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| KID > SEC Filings for KID > Form 10-Q on 4-Nov-2009 | All Recent SEC Filings |
4-Nov-2009
Quarterly Report
As a result of the Gift Sale, the Consolidated Statements of Operations have
been restated to show the Gift Business as discontinued operations for the three
and nine months ended September 30, 2008. Neither the Consolidated Balance Sheet
for the year ended December 31, 2008 nor the quarter ended September 30, 2009
include the Gift Business assets and liabilities, as a result of the
consummation of the Gift Sale as of December 23, 2008, but each include the fair
value of the consideration received from the Gift Sale, which was fully impaired
and reserved during the quarter ended June 30, 2009. The Consolidated Statement
of Cash Flows for the nine months ended September 30, 2008 has not been
restated. The Notes to Unaudited Consolidated Financial Statements have been
restated to reflect the discontinued operations presentation described above for
the basic financial statements where applicable.
Continuing Operations
Our infant and juvenile business - which currently consists of Kids Line,
LaJobi, Sassy and CoCaLo - designs, manufactures through third parties, imports
and sells products in a number of complementary categories including, among
others: infant bedding and related nursery accessories (Kids Line and CoCaLo);
infant furniture and related products (LaJobi); and developmental toys and
feeding, bath and baby care items with features that address the various stages
of an infant's early years (Sassy). Our products are sold primarily to retailers
in North America, the UK 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 UK and Australia, and
sell through independent manufacturers' representatives and distributors in
certain other countries. International sales from continuing operations, defined
as sales outside of the United States, including export sales, constituted 7.8%
and 8.9% of our net sales for the nine months ended September 30, 2009 and 2008,
respectively. One of our 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.
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 may grant certain
accommodations and allowances to certain customers in order to assist these
customers with inventory clearance or promotions. Such amounts, together with
discounts, are deducted from gross sales in determining net sales.
Our products are manufactured by third parties, principally located in the PRC
and other Eastern Asian countries. Our purchases of finished products from these
manufacturers are primarily denominated in U.S. dollars. Expenses for these
manufacturers are primarily denominated in Chinese Yuan. As a result, any
material increase in the value of the Yuan relative to the U.S. dollar, as
occurred in 2008, would increase our expenses, and therefore, adversely affects
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
those 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.
Additionally, 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. To the extent we are unable to
pass such price increases along to our customers, our gross margins would
decrease. For example, increased costs in the PRC, primarily for raw materials,
labor, taxes and currency lead our vendors to raise our prices, resulting in
increased cost of goods sold and reduced gross margins in 2008.
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. For the three and nine months ended September 30, 2009, the costs of
warehousing, outbound handling costs and outbound shipping costs were
$1.7 million and $5.2 million, 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.
In addition, our gross profit margins have declined in recent periods as a
result of: (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); and (ii) our acquisition of LaJobi, which has experienced significant
sales growth but which also typically generates lower gross margins, on average,
than our other business units; and (iii) increased pressure from major
retailers, primarily 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.
We continue to seek to mitigate this margin pressure through the development of
new products that can command higher pricing, the identification of alternative,
lower-cost sources of supply 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, we have generally
focused on maintaining (or increasing) shelf space at retailers and, as a
result, our market share.
We have previously carried significant goodwill and intangible assets on our
balance sheet. We recorded, in our consolidated financial statements for the
fourth quarter and fiscal year ended December 31, 2008, non-cash impairment
charges to: (i) goodwill related to our continuing infant and juvenile
operations in the approximate amount of $130.2 million, in connection with our
annual assessment of goodwill in accordance with ASC Topic 350
"Intangibles-Goodwill and Other"; (ii) our Applause® trademark in connection
with the Gift Sale of $6.7 million; and (iii) intangible assets related to our
continuing infant and juvenile operations of $3.7 million, in connection with
our annual assessment of indefinite-life intangible assets in accordance with
ASC Topic 350. We will continue to evaluate the carrying amount of our
indefinite-life intangible assets in accordance with ASC Topic 350, and there
can be no assurance that we will not incur additional impairment charges in the
future. See Note 7 of Notes to Consolidated Financial Statements for details
with respect to impairment changes incurred during 2008. Due to current economic
conditions and the impairment recorded on all of our goodwill in the fourth
quarter of 2008, we evaluated the useful life of our Kids Line customer
relationships intangible asset and determined that the Kids Line customer
relationships is a finite-lived asset and, as such, will be amortized over a
20-year life. In connection with such determination, we recorded $389,000 of
amortization expense in the three months and year ended December 31, 2008.
We completed our annual goodwill assessment for our continuing operations as of
December 31, 2008 in accordance with ASC Topic 350. As required by ASC Topic
350, the goodwill impairment test is accomplished using a two-step process. The
first step compares the fair value of a reporting unit that has goodwill to its
carrying value. The fair value of a reporting unit using discounted cash flow
analysis is estimated. If the fair value of the reporting unit is determined to
be less than its carrying value, a second step is performed to compute the
amount of goodwill impairment, if any. Step two allocates the fair value of the
reporting unit to the reporting unit's net assets other than goodwill. The
excess of the fair value of the reporting unit (using fair-value based tests)
over the amounts assigned to its net assets other than goodwill is considered
the implied fair value of the reporting unit's goodwill. The implied fair value
of the reporting unit's goodwill is then compared to the carrying value of its
goodwill. Any shortfall represents the amount of goodwill impairment.
As of December 31, 2008, after completing the first step of the impairment test,
there was indication of impairment because our carrying value exceeded our
market capitalization.
Management's determination of the fair value of the goodwill for the second step
in the analysis was performed with the assistance of a public accounting firm,
other than the Company's auditors. The analysis used a variety of testing
methods that are judgmental in nature and involve the use of significant
estimates and assumptions, including: (i) the Company's operating forecasts;
(ii) revenue growth rates; (iii) risk-commensurate discount rates and costs of
capital; and (iv) price or market multiples. The Company's estimates of revenues
and costs are based on historical data, various internal estimates and a variety
of external sources, and are developed by the Company's routine long-range
planning process.
During the year ended December 31, 2008, stock market valuations in general, and
the Company's stock price in particular, declined substantially. Such decline in
the Company's stock price in 2008 indicated the potential for impairment of the
Company's goodwill. In addition, during 2008, continuing gross margins for Kids
Line and Sassy declined substantially from the previous year, and Sassy
terminated a distribution agreement (the "MAM Agreement") that had contributed
approximately $22 million in revenues that was not expected to recur in 2009.
These adverse conditions, resulting in part from difficult equity and credit
market conditions, led the Company to revise its estimates with respect to net
sales and gross margins, which in turn negatively impacted our cash flow
forecasts for Kids Line and Sassy. These revised cash flows forecasts resulted
in the conclusion in the Step 2 test that the Company's goodwill was entirely
impaired (it was determined to have no implied value), and as a result, the
Company recorded a goodwill impairment charge in the amount of $130.2 million,
representing the shortfall between the fair value of its continuing operations
for which goodwill had been allocated and its carrying value.
Inventory, which consists of finished goods, is carried on our balance sheet at
the lower of cost or market. Cost is determined using the weighted average cost
method and includes all costs necessary to bring inventory to its existing
condition and location. Market represents the lower of replacement cost or
estimated net realizable value of such inventory. Inventory reserves are
recorded for damaged, obsolete, excess and slow-moving inventory if management
determines that the ultimate expected proceeds from the disposal of such
inventory will be less than its carrying cost as described above. Management
uses estimates to determine the necessity of recording these reserves based on
periodic reviews of each product category based primarily on the following
factors: length of time on hand, historical sales, sales projections (including
expected sales prices), order bookings, anticipated demand, market trends,
product obsolescence, the effect new products may have on the sale of existing
products and other factors. Risks and exposures in making these estimates
include changes in public and consumer preferences and demand for products,
changes in customer buying patterns, competitor activities, our effectiveness in
inventory management, as well as discontinuance of products or product lines. In
addition, estimating sales prices, establishing markdown percentages and
evaluating the condition of our inventories all require judgments and estimates,
which may also impact the inventory valuation. However, we believe that, based
on our prior experience of managing and evaluating the recoverability of our
slow moving, excess, damaged and obsolete inventory in response to market
conditions, including decreased sales in specific product lines, our established
reserves are materially adequate. If actual market conditions and product sales
were less favorable than we have projected, however, additional inventory
reserves may be necessary in future periods.
Company Outlook
The principal elements of our 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 penetration (selling to more store locations within each large, national retail customer); and
(iv) expanding and diversifying of our distribution channels, with particular emphasis on sales into international markets;
• 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 each of our businesses.
We believe that we have made substantial progress in successfully implementing
this strategy. As noted above, we acquired each of LaJobi and CoCaLo on April 2,
2008, which enabled us to significantly expand our infant and juvenile business
and offer a more complete range of products for the baby nursery. We also sold
our Gift Business on December 23, 2008, enabling us to focus our efforts and
resources on our infant and juvenile business. In addition, during 2008 and
2009, we expanded our product line to offer products at a broader variety of
price points and also added several environmentally friendly products. For
example, Kids Line significantly increased its sales of Carter's ® brand bedding
separates, while Kids Line and CoCaLo each introduced new organic, eco-friendly
brands. CoCaLo also expanded and refined its CoCaLo Couture brand, which targets
higher price points. LaJobi also developed a new brand - Nursery 101
®-introduced in 2009, which represents products at a lower price point than the
rest of its line.
Effective December 2008, Sassy terminated its distribution agreement with MAM
Babyartikel GmbH, which accounted for approximately $22 million of sales in 2008
that will not recur in 2009, and also terminated its license agreement with Leap
Frog during 2008 due to unacceptable levels of sales and profitability
associated with this agreement. During the fourth quarter of 2008, Sassy
right-sized its operations in light of the termination of the MAM distribution
agreement. Under this plan, in addition to reducing approximately 30% of its
full-time workforce, Sassy repositioned its operations around its core strength
as a developmental product company and developed new products and packaging to
support this effort.
As discussed in the section captioned "Continuing Operations" above, in the year
ended December 31, 2008, we recorded an impairment charge to goodwill in the
approximate amount of $130.2 million, resulting from decreased cash flow
forecasts due in part to adverse equity and credit market conditions that
caused, among other things, a sustained decrease in our stock price and a
continued challenging retail environment. As a result of the current challenging
retail environment, future sales and/or margins may be lower than what was
historically forecasted, which would negatively impact our prior cash flow
forecasts. However, we expect the acquisitions of LaJobi and CoCaLo to partially
mitigate the impact of such lower forecasts. There can be no assurance that the
outcome of future reviews will not result in further impairment charges.
Impairment assessments inherently involve judgments as to assumptions about
expected future cash flows and the impact of market conditions on those
assumptions. Future events and changing market conditions may impact our
assumptions as to prices, costs or other factors that may result in changes in
our estimates of future cash flows. Although we believe the assumptions we use
in testing for impairment are reasonable, significant changes in any of our
assumptions could produce a significantly different result.
General Economic Conditions as they Impact Our Business
Economic conditions have deteriorated significantly in the United States and
many of the other regions in which we do business and may remain depressed for
the foreseeable future. Global economic conditions have been challenged by
slowing growth and the sub-prime debt devaluation crisis, causing worldwide
liquidity and credit concerns. 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 Factors-The state of the economy may impact our business" of the
2008 10-K. In addition, our operations and performance depend significantly on
levels of consumer spending, which have deteriorated significantly in many
countries and regions as a result of fluctuating energy costs, conditions in the
residential real estate and mortgage markets, stock market conditions, labor and
healthcare costs, access to credit, consumer confidence and other macroeconomic
factors affecting consumer spending behavior.
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 that credit facility is
dependent on the ability of the banks that are parties to the facility to meet
their funding commitments. Those banks may not be able to meet their funding
commitments to us if they experience shortages of capital and liquidity or if
they experience excessive volumes of borrowing requests from us and other
borrowers within a short period of time. Such disruptions could require us to
take measures to conserve cash until the markets stabilize or until alternative
credit arrangements or other funding for our business needs can be arranged. See
Item 1A, "Risk Factors-If the national and world-wide financial crisis
intensifies, 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 2008 10-K.
SEGMENTS
The Company currently operates in one segment, the infant and juvenile business.
BASIS OF PRESENTATION
As discussed above, as a result of the Gift Sale, the Consolidated Statement of
Operations has been restated to show the Gift Business as discontinued
operations for the three and nine months ended September 30, 2008. The
discussion below conforms to such presentation. In addition, as each of LaJobi
and CoCaLo was acquired on April 2, 2008, the results of operations of each such
entity are not included in the consolidated results of operations for the first
quarter of 2008.
RESULTS OF OPERATIONS-THREE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008
Net sales for the three months ended September 30, 2009 decreased by 13.9% to
$60.1 million, compared to $69.8 million for the three months ended
September 30, 2008. This decrease was the result of a significant decline at
Sassy, including the loss of approximately $5.4 million in Sassy sales generated
in the third quarter of 2008 by the MAM Agreement, and an approximate 16%
decline in Kids Line sales from the prior year period primarily resulting from
sustained conservative retailer ordering associated with the continued
challenging retail environment, partially offset by strong sales growth at
LaJobi as compared to the prior year period.
Gross profit was $18.5 million, or 30.7% of net sales, for the three months
ended September 30, 2009, as compared to $22.6 million, or 32.4% of net sales,
for the three months ended September 30, 2008. Gross profit margins were
negatively impacted in the third quarter of 2009 primarily by: (i) sales mix
changes resulting in higher sales of lower margin products, including higher
sales of licensed products, including Carters® and Graco® branded products; and
(ii) increases in mark downs and advertising allowances provided to support
retail sales or promotions in light of the present economic environment.
Selling, general and administrative expense was $12.1 million, or 20.1% of net
sales, for the three months ended September 30, 2009, compared to $13.4 million,
or 19.2% of net sales, for the three months ended September 30, 2008. On an
absolute basis, selling, general and administrative expense decreased at all of
the Company's operating subsidiaries (other than LaJobi), primarily as a result
of focused efforts to control spending in the current economic climate, as well
as the impact of workforce reductions implemented by Sassy in late 2008. Only
LaJobi experienced higher selling, general and administrative expenses on an
absolute basis, driven by higher sales volume for the period.