Item 1. Business.
General
Harvey Electronics is engaged in the retail sale, service and custom installation of high quality audio, video and home theater equipment. The equipment includes high fidelity components and systems, digital versatile disc players ("DVD"), digital video recorders ("DVR"), high definition television ("HDTV"), plasma flat-screen and LCD flat panel television sets, integrated remote controls, media servers, audio/video furniture, conventional telephones, MP3 players, iPods, satellite and analog radios, service contracts and related accessories. The Company has been engaged in this business in the New York Metropolitan area for eighty years. The Company currently operates nine locations; eight Harvey specialty retail stores and one separate Bang & Olufsen branded store. There are two Harvey locations in Manhattan and six suburban locations in Paramus, New Jersey; Mt. Kisco, in Westchester, New York; Greenwich, Connecticut; Greenvale/Roslyn, on the north shore of Long Island, New York; Eatontown, New Jersey; and our newest store in Bridgewater, New Jersey, which opened in late June 2005. The Bang & Olufsen branded store is located in Union Square at Broadway and 21st Street in Manhattan. The Company also has a Bang & Olufsen showroom within our Harvey retail store in Greenwich, Connecticut.
The Company's stores are designed to offer an attractive and pleasing environment and to display its products and custom installation services in realistic home settings commonly known in the industry as "lifestyle home vignettes." Sales personnel are highly trained professionals with extensive product knowledge. This contrasts sharply with a more rushed atmosphere and lesser-trained personnel of mass merchants.
Private Placement and Change of Control
As fully disclosed in Note 2 to the financial statements, on April 17, 2006, the Company entered into a Securities Purchase Agreement (the "Purchase Agreement"), modified by an amendment dated September 8, 2006, with several institutional and other accredited investors (the "Investors") led by Trinity Investment Partners LLC ("Trinity"). On November 10, 2006, the Company completed this transaction. Pursuant to the Purchase Agreement, the Company received gross proceeds of $4,000,000 from the sale (the "Private Placement") of 8% Series B Convertible Preferred Stock (the "Series B Preferred Stock"). The proceeds from the Private Placement will be used by the Company primarily for general corporate and working capital purposes, to fund increased advertising expenditures, to replace the Company's website and to refurbish existing stores.
The Company's shareholders incurred substantial dilution of their percentage ownership in the Company upon the closing of the Private Placement. Based on the number of common shares outstanding at October 28, 2006, the aggregate ownership of all holders of the common stock immediately prior to the issuance of the securities pursuant to the Private Placement, on a fully diluted basis, would be reduced by approximately 82.4%. While this represents significant dilution, the Company received the funds necessary to substantially advance its business. If all warrants issued in connection with the Private Placement are exercised, the Company will receive approximately $13.4 million including the $4.0 million received at closing.
The Purchase Agreement and the related transactions were approved by the Company's shareholders, at the annual meeting of shareholders on October 27, 2006.
Products
The Company offers its customers a wide selection of high-quality consumer audio, video and home theater products, the distribution of which is limited to specialty retailers. The Company is one of the country's largest retailers of "premium brands" manufactured by Bang & Olufsen, Crestron, Marantz, McIntosh, NAD, Vienna Acoustics, Sonus Faber, Krell, Boston Acoustics, Martin Logan and Fujitsu. Many of these vendors' products have been sold by the Company for a number of years. The Company believes that it benefits from strong working relationships with these manufacturers.
For the fiscal year ended October 28, 2006, the Company's audio product sales represented approximately 48% of the Company's net sales and yielded gross profit margins of approximately 42%. The Company's video product sales represented approximately 40% of the Company's net sales and yielded gross profit margins of approximately 29%. The Company also provides installation services for the products it sells. Custom installation, as commonly referred to in the industry, includes both equipment sales and labor income. Custom installation of both equipment and related labor accounted for approximately 65% of the Company's net sales in fiscal 2006. The labor portion of custom installation presently represents approximately 12% of net sales. The Company also sells extended warranties on behalf of third party providers. Sales of extended warranties yield higher gross profit margins and represented approximately 3% of the Company's overall net sales.
The following table shows the Company's net product sales, as a percentage of equipment sales (excluding labor income) attributable to each of the product categories for the periods indicated. Audio components include speakers, subwoofers, receivers, amplifiers, preamplifiers, compact disc players, turntables and tuners. Accessories primarily include integrated remote controls, headphones, surge protectors and projection screens. The miscellaneous category includes conventional telephones, iPods, MP3 players, satellite and analog radios and other portable products.
The percentage of sales by each product category is affected by, among other things, promotional activities, consumer preferences, store displays, the development of new products and elimination or reduction of existing products and, thus, a current sales mix may not be indicative of the future sales mix.
The Company believes that it is well positioned to benefit from advances in technologies because new technologies tend to be expensive when first introduced and the Company's target customers desire and can afford such products. Newer technologies, such as HDTV, plasma flat-screen and LCD flat panel televisions are strongly desired by the Company's customers. The plasma flat-screen or LCD flat panel television allows the set to be far less obtrusive and more easily integratable into the home. High definition television has significantly improved picture quality.
The Company intends to continue to support its retail business and maintain a bias towards custom installation (representing 65% of net sales in fiscal 2006), which can extend from a single room audio/video system to an entire house with a combined selling price of installation, labor and product from approximately $5,000 to in excess of $100,000. The Company believes custom installation provides the opportunity to bundle products and increase margins. In fiscal 2007, the Company will continue to refine its merchandising efforts demonstrating complete movie theaters in the home, in-home lighting systems, media servers and distributed in-home cabling for the integration of computer networks, entertainment systems and other related services. The Company will continue to showcase the lifestyle benefits of flat panel televisions.
Based on customers' desires, custom installation projects frequently expand on-site. A single room home theater, for example, during the course of the installation can grow into a multi-room system with increased margins.
Offering custom installation affords the Company a unique selling opportunity because it may not be available at certain mass merchants and can generate repeat customers and customer referrals. Due to the complexity of the installation provided by the Company, customers generally remain with the Company, providing the opportunity to sell upgrades to existing customers. We believe digital video products, network cabling, in-home lighting systems, as well as other emerging satellite and internet technologies, present significant opportunities for such upgrades.
Operations
Supplies, Purchasing and Distribution
The Company purchases its products from approximately eighty manufacturers, ten of which accounted for approximately 61% of the Company's purchases for the fiscal year ended October 28, 2006. These ten manufacturers are Bang & Olufsen, Crestron, Fujitsu, Marantz, Monster Cable, Monster Power, Pioneer Elite, Runco, Sharp and Sony. Fujitsu accounted for more than ten (10%) percent of the Company's purchases for fiscal 2006, and Bang & Olufsen, Marantz, Monster Cable, Pioneer Elite, Sharp and Sony, each accounted for more than five (5%) percent of purchases for such period.
The Company has entered into dealer agreements with some of its vendors. Under each dealer agreement, the Company is authorized to sell the manufacturer's products from specified retail locations to retail customers and cannot sell the products by telephone or mail order. Each agreement is for a term of a year or two, subject to renewal or extension.
The Company believes that competitive sources of supply would be available for many of the Company's products if a current vendor ceased to supply to the Company. However, a loss of a major source of supply of limited distribution products could have an adverse impact on the Company.
Bang & Olufsen ("B&O") products have been sold by the Company since 1980. As B&O focused on developing B&O licensed stores ("Branded Stores") throughout the world, its products become available only in Branded Stores. Currently, the Company operates one B&O Branded Store and operates a second showroom within the Harvey store in Greenwich, Connecticut, under a store-within-a store concept. These stores sell highly differentiated Bang & Olufsen products, including uniquely designed audio systems, speakers, telephones, headphones and accessories. The stores also sell video products including LCD projectors, HDTV's, DVD players, plasma flat-screen and LCD flat panel televisions, A/V furniture and accessories. These stores also offer professional custom installation of multi-room audio and home theater systems.
Due to the Company's strong relationships with many of its suppliers and its volume of purchases, the Company has also been able to obtain manufacturers' rebates based on volume buying levels. With many vendors, the Company has been able to negotiate favorable terms, such as extended payment terms, additional cooperative advertising contributions or lower prices, on large purchases. In fiscal 2006, the Company became a member of a consumer electronics industry buying group called Progressive Retailers Organization (PRO). We are also a member of Professional Audio Retailers Association (PARA) and Custom Electronics Design Installation Association (CEDIA), both of which provide the Company with additional training in sales and technology.
Purchases are received at the Company's 11,800 square foot warehouse located in Fairfield, New Jersey. Merchandise is distributed to the Company's retail stores at least twice a week (and more frequently, if needed), using the Company's employees and transportation.
The Company's management information system tracks current levels of sales, inventory, purchasing and other key information and provides management with information which facilitates merchandising, pricing, sales management and the management of warehouse and store inventories. This system enables management to review and analyze the performance of each of its stores and sales personnel on a periodic basis. The central purchasing department of the Company monitors current sales and inventory at the stores on a daily basis. In addition, the Company currently conducts a physical inventory two times a year and between such physical inventories it conducts monthly and daily cycle counts on selected types of inventory. The purchasing department also establishes appropriate levels of inventory at each store and controls the replenishment of store inventory based on the current delivery or replenishment schedule. At the beginning of fiscal 2007, the Company implemented its new management information system, which should allow the Company, in the second quarter of fiscal 2007, to better track its costs relating to its custom installation services.
The Company historically has not had material losses of inventory and does not experience material losses due to cost and market fluctuations, overstocking or changes in technology. The Company maintains specific and general inventory reserves aggregating $140,000, $150,000, and $130,000, for fiscal years 2006, 2005 and 2004, respectively. The Company's inventory turnover for fiscal years 2006, 2005 and 2004 was approximately 2.94, 3.0 and 3.2 times, respectively.
Sales and Store Operations
Retail sales are primarily made for cash or by major credit cards. Revenues are recorded by the Company when the product or service is delivered or rendered to customers. Customer deposits are recorded as liabilities until the product is delivered, at which time a sale is recorded and the liability for the customer deposit is relieved.
In addition, customers who qualify can obtain longer term financing with a Harvey credit card, which the Company makes available to its customers. The Harvey credit cards are issued by an unrelated finance company. All transactions with this unrelated finance company are without recourse to the Company. The Company also periodically, as part of its promotional activities, offers manufacturer sponsored financing to its customers.
Each store is operated by a store manager and a senior sales manager. Store managers report to a Vice President of Operations who oversees all sales and store operations, and who is further responsible for sales training and the hiring of all retail employees. Every Company store has in-home audio/video specialists who will survey the job site at a customer's home, design the custom installation and provide a cost estimate. Each store independently services its custom installations through a project manager and experienced installers employed at the store. The Company's stores are aided by the Company's Director of Custom Installation and additionally, a highly-specialized programmer for more difficult and technical projects. The Vice President of Merchandising and Interim Chief Executive Officer of the Company determine what products will be demonstrated and presented at each store. All stores are staffed with professionally trained salespeople and warehouse personnel. Salespeople are paid a base salary plus commission based on gross margins.
All stores have an on-line point of sale computer system which enables the store managers and corporate headquarters to track sales, margins, inventory levels, customer deposits, back orders, merchandise on loan to customers, salesperson performance and customer histories. The Company's computer system was replaced by a new management information system effective October 29, 2006. Store managers perform sales audit functions before reporting daily results to the sales audit group in the main office in Lyndhurst, New Jersey.
Services and Repairs
Products under warranty are delivered to the appropriate manufacturer for repair. Other repairs are sent to the manufacturers or an independent repair company. Revenues from non-warranty services are not material.
The Company offers an extended warranty contract for most of the audio, video and other merchandise it sells, which provides coverage beyond the manufacturer warranty period. Extended warranties are provided by an unrelated warranty insurance company on a non-recourse basis to the Company. The Company collects the retail sales price of the extended warranty contract from customers and remits the customer information and the cost of the contract to this company. Sales of extended warranty contracts in fiscal 2006 represented approximately 3% of the Company's net sales, including labor income. The warranty obligation is solely the responsibility of the warranty insurance company. See notes to the financial statements for additional information on warranty sales and the presentation of such sales in the Company's Statements of Operations.
Competition
The Company competes in the New York Metropolitan area with mass merchants, mail order houses, discount stores and numerous other consumer electronics specialty stores. The retail electronics industry is dominated by large retailers with massive, "big box" retail facilities which aggressively discount merchandise. These retailers operate on narrow profit margins and high volume, driven by aggressive advertising emphasizing low prices. Nationwide industry leaders are Circuit City and Best Buy. The New York region has a material presence from Circuit City, Best Buy, and local chains including P.C. Richard & Son, J&R Music World, 6th Avenue Electronics and Electronics Expo.
Many of the competitors sell a broader range of electronic products, including computers, camcorders, digital cameras and office equipment, and many have substantially larger sales and greater financial and other resources than the Company. The Company competes by positioning itself as a retailer of high quality limited distribution audio and video products and, we believe, more importantly, by offering upscale sophisticated design and custom installations, which are not offered by all of the mass merchants.
Very few, if any, of the audio products sold by the Company, other than Bose and certain radios and other portable products, are available at the mass merchants. Of the major video brands sold by the Company, Sony, Pioneer, Sharp and Hitachi televisions are sold by the mass merchants. The Company does sell models which are not sold by the mass merchants such as Fujitsu and Runco.
The Company seeks to reinforce its positioning by displaying its higher-end products and custom installation services in customized movie theaters built within the home and in lifestyle home vignettes in an attractive and pleasing store environment and by offering personalized service through trained sales personnel who are fully familiar with all of the Company's products. Additionally, we believe the Company differentiates itself by offering programming capabilities that address complex technological integration issues and ultimately give the consumer easy remote control access to multiple devices.
Internet Website
The Company offers its website, to its customers to augment its retail showrooms. The website was designed to extend Harvey's extraordinary in-store experience onto the Internet as a vehicle to increase customer traffic at the Company's retail locations. On-line sales, which are insignificant, are available seven days a week, twenty-four hours a day, and are a secondary goal of the website. Harvey customers can order on-line within the Company's trading area in the metropolitan New York marketplace.
Visitors to the website are able to leave inquiries, request home theater systems based on budget and room size, reserve equipment or schedule an in-home or in-store consultation with a Harvey professional. Current promotions, special product offerings, product specification, price and warranty comparisons are also available on the site.
The Company expects to replace its website in fiscal 2007.
Advertising
The Company believes it has a strong and important brand in its marketplace. The Company strives to promote its superior products and sophisticated services in its advertising campaign to both men and women. In October 2006, the Company engaged a new advertising agency to effectively promote its brand and to increase awareness in the Company's service offerings. In fiscal 2007, the Company will also promote its new price match policy on advertised prices from local manufacturer-authorized retail competitors. In fiscal 2007, the Company will also continue to expand its efforts in its important customer relations management program.
Currently, the Company has radio, direct mail, print advertising, e-mail broadcasts, keyword searches and the Internet with the Company's website, to promote its brand.
In fiscal 2006, the Company used frequent print advertising, emphasizing image, products, and technology in The New York Times, New York Magazine, Courier News, The Journal News and the Asbury Park Press. The Company also uses The Wall Street Journal for certain Bang & Olufsen advertising. The Company distributes direct mail advertising and specific e-mail broadcasts to reach its significant customer database. Direct mail promotions can update customers on new products, or technology, and can be supported, in part, by the manufacturers. In fiscal 2006, radio advertising was primarily run on the two most listened to news stations on AM radio within the Company's market.
Certain promotional activities offer attractive financing alternatives on purchases on credit without interest for an extended period of time.
The following table shows the Company's gross advertising costs and net advertising expense as a percentage of net sales for the periods presented. Net advertising expense represents gross advertising cost less advertising income received from the manufacturers.
Licenses and Intellectual Properties
The Company owns four registered service marks. "HARVEY ELECTRONICS," issued in June 1982, and "Harvey", issued March 7, 1989 are currently used by the Company. The Company believes that the service marks HARVEY ELECTRONICS and HARVEY have significant value and are important in marketing the Company's products and services.
Employees
As of October 28, 2006, the Company employed approximately 128 full-time employees of which 15 were management personnel, 15 were administrative personnel, 47 were salespeople, 9 were warehouse workers and truck drivers and 42 were engaged in custom installation.
Of the salespeople, warehouse workers, truck drivers and installation staff, 82 people are covered by a collective bargaining agreement with the Company, which expires August 1, 2008. The Company has never experienced a work stoppage and believes that its relationships with its employees and the union are satisfactory.
Item 1A.
Item 1A. Risk Factors
You should carefully consider the following risk factors and all other information set forth in this Form 10-K in evaluating our Company and our business. If any of the following risks actually occur, our business, financial condition and results of operations could be harmed. In that case, the trading price of our securities could decline and you could lose all or part of your investment. Additional risks not presently known to us or that we currently deem immaterial may also impair our business operations.
Competing companies may reduce the demand for our products and services, as we are subject to the risks of strong competition.
We compete in the New York Metropolitan area with mass merchants, mail order houses, discount stores and numerous other consumer electronics specialty stores. The retail electronics industry is dominated by large retailers with massive, "big box" retail facilities which aggressively discount merchandise. These retailers operate on narrow profit margins and high volume, driven by aggressive advertising emphasizing low prices. Nationwide industry leaders are Circuit City and Best Buy. The New York region is dominated by Circuit City, Best Buy, and local chains including P.C. Richard & Son, 6th Avenue Electronics and Electronics Expo.
Many of the competitors sell a broader range of electronic products, including computers, camcorders, digital cameras and office equipment, and many have substantially larger sales and greater financial and other resources than we have. While we compete by positioning ourselves as a retailer of high quality limited distribution audio and video products and, by offering upscale sophisticated custom installations, which are not offered by all of the mass merchants, there can be no assurance that we will be able to successfully execute our marketing strategy.
In addition, a number of different competitive factors could have a material adverse effect on Harvey's results of operations and financial condition, including:
o Increased operational efficiencies of competitors;
o Competitive pricing strategies;
o Expansion into Harvey's markets by existing competitors;
o Entry by new competitors into markets in which Harvey is currently operating; or
o Adoption by existing competitors of innovative store formats or retail sales methods that are similar to the formats or retail sale method implemented by Harvey.
We have significant working capital requirements.
We expect that cash flow from operations, together with the proceeds of our recent private placement and funds available under our revolving line of credit facility, will meet our working capital requirements through the fiscal year ending October 29, 2007. However, additional financing may be required in the event we want to open additional retail stores in the future. Any future financings that involve the sale of our equity securities may result in dilution to the then current stockholders. Shortages of product or delayed delivery of product from suppliers may delay or reduce our sales, which may affect profitability.
Our inability to obtain sufficient quantities of certain product could result in delayed sales or lost orders, and may also delay the completion of service orders for which our customers contract. In the last twelve months, we have experienced such delays in receipt of product from our suppliers on various occasions which has caused us to lose sales. We place orders for products and plan inventory in advance based on our forecast of consumer demand, which is highly volatile and difficult to predict. We may experience a shortage of LCD panels, for example, which may result in our inability to meet demand for our LCD televisions, or a surplus of LCD panels that may result in the recording of losses should LCD panel prices decline. Market fluctuations may cause a shortage of products and may affect the cost of goods sold. Our profitability may also be adversely affected by supply or inventory shortages.
We are entirely dependent on leased locations for the operation of our retail stores.
All of our retail stores are located in leased premises. Several of the leases will expire within five years. There can be no assurance that we will be able to renew our current leases, locate suitable locations for new stores, arrange acceptable leases for new locations, or open new retail stores in a timely manner. Our inability to properly address those concerns may prevent us from achieving our expansion plans which may have a material adverse effect on our financial condition.
Our secured loans and existence of liens on our assets make such assets unavailable to secure additional debt financing. Substantially all of our assets have been pledged to a financial institution to secure certain indebtedness under a revolving line of credit facility and term loan. In the event that we default on our obligations, including the payment of principal and interest, our indebtedness could be accelerated and, in certain cases, our assets could be subject to foreclosure. Moreover, to the extent that our assets continue to be pledged to secure outstanding indebtedness, such assets will remain unavailable to secure additional debt financing. Such unavailability may adversely affect our ability to borrow in the future.
Our business depends on economic conditions and consumer preferences.
Our business is subject to economic cycles and changing consumer preferences. Purchases of high quality audio, video and home theatre products may decline in periods of economic uncertainty. We are particularly vulnerable since our products are upscale and expensive. As such, any significant decline in general economic conditions or uncertainties regarding future economic prospects that affect consumer spending could have a material adverse effect on our business, results of operations and financial condition.
The development of technology may erode our market position and cause other adverse effects.
The retail consumer electronics market is dominated by mass merchants. Historically, mass merchants have emphasized volume by selling lower performing products at lower prices. In contrast, specialty boutiques, including the Company, have emphasized selling higher quality products at higher prices. However, development of technologies, which has been extremely rapid in the electronics industry, has substantially reduced the difference between more expensive and less expensive products. Future technological advances may further reduce this difference, possibly to the point at which performance and features will be indistinguishable. Thus, there can be no assurance that we will be able to continue to rely on this difference to implement our operating strategy.
In addition, the periodic introduction and availability of new products and technologies at price levels that generate wide consumer interest stimulate the demand for audio, video and home theatre consumer electronics products. Also, many products that incorporate the newest technologies, such as HDTV, are subject to significant technological and pricing limitations and to the actions and cooperation of third parties such as television broadcasters. It is possible that these products or other new products will never achieve widespread consumer acceptance. Furthermore, the introduction of new products or technologies may depress sales of existing products and technologies. Significant deviations from the projected demand for products Harvey sells would have a materially adverse effect on our results of operations and financial condition, either from lost sales or lower margins due to the need to mark down excess inventory. Any sustained failure by Harvey to identify and respond to changes in consumer demand and preferences would have a material adverse effect on Harvey's results of operations and financial condition.
We depend on a limited number of key personnel.
The success of the Company is largely dependent upon the abilities and efforts of D. Andrew Stackpole, Chairman, Martin W. McClanan, Interim Chief Executive Officer, Joseph J. Calabrese, Executive Vice President and Chief Financial Officer, Michael Beck, Vice President of Operations, Roland Hiemer, Vice President of Merchandising and Patricia Kross, Controller of the Company. The loss of the services of any of these executive officers or the services of other key management personnel could have a material adverse effect upon the Company. The Company does not maintain key man life insurance with respect to any of its executive officers. We are subject to the risk of possible delisting of our Common Stock.
Our Common Stock trades on the NASDAQ Capital Market. If we fail to meet any of the criteria trading on the NASDAQ Capital Market, the Common Stock could be delisted from trading on the NASDAQ Capital Market, which delisting could materially adversely affect the trading market for the Common Stock. There can be no assurance that we will meet all the criteria and the Common Stock will not be delisted. Existing NASDAQ Capital Market maintenance criteria require, among other things, that an issuer (such as the Company) have stockholders' equity of $2.5 million (or alternatively net income of $500,000 in the latest fiscal year or in two of the most recent three fiscal years, or a market capitalization of $50 million) and that the listed security has a minimum bid price of $1.00. We recently regained compliance with Nasdaq Capital Market requirements for continued listing but there can be no assurance that we will not be subject to delisting in the future.
Item 1B.
Item 1B. Unresolved Staff Comments
Not applicable.
Item 2.
Item 2. Properties
All of the premises the Company presently occupies are leased. Management believes that the Company's facilities are adequate and suitable for its present business. The Company believes that adequate locations are available for future expansion.
The Company leases approximately 3,900 square feet at 205 Chubb Avenue, Lyndhurst, New Jersey, which the Company uses as its corporate office at approximately $45,000 per year, including other occupancy costs. This office space is under lease through January 2009. The Company also leases an 11,800 square foot warehouse in Fairfield, New Jersey at approximately $140,000 per year, including other occupancy costs, pursuant to a lease which expires December 2008.
The Company leases the following retail premises:
(1) Includes a Bang & Olufsen showroom under a store-within-a-store concept with this Harvey Store in Greenwich, Connecticut.
Item 3.
Item 3. Legal Proceedings.
Except as set forth herein, the Company believes that it is not a party to any material asserted legal proceedings other than those arising in the ordinary course of business and which are most likely fully covered by insurance (except for deductible amounts). The Company maintains general liability and commercial insurance in amounts believed to be adequate. However, there can be no assurance that such amounts of insurance will fully cover claims made against the Company in the future.
In July 2003, the Company received a notice and information request from the Pennsylvania Department of Environmental Protection ("PADEP"). The notice stated that PADEP considers the Company a potentially responsible party for contamination related to a septic drain field located at a former Chem Fab Corporation ("Chem Fab") site in Doylestown, Pennsylvania.
PADEP's notice stated that if Chem Fab was previously owned by Harvey Radio, Inc. ("Harvey Radio") and if the Company was a successor to Harvey Radio, then the Company could be, in part, responsible for any environmental investigation or clean up actions necessary at this site.
Harvey Radio was the predecessor of The Harvey Group, Inc. ("Harvey Group"), which filed for relief under Chapter 11 of the United States Bankruptcy Code in August 1995. The Company is the surviving retail business of the Harvey Group, which emerged from bankruptcy in December 1996. Chem Fab was a wholly-owned subsidiary of Harvey Radio as of September 1967. The capital stock of Chem Fab (a then wholly-owned subsidiary of Harvey Group) was sold by the Company to the Boarhead Corporation in January 1978. The disposition of Chem Fab was prior in time to the Company's bankruptcy petition date of August 3, 1995.
In August 2003, the Company sent its response letter to PADEP. The Company's response stated that any action by PADEP to recover any money from the Company relating to any environmental investigation or cleanup related to Chem Fab is in violation of the injunctions imposed by virtue of the Company's 1995 Bankruptcy proceeding. The response letter to PADEP specifically referred to two cases with respect to entities subject to a discharge in bankruptcy by the Southern District of New York and the Second Circuit Court of Appeals. These cases may support the Company's position enjoining any further action against the Company.
The Company believes PADEP's claim, even absent the bankruptcy injunction, would be improper against the Company, as Harvey Group was a shareholder of Chem Fab and Chem Fab's capital stock was sold in 1978, as previously stated.
The Company advised PADEP that any further action to pursue a claim against the Company would result in the Company bringing a motion to reopen its bankruptcy case, solely to address the PADEP claim and further, the Company would commence contempt proceedings against PADEP. To date, the Company has not received a response from PADEP.
The Company has also retained special environmental counsel for advice with respect to PADEP's request for information and other matters with respect to the claim.
Furthermore, the number of other parties that may be responsible, their ability to share in the cost of a clean up and whether the Company's existing or prior insurance policies provide coverage for this matter is not known. At this time, it is impossible for the Company to determine the outcome or cost to the Company of this matter.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders.
On October 27, 2006, the Company held its annual meeting:
1. To approve the Trinity Investment-led Private Placement:
2. To consider and vote upon a proposal to amend and restate the Company's Certificate of Incorporation to, among other things, add a new class of Series B Preferred Stock and increase the Company's authorized number of shares of common stock to accommodate the Private Placement:
3. To consider and vote upon a proposal to amend and restate the Company's bylaws to, among other things, provide for a staggered board of directors and limitations on the removal of directors.
4. Election of New Directors
For % Withhold --- - -------- Robert E. Albus 914,871 97.0 28,004 Charles M. Berger 913,620 96.9 29,254 Scott Galloway 914,871 97.0 28,004 Patrick E. Hobbs 914,871 97.0 28,004 Ron L. Jones 914,870 97.0 28,004 Ira J. Lamel 914,871 97.0 28,004 Michael E. Recca 914,320 97.0 28,554 D.Andrew Stackpole 914,593 97.0 28,282 Jonathan Stearns 914,871 97.0 28,004
5. To consider and vote upon a proposed employment agreement with D. Andrew Stackpole to become Chairman of the Board upon the closing of the Private Placement.
6. To consider and vote upon a proposed to amend the Company's Certificate of Incorporation in order to effect a one-for-four reverse stock split of the Company's outstanding common shares.
7. To ratify the appointment of BDO Seidman, LLP as the Company's independent registered public accountants for the fiscal year ending October 28, 2006.
Part II
Item 5.
Item 5. Market for Registrants Common Equity and Related Stockholder Matters.
The Company's Common Stock is traded on the NASDAQ Capital Market under the symbol "HRVE".
On October 28, 2006, the outstanding shares of Common Stock were held by approximately 1,500 shareholders of record. The transfer agent and registrar for the Common Stock is Registrar and Transfer Company, 10 Commerce Drive, Cranford, New Jersey 07016.
The following table indicates the quarterly high and low stock prices for fiscal years 2006 and 2005 adjusted retroactively for the 1 for 4 reverse stock split:
Fiscal Year 2006 High Low - --------------------------------- ----------------- ---------------- First Quarter 2006 $4.20 $2.36 Second Quarter 2006 4.12 2.16 Third Quarter 2006 3.80 2.16 Fourth Quarter 2006 2.76 1.40
Fiscal Year 2005 High Low - --------------------------------- ----------------- ---------------- First Quarter 2005 $12.00 $4.60 Second Quarter 2005 7.04 4.80 Third Quarter 2005 5.60 4.28 Fourth Quarter 2005 5,96 3.20
The Company has paid no dividends on its Common Stock for the last two years. The Company's lender restricts the payment of dividends on the Company's Common Stock. The Company does not expect to pay cash dividends on Common Stock in 2007.
Reverse Stock Split
As fully described in Note 9 to the financial statements, the Company's shareholders, at the annual meeting, approved a reverse stock split of its common stock at an exchange ratio of 1 for 4. The reverse stock split was completed November 10, 2006 together with the Private Placement. For a period of ten (10) consecutive trading days following the closing, the Company's common stock remained above $1.00 per share, enabling the Company to regain compliance with the NASDAQ minimum bid price listing requirement. The reverse stock split has been retroactively adjusted for all periods presented.
On December 6, 2006, the Company announced that it was notified by the Panel that the Company had satisfied the conditions set forth by the Panel and regained compliance with the NASDAQ Market Place Rules. Accordingly, the Panel determined to continue the listing of the Company's securities on The NASDAQ Capital Market.
Description of Securities
The Company is authorized to issue 30,014,350 Shares of capital stock, as follows: 30,000,000 shares of Common Stock and 14,350 shares of Preferred Stock, of which 10,000 represent Series A Preferred Stock ("Series A Preferred Stock") (of which none are outstanding at October 28, 2006) and 4,350 shares of Series B Preferred Stock, all of which are outstanding. The following description of the Company's capital stock is intended to be a summary and does not describe all provisions of our Certificate of Incorporation or Bylaws or New York law applicable to us. For a more thorough understanding of the terms of our capital stock, you should refer to the Company's Amended and Restated Certificate of Incorporation and Bylaws.
Common Stock
As of October 28, 2006, 998,771 shares of Common Stock are outstanding. After the completion of the reverse stock split, 998,771 Shares are outstanding and held by approximately 1,500 Shareholders of record as of January 26, 2007. The holders of Common Stock are entitled to one vote per Share on all matters to be voted on by Shareholders. There is no cumulative voting with respect to the election of directors, with the result that holders of more than 50% of the Shares voted for the election of directors can elect all of the directors. Standing for election at any given meeting of shareholders at which directors are being elected. The holders of Common Stock are entitled to receive dividends when, as and if declared by the Board of Directors from sources legally available therefore. In the event of liquidation, dissolution or winding up of the Company, whether voluntary or involuntary, and after payment in full of the amount payable in respect of any preferred stock of the Company, the holders of Common Stock are entitled, to the exclusion of the holders of the preferred stock, to Share ratably in the assets of the Company available for distribution to stockholders after payment of liabilities and after provision for each class of stock, if any, having preference over the Common Stock. Holders of Common Stock have no preemptive rights. All outstanding Shares are, and all Shares to be sold and issued as contemplated hereby, will be fully paid and non-assessable and legally issued. The Board of Directors is authorized to issue additional Shares of Common Stock within the limits authorized by the Company's charter and without Shareholder action.
Series A Preferred Stock
The Company's Certificate of Incorporation authorizes the issuance of 10,000 shares of Series A Preferred Stock. These represent 8.5% Cumulative Convertible Preferred Stock also with a par value of $1,000 per share, of which none are outstanding at October 28, 2006.
The Series A Preferred Stock may be issued from time-to-time without shareholder approval in one or more classes or series. A holder of the Series A Preferred Stock is not entitled to vote except as required by law.
Dividends on the Series A Preferred Stock are cumulative from the day of original issuance, whether or not earned or declared. In the event the Board of Directors declares dividends to be paid on the Series A Preferred Stock, the holders of such stock will be entitled to receive semiannual dividends at the rate of eighty-five ($85) dollars per share payable in cash on the last business day of June and December in each year. Total Series A Preferred Stock dividends of $51,000, $53,000 and $70,000 were paid in fiscal years 2006, 2005 and 2004, respectively. In addition, no dividend shall be paid, or declared, or set apart for payment upon, and no other distribution shall at any time be declared or made in respect of, any shares of Common Stock, other than a dividend payable solely in, or a distribution of, Common Stock, unless full cumulative dividends of the Series A Preferred Stock for all past dividend periods and for the then current dividend period have been paid or have been declared and a sum sufficient for the payment thereof has been set apart.
If and when issued, the Series A Preferred Stock is redeemable, at our option, in whole or in part, upon payment in cash of the Redemption Price in respect of the shares so redeemed. The "Redemption Price" per share shall be equal to the sum of (i) One Thousand and 00/100 ($1,000.00) Dollars and (ii) all dividends accrued and unpaid on such shares to the date of redemption. If less than all of the then outstanding Series A Preferred Stock is to be redeemed, the redemption will be in such amount and by such method (which need not be by lot or pro rata), and subject to such other provisions, as may from time to time be determined by the Board of Directors.
In the event of liquidation, dissolution or winding-up of the Company, whether voluntary or involuntary, resulting in any distribution of its assets to its shareholders, the holders of the Series A Preferred Stock then outstanding shall be entitled to receive in respect of each such share an amount which shall be equal to the Redemption Price, and no more, before any payment or distribution of the assets of the Company is made to or set apart for the holders of Common Stock.
875 shares of 8.5% convertible Series A Preferred Stock were originally issued in conjunction with the Company's reorganization, effective October 26, 1996.
Prior to January 1, 2001, 50% of the Series A Preferred Stock was convertible at a price of $6.00 per share and 50% of the Series A Preferred Stock was convertible at $7.50 per share. Commencing January 1, 2001, each share of Series A Preferred Stock became convertible into shares of common stock at a conversion price equal to the average of the closing bid price of one share of Common Stock over the 45 trading days preceding January 1, 2001, if traded on the NASDAQ Capital Market. This conversion price was set at $1.2333 on January 1, 2001.
875 shares of Series A Preferred Stock were originally issued by the Company. In fiscal 2002, 48 shares of Series A Preferred Stock were converted to 38,920 (9,730 post reverse stock split) shares of the Company's Common Stock. In December 2004, 227 shares of Series A Preferred Stock were converted to 184,059 (46,015 post reverse stock split) shares of the Company's Common Stock. On September 20, 2006, the remaining 600 shares of the Series A Preferred Stock were converted to 486,500 (121,625 post reverse stock split) shares of the Company's Common Stock. At October 28, 2006, no shares of Series A Preferred Stock were issued and outstanding.
If at any time prior to the exercise of the conversion rights afforded the holders of the Series A Preferred Stock, this stock is redeemed by the Company, in whole or in part, then the conversion right shall be deemed canceled with respect to such redeemed stock, as of the date of such redemption.
In case of any capital reorganization or any reclassification of the Common Stock, or in case of the consolidation or merger of the Company with or into another corporation, or the conveyance of all or substantially all of the assets of the Company to another corporation, each share of Series A Preferred Stock shall thereafter be convertible into the number of shares of stock or other securities or property to which a holder of the number of shares of Common Stock deliverable upon conversion of such Series A Preferred Stock would have been entitled upon such reorganization, reclassification, consolidation, merger, or conveyance.
Series B Preferred Stock
The Company's Series B Preferred Stock consists of 4,350 shares of 8% Series B Convertible Preferred Stock with a stated value of $1,000 per share. Annual dividends payable in connection with the Series B Preferred Stock will total approximately $348,000, which is payable in cash or stock at our option, and are payable on March 1 of each year. The Series B Preferred Stock is convertible into 1,553,571 shares of common stock at $2.80 per share. The holders of Series B Stock have no voting rights unless and until such shares are converted to common stock, at which time, the holders of such shares shall have the same voting rights as other holders of our common stock.
In the event the Company fails, among other things, to provide to the holders of the Series B Preferred Stock, within specified time periods, shares of common stock upon conversion of the Series B Preferred Stock, the Company will be required to make payments of liquidated damages to such Investors. The events which may cause the Company to make payments of liquidated damages are contained within the Registration Rights Agreement executed by the Company and the holders of Series B Preferred Stock. The Company is also required to reserve a sufficient number of shares of common stock to cover the conversion of the Series B Preferred Stock and the payment of dividends in stock. As long as Series B Preferred Stock remains outstanding, the Company cannot redeem, purchase or acquire junior securities except as specifically provided in the Company's Certificate of Incorporation. In addition, as long as 10% of the Series B Preferred Stock remains outstanding, the Company cannot, without the written consent of the holders of a majority of the then outstanding Series B Preferred Stock (i) enter into, create, incur, assume, guarantee or suffer to exist any indebtedness for borrowed money of any kind, including but not limited to, a guarantee, on or with respect to any of the Company's property or assets now owned or hereafter acquired or any interest therein or any income or profits, except for Permitted Indebtedness, (ii) enter into, create, incur, assume or suffer to exist any Liens of any kind, on or with respect to any of our property or assets now owned or hereafter acquired or any interest therein or any income or profits except for Permitted Liens, (iii) amend the Company's certificate of incorporation, bylaws or other charter documents so as to materially and adversely affect any rights of any Holder, (iv) repay, repurchase or offer to repay, repurchase or otherwise acquire more than a de minimis number of shares of our common stock, Common Stock Equivalents or Junior Securities, except for the Conversion Shares to the extent permitted or required under the Transaction Documents or as otherwise permitted by the Transaction Documents, (v) enter into any agreement or understanding with respect to any of the foregoing, or (vi) pay cash dividends or distributions on Junior Securities of the Company. Defined terms used but not defined above shall have the meaning ascribed to them in the Company's Amended and Restated Certificate of Incorporation.
Series A Warrants
The Series A warrants grant Investors in the Private Placement the right to purchase 534,823 shares of common stock and vFinance (the placement agent for the Private Placement) the right to purchase 18,750 shares of common stock. The Series A warrants are exercisable at a price of $5.60 per share, subject to customary anti-dilution adjustments. The exercise period of the Series A warrants commenced on November 10, 2006 and continues for seven years following that date. During this period, the Investors may exercise the Series A warrants in full or in part. If at any time after one year from the date of issuance of the warrant there is no effective registration statement relating to the underlying shares of common stock, then such warrants may be exercised by means of cashless exercise.
Series B Warrants
The Series B warrants grant Trinity the right to purchase 500,000 shares of common stock and are exercisable at a price of $2.80 per share, subject to customary anti-dilution adjustments. The exercise period of the Series B warrants commenced on November 10, 2006 and are exercisable for seven years. If at any time after one year from the date of issuance of the warrant there is no effective registration statement relating to the underlying shares of common stock, then such warrants may be exercised by means of cashless exercise.
Series C Warrants
The Series C warrants grant Trinity the right to purchase 875,000 shares of common stock and are exercisable at a price of between $3.20 and $6.80 per share in ten equal tranches, with the exercise price increasing by $0.10 in each tranche, subject to customary anti-dilution adjustments. The exercise period of the Series B warrants commenced on November 10, 2006 and are exercisable for seven years. If at any time after one year from the date of issuance of the warrant there is no effective registration statement relating to the underlying shares of common stock, then such warrants may be exercised by means of cashless exercise.
Registration Rights Agreement
In connection with the Private Placement, the Company agreed to enter into a Registration Rights Agreement with the Investors, pursuant to which it would be required to file with the SEC a registration statement for the resale of the Common Shares and the Warrant Shares issuable upon exercise of the Warrants within 30 days following the closing of the Private Placement. On December 11, 2006, we filed a registration statement on Form S-3, which registration statement is not yet effective. The Company will bear all of the costs of the registration other than underwriting discounts and commissions and certain other expenses. The Registration Rights Agreement would obligate the Company to use its commercial best efforts to have the registration statement declared effective as soon as practicable after it is filed. If the registration statement is not declared effective by the SEC within 180 days following the closing of the Private Placement, we must make liquidated damages payments to the Investors during such delay in filing or effectiveness.
Once the registration statement has been declared effective, the Company is required to maintain the effectiveness of the registration statement until the earlier of (i) the date by which all registered shares have been sold thereunder or become eligible for resale pursuant to SEC Rule 144(k) and (ii) the second anniversary of the effective date of the registration statement. In limited circumstances, the Company may suspend the use of the registration statement after it has been declared effective without incurring the obligation to pay liquidated damages so long as the suspension does not exceed 15 consecutive days and during any 12-month period the use of the registration statement is not suspended for more than 20 days in the aggregate.
The Company has also entered into a Registration Rights Agreement with Trinity and the Company's Chairman, Mr. Stackpole upon substantially similar terms in connection with the Warrants and shares issued to Trinity and Mr. Stackpole; provided, however, that such shares will not be registered until at least six months following the effective date of the Registration Rights Agreement for the benefit of the Investors.
The Registration Rights Agreements contain customary indemnification provisions that obligate the Company to indemnify and hold harmless each Investor, Trinity and their directors, legal counsel and accountants and any underwriter for losses caused by (i) any untrue statement of material fact or omission of a material fact in the registration statement or any prospectus included therein, (ii) the violation by us of the 1933 Act or 1934 Act or any rule or regulation thereunder relating to our acts or omissions in connection with the registration statement.
The laws of New York would govern the construction and enforcement of the Registration Rights Agreements. The Registration Rights Agreements also contain other customary terms found in such agreements, including provisions concerning registration procedures.
Item 6.
Item 6. Selected Financial Data (amounts in thousands, except per share and number of stores data)
Set forth below is selected financial and operating data for each of the five years ended October 28, 2006. The selected statement of operations and balance sheet data for each of the five years ended October 28, 2006 have been derived from our audited financial statements. Certain items in the fiscal 2004, 2003 and 2002 financial data have been reclassified to conform to fiscal 2005 presentation. Certain items in the fiscal 2002 financial data have been reclassified to conform to fiscal 2003 presentation. The information set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our financial statements and the notes thereto included elsewhere in this Form 10K.
Balance Sheet Data:
(1) It is important to note that at the end of fiscal 2002 and 2001, the Company's outstanding balances on its revolving line of credit facility ($3,119,000 and $3,442,000, respectively) were classified as current liabilities, despite the long-term nature of the Company's then outstanding credit facility. The presentation as a current liability was in accordance with Emerging Issue Task Force ("EITF") 95-22, "Balance Sheet Classification of Borrowings Outstanding under Revolving Credit Agreements that include both a Subjective Acceleration Clause and a Lock-Box Arrangement". Working capital was negatively impacted by the Company's significant increase in the revolving line of credit facility in fiscal 2005 and 2001, which was necessary to fund retail store expansion and renovation. (2) The Company entered into a $7.5 million credit facility on November 21, 2003. The credit facility expires in two years and does not include both a subjective acceleration clause and a lock box arrangement, in accordance with EITF 95-22, the Company classified the balance outstanding, at October 28, 2006, ($3,348,000), October 29, 2005 ($3,486,000), October 30, 2004 ($1,825,000) and November 1, 2003 ($2,726,000), under the new credit facility as a long-term liability. (3) The Company sells extended warranty contracts for a third party provider. The profit on extended warranty sales is considered commission at the time of sale. As a result, the net amount earned on these sales is recorded in net sales, in accordance with EITF 99-19, "Reporting Revenue Gross as a Principal Versus Net as an Agent." (4) At October 30, 2004, the Company reassessed the valuation allowance previously established against its net deferred tax assets. Based on the Company's earnings history and projected future taxable income, the Company determined that it is more likely than not that a portion of its deferred tax assets would be realized and recorded an income tax benefit of approximately $977,000 and a reduction of reorganization value of approximately $373,000. In the third quarter of fiscal 2006, the Company provided a full valuation allowance against previously recorded net deferred tax assets. In accordance with SFAS 109, "Accounting For Income Taxes", this valuation allowance was necessary because the Company experienced cumulative losses for its last two fiscal years, including the increased loss in fiscal 2006 and declining sales, which created a degree of uncertainty regarding the future realization of such net deferred tax assets. As a result, the Company recorded a deferred tax expense of $1,350,000 in the third quarter of fiscal 2006. (5) Adjusted to retroactively affect the 1 for 4 reverse stock split completed November 10, 2006.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis contains forward-looking statements which involve risks and uncertainties. When used herein, the words "anticipate," "believe," "estimate," and "expect" and similar expressions as they relate to the Company or its management are intended to identify such forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The Company's actual results, performance or achievements could differ materially from the results expressed in or implied by these forward-looking statements. Historical results are not necessarily indicative of trends in operating results for any future period. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date the statement was made.
General
The following discussion should be read in conjunction with the Company's audited financial statements for the fiscal years ended October 28, 2006, October 29, 2005 and October 30, 2004, appearing elsewhere in this Form 10-K.
Results of Operations
Fiscal Year Ended October 28, 2006, as Compared To Fiscal Year Ended October 29, 2005
Net (Loss)
The Company's pre-tax loss for the year ended October 28, 2006 was $1,888,000 as compared to a pre-tax loss of $830,000 for the year ended October 29, 2005. The net loss for fiscal 2006 was $3,237,000 as compared to a net loss of $830,000 for fiscal 2005.
In the third quarter of fiscal 2006, the Company recorded a $1,350,000 non-cash deferred tax expense. As discussed below, this related to the full valuation allowance recorded on the Company's net deferred tax assets as there is uncertainty regarding the future realization of such assets.
The Company believes the non-GAAP measurement of earnings before interest, taxes, depreciation and amortization ("EBITDA") is an important operational measure. Depreciation and amortization have historically been significant in relation to net income or net loss. The Company's depreciation and amortization expense, as is interest expense from its line of credit, primarily relates to the Company's retail stores and expansion of its retail stores. The Company's income tax equivalent provisions or deferred tax expense have also had a significant impact on earnings, but have primarily not required the use of the Company's cash, due to the reporting requirements of Fresh Start Accounting.
The Company's Management, Board of Directors and its lender review EBITDA monthly, quarterly and annually to gauge the Company's performance. EBITDA may also be used in simple valuation measures of the Company, by its shareholders and potential investors. Management understands that there are limitations associated with the use of this non-GAAP measure of EBITDA as compared to net loss. Specifically, a portion of interest expense does relate to the Company's operations and a portion of the income tax equivalent provision, if any, does relate to the payment of certain state taxes, although these amounts are not material. Additionally, the Company will not eliminate any other recurring or non-recurring expenses in its reconciliation of the Company's net loss to EBITDA.
The following is a reconciliation of the Company's net loss to the non-GAAP measure of EBITDA:
Fiscal 2006 Fiscal 2005 ----------- ----------- Net loss $ (3,237,000) $ (830,000)
Add back Interest Expense 394,000 232,000 Income Taxes (benefit) 1,350,000 - Depreciation and amortization 728,000 739,000 =================== ================ EBITDA $ (765,000) $ 141,000 =================== ================
The Company's net loss for fiscal 2006 was negatively impacted by reduced comparable store sales, as discussed below.
Additionally, the net loss was negatively affected by the provision for severance costs, recorded in the Company's fourth quarter of fiscal 2006 aggregating $284,000 and relating to the departure of the Company's President/Chief Executive Office and the former Chairman of the Board. The former Chairman will remain a Board member in fiscal 2007.
The Company's net loss for fiscal 2006 and 2005 included net advertising expense of $614,000 and $725,000, respectively. In fiscal 2006, the Company realized less cooperative advertising support from its vendors. Additionally, the Company's advertising expenditures decreased 27% in fiscal 2006 to approximately $1,970,000 as compared to $2,700,000 for fiscal 2005. Management believes that the reduced promotional spending in fiscal 2006 negatively affected sales results.
In the fourth quarter of fiscal 2006, the Company initiated a change in its advertising campaign which was modified to reflect current market conditions, customer needs and service demands. The new marketing strategy was designed to better promote the Harvey brand and its installation and home integration offerings.
Accordingly, certain promotional allowances received by vendors that were previously recorded as a reduction of advertising expense are now recorded as a reduction of inventory costs if the expenditure no longer represents identifiable costs incurred by the Company to promote its products.
As a result, $360,000 of promotional allowances were reflected as an adjustment to inventory ($100,000) and a reduction of cost of goods sold ($260,000) in the fourth quarter of fiscal 2006 for promotional allowances related to the fourth quarter.
For fiscal 2005, no income tax provision was necessary due to net losses.
Additionally, the Company provided no income tax benefit against current operating losses because of uncertainly regarding their future realization. In addition, as of the third quarter ended July 29, 2006, the Company provided a full valuation allowance against previously recorded net deferred tax assets. In accordance with SFAS 109, "Accounting For Income Taxes", this valuation allowance was necessary because the Company experienced cumulative losses for its last two fiscal years, including the increased loss in fiscal 2006 and declining sales, which create a degree of uncertainty regarding the future realization of such net deferred tax assets. As a result, the Company recorded a deferred tax expense of $1,350,000 in the third quarter of 2006.
In fiscal 2005, the Company's net loss was negatively affected by approximately $200,000 in pre-opening expenses, operating losses and related promotional expenses related to the Company's Bridgewater, New Jersey store, which opened in late June 2005.
Revenues
For the year ended October 28, 2006, net sales aggregated $36,028,000, a decrease of approximately $4.4 million or 10.9% from the prior year. Comparable store sales for fiscal 2006, exclusive of a portion of the Company's sales from the new Bridgewater store, decreased approximately $6.0 million or 14.9% from the prior year.
In fiscal 2006, the Company's comparable store sales declined due to a reduction in retail store traffic, increased competition and price compression on high definition flat panel televisions, reduced marketing expenditures and flat panel shortages from certain key video vendors. The Company's third and fourth quarters were particularly impacted from a very soft retail climate and a further slowdown in retail store traffic. This slowdown has continued into the Company's first quarter of fiscal 2007.
During the fourth quarter of fiscal 2006, the Company experienced improved products availability of key flat panel product from its video vendors. However, the Company continued to experience video price compression and expects this price compression to continue in the future.
For fiscal 2006, the Company has experienced a decline in its audio and video sales, marginally offset by an increase in its labor revenue.
While flat panel product shortages and video price compression negatively impacted the Company in fiscal 2006, demand for flat-panel televisions has increased and unit sales have increased approximately 9%. The increase in unit sales was experienced from the sale of larger size plasma and LCD televisions. This continues to provide a service opportunity for the Company, as customers require custom installations of these televisions and related home theaters. The Company's overall flat-panel sales in dollars decreased for fiscal 2006 by 12% from fiscal 2005. Additionally, the Company's overall video sales declined approximately 14.6% in fiscal 2006 from fiscal 2005.
Video sales ($14.7 million) represented approximately 40.2% of gross sales for fiscal 2006, as compared to 41.9% of gross sales for the same period last year.
The Company's higher margin audio sales ($17.5 million) decreased 10.3% for fiscal 2006, as compared to the same period last year, and represented 48% of gross sales, as compared to 47.6% of gross sales for the same period last year. Audio sales were negatively impacted by reduced audio components, systems, radio and portables, audio accessories and furniture. The Company's cable, wire and surge protector sales continued to be strong, despite the overall reduction in sales.
The Company's higher margin labor revenue ($4.3 million) increased .1% for fiscal 2006 from the same period last year and represents approximately 11.8% of gross sales as compared to 10.5% for the same period last year. In the second quarter of fiscal 2006, the Company increased its labor rates, and as a result has increased labor revenue and resulting labor margins.
The Company believes it continues to benefit from the strong demand for its custom installation services. Additionally, despite increased competition and a decline in retail store traffic, customer demand continues to be strong for digital video products including larger plasma flat screen, LCD flat panel, high-definition televisions, integrated remote controls and related custom home installations. Custom installation projects continue to increase, as a percentage of gross sales and accounted for 64.7% of gross sales for fiscal 2006, as compared to approximately 62.8% of gross sales for fiscal 2005. Overall custom installation sales, including both equipment sales and labor income declined 8% and aggregated $23.6 million for fiscal 2006, as compared to $25.7 million for fiscal 2005. The Company's custom installation services yield higher gross profit margins and stronger net profitability, as compared to normal retail store sales.
The Company believes it differentiates itself by offering sophisticated custom installation services, including programming capabilities that address complex technological integration issues giving its customers easy remote control operations for a variety of functions. Management believes installations of dedicated theater rooms, media servers, hard drive video and audio storage and distribution, video mounts, lighting systems in the home, as well as network cabling will continue to attract affluent customers to the Company. The home theater room will be the forefront of the smart home, for the desired integration of all electronics, lighting, security and networking within the home. These offerings should continue to benefit sales, enhance gross margins and improve overall store profitability.
The Company believes it can expand its service niche in offering custom labor and other accessories for both Harvey customers and customers that have purchased products elsewhere, specifically on the internet or from mass merchants. The Company is offering a 48-hour response time to address the needs of a qualified customer at an additional labor cost. Additionally, the Company has an agreement with Cablevision offering and installing their high speed cable modems and digital cable boxes in conjunction with our installation services to Cablevision's iO digital cable customers. The Company is also working with Time Warner and Patriot Media and Communications in offering these services.
Net sales for the new Harvey retail store located in Bridgewater, New Jersey have been encouraging. The Company believes that this store, opened June 2005, will take some time to mature as its sales have significantly come from new home construction and custom installations which take time to cultivate and complete. The new Bridgewater store contributed net cash flow in fiscal 2006 and essentially achieved a break-even level of store profitability in its first full year of operation.
In fiscal 2005, the Company relocated and consolidated its Bang & Olufsen store in Greenwich, Connecticut with its Harvey Greenwich store, one block away. This store-within-a-store concept presents Bang & Olufsen products in a unique and separate showcase within a Harvey store. The Company has been able to increase its Bang & Olufsen sales with this new store-within-a-store concept without the overhead of a separate store.
Net sales for all of the Company's retail stores experienced declines for fiscal 2006, as compared to fiscal 2005, except the Company's Mt. Kisco, New York and Greenwich, Connecticut stores and its newest store in Bridgewater, New Jersey.
As discussed above, comparable store sales results were negatively impacted by a slowdown in retail store traffic, flat panel product shortages and price compression of these video products. Comparable store sales results were exacerbated by the poor results of the Company's Midtown Manhattan, Eatontown, New Jersey, Greenvale, Long Island stores and its store within ABC Carpet and Home in Manhattan. These stores all experienced slower than normal retail store traffic for the periods reported.
The Company's marketing efforts continued to be in a transition stage in fiscal 2006. Effective September 1, 2005, the Company engaged a new advertising agency, Avrett Free Ginsberg, to promote its brand and increase awareness in the Company's service initiatives. The advertising campaign, which was expected to be released in the second quarter of fiscal 2006, was modified to reflect current market conditions, customer needs and service demands. We believe the delay in releasing the new campaign had a negative impact on second, third and fourth quarter sales. Additionally, in fiscal 2006 and early fiscal 2007, the Company conducted consumer focus groups, which should help develop an appropriate campaign for fiscal 2007. In October 2006, the Company engaged a new advertising agency, Warren Kremer Paino, to better promote the Company's brand, product and service offerings. In fiscal 2007, the Company also expects to increase its marketing expenditures by an effective rate of approximately 49.7%, using the funds from the recently completed Private Placement. The Company's new campaign is expected to be launched in the second quarter of fiscal 2007.
In the third quarter of fiscal 2006, the Company engaged a consultant and marketing brand advisor who became a member of the Board after the Private Placement was consummated. This Board Member assisted in developing new strategies to best promote and build the Harvey brand. The Company paid this Board Member $50,000 in fiscal 2006.
Advertising efforts will continue to include radio, newspaper, direct mail and e-mail broadcasts, as well as the continued promotion of the Company's website, harveyonline.com, as well as potentially adding other marketing mediums. The Company expects to replace its website in fiscal 2007.
Furthermore, in fiscal 2007, the Company also will endeavor to put additional efforts and resources into its important customer relations management initiatives and plans to be more aggressive with internet keyword searches and specific e-mail promotions to prospective and existing customers.
Cost and Expenses
Total cost of goods sold for fiscal 2006 decreased 11.4% to $20,908,000 as compared to fiscal 2005. The decline in cost of goods sold for fiscal 2006 was due primarily to the overall 10.9% decrease in net sales, as noted above.
In the fourth quarter of fiscal 2006, the Company initiated a change in its advertising campaign as discussed above. As a result, $360,000 of promotional allowances were reflected as an adjustment to inventory ($100,000) and a reduction of cost of goods sold ($260,000) in the fourth quarter of fiscal 2006 for promotional allowances related to the fourth quarter. This adjustment in the Company's fourth quarter, decreased cost of goods sold and improved the gross margin.
The gross profit margin for fiscal 2006 increased to 42.0% from 41.7% in fiscal 2005. The increase in the gross profit margin was primarily due to the $260,000 in promotional allowances discussed above. Excluding this adjustment, the gross margin was approximately 41.2% and declined as compared to fiscal 2005 due to continued video price compression, reduced higher margin audio sales, and additional from price promotions offered throughout fiscal 2006. This was offset somewhat by an increase in higher margin labor revenues.
Additional higher margin cable, wire and surge protector sales helped to mitigate the decline in the Company's overall gross profit margin for fiscal 2006.
The Company's total cost of goods sold also includes freight costs, purchase discounts from its vendors and inventory shrink. The Company's gross profit margin may not be comparable to other reporting electronics retailers as other entities may include the costs relating to their warehousing and distribution networks. Warehouse and distribution network costs for fiscal 2006 and 2005 approximated $573,000 and $704,000, respectively, and are included in SG&A expenses.
Selling, general and administrative ("SG&A") expenses for fiscal 2006 decreased by 6.6% to $16,366,000 as compared to fiscal 2005. The decrease for fiscal 2006 was offset by additional SG&A expenses aggregating $583,000, relating to the Company's new Bridgewater, New Jersey store.
Net advertising expense, which is included in SG&A expenses in the Company's Statements of Operations declined to $614,000 in fiscal 2006 from $725,000 in fiscal 2005. This decrease was primarily related to a reduction in advertising expenditures and a decline in cooperative advertising support from its vendors.
Management has been proactive in response to the sales decline with its cost reduction program. As a result, SG&A expenses declined from reduced payroll and payroll related expenses, management bonuses, other selling expenses, professional fees and communications. These decreases were offset by increased occupancy costs.
As part of its ongoing cost reduction program, Management will continue to examine ways to reduce expenses further in fiscal 2007. More importantly, Management will continue it efforts to improve its purchasing and inventory efficiencies, implement positive merchandising changes, while cultivating its profitable service offerings.
The Company plans to continue to hire and train custom installation personnel, as needed, and incur the necessary associated expenses relating to the expansion of its custom installation services. Management believes these services differentiate Harvey and are vital to the Company's business plan. Management also expects to intensify its sales training efforts in fiscal 2007 to ensure that its customers are given an exceptional and unsurpassed retail experience.
Interest expense increased by approximately $162,000 or 69.9% in fiscal 2006 from fiscal 2005. This was primarily due to increased borrowings and higher interest rates. In fiscal 2005, the Company's balance outstanding on its credit facility had increased as the Company used the credit facility to finance the construction of its new retail store in Bridgewater, New Jersey. Additionally, the credit facility was used to fund current operating losses, expenditures for computer equipment, software deposits and development work relating to the replacement of its legacy computer system. The new computer system was launched in November 2007.
For fiscal 2005, no income tax provision was necessary due to net losses.
Fiscal Year Ended October 29, 2005, as Compared to Fiscal Year Ended October 30, 2004
Net (Loss) Income
The Company's pre-tax loss for the year ended October 29, 2005, was $830,000 as compared to pre-tax income of $492,000 for the year ended October 30, 2004. The net loss for fiscal 2005 was $830,000 as compared to net income of $1,274,000 for fiscal 2004.
The Company believes the non-GAAP measurement of earnings before interest, taxes, depreciation and amortization ("EBITDA") is an important operational measure. Depreciation and amortization have historically been significant in relation to net (loss) income. The Company's depreciation and amortization expense, as is interest expense from its line of credit, primarily relates to the Company's retail stores and expansion of its retail stores. The Company's income tax equivalent provisions (benefit) or deferred tax expense (benefit) have also had a significant impact on earnings, but have primarily not required the use of the Company's cash, due to the reporting requirements of Fresh Start Accounting.
The Company's Management, Board of Directors and bank comparably review EBITDA monthly, quarterly and annually to gauge the Company's performance. EBITDA may also be used in simple valuation measures of the Company, by its shareholders and potential investors. Management understands that there are limitations associated with the use of this non-GAAP measure of EBITDA as compared to net income. Specifically, a portion of interest expense does relate to the Company's operations and a portion of the income tax equivalent provision does relate to the payment of certain state taxes, although these amounts are not material. Additionally, the Company will not eliminate any other recurring or non-recurring expenses in its reconciliation of the Company's net (loss) income to EBITDA.
The following is a reconciliation of the Company's net (loss) income to the non-GAAP measure of EBITDA:
Fiscal 2005 Fiscal 2004 ----------- ----------- Net (loss) income ($830,000) $1,274,000
Add back Interest expense 232,000 175,000 Income taxes (benefit) - (782,000) Depreciation and amortization 739,000 683,000 ------- ------- EBITDA $141,000 $1,350,000 ======== ==========
The Company's net loss for fiscal 2005 was negatively impacted by reduced comparable store sales, as discussed below.
Additionally, the Company's net loss was negatively affected by approximately $200,000 in pre-opening expenses, operating losses and related promotional expenses related to the Company's new Bridgewater, New Jersey store, which opened in late June 2005.
A 54.3% increase in net advertising expense also contributed to the Company's net loss in fiscal 2005. Net advertising expense in fiscal 2005 increased to $725,000 from $470,000 in fiscal 2004, and is discussed below.
Net income for fiscal 2004 was negatively impacted by a fourth quarter provision for impairment of long-lived assets aggregating $144,000, relating to the relocation of the Company's Bang & Olufsen branded store in Greenwich, Connecticut. Net income for fiscal 2004 was also negatively impacted by $133,000 relating to the Company's estimates of unclaimed property due to certain states.
No income tax provision was required for fiscal 2005, as a result of the Company's net loss. In fiscal 2004, the Company reversed a portion of its valuation allowance against its deferred tax assets, recognizing an income tax benefit of $977,000. This income tax benefit was partially offset by an income tax provision of $195,000 recorded in fiscal 2004.
Revenues
For the year ended October 29, 2005, net sales aggregated $40,444,000, a decrease of approximately $2.7 million or 6.3% from the prior year. Comparable store sales for fiscal 2005, excluding the sales from the Company's new Bridgewater store, decreased approximately $3.5 million or 8% from the prior year.
The Company's net sales for fiscal 2005 were negatively impacted by a decline in retail store traffic, which began in January 2005, coupled with a 15.4% reduction in its video business.
The Company believes the slowdown was due to a deceleration of consumer spending during the year, as well as consumer expectations that flat panel television prices would continue to significantly decline, thus delaying the purchase decision. Additionally, consumer uncertainties and confusion regarding current technologies continue to be somewhat problematic for the industry.
Audio sales declined 1.2%, while video sales declined approximately 15.4% for fiscal 2005 as compared to fiscal 2004. Video sales have declined as a result of reduced DLP, CRT and DVD sales and to a lesser extent from price compression, an overall 1% reduction of flat panel unit sales and certain product shortages, particularly in the third and fourth quarters.
The Company has experienced flat panel growth in larger size plasma and LCD televisions while reporting declines in smaller screen sizes. Sales of larger screen flat panels provided installation opportunities for the Company. The Company's labor revenue increased approximately 17.1% for fiscal 2005 as compared to fiscal 2004 as custom installation demand continues to be strong.
The Company's overall video sales ($17.2 million) have been negatively impacted by price compression in the industry as well as competitive pressures in the market. Management believes this trend will continue. As video products are affected by price compression, Management believes it is an opportunity for the Company to attach additional higher margin audio components, accessories and labor. Video sales declined to approximately 41.9% of gross sales in fiscal 2005, from 46.5% of gross sales for fiscal 2004.
The Company's higher margin audio sales ($19.5 million) for fiscal 2005 increased to 47.6% of gross sales for fiscal 2005 from 45.2% of gross sales for fiscal 2004. Audio sales were positively impacted by additional cable sales, headphones, furniture, radio and portables. Labor income ($4.3 million) for fiscal 2005 represented approximately 10.5% of gross sales as compared to approximately 8.4% of gross sales for fiscal 2004.
The Company believes it continues to benefit from the strong demand for its custom installation services. Additionally, despite increased competition and a decline in retail store traffic, customer demand continues to be strong for digital video products including larger plasma flat screen, LCD flat panel, high-definition televisions, integrated remote controls and related custom home installations. Custom installation projects continued to increase, as a percentage of net sales and in actual dollars, and accounted for 63% of net sales for fiscal 2005 as compared to approximately 59% of net sales for fiscal 2004. Custom installation sales, including both equipment sales and labor income aggregated $25.7 million for fiscal 2005, as compared to $25.6 million for fiscal 2004. The Company's custom installation services yield higher gross profit margins and stronger net profitability, as compared to normal retail store sales.
The Company believes it differentiates itself by offering sophisticated custom installation services, including programming capabilities that address complex technological integration issues giving its customers easy remote control operations for a variety of functions. Management believes installations of dedicated theater rooms, hard drive video and audio storage and distribution, lighting systems in the home, as well as network cabling will continue to attract affluent customers to the Company. The home theater room will be the forefront of the smart home, for the desired integration of all electronics, lighting, security and networking within the home. These offerings should continue to benefit sales, enhance gross margins and improve overall store profitability.
The Company also offers a service initiative called "Harvey on Demand". The Company believes it can expand its service niche in offering custom labor and other accessories for both Harvey customers and customers that have purchased products elsewhere, specifically on the internet or from mass merchants. The Company is offering a forty-eight hour response time to address the needs of a qualified customer at an additional labor cost. Additionally, the Company has been working with Cablevision and Time Warner in offering and installing their high speed cable modems and digital cable boxes in conjunction with our installation services.
Net sales for the new Harvey retail store located in Bridgewater, New Jersey have been encouraging. The Company believes that this store will take some time to mature as its sales have significantly come from new home construction and custom installations which take time to cultivate and complete.
As previously disclosed, the Company elected not to renew the lease for its Bang & Olufsen store in Greenwich, Connecticut, which expired in April 2005. Management decided to relocate and consolidate this operation within its Harvey Greenwich store, one block away. This relocation was completed in late April 2005. This store-within-a-store concept presents Bang & Olufsen products in a unique and separate showcase within a Harvey store. The Company is excited about this new store-within-a-store concept. The Company has been able to increase its Bang & Olufsen sales without the overhead of a separate store.
Net sales for all of the Company's retail locations have experienced declines in fiscal 2005, as compared to fiscal 2004, due primarily from reasons stated above, except the Company's Greenvale, Long Island store. This store has benefited from additional custom installation business from various new home development sites, where the Company has exclusive rights to service these new developments.
The Company's marketing efforts were in a transition stage in fiscal 2005. Effective September 1, 2005, the Company engaged a new advertising agency to promote its brand and increase awareness in the Company's service initiatives. The new campaign is expected to be introduced after the completion of the holiday shopping season. In fiscal 2005, the Company's marketing efforts remained stable, as compared to fiscal 2004. These efforts included radio, newspaper, direct mail and e-mail broadcasts, as well as the continued promotion of the Company's website.
For fiscal 2006, the Company also will endeavor to put additional efforts and resources into its important customer relations management initiatives and plans to be more aggressive with specific e-mail promotions to prospective and existing customers.
Costs and Expenses
Total cost of goods sold for fiscal 2005 decreased 7.1% to $23,589,000, as compared to fiscal 2004. The decline in cost of goods sold was primarily due to the decrease in net sales as noted above. This decline was offset by the slight improvement in the Company's gross profit margin in fiscal 2005.
The gross profit margin for fiscal 2005 increased to 41.7% from 41.1% for fiscal 2004.
The increase in the gross profit margin in fiscal 2005 was due to a decline in the Company's overall video business, which generally has lower margins than audio and labor sales. This was offset by higher margin audio sales and additional labor income, wire and cable sales, which generate strong gross margins.
The Company's total cost of goods sold includes freight costs, purchase discounts from its vendors and inventory shrink. The Company's gross profit margin may not be comparable to other reporting electronics retailers as other entities may include the costs relating to their warehousing and distribution networks. Warehouse and distribution network costs for fiscal 2005 and 2004 approximated $704,000 and $711,000, respectively, and are included in SG&A expenses.
Selling, general and administrative expenses (SG&A expenses) for fiscal 2005 increased by approximately $460,000 or 2.9%, as compared to fiscal 2004. Pre-opening and operating expense relating to the Company's new Harvey store in Bridgewater, New Jersey contributed to this increase, in addition to the substantial increase in net advertising expense for fiscal 2005. Net advertising expense for fiscal 2005 increased to $725,000 from $470,000 in fiscal 2004. Advertising expenditures remained stable at $2,700,000 for both fiscal 2005 and 2004. However, the Company realized lost cooperative advertising support from its vendors due to a decline in the Company's sales.
As a result, net advertising expense, which is included in SG&A expenses in the Company's Statements of Operations, has increased 54.3% or $255,000 in fiscal 2005 as compared to fiscal 2004. SG&A expenses also increased from additional payroll and payroll related costs, professional fees, occupancy costs, truck expenses, depreciation and amortization, EDP expenses and various other general store operating expenses. These increases were offset by a decline in communication expense, bad debt expense, supplies expense, other selling expenses and the reduced provision relating to unclaimed property due to certain states.
The Company plans to continue to hire and train custom installation personnel, as needed, and incur the necessary associated expenses relating to the expansion of its custom installation services. Management believes these services differentiate Harvey and are vital to the Company's business plan.
Due to the slowdown in the Company's business, Management elected to begin a cost reduction program which began in the third quarter of fiscal 2005. Management implemented a one-week non-paid furlough for all employees and reduced its work force and SG&A expenses, where appropriate.
Interest expense increased by approximately $57,000, or 32.7% for fiscal 2005, as compared to fiscal 2004. This was primarily due to increased borrowings and higher interest rates. The Company's balance outstanding on its credit facility increased as the Company used the credit facility to finance the construction of its new retail store in Bridgewater, New Jersey, as well as computer equipment, software deposits and development work relating to the replacement of its computer systems expected to be completed in fiscal 2006.
In connection with the Company's emergence from its reorganization proceeding, in 1996, the Company adopted Fresh Start Accounting. Fresh Start Accounting requires that the Company report an income tax equivalent provision when there is book income and pre-organization net operating loss carryforward. This requirement applies despite the fact that the Company's pre-organization net operating loss carryforward will be utilized to reduce the related income tax payable. The current and any future year benefit arising from utilization of the pre-reorganization carryforward is not reflected as a reduction of the tax equivalent provision in determining net income, but instead is recorded first as a reduction of reorganization value in excess of amounts allocable to identifiable assets until exhausted, and thereafter as a direct addition to paid-in capital.
As noted above, for fiscal 2004, the income tax equivalent provision and the reduction of the organization value in excess of amounts allocable to identifiable assets was $135,000.
No income tax provision was required for fiscal 2005, as a result of the Company's net loss.
Liquidity and Capital Resources
At October 28, 2006 and October 29, 2005, the Company's ratio of current assets to current liabilities was 1.08 and 1.52, respectively.
The current ratio at October 28, 2006 was negatively impacted by the Company's net loss, the decline in inventory, current deferred tax assets and the increase in trade accounts payable and accrued expenses.
Net cash provided by operating activities for fiscal 2006 was $1,099,000, as compared to cash provided by operating activities of $211,000 for fiscal 2005. For fiscal 2006, the Company reported a net loss from operations of $3,237,000 as compared to a net loss from operations of $830,000 for fiscal 2005. The increased net loss was offset by the planned reduction in inventory for fiscal 2006, where in fiscal 2005, inventories were increased. Additionally, the Company experienced an increase in accrued expenses and trade accounts in payables in fiscal 2006, where there was a significant reduction of accrued expenses and customer deposits for fiscal 2005.
Net cash used in investing activities for fiscal 2006 was $561,000 as compared to $1,771,000 for fiscal 2005. Net cash used in investing activities included the purchase of equipment and software aggregating $189,000 and deposits on development work aggregating $378,000 related to the planned replacement of the Company's legacy computer system. For fiscal 2005, $1,459,000 was used for the purchase of leasehold improvements, software and equipment, primarily relating to the new Bridgewater, New Jersey retail store opened in June 2005. Additionally, in fiscal 2005, the Company incurred $150,000 relating to software purchases and $170,000 in related development and hardware purchases for its computer conversion.
Net cash used in financing activities for fiscal 2006 was $538,000, as compared to cash provided of $1,771,000. Financing activities included net payments of $138,000 decreasing the credit facility, preferred stock dividends of $51,000 and principal payments on note payables of $56,000. Additionally, fees relating to the Company's Private Placement aggregated $293,000. Financing activities for fiscal 2005 included net borrowings of $1,661,000, increasing the credit facility, preferred stock dividends paid of $59,000 and principal payments on note payables of $42,000.
In November 2003, the Company entered into a five-year $7.5 million credit facility with Webster Business Credit Corporation ("Webster"), a subsidiary of Connecticut based Webster Bank. Under the credit facility, the Company can borrow up to $7.5 million based upon lending formulas calculated on eligible credit card receivables and inventory, less certain reserves, as defined. The Webster credit facility expires November 21, 2008.
The interest rate on all borrowings under the credit facility is either 0.25% over Webster Bank's prime rate (8.50% at October 28, 2006) or LIBOR plus 2.75%, at the Company's option. Under the credit facility, the Company pays Webster a reduced maintenance fee of $1,000 per month and a monthly unused line fee, as defined in the credit facility.
In connection with the credit facility, the Company granted Webster a senior security interest in all of the Company's assets. The credit facility provides Webster with rights of acceleration upon the occurrence of certain customary events of default. The Company is restricted from paying dividends on its Common Stock, retiring or repurchasing its Common Stock and entering into additional indebtedness (as defined).
On November 9, 2006, the Company entered into the Sixth Amendment and Consent Agreement with Webster which (i) provided Webster's consent to the Private Placement and change in control, (ii) modified certain Availability Reserves and the Fixed Charge Ratio, as defined, and (iii) modified the Financial Covenants including the Capital Expenditures and Excess Availability/Cash requirements covenants, as defined. The Company was in compliance with all financial covenants at October 28, 2006.
As the credit facility expires in two years and does not include both a subjective acceleration clause and a lock box arrangement, in accordance with EITF 95-22, the Company classified the balance outstanding, at October 28, 2006 ($3,348,000) and October 29, 2005 ($3,486,000), under the credit facility as a long-term liability.
At January 26, 2007, there was approximately $3,734,000 in outstanding borrowings under the credit facility, with approximately $1,736,000 available to borrow under this credit facility.
As fully described in Note 2 to the financial statements, the Company entered into a Securities Purchase Agreement with several institutional and other accredited investors. On November 10, 2006, the Company completed the Private Placement and the Company received $4,000,000 ($3,430,000 net of closing costs) from the sale of a new 8% Series B Convertible Preferred Stock. The proceeds will be used by the Company primarily for general corporate and working capital purposes, to fund its increased advertising efforts, to replace its website and to refurbish existing stores. These funds will also be used to help develop new retail technology centers within our stores emphasizing and reinforcing the changing services and products that the Company offers.
The Company's newest 4,500 square foot Harvey retail showroom in Bridgewater, New Jersey opened in late June 2005. In fiscal 2005, the Company financed all necessary leaseholds, equipment, furniture, fixtures and inventory, aggregating $1,560,000, with its credit facility.
The Company replaced its existing computer system in November 2006. The project cost is estimated at $650,000 - $700,000. At October 28, 2006, the remaining costs to complete the project are estimated at $50,000 - $75,000. These costs will be financed using the Company's credit facility in fiscal 2007.
The Company intends to launch its new advertising campaign in the second quarter of fiscal 2007, primarily with print, radio, direct mail, keyword searches and e-mail broadcasts. Advertising expenditures are expected to significantly increase by almost 50% for fiscal 2007 using funds available from the Private Placement.
The Company's website gives its customers access to one of Harvey's upscale retail showrooms or offers its customers a private, in-home consultation through the convenience of the Internet. The Company is expected to improve or replace its website in fiscal 2007 at an estimated cost of between $80,000 - $100,000 using funds available from the Private Placement.
In fiscal 2004, the Company amended and extended the lease for its flagship store in Midtown Manhattan. This amendment increased the Company's occupancy costs in fiscal 2005 and significantly increased these costs in fiscal 2006. The annual increase in rent expense for this store beginning in fiscal 2006, calculated on a straight-line basis, approximated $200,000.
In July 2003, the Company received a notice and information request from the Pennsylvania Department of Environmental Protection ("PADEP"). See Part I, Legal Proceedings, for details on this matter.
The Securities and Exchange Commission has extended the compliance dates for non-accelerated filers, pursuant to 404 of the Sarbanes-Oxley Act of 2002. The Company will further evaluate its implementation plan in fiscal 2007 to meet its compliance requirements for the fiscal year ending 2008. In connection with this significant effort, Management believes that normal and customary expenses related to implementation of the required current provisions of the Act may be in the range of $250,000 - $350,000 for fiscal 2008.
As fully disclosed in Note 9 to the financial statements, The Company's shareholders, at the annual meeting, approved a reverse stock split of its common stock at an exchange ratio of 1 for 4. The reverse stock split was completed November 10, 2006 together with the Private Placement. For a period of ten (10) consecutive trading days following the closing, the Company's common stock remained above $1.00 per share, enabling the Company to regain compliance with the NASDAQ minimum bid price listing requirement.
On December 6, 2006, the Company announced that it was notified by the Panel that the Company had satisfied the conditions set forth by the Panel and regained compliance with the NASDAQ Market Place Rules. Accordingly, the Panel determined to continue the listing of the Company's securities on The NASDAQ Capital Market.
Management believes that cash on hand, cash available from the successful Private Placement, cash flow from operations and funds made available under the credit facility with Webster, will be sufficient to meet the Company's anticipated working capital needs for at least the next twelve-month period.
The following is a summary of the Company's significant contractual cash obligations for the periods indicated that existed as of October 28, 2006 and is based on information appearing in the Notes to the Financial Statements:
Interest costs are not included in the above table as interest amounts will vary, however using similar interest rates and outstanding borrowings consistent with fiscal 2006, interest would approximate $400,000 per year.
The Company has no off-balance sheet arrangements as of October 28, 2006.
Seasonality
The Company's business is subject to seasonal variations. Historically, the Company has realized a slight increase in its total revenue and a majority of its net income for the year during the first fiscal quarter. Due to the importance of the holiday shopping season, any factors negatively impacting the holiday selling season could have an adverse effect on the Company's revenues and its ability to generate a profit. The Company's quarterly results of operations may also fluctuate significantly due to a number of factors, including the timing of new store openings and acquisitions and unexpected changes in volume-related rebates or changes in cooperative advertising policies from manufacturers. In addition, operating results may be negatively affected by increases in merchandise costs, price changes in response to competitive factors and unfavorable local, regional or national economic developments that result in reduced consumer spending.
Impact of Inflation
Management does not believe that inflation has had a material adverse effect on our results of operations. However, we cannot predict accurately the effect of inflation on future operating results.
Critical Accounting Estimates
The discussion and analysis of the Company's financial condition and results of operations are based upon its financial statements which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities and related disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts for revenues and expenses during the reporting period. On an ongoing basis, Management evaluates estimates, including those related to income taxes, inventory allowances, contingencies and to a lesser extent, bad debts. The Company bases its estimates on historical data, when available, experience, and on various other assumptions that are believed to be reasonable under the circumstances, the combined results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.
Critical Accounting Policies
The accompanying financial statements were prepared in accordance with accounting principles generally accepted in the United States of America. Significant accounting policies are discussed in Footnote 1 to the Financial Statements, Item 8. Inherent in the application of many of these accounting policies is the need for management to make estimates and judgments in the determination of certain revenues, expenses, assets and liabilities. As such, materially different financial results can occur as circumstances change and additional information becomes known. The policies with the greatest potential effect on our results of operation and financial position include:
Revenue Recognition
Net sales include the sale of goods to customers and custom installation revenue. Retail sales are recorded at the time of sale to the customer. Custom installation revenue, which is comprised of both the sale of products and the labor in connection with the installation of the products, are recorded in accordance with the provisions of EITF 00-21, "Revenue Arrangements with Multiple Deliverables". The revenue related to the sale of the products is recognized when the product is delivered to the customers. The revenue related to the labor in connection with the installation of the products, is recorded when the service has been substantially completed. If the custom installation project requires a pre-wire phase, this phase will be considered a separate and distinct stage of work. The customer agrees to take title of wire and any in-wall speakers when delivered to the site as they have fair value. The customer agrees that amounts paid in advance for wire or in-wall speakers delivered to the site are non-refundable and as a result, these amounts are recognized as revenue when delivered. Labor on the pre-wire phase is recognized as revenue when the pre-wire installation is substantially completed. Revenues relating to these elements are recorded based on their fair values in the market.
In addition, the Company sells extended warranty contracts for a third party provider. The profit on extended warranty sales is considered commission at the time of sale. The net amount earned on these sales, which is not significant, is recorded in net sales, in accordance with EITF 99-19, "Reporting Revenue Gross as a Principal Versus Net as an Agent."
Inventory
Inventory is the Company's largest asset class, comprising over 54% of the Company's total assets. The Company's inventory consists of finished goods held for retail sale. Purchase-based volume rebates are credited to inventory or cost of products sold, as appropriate. The Company assesses the market value of its inventory on a regular basis by reviewing, on an item-by-item basis, the realizable value of its inventory; net of specific or general lower of cost or market reserves. If it is Management's judgment that the selling price of an item must be lowered below its cost in order for it to be sold, then the carrying value of the related inventory is written down to estimated realizable sales value. A number of factors would be taken into consideration in assessing realizable value including the quantity on hand, historical sales, technological advances, the existence of a replacement product, and consumer demand and preferences. Depending on market conditions, the actual amount received on sale could differ from management's estimate.
As a result, the Company reduced its net inventory value to reflect the estimated amount of inventory with lower of cost or market issues. The Company's inventory reserve at October 28, 2006 October 29, 2005 is $140,000 and $150,000, respectively.
Long-Lived Assets
Long-lived assets such as property, plant and equipment, goodwill, and reorganization value are reviewed for impairment when events or changes in circumstances indicate the carrying value of the assets may not be recoverable. The Company recognizes an impairment loss when estimated future undiscounted cash flows expected to result from the use of the asset and its value upon disposal are less than its carrying amount. If the Company's estimates regarding future undiscounted cash flows or useful lives were to change, we could be exposed to losses that are material in nature. In fiscal 2004, the Company provided a provision for the impairment of long-lived assets aggregating $144,000, relating to the relocation of its Bang & Olufsen branded store in Greenwich, Connecticut.
Cash Discounts and Promotional Allowances
The Company receives cash discounts for timely payment of merchandise invoices and recognizes these amounts in its statement of operations as a reduction of cost of sales.
The Company also receives substantial funds from its suppliers for promotional allowances. These funds are used for advertising purposes and the funds earned are recorded net of advertising expenditures, and are included in selling, general and administrative expenses on the Statements of Operations.
In the fourth quarter of fiscal 2006, the Company initiated a change in its advertising campaign which was modified to reflect current market conditions, customer needs and service demands. The new marketing strategy was designed to better promote the Harvey brand and its installation and home integration offerings.
Accordingly, certain promotional allowances received by vendors that were previously recorded as a reduction of advertising expense are now recorded as a reduction of inventory costs and costs of goods sold relating to the fourth quarter, if the expenditure no longer represents identifiable costs incurred by the Company to promote its products.
Accrued expenses
The Company is constantly required to make estimates of future payments that will be made which relate to the current accounting period. These estimates range from things such as accrued bonuses to estimates of pending litigation claims and income taxes. In establishing appropriate accruals, Management must make judgments regarding the amount of the disbursement that will ultimately be incurred. In making such assessments, Management uses historical experience as well as any other special circumstances surrounding a particular item. The actual amount paid could differ from Management's estimate.
Recent Accounting Pronouncements
In July 2006, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes -- an interpretation of FASB Statement No. 109" ("FIN 48"). FIN 48 clarifies the accounting and reporting for uncertainties in income tax law. The interpretation prescribes a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of uncertain tax positions taken or expected to be taken in income tax returns. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company is currently assessing the impact, if any, of FIN 48 which it will adopt at the beginning of Fiscal 2008.
In June 2006, the FASB ratified Emerging Issues Task Force ("EITF") Issue No. 06-3, "How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (that is, Gross versus Net Presentation)", which allows companies to adopt a policy of presenting taxes in the income statement on either a gross or net basis. Taxes within the scope of this EITF would include taxes that are imposed on a revenue transaction between a seller and a customer. If such taxes are significant, the accounting policy should be disclosed as well as the amount of taxes included in the financial statements if presented on a gross basis. EITF 06-3 is effective for interim and annual reporting periods beginning after December 15, 2006. The Company is currently assessing the impact, if any, of EITF Issue No. 06-03 which it will adopt at the beginning of Fiscal 2008.
Item 7a.
Item 7a. Quantitative and Qualitative Disclosures About Market Risk
The Company's primary market risk exposure with regard to financial instruments are the changes in interest rates. The revolving credit facility between the Company and Webster Bank bears interest at either the bank's prime rate plus ..25% or LIBOR plus 2.75%, at the Company's option. Historically, the Company has not used derivative financial instruments to manage exposure to interest rate changes. The Company estimates that a hypothetical 10% adverse change in interest rates would not materially affect the consolidated operating results of the Company.
Item 8.
Item 8. Financial Statements and Supplementary Data
The information required by this item is incorporated by reference to the Company's financial statements set forth on page.
Item 9.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.
None
Item 9A.
Item 9A. Disclosure Controls and Procedures
Under the supervision and with the participation of the Company's Management, including the Interim Chief Executive Officer and the Chief Financial Officer, the Company carried out an evaluation of the effectiveness of the design and operation of the disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Based upon that evaluation, the Company's Interim Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective, as of the end of the period covered by this Report (October 28, 2006), in ensuring that material information relating to the Company required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, including ensuring that such material information is accumulated and communicated to the Company's Management, including the Company's Interim Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
As noted above, the Securities and Exchange Commission has extended the compliance dates for non-accelerated filers, pursuant to 404 of the Sarbanes-Oxley Act of 2002. The Company will further evaluate its implementation plan in fiscal 2007 to meet its compliance requirements of fiscal year 2008.
There were no changes in the Company's internal control over financial reporting (as required by the Exchange Act) that occurred during the Company's last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company's internal controls over financial reporting.
Item 9B.
Item 9B. Other Information
None
Part III
Item 10.
Item 10. Directors, Executive Officers, Promoters and Control Persons; Compliance With Section 16(a) of the Securities Exchange Act.
Following the end of the 2006 fiscal year and in connection with the closing of the Private Placement on November 10, 2006, certain of the Company's officers and directors resigned or were replaced. The biographies of the new officers and directors of the Company appear following the listing of the directors and executive officers of the Company in fiscal 2006 were as follows:
(1) As of October 28 2006.
(2) Effective October 26, 2006, Mr. Karp is no longer an officer or director of the Company.
(3) Effective November 10, 2006, Mr. Recca no longer serves as the Chairman but remains on the Company's Board.
Michael E. Recca became the Chairman of the Board of Directors of the Company in November 1996. Mr. Recca is also a member and the sole manager of Harvey Acquisition Company, LLC, which is a stockholder of the Company. Mr. Recca was an employee of Taglich Brothers, Inc., an NASD registered broker-dealer, through December 31, 1998. Beginning in January 2002 and continuing through April 2002, Mr. Recca was self-employed as a financial restructuring consultant, and, in this capacity, was also associated with NorthStar Capital, LLC, a joint venture with Ruskin Moscou Faltischek, P.C., the Company's corporate counsel. From April 2002 through November 2006, Mr. Recca was an officer and director of Sky Capital Holdings, LTD, and of several wholly owned subsidiaries of Sky Capital Holdings and the President of Sky Capital, LLC, a wholly owned subsidiary of Sky Capital Holdings, LTD and an NASD broker-dealer. Mr. Recca is also an officer and a director of Sky Capital Enterprises and of Sky Capital Ventures, (companies affiliated with Sky Capital Holdings, LTD) and several of their wholly or partially owned subsidiaries, including Global Secure Holdings, Ltd., and its wholly owned subsidiaries. Mr. Recca remains on the Board in fiscal 2007.
Franklin C. Karp began his career in the retail consumer electronics industry over 25 years ago, working as a salesman for what was then one of the most successful chain operations in the New York metropolitan area. He held various positions in sales management, purchasing and operations. In 1990, Mr. Karp joined Harvey as Merchandise Manager and later as Vice President in charge of merchandising. Mr. Karp was appointed President of Harvey in 1996 and Chief Executive Officer in 2004. Effective October 26, 2006, Mr. Karp is no longer an officer or director of the Company.
Joseph J. Calabrese, a certified public accountant, joined the Company as Controller in 1989. Since 1991, Mr. Calabrese has served as Vice President, Chief Financial Officer, Treasurer and Secretary of the Company. Mr. Calabrese was elected Executive Vice President and a Director of the Company in 1996. Mr. Calabrese began his career with Ernst & Young LLP in 1981 where for the eight-year period prior to his joining the Company he performed audit services with respect to the Company. Effective November 10, 2006, Mr. Calabrese is no longer a member of the Board.
Fredric J. Gruder served as a director from July 1998 until November 10, 2006. Since December 2001, Mr. Gruder has been a sole practitioner in his own law firm. From July 1999 to December 2001, Mr. Gruder was of counsel to Dorsey & Whitney LLP. From September 1996 to July 1999, he was a partner in the law firm of Gersten, Savage, Kaplowitz & Fredericks, LLP ("Gersten"), which represented Thornwater Company, L.P. ("Thornwater"), representative of the Company's underwriters in the Offering. From March 1996 through September 1996, Mr. Gruder was of counsel to Gersten, having been a sole practitioner from May 1995 through March 1996. From March 1992 until March 1996, Mr. Gruder served as vice president and general counsel to Sbarro, Inc., then a publicly traded corporation which owns, operates, and franchises Italian restaurants. Prior to this time, Mr. Gruder practiced law in New York for over twenty years, specializing in corporate securities and retail real estate. Effective November 10, 2006, Mr. Gruder is no longer a member of the Board.
William F. Kenny, III served as a director of the Company from 1975 November 10, 2006. From January 1992 to December 2000, Mr. Kenny was a consultant to Meenan Oil Co., Inc. Prior to 1992, Mr. Kenny was the President and Chief Executive Officer of Meenan Oil Co., Inc. Mr. Kenny has also served as a director of the Empire State Petroleum Association, Petroleum Research Foundation and was the President of the East Coast Energy Council. Mr. Kenny was also the President of the Independent Fuel Terminal Operators Association and the Metropolitan Energy Council. Effective November 10, 2006, Mr. Kenny is no longer a member of the Board.
Nicholas A. Marshall served as a director of the Company from May 2003 to November 10, 2006. Since 1998, Mr. Marshall has worked as a consultant and trustee of a family estate. From 1983 - 1997, Mr. Marshall served as a director of the Greater New York Savings Bank and from 1997-1998 he was an Advisory Board member of Astoria Federal Corporation. Mr. Marshall has over 37 years of experience in investment banking and has held senior executive positions in several asset management firms. Mr. Marshall has a BA degree from Yale University and an MBA from Harvard Business School. Effective November 10, 2006, Mr. Marshall is no longer a member of the Board.
Ira J. Lamel was appointed to the Company's Board of Directors and Audit Committee (Chairman) in November 2003. He has been the Executive Vice President, Chief Financial Officer and Treasurer of The Hain Celestial Group, Inc. since October 1, 2001. Mr. Lamel, a certified public accountant, was a partner at Ernst & Young LLP where he served in various capacities from June 1973 to September 2001. Ernst & Young LLP served as the Company's independent accountants until fiscal 2001. Mr. Lamel directed all of Ernst & Young's services to the Company, including the audits of our financial statements, from fiscal 1997 through fiscal 2000. Mr. Lamel is also a director of Excel Technology, Inc. (NASDAQ - XLTC). Mr. Lamel remains on the Board in fiscal 2007.
Michael A. Beck has been Vice President of Operations of the Company since April 1997. From June 1996 until such date he was the Company's Director of Operations and from October 1995 until April 1996 he served as Director of Operations for Sound City, a consumer electronics retailer. Mr. Beck was a store manager for the Company from August 1989 until October 1995. Mr. Beck holds a BA in Psychology from Merrimack College.
Roland W. Hiemer has been with the Company since 1990. He started with the Company as a salesman and advanced to Senior Sales Manager for the Paramus store in 1991. He was further promoted to Inventory Control Manager in 1991. In 1997, he was promoted to Director of Inventory Control and in 2001, Mr. Hiemer was promoted to Merchandise Manager. In January 2004, Mr. Hiemer was promoted to Vice President of Merchandising. Mr. Hiemer holds a BA in Business Administration from Hofstra University.
Committees of the Board of Directors
The Board of Directors, which met six times either in person or telephonically during fiscal 2006, has an Audit Committee and a Compensation and Stock Option Committee.
The Board generally relies on its network of industry and professional contacts in connection with identifying potential Board members. The Board will only consider nominees that have the requisite industry or financial experience to be able to advise and direct senior management in the Company's operations. At a minimum, each nominee: (i) must be prepared to represent the best interests of all of the Company's stockholders, (ii) must be an individual who has demonstrated integrity and ethics in his/her personal and professional field and has established a record of professional accomplishment in his/her chosen field; (iii) must not have (and his/her family members must not have) any material personal, financial or professional interest in any present or potential competitor of the Company; and (iv) must be prepared to participate fully in Board activities, including attendance at, and active participation in, meetings of the Board and not have other personal or professional commitments that would interfere or limit his or her ability to do so.
Compensation and Stock Option Committee. During fiscal 2006, Fredric J. Gruder, William F. Kenny, III, Nicholas A. Marshall and Ira J. Lamel served on the Compensation and Stock Option committee (the "Compensation Committee"). Each director who served on the Compensation Committee during fiscal 2006 qualified as an "independent director" as such term is defined in Marketplace Rule 4200(a)(15) of the National Association of Securities Dealers (the "NASD"). The function of the Compensation Committee is to make recommendations to the Board with respect to the compensation of management level employees and to administer plans and programs relating to stock options, pension and other retirement plans, employee benefits, incentives, and compensation. The Compensation Committee met one time in fiscal 2006.
Audit Committee. During fiscal 2006, William F. Kenny, III, Nicholas A. Marshall and Ira J. Lamel (Chairman) served on the Audit Committee. Each of the Audit Committee members in 2006 met the independence criteria prescribed by Rule 10A-3 promulgated under the Exchange Act and was an "independent director" as defined in NASD Rule 4200(a)(15). Each Audit Committee member met NASDAQ's financial knowledge requirements, and Ira J. Lamel, designated by the Board of Directors as the "Audit Committee financial expert" under the SEC rules, meets NASDAQ's professional experience requirements as well. The Audit Committee is governed by, and operates pursuant to, a written charter adopted by the Board of Directors. Such charter complies with the applicable provisions of the Sarbanes-Oxley Act of 2002 and related rules of the SEC and NASDAQ. As more fully described in the charter, the Audit Committee is responsible for overseeing the accounting and financial reporting processes and the audits of the financial statements of the Company. The Audit Committee met four times in fiscal 2006.
Affirmative Determinations Regarding Director Independence
The Board of Directors determined each of the following directors to be an "Independent Director" as such term is defined in the NASD Marketplace rule 4200(a)(15):
Fredric J. Gruder William F. Kenny, III Nicholas A. Marshall Ira J. Lamel
As provided by NASD Rule 4350(c)(2), the Independent Directors regularly schedule "Executive Sessions" whereby the Independent Directors hold meetings with only the Independent Directors present.
Code of Ethics
The Company adopted a code of ethics applicable to its Chief Executive Officer/President, Chief Financial Officer and Controller, which is a "code of ethics" as defined by applicable rules of the Securities and Exchange Commission. This code of ethics is publicly available on the Company's website. If the Company makes any amendments to this code of ethics other than technical, administrative, or other non-substantive amendments, or grants any waivers, including implicit waivers, from a provision of this code of ethics to the Company's Chief Executive Officer, Chief Financial Officer or Controller, the Company will disclose the nature of the amendment or waiver, its effective date and to whom it applies in a report on Form 8-K filed with the SEC. The Company also has a third party anonymous ethics and compliance hotline available to all employees and is reportable by phone or by website, www.reportit.net.
Directors' Compensation
In fiscal 2006, each of the Company's outside directors received a $1,000 monthly retainer.
No options to purchase the Company's Common Stock were granted to the outside directors in fiscal 2006.
Policy for Nomination of Directors
In fiscal 2006, the Company established a resolution outlining its policy on the nomination of directors, under the Standards of the NASDAQ Capital Market. Director nominees shall be recommended by a majority of the directors who are independent. The independent directors will only consider nominees that have requisite industry or financial experience.
Election of New Directors
Pursuant to the Private Placement, The Company amended and restated its bylaws, which, among other things, (i) provided for a staggered, or classified, Board of Directors, (ii) limits the removal of directors, and (iii) enable directors to consider multiple factors when making major decisions.
In fiscal 2006, the Company's Board of Directors was comprised of seven members who were not divided into classes. With the completion of the Private Placement, in fiscal 2007, the newly elected Board of Directors are divided into three classes, the term of each respective director will end at our annual meeting of stockholders in 2007, 2008 or 2009 depending on the class to which each such director belongs.
At the Annual Shareholders Meeting held October 27, 2006, the Shareholders elected the following persons as directors: D. Andrew Stackpole, Ron L. Jones, Robert E. Albus, Patrick E. Hobbs, Charles Berger, Scott Galloway, Ira J. Lamel, Michael E. Recca and Jonathan Stearns. Robert E. Albus, Ira J. Lamel and Michael E. Recca, shall serve as Class I Directors, Patrick E. Hobbs, Scott Galloway and Jonathan Stearns shall serve as Class II Directors and D. Andrew Stackpole, Ron L. Jones, and Charles Berger shall serve as Class III Directors. Messrs. Albus, Hobbs, Galloway, Lamel, Recca and Stearns will be independent directors.
Set forth below is biographical information for each new director.
Class I Directors: Continuing in Office Until the 2007 Annual Meeting
Robert E. Albus, 60, is currently President & CEO of Goodrich Capital, a financial Advisory Firm. Prior to this he was President of Premier Business Development, a Management Consulting Company, and since 1998 has been Managing Partner of ChemPro LLC, a technology development company he founded. Mr. Albus served as President and Chief Executive officer of Home-Link Services from 2002 to 2003. Prior to joining Home-Link Services, Mr. Albus was President of the Toiletry Division of Advanced Polymer Services, Inc., where he was employed from 1997 to 2000. Prior to that, Mr. Albus served as Director of Marketing of Combe, Inc, (U.S.); General Manager of Combe, Inc. (Canada); Vice President of Business Development of the W.B. Saunders Division of CBS; and a Product Director of Johnson & Johnson. Mr. Albus is a Director of Merisant Worldwide, Inc. a position he has held since May 2004. He received a BA from Lafayette College and an MBA from Lehigh University.
Ira J. Lamel, 59, continues to serve on the Board of Directors following the Private Placement. His biography appears above.
Michael E. Recca, 56, continues to serve on the Board of Directors following the Private Placement. His biography appears above.
Class II Directors: Continuing in Office Until the 2008 Annual Meeting
Patrick E. Hobbs, 46, has served as the Dean of the Law School at Seton Hall University since 1999, and from 1995 until 1999 he served as the Associate Dean for Finance. Mr. Hobbs joined the faculty of Seton Hall in 1990, and he continues to teach in the area of tax law, including Federal Income Taxation, Corporate Taxation, Business Planning, and Law and Literature. Mr. Hobbs is a Commissioner on the New Jersey State Commission of Investigation. He is a member of the Standards Review Committee of the American Bar Association, Section of Legal Education and Admissions to the Bar, and has twice chaired the Law School Development Committee. He serves as a member of the boards of the Newark Alliance, Lexis-Nexis, Newark Beth Israel Medical Center, the New Jersey Commission of Professionalism, and the New Jersey Institute for Continuing Legal Education. In 2004 he served as the Chairman of the Newark, New Jersey Mayor's Blue Ribbon Commission on the Downtown Core Redevelopment. Mr. Hobbs received a BS from Seton Hall University, a JD from the University of North Carolina at Chapel Hill, and an LL.M. from New York University.
Scott Galloway, 41, is a Clinical Associate Professor at the NYU Stern School of Business where he teaches brand strategy to 2nd year MBA students. In 1997, he co-founded Red Envelope (an Internet-based gift retailer) and served as Chairman until 2000 and on the firm's Board until 2004. He also co-founded Prophet Brand Strategy in 1992, an international consultancy that employs over 100 professionals, serving as CEO until 2000 and Chairman until 2002. Mr. Galloway was named one of the one hundred Global Leaders for Tomorrow in 1999 by the World Economic Forum in Davos, Switzerland. He received a BA from UCLA and an MBA from UC Berkeley.
Jonathan Stearns, 47, is the Managing Director of the Private Equity Group at AIG, since September 2006. Prior to this, he was a Managing Director since 2004, and was a founding member of Associated Partners, LLC, where he managed co-investment portfolios totaling $175 million for Abbott Capital, and rendered other advisory services and participated in the private equity fund investment program. Prior to 2004 he was a Managing Director of Abbott Capital Management, LLC, where since 2001 he was the head of a co-investment team responsible for direct investments in private companies. Mr. Stearns has also been a Managing Director and co-head of Equinox Investment Partners, LLC from 1996 to 2001, where he focused primarily on investing in private, middle-market companies. He previously spent several years in the private capital group of Kleinwort Benson Limited, ultimately as a Director with significant involvement in forming and raising capital for the $180 million KB Mezzanine Fund II, LP. Mr. Stearns received a BA from The University of the South in Sewanee, Tennessee and completed graduate studies in political economics, with an emphasis on Japan, at Cornell University.
Class III Directors: Continuing in Office Until the 2009 Annual Meeting
D. Andrew Stackpole, 42, is a founder and has been Managing Partner of Trinity Investment Partners LLC since 2002. From 1999 until 2001 he was a Managing Director in the Global Consumer Products group of Merrill Lynch. Prior to joining Merrill Lynch, Mr. Stackpole was a Managing Director in the Mergers & Acquisitions department of Bear Stearns, and prior to that an Executive Director at SBC Warburg where he held various positions including Co-Head of the U.S. Mergers and Acquisitions group. Mr. Stackpole has been a Term Member of the Council on Foreign Relations, where he was nominated an International Affairs Fellow. He is a Director of the Michael J. Berkeley Foundation, a charity focused on providing academic scholarships for minority college students, and is also a Director of TechFoundation, a nonprofit provider of technology resources to charitable organizations. Mr. Stackpole received a BA from Trinity College, an MPA from the Kennedy School of Government at Harvard University, and an MBA from the Wharton School of the University of Pennsylvania.
Ron L. Jones, 63, has been a Management Partner in Trinity Investment Partners LLC since 2003. Mr. Jones was President and CEO of Sealy, Inc. from 1996 to 1997 and Chairman, President and CEO of Sealy from 1997 to 2002 and continued to serve as Chairman until retiring in 2004. He was President of the Home Furnishings Group of Masco, Inc. from 1988 to 1996. Mr. Jones also served as President of The HON Company from 1983 to 1987 and was elected to the Board of HON Industries (now dba HNI Corporation) in 1996. Mr. Jones was named President of HON Industries in 1987 and served in that capacity until joining Masco in 1988. He also served as a Director of Vermeer Corporation from 2000 to 2002. He is currently a Director of AOT Bedding Holdings Corporation (National Bedding Company). Mr. Jones serves as a Trustee of the High Point Regional Health System, of High Point University, The Piedmont School, and of Southern Virginia University. Mr. Jones received a BS from Central Methodist College and has received an honorary doctorate degree from Southern Virginia University.
Charles M. Berger, 70, has been a Management Partner in Trinity Investment Partners LLC since 2003. Mr. Berger served as Chairman of the Board of The Scotts Company from 1996 through 2002. From 1996 to 2001, he was also Chief Executive Officer, and from 1996 until 2000, he was President. Prior that, during his 32-year career at H.J. Heinz Company, he held the positions of Chairman and Chief Executive Officer of Heinz India Pvt. Ltd. (Bombay); Chairman, President, and Chief Executive Officer of Weight Watchers International, a Heinz affiliate; Managing Director and Chief Executive Officer of Heinz-Italy (Milan), the largest Heinz profit center in Europe; General Manager, Marketing, for all Heinz U.S. grocery products; Marketing Director for Heinz U.K. (London); and Director of Corporate Planning at Heinz World Headquarters. Mr. Berger is a Director of the Colibri Corporation of Providence, Rhode Island, and of Salerno Plastics, Plattsburgh, New York. He is also on the Board of the Philharmonic Center for the Arts in Naples, Florida, the North Shore Hospital System in Manhasset, New York, and Chairman of the Naples Botanical Garden. Mr. Berger is also Executive in Residence at Ohio Wesleyan University. He graduated from Princeton University and received an MBA from Harvard Business School.
Vacancies on the New Board of Directors
In fiscal 2007, vacancies on the Board of Directors may be filled by a majority of the remaining independent directors. A director elected by the Board of Directors to fill a vacancy, including a vacancy created by an increase in the number of directors, shall serve for the remainder of the full term of the class of directors in which the vacancy occurred and until the director's successor is elected and qualified.
Independence of the New Board of Directors
As required under applicable NASDAQ Marketplace Rules, a majority of the members of a listed company's Board of Directors must qualify as "independent," as affirmatively determined by the board of directors. Our Board of Directors consults with our counsel to ensure that the Board of Directors' determinations are consistent with all relevant securities and other laws and regulations regarding the definition of "independent," including those set forth in pertinent NASDAQ Marketplace Rules, as in effect time to time.
Consistent with these considerations, after review of all relevant transactions or relationships between each director or any of his family members, and our senior management, our independent registered public accounting firm and us, the Board of Directors affirmatively has determined that all of the directors are independent directors within the meaning of the applicable NASDAQ Marketplace Rules, except for D. Andrew Stackpole, Ron L. Jones and Charles Berger.
Item 11.
Item 11. Executive Compensation.
The following table sets forth the cash compensation paid by the Company, as well as any other compensation paid to or earned by the Chairman of the Company, the Chief Executive Officer/President of the Company and those executive officers compensated at or greater than $100,000 for services rendered to the Company in all capacities during the three most recent fiscal years.
Summary Compensation Table
(1)--In September 2005, Mr. Recca's annual salary was reduced to $48,000. Mr. Recca no longer serves as Chairman. (2)--No longer serves as Chief Executive Officer & President.
Severance Agreements
In fiscal year 2000, the Company's Board of Directors approved and the Company entered into substantially similar Amended and Restated Severance Agreements (each an "Amended Severance Agreement") with each of Michael E. Recca, Franklin C. Karp, Joseph J. Calabrese, and Michael A. Beck, executives of the Company.
Each Amended Severance Agreement provides that in the event the executive is terminated for any reason other than for cause, as defined in the agreement, and in the event of a change in control (as defined), such as a merger, sale or disposition of assets, change in the constitution of the Board of Directors or the current Chairman, the assignment to the executive of a position inconsistent with the executive's current position or relocation of the corporate office (as defined), or in the event of a potential change in control (as defined), or disability (as defined), and within one hundred eighty (180) days from the day of one of the foregoing events the executive is terminated for reasons other than for cause or the executive terminates his employment for any reason, the respective executive shall receive, among other things:
i. a cash amount equal to the higher of: (x) the executive's base salary prior to termination or the event giving rise to the change in control, potential change in control or disability, or (y) the executive's base salary prior to the event giving rise to the executive's right to terminate his employment for any reason;
ii. a cash payment equal to the higher of: (x) twelve (12) months of the executive's highest monthly car allowance or monthly average travel reimbursement in effect within the six (6) month period immediately prior to termination or the change in control, potential change in control or disability, not to exceed twelve thousand and 00/100 ($12,000) dollars, or (y) twelve (12) months of the executives highest monthly car allowance or monthly average travel reimbursement in effect within the six (6) month period immediately prior to the date the executive terminates his employment for any reason, not to exceed twelve thousand and 00/100 ($12,000) dollars; and
iii. the maximum /highest benefits which the executive was receiving at any time during a two-year period prior to termination, relating to health insurance, accident insurance, long-term care, life insurance and disability, which shall continue for one (1) year beyond the date of termination of the executive's employment.
Roland W. Hiemer's severance agreement provides that in the event the Company is sold or merged with another company, involved in a corporate reorganization, among other things, and Mr. Hiemer is terminated or asked to accept a position other than that of a senior officer requiring similar responsibilities as a result of a reorganization or change in ownership or control, and he declines the new position, the Company or its successor in control will be obligated, and continue to pay him at the same salary and car allowance, if any, he had most recently been earning, plus benefits, for a period of six months.
The severance agreement for Mr. Hiemer also provides that in the event he is terminated for any other reasons, except conduct that is materially injurious to the Company or conviction of any crime involving moral turpitude, the Company will be obligated and continue to pay Mr. Hiemer at the same salary he has most recently been earning, for a period following termination of three months plus full coverage of the Company's benefits for the same period.
Effective October 26, 2006, the Company entered into a termination agreement with our then President and Chief Executive Officer whereby the executive agreed to resign from his employment and directorship. In consideration, the executive received $55,000 in November 2006 and additionally will receive $10,000 per month for twelve consecutive months, aggregating $175,000. The executive will also continue his medical coverage under COBRA for the one year period, where the Company will continue to pay its portion of the premiums for this twelve month period. This agreement supersedes the executive's severance agreement.
As previously authorized by the Company's Compensation Committee for services up to the end of fiscal 2006, and upon the shareholders' approval of the Private Placement on October 27, 2006, the Company's Chairman entered into a termination settlement agreement with the Company. In connection with this agreement, the Chairman received $100,000, resigned his position as Chairman and will continue his medical coverage under COBRA for a one year period (with the Company paying its portion of the insurance premiums). This agreement supersedes the Chairman's severance agreement.
In connection with the Private Placement, the Company's Vice Presidents were required, as a condition to closing, to agree that neither the Private Placement nor any purported tender offer by Modern Technology Group, Inc. publicly announced prior to the closing shall constitute a change of control or Potential Change of Control as defined in their Amended Severance Agreements.
In addition, the Company's Vice Presidents are entitled to receive, and the Company has been accruing, quarterly special retention bonuses of $10,000 each, per quarter, for ten quarters commencing in May 2006 and continuing during such time for as long as such members of the management team continue their employment with the Company. These retention bonuses accrue monthly. For fiscal 2006, these retention bonuses aggregated $60,000 and are included in accrued expenses at October 28, 2006.
Compensation Committee Report on Executive Compensation
The Compensation Committee of the Board of Directors establishes the Company's general compensation policies as well as the compensation plans and specific compensation levels for executive officers. It also administers our employee stock option plan for executive officers.
In fiscal 2006, the Compensation Committee consisted of Fredric J. Gruder, William F. Kenny, III, Nicholas A. Marshall and Ira J. Lamel. Following the closing of the Private Placement, the Compensation Committee membership changed, and now includes Robert Albus, Scott Galloway and Jonathan Stearns.
The 2006 Compensation Committee believed that the compensation of the Company's executive officers should be influenced by performance. Base salary levels, and any salary increases are approved by the Compensation Committee. In fiscal 2006, 2005 and 2004, additional compensation in the form of cash bonuses were made in accordance with a quarterly and annual bonus plan, as approved by the Compensation Committee then in place. In fiscal 2002, stock options were also made in accordance with the quarterly and annual bonus plan, as approved by the Compensation Committee. The 2006 Compensation Committee believed that the executive officers salaries during these years did not exceed levels in the industry for similarly-sized businesses. Severance agreements exist for all executive officers.
In fiscal 2006, the Company's executive officers (excluding the Chairman) received a significantly reduced bonus plan, as approved by the Compensation Committee due to the recent performance of the Company. Under the plan, sixty percent (60%) of the annual bonus potential was based on financial performance and the achievement of the Company's quarterly budgets. The remaining forty percent (40%) was an annual bonus based on the achievement of specific Company goals.
As previously mentioned, stock option grants, prior to 2003, had been part of the bonus plan for executive officers. The Compensation Committee viewed these option grants as an important component of its long-term, performance-based compensation philosophy. Since the value of an option bears a direct relationship to our stock price, the Compensation Committee believed that options motivate executive officers to manage the Company in a manner that will also benefit stockholders. As such, options were granted, only if performance levels were achieved, at the current market price. One of the principal factors considered in granting options to an executive officer was the executive officer's ability to influence the Company's long-term growth and profitability. No options were granted in fiscal 2006.
With respect to the base salary granted to Mr. Karp, our Chief Executive Officer/President in fiscal 2006, the Compensation Committee made an assessment of the Company's actual operating results for fiscal 2005, as compared to the Company's goals and from the performance of Mr. Karp on various accomplishments for fiscal 2005. The Compensation Committee also considered Mr. Karp's relative position as compared to his peers in the industry. Based on these factors, Mr. Karp's salary was retained at $170,000 for fiscal 2006. Mr. Karp took a voluntary reduction in salary and reduced this amount to $165,000.
In fiscal 2006, no options were granted to the Company's executive officers.
The 2007 Compensation Committee played no role in determining compensation for the Company's officers and directors in fiscal 2006.
Robert Albus Scott Galloway Jonathan Stearns
Stackpole Employment Agreement
Pursuant to the Private Placement, D. Andrew Stackpole, the founder of Trinity, became Chairman of the Board pursuant to the terms of the Employment Agreement. Mr. Stackpole will receive base salary at an annual rate of $150,000 payable on the Termination Date (as defined in the Employment Agreement) in vested warrants to purchase common stock of the Company, and a quarterly bonus of $50,000, also payable in the month immediately following such quarter. For purposes of Mr. Stackpole's base salary and bonus calculations, common stock of the Company will be deemed to have a value equal to the average VWAP (as defined) over the period with respect to which the payment is being made. Warrants will be issued with a strike price of 50% of the average VWAP over such period and shall be deemed to have a value for purposes of this calculation equal to 50% of the average VWAP over such period and shall be exercisable no later than March 15 of the calendar year following the calendar year in which they are issued. Notwithstanding anything to the contrary set forth in the Employment Agreement, in no event shall warrants issued thereunder be exercisable for more than 1,000,000 shares of common stock, except upon a termination of Mr. Stackpole's employment without Cause, in which event the number of shares issued will not exceed 3,000,000.
Mr. Stackpole is entitled to receive employee benefits (including fringe benefits, vacation, pension and profit sharing plan participation and life, health, accident and disability insurance) on the same basis as those benefits are generally made available to senior executives of the Company, and will be reimbursed for reasonable travel, entertainment and other business expenses incurred by him in the performance of his duties, all in accordance with Company policies. In the event Mr. Stackpole is terminated due to his death or disability, he shall continue to receive payments of base salary, bonus and other benefits specified in the Employment Agreement for a period of twelve (12) months. In the event Mr. Stackpole is terminated without Cause, he shall receive in a single lump sum as soon as practicable but not later than 30 days following such termination equal to (1) in the case of termination other than a Change in Control or Potential Change in Control, the equivalent of one year of base salary and bonus and (2) in the case of termination as a result of a Change in Control or Potential Change in Control, three (3) times annual base salary and bonus, payable in each case in cash or common stock of the Company, at the option of Mr. Stackpole.
Stock Option Plan
In April 1997, the Company adopted a stock option plan, which currently covers 1,000,000 (250,000 retroactively adjusted for the 1 for 4 reverse stock split) shares of the Common Stock. At October 28, 2006, options currently outstanding aggregate 205,525 and options available for grant aggregate 44,475. Options may be designated as either (i) incentive stock options ("ISOs") under the Internal Revenue Code of 1986, as amended (the "Code") or (ii) non-qualified stock options. ISOs may be granted under the Stock Option Plan to employees and officers of the Company. Non-qualified options may be granted to consultants, directors (whether or not they are employees), employees or officers of the Company (collectively "Options"). In certain circumstances, the exercise of Options may have an adverse effect on the market price of the Common Stock. The Stock Option Plan was approved by the Company's shareholders in fiscal 1998.
The Stock Option Plan is intended to encourage stock ownership by employees of the Company, so that they may acquire or increase their proprietary interest in the Company and to encourage such employees and directors to remain in the employ of the Company and to put forth maximum efforts for the success of the business. Options granted under the Stock Option Plan may be accompanied by either stock appreciation rights ("SARS") or limited stock appreciation rights (the "Limited SARS"), or both.
The Plan is administered by the Compensation Committee as the Board may establish or designate.
The Compensation and Stock Option Committee, within the limitation of the Stock Option Plan, shall have the authority to determine the types of options to be granted, whether an Option shall be accompanied by SARS or Limited SARS, the purchase price of the shares of Common Stock covered by each Option (the "Option Price"), the persons to whom, and the time or times at which, Options shall be granted, the number of shares to be covered by each Option and the terms and provisions of the option agreements. The maximum aggregate number of shares of Common Stock as to which Options, Rights and Limited Rights may be granted under the Stock Option Plan to any one optionee during any fiscal year of the Company is 100,000 (25,000 post reverse stock split), as approved and amended by the shareholders in fiscal 2000.
With respect to the ISOs, in the event that the aggregate fair market value, determined as of the date the ISO is granted, of the shares of Common Stock with respect to which Options granted and all other option plans of the Company, if any, become exercisable for the first time by any optionee during any calendar year exceeds $100,000, Options granted in excess of such limit shall constitute non-qualified stock options for all purposes. Where the optionee of an ISO is a ten (10%) percent shareholder, the Option Price will not be less than 110% of the fair market value of the Company's Common Stock, determined on the date of grant, and the exercise period will not exceed five (5) years from the date of grant of such ISO. Otherwise, the Option Price will not be less than one hundred (100%) percent of the fair market value of the shares of the Common Stock on the date of grant, and the exercise period will not exceed ten (10) years from the date of grant. Options granted under the Plan shall not be transferable other than by will or by the laws of descent and distribution, and Options may be exercised, during the lifetime of the optionee, only by the optionee or by his guardian or legal representative.
In fiscal 2006, no stock options were granted to the Company's executives or directors.
No stock options were exercised by executives or directors in fiscal 2006.
It is expected that in connection with the closing of the Private Placement, directors' options which are currently issued and outstanding will not terminate after 180 days of leaving the Company's Board of Directors, as prescribed, but rather will be modified to retain the original term of the option grant. Additional compensation expense may be incurred based on this modification, but Management does not believe that this modification will have a material impact on the Company's financial statements. It is also expected that, following the closing of the Private Placement, options will be granted to newly elected outside directors commensurate with standard practices.
Exercise prices for options outstanding as of October 28, 2006 are as follows:
Weighted- Number of Average Options Options Remaining Range of Outstanding at Exercisable at Contractual Life Exercise Price Year End End of Year In Years - -------------------- ------------------- ------------------ ------------------ $3.25 18,750 18,750 5 $3.75 22,500 22,500 5 $4.00 13,156 13,156 2 $4.60 22,500 22,500 6 $5.06 6,250 6,250 1 $5.40 22,500 22,500 6 $5.50 7,500 7,500 5 $6.00 43,125 43,125 3 $7.00 22,500 22,500 4 $7.44 11,250 11,250 4 $8.00 744 744 1 $12.00 14,750 14,750 1 ----------------- ------------------ 205,525 205,525 4.02 ================= ==================
PERFORMANCE GRAPH
The following graph shows a five year comparison of the cumulative total return to shareholders for the Company, the Russell 2000 Index and a peer group of substantially larger electronics companies. The graph assumes that the value of investment in the Company's Common Stock and in each index was $100 on October 27, 2001, including the reinvestment of dividends, if any. The company's fiscal year is either a 52 or 53-week year with the fiscal year ending on the Saturday closest to October 31. All fiscal years presented in the performance graph include 52 weeks, except fiscal 2003, which includes 53 weeks.
[GRAPHIC OMITTED]
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The following table sets forth certain information with respect to the beneficial ownership of shares of Common Stock as of October 28, 2006, based on information obtained from the persons named below, by (i) each person known to the Company to beneficially own more than 5% of the outstanding shares of Common Stock, (ii) each executive officer and director of the Company, and (iii) all officers and directors of the Company as a group:
(1) Includes 10,983 shares of the Company's Common Stock owned by Harvey Acquisition Company LLC ("HAC"), of which Mr. Recca is a member and the sole manager, plus options to purchase up to 40,000 shares of the Company's Common Stock which are exercisable at prices of between $3.575-7.70 per share.
(2) Includes options to purchase up to 10,000 shares of the Company's Common Stock, which are exercisable at prices of between $3.25-5.50 per share.
(3) Mr. Karp resigned October 26, 2006. As a result, his options to purchase up to 53,125 shares of the Company's Common Stock, which are exercisable at an exercise price of between $3.25-12.00 per share were not included.
(4) Includes options to purchase up to 47,500 shares of the Company's Common Stock, which are exercisable at an exercise price of between $3.25-12.00 per share.
(5) Includes options to purchase up to 26,250 shares of the Company's Common Stock, which are exercisable at an exercise price of between $3.25-12.00 per share.
(6) Includes options and warrants to purchase up to 245,625 shares of Common Stock, which are exercisable at an exercise price of between $3.25-15.00 per share.
(7) Information relating to the McGlenns is based solely upon a review of Form 4s and the Schedule 13G filed by the McGlenns with the SEC covering the period through October 28, 2006.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 requires the Company's officers and directors, and persons who own more than ten percent of the Company's common stock, to file reports of ownership and changes in ownership on Forms 3, 4 and 5 with the Securities and Exchange Commission and NASDAQ. In addition, officers, directors and greater than ten percent shareholders are required by Securities and Exchange Commission regulations to furnish the Company with copies of all Section 16(a) forms they file.
To the Company's knowledge, based solely on its review of the copies of such forms received by it, and written representations from certain reporting persons that no Forms 5 were required for those persons, the Company believes that during the fiscal year ended October 28, 2006, except Richard and Frances McGlenn. All Section 16(a) filing requirements applicable to its officers, directors and greater than ten percent beneficial owners were fully satisfied.
Item 13.
Item 13. Certain Relationships and Related Transactions.
From January 2001 to April 2002, Mr. Recca also served as a principal of NorthStar Capital, LLC which was a joint venture between certain of the partners of Ruskin Moscou Faltischek, P.C. ("Ruskin"), the Company's corporate counsel, and Mr. Recca. From April 2002 through November 2006, Mr. Recca has been a director of Sky Capital Holdings, LTD, and of several wholly owned subsidiaries of Sky Capital Holdings, and the President of Sky Capital, LLC, a wholly owned subsidiary of Sky Capital Holdings, LTD and a NASD broker-dealer. Mr. Recca was also a director of Sky Venture Capital and Sky Capital Ventures and several of their wholly or partially owned subsidiaries during this period.
Dividends paid to preferred stockholders aggregated $51,000, $53,000 and $70,000 for fiscal years 2006, 2005 and 2004, respectively.
Item 14.
Item 14. Principal Accountant's Fees and Services
The following represents amounts billed and amounts expected to be billed to the Company for the professional services of BDO Seidman, LLP rendered during fiscal years 2006 and 2005.
2006 2005 ---- ----
Audit Fees $106,000 $101,000
Audit - Related Fees 58,000(1),(2) 23,500(1)
Tax Fees - -
All Other Fees - - ------------ ---------- Total $164,000 $124,500 ============ ==========
(1) For fiscal 2006 and 2005, amounts related to consultations on accounting and SEC matters.
(2) For fiscal 2006, fees relate to consultation and review of the proxy statement for the Private Placement.
All fees for the years presented were approved by the Company's Audit Committee.
Item 15.
Item 15. Exhibits and Financial Statement Schedule
(a)--List of Financial Statements and Financial Statement Schedule and Exhibits:
(1) List of Financial Statements:
Balance Sheets - October 28, 2006 and October 29, 2005
Statements of Operations - Fiscal years ended October 28, 2006, October 29, 2005 and October 30, 2004
Statements of Shareholders' Equity - Fiscal years ended October 28, 2006, October 29, 2005 and October 30, 2004
Statements of Cash Flows - Fiscal years ended October 28, 2006, October 29, 2005, and October 30, 2004
Notes to Financial Statements
(2) List of Financial Statements Schedule:
Schedule II - Valuation and Qualifying Accounts
All other schedules for which provision is made in the applicable accounting regulation of the Securities Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted.
(3) The following exhibits are hereby incorporated by reference from the corresponding exhibits filed under the Company's Form SB-2 under Commission File #333--42121:
Exhibit Number Description
3.1.1--Restated Certificate of Incorporation of 1967
3.1.2--Certificate of Amendment of the Certificate of Incorporation of 1997
3.1.3--Certificate of Amendment of the Certificate of Incorporation of December
3.1.4--Certificate of Amendment of Certificate of Incorporation of July 1988
3.1.5--Certificate of Amendment of Certificate of Incorporation of July 1971
3.1.6--Certificate of Amendment of Certificate of Incorporation of February 1971
3.1.7--Certificate of Amendment of Certificate of Incorporation of June 1969
3.1.8--Certificate of Amendment of Certificate of Incorporation of September
4.1--Sections in Certificate of Incorporation and the Amended and Restated By-Laws of Harvey Electronics, Inc., that define the rights of the holders of shares of Common Stock, Preferred Stock and holders of Warrants (included in Exhibit Nos. 3.1.2 and 3.1.3)
4.2--Form of Common Stock Certificate
4.3--Form of Redeemable Common Stock Purchase Warrant
4.4--Form of Representative's Warrant
4.5--Form of Warrant to Holders of Preferred Stock
10.1.1--Stock Option Plan of Harvey Electronics, Inc.
10.1.2--Form of Stock Option Agreement
10.2.1--Severance Agreement with Franklin C. Karp
10.2.2--Severance Agreement with Joseph J. Calabrese
10.2.3--Severance Agreement with Michael A. Beck
10.2.4--Severance Agreement with Roland W. Hiemer
10.4.1--Dealer Agreement between the Company and Mitsubishi Electronics America, Inc.
10.4.2--Dealer Agreement between the Company and Niles Audio Corporation, Inc.
10.5.1--Lease between the Company and Joseph P. Day Realty Corp. (2)
10.5.2--Lease between the Company and Goodrich Fairfield Associates, L.L.C. (2)
10.5.3--Lease between the Company and Sprout Development Co. (2)
10.5.4--Lease between the Company and Service Realty Company (2)
10.5.5--Lease between the Company and 205 Associates (2)
10.5.6--Sublease between the Company and Fabian Formals, Inc. and Affiliate First Nighter of Canada (2)
10.6--Loan and Security Agreement, Master Note and Trademark Security Agreement with Paragon Capital L.L.C.
(ii) The following exhibits are hereby incorporated by reference from Exhibit A filed as part of the registrant's Form 8-K dated November 3, 1997:
2.1.1--Restated Modified Amended Joint and Substantially Consolidated Plan of Reorganization of Harvey Electronics, Inc.
2.1.2--Order dated November 13, 1996 Confirming Plan of Reorganization
(iii) The following exhibits are hereby incorporated by reference from Item 7 filed as part of the registrant's Form 8-K dated April 7, 1998:
4.4--Representative's Warrant Agreement
4.5--Warrant Agent Agreement
10.1--Underwriting Agreement
10.2--Financial Advisory and Investment Banking Agreement between the Company and The Thornwater Company, L.P.
(iv) The following exhibits are hereby incorporated by reference to the corresponding exhibits filed with the Company's Form 8-K dated October 12, 1998:
10.01--Bang & Olufsen America, Inc. Termination Letter dated September 7, 1998
10.02--Bang & Olufsen America, Inc. New Agreement Letter dated October 8, 1998
10.03--Agreement with Thornwater regarding termination of agreements and lock-up amendments dated October 31, 1998
(v) The following exhibits are hereto incorporated by reference to the Company's Form 10KSB dated October 31, 1998:
10.5.7--Lease Agreement with Martin Goldbaum and Sally Goldbaum
10.5.8--Lease Agreement with Bender Realty
10.7--Surrender of Lease with 873 Broadway Associates
10.8--Contract of Sale with Martin Goldbaum, Sally Goldbaum, the Sound Mill, Inc. and Loriel Custom Audio Video Corp.
10.9--License Agreement with ABC Home Furnishings, Inc.
(vii) The following exhibits are hereto incorporated by reference to the Company's Form 10KSB dated October 28, 2000:
10.2.5--Severance Agreement between the Company and Michael E. Recca
10.2.6--Amended and Restated Severance Agreement between the Company and Franklin C. Karp
10.2.7--Amended and Restated Severance Agreement between the Company and Joseph J. Calabrese
10.2.8--Amended and Restated Severance Agreement between the Company and Michael A. Beck
10.5.9--Sublease Agreement between the Company and Bang & Olufsen America, Inc.
10.6--Lease Agreement between the Company and WSG Eatontown LP
10.6.1--Lease Modification Agreement between the Company and WSG Eatontown LP
10.6.2--Renewal of License Agreement with ABC Home Furnishings, Inc.
10.10--Repurchase Agreement between the Company, Bang & Olufsen America, Inc. and Paragon Capital, L.L.C.
10.11--Addendum to Repurchase Agreement between the Company, Bang & Olufsen America, Inc. and Paragon Capital, L.L.C.
10.12--Second Amendment to Loan and Security Agreement with Paragon Capital, L.L.C.
10.13--Third Amendment to Loan and Security Agreement with Paragon Capital, L.L.C.
10.14--Consulting Agreement with Mesa Partners Inc.
10.15--Addendum to Consulting Agreement with Mesa Partners, Inc.
10.16--Warrant to purchase 15,000 shares of the Company's Common Stock, issued to Mesa Partners, Inc.
10.17--Investor relations agreement with Porter, LeVay & Rose
(viii)--The following exhibits are hereto incorporated by reference to the Company's Form 10KSB dated October 27, 2001:
10.6.3--Modification of Lease between the Company and Service Realty Company
10.6.4--First Amendment of Lease between the Company and 205 Associates
(ix) --The following exhibits are hereto incorporated by reference to the Company's Form 10K dated October 26, 2002:
10.6.5--Lease Extension Agreement between the Company and Sprout Development Co.
10.6.6--Second Amendment of lease between the Company and 205 Chubb Avenue, LLC
(x) --The following exhibits are hereby incorporated by reference to the corresponding exhibits filed with the Company's Form 8-K dated November 25, 2003:
10.18--Loan and Security Agreement by and between Harvey Electronics, Inc. and Whitehall Retail Finance, (currently Webster Business Credit), a subsidiary of Webster Bank, dated November 21, 2003.
10.19--Trademark Security Agreement by and between Harvey Electronics, Inc. and Whitehall Retail Finance, (currently Webster Business Credit), a subsidiary of Webster Bank, dated November 21, 2003.
10.20--Repurchase Agreement by and among Bang & Olufsen America, Inc., Whitehall Retail Finance, (currently Webster Business Credit) a subsidiary of Webster Bank and Harvey Electronics, Inc., dated November 21, 2003.
(xi)--The following exhibits are hereby incorporated by reference to the corresponding exhibits filed with the Company's Form 10-K dated November 1, 2003:
10.6.7--Renewal of License Agreement with ABC Home Furnishings, Inc.
(xii)--The following exhibit is hereby incorporated by reference to the corresponding exhibit filed with the Company's Form 8-K dated May 6, 2004:
10.6.7--Lease Agreement between Harvey Electronics, Inc. and 724 R202 Associates, L.L.C. dated May 3, 2004.
(xiii)--The following exhibit is hereby incorporated by reference to the corresponding exhibit filed with the Company's Form 8-K dated May 19, 2004:
10.6.8--Lease Modification Agreement and Extension Agreement between Joseph P. Day Realty and Harvey Electronics, Inc. dated May 7, 2004.
(xiv)--The following exhibit is hereby incorporated by reference to the corresponding exhibit filed with the Company's form 10-K:
10.6.9 --Second Amendment of the Lease between Harvey Electronics, Inc. and Martin Goldbaum and Sally Goldbaum dated December 1, 2004.
(xv)--The following exhibit is hereby incorporated by reference to the Company's third quarter Form 10Q filed September 13, 2005.
10.21--First Amendment and Waiver Agreement between the Company and Webster Bank dated September 13, 2005.
(xvi)--The following exhibits are hereby incorporated by reference to the Company's Form 10-K dated October 29, 2005:
10.22 -- Second Amendment and Waiver Agreement dated January 20, 2006.
10.6.9 -- Third Amendment of Lease between the Company and 205 Chubb Avenue, LLC.
10.6.10--Lease Modification and Extension Agreement between the Company and Fairfield Property Associates, LLC dated September 21, 2005.
(xvii)--The following exhibits are hereby incorporated by reference to the Company's Form 8-K filed April 18, 2006.
99.1 Securities Purchase Agreement, dated April 17, 2006, by and between Harvey Electronics, Inc. and certain Purchasers listed therein
Exhibit A Amended and Restated Certificate of Incorporation Exhibit B Registration Rights Agreement Exhibit C Series A Common Stock Purchase Warrant Exhibit D Employment Agreement with D. Andrew Stackpole Exhibit E Consulting Agreement with Trinity Investment Partners, LLC Exhibit F Placement Agency Agreement with vFinance Investments, Inc.
99.2 Series B Common Stock Purchase Warrant, dated April 17, 2006 in favor of Trinity Investment Partners LLC
99.3 Series C Common Stock Purchase Warrant, dated April 17, 2006 in favor of Trinity Investment Partners LLC
99.4 Registration Rights Agreement, dated April 17, 2006, by and between Harvey Electronics, Inc. in favor of Trinity Investment Partners LLC and D. Andrew Stackpole
99.5 Consulting Agreement, dated April 17, 2006, by and between Harvey Electronics, Inc. and Trinity Investment Partners LLC
99.6 Placement Agency Agreement, dated April 17, 2006, by and between Harvey Electronics, Inc. and vFinance Investments, Inc.
(xviii)--The following exhibit is hereby incorporated by reference to the Company's Form DEF14A, filed on September 22, 2006
Appendix M--Amendment No. 1 to the Securities Purchase Agreement dated September 8, 2006.
(xixi)--The following exhibits are hereby incorporated by reference to the Company's third quarter Form 10-Q filed September 18, 2006.
10.23--Fourth Amendment to its loan agreement with Webster dated July 31, 2006.
10.24--Fifth Amendment to its loan agreement with Webster dated September 18, 2006.
(xx)--The following exhibit is hereby incorporated by reference to the Company's Form 8-K filed November 6, 2006:
99.1 Franklin Karp Termination Agreement.
(xxi)--The following exhibits are annexed hereto:
3.1.9--Amended and Restated Certificate of Incorporation of November 2006
4.1.1--Amended and Restated Bylaws (2006)
10.25--Amended and Restated Registration Rights Agreement
10.26--Sixth Amendment to its loan agreement with Webster dated November 9, 2006.
10.27--Severance Agreement with Michael E. Recca effective October 2006.
10.28--Employment Agreement with Martin McClanan, Interim CEO, dated December 19, 2006.
23.1--Consent of BDO Seidman, LLP
31.1--Certification - Chief Executive Officer
31.2--Certification - Chief Financial Officer
32.1--Certification - Chief Executive Officer
32.2--Certification - Chief Financial Officer
(b)--Reports on Form 8-K:
November 6, 2006: Letter agreement between the Company and Franklin C. Karp, President and Chief Executive Officer.
November 16, 2006: The Company announced consummation of the Private Placement and appointment of new Board members.
November 30, 2006: The Company announced the new members of the Audit and Compensation Committees.
December 6, 2006: The Company announced that it was notified by the NASDAQ that the Company had satisfied the conditions set forth by the Qualifications Listing Panel and regained compliance with the NASDAQ Market Place Rules. Accordingly, the Panel determined to continue the listing of the Company's securities on The NASDAQ Capital Market.
Signatures
In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Harvey Electronics, Inc. By: /s/ Martin W. McClanan ------------------------------ Martin W. McClanan Interim Chief Executive Officer Dated: January 26, 2007
In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dated indicated.
Item 8. Financial Statements and Supplementary Data
Harvey Electronics, Inc.
Index to Financial Statements and Supplemental Data
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders Harvey Electronics, Inc. Lyndhurst, New Jersey
We have audited the accompanying balance sheets of Harvey Electronics, Inc. as of October 28, 2006 and October 29, 2005, and the related statements of operations, shareholders' equity and cash flows for the years ended October 28, 2006, October 29, 2005 and October 30, 2004. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits include consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principals used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Harvey Electronics, Inc. as of October 28, 2006 and October 29, 2005, and the results of its operations and its cash flows for the years ended October 28, 2006, October 29, 2005 and October 30, 2004 in conformity with accounting principles generally accepted in the United States of America.
s/BDO Seidman, LLP BDO Seidman, LLP Melville, New York January 10, 2007
Harvey Electronics, Inc. Statements Of Operations
See accompanying summary of significant accounting policies and notes to financial statements.
Harvey Electronics, Inc. Balance Sheets
See accompanying summary of significant accounting policies and notes to financial statements.
See accompanying summary of significant accounting policies and notes to financial statements.
Harvey Electronics, Inc Statements of Cash Flows
See accompanying summary of significant accounting policies and notes to financial statements.
1. Description of Business and Summary of Significant Accounting Policies Description of Business
The Company is a specialty retailer and custom installer of high quality audio/video consumer electronics and home theater products in the Metropolitan New York area. Operations of the Company consist solely of this single segment. The Company's fiscal year ends the Saturday closest to October 31.
Net sales and operating results for the Company's first quarter of its fiscal year are positively affected by generally stronger demand for the Company's products during the holiday selling season.
Accounting Estimates
The preparation of the financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the financial statements and accompanying notes. Management bases its estimates on certain assumptions, which they believe are reasonable in the circumstances, and does not believe that any change in those assumptions would have a significant affect on the financial position or results of operations. Actual results could differ from those estimates.
Revenue Recognition
Net sales include the sale of goods to customers and custom installation revenue. Retail sales are recorded at the time of the sale to the customer. Custom installation revenue, which is comprised of both the sale of products and the labor in connection with the installation of the products, are recorded in accordance with the provisions of EITF 00-21, "Revenue Arrangements with Multiple Deliverables". The revenue related to the sale of the products is recognized when the product is delivered to the customers. The revenue related to the labor in connection with the installation of the products, is recorded when the service has been substantially completed. If the custom installation project requires a pre-wire phase, this phase will be considered a separate and distinct stage of work. The customer agrees to take title of wire and any in-wall speakers when delivered to the site as they have fair value. The customer agrees that these amounts paid in advance for wire or in-wall speakers delivered to the site are non-refundable and as a result, these amounts are recognized as revenue when delivered. Labor on the pre-wire phase is recognized as revenue when the pre-wire installation is substantially completed. Revenues relating to these elements are recorded based on their fair values in the market.
In addition, the Company sells extended warranty contracts for a third party provider. The profit on extended warranty sales is considered commission at the time of sale. The net amount earned on these sales, which is not significant, is recorded in net sales, in accordance with EITF 99-19, "Reporting Revenue Gross as a Principal Versus Net as an Agent."
Long-Lived Assets
Property and equipment are stated at cost. Depreciation and amortization are computed by the straight-line method over the estimated useful lives of the respective assets. Depreciable lives are as follows; leasehold improvement, 3-10 years, machinery and equipment, 3-7 years, furniture and fixtures, 5-7 years, signs, 3-7 years, trucks, 3-7 years and software, 3-5 years. Amortization of improvements to leased properties is based upon the remaining terms of the leases or the estimated useful lives of such improvements, whichever is shorter. The Company evaluates the periods of amortization continually in determining whether events and circumstances warrant revised estimates of useful lives. If estimates are changed, the unamortized cost will be allocated to the number of remaining periods in the revised lives.
When conditions indicate a need to evaluate recoverability, SFAS No. 144 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of" requires that the Company (1) recognize an impairment loss only if the carrying amount of a long-lived asset is not recoverable based on its undiscounted future cash flows and (2) measure an impairment loss as the difference between the carrying amount and fair value of the asset. In the fourth quarter of fiscal 2004, the Company recorded a provision for impairment of long-lived assets aggregating $144,000, relating to the planned relocation of a retail store, (See Note 10).
Store Opening Costs
Costs of a non-capital nature incurred prior to store openings are expensed as incurred. The Company capitalized interest and rent, aggregating $12,000 and $53,000, respectively, relating to the construction of the new Bridgewater, New Jersey retail store, in fiscal 2005. There were no store openings in fiscal 2006 and 2004.
Stock-Based Compensation
In fiscal 2005, the Company adopted the provisions of FAS No. 123(R), "Share-Based Payment" ("FAS 123(R)"). Under FAS123(R), share-based compensation cost is measured at the grant date, based on the estimated fair value of the award, and is recognized as expense over the requisite service period. The Company adopted the provisions of FAS123(R) using a modified prospective application. Under this method, compensation cost is recognized for all share-based payments granted, modified or settled after the date of adoption, as well as for any unvested awards that were granted prior to the date of adoption. Prior periods are not revised for comparative purposes. In prior years, the Company previously adopted only the pro forma disclosure provisions of SFAS 123.
There were no stock options issued or vested during the fiscal years 2006, 2005 and 2004 under the provisions of SFAS No. 123, as a result, there would be no impact on the Company's net income (loss) and earnings (loss) per share.
Inventories
Inventories, consisting of finished goods, are stated at the lower of cost (average-cost method, which approximates the first-in, first-out method) or market value.
Internet Website
The Company follows the provisions of EITF 00-2, "Accounting for Website Development Costs," which provides guidance on how an entity should account for website development costs. In accordance with EITF 00-2, costs incurred in the website application and infrastructure development stage relating to the acquisition or development of software or the development of graphics for internal use, should be accounted for under the provisions of Statement of Position ("SOP") 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use" and capitalized. In accordance with SOP 98-1, the Company capitalized approximately $ - 0 - and $5,000 for fiscal years 2006 and 2005, respectively, relating to the development of its website. These costs are being amortized on a straight-line basis over a period of one to three years.
Income Taxes
The Company follows the liability method in accounting for income taxes as described in SFAS No. 109, "Accounting for Income Taxes." Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Deferred income taxes reflect the net effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes (see Note 6).
Net (Loss) Income Per Share
Basic and diluted net (loss) earnings per share are calculated in accordance with SFAS No. 128, "Earnings Per Share" ("SFAS No. 128"). Basic net (loss) earnings per share excludes the dilutive effects of options and convertible preferred stock. Diluted net (loss) earnings per share includes only the dilutive effects of common stock equivalents such as stock options and convertible preferred stock.
The following table sets forth the computation of basic and diluted net (loss) earnings per share for the years presented pursuant to SFAS No. 128.
No Preferred Stock was outstanding at October 28, 2006. Common Stock equivalents were not included in the diluted earnings per share calculation for fiscal 2006, as they were anti-dilutive. Convertible preferred stock and common stock equivalents were not included in the diluted earnings per share calculation for the fiscal 2005, as they were anti-dilutive.
Options and warrants aggregating 209,250, 86,800 and 168,707 were excluded from the computation for fiscal years 2006, 2005 and 2004, respectively, as their effect would have been antidilutive.
Cash Equivalents
The Company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents.
Fair Value of Financial Instruments
The recorded amounts of the Company's cash and cash equivalents, accounts receivable and accounts payable approximate their fair values principally because of the short-term nature of these items. The carrying value of borrowings under the revolving line of credit facility approximate fair value, due to its variable market interest rates.
Concentration of Credit Risk
The Company's operations consist of the retail sale, service and custom installation of high quality audio, video and home theater equipment in the New York Metropolitan area. The Company performs credit evaluations of its customers' financial condition and payment history but does not require collateral. Generally, accounts receivable are due within 30 days and credit losses have historically been immaterial.
Components of Selling, General and Administrative Expenses and Cost of Goods Sold
Major components of selling general and administrative expenses include payroll related expenses, net advertising expense, occupancy costs, professional fees, truck expenses, warehouse costs, distribution costs, insurance expense, depreciation expense and credit card fees. Cost of goods sold includes inventory shrink, purchase discounts and certain promotional allowances from its vendors and freight costs. The Company's computation of cost of goods sold and gross profit may not be comparable to other reporting electronics retailers as other entities may include the costs relating to warehousing and distribution networks.
Net Advertising Expense
In accordance with EITF 02-16, "Accounting by a Customer for Certain Consideration Received from a Vendor" ("EITF 02-16") which addresses how and when to reflect consideration received from suppliers in the financial statements, the Company's advertising expense, net of cooperative advertising allowances, is charged to operations when the advertising takes place. Net advertising expense is included in selling, general and administrative expenses in the Company's Statements of Operations.
Manufacturer rebates received by the Company are recorded based on the quarterly estimated progress in earning such rebates. The Company's estimates, to record these rebates are based on historical information and current programs with such vendors.
In the fourth quarter of fiscal 2006, the Company initiated a change in its advertising campaign which was modified to reflect current market conditions, customer needs and service demands. The new marketing strategy was designed to better promote the Harvey brand and its installation and home integration offerings.
Accordingly, certain promotional allowances received by vendors that were previously recorded as a reduction of advertising expense are now recorded as a reduction of inventory costs and cost of goods sold, relating to the fourth quarter, if the expenditure no longer represents identifiable costs incurred by the Company to promote its products.
As a result, $360,000 of promotional allowances were reflected as an adjustment to inventory ($100,000) and a reduction of cost of goods sold ($260,000) in the fourth quarter of fiscal 2006 for promotional allowances related to the fourth quarter.
The following represents the gross amounts of advertising expenditures, cooperative advertising reimbursements and net advertising expense for the periods reported:
Reorganization Value and Fresh Start Reporting
The Company adopted Fresh Start Reporting in accordance with SOP 90-7, "Financial Reporting by Entities in Reorganization under the Bankruptcy Code," when it emerged from a Chapter 11 proceeding on December 26, 1996. At that time, Fresh Start Reporting resulted in changes to the balance sheet, including valuation of assets and liabilities at fair market value, elimination of the accumulated deficit and valuation of equity based on the reorganization value of the ongoing business.
The reorganization value of the Company was determined based on the consideration received from Harvey Acquisition Company LLC (HAC) to obtain its principal ownership in the Company. A carrying value of $318,000 was assigned to the Series A Preferred Stock. All of the Series A Preferred Stock have been converted to the Company's Common Stock as of October 28, 2006. Subsequent to the Reorganization Date, the Company issued an additional 51,565 shares of Common Stock to InterEquity Capital Partners, L.P., a pre-reorganization subordinated secured debtholder, as authorized by the Court, for an approved finder's fee. The excess of the reorganization value over the fair value of net assets and liabilities ($283,000 at October 28, 2006 and October 29, 2005, respectively) is reported as "Reorganization value in excess of amounts allocable to identifiable assets".
The Company follows the provisions of Financial Accounting Standards Board Statements of Financial Accounting Standards ("SFAS") SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. Under these standards, both goodwill and the Company's other intangible asset, reorganization value in excess of amounts allocable to identifiable assets which are deemed to have indefinite lives are subject to annual impairment tests in accordance with SFAS 142. Other intangible assets continue to be amortized over their estimated useful lives.
At October 28, 2006 and again in the second quarter of fiscal 2006 and 2005, the Company engaged a qualified independent firm, to perform a valuation of the Company and to prepare the necessary goodwill impairment analysis. After completion, this independent firm found no impairment of the Company's goodwill and other intangible asset, reorganization value in excess of amounts allocable to identifiable assets. Goodwill and this other intangible asset is tested annually to identify if impairment has occurred.
Recent Accounting Pronouncements
In July 2006, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes -- an interpretation of FASB Statement No. 109" ("FIN 48"). FIN 48 clarifies the accounting and reporting for uncertainties in income tax law. The interpretation prescribes a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of uncertain tax positions taken or expected to be taken in income tax returns. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company is currently assessing the impact, if any, of FIN 48 which it will adopt at the beginning of Fiscal 2008.
In June 2006, the FASB ratified Emerging Issues Task Force ("EITF") Issue No. 06-3, "How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (that is, Gross versus Net Presentation)", which allows companies to adopt a policy of presenting taxes in the income statement on either a gross or net basis. Taxes within the scope of this EITF would include taxes that are imposed on a revenue transaction between a seller and a customer. If such taxes are significant, the accounting policy should be disclosed as well as the amount of taxes included in the financial statements if presented on a gross basis. EITF 06-3 is effective for interim and annual reporting periods beginning after December 15, 2006. The Company is currently assessing the impact, if any, of EITF Issue No. 06-03 which it will adopt at the beginning of Fiscal 2008.
2. Private Placement and Change of Control
On April 17, 2006, the Company entered into a Securities Purchase Agreement (the "Purchase Agreement"), modified by an amendment dated September 8, 2006, with several institutional and other accredited investors (the "Investors") led by Trinity Investment Partners LLC ("Trinity"). On November 10, 2006, the Company completed this transaction. Pursuant to the Purchase Agreement, the Company received $4,000,000 ($3,430,000 net of closing costs) from the sale (the "Private Placement") of 8% Series B Convertible Preferred Stock (the "Series B Preferred Stock"). The proceeds from the Private Placement will be used by the Company primarily for general corporate and working capital purposes, to fund increased advertising expenditures, to replace the Company's website and to refurbish existing stores.
The Company's shareholders incurred substantial dilution of their percentage ownership in the Company upon the closing of the Private Placement. Based on the number of common shares outstanding at October 28, 2006, the aggregate ownership of all holders of the common stock immediately prior to the issuance of the securities pursuant to the Private Placement, on a fully diluted basis, would be reduced by approximately 82.4%. While this represents significant dilution, the Company received the funds necessary to substantially advance its business. If all warrants issued in connection with the Private Placement are exercised, the Company will receive approximately $13.4 million including the $4.0 million received at closing.
The Purchase Agreement and the related transactions were approved by the Company's shareholders, at the annual meeting of shareholders on October 27, 2006.
The Series B Preferred Stock is convertible at any time into 1,428,571 shares of the Company's common stock at $2.80 per share. The Investors also received Series A seven-year warrants to purchase an aggregate of 428,573 shares of the Company's common stock, exercisable at $5.60 per share. The dividend on the Series B Preferred Stock can be paid in cash or common stock at the option of the Company and must be approved by the Company's lender. The rights, preferences and privileges of the holders of the new Series B Stock are set forth in the required Amended and Restated Certificate of Incorporation.
In connection with the Private Placement, the Company also entered into a Consulting Agreement, as amended, with Trinity. Trinity received reimbursement of $350,000 in expenses at the closing, received a Series B seven-year warrant to purchase 500,000 shares of the Company's common stock exercisable at $2.80 per share, and a Series C seven-year warrant to purchase 875,000 shares of the Company's common stock exercisable between $3.20 and $6.80 per share in ten equal tranches, with the exercise price increasing by $0.10 in each tranche. Cash transaction expenses in connection with the proposed Private Placement approximate $743,000, including the $350,000 reimbursed to Trinity.
A Registration Rights Agreement was executed by the Company and the Investors. Pursuant to this agreement, the Company is obligated to register with the Securities and Exchange Commission ("SEC") the shares of common stock that are issuable upon exercise of the Series A Warrant and upon conversion of the Series B Preferred Stock. In accordance with the separate Registration Rights Agreement between the Company, Trinity, and D. Andrew Stackpole, the Company has agreed to register with the SEC the shares of common stock that are issuable upon exercise of the Series B and Series C Warrants and shares issued or issuable pursuant to the warrants relating to the Employment Agreement ("Employment Agreement") with D. Andrew Stackpole, provided that such shares will not be registered until at least six months following the effective date of the Registration Rights Agreement for the benefit of the Investors. In connection with all registerable securities, the Company will be required to pay a penalty (9%) for failure to timely file the Registration Rights Agreement or have it declared effective.
vFinance Investments, Inc. ("vFinance") acted as placement agent for the Private Placement. At the closing of the transaction, vFinance and its affiliate Harborview Capital Management, an institutional investor in the Private Placement, received 350 shares of Series B Preferred Stock and a Series A seven-year warrant to purchase 125,000 shares of the Company's common stock exercisable at $5.60 per share in lieu of a cash fee. In addition, vFinance received the sum of $50,000 in cash which shall be donated to a charity of its choice and also received reimbursement of its legal fees aggregating $50,000.
At the closing of the transaction, D. Andrew Stackpole, the founder of Trinity, became the Company's new Chairman pursuant to the terms of an Employment Agreement between the Company and Mr. Stackpole. The Employment Agreement was a condition for closing of the Purchase Agreement, and provides for the payment to Mr. Stackpole of salary and bonus of $350,000 at the end of the twelve month period following the closing of the transaction, which will be paid in warrants to purchase the Company's common stock. Trinity will receive no additional compensation for services of its employees or advisors made available to the Company.
As a result of the closing of the Private Placement, the Company's current Board of Directors was replaced by a new slate of nine Directors, six of which were appointed by Trinity. This new slate of Directors, as well as the restated bylaws to provide for a staggered board of directors and limitations on the removal of such directors were approved by the Company's shareholders at the annual meeting.
The Company's current management team has remained in their current positions following the transaction except the Chairman and President /Chief Executive Officer. In connection with this transaction only, the Company's management team waived certain change of control provisions contained in their severance agreements and, for doing so, are receiving special retention bonuses of $10,000 per quarter for the next ten consecutive quarters which began in May 2006.
The Company's certificate of incorporation was also amended and restated, as approved by the shareholders, to add the new class of Series B Preferred Stock and to increase the Company's authorized number of shares of common stock to accommodate the Private Placement.
Furthermore, at the closing of the Private Placement, the Company's utilization of its net operating loss carryforwards has been limited as a change of control has taken place pursuant to Internal Revenue Code Section 382.
Following the resignation of the President/Chief Executive Officer in October 2006, the Company appointed a new interim Chief Executive Officer.
3. Revolving Line of Credit Facility
In November 2003, the Company entered into a five-year $7.5 million credit facility with Webster Business Credit Corporation ("Webster"), a subsidiary of Connecticut based Webster Bank. Under the credit facility, the Company can borrow up to $7.5 million based upon lending formulas calculated on eligible credit card receivables and inventory, less certain reserves, as defined. The Webster credit facility expires November 21, 2008.
The interest rate on all borrowings under the credit facility is either 0.25% over Webster Bank's prime rate (8.50% at October 28, 2006) or LIBOR plus 2.75%, at the Company's option. Under the credit facility, the Company pays Webster a reduced maintenance fee of $1,000 per month and a monthly unused line fee, as defined in the credit facility.
In connection with the credit facility, the Company granted Webster a senior security interest in all of the Company's assets. The credit facility provides Webster with rights of acceleration upon the occurrence of certain customary events of default. The Company is restricted from paying dividends on its Common Stock, retiring or repurchasing its Common Stock and entering into additional indebtedness (as defined).
In September 2005, the Company entered into a First Amendment and Waiver Agreement with Webster which waived any covenant defaults existing at the end of the third quarter of fiscal 2005 and modified the EBITDA and capital expenditures covenants for the fourth quarter of fiscal 2005. On January 20, 2006, the Company entered into a Second Amendment with Webster which modified the EBITDA and capital expenditures covenants for the first quarter of fiscal 2006. In February 2006, the Company entered into a Third Amendment with Webster, which further modified the EBITDA covenant, effective at the beginning of the Company's second quarter. On July 31, 2006, the Company entered into a Fourth Amendment with Webster which waived certain EBITDA covenant defaults and additionally provided additional financing in the form of an over-advance, if needed, on the credit facility through September 30, 2006. On September 18, 2006, the Company entered into the Fifth Amendment and Waiver Agreement with Webster which (i) waived certain EBITDA covenant defaults, (ii) modified certain financial covenants for September and October 2006, (iii) outlined new covenants for November and December 2006, and (iv) in the event the Private Placement (as defined herein) is funded, requires that (A) a new operational and business plan be received from the Company within thirty days of funding, and (B) new covenants be set within sixty days of funding.
On November 9, 2006, the Company entered into the Sixth Amendment and Consent Agreement with Webster which (i) consented to the Private Placement and change in control, (ii) modified certain Availability Reserves and the Fixed Charge Ratio, as defined and, (iii) and modified the Financial Covenants including the Capital Expenditures and Excess Availability/Cash requirements, as defined. The Company was in compliance with all financial covenants at October 28, 2006.
As the credit facility expires in two years and does not include both a subjective acceleration clause and a lock box arrangement, in accordance with EITF 95-22, the Company classified the balance outstanding, at October 28, 2006 ($3,348,000) and October 29, 2005 ($3,486,000), under the credit facility as a long-term liability.
4. Stock-Based Compensation
Stock Option Plan
The Company's Board of Directors and shareholders approved the Harvey Electronics, Inc. Stock Option Plan ("Stock Option Plan") in fiscal 1998. The Stock Option Plan provides for the granting of up to 1,000,000 (250,000 shares retroactive for the 1 for 4 reverse stock split) shares of incentive and non-qualified Common Stock options and stock appreciation rights to directors, officers and employees. All options are exercisable at times as determined by the Board of Directors not to exceed ten years from the date of grant.
Common equivalent shares relating to stock options aggregating 9,602 were included in the weighted average number of common shares outstanding for the diluted earnings per share computation for the fiscal year 2004. Common equivalent shares were not included for fiscal 2006 and 2005 as they were antidilutive.
In fiscal 2006, 2005 and 2004, no stock options were granted.
The following table summarizes activity in stock options during fiscal 2006, 2005 and 2004:
At October 28, 2006, October 29, 2005 and October 30, 2004, all outstanding options are exercisable.
Exercise prices for options outstanding as of October 28, 2006 are as follows:
Weighted- Number of Average Options Options Remaining Range of Outstanding at Exercisable at Contractual Life Exercise Price Year End End of Year In Years - ------------------- ----------------- ----------------- ---------------- $3.25 18,750 18,750 5 $3.75 22,500 22,500 5 $4.00 13,156 13,156 2 $4.60 22,500 22,500 6 $5.06 6,250 6,250 1 $5.40 22,500 22,500 6 $5.50 7,500 7,500 5 $6.00 43,125 43,125 3 $7.00 22,500 22,500 4 $7.44 11,250 11,250 4 $8.00 744 744 1 $12.00 14,750 14,750 1 ----------------- ------------------ 205,525 205,525 4.02 ================= ==================
A summary of stock option transactions is as follows for the year ended October 28, 2006.
In fiscal 2005, the Company adopted the provisions of FAS No. 123(R), "Share-Based Payment" ("FAS 123(R)"). Under FAS123(R), share-based compensation cost is measured at the grant date, based on the estimated fair value of the award, and is recognized as expense over the requisite service period. The Company adopted the provisions of FAS123(R) using a modified prospective application. Under this method, compensation cost is recognized for all share-based payments granted, modified or settled after the date of adoption, as well as for any unvested awards that were granted prior to the date of adoption. Prior periods are not revised for comparative purposes. In prior years, the Company previously adopted only the pro forma disclosure provisions of SFAS 123.
The fair value of each future option award will be estimated on the date of grant using a Black-Scholes option valuation model. Expected volatility will be based on the historical volatility of the price of the Company's stock. The risk-free interest rate will be based on U.S. Treasury issues with a term equal to the expected life of the option. The Company will use historical data to estimate expected dividend yield, expected life and forfeiture rates.
The revised Statement required entities to disclose information about the nature of the share-based payment transactions and the effects of those transactions on the financial statements. This pronouncement was adopted in fiscal year 2005 and has had no impact on the Company's financial position or results of operations as no stock options were granted, and no previously issued stock options vested in fiscal 2005 or fiscal 2006.
At October 28, 2006 and October 29, 2005, the Company has reserved shares of Common Stock for issuance under Common Stock options, warrants and preferred stock of approximately 209,250 and 226,000, respectively.
5. 8.5% Cumulative Convertible Series A Preferred Stock
The Company's Series A Preferred Stock has no voting rights and is redeemable at the option of the Company's Board of Directors, in whole or in part, at face value plus any accrued dividends. The carrying value of the Series A Preferred Stock is $-0- and $275,682 at October 28, 2006 and October 29, 2005, respectively.
In the event of liquidation of the Company, the holders of outstanding Series A Preferred Stock shall receive preferential rights and shall be entitled to receive an aggregate liquidation preference plus any outstanding dividends, prior to any distributions to common shareholders. The holders of the Series A Preferred Stock shall receive a semiannual 8.5% cumulative dividend ($85 per share), payable on the last business day in June and December.
875 shares of the Series A Preferred Stock were originally issued in conjunction with the Company's reorganization, effective October 26, 1996. As specified in the Company's By-laws, the preferred stock has a conversion feature.
Prior to January 1, 2001, 50% of the preferred stock was convertible at a price of $6.00 per share and 50% of the preferred stock was convertible at $7.50 per share. Commencing January 1, 2001, each share of preferred stock became convertible into shares of common stock at a conversion price equal to the average of the closing bid price of one share of common stock over the 45 trading days preceding January 1, 2001, if traded on the NASDAQ Capital Market. This conversion price was set at $1.2333 on January 1, 2001.
Cumulative Series A Preferred Stock dividends payable of $11,000 and $17,000 are outstanding and classified as a current liability at October 28, 2006 and October 29, 2005, respectively. Dividends aggregating $44,000, $53,000 and $70,000 were recorded as a charge to accumulated deficit in fiscal years 2006, 2005 and 2004, respectively.
6. Income Taxes (Benefit)
Fresh Start Accounting requires the Company to report an income tax equivalent provision when there is book taxable income and a pre-reorganization net operating loss carryforward. This requirement applies despite the fact that the Company's pre-reorganization net operating loss carryforward would eliminate (or reduce) the related income tax payable. The current and future year benefit related to the carryforward is not reflected in net income, but instead is recorded as an adjustment to reorganization value in excess of amounts allocable to identifiable assets. During the year ended October 28, 2006, October 29, 2005 and October 30, 2004, the Company recorded an income tax equivalent provision of $ - 0 -, $ -0- and $135,000, respectively, and reduced Reorganization Value in Excess of Amounts Allowable to Identifiable Assets by the same amount. The income tax equivalent provisions did not materially affect the Company's tax liability.
In the fourth quarter of fiscal 2004, the Company reassessed the valuation allowance previously established against its net deferred tax assets. Based on the Company's earnings history and projected future taxable income, the Company determined that it is more likely than not that a portion of its deferred tax assets would be realized. Accordingly, the Company removed $1,518,000 of the valuation allowance from its deferred tax assets. In conjunction therewith, the Company also recognized an income tax benefit of approximately $977,000 and a reduction of reorganization value of approximately $373,000. At October 29, 2005, Management of the Company determined that the valuation allowance would be increased by $338,000 due to the current year loss and the revised projected future taxable income.
In the third quarter of fiscal 2006, the Company provided a full valuation allowance against previously recorded net deferred tax assets. In accordance with SFAS 109, "Accounting For Income Taxes", this valuation allowance was necessary because the Company experienced cumulative losses for its last two fiscal years, including the increased loss in fiscal 2006 and declining sales, which create a degree of uncertainty regarding the future realization of such net deferred tax assets. As a result, the Company recorded a deferred tax expense of $1,350,000 in the third quarter of 2006.
The provision for income taxes (benefits) for the years ended October 28, 2006, October 29, 2005 and October 30, 2004 consists of the following:
October 28, 2006 October 29, 2005 October 30, 2004 ---------------- ---------------- ---------------- Current: Federal $ - $ - $ 25,000 State - - 35,000 Equivalent tax expense - - 135,000 ----------------- ----------------- ----------------- - - 195,000 Deferred tax (benefit) 1,350,000 - (977,000) ----------------- ----------------- ----------------- $1,350,000 $ - ($782,000) ================= ================= =================
The effective income tax rate differed from the Federal statutory rate as follows:
The Company has deferred tax assets and deferred tax liabilities as presented in the table below. The net deferred tax assets are subject to a valuation allowance, which was approximately $2,872,000 and $812,000, at October 28, 2006 and October 29, 2005, respectively.
Deferred tax assets and liabilities as of October 28, 2006 and October 29, 2005 consisted of the following:
At October 28, 2006, the Company determined that the valuation allowance would be increased by $2,060,000 due to the current year operating losses and revised projected taxable income.
At October 28, 2006, the Company has available net operating loss carryforwards of approximately $4,700,000 which expire in various years through fiscal 2026. Due to a change in control of the ownership of the Company, the annual usage of these net operating loss carry- forwards will be subject to limitation. Under section 382 of the IRS code, it is estimated that these pre-reorganization net operating loss carryforwards and other pre-reorganization tax attributes will be limited to approximately $100,000 per year.
7. Pension and Profit Sharing Plan
The Company maintains the Harvey Electronics, Inc. Savings and Investment Plan (the "Plan") which includes profit sharing, defined contribution and 401(k) provisions and is available to all eligible employees of the Company. There were no employer contributions to the Plan for fiscal 2006, 2005 and 2004.
8. Commitments and Contingencies
Commitments
The Company leases stores and warehouse facilities under operating leases, which provide, in certain cases, for payment of additional rentals based on a percentage of sales over a fixed amount. Future minimum rental commitments, by year and in the aggregate, for non-cancelable operating leases with initial or remaining terms of one-year or more consisted of the following at October 28, 2006:
Operating Leases ---------------------
Fiscal 2007 $ 2,301,000 Fiscal 2008 2,265,000 Fiscal 2009 2,047,000 Fiscal 2010 1,637,000 Fiscal 2011 1,369,000 Thereafter 5,720,000 --------------------- Total minimum lease payments $ 15,339,000 =====================
Total rental expense for operating leases was approximately $3,363,000, $3,163,000 and $3,097,000 for fiscal years 2006, 2005 and 2004, respectively. Certain leases provide for the payment of insurance, maintenance charges, electric and taxes and contain renewal options.
Contingencies
The Company is a party in certain legal actions which arose in the normal course of business. The outcome of these legal actions, in the opinion of management, will not have a material effect on the Company's financial position, results of operations or liquidity.
In July 2003, the Company received a notice and information request from the Pennsylvania Department of Environmental Protection ("PADEP"). The notice stated that PADEP considers the Company a potentially responsible party for contamination related to a septic drain field located at a former Chem Fab Corporation ("Chem Fab") site in Doylestown, Pennsylvania.
PADEP's notice stated that if Chem Fab was previously owned by Harvey Radio, Inc. ("Harvey Radio") and if the Company was a successor to Harvey Radio, then the Company could be, in part, responsible for any environmental investigation or clean up actions necessary at this site.
Harvey Radio was the predecessor of The Harvey Group, Inc. ("Harvey Group"), which filed for relief under Chapter 11 of the United States Bankruptcy Code in August 1995. The Company is the surviving retail business of the Harvey Group, which emerged from bankruptcy in December 1996. Chem Fab was a wholly-owned subsidiary of Harvey Radio as of September 1967. The capital stock of Chem Fab (a then wholly-owned subsidiary of Harvey Group) was sold by the Company to the Boarhead Corporation in January 1978. The disposition of Chem Fab was prior in time to the Company's bankruptcy petition date of August 3, 1995.
On August 29, 2003, the Company sent its response letter to PADEP. The Company's response stated that any action by PADEP to recover any money from the Company relating to any environmental investigation or cleanup related to Chem Fab is in violation of the injunctions imposed by virtue of the Company's 1995 Bankruptcy proceeding. The response letter to PADEP specifically referred to two cases with respect to entities subject to a discharge in bankruptcy by the Southern District of New York and the Second Circuit Court of Appeals. These cases may support the Company's position enjoining any further action against the Company.
The Company believes PADEP's claim, even absent the bankruptcy injunction, would be improper against the Company, as Harvey Group was a shareholder of Chem Fab and Chem Fab's capital stock was sold in 1978, as previously stated.
The Company advised PADEP that any further action to pursue a claim against the Company would result in the Company bringing a motion to reopen its bankruptcy case, solely to address the PADEP claim and further, the Company would commence contempt proceedings against PADEP. To date, the Company has not received a response from PADEP.
The Company has also retained special environmental counsel for advice with respect to PADEP's request for information and other matters with respect to the claim.
Furthermore, the number of other parties that may be responsible, their ability to share in the cost of a clean up and whether the Company's existing or prior insurance policies provide coverage for this matter is not known. At this time, it is impossible for the Company to determine the outcome or cost to the Company relating to this matter.
9. Reverse Stock Split
The Company's shareholders, at the annual meeting, approved a reverse stock split of its common stock at an exchange ratio of 1 for 4. The reverse stock split was completed November 10, 2006 The reverse stock split was retroactively reflected in the financial statements.
10. Other Information
Fourth Quarter Adjustments
Effective October 26, 2006, the Company entered into a termination agreement with its President and Chief Executive Officer whereby the executive agreed to resign employment and his directorship. In consideration, the executive received $55,000 in November 2006 and additionally will receive $10,000 per month for twelve consecutive months, aggregating $175,000. The executive will also continue his medical coverage under COBRA for the one year period, where the Company will continue to pay its portion of the premiums for this twelve month period. This agreement replaced the executive's severance agreement.
As previously authorized by the Company's Compensation Committee for services up to the end of fiscal 2006, and upon the shareholders' approval of the Private Placement on October 27, 2006, the Company's former Chairman entered into a termination settlement agreement with the Company. In connection with this agreement, the Chairman received $100,000 and resigned. The Chairman will remain as a Board member in fiscal 2007. The Company's Chairman will also continue his medical coverage under COBRA for a one year period, where the Company will continue to pay its portion of the insurance premiums. This agreement replaced the Chairman's severance agreement.
As a result of the contractual arrangements with the President/Chief Executive Officer and former Chairman relating to their termination, the Company recorded a provision for severance costs of $284,000 in the fourth quarter of fiscal 2006.
In connection with the Private Placement, the Company's Vice Presidents were required, as a condition to closing, to agree that neither the Private Placement nor the purported tender offer by Modern Technology Group, Inc. publicly announced prior to the closing shall constitute a change of control or Potential Change of Control as delivered in their Amended Severance Agreements.
In addition, the Company's Vice Presidents are entitled to receive, and the Company has been accruing, quarterly special retention bonuses of $10,000 each, per quarter, for ten quarters commencing in May 2006 and continuing during such time for as long as such members of the management team continue their employment with the Company. These retention bonuses accrue monthly. For fiscal 2006, these retention bonuses aggregated $60,000 and are included in accrued expenses at October 28, 2006.
In the fourth quarter of fiscal 2004, the Company recorded a provision for impairment of long-lived assets aggregating $144,000 relating to the planned relocation of one of its retail locations. This amount was presented separately on the Statement of Operations for the year ended October 30, 2004.
In the fourth quarter of fiscal 2004, the Company reassessed the valuation allowance previously established against its net deferred tax assets. Based on the Company's earnings history and projected future taxable income, the Company determined that it is more likely than not that a portion of its deferred tax assets would be realized. Accordingly, the Company recorded a deferred tax asset in the amount of $1,350,000, which resulted in the recognition of an income tax benefit of approximately $977,000 and a reduction of reorganization value of approximately $373,000.
Union Contract
The Company is party to a collective bargaining agreement with a union which covers certain sales, warehouse and installation employees. This agreement expires on August 1, 2008.
Other
Effective September 22, 2006, the Company engaged a consultant under a month-to-month consulting services agreement. The consulting services agreement called for a weekly fee of $5,765 plus expenses. Total fees paid to the consultant in fiscal 2006, under the consulting services agreement aggregated $58,000.
Subsequent to the termination of the Company's President and Chief Executive Officer, the consultant was named Interim Chief Executive Officer ("Interim CEO") of the Company.
On December 19, 2006, the Company entered into an employment agreement with the Interim CEO. The terms of the employment agreement shall continue through January 31, 2007, with one month extension periods for three months, at the Company's option. The Interim CEO is receiving a salary of $21,500 a month plus expenses in accordance with the employment agreement.
Pursuant to this agreement, the Company has agreed to grant the Interim CEO non-qualified vested stock options of 37,500 on January 31, 2007, provided the Interim CEO continues to be employed until such date. 12,500 additional non-qualified stock options will be granted and will vest on February 28, 2007, March 31, 2007 and April 30, 2007, respectively, aggregating 75,000 options, provided the Company has elected to extend the employment agreement for these monthly extension periods. The exercise price on all options for the purchase of each share of the Company's Common Stock is $4.00 per share. These monthly options will vest on a pro rata basis if the Company or Interim CEO elect to terminate the employment agreement during any of the specified extended monthly periods.
In fiscal 2004, the Company received $21,000 from a shareholder owning 5% of the Company's Common Stock, representing the return of short-swing profits. The Company recorded this amount received to additional paid-in capital.
In fiscal 2004, the Company recorded $133,000, relating to the Company's estimate of unclaimed property due to certain states. This expense is included in selling, general and administrative expenses for fiscal 2004.
In January 2004, the Company agreed to satisfy certain long outstanding and disputed tax claims under an amnesty program offered by the City of New York. The tax claims related to a prior subsidiary for fiscal years 1987 and 1988. The Company satisfied the claim, in full, paying $90,000 (including interest), under the amnesty program. The Company recorded $50,000 to selling, general and administrative expenses in fiscal 2003 relating to this matter. Prior to the settlement of this matter, the Company had recorded a liability of $40,000 relating to this claim.
A Director of the Company who resigned effective July 31, 2005, is also a Senior Partner in a law firm providing the Company with legal services. At October 29, 2005 the Company had $40,000 payable to this law firm. The Company paid legal fees to this law firm of approximately $41,000, in fiscal year 2005.
11. Quarterly Financial Data (Unaudited)
(1) See Note 10 relating to fourth quarter adjustments. (2) Includes deferred tax expense of $1,350,000.
Schedule II - Valuation and Qualifying Accounts
Harvey Electronics, Inc.
(1) Uncollectible accounts written off, net of recoveries.
(2) Sales returns charged against net sales.
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders Harvey Electronics, Inc. Lyndhurst, New Jersey
The audits referred to in our report dated January 10, 2007 relating to the financial statements of Harvey Electronics, Inc., which is included in Item 8 of this Form 10-K, included the audits of the financial statement schedule II - Valuation and Qualifying Accounts for the three year period ended October 28, 2006. The financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits.
In our opinion, such financial statement schedule presents fairly, in all material respects, the information set forth therein.
/s/ BDO Seidman, LLP - -------------------- BDO Seidman, LLP Melville, New York January 10, 2007