SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13
OR 15 (d) OF THE SECURITITES AND EXCHANGE
ACT OF 1934
For the Quarterly Period Ended:
June 30, 2005
Commission File Number 1-12506
LUCILLE FARMS, INC.
------------------
(Exact Name of Registrant as Specified in its charter)
Delaware 13-2963923
--------------------------- ---------------------
(State or other Jurisdiction (I.R.S. Employer
of Incorporation) Identification number)
12 Jonergin Drive, P.O. Box 125
Swanton, Vermont 05488
--------------------- --------
(Address of Principal Executive Offices) (zip code)
(Registrant's Telephone Number, Including Area Code)
(802)868-7301
Former name, former address and former fiscal year, if changed since last
report. N/A
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 and Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES [X] NO [ ]
The number of shares of Registrant's common stock, par value $.001 per share,
outstanding as of August 2, 2005 was 3,353,937.
CONTENTS
PART I. FINANCIAL INFORMATION Page
Item 1. Consolidated Financial Statements:
Consolidated Balance Sheets as of June 30, 2005
(unaudited) and March 31, 2005 3-4
Consolidated Statements of Operations (unaudited) for the
Three months ended June 30, 2005 and June 30, 2004 5
Consolidated Statements of Cash Flows (unaudited) for the
Three months ended June 30, 2005 and June 30, 2004 6
Notes to Consolidated Financial Statements (unaudited) 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 12
Item 3. Qualitative and Quantitative Disclosure about Market Risk 17
Item 4. Controls and Procedures 17
PART II OTHER INFORMATION 18
Item 1. Legal Proceedings 18
Item 2. Unregistered Sale of Equity in Securities and Use of Proceeds;
Purchases of Equity Securities by Issuer and Affiliated Purchasers 18
Item 3. Defaults upon Senior Securities 18
Item 4. Submission of Matters to a Vote of Security-Holders 18
Item 5. Other Information 18
Item 6. Exhibits and Reports on Form 8-K 18
(a) Exhibits - (31) Certifications pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 21
(32) Certifications Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, 18 U.S.C.
Section 1350 23
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
LUCILLE FARMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
JUNE 30, 2005 MARCH 31, 2005
------------- --------------
(UNAUDITED)
-------------
CURRENT ASSETS:
Cash and cash equivalents $ 212,000 $ 132,000
Accounts receivable, net
of allowances of $67,000
at June 30, 2005 and
at March 31, 2005 4,476,000 5,172,000
Inventories 2,087,000 2,739,000
Prepaid expenses and other
current assets 735,000 621,000
----------- -----------
Total current assets 7,510,000 8,664,000
----------- -----------
PROPERTY, PLANT AND EQUIPMENT, NET 9,023,000 9,206,000
----------- -----------
OTHER ASSETS:
Deferred costs, net 619,000 637,000
Other
54,000 54,000
----------- -----------
Total other assets 673,000 691,000
----------- -----------
TOTAL ASSETS $17,206,000 $18,561,000
=========== ===========
See accompanying notes to consolidated financial statements
3
LUCILLE FARMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
LIABILITIES AND STOCKHOLDERS' EQUITY
JUNE 30, 2005 MARCH 31, 2005
------------- --------------
(UNAUDITED)
-------------
CURRENT LIABILITES:
Accounts payable $ 4,879,000 $ 3,730,000
Current portion of long-term debt 665,000 665,000
Accrued expenses 240,000 662,000
------------ ------------
Total Current Liabilities 5,784,000 5,057,000
------------ ------------
Long-term debt 12,258,000 13,766,000
------------ ------------
TOTAL LIABILITIES 18,042,000 18,823,000
------------ ------------
STOCKHOLDERS' EQUITY:
Preferred stock, $ 0.001 per value, 250,000 shares authorized:
583 shares Series B convertible
issued and outstanding 1,000 1,000
Common stock, $ 0.001 par value,
25,000,000 shares authorized, 3,570,675
shares issued, 3,353,937 outstanding 4,000 4,000
at June 30, 2005 and March 31, 2005
Additional paid in capital 8,548,000 8,548,000
Accumulated deficit (9,077,000) (8,503,000)
------------ ------------
(525,000) 50,000
Less: cost of 216,738 shares of treasury stock (312,000) (312,000)
------------ ------------
Total Stockholders' Equity (836,000) (262,000)
------------ ------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 17,206,000 $ 18,561,000
============ ============
See accompanying notes to consolidated financial statements
4
LUCILLE FARMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED JUNE 30,
2005 2004
------ ------
SALES $ 10,889,000 $ 12,964,000
COST OF SALES 10,580,000 11,774,000
------------ ------------
GROSS PROFIT 309,000 1,190,000
------------ ------------
OTHER EXPENSES:
SELLING 283,000 241,000
GENERAL AND ADMINISTRATIVE 352,000 230,000
INTEREST EXPENSE 248,000 243,000
------------ ------------
TOTAL OTHER EXPENSES 883,000 714,000
------------ ------------
INCOME (LOSS) BEFORE INCOME TAXES (574,000) 476,000
PROVISION FOR INCOME TAXES -- 1,000
------------ ------------
NET INCOME (LOSS) $ (574,000) $ 475,000
------------ ------------
NET INCOME (LOSS) PER SHARE:
BASIC:
$ (.17) $ .15
------------ ------------
DILUTED: $ (.17) $ .15
------------ ------------
WEIGHTED AVERAGE SHARES
OUTSTANDING USED TO COMPUTE
NET INCOME (LOSS) PER SHARE
BASIC: 3,353,937 3,137,937
DILUTED: 3,353,937 3,138,899
See accompanying notes to consolidated financial statements
5
LUCILLE FARMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Three Months Ended June 30,
2005 2004
---------- -----------
Cash flows from operating activities:
Net Income (Loss) $ (574,000) $ 475,000
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation and amortization 247,000 236,000
Provision for doubtful accounts -- 40,000
(Increase) decrease in assets:
Accounts receivable 696,000 (505,000)
Inventories 652,000 (119,000)
Prepaid expenses and other current
assets (114,000) 63,000
Other assets -- 15,000
Increase (decrease) in liabilities:
Accounts payable 1,149,000 86,000
Accrued expenses (422,000) (86,000)
----------- -----------
Net cash provided by
operating activities 1,634,000 205,000
----------- -----------
CASH FLOW FROM INVESTING ACTIVITIES:
Purchase of property, plant
and equipment (36,000) (158,000)
----------- -----------
Net cash used in investing
Activities (36,000) (158,000)
----------- -----------
CASH FLOW FROM FINANCING ACTIVITIES:
Proceeds from revolving
credit loan-net -0- 71,000
Principal Payments on long-term debt (1,508,000) (551,000)
Increase in Loan Costs (10,000) --
----------- -----------
Net cash used in financing activities (1,518,000) (480,000)
----------- -----------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS 80,000 (433,000)
CASH AND CASH EQUIVALENTS-BEGINNING 132,000 611,000
----------- -----------
CASH AND CASH EQUIVALENTS-ENDING $ 212,000 $ 178,000
----------- -----------
See accompanying notes to consolidated financial statements
6
LUCILLE FARMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. CONSOLIDATED FINANCIAL STATEMENTS
The Consolidated Balance Sheet as of June 30, 2005 and the Consolidated
Statements of Operations and Cash Flows for the three month periods ended June
30, 2005 and 2004 have been prepared by the Company without audit. In the
opinion of management, the accompanying consolidated financial statements
contain all adjustments (consisting only of normal recurring adjustments)
necessary to present fairly the financial position of Lucille Farms, Inc. and
subsidiaries as of June 30, 2005, the results of its operations and its cash
flows for the three months ended June 30, 2005 and 2004.
Certain information and footnote disclosures normally included in
financial statements prepared in accordance with accounting principles generally
accepted in the United States of America have been condensed or omitted pursuant
to the rules and regulations of the Securities and Exchange Commission ("SEC").
Although the Company believes that the disclosures are adequate to make the
information presented not misleading, it is suggested that these financial
statements be read in conjunction with the year-end financial statements and
notes thereto for the fiscal year ended March 31, 2005 included in the Company's
Annual Report on Form 10-K as filed with the SEC.
The accounting policies followed by the Company are set forth in the
notes to the Company's consolidated financial statements as set forth in its
Annual Report on Form 10-K as filed with the SEC.
GOING CONCERN
The financial statements have been prepared on a going concern basis,
which contemplates the realization of assets and the satisfaction of liabilities
in the normal course of business. For the three months ended June 30, 2005, the
Company has a loss from continuing operations of $574,000 and a deficiency in
assets of $836,000. These conditions raise substantial doubt about the Company's
ability to continue as a going concern. The financial statements do not include
any adjustments to reflect the possible future effects on the recoverability and
classification of assets or the amounts and classifications of liabilities that
may result from the outcome of this uncertainty.
The Company has developed a business plan designed to improve gross
margins and reduce its dependency on the spread allowed by the calculation of
the milk price. The plan calls for various capital improvements that will
significantly reduce the cost of producing cheese and change the type of whey
produced by the Company to whey protein concentrate for human and animal
consumption. The capital improvements needed to achieve the business plan will
require an infusion of capital of approximately $8,000,000. Discussions are
currently underway with St. Albans Cooperative, the Company's milk supplier, the
Vermont Economic Development Authority, the Village of Swanton, Vermont, UPS
Business Credit, LLC and LaSalle Business Credit, LLC to structure a financing
package that would provide a portion of such financing as well as strengthen the
Company's balance sheet. Also, the Company is having conversations with a
potential joint venture partner that would provide the necessary financing to
modify the Company's whey facility. There can be no assurance that such a
financing package or joint venture will be forthcoming.
7
B. RECENT ACCOUNTING PRONOUNCEMENTS
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs." This
statement requires the allocation of fixed production overhead to inventory
based on the normal capacity of the production facilities and clarifies that
abnormal amounts of idle facility expense, freight, handling costs and wasted
materials should be recognized as period expense. The Statement is effective for
inventory costs incurred during fiscal years beginning after June 15, 2005. The
Company is evaluating the impact of this Statement but does not expect it to
have a significant effect on financial position or results of operations.
In December 2004, the FASB issued SFAS 123R, "Share Based Payment."
SFAS 123R is a revision to SFAS 123 and supersedes APB 25, "Accounting for Stock
Issued to Employees," and amends SFAS 95, "Statement of Cash Flows." This
statement requires a public entity to expense the cost of employee services
received in exchange for an award of equity instruments. This statement also
provides guidance on valuing and expensing these awards, as well as disclosure
requirements of these equity arrangements. The initial effective date for SFAS
123R was the first interim reporting period set to begin after June 15, 2005. On
April 14, 2005 the SEC deferred the effective date six months therefore Lucille
Farms, Inc. must comply with the provision of SFAS 123R in the third quarter of
fiscal year 3/30/06. SFAS 123R permits public companies to choose between the
following two adoption methods:
1. A "modified prospective" method in which compensation cost is
recognized beginning with the effective date (a) based on the requirements of
SFAS 123R for all share-based payments granted after the effective date and (b)
based on the requirements of Statement 123 for all awards granted to employees
prior to the effective date of SFAS 123R that remain unvested on the effective
date, or
2. A "modified retrospective" method which includes the requirements of
the modified prospective method described above, but also permits entities to
restate based on the amounts previously recognized under SFAS 123 for purposes
of pro forma disclosures either (a) all prior periods presented or (b) prior
interim periods of the year of adoption Lucille currently accounts for
share-based payments to employees using APB 25's intrinsic value method and, as
such, recognizes no compensation expense for employee stock options. The impact
of the adoption of SFAS 123R on Lucille cannot be predicted at this time because
it will depend on levels of share-based payments granted in the future. There
would have been no material impact on reported results of operations and
earnings per share had the Company applied the fair value provisions of SFAS 123
to share-based payments.
The adoption of SFAS 123R's fair value method may have an impact,
possibly material, on Lucille's future results of operations but no material
impact on overall financial position. SFAS 123R also requires the benefits of
tax deductions in excess of recognized compensation expense, if any, to be
reported as financing cash flow, rather than as operating cash flow as required
under current literature. This requirement may reduce net operating cash flows
and increase net financing cash flows in the consolidated statement of cash
flows of periods after adoption. Due to timing of the release of SFAS 123R and
the choice between the two adoption methods, the Company is still analyzing the
ultimate impact that this new pronouncement may have on its results of
operations.
In December 2004, the FASB issued Statement of Financial Accounting
Standards No. 153, "Exchanges of Nonmonetary Assets an amendment of APB Opinion
No. 29". The guidance in APB Opinion No. 29, Accounting for Nonmonetary
Transactions, is based on the principle that exchanges of nonmonetary assets
should be measured based on the fair value of the assets exchanged. The guidance
in that Opinion, however, included exceptions to that principle. This statement
amends Opinion 29 to eliminate the exception for nonmonetary exchanges of
similar productiveassets and replaces it with a general exception for exchanges
of nonmonetary assets that do not have commerical substance. A nonmonetary
exchange has commercial substance if the future cash flows of the entity are
expected to change significantly as a result of the exchange. Lucille intends to
follow the interpretive guidance on accounting for exchanges for nonmonetary
assets as set forth in SFAS No. 153.
8
On March 29, 2005, the Staff of the Securities and Exchange Commission
(SEC or the Staff) issued Staff Accounting Bulletin No. 107, "Share-Based
Payment" (SAB 107). Although not altering any conclusions reached in SFAS 123R,
SAB 107 provides the views of the Staff regarding the interaction between SFAS
123R and certain SEC rules and regulations and, among other things, provide the
Staff's views regarding the valuation of share-based payment arrangements for
public companies. Lucille intends to follow the interpretative guidance on
share-based payment set forth in SAB 107 during the Company's adoption of SFAS
123R.
In May 2005, the FASB issued Statement of Financial Accounting
Standards No. 154, "Accounting Changes and Error Corrections a replacement of
APB Opinion No. 20 and FASB Statement No. 3". This statement changes the
requirements for the accounting for and the reporting of a change in accounting
principle. This statement applies to all voluntary changes in accounting
principle. It also applies to changes required by an accounting pronouncement in
the unusual instance that the pronouncement does not include specific transition
provisions. Opinion 20 previously required that most voluntary changes in
accounting principle be recognized by including in net income of the period of
the change the cumulative effect of changing to the new accounting principle.
This statement requires retrospective application to prior periods' financial
statements of changes in accounting principle. Lucille intends to follow the
interpretive guidance on accounting for changes and error corrections as set
forth in FASB No. 154 if applicable.
C. ACCOUNTING FOR STOCK BASED COMPENSATION
The Company has elected to follow Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees" and related interpretations
in accounting for stock options and rewards. Accordingly, no compensation costs
for stock options are included in operating results since all awards were made
at exercise prices at or above their fair value on the dates of grants.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation- Transition and Disclosure", amending FASB Statement
No. 123, "Accounting for Stock Based Compensation." This statement amends SFAS
No. 123 to provide alternative methods of transition for an entity that
voluntarily changes to the fair value based method of accounting for stock-based
employee compensation. It also amends the disclosure provisions of SFAS No. 123
to require prominent disclosure about the effects on operating results of an
entity's accounting policy decisions with respect to stock-based employee
compensation. SFAS No. 148 also amends APB Opinion No. 128, "Interim Financial
Reporting" to require disclosure about those effects in interim financial
information.
The following table illustrates the effect on results of operations if
the Company had applied the fair value recognition provisions of SFAS No. 123
for the three-month periods ended June 30, 2005 and 2004 (unaudited).
9
3-Mos. ended
======================
2005 2004
===== =====
Net Income as reported $(574,000) $ 475,000
Deduct: Total stock-based
Employee Compensation
determined under fair value
method for stock options, net of tax -- 42,000
========= ===========
Pro forma income applicable
to common stockholders $(574,000) $ 433,000
========= ===========
Basic income per share, as reported $ (0.17) $ 0.15
========= ===========
Basic income per share, pro forma $ (0.17) $ 0.14
========= ===========
Diluted income per share, as reported $ (0.17) $ 0.15
========= ===========
Diluted income per share, pro forma $ (0.17) $ 0.14
========= ===========
D. INVENTORIES
Inventories are summarized as follows:
June 30, 2005 March 31, 2005
------------- --------------
Finished Goods $1,327,000 $2,244,000
Raw Materials 361,000 217,000
Supplies and Packaging 560,000 489,000
---------- ----------
$2,248,000 $2,950,000
Less: Reserve for Obsolescence 161,000 211,000
---------- ----------
$2,087,000 $2,739,000
E. REVOLVING CREDIT LOAN
On December 2, 2004, the Company obtained an $11 million borrowing
facility from LaSalle Business Credit, LLC, consisting of (a) a $7,000,000
revolving loan, with interest payable at 1/4 of 1% over the LaSalle Bank prime
lending rate, (b) a $2,000,000, five-year, "Term Loan A", with interest payable
at 1/4 of 1% over the LaSalle Bank prime lending rate, payable interest only for
the first two years with principal payments beginning in year 3 (based on a 7
year amortization schedule), the proceeds of which were used to repay
outstanding loans, (c) a $1,000,000, two year, "Term Loan B", with interest
payable at 1.50% over the LaSalle Bank prime lending rate, payable in equal
monthly installments commencing January 1, 2005, the proceeds of which are to be
used for working capital, and (d) a $1,000,000 capital equipment line, with
interest at 1.25% over the LaSalle Bank prime lending rate, the proceeds of
which are to be used to purchase equipment. The commitment contains various
10
restrictive covenants. In addition, the Company is required to maintain defined
levels of net worth annually. At December 31, 2004, due to a significant adverse
pricing move between the price of cheese and the price of milk for the month of
December, the Company was in default of certain covenants under its borrowing
facility for the test period ended December 31, 2004. On February 14, 2005,
LaSalle and the Company entered into a First Amendment and Waiver to its Loan
and Security Agreement which, among other things, waived the foregoing defaults,
amended such covenants on a going forward basis, and suspended the capital
expenditure loans unless and until (m) on or before February 15, 2006, LaSalle
Business Credit, LLC shall have received the Company's internally-prepared
quarterly financial statements for the fiscal quarter ended December 31, 2006,
and (n) the Company shall have maintained a ratio of its FC Numerator to Fixed
Charges of not less than 1.20 to 1.00 with respect to the twelve (12) month
period then ended. At March 31, 2005, due to a significant adverse pricing move
between the price of cheese and the price of milk for the month of February, the
Company was in default of certain covenants under its borrowing facility, for
the test period ended March 31, 2005, relating to, among other things, the
maintenance of a Tangible Net Worth of not less than $2,500,000, and the
maintenance of a Fixed Charge Coverage Ratio of not less than 1.00 x 1.00. On
July 14, 2005 the Company has received waivers for the existing defaults at
March 31, 2005 and amended such covenants to suspend the Company's compliance
with (r) the Tangible Net Worth Covenant for the test periods ended April 30,
2005, May 31, 2005 and June 30, 2005, and (s) the Fixed Charge Coverage test for
the ten (10) month period ended April 30, 2005, the eleven (11) month period
ending May 31, 2005, and the twelve (12) month period ended June 30, 2005. Also,
the Company's borrowing facility was amended to (x) reduce the total borrowing
facility to $9,200,000 from $11,000,000, (y) reduce the revolving loan to
$5,500,000 from $7,000,000, and (z) reduce the capital expenditure loans to
$700,000 from $1,000,000 and make it subject to various conditions precedent.
F. EARNINGS PER SHARE
Basic earnings per share are computed by dividing net earnings
available to common shareholders by the weighted average common shares
outstanding for the period. Diluted earnings per share is computed by dividing
net earnings available to common shareholders by the weighted average common
shares outstanding adjusted for the dilutive effect of options granted under the
Company's stock option plans, outstanding warrants, and convertible preferred
stock.
At June 30, 2005 and 2004, 1,166,666 and 1,382,666, respectively, of
potential common shares, issuable upon conversion of preferred stock and
exercise of warrants are excluded from the determination of diluted earnings per
share as the related contingencies have not been met. The 395,000 potential
common shares from stock options are excluded from the determination of diluted
earnings per share at June 30, 2005 as their affect would be antidilutive. The
dilutive effect of 330,000 potential common shares at June 30, 2004, are
outlined in the following schedule:
11
Three Months Three Months
Ended Ended
June 30, 2005 June 30, 2004
------------------ -----------------
Numerator:
Net income (Loss) -basic $ (574,000) $ 475,000
=========== ===========
Net income (Loss)- diluted $ (574,000) $ 475,000
=========== ===========
Denominator:
Denominator for basic earnings (Loss) per share
Weighted avg. shares 3,353,937 3,137,937
Effect of dilutive securities
Stock options -- 962
----------- -----------
Denominator for diluted earnings (Loss) per share 3,353,937 3,138,899
Earnings (Loss) per share:
Basic: $ (0.17) $ 0.15
=========== ===========
Diluted: $ (0.17) $ 0.15
=========== ===========
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Results of Operations
General
The Company's low moisture mozzarella cheese, which accounts for a
significant portion of the Company's sales, is a commodity item. The Company
prices this product competitively with others in the industry off of the Chicago
Mercantile Exchange Block Cheddar Market (CME Block Market). The price the
Company pays for fluid milk and condensed skim milk solids, a significant
component of cost of goods sold, is not determined until the start of the month
after its cheese has been sold. Thus, the company must produce and sell its
cheese without knowing the cost of making the cheese. Generally, the price of
milk for any particular month, is computed, based on formulas determined by the
United States Department of Agriculture (USDA), by the National Agricultural
Statistical Service (NASS) after the end of the month by reference to the
average selling price of block cheddar cheese, barrel cheddar cheese, butter,
non-fat dry milk and whey. Thus, everything else being equal and there being
stability in the price of cheese, the price of milk will follow the price of
cheese in an orderly manner, the normal spread between the selling price of
cheese and the cost of milk will be maintained, and there will be stability in
the Company's gross profit margin. However, sometimes things are not equal. For
one thing, the market information required by NASS to compile the price of milk
is not immediately available and takes time to collect. For this reason, the
commodity prices used to calculate the milk price is two weeks old when the NASS
receives it at the end of a particular month (i.e. it includes the commodity
prices for two weeks of the current month and two weeks of the prior month),
creating a "lag" between the data used for determining the selling price of
cheese for the month (the CME Block Market prices for the month) and the data
used for determining the cost of milk for the month. Thus, if there is a
precipitous increase or decrease in the price of block cheddar cheese during a
given month, it may not be reflected in the average selling price of block
cheddar cheese utilized in computing the price of milk for such month. In such
event, there is a disconnect between the average price of cheese for the month
and the cost of milk for the month, and the price of milk does not increase or
decrease as fast as the price of cheese. As a consequence thereof, the Company's
gross profit margin for its product is subject to fluctuation, which
fluctuation, however slight, can have a significant effect on profitability.
12
Results for the quarter ended June 30, 2005 were down significantly from 2004.
Sales were down due to lower market prices. The volume of cheese sold was up
166,000 pounds compared to 2004, but the average CME Block market averaged only
$1.51 compared to $1.95 in 2004. The spread between the selling price of cheese
and the cost of milk remained lower than historical averages (as they did for
most of the fiscal year ended March 31, 2005). This coupled with high protein
costs and lower cheese sales led to a much lower gross profit for the first
quarter of 2005. These strained gross profits have affected all cheese makers
throughout the United States. The Company is unable to predict any future
increase or decrease in the prices in the CME Block Market as such market is
subject to fluctuation based on factors and commodity markets outside the
control of the Company. Although the cost of fluid milk does tend to move
correspondingly with the CME Block Market, the extent of such movement and the
timing thereof is not predictable. As a result of these factors, the Company is
unable to predict pricing trends.
The Company has developed a business plan designed to improve gross
margins and reduce its dependency on the spread allowed by the calculation of
the milk price. The plan calls for various capital improvements that will
significantly reduce the cost of producing cheese and change the type of whey
produced by the Company to whey protein concentrate for human and animal
consumption. The capital improvements needed to achieve the business plan will
require an infusion of capital of approximately $8,000,000. Discussions are
currently underway with St. Albans Cooperative, the Company's milk supplier, the
Vermont Economic Development Authority, the United States Department of
Agriculture, the Franklyn County Economic Development Authority, the Village of
Swanton, Vermont, UPS Business Credit, LLC and LaSalle Business Credit, LLC to
structure a financing package that would provide a portion of such financing as
well as strengthen the Company's balance sheet. Also, the Company is having
conversations with a potential joint venture partner that would provide the
necessary financing to modify the Company's whey facility. There can be no
assurance that such a financing package or joint venture will be forthcoming.
Three months ended June 30, 2005 compared to the three months ended June 30,
2004
Sales for the three month period ended June 30, 2005 decreased to
$10,889,000 from $12,964,000 for the comparable period in 2004, a decrease of
$2,075,000 or (16.0%). Approximately $2,987,000 or (110%) was due to a decrease
in the average selling price per pound of cheese comparing $1.60 this year
versus $2.06 last year. Like the cheese market, the whey market also experienced
a lower market. The Dry Sweet Whey Market, upon which the company bases the
selling price of its whey, averaged $.26 for the three month period ended June
30, 2005 compared to $.30 for the comparable period in 2004. Sales for whey
amounted to $318,000 in 2005 compared to $521,000 for the same period last year,
a decrease of $203,000 (or 39.0%).
13
Cost of sales and gross profit margin for the three month period ended June 30,
2005 were $10,580,000 or (97.2% of sales) and, $309,000 or (2.8% of sales),
respectively, compared to a cost of sales and gross profit margin of $11,774,000
or (90.8% of sales) and $1,190,000 or (9.2% of sales), respectively, for the
comparable period in 2004. The increase in the cost of sales and corresponding
decrease in gross profit margin as a percentage of sales, for the three month
period ended June 30, 2005, were the result of a larger increase in the price of
milk compared to the increase in the price of cheese. As discussed above, the
spread between the selling price of cheese and the cost of milk was well below
historical averages during the three month period ended June 30, 2005.
Manufacturing overhead applied to cost of sales was less than 2004.
Selling, general, and administrative expenses for the three-month
period ended June 30, 2005 amounted to $635,000 (or 5.8% of sales) compared to
$471,000 (or 3.5% of sales) for the comparable period in 2004. Higher labor
costs accounted for half of the increase. A new CFO was hired in February 2005
at a higher pay rate than his predecessor, and salary increases were awarded to
other employees on the payroll. Travel and entertainment and commissions were up
$20,000 and $17,000, respectively, in an effort to bolster sales. Bank charges
were up $20,000 due to loan covenant waiver fees.
Interest expense for the three month period ended June 30, 2005
amounted to $248,000 compared to $243,000 for the same period of the prior year,
a slight increase of $5,000.
There is no provision for income tax for the three month period ended
June 30, 2005 due to the Company having a loss before income taxes of $574,000
coupled with the fact that any deferred tax assets would have full valuation
allowances against them. The provision for income tax for the period ended June
30, 2004 reflects a minimum state tax, with the tax benefits of operating losses
being offset by the effect of changes in the valuation allowance. Such amounts
are re-evaluated each period based on the results of operations.
The company's net loss was $574,000 for the three month period ending
June 30, 2005 compared to net income of $475,000 for the comparable period in
2004, an decrease of $1,049,000. The primary factors contributing to these
changes are discussed above.
Liquidity and Capital Resources
On December 2, 2004, the Company obtained an $11 million borrowing
facility from LaSalle Business Credit, LLC, consisting of (a) a $7,000,000
revolving loan, with interest payable at 1/4 of 1% over the LaSalle Bank prime
lending rate, (b) a $2,000,000, five-year, "Term Loan A", with interest payable
at 1/4 of 1% over the LaSalle Bank prime lending rate, payable interest only for
the first two years with principal payments beginning in year 3 (based on a 7
year amortization schedule), the proceeds of which were used to repay
outstanding loans, (c) a $1,000,000, two year, "Term Loan B", with interest
payable at 1.50% over the LaSalle Bank prime lending rate, payable in equal
monthly installments commencing January 1, 2005, the proceeds of which are to be
used for working capital, and (d) a $1,000,000 capital equipment line, with
interest at 1.25% over the LaSalle Bank prime lending rate, the proceeds of
which are to be used to purchase equipment. The commitment contains various
14
restrictive covenants. In addition, the Company is required to maintain defined
levels of net worth annually. At December 31, 2004, due to a significant adverse
pricing move between the price of cheese and the price of milk for the month of
December, the Company was in default of certain covenants under its borrowing
facility for the test period ended December 31, 2004. On February 14, 2005,
LaSalle and the Company entered into a First Amendment and Waiver to its Loan
and Security Agreement which, among other things, waived the foregoing defaults,
amended such covenants on a going forward basis, and suspended the capital
expenditure loans unless and until (m) on or before February 15, 2006, LaSalle
Business Credit, LLC shall have received the Company's internally-prepared
quarterly financial statements for the fiscal quarter ended December 31, 2006,
and (n) the Company shall have maintained a ratio of its FC Numerator to Fixed
Charges of not less than 1.20 to 1.00 with respect to the twelve (12) month
period then ended. At March 31, 2005, due to a significant adverse pricing move
between the price of cheese and the price of milk for the month of February, the
Company was in default of certain covenants under its borrowing facility, for
the test period ended March 31, 2005, relating to, among other things, the
maintenance of a Tangible Net Worth of not less than $2,500,000, and the
maintenance of a Fixed Charge Coverage Ratio of not less than 1.00 x 1.00. On
July 14, 2005 the Company has received waivers for the existing defaults at
March 31, 2005 and amended such covenants to suspend the Company's compliance
with (r) the Tangible Net Worth Covenant for the test periods ended April 30,
2005, May 31, 2005 and June 30, 2005, and (s) the Fixed Charge Coverage test for
the ten (10) month period ended April 30, 2005, the eleven (11) month period
ending May 31, 2005, and the twelve (12) month period ended June 30, 2005. Also,
the Company's borrowing facility was amended to (x) reduce the total borrowing
facility to $9,200,000 from $11,000,000, (y) reduce the revolving loan to
$5,500,000 from $7,000,000, and (z) reduce the capital expenditure loans to
$700,000 from $1,000,000 and make it subject to various conditions precedent.
At June 30, 2005, the Company had working capital of $1,726,000 as
compared to working capital of $3,607,000 at March 31, 2005. The Company's
revolving bank line of credit is available for the Company's working capital
requirements.
At June 30, 2005, $4,404,000 was outstanding under the revolving credit
line and $174,000 was available for additional borrowing.
In connection with the LaSalle Business Credit, LLC borrowing facility,
St. Albans Cooperative Creamery, Inc., the Company's milk supplier, agreed to
subordinate to LaSalle a $1,500,000 outstanding trade account payable due from
the Company to St. Albans, on which trade account payable the Company is paying
interest at the Bank North short-term repo rate. Pursuant to the terms of the
subordination, St. Albans may receive, so long as no default exists with respect
to the LaSalle borrowing facility (a) regularly scheduled payments of interest
and principal, on a current basis, up to a maximum of $75,000 in any fiscal year
of the Company (the "Basic Payment"), and (b) commencing with the Company's
fiscal year ended March 31, 2006, a prepayment in an amount equal to 10% of the
Company's Excess Cash Flow (as defined in the LaSalle lending documents) for the
fiscal year, minus the amount of the Basic Payment made to St. Albans during the
fiscal year, and (c) if LaSalle elects to defer all or a portion of its right to
be paid 25% of the Company's Excess Cash Flow for any fiscal year (the "Deferred
Amount"), St. Albans may receive an additional payment not to exceed the
Deferred Amount, provided, however that the payments contemplated by clauses (b)
and (c) may only be paid to St. Albans so long as and to the extent that at the
time of and at all times during the thirty (30) day period immediately preceding
such payments and after giving effect to such payments, the Company has Excess
Availability (as defined in the LaSalle lending documents) of at least $300,000.
Also, St. Albans may receive, toward the payment of such trade account payable,
fifty percent (50%) of the amount of new equity capital raised by the Company in
excess of six million dollars.
On February 8, 1999, a $4,950,000 bank loan agreement was signed. The
loan is collateralized by the Company's plant and equipment and guaranteed by
the USDA. Provisions of the loan are as follows:
A $3,960,000 commercial term note with interest fixed at 9.75 percent
having an amortization period of 20 years with maturity in February, 2019.
15
A $990,000 commercial term note with interest fixed at 10.75 percent
having an amortization period of 20 years with maturity in February 2019.
On May 16, 2002, the Company entered into an agreement with St. Albans
Cooperative Creamery, Inc. ("St. Albans"), the Company's primary supplier of raw
materials, pursuant to which St. Albans (i) converted $1,000,000 of accounts
payable owed by the Company to St. Albans into 333,333 shares of common stock,
(ii) converted $3,500,000 of accounts payable owed by the Company to St. Albans
into (A) preferred stock convertible into 583,333 shares of common stock, which
preferred stock (1) automatically converts into such number of shares of common
stock if the common stock is $8.00 or higher for 30 consecutive trading days,
and (2) may be redeemed by the Company for $3,500,000, and (B) a 10-year warrant
to purchase 583,333 shares of common stock (subject to adjustment under certain
circumstances to a maximum of 1,416,667 shares of common stock) at $.01 per
share, which warrant (1) may not be exercised for a period of three-years, (2)
terminates if, during such three-year period, the Company's common stock is
$8.00 or higher for 30 consecutive trading days, and, (3) in the event the
Company's common stock is not $8.00 or higher for 30 consecutive trading days
during such three-year period, may only be exercised on the same basis
percentage wise as the preferred shares are converted, (iii) converted an
additional $1,000,000 of accounts payable owed by the Company to St. Albans into
a convertible promissory note due on April 14, 2005, which note was convertible
into common stock at $6.00 per share at any time by St. Albans and, at the
option of the Company, automatically converts into common stock at $6.00 per
share if the common stock was $8.00 or higher for a period of 30 consecutive
trading days, and (iv) provided the Company with a pricing structure for milk
and milk by-products, for a minimum of one-year and a maximum of four-years
(subject to renegotiation at the expiration of the applicable period), designed
to produce profitability for the Company. The $1,000,000 convertible promissory
note was paid as part of the refinancing arrangement with LaSalle Business
Credit, LLC. The applicable period for the milk and milk by-products pricing
structure expired in May 2003. Thereafter, St. Albans maintained the pricing
structure through June 30, 2003. Commencing July 2, 2003, and again as of
September 1, 2003, the pricing structure was modified to progressively decrease
the benefits accruing to the Company in light of the profitability of the
Company.
The Company's major source of external working capital financing is the
revolving line of credit. For the foreseeable future the Company believes that
the Company's revolving line of credit will continue to represent the major
source of working capital financing besides any income generated from
operations. Currently, the Company is seeking, as part of the financing package
discussed above, an enhancement of $750,000 to the revolving line of credit to
be guaranteed by the Vermont Economic Development Authority (VEDA). However,
there is no assurance that the enhancement to the revolving line of credit can
be secured and failure to secure such enhancement can have a significant
negative effect on the Company's liquidity.
For the three-month period ended June 30, 2005, cash provided by
operating activities was $1,634,000. Significant operating losses contributed to
the use of cash for operating activities mostly due to low gross margins as
explained above. Efforts to reduce inventory and accounts receivable generated
$1,348,000 in cash flow offsetting cash used by operating losses. An increase in
accounts payable provided the rest of the cash provided by operating activities.
The Company's Business Plan is designed to improve gross margins and reduce its
dependency on the spread between the selling price of cheese and the cost of
milk. The Business Plan will be executed when financing efforts for capital
improvements are completed as explained above. There is no assurance that
financing for the Business Plan can be secured and failure to secure such
financing can have a significant negative effect on the Company's liquidity.
Net cash used in investing activities was $36,000 for the three month
period ended June 30,2005, which represented purchase of property, plant and
equipment. Net cash used in financing activities was $1,518,000 for the three
month period ended June 30,2005. Cash generated through the reduction of
inventory and accounts receivable and the increase in accounts payable was used
to pay down the revolving line of credit with LaSalle Bank. Installment payments
on term debt with LaSalle Bank amounted to $125,000 for the quarter.
16
Safe Harbor Statement
This Quarterly Report on Form 10-Q (and any other reports issued by the
Company from time to time) contains certain forward-looking statements made in
reliance upon the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995. Such forward-looking statements are based on current
expectations that involve numerous risks and uncertainties. Actual results could
differ materially from those anticipated in such forward-looking statements as a
result of various known and unknown factors including, without limitation,
future economic, competitive, regulatory, and market conditions, future business
decisions, the uncertainties inherent in the pricing of cheese on the Chicago
Mercantile Exchange upon which the Company's prices are based, changes in
consumer tastes, fluctuations in milk prices, and those factors discussed above
under Management's Discussion and Analysis of Financial Condition and Results of
Operations. Words such as "believes," "anticipates," "expects," "intends,"
"may," and similar expressions are intended to identify forward-looking
statements, but are not the exclusive means of identifying such statements. The
Company undertakes no obligation to revise any of these
forward-lookingstatements.
ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK
The Company is subject to interest rate exposure on variable rate debt.
The amount of that debt at the balance sheet date, June 30, 2005 and March 31,
2005 amounted to $7,154,000 and $8,626,000, respectively. Since the interest
rate on debt is based upon the prime rate plus .25%, or 1.50%, the cost of this
debt will increase or decrease accordingly with changes in the prime rate.
The Company has exposure to the commodity price for cheese, dry whey
and fluid milk. We have addressed these exposures in the general paragraph of
Management's Discussion and Analysis, Item 2 above.
ITEM 4. CONTROLS AND PROCEDURES
As of the end of the period covered by this Report on Form 10-Q, the Company
carried out an evaluation, under the supervision and with the participation of
the Company's management, including the CEO and CFO, of the effectiveness of the
design and operation of the Company's disclosure controls and procedures
pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Company's
CEO and CFO concluded that the Company's disclosure controls and procedures are
effective in timely alerting them to material information relating to the
Company required to be included in the Company's periodic SEC filings and
ensures that information required to be disclosed by the Company in the report
it files or submits under the Exchange Act is recorded, processed, summarized
and reported, within time periods specified by the rules and forms.
The Company and its auditors had identified deficiencies within its internal
control framework which, if left uncorrected could result in a material control
weakness. Our internal control deficiencies related to the account
reconciliation process and lack of compliance with established procedures for
monitoring and adjusting balances relating to certain accruals and provisions.
As a result of the above actions, a reorganization and centralization of its
accounting department, has been implemented. Procedures have also been
implemented to monitor and adjust all balances and provisions.
17
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Unregistered Sale of Equity Securities and Use of Proceeds; Purchase
of Equity, Securities By Issuer and Affiliated Purchasers None
Item 3. Defaults Upon Senior Securities
None
Item 4 Submission of Matters to a Vote of Security Holders
None
Item 5 Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
31.1 Certification of Periodic Report pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Periodic Report pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Periodic Report pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Periodic Report pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on form 8-K filed in the quarter ended June 30, 2005.
None
18
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of
1934, the Registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
Date: August 12, 2005 Lucille Farms, Inc.
(Registrant)
By: /s/ Jay Rosengarten
------------------------
Jay Rosengarten,
Chief Executive Officer
By: /s/ Don Desjarlais
-----------------------
Don Desjarlais,
Chief Financial Officer
(chief financial and accounting officer)
19
EXHIBIT INDEX
Exhibit
Number Description of Exhibit
31.1* Certification of Periodic Report pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
31.2* Certification of Periodic Report pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
32.1* Certification of Periodic Report pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002. 18 U.S.C. Section 1350.
32.2* Certification of Periodic Report pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002,18 U.S.C.Section 1350.
* Filed herewith
20