credit Agreement with the Administrative Agent, as successor by merger to LaSalle Bank
National Association, and the other lenders party thereto, dated April 2, 2008, as amended on each
of August 13, 2008, March 20, 2009, and March 30, 2011 (collectively, the Old Credit Agreement),
which provided for a $50.0 million revolving credit facility (the Old Revolver) based on eligible
receivables and inventory, with a $5.0 million sub-facility for letters of credit, and an $80.0
million term loan facility (the Old Term Loan), which was scheduled to mature on April 1, 2013.
The New Credit Agreement represents a refinancing of the Borrowers senior secured debt under the
Old Credit Agreement. Additional details with respect to the Old Credit Agreement can be found in
Note 4 of the Notes to Unaudited Consolidated Financial Statements of the Q2 10-Q and in the
section captioned Old Credit Agreement below.
Upon the execution of the New Credit Agreement, the Borrowers drew down $47.5 million under
the New Revolver, and utilized the proceeds to repay the Old Term Loan in full. Outstanding
amounts under the Old Revolver (in the approximate amount of an additional $29.4 million) were
reallocated among the continuing Lenders in accordance with their respective commitments under the
New Credit Agreement. Outstanding letters of credit were deemed to have been issued under the New
Credit Agreement. In addition to increased borrowing capacity, anticipated benefits of the New
Credit Agreement include higher aggregate commitments, the elimination of borrowing base
limitations, reduced debt service requirements (as the Old Term Loan was paid in full), lower
minimum and maximum interest rate margins, an extended maturity date, and a generally less
restrictive payment and cash utilization structure.
At September 30, 2011, an aggregate of $65.3 million was borrowed under the New Revolver and
at December 31, 2010, an aggregate of $72.6 million was borrowed under the Old Credit Agreement
(consisting of $54.0 million of long-term debt outstanding under the Old Term Loan and $18.6
million of short-term debt outstanding under the Old Revolver). All amounts outstanding under the
New Credit Agreement at September 30, 2011 are classified as long-term debt as permitted by
applicable accounting standards. At September 30, 2011, revolving loan availability was $12.6
million. At December 31, 2010, revolving loan availability under the Old Credit Agreement was $28.3
million.
The aggregate amounts outstanding under the New Credit Agreement (other than letters of
credit, which may generally remain outstanding until August 1, 2017) are due and payable on August
8, 2016 (subject to customary early termination provisions).
The New Revolver bears interest, at the Borrowers option, at a specified base rate (the
higher of (x) the Administrative Agents prime rate and (y) the Federal Funds rate plus 0.50%), or
a specified Eurodollar rate based on specified British Bankers Association LIBOR, plus (in each
case) applicable margins. Applicable margins range from 1.75% to 2.75% on Eurodollar rate loans
and 0.75% to 1.75% on base rate loans, based on the Companys Consolidated Leverage Ratio (as
defined below) for the most recently ended fiscal quarter. At least until receipt by the
Administrative Agent and the Lenders of the financial statements and
compliance certificates with respect to the quarter ending September 30, 2011, the applicable
margins will be 2.75% for Eurodollar loans and 1.75% for base rate loans. Swing-line loans bear
interest at the base rate plus the applicable margin for base rate loans. Interest on base rate
loans is payable quarterly, and at maturity. Interest on Eurodollar loans is payable at the end of
the selected interest period (provided, that if the selected interest period is in excess of three
months, interest is payable on the three-month anniversary of the first day of such interest
period), and at maturity. During the continuance of any default under the New Credit Agreement, the
applicable margin shall increase by 2% (subject, in all cases other than a default in the payment
of principal, to the written consent of Lenders holding a majority of the commitments (the
Required Lenders) and prior written notice to KID).
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As of September 30, 2011, the applicable interest rate margins were: 2.75% for Eurodollar
Loans and 1.75% for Base Rate Loans. The weighted average interest rates for the outstanding loans
as of September 30, 2011was as follows:
At September 30, 2011 | ||||||||
Eurodollar Loans | Base Rate Loans | |||||||
New Revolver |
2.97 | % | 5.00 | % |
The Borrowers may prepay the New Revolver (and swing-line loans) at any time and from time to
time without premium or penalty, and without a corresponding commitment reduction (subject to
reimbursement of the Lenders breakage and redeployment costs in the case of Eurodollar rate
loans). The unutilized portion of the New Revolver may be reduced or terminated by the Borrowers at
any time and from time to time without premium or penalty.
Under the terms of the New Credit Agreement, the Company is required to comply with the
following financial covenants (the Financial Covenants): (a) a quarterly minimum Consolidated
Fixed Charge Coverage Ratio (defined below) of 1.50:1.00; and (b) a quarterly maximum Consolidated
Leverage Ratio (defined below) of 3.25:1.00 (stepping down to 3.00:1.00 for the quarter ending June
30, 2013, provided, that in the event a permitted acquisition is consummated prior to August 8,
2013, such maximum ratio shall remain 3.25:1.00 until the later of June 30, 2013 and the date that
is 18 months after such consummation).
The Consolidated Fixed Charge Coverage Ratio under the New Credit Agreement is the ratio of:
(a) Covenant EBITDA (as described below) for the most recently completed four quarters minus the
sum of (i) all unfinanced capital expenditures incurred during such period; (ii) all cash taxes
paid during such period; and (iii) all cash dividends paid by KID during such period, to (b) an
amount generally equal to, with respect to the Company, the sum for such period of all scheduled
interest and principal payments of debt, including the principal component of any capital lease,
paid or payable in cash. The Consolidated Leverage Ratio under the New Credit Agreement is the
ratio of the indebtedness of the Company to Covenant EBITDA for the most recently completed four
quarters. Indebtedness, as used in the determination of the maximum Consolidated Leverage Ratio,
generally means the outstanding principal amount of all debt (including obligations under capital
leases plus the face amount of all letters of credit). The Borrowers were in compliance with all
applicable Financial Covenants as of September 30, 2011.
Covenant EBITDA, as defined in the New Credit Agreement, is a non-GAAP financial measure used
to determine relevant interest rate margins and the Borrowers compliance with the Financial
Covenants, as well as the determination of whether certain repurchases of equity securities,
acquisitions, payments of specified Duty Amounts (defined below) and other specified customs duty
underpayments, and payment of LaJobi Earnout Consideration, if any, can be made if other specified
prerequisites are met, and the determination of the amount of specified fees. Covenant EBITDA is
defined generally as the net income of KID and its consolidated subsidiaries (excluding
extraordinary after-tax or non-recurring gains or losses, non-cash gains or losses from
dispositions other than the write-down of current assets, non-cash restructuring charges, tax
refunds, and net operating losses or other net tax benefits and any after-tax gains and losses from
discontinued operations), as adjusted for interest expense; income tax expense; depreciation;
amortization; other non-cash charges (gains); if expensed, reasonable costs incurred in connection
with the execution of the New Credit Agreement and related documentation; and non-cash transaction
losses (gains) due solely to fluctuations in currency values. Covenant EBITDA is further adjusted
(up to an aggregate maximum of $14.855 million for all periods, less any LaJobi Earnout
Consideration paid, if any, other than in accordance with the New Credit Agreement and/or to the
extent not deducted in determining consolidated net income) for: (i) all customs duties, interest,
penalties and other related amounts (Duty Amounts) owed by LaJobi to U.S. Customs and Border
Protection (U.S. Customs) to the extent they relate to the nonpayment or incorrect payment by
LaJobi of import duties to U.S. Customs on certain wooden furniture imported by LaJobi from vendors
in China resulting in a violation prior to March 30, 2011 of anti-dumping regulations, the related
misconduct on the part of certain LaJobi employees, and LaJobis business and staffing practices in
Asia prior to March 30, 2011 relating thereto (Duty Events); (ii) fees and expenses incurred in
connection with the internal and U.S. Customs investigation of the Duty Amounts and Duty Events
(the Investigations); and (iii) LaJobi Earnout Consideration, if any, paid in accordance with the
terms of the New Credit Agreement.
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The New Credit Agreement contains customary representations and warranties, as well as various
affirmative and negative covenants in addition to the Financial Covenants, including, without
limitation, financial reporting (including annual delivery of projections) requirements, notice
requirements with respect to specified events and required compliance certificates. In addition,
among other restrictions, the Loan Parties (and their subsidiaries other than the Licensor
until such time as it becomes a Loan Party) are prohibited from consummating a merger or other
fundamental change, paying dividends and making distributions, purchasing or redeeming stock,
incurring additional debt, making acquisitions, disposing of assets and other transactions outside
of the ordinary course of business, making specified payments and investments, engaging in
transactions with affiliates, paying Duty Amounts and other specified customs duty underpayments
(see Note 10 of the Notes to Unaudited Consolidated Financial Statements under paragraph (b)), or
paying any LaJobi Earnout Consideration, subject in each case to specified exceptions, some of
which are described below. The activities of the Licensor are also limited until it becomes
subject to the restrictions set forth above as a Loan Party.
At the time of any accrual in excess of $1.0 million, or proposed payment, of any Duty Amounts
or other specified customs duty underpayments (see Note 10 of the Notes to Unaudited Consolidated
Financial Statements under paragraph (b)): (i) the Consolidated Fixed Charge Coverage Ratio,
calculated on a pro forma basis as of the last day of the most recently ended quarter with respect
to the four most recently ended quarters ending on such date, as if such accrual or payment
occurred during such quarter, must be at least 1:50:1.0; or (ii) the Consolidated Leverage Ratio,
calculated on a pro forma basis as of the last day of the most recently ended quarter with respect
to the four most recently ended quarters ending on such date, as if such accrual or payment
occurred during such quarter, must be equal to or less than 3.25:1:0.
With respect to the payment by KID of dividends, among other things, so long as no event of
default or unmatured event of default then exists or would result therefrom, and no violation of
the Financial Covenants then exists or would result therefrom, KID may pay a regular quarterly
dividend, provided, however, that prior to such time that the focused assessment of U.S. Customs
has been deemed concluded and all Duty Amounts required thereby have been remitted by LaJobi (the
Duty Conclusion Date), such payments, when aggregated with permitted repurchases of KIDs equity
securities as described below, shall be limited to an aggregate amount not to exceed $5.0 million.
With respect to the repurchase by KID of its equity securities, among other things, so long as
no event of default or unmatured event of default then exists or would result therefrom, no
violation of the Financial Covenants then exists or would, on a pro forma basis, result therefrom,
and the Consolidated Leverage Ratio, on a pro forma basis, is at least 0.25x less than the maximum
then permitted, KID may repurchase or redeem its equity securities, provided, however, that prior
to the Duty Conclusion Date, such payments, when aggregated with permitted quarterly dividends as
described above, shall be limited to an aggregate amount not to exceed $5.0 million.
With respect to acquisitions, specified non-hostile acquisitions will be permitted (without a
ceiling on the purchase price therefor), provided that, among other things, immediately before and
after giving effect to such acquisition, no event of default or unmatured event of default exists,
the Loan Parties are in pro forma compliance with the Financial Covenants, the pro forma
Consolidated Leverage Ratio is at least 0.25x less than the maximum level then permitted, and
minimum availability under the New Revolver is at least $15.0 million.
Generally with respect to the payment of LaJobi Earnout Consideration, if any, both before and
immediately after giving effect to any such payment, (i) no event of default or unmatured event of
default may then exist or result therefrom, (ii) no violation of the Financial Covenants or
covenants with respect to Duty Amount accruals or payments may then exist or would, on a pro forma
basis, result therefrom, and (iii) the Consolidated Leverage Ratio (calculated on a pro forma
basis) is at least, if the Duty Conclusion Date has not yet occurred, 0.25 to 1.0 less than the
maximum then permitted.
Under the New Credit Agreement, KID may sell the membership interests or the assets of the
Licensor for fair market value without the consent of the Administrative Agent or the Lenders, so
long as all net cash proceeds from any such disposition are applied to the prepayment of
outstanding indebtedness under the New Credit Agreement (without a corresponding commitment
reduction).
The New Credit Agreement contains customary events of default (including any failure to remain
in compliance with the Financial Covenants), as well as specified defaults with respect to the
LaJobi Earnout Consideration. If an event of default occurs and is continuing (in addition to
default interest as described above, and other remedies available to the Lenders), with the consent
of the Required Lenders, the Administrative Agent is entitled to, and at the request of such
Lenders, the Administrative Agent is required to, declare commitments under the New Credit
Agreement to be terminated, declare outstanding obligations thereunder to be due and payable,
and/or demand cash collateralization of letters of credit (provided that upon events of bankruptcy,
the commitments will be immediately due and payable, and the Borrowers will be required to cash
collateralize letters of credit). In addition, an event of default under the New Credit Agreement
could result in a cross-default under certain license agreements that we maintain.
The New Credit Agreement also contains customary conditions to lending.
Although there were no Guarantors as of the date of execution of the New Credit Agreement,
Guarantors in the future will include domestic subsidiaries that do not become Borrowers in
accordance with the terms of the New Credit Agreement, and the
Borrowers with respect to specified swap contracts and treasury management agreements.
Guarantors will jointly and severally guarantee the payment of all obligations of the Borrowers
under the New Credit Agreement.
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In order to secure the obligations of the Loan Parties under the New Credit Agreement, each
Loan Party has pledged 100% of the equity interests of its domestic subsidiaries, including a
pledge of the capital stock of each Borrower (other than KID) and the Licensor, and 65% of the
equity interests of specified foreign subsidiaries, to the Administrative Agent, and has granted
security interests to the Administrative Agent in substantially all of its personal property (other
than the assets of the Licensor until it becomes a Loan Party), all pursuant to the terms of a
Second Amended and Restated Security and Pledge Agreement dated as of August 8, 2011 (the New
Security Agreement), which amends and restates the Amended and Restated Guaranty and Collateral
Agreement dated as of April 2, 2008, as amended, among the Borrowers in favor of the Administrative
Agent (the Old Security Agreement). As additional security for Sassy, Inc.s obligations under
the New Credit Agreement, Sassy, Inc. has continued its grant of a mortgage for the benefit of the
Administrative Agent and the continuing Lenders on the real property located at 2305 Breton
Industrial Park Drive, S.E., Kentwood, Michigan.
The Borrowers paid an arrangement fee to ML in an aggregate amount of approximately $656,000
and an up-front fee to the Lenders in an aggregate amount of approximately $665,000 in connection
with the execution of the New Credit Agreement and related documentation. The Borrowers are also
required to pay a quarterly commitment fee ranging from 0.30% to 0.45% (based on the Consolidated
Leverage Ratio) on the daily unused portions of the New Revolver (outstanding amounts under letters
of credit are considered utilization for this purposes; outstanding swing-line loans are not so
considered); letter of credit fees ranging from 1.75% to 2.75% (based on the Consolidated Leverage
Ratio) on the maximum daily amount available to be drawn, plus fronting fees and other customary
fees as are set forth in the New Credit Agreement.
Financing costs, including the arrangement fee and up-front fee, associated with the New
Credit Agreement will be deferred and amortized over the contractual term of the New Credit
Agreement. In connection with the execution of the New Credit Agreement, the Company also
wrote-off $1.0 million of unamortized deferred financing costs pertaining to the Old Credit
Agreement during the three and nine months ended September 30, 2011.
As described above, effective immediately upon the execution of the New Credit Agreement and
the New Security Agreement by the respective parties thereto, the terms and conditions of the Old
Credit Agreement and the Old Security Agreement were amended as set forth in, and restated in their
entirety and superseded by, the New Credit Agreement and the New Security Agreement, respectively.
In addition, as the obligations of the Guarantors are set forth in the New Credit Agreement and the
New Security Agreement, and equity pledges are included in the New Security Agreement, the Amended
and Restated Pledge Agreement dated as of April 2, 2008, as amended, by the Borrowers for the
benefit of the Lenders was terminated and superseded by the New Credit Agreement and the New
Security Agreement.
Interest Rate Swap Agreement
The Borrowers entered into an interest rate swap agreement as of December 21, 2010, with a
notional amount of $28.6 million. A net loss of $23,000 for such interest rate swap agreement was
recorded as interest expense for the three and nine months ended September 30, 2011 (see Note 7 of
Notes to Unaudited Consolidated Financial Statements).
Old Credit Agreement effective until August 8, 2011
The Old Credit Agreement provided for: (a) the Old Revolver ($50.0 million), with a
subfacility for letters of credit in an amount not to exceed $5.0 million, and (b) the Old Term
Loan ($80.0 million). The total borrowing capacity was based on a borrowing base, which was defined
as 85% of eligible receivables plus the lesser of (x) $25.0 million and (y) 55% of eligible
inventory. The scheduled maturity date of the facility was April 1, 2013.
Loans under the Old Credit Agreement bore interest, at the Borrowers option, at a base rate
or at LIBOR, plus applicable margins based on the most recent quarter-end Total Debt to Covenant
EBITDA Ratio. Applicable margins varied between 2.0% and 4.25% on LIBOR borrowings and 1.0% and
3.25% on base rate borrowings (base rate borrowings included a floor of 30 day LIBOR plus 1%). The
principal of the Old Term Loan was required to be repaid in quarterly installments of $3.25 million
through December 31, 2012, and a final payment of $28.0 million due on April 1, 2013. The Old Term
Loan was also required to be prepaid upon the occurrence, and with the proceeds, of certain
transactions, including most asset sales or debt or equity issuances, and extraordinary receipts.
The Borrowers were also required to pay an agency fee of $35,000 per annum, an annual non-use fee
of 0.55% to 0.80% of the unused amounts under the Old Revolver, as well as other customary fees as
are set forth in the Old Credit Agreement.
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Under the terms of the Old Credit Agreement, the Company was required to comply with the
following financial covenants: (a) a quarterly minimum Fixed Charge Coverage Ratio of 1.35:1.00;
(b) a quarterly maximum Total Debt to Covenant EBITDA Ratio of 2.75:1.00; and (c) an annual capital
expenditure limitation.
Due to the facts and circumstances discovered in connection with the Companys internal
investigation of LaJobis import, business and staffing practices in Asia (including misconduct by
various LaJobi employees resulting in the underpayment of specified import duties), the
approximately $6,860,000 charge we recorded for anticipated import duties and interest related
thereto, and additional amounts and penalties that may be required by U.S. Customs, we determined
that various events of default, and potential events of default under the Old Credit Agreement (and
related loan documents) occurred as a result of breaches and potential breaches of various
representations, warranties and covenants in the Old Credit Agreement, including, but not limited
to, an unmatured event of default with respect to a breach of the Fixed Charge Coverage Ratio
covenant for the quarter ended December 31, 2010 (as well as projected breaches of the Fixed Charge
Coverage Ratio and Total Debt to Covenant EBITDA Ratio for certain future periods). In connection
therewith, the Old Credit Agreement was amended on March 30, 2011 (the March 2011 Amendment), to
permanently waive, among other things, specified existing events of default resulting from such
LaJobi events and related breaches and potential breaches (and future events of default as a result
of the accrual or payment of Duty Amounts), and to amend the definition of Covenant EBITDA for
all purposes under the Old Credit Agreement and related loan documents (including for the
determination of the applicable interest rate margins and compliance with financial covenants) for
the December 31, 2010 reporting period and all periods thereafter. The Borrowers paid fees of
approximately $131,000 during the first quarter of 2011 in connection with the execution of the
March 2011 Amendment. As a result of the March 2011 Amendment, the Company was required to be in
compliance with the financial covenants described above at the time of any accrual in excess of
$1.0 million or proposed payment of any Duty Amounts. The fees for the March 2011 Amendment were
recorded as expense for the three months ended March 31, 2011.
Covenant EBITDA, for purposes of the Old Credit Agreement, was a non-GAAP financial measure
used to determine relevant interest rate margins and the Companys compliance with the financial
covenants set forth above, as well as the determination of whether certain dividends and
repurchases would have been permitted if other specified prerequisites were met. Covenant EBITDA
under the Old Credit Agreement was defined generally as consolidated net income (after excluding
specified non-cash, non-recurring and other specified items), as adjusted for interest expense;
income tax expense; depreciation; amortization; other non-cash charges (gains); specified costs in
connection with each of our senior financing, specified acquisitions, and specified requirements
under the Old Credit Agreement, and non-cash transaction losses (gains) due solely to fluctuations
in currency values. As a result of the March 2011 Amendment, Covenant EBITDA was further adjusted
(up to an aggregate maximum of $14.855 million for all periods, less LaJobi Earnout Consideration
paid, if any, other than in accordance with the Old Credit Agreement and/or to the extent not
deducted in determining consolidated net income) for: (i) all Duty Amounts owed by LaJobi to U.S.
Customs to the extent they related to the Duty Events; (ii) fees and expenses incurred in
connection with the Investigations; and (iii) LaJobi Earnout Consideration, if any, paid in
accordance with the terms of the Old Credit Agreement. For purposes of the Fixed Charge Coverage
Ratio, Covenant EBITDA was further adjusted for unfinanced capital expenditures; specified cash
taxes and distributions pertaining thereto; and specified cash dividends. The Fixed Charge Coverage
Ratio was the ratio of Covenant EBITDA to an amount generally equal to, with respect to the
Company, the sum for the applicable testing period of all scheduled interest and principal payments
of debt, including the principal component of any capital lease, paid or payable in cash. Total
Debt, as used in the Old Credit Agreement for purposes of the determination of the Total Debt to
Covenant EBITDA Ratio, generally meant, with respect to the Company, the outstanding principal
amount of all debt (including debt of capital leases plus the undrawn face amount of all letters of
credit).
The Old Credit Agreement also contained customary affirmative and negative covenants. Among
other restrictions, the Company was restricted in its ability to purchase or redeem stock, incur
additional debt, make acquisitions above certain amounts and pay any Earnout Consideration (LaJobi
or CoCaLo) or any amounts due with respect to a promissory note to CoCaLo as part of such
acquisition (the CoCaLo Note), unless in each case certain conditions were satisfied. With
respect to the payment of any LaJobi Earnout Consideration, as a result of the March 2011
Amendment, such conditions included that excess revolving loan availability equal or exceed the
greater of (A) $18,000,000 less the amount of any Duty Amounts previously paid by LaJobi to U.S.
Customs and (B) $9,000,000, until the Duty Conclusion Date, such that after the Duty Conclusion
Date, this condition would have required only that excess revolving loan availability equal or
exceed $9,000,000 (previously, such condition with respect to the payment of any Earnout
Consideration (LaJobi or CoCaLo) was limited to excess revolving loan availability being equal to
or exceeding $9,000,000, and such requirement with respect to the payment of any CoCaLo Earnout
Consideration remained unchanged). See Note 10 of the Notes to Unaudited Consolidated Financial
Statements for a discussion of the LaJobi Earnout Consideration (and related finders fee) in light
of the Duty Events and a demand letter from Mr. Bivonas counsel in connection therewith. No CoCaLo
Earnout Consideration was earned and the final installment of the CoCaLo Note was paid on April 2,
2011. The Old Credit Agreement also contained specified events of default related to the CoCaLo
Earnout Consideration and LaJobi Earnout Consideration. In addition, KID was not permitted to pay a
dividend to its shareholders unless the Earnout Consideration (LaJobi or CoCaLo), if any, had been
paid, no default existed or would result therefrom (including compliance with the financial
covenants), availability under the Old Revolver was at least $4.0 million, and the Total Debt to
Covenant EBITDA Ratio for the two most recently completed fiscal quarters was less than 2.00:1.00.
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Upon the occurrence of an event of default under the Old Credit Agreement, including a failure
to remain in compliance with all applicable financial covenants, the lenders could elect to declare
all amounts outstanding under the Old Credit Agreement to be immediately due and payable. In
addition, an event of default under the Old Credit Agreement could have resulted in a cross-default
under certain license agreements that we maintain. As a result of the March 2011 Amendment, among
other things, specified existing events of default related to the Duty Events (and specified future
events of default relating to the payment of any Duty Amounts) were permanently waived, and the
Borrowers were deemed to be in compliance with all applicable financial covenants in the Old Credit
Agreement as of December 31, 2010 (see discussion above).
Under the Old Credit Agreement, the Borrowers were required to maintain in effect Hedge
Agreements to protect against potential fluctuations in interest rates with respect to a minimum of
50% of the outstanding amount of the Old Term Loan. Pursuant to the requirement to maintain Hedge
Agreements, on May 2, 2008, the Borrowers entered into an interest rate swap agreement with a
notional amount of $70 million which expired on April 30, 2010. The Borrowers entered into a new
interest rate swap agreement with a notional amount of $31.9 million on April 30, 2010, which
expired December 21, 2010, and was replaced by a new interest rate swap agreement on such date with
a notional amount of $28.6 million. The December 2010 interest rate swap agreement was in effect
as of September 30, 2011 (see Interest Rate Swap Agreement above).
The Old Credit Agreement was secured by substantially all of the Companys domestic assets,
including a pledge of the capital stock of each Borrower and Licensor, and a portion of KIDs
equity interests in its active foreign subsidiaries, and was also guaranteed by KID.
Financing costs associated with the Old Credit Agreement were deferred and amortized over
their contractual term. The fees for the March 2011 Amendment ($131,000), were recorded as expense
in the consolidated statements of operations for the three months ended March 31, 2011.
Other Events and Circumstances Pertaining to Liquidity
A discussion of, among other things: (i) the Focused Assessment of KIDs LaJobi subsidiary,
charges recorded in connection therewith, and an informal SEC investigation pertaining thereto;
(ii) the Customs Review, charges recorded in connection therewith, and the Customs Investigation;
(iii) a putative class action filed against KID and certain of its officers and directors in March
of 2011, the filing of an amended complaint with respect thereto eliminating the directors other
than Mr. Benaroya as defendants, and the subsequent filing of a voluntary dismissal without
prejudice of the proceeding against Mr. Benaroya; (iv) a putative derivative shareholder litigation
instituted on May 20, 2011, and the subsequent dismissal without prejudice of such proceeding as to
all defendants; (v) the LaJobi Earnout Consideration in light of the Focused Assessment and
related investigations, and a demand letter from Mr. Bivonas counsel in connection therewith; (vi)
the voluntary bankruptcy petition filed by TRC and the Settlement entered into in connection
therewith; and (vii) a contingent liability associated with the TRC Lease and related complaint
filed against KID by the landlord (and charge recorded in connection therewith), can be found in
either the section captioned Recent Developments above or Notes 10 and 12 of Notes to Unaudited
Consolidated Financial Statements.
In addition to the matters referred to above, we are from time to time party to various
copyright, patent and trademark infringement, unfair competition, breach of contract, customs,
employment and other legal actions incidental to the Companys business, as plaintiff or defendant.
In the opinion of management, the amount of ultimate liability with respect to any such actions
that are currently pending will not, individually or in the aggregate, materially adversely affect
the Companys consolidated results of operations, financial condition or cash flows. In addition,
KID may remain obligated with respect to certain contracts and other obligations that were not
novated in connection with their transfer. To date, no payments have been made by KID in
connection with such contracts, nor is KID aware of any remaining potential obligations (other than
the TRC Lease described elsewhere herein), but there can be no assurance that payments will not be
required of KID in the future with respect thereto.
We commenced the implementation in 2010 of a new consolidated information technology system
for our operations, which we believe will provide greater efficiencies, and greater reporting
capabilities than those provided by the current systems in place across our individual infant and
juvenile companies. In connection with such implementation, we anticipate incurring aggregate costs
of approximately $3.7 million, of which $1.6 million has been incurred as of September 30, 2011.
We anticipate the balance of the costs to be incurred during the remainder of 2011 and 2012. Such
costs have been financed to date with borrowings under our credit facility, and are intended to be
so financed in the future. Our business may be subject to transitional difficulties as we replace
the current systems. These difficulties may include disruption of our operations, loss of data, and
the diversion of our management and key employees attention away from other business matters. The
difficulties associated with any such implementation, and our failure to realize the anticipated
benefits from the implementation, could harm our business, results of operations and cash flows.
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On November 8, 2011, the Board approved a share repurchase program. Under the share repurchase
program, the Company is authorized to purchase up to $10.0 million of its outstanding shares of
common stock (and in connection therewith, the Board
terminated the repurchase program authorized in March of 1990). The purchases may be made from
time to time on the open market or in negotiated transactions. The timing and extent to which the
Company repurchases its shares will depend on market conditions and other corporate considerations
as may be considered in the Companys sole discretion, including limitations in the New Credit
Agreement, which, in addition to limits on revolver availability and
a stricter Consolidated Leverage Ratio (0.25x less than the
maximum then permitted), limits the aggregate amount that
can be expended on share repurchases and dividends to $5.0 million until the LaJobi focused
assessment has been concluded and all duty amounts required thereby have been paid. (see New
Credit Agreement above). The share repurchase program may be suspended or discontinued at any time
without prior notice. The Company intends to finance the share repurchase program from available
cash and/or proceeds under the New Credit Agreement (to the extent available therefor).
Consistent with our past practices and in the normal course of our business, we regularly
review acquisition opportunities of varying sizes. We may consider the use of debt or equity
financing to fund potential acquisitions. The New Credit Agreement includes provisions that place
limitations on our ability to enter into acquisitions, mergers or similar transactions, as well as
a number of other activities, including our ability to incur additional debt, create liens on our
assets or make guarantees, make certain investments or loans, pay dividends, repurchase our common
stock, or dispose of or sell assets (subject to exceptions specified therein). These covenants
could restrict our ability to pursue opportunities to expand our business operations. We are
required to make pre-payments of our debt upon the occurrence of certain transactions, including a
sale of the assets of membership interests in the Licensor.
We have entered into certain transactions with certain parties who are or were considered
related parties, and these transactions are disclosed in Note 12 of Notes to Unaudited Consolidated
Financial Statements.
Contractual Obligations
The following table summarizes the Companys significant known contractual obligations as of
September 30, 2011 and the future periods in which such obligations are expected to be settled in
cash (in thousands):
Total | 2011 | 2012 | 2013 | 2014 | 2015 | Thereafter | ||||||||||||||||||||||
Operating Lease Obligations |
$ | 14,210 | $ | 695 | $ | 3,060 | $ | 3,165 | $ | 1,916 | $ | 1,982 | $ | 3,392 | ||||||||||||||
Purchase Obligations (1) |
50,617 | 31,789 | 18,828 | | | | | |||||||||||||||||||||
New Revolver (3) |
65,265 | | | | | | 65,265 | |||||||||||||||||||||
Royalty Obligations |
11,369 | 1,758 | 5,021 | 3,268 | 1,322 | | | |||||||||||||||||||||
Total
Contractual Obligations (2)(3)(4) |
$ | 141,461 | $ | 34,242 | $ | 26,909 | $ | 6,433 | $ | 3,238 | $ | 1,982 | $ | 68,657 | ||||||||||||||
(1) | The Companys purchase obligations consist primarily of purchase orders for inventory. |
|
(2) | Does not include contingent obligations under the TRC Lease (or contingent obligations
under off-balance sheet arrangements, if any, or otherwise), as the amount if any and/or timing of
their potential settlement is not reasonably estimable. See Other Events and Circumstances
Pertaining to Liquidity above and Note 10 to the Notes to Unaudited Consolidated Financial
Statements. In connection with the acquisitions of LaJobi and CoCaLo, the Company has concluded
that no CoCaLo Earnout Consideration and no LaJobi Earnout Consideration (or related finders fee)
was earned or will become payable, therefore no amounts with respect thereto are included in the
table above. (See Note 10 of the Notes to Unaudited Consolidated Financial Statements.) |
|
(3) | In accordance with applicable accounting standards amounts outstanding under the New Revolver
are classified as Long Term Debt.
The amount in the table represents amounts outstanding under the New Revolver as of September 30, 2011. Amounts outstanding under the New Revolver are due and payable on August 8, 2016.
Required interest under the New Revolver is based on the
outstanding debt and the applicable interest spread and cannot be calculated. The 2011 interest
payments for the New Revolver using an assumed 3.0% interest rate would be $0.5 million. Such
amounts are estimates only and actual interest payments could differ materially. See Debt
Financings for a description of the New Credit Agreement, executed as of August 8, 2011, including
amount and dates of repayment and interest obligations and provisions that create, increase and/or accelerate
obligations thereunder. |
|
(4) |
Of the total income tax payable for uncertain tax positions of $737,000, we have classified
$700,000 as a current liability as of September 30, 2011, as such amount is expected to be resolved within one
year. The remaining amount has been classified as a long-term liability and is not included in the
above table as the timing of its potential settlement is not reasonably estimable.
|
Off Balance Sheet Arrangements
As of September 30, 2011, there have been no material changes in the information provided
under the caption Off Balance Sheet Arrangements of Item 7 of the 2010 10-K, except as set forth
in the last paragraph of Item (e) of Note 10 of the Notes to Unaudited Consolidated Financial
Statements above.
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CRITICAL ACCOUNTING POLICIES
The SEC has issued disclosure advice regarding critical accounting policies, defined as
accounting policies that management believes are both most important to the portrayal of the
Companys financial condition and results and require application of managements most difficult,
subjective or complex judgments, often as a result of the need to make estimates about the effects
of matters that are inherently uncertain.
Management is required to make certain estimates and assumptions during the preparation of its
consolidated financial statements that affect the reported amounts of assets, liabilities, revenue
and expenses, and related disclosure of contingent assets and liabilities. Estimates and
assumptions are reviewed periodically, and revisions made as determined to be necessary by
management. There have been no material changes to the Companys significant accounting estimates
and assumptions or the judgments affecting the application of such estimates and assumptions during
the period covered by this report from those described in the Companys 2010 10-K.
See Note 2 of Notes to Consolidated Financial Statements of the 2010 10-K for a summary of the
significant accounting policies used in the preparation of the Companys consolidated financial
statements. Also see Note 2 of Notes to Unaudited Consolidated Financial Statements herein.
Recently Issued Accounting Standards
See Note 11 of the Notes to Unaudited Consolidated Financial Statements for a discussion of
recently issued accounting pronouncements.
Forward-Looking Statements
This Quarterly Report on Form 10-Q contains certain forward-looking statements. Additional
written and oral forward-looking statements may be made by us from time to time in Securities and
Exchange Commission (SEC) filings and otherwise. The Private Securities Litigation Reform Act of
1995 provides a safe-harbor for forward-looking statements. These statements may be identified by
the use of forward-looking words or phrases including, but not limited to, anticipate, project,
believe, expect, intend, may, planned, potential, should, will or would. We
caution readers that results predicted by forward-looking statements, including, without
limitation, those relating to our future business prospects, revenues, working capital, liquidity,
capital needs, interest costs and income are subject to certain risks and uncertainties that could
cause actual results to differ materially from those indicated in the forward-looking statements.
Specific risks and uncertainties include, but are not limited to, those set forth under Part I,
Item 1A, Risk Factors, of the 2010 10-K as supplemented by Part II, Item 1A, Risk Factors, of each
of the Q1 10-Q, the Q2 10-Q and this Quarterly Report on Form 10-Q. We undertake no obligation to
publicly update any forward-looking statement, whether as a result of new information, future
events or otherwise.
ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
As of September 30, 2011, there have been no material changes in the Companys market risks as
described in Item 7A of our 2010 10-K, except as set forth below with respect to interest rate risk
Interest Rate Changes
Upon execution of the New Credit Agreement on August 8, 2011, the Borrowers drew down $47.5
million under the New Revolver, and utilized the proceeds to repay the Old Term Loan in full.
Outstanding amounts under the Old Revolver (in the approximate additional amount of $29.4 million)
were reallocated among the continuing Lenders in accordance with their respective commitments under
the New Credit Agreement.
The New Revolver bears interest, at the Borrowers option, at a specified base rate (the
higher of (x) the Administrative Agents prime rate and (y) the Federal Funds rate plus 0.50%), or
a specified Eurodollar rate based on specified British Bankers Association LIBOR, plus (in each
case) applicable margins. At September 30, 2011, a sensitivity analysis to measure potential
changes in interest rates indicates that a one percentage point increase in interest rates would
increase our interest expense by approximately $0.7 million annually. See Item 2, Managements
Discussion and Analysis of Financial Condition and Results of Operations Liquidity and Capital
Resources under the section captioned Debt Financings for a discussion of the applicable
interest rates under and other material provisions of our New Credit Agreement and our Old Credit
Agreement.
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Prior to the execution of the New Credit Agreement, Borrowers were required to maintain in
effect Hedge Agreements to protect against potential fluctuations in interest rates with respect to
a minimum of 50% of the outstanding amount of the Old Term Loan. The Borrowers have maintained a
series of interest rate swap agreements since such requirement became effective, the latest of
which (instituted in December of 2010) for a notional amount of $28.6 million. A net loss of
$23,000 for such interest rate swap agreement was recorded as interest expense for the three and
nine months ended September 30, 2011. See Note 7 of Notes to Unaudited Consolidated Unaudited
Financial Statements for information with respect to this and previous interest rate swap
agreements. Although the requirement to maintain Hedge Agreements has been eliminated from the New
Credit Agreement (as the Old Term Loan has been repaid), the Company has not terminated its current
interest rate swap agreement, however, the Company has discontinued hedge accounting thereon as of
August 8, 2011, after which all changes in fair value of the interest rate swap are recorded
directly in earnings.
ITEM 4. | CONTROLS AND PROCEDURES |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures as defined in Rules 13a-15(e) or 15d-15(e) of
the Securities Exchange Act of 1934, as amended (the Exchange Act) that are designed to ensure
that information required to be disclosed in our Exchange Act reports is recorded, processed,
summarized and reported within the time periods specified in the Securities and Exchange
Commissions rules and forms and that such information is accumulated and communicated to our
management, including our principal executive officer and principal financial officer (together,
the Certifying Officers), to allow for timely decisions regarding required disclosure.
In designing and evaluating disclosure controls and procedures, management recognizes that any
controls and procedures, no matter how well designed and operated, can provide only reasonable, not
absolute assurance of achieving the desired objectives.
Under the supervision and with the participation of management, including the Certifying
Officers, we carried out an evaluation of the effectiveness of the design and operation of our
disclosure controls and procedures pursuant to paragraph (b) of Exchange Act Rules 13a-15 or 15d-15
as of September 30, 2011. Based upon that evaluation, the Certifying Officers have concluded that
our disclosure controls and procedures are effective as of September 30, 2011.
Changes in Internal Control over Financial Reporting
There was no change in our internal control over financial reporting identified in connection
with the evaluation required by paragraph (d) of Exchange Act Rule 13a-15 or 15d-15 that occurred
during the fiscal quarter ended September 30, 2011 that has materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting. However, the Company
has initiated certain enhancements to its processes and procedures in areas where import duty
underpayments were found, and will continue to review its internal controls for areas of potential
improvement.
PART II OTHER INFORMATION
ITEM 1. | LEGAL PROCEEDINGS |
Putative Class Action. As previously reported in the Q1 10-Q and the Q2 10-Q, on March 22,
2011, a complaint was filed in the United States District Court, District of New Jersey,
encaptioned Shah Rahman v. Kid Brands, et al. (the Putative Class Action). The Putative
Class Action is brought by one plaintiff on behalf of a putative class of all those who purchased
or otherwise acquired the common stock of the Company between March 26, 2010 and March 15, 2011. In
addition to KID, Bruce G. Crain, KIDs then- President, Chief Executive Officer and a member of
KIDs board of directors, Guy A. Paglinco, KIDs Vice President and Chief Financial Officer,
Raphael Benaroya, Mario Ciampi, Frederick J. Horowitz, Salvatore Salibello and Michael Zimmerman,
each members of KIDs board of directors, as well as Lauren Krueger and John Schaefer, each a
former member of KIDs board of directors, were named as defendants.
The Putative Class Action alleges one claim for relief pursuant to Section 10(b) of the
Securities Exchange Act of 1934, as amended (the Exchange Act), and Rule 10b-5 promulgated
thereunder, and a second claim pursuant to the Exchange Act, claiming generally that the Company
and/or the other defendants issued materially false and misleading statements during the relevant
time period regarding compliance with customs laws, the Companys financial reports and internal
controls. The Putative Class Action does not state the size of the putative class. The Putative
Class Action seeks compensatory damages but does not quantify the amount of damages sought. The
Putative Class Action also seeks unspecified extraordinary and injunctive relief, the costs and
disbursements of the lawsuit, including attorneys and experts fees and costs, and such equitable
relief as the court deems just and proper. By order dated July 26, 2011, Shah Rahman was appointed
lead plaintiff pursuant to Section 21D (a) (3) (B) of the Exchange Act.
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On September 26, 2011, an amended complaint was filed by the lead plaintiff to expand the
allegations under the claims for relief made in the original complaint, to extend the putative
class to all those who purchased or otherwise acquired KIDs common stock between March 26, 2010
and August 16, 2011, and to eliminate all of the named defendants other than KID, Bruce G. Crain,
Guy A. Paglinco and Raphael Benaroya. The amended complaint was dismissed without prejudice
against Raphael Benaroya by a Notice of Voluntary Dismissal filed by the lead plaintiff on October
21, 2011 and so ordered by the Court on October 25, 2011. Defendants have until November 10, 2011
to respond to the amended complaint.
The Company intends to defend the Putative Class Action vigorously, and has notified its
insurance carriers of the existence of the action; however, no amounts have been accrued in
connection therewith, although legal costs are being expensed as incurred.
Putative Shareholder Derivative Action. As previously reported on the Companys current
Report on Form 8-K filed on May 26, 2011, on May 20, 2011 and in the Q2 10-Q, a putative
stockholder derivative complaint was filed by the City of Roseville Employees Retirement System in
the United States District Court of the District of New Jersey (the Putative Derivative Action),
against Bruce Crain, KIDs then CEO, Guy Paglinco, KIDs CFO, Marc Goldfarb, KIDs Senior Vice
President and General Counsel, each member of KIDs current Board of Directors, and John Schaefer,
a former member of KIDs Board of Directors (collectively, the Defendants). In addition, KID has
been named as a nominal defendant.
The Putative Derivative Action alleges, among other things, that the Defendants breached their
fiduciary duties to the Company by allegedly failing to implement an internal controls system for
compliance with US Customs laws for imported goods and applicable local foreign laws, and issuing
false and misleading public statements about the Companys related party transactions with the
former owners of its LaJobi subsidiary and about its internal controls, all in violation of state
law. In addition, the Putative Derivative Action alleges that such failures also constitute gross
mismanagement, abuse of control and commission of corporate waste and resulted in unjust
enrichment. The Putative Derivative Action seeks monetary damages against the individual Defendants
in an unspecified amount together with interest, in addition to exemplary damages, the costs and
disbursements of the lawsuit, including attorneys and experts fees and costs, and such equitable
relief as the court deems just and proper.
On July 25, 2011, the Company filed a motion to dismiss the complaint in this action. On
October 24, 2011, the Court granted Defendants motion to dismiss without prejudice in a decision that cited the complaints failure to meet
applicable pleading standards required to bring a shareholder
derivative claim. Plaintiff was granted leave to amend the complaint in a manner consistent with the Courts decision.
The Company has notified its insurance carriers
of the Putative Derivative Action. While the
Company incurred costs in connection with the defense of this lawsuit, and may incur additional
costs (which costs were or will be expensed as
incurred), the lawsuit did not seek monetary damages against the Company, and no amounts have been
accrued in connection therewith.
SEC Informal Investigation. As noted in Note 10 of Notes to Unaudited Consolidated Financial
Statements, the Company voluntarily disclosed to the SEC the findings of its internal investigation
of LaJobis customs and Asia staffing practices. As reported in the Q2 10-Q, on June 20, 2011, the
Company received a letter from the SEC indicating that the Staff was conducting an informal
investigation and requesting that the Company provide certain documents on a voluntary basis.
More recently, the Company voluntarily disclosed to the SEC the existence of the Customs Review and
the Customs Investigation. The Company believes that it has fully cooperated, and will continue to
fully cooperate, with the SEC. The Company is currently unable to predict the duration, resources
required or outcome of the investigation or the impact such investigation may have on the Companys
financial condition or results of operations.
U.S. Attorneys Office Investigation. On August 19, 2011, the United States
Attorneys Office for the District of New Jersey (USAO) contacted Company
counsel, requesting information relating to LaJobi previously provided by the Company to U.S.
Customs and the SEC, as well as additional documents. The Company is cooperating with the USAO on
a voluntary basis. The Company is currently unable to predict the duration, the resources required
or outcome of the USAO investigation or the impact such investigation may have.
TRC Landlord Litigation. In connection with the sale of KIDs former gift business in
December 2008 (the Gift Sale), KID and Russ Berrie U.S. Gift, Inc. (U.S. Gift), KIDs
subsidiary at the time (and currently a subsidiary of TRC), sent a notice of termination with
respect to the lease (the TRC Lease), originally entered into by KID (and subsequently assigned
to U.S. Gift) of a facility in South Brunswick, New Jersey. Although the TRC Lease became the
obligation of TRC (through its ownership of U.S. Gift), KID remains potentially obligated for
rental and other specified payments due thereunder (to the extent they are owed but have not been
paid by U.S. Gift). On April 27, 2011, KID received a letter on behalf of the landlord under the
TRC Lease (the TRC Landlord) demanding payment by KID of specified rent and other additional
charges allegedly owed by U.S. Gift in an aggregate amount of approximately $5.9 million
(including, among other things, approximately $3.8 million in rent and other charges for periods
subsequent to the effective date of the termination of the TRC Lease (December 23, 2010), for which
KID does not believe it is responsible, and approximately $1.0 million in specified repairs
(Repair Charges)).
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As reported in the Q2 10-Q, on July 18, 2011, the TRC Landlord filed a complaint in the
Superior Court of New Jersey Law Division: Middlesex County, alleging that KID, having agreed via
an assignment agreement to remain liable for the obligations of the tenant under the TRC Lease, has
breached the TRC Lease and such assignment by failing to pay rent and other charges due and owing
pursuant to the TRC Lease, in an aggregate amount of approximately $12 million as of June 11,
2011. The complaint also demands payment of costs in an unspecified amount, including late charges,
pre-judgment interest and the TRC Landlords attorneys fees in connection with the action. The
complaint provides no itemization of the amounts claimed to be due and owing under the TRC Lease;
however, KID believes that such amounts likely reflect amounts specified in the demand letter, plus
similar amounts accrued from the date of such letter through June 11, 2011 (although there can be
no assurance that this is the case). KID believes that any liability it may have under the TRC
Lease expired upon the date of its termination. We currently estimate that KIDs potential
liability for rental and related amounts under the TRC Lease is approximately $1.1 million and,
accordingly, we have accrued such amount for the nine month period ended September 30, 2011. With
respect to the alleged Repair Charges, KID is currently unable to assess its potential liability
therefor, if any, under the TRC Lease. In addition, KID believes it has potential defenses to some
or all of the amounts claimed. As a result, the aggregate amount of any payments that may
potentially be required to be made by KID with respect to the TRC Lease cannot be ascertained at
this time.
TRC Bankruptcy. As has been previously disclosed in the Q1 10-Q and the Q2 10-Q, on April 21,
2011, TRC, the acquirer of KIDs former gift business, and TRCs domestic subsidiaries, filed a
voluntary petition under Chapter 7 of the United States Bankruptcy Code in the United States
Bankruptcy Court for the District of New Jersey (the Bankruptcy Court). As reported in the
Companys Current Report on Form 8-K filed on June 22, 2011, on June 16, 2011, the Bankruptcy Court
entered an order which, among other things, approves a settlement with the secured creditors of the
debtors, including KID (the Settlement). Details of the Settlement are described in Note 12 of
the Notes to Unaudited Consolidated Financial Statements.
ITEM 1A. | RISK FACTORS |
There have been no material changes to the risk factors set forth in Part I, Item 1A, Risk
Factors, of the 2010 10-K, as supplemented by Part II, Item 1A, Risk Factors of each of the Q1
10-Q and Q2 10-Q except as set forth below:
We cannot assure our shareholders that our share repurchase program will enhance long-term
shareholder value, and share repurchases could increase the volatility of the price of our common
stock and will diminish our cash availability.
On November 8, 2011, our Board approved a share repurchase program. Under the program, we are
authorized to repurchase shares of our common stock, in the open market or privately negotiated
transactions, at times and prices considered appropriate by them depending upon prevailing market
conditions and other corporate considerations, up to an aggregate purchase price of $10.0 million.
The timing and actual number of shares repurchased depend on a variety of factors including the
timing of open trading windows, price, corporate and regulatory requirements, and other market
conditions, including limitations under the New Credit Agreement
(which, in addition to limits on revolver availability and a stricter
Consolidated Leverage Ratio (0.25x less than the maximum then
permitted), limits the aggregate amount that can be expended on share repurchases and
dividends to $5.0 million until the LaJobi focused assessment has been concluded and all duty amounts required thereby have been paid). The program may be suspended or
discontinued at any time without prior notice. Repurchases pursuant to our share repurchase program
could affect our share price and increase its volatility. The existence of a share repurchase
program could also cause our share price to be higher than it would be in the absence of such a
program and could potentially reduce the market liquidity for our common stock. Additionally,
repurchases under our share repurchase program will diminish our cash reserves and/or availability
under the New Revolver, which could impact our ability to pursue possible future strategic
opportunities and acquisitions. There can be no assurance that any share repurchases will enhance
shareholder value because the market price of our common stock may decline below the levels at
which we repurchased such shares. Any failure to repurchase shares after we have announced our
intention to do so may negatively impact our reputation and investor confidence in us and may
negatively impact our stock price. Although our share repurchase program is intended to enhance
long-term shareholder value, short-term stock price fluctuations could reduce the programs
effectiveness. As of November 8, 2011, no repurchases have been made under the new program.
Our hosted software and web-based services and web site may be subject to intentional
disruption.
Our hosted software and web-based services and web site may be subject to intentional
disruption. Although we believe we have sufficient controls in place to prevent intentional
disruptions, such as software viruses specifically designed to impede the performance of our
software and web-based services, we may be affected by such efforts in the future. Further, despite
the implementation of security measures, this infrastructure or other systems that we interface
with, including the Internet and related systems, may be vulnerable to physical break-ins, hackers,
improper employee or contractor access, programming errors, attacks by third parties or similar
disruptive problems, resulting in the potential misappropriation of our proprietary information or
interruptions of our services. Any compromise of our security, whether as a result of our own
systems or systems that they interface with, could substantially disrupt our operations, harm our
reputation and reduce demand for our services.
Unauthorized disclosure of confidential information provided to us by our customers or third
parties, whether through breach of our secure network by an unauthorized party, employee theft or
misuse, or otherwise, could harm our business.
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The difficulty of securely transmitting confidential information has been a significant issue
when engaging in sensitive communications over the Internet. Our business relies on using the
Internet to transmit confidential information. We believe that any
well-publicized compromise of Internet security may deter companies from using the Internet
for these purposes. Our services present the potential for embezzlement, identity theft, or other
similar illegal behavior by our employees or subcontractors with respect to third parties. If there
was a disclosure of confidential information, or if a third party were to gain unauthorized access
to the confidential information we possess, our operations could be seriously disrupted, our
reputation could be harmed and we could be subject to claims pursuant to our agreements with our
customers or other liabilities. In addition, if this were to occur, we could be perceived to have
facilitated or participated in illegal misappropriation of funds, documents, or data and therefore
be subject to civil or criminal liability or regulatory action. While we maintain professional
liability insurance coverage in an amount that we believe is sufficient for our business, we cannot
assure you that this coverage will prove to be adequate or will continue to be available on
acceptable terms, if at all. A claim that is brought against us that is uninsured or under-insured
could harm our business, financial conditions and results of operations. Even unsuccessful claims
could result in substantial costs and diversion of management resources.
6. EXHIBITS
Exhibits to this Quarterly Report on Form 10-Q.
10.49 | Agreement between RB, Inc. and the Company dated September 12, 2011, incorporated herein by reference
to the Current Report on Form 8-K filed by the Company on September 14, 2011.* |
|||
10.50 | Separation Agreement and Release between the Company and Bruce G. Crain dated September 12, 2011.* |
|||
31.1 | Certification of principal executive officer required by Section 302 of the Sarbanes Oxley Act of 2002. |
|||
31.2 | Certification of principal financial officer required by Section 302 of the Sarbanes Oxley Act of 2002. |
|||
32.1 | Certification of principal executive officer required by Section 906 of the Sarbanes Oxley Act of 2002. |
|||
32.2 | Certification of principal financial officer required by Section 906 of the Sarbanes Oxley Act of 2002. |
|||
101.INS | XBRL Instance Document 1,2 |
|||
101.SCH | XBRL Taxonomy Extension Schema Document 1,2 |
|||
101.CAL | XBRL Taxonomy Extension Calculation Linkbase Document 1,2 |
|||
101.LAB | XBRL Taxonomy Extension Label Linkbase Document 1,2 |
|||
101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document 1,2 |
* | Management Contract |
|
1 | Pursuant to Rule 405 of Regulation S-T, includes the following financial information
from the Companys Quarterly Report on Form 10-Q for the quarter ended September 30, 2011,
formatted in eXentsible Business Reporting Language (XBRL) interactive data files: (i) the
Consolidated Statement of Operations for the three and nine months ended September 30, 2011 and
2010, (ii) the Consolidated Balance Sheet as of September 30, 2011 and December 31, 2010, (iii) the
Consolidated Statement of Cash Flows for the nine months ended September 30, 2011 and 2010, and
(iv) the Notes to Unaudited Consolidated Financial Statements. |
|
2 | As provided in Rule 406T of Regulation S-T, this information shall be not deemed
filed for purposes of Section 11 and 12 of the Securities Act of 1933, as amended, and Section 18
of the Securities Exchange Act of 1934, as amended, or otherwise subject to liability under those
sections. |
Items 2, 3, 4 and 5 are not applicable and have been omitted.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized.
KID BRANDS, INC. (Registrant) |
||||
By | /s/ Guy A. Paglinco | |||
Date: November 8, 2011 | Guy A. Paglinco | |||
Vice President and Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer) |
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EXHIBIT INDEX
10.50 | Separation Agreement and Release between the Company and Bruce G. Crain dated September 12, 2011* |
|||
31.1 | Certification of principal executive officer required by Section 302 of the Sarbanes Oxley Act of 2002. |
|||
31.2 | Certification of principal financial officer required by Section 302 of the Sarbanes Oxley Act of 2002. |
|||
32.1 | Certification of principal executive officer required by Section 906 of the Sarbanes Oxley Act of 2002. |
|||
32.2 | Certification of principal financial officer required by Section 906 of the Sarbanes Oxley Act of 2002. |
|||
101.INS | XBRL Instance Document 1,2 |
|||
101.SCH | XBRL Taxonomy Extension Schema Document 1,2 |
|||
101.CAL | XBRL Taxonomy Extension Calculation Linkbase Document 1,2 |
|||
101.LAB | XBRL Taxonomy Extension Label Linkbase Document 1,2 |
|||
101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document 1,2 |
* | Management Contract |
|
1 | Pursuant to Rule 405 of Regulation S-T, includes the following financial information
from the Companys Quarterly Report on Form 10-Q for the quarter ended September 30, 2011,
formatted in eXentsible Business Reporting Language (XBRL) interactive data files: (i) the
Consolidated Statement of Operations for the three and nine months ended September 30, 2011 and
2010, (ii) the Consolidated Balance Sheet as of September 30, 2011 and December 31, 2010, (iii) the
Consolidated Statement of Cash Flows for the nine months ended September 30, 2011 and 2010, and
(iv) the Notes to Unaudited Consolidated Financial Statements. |
|
2 | As provided in Rule 406T of Regulation S-T, this information shall be not deemed
filed for purposes of Section 11 and 12 of the Securities Act of 1933, as amended, and Section 18
of the Securities Exchange Act of 1934, as amended, or otherwise subject to liability under those
sections. |
47