KID BRANDS, INC AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The assumptions used to estimate the fair value of the SARs granted during the three
months ended March 31, 2013 and 2012 were as follows:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
|
|
2013
|
|
|
2012
|
|
Dividend yield
|
|
|
|
%
|
|
|
|
%
|
Risk-free interest rate
|
|
|
0.84
|
%
|
|
|
0.90
|
%
|
Volatility
|
|
|
75.6
|
%
|
|
|
85.0
|
%
|
Expected term (years)
|
|
|
4.1
|
|
|
|
5.0
|
|
Weighted-average fair value of SARs granted
|
|
$
|
0.85
|
|
|
$
|
2.02
|
|
Activity regarding outstanding SARs for the three months ended March 31, 2013 is as follows:
|
|
|
|
|
|
|
|
|
|
|
All SARs Outstanding
|
|
|
|
|
|
|
Weighted Average
|
|
|
|
Shares
|
|
|
Exercise Price
|
|
SARs Outstanding as of December 31, 2012
|
|
|
1,521,385
|
|
|
$
|
3.38
|
|
SARs Granted
|
|
|
700,000
|
|
|
$
|
1.51
|
|
SARs Exercised
|
|
|
|
|
|
|
|
|
SARs Forfeited/Cancelled*
|
|
|
(67,330
|
)
|
|
$
|
4.59
|
|
|
|
|
|
|
|
|
|
|
SARs Outstanding as of March 31, 2013
|
|
|
2,154,055
|
|
|
$
|
2.73
|
|
|
|
|
|
|
|
|
|
|
SAR price range at March 31, 2013
|
|
$
|
1.348.50
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
*
|
See disclosure below regarding forfeitures.
|
The aggregate intrinsic value of the unvested and vested outstanding SARs at March 31, 2013 and December 31, 2012 was $164,438 and $136,348, 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.
A summary of the Companys unvested SARs at March 31, 2013 and changes during the three months ended March 31, 2013 is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-Average Grant
|
|
|
|
Shares
|
|
|
Date Fair Value Per
Share
|
|
Unvested at December 31, 2012
|
|
|
1,265,645
|
|
|
$
|
1.94
|
|
Granted
|
|
|
700,000
|
|
|
$
|
0.85
|
|
Vested
|
|
|
(106,775
|
)
|
|
$
|
2.18
|
|
Forfeited*
|
|
|
(44,930
|
)
|
|
$
|
2.45
|
|
|
|
|
|
|
|
|
|
|
Unvested at March 31, 2013
|
|
|
1,813,940
|
|
|
$
|
1.49
|
|
|
|
|
|
|
|
|
|
|
*
|
See disclosure below regarding forfeitures.
|
As of March 31, 2013, there was approximately $2.3 million of unrecognized compensation cost related to unvested SARs, which is expected to be recognized over a weighted-average period of 3.2 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, 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 typically forfeited, except in the event of disability or death, in which case all restrictions lapse.
11
KID BRANDS, INC AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Employee Stock Purchase Plan
Under the 2009 ESPP (until its suspension for the 2012 and 2013 plan years), eligible employees were provided the opportunity to purchase
KIDs Common Stock at a discount. Pursuant to the 2009 ESPP, options were granted to participants as of the first trading day of each plan year, which is the calendar year, and were exercised as of the last trading day of each plan year, to
purchase from KID the number of shares of Common Stock that could have been purchased at the relevant purchase price with the aggregate amount contributed by each participant. In each plan year (through 2011), an eligible employee could 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 had the right to purchase Common Stock under the 2009 ESPP that had 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 was 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 did not elect to exercise his or her option, the total amount credited to his or her account during that plan year was returned to such employee without interest, and his or her option expired. At March 31, 2013
and December 31, 2012, 6,663 shares were available for issuance under the 2009 ESPP. The Company has suspended the 2009 ESPP for fiscal years 2012 and 2013, and deregistered such remaining shares.
NOTE 3WEIGHTED 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 per share is set forth below (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
March
31,
|
|
|
|
2013
|
|
|
2012
|
|
Weighted average common shares outstanding-Basic
|
|
|
21,850
|
|
|
|
21,815
|
|
Dilutive effect of common shares issuable upon exercise of stock options, RSUs and SARs
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding assuming dilution
|
|
|
21,850
|
|
|
|
21,815
|
|
|
|
|
|
|
|
|
|
|
The computation of diluted net loss per common share for the three months ended March 31, 2013 and
March 31, 2012 did not include stock options and stock appreciation rights to purchase an aggregate of approximately 2.0 million and 1.3 million shares of common stock, respectively, because their inclusion would have been
anti-dilutive due to the net loss incurred during such periods.
NOTE 4 DEBT
Credit Agreement
On December 21, 2012, the Company, specified domestic subsidiaries consisting of Kids Line, LLC, Sassy, Inc., LaJobi, Inc., CoCaLo, Inc., I&J Holdco, Inc., and RB Trademark Holdco, LLC (such entities
collectively with the Company, the Borrowers), executed a Credit Agreement (the Credit Agreement) with Salus Capital Partners, LLC, as Lender, Administrative Agent and Collateral Agent (the Agent), and the other
lenders from time to time party thereto (the Lenders). The obligations of the Borrowers under the Credit Agreement are joint and several. All of the Companys indebtedness for borrowed money under the Credit Agreement is classified
as short term debt. The Credit Agreement was amended on each of April 16, 2013 and May 16, 2013. The April 2013 amendment amended the definition of Adjusted EBITDA for purposes of determining compliance with applicable financial covenants. The May
2013 amendment, among other things: (i) instituted quarterly (as opposed to the previous monthly) testing of the Adjusted EBITDA covenant, unless and until specified trigger events occur (in which case monthly testing will resume); (ii) lowered the
minimum Adjusted EBITDA required pursuant to such covenant for all remaining testing periods other than the trailing twelve-month period ending December 31, 2013; and (iii) amended the definition of Adjusted EBITDA to increase the amount of certain
permissible add-backs to net income in the calculation thereof, in each case as of April 1, 2013. Each such amendment to the Credit Agreement is described in detail below.
12
KID BRANDS, INC AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The Credit Agreement provides for an aggregate maximum $80.0 million revolving credit
facility, composed of: (i) a revolving $60.0 million tranche (the Tranche A Revolver), with a $5.0 million sublimit for letters of credit; and (ii) a $20.0 million first-in last-out tranche (the Tranche A-1 Revolver). The
Borrowers may not request extensions of credit under the Tranche A Revolver unless they have borrowed the full amount available under the Tranche A-1 Revolver. Borrowers must cash collateralize all outstanding letters of credit.
At March 31, 2013, an aggregate of $52.1 million was borrowed under the Credit Agreement ($33.4 million under the Tranche A Revolver and
$18.7 million under the Tranche A-1 Revolver). At December 31, 2012, an aggregate of $57.5 million was borrowed under the Credit Agreement ($38.8 million under the Tranche A Revolver and $18.7 million under the Tranche A-1 Revolver). At March 31,
2013 and December 31, 2012, revolving loan availability was $10.7 million and $11.4 million, respectively.
Loans under the
Credit Agreement bear interest at a specified 30-day LIBOR rate (subject to a minimum LIBOR floor of 0.50%), plus a margin of 4.0% per annum with respect to the Tranche A Revolver and a margin of 11.25% per annum with respect to the Tranche A-1
Revolver. Interest is payable monthly in arrears and on the maturity date of the facility. During the continuance of any event of default, existing interest rates would increase by 3.50% per annum. The weighted average interest rates for the
outstanding loans under the Credit Agreement as of March 31, 2013 and December 31, 2012 were 4.5% with respect to the Tranche A Revolver and 11.75% with respect to the Tranche A-1 Revolver.
Subject to the borrowing base described below, the Borrowers may borrow, repay (without premium or penalty) and re-borrow advances under
each of the Tranche A Revolver and the Tranche A-1 Revolver until December 21, 2016 (the Maturity Date), at which time all outstanding obligations under the Credit Agreement are due and payable (subject to early termination provisions).
Other than in connection with a permanent reduction of the Tranche A-1 Revolver as described below, repayments shall be first applied to the Tranche A Revolver, and upon repayment of the Tranche A Revolver in full, to the Tranche A-1 Revolver.
The Borrowers may in their discretion terminate or permanently reduce the commitments under the Tranche A Revolver or the
Tranche A-1 Revolver,
provided
that the Borrowers may not reduce the commitments under the Tranche A-1 Revolver to less than $15.0 million while commitments under the Tranche A Revolver remain outstanding, and if the commitments under the
Tranche A Revolver are terminated or reduced to zero, the commitments under the Tranche A-1 Revolver will be automatically terminated. In the event of such permanent reduction (or in the event of any termination of the commitments prior to the
Maturity Date), the Borrowers shall pay to the Agent for the benefit of the Lenders or as otherwise determined by the Agent, a termination fee in the amount of: (i) 2.0% of the amount of the commitments so reduced or outstanding at the time of
termination, if reduced or terminated prior to the first anniversary of the closing date of the Credit Agreement (the First Anniversary); (ii) 1.5% of the amount of the commitments so reduced or outstanding at the time of termination, if
reduced or terminated on or after the First Anniversary but prior to the second anniversary of such closing date (the Second Anniversary); and (iii) 0.50% of the amount of the commitments so reduced or outstanding at the time of
termination, if reduced or terminated on or after the Second Anniversary,
provided
that the Borrowers may permanently reduce the commitments under the Tranche A-1 Revolver from time to time to no less than $15.0 million without the incurrence
of any premium, penalty or fee, so long as no event of default has occurred and is continuing.
The Tranche A Revolver is
subject to borrowing base limitations based on 95% of the face amount of specified eligible accounts receivable, net of reserves established in the reasonable discretion of the Agent, including dilution reserves;
plus
the lesser of: (x) 68%
of eligible inventory stated at the lower of cost or market value (in accordance with the Borrowers accounting practices), net of reserves established in the reasonable discretion of the Agent; and (y) 100% of the appraised orderly liquidation
value, net of costs and expenses, of eligible inventory stated at the lower of cost or market value, net of inventory reserves;
minus
an availability block of $4.0 million (or if an event of default exists, such other amount established by
the Agent);
minus
customary availability reserves (without duplication).
The Tranche A-1 Revolver is subject to
borrowing base limitations based on the lesser of: (i) 50% of the fair market value (as determined by an independent appraiser engaged by the Agent from time to time) of specified registered eligible intellectual property, net of reserves
established in the reasonable discretion of the Agent, and (ii) the aggregate commitments for the Tranche A-1 Revolver at such time ($20.0 million at the time of closing); provided that availability under the Tranche A-1 Revolver is capped at 40% of
the combined borrowing bases of the Tranche A Revolver and Tranche A-1 Revolver.
13
KID BRANDS, INC AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Under the Credit Agreement, the Company is subject to a minimum Adjusted EBITDA covenant
(defined below), based on a trailing twelve-month period ending on the applicable testing date, and commencing March 31, 2013, a minimum consolidated Fixed Charge Coverage Ratio (defined below) of 1.1:1.0 (the Financial Covenants).
As has been previously disclosed, in March 2013, a large customer of ours deducted approximately $900,000 from its payment of
outstanding amounts due (the Deduction). In connection with our investigation of the matter, we determined that the Deduction represented the customers annual accounting of product returns. The Company currently believes that a
substantial portion of such claim is without merit or can be offset against other amounts owed to us by, or credited to, such customer. As a result, no amount in excess of our previously accrued 2012 product return reserve for this customer was
recorded for the period ended December 31, 2012, and no additional amounts were accrued with respect to the Deduction as of March 31, 2013. Although the Company believes that this matter can be successfully resolved without recording any additional
material amounts, there can be no assurance that this will be the case. As the matter had not been resolved (and remains pending), the Borrowers and the Agent under the Credit Agreement executed a First Amendment to Credit Agreement (Amendment
No. 1), to amend the definition of Adjusted EBITDA for purposes of determining compliance with the financial covenants under the Credit Agreement, commencing with the month ended December 31, 2012 through April 30, 2014, to include an
additional add-back to net income for the amount of any additional expense or accrual in excess of the Companys existing product return reserves in connection with the Deduction, up to a maximum aggregate amount of $600,000 (an Excess
Accrual). The Borrowers paid a fee of $50,000 in connection with the execution of Amendment No. 1, and will pay an additional $50,000 if and when the Borrowers first use the amount of any Excess Accrual as an add-back to net income in
determining compliance with the financial covenants as permitted by Amendment No. 1.
Under the original terms of the Credit
Agreement, the Adjusted EBITDA covenant was tested on a monthly basis, for the trailing twelve-month period ending on the last day of each month. As of March 31, 2013, the Company was in compliance with all Financial Covenants in the Credit
Agreement. However, the Company believed that it would be unlikely to remain in compliance with the Adjusted EBITDA covenant for the month ended April 30, 2013 and, potentially, certain future monthly testing periods. The Company believes that
quarterly covenant testing is more appropriate due to monthly sales fluctuations often experienced by the Company in the conduct of its business. Accordingly, the Borrowers and the Agent executed a Second Amendment to Credit Agreement
(Amendment No. 2) on May 16, 2013, effective as of April 1, 2013. Pursuant to Amendment No. 2, among other things: (i) the Adjusted EBITDA covenant will be tested on a quarterly basis, unless and until specified trigger events described
below occur; (ii) the minimum Adjusted EBITDA required has been lowered for all remaining testing periods other than the trailing twelve-month period ending December 31, 2013; and (iii) the definition of Adjusted EBITDA has been amended to increase
the amount of certain permissible add-backs to net income in the calculation thereof (described below). Monthly testing of the Adjusted EBITDA covenant will resume in the event that the Loan Parties fail to maintain: (x) average daily availability
for a trailing two month period of $9.0 million, measured on each of July 1, 2013 and August 1, 2013, and $11.0 million, measured on the first day of each month commencing September 1, 2013; or (y) a ratio of operating expenses to gross profit,
tested as of the last day of each month, commencing June 30, 2013, for the year-to-date period, of not more than 105% (either of such events, a Trigger Event). The Borrowers paid a fee of $50,000 in connection with the execution of
Amendment No. 2, and agreed to a four month increase in the Agents monthly monitoring fee (for an aggregate additional payment of $30,000).
Prior to Amendment No. 2, the minimum monthly consolidated Adjusted EBITDA required was as follows:
|
|
|
|
|
Trailing Twelve-Month Period Ending
|
|
Minimum Adjusted EBITDA
|
|
March 31, 2013
|
|
$
|
9,516,000
|
|
April 30, 2013
|
|
$
|
9,925,000
|
|
May 31, 2013
|
|
$
|
9,782,000
|
|
June 30, 2013
|
|
$
|
10,534,000
|
|
July 31, 2013
|
|
$
|
11,811,000
|
|
August 31, 2013
|
|
$
|
12,007,000
|
|
September 30, 2013
|
|
$
|
12,363,000
|
|
October 31, 2013
|
|
$
|
13,717,000
|
|
November 30, 2013
|
|
$
|
14,411,000
|
|
December 31, 2013
|
|
$
|
14,338,000
|
|
Subsequent to Amendment No. 2, the minimum quarterly consolidated Adjusted EBITDA required is as follows:
|
|
|
|
|
Trailing Twelve Month Period Ending
|
|
Minimum Adjusted EBITDA
|
|
June 30, 2013
|
|
$
|
8,200,000
|
|
September 30, 2013
|
|
$
|
10,900,000
|
|
December 31, 2013
|
|
$
|
14,338,000
|
|
provided
, that as of the last day of each month ending after any Trigger Event is first determined to have
occurred, the Adjusted EBITDA covenant will be tested monthly (in accordance with the minimum Adjusted EBITDA requirements set forth below), for the trailing twelve month period ending on the last day of each applicable month:
|
|
|
|
|
Trailing Twelve Month Period Ending
|
|
Minimum Adjusted EBITDA
|
|
June 30, 2013
|
|
$
|
8,200,000
|
|
July 31, 2013
|
|
$
|
9,000,000
|
|
August 31, 2013
|
|
$
|
9,700,000
|
|
September 30, 2013
|
|
$
|
10,900,000
|
|
October 31, 2013
|
|
$
|
12,800,000
|
|
November 30, 2013
|
|
$
|
14,300,000
|
|
December 31, 2013
|
|
$
|
14,338,000
|
|
14
KID BRANDS, INC AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
and
provided further
, that, for trailing twelve month periods ending after December 31, 2013, the
Agent will set the minimum Adjusted EBITDA covenant levels based on those included in the relevant annual business plan required to be provided to the Agent, using a comparable methodology to that used to establish Adjusted EBITDA requirements for
2013, including a set-back at least equal to the original minimum set-back used to establish Adjusted EBITDA requirements upon execution of the Credit Agreement in December 2012. The Adjusted EBITDA covenant will continue to be tested on a quarterly
basis for periods after December 31, 2013 (unless a Trigger Event is determined to have occurred, in which case monthly testing will resume). Notwithstanding the foregoing, if no additional Trigger Event is determined to have occurred during the
6-month period after a previous determination that a Trigger Event has occurred, and so long as no event of default has occurred and is continuing, quarterly testing will again commence until the next determination that a Trigger Event has occurred
(in which case monthly testing will again resume).
For purposes of the definition of Adjusted EBITDA: (i) Duty
Amounts refer to all customs duties, interest, penalties and any other amounts payable or owed to U.S. Customs and Border Protection (U.S. Customs) by LaJobi, Kids Line, CoCaLo or Sassy, to the extent that such amounts relate to
specified duty underpayments by such subsidiaries to U.S. Customs and LaJobis business and staffing practices in Asia prior to March 30, 2011 (the Duty Events); and (ii) Consolidated Net Income means, as of any date of
determination, the Companys consolidated net income for the most recently completed trailing twelve-month period in accordance with GAAP, subject to specified exclusions including, among other things, extraordinary gains and losses for such
period, and the income (or loss) of the Companys subsidiaries under specified circumstances (e.g., the income (or loss) of a subsidiary in which another person has a joint interest, except to the extent of actual distributions received, the
income (or loss) of a subsidiary accrued prior to the date it became a subsidiary, and the income of any subsidiary to the extent distributions made by such subsidiary were not then-permitted).
Adjusted EBITDA is defined as an amount equal to the Companys Consolidated Net Income for the most recently completed trailing
twelve-month period (from the date of determination),
plus
: (a) the following to the extent deducted in calculating such Consolidated Net Income: (i) specified consolidated interest charges; (ii) the provision for income taxes; (iii)
depreciation and amortization expense; (iv) other non-recurring non-cash expenses reducing such Consolidated Net Income for such period (such expenses will be deducted from Adjusted EBITDA during the period when paid in cash); (v) (a) all Duty
Amounts accrued or expensed, (b) the amount of any earnout consideration paid by LaJobi in connection with the Companys purchase of the LaJobi assets in April 2008 (LaJobi Earnout Consideration), and (c) fees and expenses incurred
by the Borrowers in connection with any investigations of the Duty Amounts and Duty Events, in an aggregate amount under clauses (a), (b) and (c) not to exceed the sum, for all periods, of (x) $14,855,000 less (y) the amount of LaJobi Earnout
Consideration, if any, paid by LaJobi other than in accordance with the terms of the Credit Agreement and/or to the extent not deducted in determining Consolidated Net Income; (vi) professional fees and expenses incurred after July 1, 2012 in an
aggregate amount not to exceed $2.75 million (this limit was $2.0 million prior to the execution of Amendment No. 2) through December 31, 2013 plus, in each case, all reasonable and necessary fees and expenses of Alix Partners in an aggregate amount
not to exceed $0.75 million; (vii) restructuring and severance costs in an amount not to exceed $2.0 million, and such additional amounts as are approved by the Agent in its discretion (this limit was $1.0 million prior to the execution of Amendment
No. 2); (viii) expenses arising as a result of the recall of specified products, in an aggregate amount not to exceed $0.6 million; (ix) actual costs incurred as a result of the wind-down of the Borrowers operations in the United Kingdom, in
an aggregate amount not to exceed $0.1 million; (x) if expensed, reasonable costs, expenses and fees incurred in connection with the Credit Agreement in an aggregate amount not to exceed $0.5 million; (xi) to the extent included in the
Companys business plan or otherwise acceptable to the Agent, non-cash stock-based compensation expenses; and (xii) for purposes of calculating the financial covenants set forth in Section 7.15, if required to be expensed or accrued during any
period commencing with the month ended December 31, 2012 through and including April 30, 2014 (in addition to related reserves recorded as of the date of execution of Amendment No. 1), the net amount of the deductions from invoices to a large
customer of the Company as reported to the Agent by KID prior to the date of execution of Amendment No. 1 in an aggregate amount not to exceed $600,000, minus (b) the following to the extent included in calculating such Consolidated Net Income: (i)
income tax credits and (ii) all non-cash items increasing Consolidated Net Income (in each case by the Company and its subsidiaries for such period).
Consolidated Fixed Charge Coverage Ratio means, at any date of determination, the ratio of: (a) (i) Adjusted EBITDA for the most recently completed trailing twelve-month period,
minus
(ii) unfinanced capital expenditures made during such period,
minus
(iii) the aggregate amount of income taxes paid in cash during such period (but not less than zero); to (b) the sum of: (i) specified debt
service charges,
plus
(ii) the aggregate amount of all restricted payments (defined generally to mean dividends or distributions with respect to equity interests, or deposits, sinking funds or payments for the purchase, redemption,
retirement or termination of any such equity interests) paid in cash by the Company and its subsidiaries, in each case determined on a consolidated basis in accordance with GAAP.
Loans under the Credit Agreement are required to be prepaid upon the occurrence, and with the net proceeds, of certain transactions,
including the incurrence of specified indebtedness, most asset sales and debt or equity issuances, as well as extraordinary receipts, including tax refunds, litigation proceeds, certain insurance proceeds and indemnity payments. Loans under the
Credit Agreement are also required to be prepaid with cash collateral required to be held by letter of credit issuers pursuant to the Credit Agreement on account of expired or reduced letters of credit. Such prepayments will be applied first to the
repayment of amounts outstanding under the Tranche A Revolver until paid in full, and then to amounts outstanding under the Tranche A-1 Revolver.
The 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 requirements, notice requirements with respect to specified events, required compliance certificates, and certificates from the Companys independent auditors. As a result of the delay in filing the 2012 10-K, the Company
was not in compliance with a covenant under the Credit Agreement that required the delivery of financial statements for 2012 within 90 days of the end of such fiscal year. Such noncompliance was waived by the Agent on April 2, 2013. In
addition, among other restrictions, the Loan Parties (the Borrowers and guarantors, if any) and their subsidiaries (other than specified inactive subsidiaries) are prohibited from: consummating a merger or other fundamental change; paying cash
dividends or distributions; purchasing or redeeming stock (including under the Companys stock purchase plan); incurring additional debt or allowing liens to exist on their assets; making acquisitions; disposing of assets; issuing equity and
consummating other transactions outside of the ordinary course of business; making specified payments and investments; engaging in transactions with affiliates; amending material contracts to the extent such amendment would result in a default or
event of default or would be materially adverse to the Lenders; paying Duty Amounts; or paying any LaJobi Earnout Consideration, subject in each case to limited specified exceptions, the more significant of which are described below.
Duty Amounts and LaJobi Earnout Consideration may be paid either: (i) in accordance with the business plan required to be provided
to the Agent for the relevant year, or (ii) otherwise, so long as no default or event of default is continuing or would result therefrom, and availability, both before and after giving effect to such payment, is at least $10.0 million.
With respect to acquisitions, the Borrowers will be permitted to make an acquisition provided that the Company would be in
pro forma compliance with the Financial Covenants, recomputed as of the last day of the most recently ended fiscal quarter for which financial statements are available, such acquisition is initiated and consummated on a friendly basis, no default or
event of default has occurred and is continuing or would result from such acquisition, and the aggregate consideration (including all acquired debt) for all such permitted acquisitions does not exceed $500,000.
15
KID BRANDS, INC AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The Company will be permitted to issue and sell equity interests (other than equity
interests that mature or are mandatorily redeemable or redeemable at the option of the holder, in whole or in part, on or prior to the date that is ninety-one days after the Maturity Date), so long as the net proceeds therefrom are applied to
repayment of outstanding obligations under the Credit Agreement, or pursuant to other specified exceptions as set forth in the Credit Agreement.
The Credit Agreement also requires that the Borrowers provide the Agent with, among other things, an annual business plan containing specified monthly information and projections, monthly compliance
certificates, and frequent and detailed financial, business and collateral reports.
Substantially all cash, other than cash
set aside for the benefit of employees (and certain other exceptions), will be swept and applied to repayment of amounts outstanding under the Credit Agreement.
The Credit Agreement contains customary events of default (including any failure to remain in compliance with the Financial Covenants). If an event of default occurs and is continuing (in addition to
default interest as described above and other remedies available to the Lenders), the Agent may, in its discretion, declare the commitments under the Credit Agreement to be terminated, declare outstanding obligations thereunder to be due and
payable, demand cash collateralization of letters of credit, and/or capitalize any accrued and unpaid interest by adding such amount to the outstanding principal balance (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, without any action of the Agent or any Lender). In addition, an event of default under the Credit Agreement could result in a cross-default under certain
license agreements that the Company maintains.
The Credit Agreement also contains customary conditions to lending, including
that no default or event of default shall exist, or would result from any proposed extension of credit.
The Company paid fees
to the Agent in the aggregate amount of approximately $1.1 million in connection with the execution of the Credit Agreement. The Borrowers are also required to pay a monthly commitment fee of 0.50% per annum on the aggregate unused portion of
each of the Tranche A Revolver and the Tranche A-1 Revolver (payable monthly in arrears); customary letter of credit fronting fees (plus standard issuance and other processing fees) to the applicable issuer; a monthly monitoring fee to the Agent; an
annual agency fee, and other customary fees and reimbursements of expenses. Financing costs, including fees and expenses paid upon execution of the Credit Agreement, were recorded in accordance with applicable financial accounting standards.
In order to secure the obligations of the Loan Parties under the Credit Agreement, each Borrower has pledged 100% of the
equity interests of its domestic subsidiaries (other than inactive subsidiaries), including a pledge of the capital stock of each Borrower (other than the Company), as well as 65% of the equity interests of specified foreign subsidiaries, to the
Agent, and has granted security interests to the Agent in substantially all of its personal property, all pursuant to a Security Agreement, dated as of December 21, 2012, by the Company and the other Borrowers and Loan Parties party thereto
from time to time in favor of the Agent, as Collateral Agent. As additional security for Sassy, Inc.s obligations under the Credit Agreement, Sassy, Inc. has granted a mortgage for the benefit of the Agent and the Lenders on the real property
located at 2305 Breton Industrial Park Drive, S.E., Kentwood, Michigan.
NOTE 5 FAIR VALUE MEASUREMENTS
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). The Company has no Level 2 assets or liabilities that are measured at a
fair value on a recurring basis.
16
KID BRANDS, INC AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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.
Cash and cash equivalents, trade accounts receivable, inventory, income tax receivable, trade accounts payable and accrued expenses 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
borrowings under both the Tranche A Revolver and the Tranche A-1 Revolver (defined and described in Note 4) 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 three months ended March 31, 2013, compared to
those used in prior periods.
NOTE 6 INTANGIBLE ASSETS
As of March 31, 2013 and December 31, 2012, the components of intangible assets consist of the following (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted Average
|
|
March 31,
|
|
|
December 31,
|
|
|
|
Amortization Period
|
|
2013
|
|
|
2012
|
|
Sassy trade name
|
|
Indefinite life
|
|
$
|
5,400
|
|
|
$
|
5,400
|
|
Kokopax trade name *
|
|
6 years
|
|
|
390
|
|
|
|
403
|
|
Kokopax customer relationships *
|
|
5 years
|
|
|
47
|
|
|
|
49
|
|
Kids Line customer relationships
|
|
20 years
|
|
|
6,478
|
|
|
|
6,583
|
|
Kids Line trade name
|
|
Indefinite life
|
|
|
5,300
|
|
|
|
5,300
|
|
LaJobi trade name
|
|
Indefinite life
|
|
|
8,700
|
|
|
|
8,700
|
|
LaJobi customer relationships
|
|
20 years
|
|
|
9,525
|
|
|
|
9,684
|
|
LaJobi royalty agreements
|
|
5 years
|
|
|
294
|
|
|
|
403
|
|
CoCaLo trade name
|
|
Indefinite life
|
|
|
5,800
|
|
|
|
5,800
|
|
CoCaLo customer relationships
|
|
20 years
|
|
|
1,902
|
|
|
|
1,934
|
|
CoCaLo foreign trade name
|
|
Indefinite life
|
|
|
31
|
|
|
|
31
|
|
|
|
|
|
|
|
|
|
|
|
|
Total intangible assets
|
|
|
|
$
|
43,867
|
|
|
$
|
44,287
|
|
|
|
|
|
|
|
|
|
|
|
|
*
|
In late September of 2012, Sassy acquired substantially all of the operating assets of Kokopax, LLC, a developer and marketer of framed infant back carriers and related
accessories, including sun hats and totes. Under the purchase method of accounting, the total purchase price for Kokopax has been assigned to the net tangible and intangible assets acquired based on their estimated fair values. Approximately
$478,000 was assigned to certain intangible assets based on preliminary valuations performed by the Company. Accordingly, the final determination of value could result in an increase or decrease to these values in future periods. See Note 9 for
information on potential earnout consideration in connection with the purchase of the Kokopax assets.
|
Aggregate
amortization expense was approximately $420,000 and $405,000 for the three months ended March 31, 2013 and 2012, 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). The Companys other intangible assets with definite lives are amortized over their estimated useful lives and
are tested if events or changes in circumstances indicate that an asset may be impaired. All intangible assets, both definite-lived and indefinite-lived, were tested for impairment in the fourth quarter of 2012, and no impairments were recorded in
connection therewith. In accordance with applicable accounting standards, there were no triggering events warranting interim testing of any intangible assets during the three months ended March 31, 2013, and no impairments of intangible assets
(either definite-lived or indefinite-lived) were recorded during such period.
17
KID BRANDS, INC AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 additional 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.
NOTE 7 GEOGRAPHIC INFORMATION AND CONCENTRATION OF RISK
The following tables present net sales and total assets of the Company by geographic area (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months ended March 31,
|
|
|
|
2013
|
|
|
2012
|
|
Net sales
|
|
|
|
|
|
|
|
|
|
|
Net domestic sales
|
|
$
|
50,104
|
|
|
|
|
$
|
52,947
|
|
Net foreign sales (Australia and United Kingdom)*
|
|
|
1,335
|
|
|
2,281
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net sales
|
|
$
|
51,439
|
|
|
|
|
$
|
55,228
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31,
2013
|
|
|
December 31,
2012
|
|
Assets
|
|
|
|
|
|
|
|
|
Domestic assets
|
|
$
|
128,074
|
|
|
$
|
137,645
|
|
Foreign assets (Australia, United Kingdom and Asia)
|
|
|
3,222
|
|
|
|
3,249
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
131,296
|
|
|
$
|
140,894
|
|
|
|
|
|
|
|
|
|
|
*
|
Excludes export sales from the United States.
|
In light of the unprofitability of Kids Lines U.K. operations, the Company substantially completed the wind-down of such operations, as of December 31, 2012.
A measure of profit or loss for the three months ended March 31, 2013 and 2012 and long lived assets for March 31, 2013 and
December 31, 2012 can be found in the Consolidated Statements of Operations and the Consolidated Balance Sheets, respectively.
The Company currently categorizes its sales in five product categories: Soft Good Basics, Hard Good Basics, Toys and Entertainment, Accessories and Décor and Other. Soft Good Basics includes
bedding, blankets and mattresses. Hard Good Basics includes cribs and other nursery furniture, appliances, feeding items, baby gear and organizers. Toys and Entertainment includes developmental toys, bath toys and mobiles. Accessories and
Décor includes hampers, lamps, rugs and décor. 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 months ended March 31, 2013 and 2012 were as follows:
|
|
|
|
|
|
|
|
|
|
|
Three months ended March 31,
|
|
|
|
2013
|
|
|
2012
|
|
Soft Good Basics
|
|
|
36.4
|
%
|
|
|
38.8
|
%
|
Hard Good Basics
|
|
|
33.5
|
%
|
|
|
36.3
|
%
|
Toys and Entertainment
|
|
|
21.0
|
%
|
|
|
14.6
|
%
|
Accessories and Décor
|
|
|
8.2
|
%
|
|
|
9.0
|
%
|
Other
|
|
|
0.9
|
%
|
|
|
1.3
|
%
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
18
KID BRANDS, INC AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Customers who account for a significant percentage of the Companys gross sales are
shown in the table below:
|
|
|
|
|
|
|
|
|
|
|
Three months ended March 31,
|
|
|
|
2013
|
|
|
2012
|
|
Toys R Us, Inc. and Babies R Us, Inc.
|
|
|
34.1
|
%
|
|
|
32.3
|
%
|
Walmart
|
|
|
19.3
|
%
|
|
|
16.8
|
%
|
Target
|
|
|
7.8
|
%
|
|
|
7.7
|
%
|
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.
During the three months ended March 31, 2013, approximately 79% of the Companys dollar volume of
purchases was attributable to manufacturing in the Peoples Republic of China (PRC), compared to 74% for the three months ended March 31, 2012. 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.
The supplier accounting for the
greatest dollar volume of the Companys purchases accounted for approximately 16% of such purchases for the three months ended March 31, 2013 and approximately 21% for the three months ended March 31, 2012. The five largest suppliers
accounted for approximately 47% of the Companys purchases in the aggregate for the three months ended March 31, 2013 and 49% for the three months ended March 31, 2012.
NOTE 8 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 March 31, 2013, the amount of liability for
unrecognized tax benefits related to federal, state, and foreign taxes was approximately $400,000, including approximately $84,000 of interest and penalties.
Activity regarding the liability for unrecognized tax benefits for the three months ended March 31, 2013 is as follows:
|
|
|
|
|
|
|
(in thousands)
|
|
Balance at December 31, 2012
|
|
$
|
395
|
|
Increase related to prior year tax positions
|
|
|
5
|
|
|
|
|
|
|
Balance at March 31, 2013
|
|
$
|
400
|
|
|
|
|
|
|
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 $319,000 within twelve months of March 31, 2013 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.
19
KID BRANDS, INC AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The valuation allowance for deferred tax assets as of March 31, 2013 and
December 31, 2012 was $74.1 million and $73.8 million, respectively. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become
deductible and other factors. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion, or all, of the deferred tax asset will not be realized. In assessing the
realization of deferred tax assets, management evaluates all available positive and negative evidence, including the Companys past operating results, the existence of cumulative losses and near-term forecasts of future taxable income that is
consistent with the plans and estimates management is using to manage its underlying businesses, the amount of taxes paid in available carry-back years, and tax planning strategies. This analysis is updated quarterly. Based on this analysis, the
Company increased its valuation allowance in the amount of $50.3 million during the year ended December 31, 2012 as a result of the Companys reduced estimates of current and future taxable income during the carry forward period, and the
fact that it is in a three-year cumulative loss position. The weight of these negative factors and level of economic uncertainty in our current business supported the Companys conclusion. Management will continue to periodically evaluate the
valuation allowance and, to the extent that conditions change, a portion of such valuation allowance could be reversed in future periods.
The income tax provision for the three months ended March 31, 2013 was $37,000 on loss before income tax provision of $946,000. The difference between the effective tax rate of -3.9% for the three
months ended March 31, 2013 and the U.S. federal tax rate of 35% was related to a loss before income tax provision for which the Company did not record a benefit due to a year-to-date loss and full valuation allowance on deferred tax assets
($331,000); offset by (i) foreign tax provisions and withholding taxes in a jurisdiction with year-to-date income and historical profitability ($32,000); and (ii) an increase in the liability for unrecognized tax benefits ($5,000) as a
result of additional interest being accrued. The income tax benefit for the three months ended March 31, 2012 was ($471,000) on loss before income tax benefit of $1.3 million. The difference between the effective tax rate of 37% for the
three months ended March 31, 2012 and the U.S. federal tax rate of 35% primarily relates to a benefit for state tax, net of federal tax benefit ($53,000), offset by: (i) an increase in the liability for unrecognized tax benefits ($7,000)
as a result of additional interest being accrued; (ii) foreign adjustments related to foreign rate differences and withholding taxes ($5,000); and (iii) the effect of permanent adjustments ($11,000).
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. For U.S. federal income tax purposes, all years prior to 2009 are closed. The Company received a letter from the Internal Revenue Service indicating the 2011 tax year has been selected for
examination. The examination is expected to commence in the second quarter of 2013. In states and foreign jurisdictions, the years subsequent to 2008 remain open and are currently under examination or are subject to examination by the taxing
authorities.
NOTE 9 LITIGATION; COMMITMENTS AND CONTINGENCIES
(a) LaJobi Anti-Dumping Duties and LaJobi Earnout Consideration
As has been previously disclosed, 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 commenced on January 19, 2011. In connection therewith, the Board initiated an investigation, which found instances at LaJobi in which, as a
result of misconduct on the part of certain LaJobi employees, incorrect anti-dumping duties were applied on certain wooden furniture imported from vendors in the PRC, resulting in a violation of anti-dumping laws. Promptly upon becoming aware of
such issues and related misconduct, 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.
In connection with the forgoing, the Company estimates that it will incur aggregate costs of approximately $7.9 million (including
approximately $0.9 million in interest) relating to anti-dumping duties it anticipates will be owed by LaJobi to U.S. Customs for the period commencing April 2, 2008 (the date of purchase of the LaJobi assets by the Company) through March 31, 2013 ,
and the Company is fully accrued for all such amounts. Of the total amount accrued as of March 31, 2013, $57,000 was recorded for anticipated interest expense in the quarter ended March 31, 2013. As a result of the previously-disclosed
restatement of certain prior period financial statements (the Restatement), these amounts are recorded in the periods to which they relate. Previously, the Company had recorded the applicable anticipated anti-dumping duty payment
requirements (and related interest) as of such date in the quarter and year ended December 31, 2010, the period of discovery (the Original Accrual), and recorded additional interest expense on such aggregate amount in subsequent
quarterly periods.
In the fourth quarter of 2012, the Company completed and submitted to U.S. Customs a voluntary prior
disclosure, which included the Companys final determination of amounts it believes are owed, as well as proposed settlement amounts and proposed payment terms with respect to anti-dumping duties owed by LaJobi (the Settlement
Submission). As part of the Settlement Submission, the Company included a payment of $0.3 million in respect of the LaJobi matters, such payment to be credited against the amounts that U.S. Customs determines is to be paid in satisfaction of
the Companys anti-dumping duty matters (see paragraph (b) below for a discussion of payments made with respect to certain of the Companys other operating subsidiaries).
20
KID BRANDS, INC AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
As the Focused Assessment is still pending, and U.S. Customs has not yet responded to
the Settlement Submission, it is possible that the actual amount of duties owed for the periods covered thereby will be higher than the amounts determined to be owed by the Company (and accrued in connection therewith). In any event, additional
interest will continue to accrue until full 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 duties determined by U.S. Customs to be owed by LaJobi, and any such 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 remains committed to working closely with U.S. Customs to address issues relating to incorrect duties.
As a result of the Original Accrual 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, prior to the Restatement, the Company had not recorded any amounts related thereto in the Companys financial statements (the Company had previously disclosed a potential earnout payment of
approximately $12.0 to $15.0 million in the aggregate relating to its acquisitions of LaJobi and CoCaLo, substantially all of which was estimated to relate to LaJobi).
As has been previously disclosed, the Company received a letter on July 25, 2011 from counsel to Lawrence Bivona demanding payment of the LaJobi Earnout Consideration to Mr. Bivona in the amount
of $15.0 million, and a letter from counsel to Mr. Bivona alleging that Mr. Bivonas termination by LaJobi for cause violated his employment agreement and demanding payment to Mr. Bivona of amounts purportedly due
under such employment agreement. In December 2011, Mr. Bivona initiated an arbitration proceeding with respect to these issues, as well as a claim for defamation, seeking damages in excess of $25.0 million. On February 22, 2012, the
Company and LaJobi filed an answer thereto, in which they denied any liability, asserted defenses and counterclaims against Mr. Bivona, and asserted a third-party complaint against Mr. Bivonas brother, Joseph Bivona, and the LaJobi
seller. Hearings with respect to the arbitration have now substantially concluded and the parties are currently preparing post-hearing briefs and closing statements.
Because the Restatement resulted in the technical satisfaction of the formulaic provisions for the payment of a portion of the LaJobi Earnout Consideration under the agreement governing the purchase of
the LaJobi assets, applicable accounting standards required that the Company record a liability in the amount of the formulaic calculation, without taking into consideration the Companys affirmative defenses, counterclaims and third party
claims. Accordingly, in connection with the Restatement, the Company recorded a liability in the approximate amount of $11.7 million for the year ended December 31, 2010 ($10.6 million in respect of the LaJobi Earnout Consideration and $1.1
million in respect of a related finders fee), with an offset in equal amount to goodwill, all of which goodwill was impaired as of December 31, 2011. While we intend to continue to vigorously defend against all of Mr. Bivonas
claims, and believe that we will prevail, based on, among other things, our affirmative defenses, counterclaims and third-party claims (in which case we will be able to reverse such liability), there can be no assurance that this will be the case.
An adverse decision in the arbitration that requires any significant payment by us to Mr. Bivona or the LaJobi seller could result in a default under our credit agreement and have a material adverse effect on our financial condition and results
of operations. See Note 4 for a description of the Companys senior secured financing facility, including a discussion of restrictions on the ability of the Company to pay Customs duties and LaJobi earnout payment requirements, if any, and the
financial covenants applicable to the Company, and see Item 2, Managements Discussion and Analysis of Financial Condition and Results of Operations Liquidity and Capital Resources for a discussion of the potential
impact of any such payment on our compliance with such financial covenants.
(b) Customs Compliance Investigation
As has been previously disclosed, following the discovery of the matters described above with respect to LaJobi, our Board authorized a
review of customs compliance practices at the Companys non-LaJobi operating subsidiaries (the Customs Review). In connection therewith, instances were identified 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.
Promptly after becoming aware of the foregoing, the Company submitted voluntary prior disclosures to U.S. Customs identifying such issues. The Board also authorized an investigation into these non-LaJobi customs matters, and did not discover
evidence that would lead it to conclude that there was intentional misconduct on the part of Company personnel.
21
KID BRANDS, INC AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
As of March 31, 2013, the Company estimates that it will incur aggregate costs of
approximately $2.6 million (including approximately $0.3 million in interest), relating to such customs duties for the years ended 2006 through 2012, and the three months ended March 31, 2013 and the Company is fully accrued for all such
amounts. Of the total amount accrued as of March 31, 2013, $18,000 was recorded for anticipated interest expense in the quarter ended March 31, 2013. As a result of the Restatement, these amounts are recorded in the periods to which they
relate. Previously, the Company had recorded the applicable anticipated customs duty payment requirements (and related interest) as of such date in the three and six months ended June 30, 2011 (the period of discovery), and recorded additional
interest expense on such aggregate amount in the subsequent quarterly period.
In the fourth quarter of 2012 (upon completion
of the Customs Review), the Company completed and submitted to U.S. Customs a voluntary prior disclosure, which included the Companys final determination of amounts it believes are owed by Kids Line and CoCaLo. Such submission with respect to
Kids Line included proposed payment terms with respect to customs duties believed to be owed by Kids Line. As part of such settlement submissions, the Company included the following initial payments to U.S. Customs, such payments to be credited
against the amounts that U.S. Customs determines is to be paid in satisfaction of the Companys customs duties matters: $0.2 million with respect to Kids Line customs duties and $0.3 million with respect to CoCaLo customs duties. With respect
to CoCaLo, the Companys payment represents the Companys determination of all amounts it believes are owed by CoCaLo for the relevant periods.
As U.S. Customs has not yet responded to the settlement submissions, it is possible that the actual amount of duties owed for the relevant periods will be higher than the amounts determined to be owed by
the Company (and accrued in connection therewith). In any event, additional interest will continue to accrue until full 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 determined by U.S. Customs to be owed, and any such 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 continues to work closely with U.S. Customs to address issues relating to incorrect
duties.
(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 KIDs common stock between specified dates. In addition to KID, various executives, and
members and former members of KIDs Board, were named as defendants.
The Putative Class Action alleged 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 did not state
the size of the putative class. The Putative Class Action sought compensatory damages but did not quantify the amount of damages sought. The Putative Class Action also sought 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 deemed 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, the lead plaintiff filed an amended
complaint, which was dismissed without prejudice on March 7, 2012. On May 7, 2012, the lead plaintiff filed a second amended complaint that named the Company, Bruce G. Crain, Guy A. Paglinco, and Raphael Benaroya as defendants. The second amended
complaint repeated the same claims for relief and many of the allegations of the previous complaints in the action, but contained new allegations that, among other things, the Company and/or the other defendants issued materially false and
misleading statements during the relevant time period regarding custom law violations and safety violations regarding certain of its products. The relief demanded and the class period were each the same as in the first amended complaint.
All of the defendants in the Putative Class Action filed motions to dismiss the second amended complaint on June 29, 2012. On
October 17, 2012, the United States District Court for the District of New Jersey granted the defendants motion to dismiss such complaint with prejudice. On November 14, 2012, plaintiff filed a Notice of Appeal to the U.S. Court of
Appeals for the Third Circuit from the judgment of the U.S. District Court, which appeal is currently pending.
The Company
intends to continue to defend the Putative Class Action vigorously. No amounts have been accrued in connection therewith, although legal costs are being expensed as incurred. As the Company has satisfied the deductible under its applicable insurance
policy, the Company has been receiving reimbursement of substantially all of the legal costs being incurred, which receivables are netted against the expense.
Putative Shareholder Derivative Action
. On May 20, 2011, a putative stockholder derivative complaint was filed by the City of Roseville Employees Retirement System
(Roseville) in the United States District Court of the District of New Jersey (the Putative Derivative Action), against Bruce Crain, Guy Paglinco, Marc Goldfarb, KIDs Senior Vice President and General Counsel, each
member of KIDs current Board, and John Schaefer, a former member of KIDs Board (collectively, the Defendants). In addition, KID was named as a nominal defendant.
The Putative Derivative Action alleged, among other things, that the Defendants breached their fiduciary duties to the Company by
allegedly failing to oversee and disclose alleged misconduct at KIDs LaJobi subsidiary relating to LaJobis compliance with certain U.S. customs laws. In addition to asserting the breach of fiduciary duty claim, the complaint also
asserted claims of gross mismanagement, abuse of control and commission of corporate waste and unjust enrichment. The Putative Derivative Action sought 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.
22
KID BRANDS, INC AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
On July 25, 2011, the individual Defendants and nominal defendant KID
moved to dismiss the complaint pursuant to Federal Rules of Civil Procedure 12(b) (6) and 23.1. On October 24, 2011, the Court granted Defendants motion to dismiss without prejudice with leave for plaintiff to amend the
complaint.
On November 23, 2011, Roseville sent a letter to KID demanding to inspect certain books and records of the
Company pursuant to New Jersey state law. On April 28, 2012, Roseville filed a motion to compel inspection of documents beyond those previously provided by the Company. On November 8, 2012, the Court issued an Order granting
Rosevilles request in part and denying the request in part. The Order provided that any non-privileged documents that were responsive to the narrow scope of the inspection permitted by the Order be produced by the Company on
December 3, 2012. The Company produced such documentation on December 3, 2012; however, Roseville has retained certain purported objections to the December 3, 2012 inspection, which the Company disputes. Some of the objections were
overruled by the Court on February 5, 2013. The remaining issues were submitted to the Court on February 21, 2013. Rosevilles time to amend its complaint has been extended by the Court until the issues raised by the books
and records inspection are resolved.
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. As the Company has satisfied the deductible under its
applicable insurance policy, the Company has been receiving reimbursement of substantially all of the legal costs being incurred, which receivables are netted against the expense.
(d) SEC Informal Investigation
The Company voluntarily disclosed to the
SEC the findings of its internal investigation of LaJobis customs practices, as well as certain previously-disclosed Asia staffing matters. 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. Subsequent thereto, the Company voluntarily disclosed to the SEC the existence of the Customs Review and related 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 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.
(f) Wages and
Hours Putative Class Action
On November 3, 2011, a complaint was filed in the Superior Court of the State of California
for the County of Los Angeles, encaptioned Guadalupe Navarro v. Kids Line, LLC (the Wages and Hours Action). The Wages and Hours Action was brought by one plaintiff on behalf of a putative class for damages and equitable relief for:
(i) failure to pay minimum, contractual and/or overtime wages (including for former employees with respect to their final wages), and failure to provide adequate meal breaks, in each case based on defendants time tracking system and
automatic deduction and related policies; (ii) statutory penalties for failure to provide accurate wage statements; (iii) waiting time penalties in the form of continuation wages for failure to timely pay terminated employees; and
(iv) penalties under the Private Attorneys General Act (PAGA). Plaintiff seeks wages for all hours worked, overtime wages for all overtime worked, statutory penalties under Labor Code Section 226(e), and Labor Code Section 203,
restitution for unfair competition under Business and Professions Code Section 17203 of all monies owed, compensation for missed meal breaks, and injunctive relief. The complaint also seeks unspecified liquidated and other damages,
statutory penalties, reasonable attorneys fees, costs of suit, interest, and such other relief as the court deems just and proper. Although the total amount claimed is not set forth in the complaint, the complaint asserts that the
plaintiff and the class members are not seeking more than $4.9 million in damages at this time (with a statement that plaintiff will amend his complaint in the event that the plaintiff and class members claims exceed $4.9 million).
23
KID BRANDS, INC AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
On January 30, 2013, the Court denied plaintiffs motion for class
certification with respect to two of the proposed classes and continued for further briefing the motion for class certification with respect to the remaining proposed classes. The Company intends to vigorously defend the Wages and Hours Action.
Based on currently available information, the Company cannot currently estimate the amount of the loss (or range of loss), if any, in connection therewith. As a result, no amounts have been accrued in connection therewith, although legal costs
are being expensed as incurred.
(g) Australia Distributorship Dispute
In November 2009, a complaint was filed in the United States District Court for the Northern District of Illinois, encaptioned Sahai Pty.
Ltd. (Sahai) v. Sassy, Inc. (the Australia Action). The plaintiff claims that Sassy breached the distribution agreement previously entered into between the parties by wrongfully terminating plaintiffs distributorship
following plaintiffs failure to achieve the minimum sales requirements included in the distribution agreement. Plaintiff seeks damages of approximately $2.0 million. In November and December 2012, the Australia Action was tried before a jury,
and a mistrial was declared when the jury failed to reach a unanimous verdict. A new trial was scheduled to commence on May 6, 2013.
Effective April 16, 2013, the parties agreed to settle their dispute and dismiss their respective claims in order to avoid the expense, distraction and unpredictability of further litigation. In
connection therewith, the parties entered into a Settlement Agreement and related Distribution Agreement, pursuant to which, among other things: (i) Sahai was appointed as Sassys distributor in Australia and New Zealand for a two year
term; (ii) Sassy agreed to pay to Sahai $375,000 (Australian dollars), or approximately U.S. $387,000, which amount has been paid; (iii) Sassy agreed to accept the return of up to $250,000 (Australian dollars), or approximately U.S.
$258,000, of existing Sassy product inventory in Sahais possession and, in exchange therefor, to provide to Sahai a credit against new inventory purchases in an equivalent amount; (iv) Sassy agreed to make available a marketing fund
contribution of up to $100,000 (Australian dollars), or approximately U.S. $103,000, to reimburse Sahai for pre-approved marketing and promotional activities in connection with the sale of Sassy products; and (v) the parties agreed to dismiss
with prejudice the Australia Action and to release each other from all claims.
(h) Consumer Product Safety Commission Staff Investigation
By letter dated July 26, 2012, the staff (the CPSC Staff) of the U.S. Consumer Product Safety Commission
(CPSC) informed the Company that it has investigated whether LaJobi timely complied with certain reporting requirements of the Consumer Product Safety Act (the CPSA) with respect to various models of drop-side and wooden-slat
cribs distributed by LaJobi during the period commencing in 1999 through 2010, which cribs were recalled voluntarily by LaJobi during 2009 and 2010. The letter states that, unless LaJobi is able to resolve the matter with the CPSC Staff, the
CPSC Staff intends to recommend to the CPSC that it seek the imposition of a substantial civil penalty for the alleged violations.
The Company disagrees with the position of the CPSC Staff, and believes that such position is unwarranted under the circumstances. As permitted by the notice, the Company has provided the CPSC Staff
with additional supplemental information in support of the Companys position, including relevant factors in the Companys favor that are required to be considered by the CPSC prior to the imposition of any civil penalty, and the Company
intends to work closely with the CPSC Staff in an effort to resolve this issue.
Given the current status of this matter,
however, it is not yet possible to determine what, if any, actions will be taken by the CPSC, whether a civil penalty will be assessed, and if so assessed, the amount thereof. Based on currently available information, the Company cannot estimate the
amount of the loss (or range of loss), if any, in connection with this matter. As a result, no amounts have been accrued in connection therewith, although legal costs will be expensed as incurred. In addition, as this matter is ongoing, the Company
is currently unable to predict its duration, resources required or outcome, or the impact it may have on the Companys financial condition, results of operations and/or cash flows.
(i) 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 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.
24
KID BRANDS, INC AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(j) Kokopax Earnout
As partial consideration for the purchase of the Kokopax
®
assets (described in Note 6), Sassy has agreed to pay to the seller of such assets, on a quarterly basis (when and if applicable), an amount equal to 10% of net sales
achieved in respect of Kokopax products (commencing July 3, 2012) in excess of the first $2.0 million of such net sales until the earlier of: (i) March 31, 2015, and (ii) the date that such Kokopax net sales equal at least $10.0
million (the Additional Consideration); provided, that the aggregate amount paid in respect of the Additional Consideration (including an advance of $200,000 accrued by Sassy at closing) shall not exceed $1.0 million.
(k) Purchase Commitments
The
Company has approximately $25.8 million in outstanding purchase commitments at March 31, 2013, consisting primarily of purchase orders for inventory.
(l) License and Distribution Agreements
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. Although the Company does not believe its business is dependent on any single license, the LaJobi Graco
®
license (which expires on December 31, 2013, subject to renewals) and the Kids Line Carters
®
license are each material to and accounted for a material portion of the net revenues of LaJobi and Kids Line, respectively, as well as a significant percentage of
the net revenues of the Company, in each case for each of the last three years. Although the Carters
®
license expired on December 31, 2012, the parties are continuing to operate under the license and are negotiating a renewal agreement, although there can be no assurance that any such renewal will be consummated. In addition, the Serta
®
license (which expires on December 31, 2013, subject to renewals) is material to and accounted for a
significant percentage of the net revenues of LaJobi; the Disney
®
license (which expires on December 31,
2013, subject to renewals) is material to and accounted for a significant percentage of the net revenues of Kids Line; and the Garanimals
®
license (which expires on December 31, 2014) is material to and accounted for a significant percentage of the net revenues of Sassy, in each case for the last
three years. While historically the Company has been able to renew the license agreements that it wishes to continue on terms acceptable to it, there can be no assurance that this will be the case, and the loss of any of the foregoing and/or other
significant license agreements could have a material adverse effect on the Companys results of operations. Several of these agreements require pre-payments of certain minimum guaranteed royalty amounts. The aggregate amount of minimum
guaranteed royalty payments with respect to all license agreements pursuant to their original terms aggregates approximately $15.4 million, of which approximately $4.8 million remained unpaid at March 31, 2013. Royalty expense for the three
months ended March 31, 2013, and 2012 was $2.4 million and $2.1 million, respectively.
(m) Letters of Credit
As of March 31, 2013, the Company had obligations under certain letters of credit that require the Company to make payments to
parties aggregating $50,000 upon the occurrence of specified events.
NOTE 10 RELATED PARTY TRANSACTIONS
Effective September 12, 2012, Renee Pepys Lowe was appointed to the position of President of Kids Line and
CoCaLo. CoCaLo contracts for warehousing and distribution services from a company that is managed by Ms. Lowes spouse. For the three months ended March 31, 2013 and 2012, CoCaLo paid approximately $0.4 million and $0.6 million,
respectively to such company for these services.
From September 12, 2011 through March 13, 2013, Mr. Benaroya
served as interim Executive Chairman and acting Chief Executive Officer of the Company pursuant to an agreement between the Company and RB, Inc., a Delaware corporation wholly-owned by Mr. Benaroya (the Interim Agreement), which
provided for the full-time services of Mr. Benaroya for a fee of $100,000 per calendar month during its term. Notwithstanding the stated contractual amount, commencing as of September 2012, RB, Inc. advised the Company to reduce the fee to
$75,000 per calendar month. Mr. Benaroya was not paid directors fees during the term of his engagement as interim Executive Chairman, nor did he participate in any bonus program, employee benefit plan or other compensation arrangement
with the Company. The Interim Agreement was terminated on March 13, 2013, in connection with the appointment of Mr. Benaroya as President and Chief Executive Officer of the Company. The Company paid $0.2 million and $0.3 million to
RB, Inc. for the services of Mr. Benaroya pursuant to the Interim Agreement for the three months ended March 31, 2013 and 2012, respectively.
NOTE 11 RECENTLY ISSUED ACCOUNTING STANDARDS
The Company has implemented all applicable accounting pronouncements in effect as of March 31, 2013, and does not
believe that there are any other new accounting pronouncements or changes in accounting pronouncements issued during the three months ended March 31, 2013, that might have a material impact on the Companys financial position, results of
operations or cash flows.
25