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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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(MARK ONE)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2000
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE PERIOD FROM ________________ TO ________________
COMMISSION FILE NUMBER: 000-23731
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NUTRACEUTICAL INTERNATIONAL CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 87-0515089
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation) Number)
1400 KEARNS BOULEVARD, 2ND FLOOR
PARK CITY, UTAH 84060
(Address of principal executive offices including zip code)
Registrant's telephone number, including area code: (435) 655-6106
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, PAR
VALUE $.01 PER SHARE
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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. / /
The aggregate market value of voting stock held by non-affiliates of the
Registrant as of December 6, 2000 at a closing sale price of $2.00 as reported
by the Nasdaq National Market was approximately $10.1 million. Shares of Common
Stock held by each officer and director and by each person who owns or may be
deemed to own 10% or more of the outstanding Common Stock have been excluded
since such persons may be deemed to be affiliates. This determination of
affiliate status is not necessarily a conclusive determination for other
purposes.
As of December 6, 2000, the Registrant had 10,919,132 shares of Common Stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE: Portions of the Registrant's Proxy
Statement to be used in connection with the solicitation of proxies for the
Registrant's 2001 Annual Meeting of Stockholders (the "Proxy Statement") are
incorporated by reference in Part III of this Annual Report on Form 10-K (the
"Form 10-K").
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NUTRACEUTICAL INTERNATIONAL CORPORATION
INDEX TO ANNUAL REPORT ON FORM 10-K
PART I
Item 1 Business.................................................... 1
Item 2 Properties.................................................. 16
Item 3 Legal Proceedings........................................... 17
Item 4 Submission of Matters to a Vote of Security-Holders......... 18
Item 4A Executive Officers of the Registrant........................ 18
PART II
Market for the Registrant's Common Equity and Related 19
Item 5 Stockholder Matters.......................................
Item 6 Selected Financial Data..................................... 19
Item 7 Management's Discussion and Analysis of Financial Condition 21
and Results of Operations.................................
Item 7A Quantitative and Qualitative Disclosure About Market Risk... 26
Item 8 Financial Statements and Supplementary Data................. 26
Item 9 Changes in and Disagreements with Accountants on Accounting 26
and Financial Disclosure..................................
PART
III
Item 10 Directors and Executive Officers of the Registrant.......... 27
Item 11 Executive Compensation...................................... 27
Security Ownership of Certain Beneficial Owners and 27
Item 12 Management................................................
Item 13 Certain Relationships and Related Transactions.............. 27
PART IV
Exhibits, Financial Statement Schedules and Reports on 27
Item 14 Form 8-K..................................................
i
PART I
ITEM 1. BUSINESS.
As used herein, the terms "Company" and "Nutraceutical" refer to
Nutraceutical International Corporation and its subsidiaries, except where
indicated otherwise.
GENERAL
Nutraceutical is one of the nation's largest manufacturers and marketers of
quality branded nutritional supplements sold to health food stores. The Company
sells its products under the widely recognized brand names
SOLARAY-Registered Trademark-, KAL-Registered Trademark-, NATURALMAX-TM-,
VEGLIFE-Registered Trademark-, PREMIER ONE-Registered Trademark-, SOLAR
GREEN-TM-, NATURAL SPORT-TM-, ACTIPET-TM-, ACTION LABS-Registered Trademark- and
THOMPSON-Registered Trademark- to health food stores in the United States, and
to distributors and stores worldwide. Under the name Woodland, the Company
markets a line of books and booklets to, among others, book distributors,
national retail bookstores and health food stores. The Company manufactures
and/or distributes one of the broadest branded product lines in the industry
with over 2,300 stock keeping units ("SKUs"), including approximately 750 SKUs
exclusively sold internationally. The Company believes that as a result of its
emphasis on quality, loyalty, education and customer service, the Company's
brands are widely recognized in health food stores and among health food store
consumers.
In addition to branded products, Nutraceutical manufactures bulk materials
for use in its own products and for sale to other manufacturers and marketers in
the nutritional supplement industry under the tradenames Monarch Nutritional
Laboratories and Great Basin Botanicals.
On May 26, 2000, the Company purchased certain assets of Thompson
Nutritional Products, a division of Rexall Sundown, Inc. and formed a new
subsidiary, Thompson Nutritionals, Inc. ("Thompson"). Thompson, with over
65 years of history in the vitamin and nutrition industry, is a marketer of
health-related products, including a full line of vitamins, minerals and other
nutritional supplements.
The Company was formed in 1993 by senior management and Bain Capital, Inc.
("Bain Capital") to effect a consolidation strategy in the fragmented vitamin,
mineral, herbal and other nutritional supplements industry (the "VMS Industry").
Since its formation, the Company has completed nine acquisitions: Solaray, Inc.
("Solaray"), Premier One Products, Inc. ("Premier One"), Makers of KAL, Inc. and
Makers of KAL, B.V. ("KAL"), Monarch Nutritional Laboratories, Inc. ("Monarch"),
Action Labs, Inc. ("Action Labs"), Ahmed's Sun Force International
Products Inc., now known as NutraForce (Canada) International, Inc. ("NutraForce
Canada"), Woodland Publishing, Inc. and Summit Graphics, Inc. (collectively,
"Woodland") and Thompson. As a result of these acquisitions and internal growth,
the Company has grown in net sales and operating income. Management believes
that the Company is well positioned to continue to capitalize on the
consolidation occurring in the VMS Industry.
The Company has adopted a strategy of selling its branded products directly
to health food stores in the United States (the "Healthy Foods Channel"). This
strategy has enabled the Company to benefit from the growth of the Healthy Foods
Channel. The Healthy Foods Channel consists of approximately 11,500 retailers
including (i) independent health and natural food stores, (ii) health food
stores affiliated with local, regional and national health food chains
(including healthy food supermarket chains, such as Whole Foods and Wild Oats)
and (iii) GNC stores. The Healthy Foods Channel has historically experienced
growth based on the continued expansion of independent health food stores and
local, regional and national health food chains in response to demand from
consumers who desire product education, service and high quality natural
ingredients. The current growth of the Healthy Foods Channel is not at (and may
not continue at) historical levels. The Company believes there are significant
differences between mass market retailers (such as drugstores, warehouse clubs
and
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supermarkets) that typically offer a limited selection of discounted and
lower-potency items and the Healthy Foods Channel, where natural ingredients,
quality, potency, selection and customer support are emphasized.
The Company believes that it is among the largest suppliers of nutritional
supplements to the Healthy Foods Channel that develops, manufactures, markets
and directly distributes a majority of its own products. The Company
manufactured over 85% of its products in fiscal 2000 and believes that the
quality of its products is among the highest in the industry. The Company
markets its branded products through one of the industry's largest sales forces
dedicated to the Healthy Foods Channel. The Company seeks to be a market leader
in the development of new and innovative products, introducing approximately 200
new SKUs in fiscal 2000. The Company believes that it benefits from
substantially greater customer diversification than most of its larger
competitors. The Company also benefits from product diversification.
The Company's principal executive offices are located at 1400 Kearns Blvd.,
Second Floor, Park City, Utah, 84060. The Company's telephone number is
(435) 655-6106.
INDUSTRY
The total United States retail market for nutritional supplements (the "VMS
Market") is highly fragmented and has grown to $9.6 billion in 1999 retail
sales, as compared to $8.9 billion in 1998 and $7.8 billion in 1997. The Company
believes that this growth is due to a number of factors, including
(i) increased interest in healthier lifestyles, living longer and living well,
(ii) the publication of research findings supporting the positive health effects
of certain nutritional supplements and (iii) the aging of the "Baby Boom"
generation combined with the tendency of consumers to purchase more nutritional
supplements as they age. Various publicly-traded nutritional supplement
companies, as well as industry analysts, have announced that there is a
slow-down in sales of nutritional supplements. The Company believes that this
slow-down may be the result of, among other things, the lack of any recent
industry-wide "hit" products.
PRODUCTS
As of September 30, 2000, the Company sold over 2,300 SKUs, including
approximately 750 SKUs exclusively sold internationally. The Company's products
generally fall into one of three categories: (i) supplements, (ii) vitamins and
minerals and (iii) diet, energy and other. The Company's products come in
various formulations and delivery forms, including capsules, tablets, softgels,
chewables, liquids, powders and whole herbs.
The Company currently markets its products through a multiple brand strategy
that the Company believes has been successful in encouraging retailers to
allocate additional shelf space to the Company's brands. The Company has worked
to enhance the strength of its brands by instituting business strategies that
have included (i) consolidating sales forces and increasing each brand's
geographic coverage through an expanded sales force, (ii) instituting
performance and growth-based incentives for sales representatives,
(iii) introducing more sophisticated management information systems and
(iv) updating each brand's packaging.
As of September 30, 2000, the Company's portfolio of established brand names
consisted of the following:
SOLARAY. Solaray began in 1973 as a pioneer in formulating and marketing
blended herbal products that contain two or more herbs with complementary
effects. From its inception, Solaray has focused on encapsulated products that
offer rapid disintegration and are easy to swallow and has sold its products
through independent sales representatives to the Healthy Foods Channel. By 1984,
Solaray had become a full line manufacturer, carrying not only herbs, but also a
full line of vitamins and
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minerals. Solaray has become one of the most popular and well-known brands of
nutritional supplements in the Healthy Foods Channel and has developed a
reputation for quality, consistency and innovation. This past year Solaray
introduced Soytein, a delicious line of soy protein beverages intended to
capitalize on the increasing consumer interest in functional foods and soy
products. Solaray's brand packaging is distinguished by white bottles with a
rainbow of five colors across the top of the label as a backdrop to the
distinctive Solaray logo.
KAL. KAL was established in Southern California in 1932 as one of the first
nutritional supplement lines in the United States. Although KAL's first products
were in powdered form, KAL soon shifted its focus to tableted products that are
generally more economical than capsules as a delivery form and which allow for
fewer units per dose than encapsulated products. KAL has been a pioneer in the
introduction of new and innovative products, as well as new and unique delivery
forms. Among its innovative product introductions was Beyond Garlic, which
remains a popular garlic product in the Healthy Foods Channel and was the first
"enteric coated softgel" garlic product. This unique delivery form allows for
fresh garlic oil inside of a softgel to pass through the stomach into the
intestine before being digested, thereby virtually eliminating any potential
garlic odor. KAL was also the first nutritional supplement marketer in the
Healthy Foods Channel to introduce pycnogenol and melatonin. In addition, KAL
was one of the first companies to introduce MSM, NADH and a complete line of
colostrum products. KAL recently launched a line of therapeutic creams intended
to provide natural skin care solutions. KAL's brand packaging consists of a
white bottle and includes the circular red and black KAL logo as a prominent
feature on the principal display panel.
NATURALMAX. NaturalMax, Inc. ("NaturalMax") was established in 1995 in
connection with the KAL acquisition in order to promote certain KAL products.
The NaturalMax product line includes diet products (with diet plans) as well as
energy and women's health products. The NaturalMax brand uses tablets, softgels,
capsules and liquids, depending on the most desired form for a particular
product. NaturalMax launched the innovative diet product Fat-X, a natural lipase
inhibition product. The packaging of NaturalMax products includes the
distinctive and recently revised NaturalMax logo.
PREMIER ONE. Premier One was founded in July 1984 in Omaha, Nebraska as one
of the first product lines devoted entirely to natural, nutritional supplements
derived from bee products. The Premier One brand uses various delivery forms,
each chosen for its particular benefits, including capsules, chewable wafers,
granules, energy bars, tinctures and products in a honey base. Royal Jelly in
Honey is one of Premier One's most popular products; some of Premier One's other
popular products include Raw Energy, an energy product that includes royal
jelly, bee pollen and a variety of herbs, and Beefense, a product that includes
bee propolis and echinacea. Premier One's brand packaging includes a distinctive
logo of a bee-harvesting scene in a mountain setting, with gold highlights on
the label.
VEGLIFE. VegLife began in 1992 as a product line under the Solaray brand.
The goal was to create a line of products that would be suitable for strict
vegetarians who avoid any animal-derived ingredients, including the avoidance of
gelatin capsules. VegLife was among the first to introduce a line of nutritional
supplements using a cellulose-based capsule with substantially equivalent
characteristics to traditional gelatin capsules. Vegetarian consumers showed
substantial interest in this product line, so the Company established it as a
separate brand in 1995 in order to allow a management team to focus on the
development of a full line of vegetarian products. This management team
scrutinizes every element of each product developed, as well as the materials
used in formulation, to ensure that strict vegetarian standards are met. The
VegLife brand focuses primarily on encapsulated products, but also now includes
a popular soy-based protein drink supplement sold under the trademark Peaceful
Planet, as well as a kava beverage sold under the trademark Peaceful Kava.
VegLife's brand packaging includes a distinctive green and blue label, as well
as a logo with an attractive depiction of a budding plant.
SOLAR GREEN. Solar Green was launched in April 1997. The Solar Green brand
is focused on chlorophyll-laden "green foods," such as algaes (including
chlorella, spirulina and blue green algae) and
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cereal grasses (such as barley and wheat grass). These products are currently
offered in tablet forms. Solar Green also introduced "green food" drink mixes
that can be combined with juice or water to create a nutritious beverage
supplement. Solar Green's brand packaging includes a distinctive Solar Green
logo and a label with green borders and accents.
NATURAL SPORT. Natural Sport was launched in September 1998. The Natural
Sport brand is focused on all-natural sport supplements for serious athletes and
also individuals who exercise for fitness, improved health or weight management.
The Natural Sport line includes two innovative sport beverage supplements,
Pre-Burn (to be taken prior to exercise to support fat metabolism and endurance)
and Post-Up (to be taken after exercise to support muscle glycogen
rejuvenation). The line also includes ProSoy, a soy protein beverage supplement,
Creatine Monohydrate and two separate sport multivitamin mineral formulas, one
for men and one for women, under the name Phyto Sport. Natural Sport's packaging
includes a distinctive Natural Sport logo in black and white, as well as blue
lids and a label with an attractive blue swath running up one side of the front
panel.
ACTION LABS. Action Labs started in 1989 with a focus on men's specialty
supplements and diet and energy products. The Company acquired this brand late
in fiscal 1998 and is now manufacturing most Action Labs products in-house. The
Action Labs brand has a relatively strong presence on the East Coast, including
a New York sales office. The packaging of Action Labs products includes the
distinctive Action Labs logo and brightly colored text.
ACTIPET. ActiPet was launched in May of 2000 after more than two years of
research and development. This premium line of pet supplements was developed to
cater to the growing segment of pet owners. ActiPet products are made with high
quality ingredients, using no animal by-products, artificial flavors, artificial
colors or preservatives. The ActiPet formulas are reviewed and approved by three
veterinarians. The packaging includes an attractive ActiPet logo with signature
paw print; dog formulas showcase a dog photo on bright blue labels and cat
formulas use maroon labels with a cat photo--both with coordinating colored
lids.
THOMPSON. Thompson started in 1932 as a complete supplement line focused
mainly on vitamins and minerals. The Company acquired Thompson in May of 2000
and relaunched the brand in November of 2000. Thompson offers a simple, high
quality product line with "Everyday Value Pricing." The product line was
expanded to a total of 240 products in the vitamin, mineral, herb and specialty
categories. In addition, count sizes were updated to provide a full 30-day
supply of product at a value price. Thompson's packaging was completely
redesigned with highly-visible product names on bright, grape-colored labels.
The Thompson logo is prominently displayed in a band of yellow, gold or green,
depending on the product category.
WOODLAND. Woodland was established in 1975 as one of the first publishers
solely dedicated to the natural health field. Originally, Woodland published
books by such authors as Bernard Jensen, John Christopher, and Louise Tenney. In
1985, Today's Herbal Health was introduced and is now considered a classic with
sales exceeding 750,000 copies. In 1995, The Woodland Health Series was created;
the series consists of one-topic booklets and has sold over 4 million copies.
With more than 160 titles in print, Woodland continues to be a pioneer in the
natural health field.
HEALTHWAY. Healthway Corporation ("Healthway"), which was established in
1958, was acquired in 1995 as part of the KAL acquisition. The goal of Healthway
is to find the highest quality products from around the world and offer them to
the consumer.
4
RESEARCH AND DEVELOPMENT; QUALITY CONTROL
The Company has a commitment to research and development. The Company
believes that product quality and innovation are fundamental to its long-term
growth and success. Through its research and development efforts, the Company
seeks to (i) test the safety, purity and potency of products, (ii) develop more
effective and efficient means of producing ingredients for use in products,
(iii) develop testing methods for ensuring and verifying the consistency of the
dosage of ingredients included in the Company's products, (iv) develop new, more
effective product delivery forms and (v) develop new products either by
combining existing ingredients used in nutritional supplements or identifying
new ingredients that can be used in nutritional supplements. The Company's
efforts are designed to lead not only to the development of new and improved
products, but also to ensure effective manufacturing quality control measures.
The Company has entered into a cooperative arrangement with Weber State
University in Ogden, Utah through which, among other things, the university
provides the Company with access to certain laboratory space and equipment. The
university has assigned one faculty member as a project director to coordinate
projects undertaken at the university facility. The Company also conducts
research and development in Company-owned facilities. The Company currently
employs various professionals in its research and development and quality
control departments with degrees in, among other things, chemistry, microbiology
and engineering and, in many cases, have received training in natural health
food products. In addition, the Company retains the services of outside
laboratories from time to time to validate its product standards and
manufacturing protocols.
The Company's quality control program seeks to ensure the superior quality
of the Company's products and that they are manufactured in accordance with
current Good Manufacturing Practices ("GMP"). The Company's processing methods
are monitored closely to ensure that only quality ingredients are used and to
ensure product purity. This monitoring process is both internal and external
through third-party inspections. The Company has taken steps toward providing
electronic access to GMPs on the manufacturing floor.
SALES AND MARKETING
The Company promotes demand for its products by educating retailers, who in
turn educate consumers, as to the quality and attributes of its natural vitamin,
mineral and herbal nutritional supplements and the wide range of its products.
The Company's branded products are currently sold in the United States to
retailers in the Healthy Foods Channel, which consists of approximately 11,500
stores, including (i) independent health and natural food stores, (ii) health
food stores affiliated with local, regional and national health food chains
(including healthy food supermarket chains such as Whole Foods and Wild Oats)
and (iii) GNC stores. Unlike many of its competitors, the Company does not sell
its branded products in the United States to mass market retailers, but instead
focuses on sales to the Healthy Foods Channel. The Company believes that its
products are attractive to retailers in the Healthy Foods Channel due to factors
such as the strength of its brand names, the quality and potency of its
products, service and the availability of sales support and educational
materials regarding its products. The Company has developed an internet site
that provides information about the Company's portfolio of branded lines and the
various products within each branded line.
The Company markets its products through a sales force dedicated to the
Healthy Foods Channel. The Company's sales representatives regularly visit each
assigned health food store in their respective territories to assist in the
solicitation of orders for products and provide related product sales
assistance. The Company monitors and periodically updates its payment structure
for its sales force in order to ensure that appropriate incentives are provided
for sales growth. The Company also sells products directly to certain retailers
through its telephone marketing organization. The Action Labs and Thompson
products are sold through distributors and supported by a telephone marketing
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organization. The Company has organized its sales and marketing force under a
subsidiary company, NutraBrands, Inc.
The Company's marketing efforts are focused on educating retailers to enable
them to then educate the ultimate consumer about the Company's products. The
Company sponsors retailer seminars which the Company believes has made an
important contribution to the growth of its brands. Participants receive product
education presentations with background information relating to existing
products and with special emphasis given to new products. The Company's seminars
are designed to foster relationships with the Company's customers in the Healthy
Foods Channel and to increase retailer and consumer awareness of the Company's
products.
Au Naturel, Inc. ("Au Naturel") was formed in fiscal 1995 for the purpose of
marketing the Company's branded products internationally. During fiscal 2000, Au
Naturel marketed products to customers in more than 30 foreign countries.
Although Au Naturel is not a product brand, it functions as a separate business
unit. Au Naturel markets domestic brands as well as custom formulations that
must meet specific product formulation and labeling requirements of certain
foreign countries.
The Company conducts international sales and support in Canada through its
Canadian subsidiary. In January of 1999, the Company incorporated Nutra-Force
(Barbados) International, Inc. to act as a foreign sales corporation for
international sales.
Monarch and Great Basin Botanicals market bulk materials as well as bulk
minerals and herbs in the United States through a separate sales force and
internationally both directly to manufacturers and through distributors.
MANUFACTURING
The Company's manufacturing process generally consists of the following
operations (i) sourcing ingredients for products, (ii) measuring ingredients for
inclusion in such products, (iii) blending ingredients into a mixture with a
homogeneous consistency and (iv) encapsulating, tableting or pouring the blended
mixture into the appropriate dosage form using either automatic or semiautomatic
equipment. The next step, bottling and packaging, involves placing the product
in packaging with appropriate tamper-evident features and sending the packaged
product to a distribution point for delivery to retailers. The Company places
special emphasis on quality control and conducts inspections throughout the
manufacturing process, including raw material verification, homogeneity testing,
weight deviation measurements and package quality sampling. See "Research and
Development; Quality Control."
The Company manufactured over 85% of its products in fiscal 2000, based on
net sales. By manufacturing the majority of its own products, the Company
believes it maintains better control over product quality and availability while
also reducing production costs. The Company's manufacturing operations are
performed in its facilities located in the greater Ogden, Utah area. The Company
also has a working relationship with numerous outside manufacturers and
packagers and utilizes these outside sources from time to time. The Company does
not have any material backlogs. The Company has organized its manufacturing
operations under a subsidiary company, NutraPure, Inc.
Monarch and Great Basin Botanicals source raw material components, provide
contract grinding and milling services, manufacture bulk materials and supply
these to the Company and other marketers of nutritional supplements, including,
in certain cases, competitors of the Company.
MANAGEMENT INFORMATION AND COMMUNICATION SYSTEMS
The Company uses a custom computer software system for handling order entry
and invoicing, shipping, warehouse operations and customer service inquiries.
The system provides product delivery and order information. The Company uses
commercially packaged software for manufacturing,
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inventory management and accounting operations. The Company believes that these
systems have improved operating efficiencies and customer service. In addition,
the Company has installed an advanced telephone communication system that
provides the platform for computer-telephone integration and facilitates
intra-company communication.
MATERIALS AND SUPPLIERS
The Company's purchasing staff includes individuals with product knowledge
and experience related to herbs, minerals, bulk products, bottles, caps, labels,
packaging and advertising, marketing and selling material and merchandise. The
purchasing staff, in cooperation with marketing, product development,
formulations and quality control personnel, maintains supplier relationships and
gathers market information to inform management of issues that might adversely
impact the Company's ability to acquire sufficient quantities of raw materials
to meet customer demand. The Company engages in extensive sample testing of raw
materials to be incorporated in the Company's products.
The Company believes that its continued success will depend upon the
availability of raw materials that permit the Company to meet its labeling
claims, quality control standards and demand for unique ingredients. Due to
issues related to quality, efficacy, safety or third-party intellectual property
protection, a number of the Company's branded products contain one or more
ingredients that may only be available from a single source or supplier. In
addition, the supply of herbal products is subject to the same risks normally
associated with agricultural production, such as climatic conditions, insect
infestations and availability of manual labor for harvesting. Any significant
delay in or disruption of the supply of raw materials could substantially
increase the cost of such materials and could require product reformulations, as
well as the qualification of new suppliers and repackaging. Accordingly, there
can be no assurance that the disruption of the Company's supply sources will not
have a material adverse effect on the Company.
Although the Company acquires the majority of its raw materials from
domestic suppliers, a number of the Company's products include one or more
ingredients that originate outside of the United States. The Company's business
is therefore subject to the risks generally associated with doing business
outside the United States, such as delays in shipments, embargoes, changes in
economic and political conditions, tariffs, foreign exchange rates and trade
disputes. The Company's business is also subject to the risks associated with
the enactment of United States and foreign legislation and regulations relating
to imports and exports, including quotas, duties, taxes or other charges or
restrictions that could be imposed upon the importation of products into the
United States.
The Company seeks to mitigate the risk of the shortage of certain raw
materials through its relationships with approximately 130 principal suppliers.
The Company also manufactures bulk materials to allow more extensive vertical
integration and to improve the quality and consistency of ingredients.
DISTRIBUTION
The Company ships the majority of its products directly to retailers via
Federal Express and UPS. Shipments are made from the Company's primary
distribution facilities in Ogden, Utah and Memphis, Tennessee. These
distribution facilities have been strategically located to ensure priority
service to the Company's customers. The Company has negotiated short-term leases
with multiple renewal options for these distribution facilities. The Company has
organized its distribution operations under a subsidiary company,
NutraForce, Inc. The Company also operates a smaller distribution facility in
Langley, British Columbia for Canadian sales.
7
GOVERNMENT REGULATION
The manufacturing, distribution and sale of dietary supplements such as
those sold by the Company are subject to regulation by one or more federal
agencies, principally the Food and Drug Administration (the "FDA") and the
Federal Trade Commission (the "FTC"), and to a lesser extent the Consumer
Product Safety Commission and United States Department of Agriculture. The
Company's activities are also regulated by various governmental agencies for the
states and localities in which the Company's products are manufactured,
distributed or sold, as well as by governmental agencies in certain countries
outside the United States in which the Company's products are distributed and
sold. Among other matters, regulation by the FDA and FTC is concerned with
product safety and claims that refer to a product's ability to treat or prevent
disease or other adverse health conditions.
Federal agencies, primarily the FDA and FTC, have a variety of remedies and
processes available to them, including initiating investigations, issuing
warning letters and cease and desist orders, requiring corrective labels or
advertising, requiring consumer redress (for example, requiring that a company
offer to repurchase products previously sold to consumers), seeking injunctive
relief or product seizure and imposing civil penalties or commencing criminal
prosecution. In addition, certain state agencies have similar authority, as well
as the authority to prohibit or restrict the manufacture or sale of products
within their jurisdiction. These federal and state agencies have in the past
used these remedies in regulating participants in the dietary supplements
industry, including the imposition by federal agencies of civil penalties in the
millions of dollars against a few industry participants. There can be no
assurance that the regulatory environment in which the Company operates will not
change or that such regulatory environment, or any specific action taken against
the Company, will not result in a material adverse effect on the Company's
business, financial condition or results of operations. In addition, increased
sales and publicity of dietary supplements may result in increased regulatory
scrutiny of the dietary supplements industry.
The Dietary Supplement Health and Education Act of 1994 ("DSHEA") was
enacted in October 1994, amending the Food, Drug and Cosmetic Act. The Company
believes DSHEA is generally favorable to the dietary supplement industry. DSHEA
establishes a statutory class of "dietary supplements," which includes vitamins,
minerals, herbs, amino acids and other dietary ingredients for human use to
supplement the diet. Dietary ingredients on the market as of October 15, 1994 do
not require the submission by the manufacturer or distributor of evidence of a
history of use or other evidence of safety establishing that the ingredient will
reasonably be expected to be safe, but a dietary ingredient which was not on the
market as of October 15, 1994 does require such submission of evidence of a
history of use or other evidence of safety. Among other things, DSHEA prevents
the further regulation of dietary ingredients as "food additives" and allows the
use of statements of nutritional support on product labels. The FDA has issued
proposed and final regulations in this area and indicates that further guidance
and regulations are forthcoming.
Advertising and label claims for dietary supplements and conventional foods
have been regulated by state and federal authorities under a number of disparate
regulatory schemes. There can be no assurance that a state will not interpret
claims presumptively valid under federal law as illegal under that state's
regulations, or that future FDA regulations or FTC decisions will not restrict
the permissible scope of such claims.
The FDA is currently proposing to regulate the sale of nonprescription
products containing ephedra, a natural product that contains a small percentage
of ephedrine alkaloids that are used in some prescriptions and over the counter
stimulants and antihistamines. Various state legislatures and agencies have also
expressed concern regarding ephedra-based products. As an example, a Texas
regulation requires a comprehensive warning on all labels as well as other label
information that is without precedent in the industry. Although the Company has
limited SKUs that contain ephedra, the
8
loss of sales of these products or a further limitation in the states and other
jurisdictions where these products may be sold could have a material adverse
effect on the Company.
The Drug Enforcement Administration ("DEA") has issued proposed regulations
governing the sale of products containing ephedrine alkaloids because of
concerns by the DEA that these products may be used in the illegal manufacture
of methamphetamines. These proposed regulations would require that certain
manufacturers, distributors and retailers who carry covered products register
with the DEA and comply with certain requirements. The proposed regulations
exempt from registration any products containing 2% or less by weight of
ephedrine alkaloids. As of September 30, 2000, all of the Company's products
which contain ephedrine alkaloids had 2% or less by weight of ephedrine
alkaloids. However, there can be no assurance that the DEA will not modify its
proposal or take a more aggressive stance such that some of the Company's
products, as well as certain of the Company's customers, might be subject to
registration and other requirements. It is possible such a regulation could have
a material adverse effect on the Company.
In November 1998, the FTC announced its new advertising guidelines for the
dietary supplement industry, which it labeled "Dietary Supplements: An
Advertising Guide for Industry." These guidelines reiterate many of the policies
the FTC has periodically announced over the years, including requirements for
substantiation of claims made in advertising about dietary supplements.
The FDA has announced its intent to issue Good Manufacturing Practices
guidelines for the dietary supplement industry. The FDA published the industry's
proposed GMP guidelines during the past year, but has not yet published its own
proposed guidelines.
The distribution and sale of the Company's products to countries outside the
United States is also regulated by the governments of those countries. The
Company's plans to commence or expand sales in those countries may be prevented
or delayed by such regulation. While compliance with such regulation is
generally assumed by the Company's international distributors, the Company
assists with such compliance and in many cases may remain liable if the
distributor fails to comply. These distributors are independent contractors over
whom the Company has limited control. In certain countries, the Company
distributes its products through its own subsidiary; in these countries the
Company's subsidiary assumes responsibility for compliance with applicable
regulations.
As a result of the Company's efforts to comply with applicable statutes and
regulations, the Company has from time to time reformulated, eliminated or
relabeled certain of its products and revised certain provisions of its sales
and marketing program. The Company cannot predict the nature of any future laws,
regulations, interpretations or applications, nor can it determine what effect
additional governmental regulations or administrative orders, when and if
promulgated, would have on its business in the future. They could, however,
require the reformulation of certain products to meet new standards, the recall
or discontinuance of certain products, additional record keeping, expanded
documentation of the properties of certain products, revised, expanded or
different labeling, and/or additional scientific substantiation. Any or all of
such requirements could have a material adverse effect on the Company's results
of operations and financial condition.
In December 2000, the Company received notice of intent to file an action
concerning an alleged Proposition 65 violation. "Proposition 65" is a California
law that mandates certain disclosures and warning labels and that allows
litigants or the California Attorney General to recover monetary penalties
and/or injunctive relief under certain circumstances. The Company has referred
this matter to outside counsel.
In October 2000, the Company received written notice from the Indiana State
Chemist and Seed Commissioner regarding certain products in its ActiPet line.
The notice raised issues regarding the labeling and registration requirements
for the products under Indiana state law. The Company has responded to the
issues and awaits further guidance on the subject.
9
In January 1998, Monarch received a written notice alleging that Monarch
violated Proposition 65 by not providing appropriate warning statements with
respect to the level of lead contained in copper gluconate. This notice alleged
that the violation arose from the sale of bulk quantities of copper gluconate to
a wholesale customer. The private party that initiated this notice alleged that
it purchased some of these bulk products from Monarch's customer. Monarch
reached a resolution of this matter with the private party and has had no
further communication from the Attorney General of the State of California.
However, the FDA contacted the Company regarding this matter and conducted an
investigation of the Company's bulk materials subsidiary with the assistance of
the Company and its outside counsel. In January of 1999, the Company received
grand jury subpoenas regarding documents with respect to the investigation; the
Company continues to cooperate with the FDA and the United States Attorney's
Office in the investigation of these matters. It is possible that either or both
of the foregoing proceedings may result in monetary penalties, adverse
publicity, lost sales or a change in the Company's labeling of affected products
and could have a material adverse effect on the Company.
In October 1997, the Company and a number of other suppliers, processors and
marketers of dietary supplements received warning letters from the FDA relating
to an allegedly contaminated batch of an herb called plantain. These letters
claimed that the plantain, which had been shipped to the United States from
Europe, had been contaminated with another botanical product with potentially
harmful side effects. The letter that the Company received alleged that some of
this plantain had been included in a shipment of products that the Company had
processed under the tradename Great Basin Botanicals for a third party on a
contract basis. The Company has replied to the FDA, explaining that, among other
things, it did not own the products or market them for human consumption but
simply provided grinding services for the owner of the herbs. The Company
further noted to the FDA that it did not process any plantain that could have
been incorporated into any products that were actually consumed because the only
batch it processed was returned to the supplier/owner following the FDA's
initial press releases on this matter. The Company has denied responsibility for
any adverse effects and affirmed its commitment to good manufacturing practices.
There can be no assurances that the FDA will not take further action and that,
if taken, such action will not result in a material adverse effect on the
Company. More recently, a private lawsuit has been filed by the distributor
against certain suppliers and processors of the plantain; the Company has not
been named in the lawsuit.
In July 1997, the Company received a notice that it may be a defendant along
with a number of other participants in the dietary supplement industry in a
threatened action by certain private litigants or the Attorney General of the
State of California, which alleged that certain products containing fish and
salmon oils may be in violation of Proposition 65 for failure to include
required warning labels. The Company has learned that the Attorney General of
the State of California completed testing of all of the products in question
sometime during the early summer of 1998, and has further been advised that the
Attorney General would contact each company individually to discuss the results.
The Company has not been contacted concerning the results of these tests, nor
has the Company received any correspondence or communication from the Attorney
General of the State of California or the private party litigant. The Company
believes that this issue may have been resolved by the test results. If not, the
Company intends to dispute the allegations. However, there can be no assurance
that this matter has been completely resolved or that the resolution would not
have an adverse impact on the Company's results of operations and financial
conditions.
In March 1993, the staff of the Cleveland Regional Office of the FTC began
an investigation into advertising claims made by the seller in the
KAL/NaturalMax Acquisition, and made an inquiry to the Company in August 1995
concerning certain products and claims associated with the KAL and NaturalMax
product lines. The Company has responded to the FTC and, to the Company's
knowledge, the FTC has taken no further action. Although none of these
investigations has had a material adverse effect on the Company, there can be no
assurance that future regulatory action, if it occurs, will not have such an
effect.
10
There can be no assurance that the foregoing proceedings or investigations,
or any future regulatory proceedings or investigations, will not have a material
adverse effect on the Company.
COMPETITION
The VMS Industry is highly competitive. The Company's principal competitors
in the Healthy Foods Channel include a number of large, nationally known
manufacturers (such as Twinlab, Solgar, Nature's Plus, Country Life and Nature's
Way) and many smaller manufacturers and distributors of nutritional supplements.
Certain of the Company's principal competitors are larger than the Company, have
greater access to capital and may be better able to withstand volatile market
conditions within the VMS Industry. Moreover, because this industry generally
has low barriers to entry, additional competitors could enter the market at any
time.
Private label products of the Company's customers also provide competition
to the Company's products. For example, a substantial portion of GNC's vitamin
and mineral supplement offerings are products offered under GNC's own private
label. Whole Foods, Wild Oats and most large health food stores also sell a
portion of their supplement offerings under their own private labels. The
Thompson line has been positioned to meet the needs of the Company's customers
in this area.
The Company believes that health food retailers are increasingly likely to
align themselves with those companies that offer a wide variety of high quality
products, have a loyal customer base, support their brands with strong marketing
and education programs and provide consistently high levels of customer service.
The Company believes that it competes favorably with other nutritional
supplement companies because of its comprehensive line of products and brands,
premium brand names, commitment to quality, ability to rapidly introduce
innovative products, competitive pricing, strong and effective sales force and
distribution strategy and sophisticated marketing and promotional support. The
wide variety and diversity of the forms, potencies and categories of the
Company's products are important points of differentiation between the Company
and many of its competitors.
Although the Company does not compete in the mass market retail channel of
distribution, it is possible that as increasing numbers of companies sell
nutritional supplement products in the mass market channels (such as NBTY,
Rexall and Weider), these product offerings may affect sales in the Healthy
Foods Channel. The Company also competes with distributors that sell products to
the Healthy Foods Channel as well as the mass market retail channel (such as
United Natural Foods, Tree of Life and Super Nutrition.) In addition, several
major pharmaceutical companies have introduced herbal lines in the mass market,
including American Home Products (Centrum) and Bayer (One-A-Day). Many of these
companies have substantially greater financial and other resources than the
Company. In that regard, although the VMS Industry to date has been
characterized by many relatively small participants, there can be no assurance
that additional national or international companies (which may include
additional pharmaceutical companies or additional suppliers to mass
merchandisers) will not seek in the future to enter or to increase their
presence in the VMS Market. Increased competition in the VMS Market could have a
material adverse effect on the Company.
INTELLECTUAL PROPERTY
The Company owns approximately 100 trademarks that have been registered with
the United States Patent and Trademark Office and has filed applications to
register additional trademarks. In addition, the Company claims domestic
trademark and service mark rights in numerous additional marks used by the
Company. The Company owns a number of trademark registrations in countries
outside the United States and is in the process of filing additional
registration applications in various countries. The Company regards its
trademarks and other proprietary rights as valuable assets and believes they
make a significant positive contribution to the marketing of its products.
11
The Company protects its legal rights concerning its trademarks by
appropriate legal action. The Company relies on common law trademark rights to
protect its unregistered trademarks. Common law trademark rights do not provide
the Company with the same level of protection as afforded by a United States
federal registration of a trademark. In addition, common law trademark rights
are limited to the geographic area in which the trademark is actually used,
while a United States federal registration of a trademark enables the registrant
to stop the unauthorized use of the trademark by any third party anywhere in the
United States, even if the registrant has never used the trademark in the
geographic area wherein the unauthorized use is being made (provided, however,
that an unauthorized third-party user has not, prior to the registration date,
perfected its common law rights in the trademark in that geographic area). The
Company has registered and intends to register its trademarks in certain
jurisdictions outside the United States where the Company's products are sold.
However, the protection available in such jurisdictions may not be as extensive
as the protection available to the Company in the United States.
The Company is currently involved in trademark infringement litigation
relating to its Solar Green mark; the Company is vigorously defending this
action; see "Legal Proceedings."
EMPLOYEES
At September 30, 2000, the Company employed approximately 500 full-time and
approximately 70 part-time employees. None of the Company's employees is
represented by a collective bargaining unit. The Company believes that it has a
good relationship with its employees.
RISK FACTORS
In addition to the other information contained in this Form 10-K, the
following factors should be considered in evaluating whether to buy, sell, or
hold Common Stock of the Company:
RISKS ASSOCIATED WITH GOVERNMENT REGULATION. The formulation,
manufacturing, processing, packaging, labeling, advertising, distribution and
sale of dietary supplements such as those sold by the Company are subject to
regulation by a number of federal, state and foreign agencies, principally, the
FDA and the FTC. Among other matters, such regulation is concerned with claims,
made with respect to a product, that assert the healing or nutritional value of
such product. Such agencies have a variety of remedies and processes available
to them, including initiating investigations, issuing warning letters and cease
and desist orders, requiring corrective labels or advertising, requiring
consumer redress (for example, by requiring that a company offer to repurchase
products previously sold to consumers), seeking injunctive relief or product
seizure, imposing civil penalties, or commencing criminal prosecution. Federal
and state agencies have in the past used these remedies in regulating
participants in the dietary supplements industry, including the imposition by
federal agencies of civil penalties in the millions of dollars against a few
industry participants. In addition, increased sales and publicity of dietary
supplements may result in increased regulatory scrutiny of the nutritional
supplements industry. There can be no assurance that the regulatory environment
in which the Company operates will not change or that such regulatory
environment, or any specific action taken against the Company, will not result
in a material adverse effect on the Company's business, financial condition or
results of operations. Additional proceedings and issues are outlined under
"Business--Government Regulation." There can be no assurance that such
proceedings or investigations or any future proceedings or investigations will
not have a material adverse effect on the Company.
NO ASSURANCE OF FUTURE INDUSTRY GROWTH. There can be no assurance that the
VMS Market or the Healthy Foods Channel are as large as reported or that
projected or expected growth will occur or continue. Market data and
projections, such as those presented in this Form 10-K, are inherently uncertain
and subject to change. In addition, the underlying market conditions are subject
to change based on economic conditions, consumer preferences and other factors
that are beyond the Company's
12
control. Recently, various publicly-traded nutritional supplement companies, as
well as industry analysts, have announced that there is a slow-down in sales of
nutritional supplements. There can be no assurance that an adverse change in
size or growth rate of the VMS Market or the Healthy Foods Channel will not have
a material adverse effect on the Company.
RELIANCE ON KEY MANAGEMENT. The operation of the Company requires
managerial and operational expertise. In particular, the Company is dependent
upon the management and leadership skills of a number of its senior managers,
including Frank W. Gay II, Bruce R. Hough, Jeffrey A. Hinrichs, Gary M. Hume and
Leslie M. Brown, Jr. Substantially all of the Company's employees are employed
"at will." None of the key management employees has a long-term employment
contract with the Company and there can be no assurance that such individuals
will remain with the Company. The failure of such key personnel to continue to
be active in management could have a material adverse effect on the Company. See
"Executive Officers of the Registrant." Effective June 2000, William T. Logan,
Senior Vice President, Marketing and Sales terminated his employment with the
Company due to health considerations. Mr. Logan's responsibilities have been
assumed by other management personnel.
PRODUCT LIABILITY; POTENTIAL ADVERSE PRODUCT PUBLICITY. The Company, like
any other retailer, distributor or manufacturer of products that are designed to
be ingested, faces an inherent risk of exposure to product liability claims in
the event that the use of its products results in injury. In the event that the
Company does not have adequate insurance or contractual indemnification, product
liability claims could have a material adverse effect on the Company. Like other
manufacturers and distributors of nutritional supplements, the Company and its
predecessors currently are or have been named as defendants in product liability
lawsuits. The successful assertion or settlement of any uninsured claim, a
significant number of insured claims, or a claim exceeding the Company's
insurance coverage could have a material adverse effect on the Company.
The Company is highly dependent upon consumers' perception of the safety and
quality of its products as well as similar products distributed by other
companies. Thus, the mere publication of reports asserting that such products
may be harmful could have a material adverse effect on the Company, regardless
of whether such reports are scientifically supported and regardless of whether
the harmful effects would be present at the dosages recommended for such
products. Although many of the ingredients in the Company's products are
vitamins, minerals, herbs and other substances for which there is a long history
of human consumption, some of the Company's products contain innovative
ingredients or combinations of ingredients. Although the Company believes all of
its products to be safe when taken as directed by the Company, there is little
long-term experience with human consumption of certain of these innovative
product ingredients or combinations thereof in concentrated form. Although the
Company performs research and/or tests the formulation and production of its
products, it has only sponsored limited clinical studies.
RISKS ASSOCIATED WITH IMPLEMENTATION OF THE BUSINESS
STRATEGY. Implementation of the Company's business strategy is subject to risks
and uncertainties, including certain factors that are within the Company's
control and other factors that are outside of the Company's control. In
addition, certain elements of the Company's business strategy, notably the
acquisition of complementary businesses or product lines, could result in
significant expenditures of cash and management resources. See "--Risk
Associated with Acquisitions." Finally, implementation of the Company's business
strategy is subject to risks associated with market and competitive conditions.
See "--Competition" and "--No Assurance of Future Industry Growth."
RISKS ASSOCIATED WITH ACQUISITIONS. The Company has completed eight
acquisitions, including the Solaray acquisition, since 1993 and expects to
pursue additional acquisitions in the future as a key component of the Company's
business strategy. See "Business--General." There can be no assurance that
attractive acquisition opportunities will be available to the Company, that the
Company will be able to obtain financing for or otherwise consummate any future
acquisitions or that any acquisitions
13
which are consummated will prove to be successful. Moreover, acquisitions
involve numerous risks, including the risk that the acquired business will not
perform in accordance with expectations, difficulties in the integration of the
operations and products of the acquired businesses with the Company's other
businesses, the diversion of management's attention from other aspects of the
Company's business, the risks associated with entering geographic and product
markets in which the Company has limited or no direct prior experience and the
potential loss of key employees of the acquired business. The acquisition of
another business can also subject the Company to liabilities and claims arising
out of such business. In addition, future acquisitions would likely require
additional financing, which would likely result in an increase in the Company's
indebtedness or the issuance of additional capital stock which could be dilutive
to holders of Common Stock. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital Resources."
CONTROL AND INFLUENCE BY EXISTING STOCKHOLDERS. Investment funds (the "Bain
Capital Funds") controlled by Bain Capital, in conjunction with holdings by
Company officers, beneficially own over 50% of the outstanding Common Stock. By
virtue of such stock ownership, these parties may be able to exert significant
influence over the election of the members of the Company's Board of Directors
and to exert significant influence over the affairs of the Company. Such
concentration of ownership could also have the effect of delaying, deterring or
preventing a change in control of the Company that might otherwise be beneficial
to stockholders. In addition, two representatives of Bain Capital currently
serve on the Company's Board of Directors. There can be no assurance that
conflicts of interest will not arise with respect to such Directors or that such
conflicts will be resolved in a manner favorable to the Company.
VOLATILITY OF STOCK PRICE. The market price of the Common Stock may
fluctuate significantly. These fluctuations could result from, among other
things, variations in the Company's results of operations, which could be
adversely affected by a number of factors (some which are beyond the Company's
control), including economic downturns, variations in demand for nutritional
supplements, changes in the mix of products sold, price changes in response to
competition, increases in the cost of raw materials and possible supply
shortages. In particular, the market price of the Common Stock could be
materially adversely affected by reports by official or unofficial health and
medical authorities and the general media regarding the potential health
benefits or detriments of products sold by the Company or of similar products
distributed by other companies regardless of whether such reports are
scientifically supported and regardless of whether the Company's operating
results are likely to be affected by such reports, as well as by consumer
perceptions regarding the safety and efficacy of nutritional supplements and
consumer preferences generally. In addition, the stock market in general has
experienced wide price and volume fluctuations in recent periods, and these
fluctuations may be unrelated to the operating performance of the specific
issuers whose stock is affected. Furthermore, the stock prices of many
publicly-traded companies in the VMS Industry (including Nutraceutical) have
experienced a significant downturn; there is no assurance that this trend will
change, or not continue to affect any specific company, despite the operating
performance of such companies or any individual company.
SHARES ELIGIBLE FOR FUTURE SALE. No prediction can be made as to the
effect, if any, that sales of shares of Common Stock or the availability of
shares of Common Stock for sale will have on the market price of the Common
Stock from time to time. The sale of a substantial number of shares held by
existing stockholders, whether pursuant to subsequent public offerings or
otherwise, or the perception that such sales could occur, could adversely affect
the market price of the Common Stock and could materially impair the Company's
future ability to raise capital through an offering of equity securities.
14
CERTAIN ANTI-TAKEOVER EFFECTS. Certain provisions of the Company's Restated
Certificate of Incorporation (the "Restated Certificate") and Amended and
Restated By-laws (the "By-laws") may inhibit changes in control of the Company
not approved by the Company's Board of Directors. These provisions include
(i) a classified Board of Directors, (ii) a prohibition on stockholder action
through written consents, (iii) a requirement that special meetings of
stockholders be called only by the Board of Directors, (iv) advance notice
requirements for stockholder proposals and nominations, (v) limitations on the
ability of stockholders to amend, alter or repeal the By-laws and (vi) the
authority of the Board to issue without stockholder approval preferred stock,
with such terms as the Board may determine. The Company is also afforded the
protections of Section 203 of the Delaware General Corporation Law, which could
have similar effects.
RISKS ASSOCIATED WITH COMPETITION. The VMS Industry is highly competitive.
Certain of the Company's principal competitors are larger than the Company, have
greater access to capital and may be better able to withstand volatile market
conditions within the VMS Industry. Moreover, because this industry generally
has low barriers to entry, additional competitors could enter the market at any
time. Private label products of the Company's customers also provide competition
to the Company's products. Although the Company does not compete in the mass
market retail channel of distribution, it is possible that as increasing numbers
of companies sell nutritional supplement products in the mass market channels,
these product offerings may affect sales in the Healthy Foods Channel. In that
regard, although the VMS Industry to date has been characterized by many
relatively small participants, there can be no assurance that additional
national or international companies (which may include additional pharmaceutical
companies or additional suppliers to mass merchandisers) will not seek in the
future to enter or to increase their presence in the VMS Market. Increased
competition in the VMS Market could have a material adverse effect on the
Company. See "Business--Competition."
RISK OF LIMITED SUPPLY SOURCES; DEPENDENCE ON FOREIGN SUPPLIERS. The
Company believes that its continued success will depend upon the availability of
raw materials that permit the Company to meet its labeling claims, quality
control standards and desire for unique ingredients. Due to issues relating to
quality or third-party intellectual property rights, a number of the Company's
branded products contain one or more ingredients that may only be available from
a single source or supplier. In addition, the supply of herbal products is
subject to the same risks normally associated with agricultural production, such
as climatic conditions, insect infestations and availability of manual labor or
equipment for harvesting. Any significant delay in or disruption of the supply
of raw materials could substantially increase the cost of such materials, could
require product reformulations, the qualification of new suppliers and
repackaging and could result in a substantial reduction or termination by the
Company of its sales of certain products, any of which could have a material
adverse effect upon the Company. Accordingly, there can be no assurance that the
disruption of the Company's supply sources will not have a material adverse
effect on the Company.
Although the Company acquires the majority of its raw materials from
domestic suppliers, the ingredients of a number of the Company's products
include one or more ingredients that originate outside of the United States. The
Company's business is therefore subject to the risks generally associated with
doing business outside the United States, such as delays in shipments,
embargoes, changes in economic and political conditions, tariffs, foreign
exchange rates and trade disputes. The Company's business is also subject to the
risks associated with the enactment of United States and foreign legislation and
regulations relating to imports and exports, including quotas, duties, taxes or
other charges or restrictions that could be imposed upon the importation of
products into the United States. See "Business--Materials and Suppliers." These
factors could result in a delay in or disruption of the supply of certain raw
materials and could have the consequences described in the preceding paragraph,
any of which could have a material adverse effect on the Company.
15
RISKS ASSOCIATED WITH INTERNATIONAL MARKETS. The Company's continued growth
is dependent in part upon its ability to expand its operations into new markets,
including international markets. The Company may experience difficulty entering
new international markets due to greater regulatory barriers, the necessity of
adapting to new regulatory systems and problems related to entering new markets
with different cultural bases and political systems. Operating in international
markets exposes the Company to certain risks, including, among other things:
(i) changes in or interpretations of foreign regulations that may limit the
Company's ability to sell certain products or repatriate profits to the United
States, (ii) exposure to currency fluctuations, (iii) the potential imposition
of trade or foreign exchange restrictions or increased tariffs and
(iv) political instability. As the Company continues to expand its international
operations, these and other risks associated with international operations are
likely to increase. See "Business--General."
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain statements contained herein under "Business," and "Management's
Discussion and Analysis of Financial Condition and Results of Operations,"
including statements concerning (i) the Company strategy, (ii) the Company's
expansion plans, (iii) the market for the Company's products, (iv) the effects
of government regulation of the Company's products and (v) the effects on the
Company of certain legal proceedings, contain certain forward-looking statements
concerning the Company's operations, economic performance and financial
condition. Because such statements involve risks and uncertainties, actual
results may differ materially from those expressed or implied by such
forward-looking statements. Factors that could cause such differences include,
but are not limited to, those discussed under "Risk Factors."
ITEM 2. PROPERTIES.
The following table describes the principal properties of the Company as of
September 30, 2000:
PURPOSE LOCATION SQUARE FOOTAGE
- ------- ------------------------ --------------
RRC*................................................. Ogden, Utah 360,036
Brand manufacturing**................................ Ogden, Utah 31,230
Eastern distribution................................. Memphis, Tennessee 24,700
Monarch manufacturing***............................. Ogden, Utah 20,800
Woodland Publishing.................................. Lindon, Utah 12,820
Brand marketing and product development.............. Park City, Utah 10,446
Administrative offices and customer services***...... Ogden, Utah 8,855
Executive offices and corporate sales and
marketing........................................... Park City, Utah 6,103
Raw material (honey and powder room)***.............. Ogden, Utah 5,000
Information systems and data management.............. Park City, Utah 3,228
Langley, British
Canadian distribution................................ Columbia 2,817
Action Labs sales and marketing...................... Long Island, New York 2,499
Research, development and quality control............ Ogden, Utah 1,813
United Kingdom sales and marketing................... Brighton, United Kingdom 580
- ------------------------
* The Company's Rapid Response Center ("RRC") is the central facility where
the Company is, and has been, consolidating operations. RRC currently
includes raw materials, manufacturing, packaging, distribution and offices.
** With the exception of this property, which is owned by the Company, the
Company leases all of the principal properties identified above. Lease terms
with respect to such properties end between fiscal years 2001 and 2004,
although the Company has negotiated early termination and extension options
in many cases. With respect to RRC, the Company also holds certain purchase
options.
*** The operations currently housed in these facilities are expected to be moved
to the Company's RRC facility in Ogden, Utah.
16
ITEM 3. LEGAL PROCEEDINGS.
As discussed in other filings and elsewhere in this Form 10-K, the Company
is subject to regulation by a number of federal, state and foreign agencies and
is involved in various legal matters arising in the normal course of business.
Material legal and regulatory matters referred to in previous filings, as well
as new matters, include the following: (i) in March 1996, International
Nutrition Company filed suit against, among others, the Company alleging
violation of a United States patent for Pycnogenol and related trademarks; in
March 2000, the United States District Court awarded summary judgment on behalf
of the Company and other defendants with regard to the patent claims and the
Plaintiff has appealed the decision to the United States Federal Circuit court,
(ii) in January 1999, the Company was sued by American Home Products, the owner
of the Solgar line of dietary supplements; the lawsuit alleges that the
Company's registered mark Solar Green infringes on the registered mark Solgar,
(iii) in October 1999, Futurebiotics filed a complaint against the Company in
New York State Court alleging a violation of the confidentiality agreement
between the parties as it pertains to trade secrets and the Futurebiotics'
product "Hair, Skin & Nails," (iv) in December 1999, the Company was sued by
Enzymatic Therapy, Inc. and Abulkalam M. Shamsuddin, M.D., claiming, among other
things, that the Solaray brand IP-6 product infringes on the plaintiffs' patent
rights.
The FDA and the United States Attorney's Office have continued the
investigation of certain matters originating with the January 20, 1998
Proposition 65 notice received by Monarch; the Company has received grand jury
subpoenas for documents with respect to the investigation; the Company continues
to cooperate with the FDA and the United States Attorney's Office in the
investigation of these matters. For more information on regulatory matters, see
"Business--Government Regulation."
The Company carries insurance coverage in the types and amounts that
management considers reasonably adequate to cover the risks it faces in the
industry in which it competes. There can be no assurance, however, that such
insurance coverage will be adequate to cover all losses which the Company may
incur in future periods or that coverage will be available for all of the types
of claims the Company faces or may face.
In the opinion of management, the Company's liability, if any, arising from
regulatory and legal proceedings related to these matters, and others in which
it is involved, is not expected to have a material adverse effect on the
Company's financial position, results of operations or cash flows.
17
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS.
None.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT.
The following table sets forth certain information concerning the executive
officers of the Company.
NAME AGE POSITION
- ---- -------- --------------------------------------------------------
Frank W. Gay II............. 55 Director, Chairman of the Board and Chief Executive
Officer
Bruce R. Hough.............. 46 President
Jeffrey A. Hinrichs......... 43 Director, Executive Vice President, Chief Operating
Officer and Secretary
Gary M. Hume................ 51 Executive Vice President
Leslie M. Brown, Jr......... 36 Senior Vice President, Finance, Chief Financial Officer
and Assistant Secretary
Frank W. Gay II has served as the Chairman of the Board of Directors of the
Company since its inception and as Chief Executive Officer since 1994. Mr. Gay
has been a partner of F.W. Gay & Sons, a private equity investment group, from
1967 to present.
Bruce R. Hough was made President of the Company in 1994. Prior to joining
the Company, Mr. Hough acted as a consultant from 1991 to 1993 and as President
of Keystone Communications, a telecommunications firm, from 1987 to 1991.
Jeffrey A. Hinrichs has served as Executive Vice President and Chief
Operating Officer of the Company since 1994. Prior to joining the Company,
Mr. Hinrichs served as President of Solaray from 1993 to 1994 and as Chief
Financial Officer, and in other management positions, with Solaray from 1984 to
1993.
Gary M. Hume has served as Executive Vice President of the Company since
September 1999. Prior to joining the Company, Mr. Hume was President and CEO of
Murdock Madaus Schwabe (Nature's Way) from 1995 to 1999. Prior to joining
Nature's Way, Mr. Hume was President of Tree of Life's Southwest Division for
over twenty years.
Leslie M. Brown, Jr. joined the Company in January 1995 as Vice President
and Controller. Mr. Brown became Senior Vice President, Finance and Chief
Financial Officer in October 1997. Prior to joining the Company, he was employed
by Price Waterhouse LLP. Mr. Brown is a Certified Public Accountant.
18
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
MARKET INFORMATION
The Company's Common Stock is traded on the Nasdaq National Market (the
"NNM") under the symbol "NUTR." The Common Stock commenced trading on
February 20, 1998. The following table sets forth the high and low closing
prices per share for the Common Stock:
HIGH LOW
-------- --------
1998:
Second Quarter (from February 20, 1998)..................... $23.63 $19.88
Third Quarter............................................... 22.25 8.50
Fourth Quarter.............................................. 12.75 5.88
1999:
First Quarter............................................... 7.69 4.69
Second Quarter.............................................. 6.00 4.06
Third Quarter............................................... 5.38 3.69
Fourth Quarter.............................................. 6.38 3.88
2000:
First Quarter............................................... 4.81 3.31
Second Quarter.............................................. 4.06 3.38
Third Quarter............................................... 3.75 2.97
Fourth Quarter.............................................. 3.69 2.66
2001:
First Quarter (through December 6, 2000).................... 2.94 1.94
HOLDERS
As of the close of business on December 6, 2000, there were 282 holders of
record of Common Stock. The Company believes that it has a significantly larger
number of beneficial holders of Common Stock. A recently reported last sale
price of the Common Stock on the NNM is set forth on the cover page of this
report.
DIVIDENDS
Since its incorporation in 1993, the Company has neither declared nor paid
any cash or other dividends on its Common Stock and does not expect to pay
dividends for the foreseeable future. Instead, the Company currently intends to
retain earnings to support its growth strategy and reduce indebtedness. Any
future determination by the Company to pay dividends will be at the discretion
of the Company's Board of Directors and will depend upon, among other factors,
the Company's results of operations, financial condition, capital requirements
and contractual restrictions, including restrictions specified in the Company's
credit agreement dated February 25, 1998 (the "New Credit Agreement").
ITEM 6. SELECTED FINANCIAL DATA.
The selected financial data presented below were derived from the
consolidated financial statements of the Company. This selected financial data
should be read in conjunction with
19
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Company's consolidated financial statements and the notes
thereto.
YEAR ENDED SEPTEMBER 30,
--------------------------------------------------------------
1996 1997 1998 1999 2000
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
CONSOLIDATED STATEMENT OF
OPERATIONS DATA:
Net sales.......................... $ 83,923 $ 98,096 $ 104,688 $ 106,809 $ 106,813
Cost of sales...................... 45,099 52,277 57,750 57,261 55,658
---------- ---------- ---------- ---------- ----------
Gross profit..................... 38,824 45,819 46,938 49,548 51,155
Operating expenses:
Selling, general and
administrative................. 27,308 28,879 31,233 36,644 37,178
Amortization of intangibles...... 1,483 1,346 1,391 1,768 1,735
Non-recurring payments to
management advisors............ 300 300 1,135 -- --
One-time payment to executive
officer........................ -- 1,700 -- -- --
---------- ---------- ---------- ---------- ----------
Income from operations............. 9,733 13,594 13,179 11,136 12,242
Interest expense, net.............. 7,126 6,572 3,971 2,493 3,060
---------- ---------- ---------- ---------- ----------
Income before provision for income
taxes............................. 2,607 7,022 9,208 8,643 9,182
Provision for income taxes......... 1,056 2,774 3,509 3,370 3,581
---------- ---------- ---------- ---------- ----------
Net income before extraordinary
loss.............................. 1,551 4,248 5,699 5,273 5,601
Extraordinary loss on early
extinguishment of debt, net of
tax............................... -- -- (3,129) -- --
---------- ---------- ---------- ---------- ----------
Net income......................... $ 1,551 $ 4,248 $ 2,570 $ 5,273 $ 5,601
========== ========== ========== ========== ==========
Net income before extraordinary
loss per common share, basic...... $ 0.17 $ 0.46 $ 0.53 $ 0.45 $ 0.49
Net income before extraordinary
loss per common share, diluted.... $ 0.15 $ 0.40 $ 0.48 $ 0.42 $ 0.46
Net income per common share,
basic............................. $ 0.17 $ 0.46 $ 0.24 $ 0.45 $ 0.49
Net income per common share,
diluted........................... $ 0.15 $ 0.40 $ 0.22 $ 0.42 $ 0.46
Weighted average shares
outstanding, basic................ 9,308,583 9,308,583 10,806,178 11,729,587 11,509,168
Weighted average shares
outstanding, diluted.............. 10,421,667 10,502,749 11,902,348 12,494,179 12,204,945
OTHER FINANCIAL DATA:
Adjusted EBITDA.................... $ 13,118 $ 19,563 $ 19,410 $ 17,082 $ 18,307
Capital expenditures (excluding
acquisitions)..................... 5,498 3,652 3,380 7,904 6,552
Cash flows provided by (used in):
Operating activities............. 4,559 9,363 10,063 6,528 15,604
Investing activities............. (5,498) (3,652) (17,815) (9,058) (8,953)
Financing activities............. 2,600 (3,617) 5,309 1,423 (5,742)
BALANCE SHEET DATA (AT PERIOD END):
Cash............................... $ 2,321 $ 4,415 $ 1,967 $ 869 $ 1,773
Working capital.................... 19,727 15,616 24,047 29,249 27,714
Total assets....................... 84,755 90,110 104,308 108,644 108,329
Total debt......................... 63,657 60,259 37,133 38,830 38,022
Stockholders' equity............... 12,091 16,354 51,622 57,290 57,944
20
"Adjusted EBITDA" is defined herein as net income before extraordinary loss
plus provision for income taxes, net interest expense, depreciation and
amortization and other non-recurring items. Management believes that Adjusted
EBITDA, as presented, represents a useful measure for assessing the performance
of the Company's ongoing operating activities as it reflects the earnings trends
of the Company without the impact of the purchase accounting applied in
connection with the Company's history of acquisitions, the financing required to
consummate such transactions and other non-recurring items. Targets and trends
in Adjusted EBITDA are used as a performance measure for determining
management's bonus compensation and are also used by the Company's creditors in
assessing debt covenant compliance. The Company understands that while Adjusted
EBITDA is frequently used by securities analysts in the evaluation of
nutritional supplement companies, it is not necessarily comparable to other
similarly titled captions of other companies due to potential inconsistencies in
the method of calculation. Adjusted EBITDA is not intended as an alternative to
cash flows from operating activities, as a measure of liquidity or as an
alternative to net income as an indicator of the Company's operating performance
or any other measure of performance in accordance with generally accepted
accounting principles. The following table sets forth a reconciliation of net
income before extraordinary loss to Adjusted EBITDA for each period included
herein:
YEAR ENDED SEPTEMBER 30,
----------------------------------------------------
1996 1997 1998 1999 2000
-------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
Net income before extraordinary loss........... $ 1,551 $ 4,248 $ 5,699 $ 5,273 $ 5,601
Provision for income taxes..................... 1,056 2,774 3,509 3,370 3,581
Interest expense, net(1)....................... 7,126 6,572 3,971 2,493 3,060
Depreciation and amortization(2)............... 3,085 3,969 5,096 5,946 6,065
Non-recurring payments to management
advisors(3).................................. 300 300 1,135 -- --
One-time payment to executive officer(4)....... -- 1,700 -- -- --
------- ------- ------- ------- -------
Adjusted EBITDA................................ $13,118 $19,563 $19,410 $17,082 $18,307
======= ======= ======= ======= =======
- ------------------------
(1) Includes amortization of capitalized debt issuance costs.
(2) Includes non-recurring amortization of inventory write-up.
(3) Represents management fees paid to Bain Capital and F.W. Gay & Sons pursuant
to a management advisory agreement, which was terminated in connection with
the Company's initial public offering (the "Offering"). As is often the case
in stand-alone acquisition scenarios such as the Company's original
acquisition of Solaray, during the early stages of the Company's development
it relied heavily on an affiliate of its equity sponsors, Bain Capital, to
provide certain management services, paying a recurring annual fee pursuant
to the management advisory agreement in respect of such services. Over time,
the Company has developed the infrastructure to provide these services
internally and, as a result, terminated the management advisory agreement
(and the recurring management fees payable thereunder) upon consummation of
the Offering.
(4) Reflects a one-time payment to the Company's chief executive officer for
successfully positioning the Company for the Offering. Such payment is in
excess of the chief executive officer's annual compensation (salary and
bonus), and the Company does not expect to make any further payments of this
nature or magnitude in the future.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion and analysis of the Company's financial condition
and results of operations should be read in conjunction with the Company's
audited consolidated financial statements and accompanying notes thereto
included elsewhere in this Form 10-K.
21
OVERVIEW
The Company was formed in 1993 by senior management and Bain Capital to
effect a consolidation strategy in the fragmented VMS Industry. The Company
purchased Solaray in October 1993 with a view toward using it as a platform for
future acquisitions of businesses in the VMS Industry. In fiscal 1995, the
Company completed three acquisitions: Premier One in October 1994,
KAL/NaturalMax in January 1995 and Monarch in September 1995 (collectively, the
"Fiscal 1995 Acquisitions"). In fiscal 1998, the Company completed two
acquisitions: Action Labs in July 1998 and NutraForce Canada in August 1998
(collectively, the "Fiscal 1998 Acquisitions"). In fiscal 1999, the Company
completed two acquisitions: Woodland Publishing, Inc. and Summit Graphics, Inc.
in April 1999 (collectively, the "Fiscal 1999 Acquisitions"). In fiscal 2000,
the Company completed one acquisition: Thompson in May of 2000 (the "Fiscal 2000
Acquisition").
RESULTS OF OPERATIONS
The following table sets forth certain consolidated statements of operations
data as a percentage of net sales for the periods indicated:
YEAR ENDED
SEPTEMBER 30,
------------------------------------
1998 1999 2000
-------- -------- --------
Net sales................................................... 100.0% 100.0% 100.0%
Cost of sales............................................... 55.2 53.6 52.1
----- ----- -----
Gross profit................................................ 44.8 46.4 47.9
Selling, general and administrative......................... 29.8 34.3 34.8
Amortization of intangibles................................. 1.3 1.7 1.6
Non-recurring payments to management advisors............... 1.1 -- --
----- ----- -----
Income from operations...................................... 12.6 10.4 11.5
Interest expense, net....................................... 3.8 2.3 2.9
----- ----- -----
Income before provision for income taxes.................... 8.8 8.1 8.6
Provision for income taxes.................................. 3.4 3.2 3.4
----- ----- -----
Net income before extraordinary loss........................ 5.4 4.9 5.2
Extraordinary loss on early extinguishment of debt, net of
tax....................................................... (2.9) -- --
----- ----- -----
Net income.................................................. 2.5% 4.9% 5.2%
===== ===== =====
COMPARISON OF FISCAL 2000 TO FISCAL 1999
NET SALES. Net sales remained flat at $106.8 million for fiscal 2000 and
for fiscal 1999. Net sales of branded products increased by $3.3 million, or
3.5%, to $96.3 million for fiscal 2000 from $93.0 million for fiscal 1999. This
increase in net sales of branded products was primarily the result of increased
sales volume. The Company believes that the increased volume was primarily
attributable to modest industry growth, the success of new product
introductions, and to a lesser extent, the Fiscal 1999 Acquisitions. Net sales
of bulk materials decreased by $3.3 million, or 23.8%, to $10.5 million for
fiscal 2000 from $13.8 million for fiscal 1999. This decrease in net sales of
bulk materials was primarily attributable to reduced sales of certain
commodity-based materials to key customers.
22
GROSS PROFIT. Gross profit increased by $1.7 million, or 3.2%, to
$51.2 million for fiscal 2000 from $49.5 million for fiscal 1999. As a
percentage of net sales, gross profit increased to 47.9% for fiscal 2000 from
46.4% for fiscal 1999. This increase in gross profit was primarily attributable
to improvements in direct material pricing and, to a lesser extent, a shift in
sales mix to a higher proportion of branded product sales, which have higher
gross profit margins, relative to bulk material sales, which have lower gross
profit margins. During fiscal 2000, direct material pricing improved due to new
material sources, increased supplier competition and reduced packaging costs,
which were higher during fiscal 1999 due to bottle and label conversions
associated with the Company's efforts to enhance quality and to comply with
labeling laws mandated by the FDA.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased by $0.6 million, or 1.5%, to $37.2 million for
fiscal 2000 from $36.6 million for fiscal 1999. As a percentage of net sales,
selling, general and administrative expenses increased to 34.8% for fiscal 2000
from 34.3% for fiscal 1999. This increase in selling, general and administrative
expenses as a percentage of net sales was primarily attributable to the
Company's investment in sales force conversion (from independent contractors to
employees), facility consolidation and the addition of key management personnel.
AMORTIZATION OF INTANGIBLES. Amortization of intangibles remained
relatively flat at $1.7 million for fiscal 2000 from $1.8 million for fiscal
1999. As a percentage of net sales, amortization of intangibles decreased to
1.6% for fiscal 2000 from 1.7% for fiscal 1999.
INTEREST EXPENSE, NET. Interest expense increased by $0.6 million, or
22.7%, to $3.1 million for fiscal 2000 from $2.5 million for fiscal 1999. As a
percentage of net sales, interest expense increased to 2.9% for fiscal 2000 from
2.3% for fiscal 1999. This increase in interest expense was primarily
attributable to increased interest rates.
PROVISION FOR INCOME TAXES. The Company's effective tax rate remained
constant at 39.0% for both fiscal 2000 and fiscal 1999. In each fiscal year, the
effective tax rate is higher than statutory rates primarily due to state tax
considerations.
COMPARISON OF FISCAL 1999 TO FISCAL 1998
NET SALES. Net sales increased by $2.1 million, or 2.0%, to $106.8 million
for fiscal 1999 from $104.7 million for fiscal 1998. Net sales of branded
products increased by $4.6 million, or 5.3%, to $93.0 million for fiscal 1999
from $88.4 million for fiscal 1998. This increase in net sales of branded
products was primarily the result of increased sales volume. The Company
believes that the increased volume was primarily attributable to industry
growth, the success of new product introductions, the Fiscal 1998 Acquisitions
and the Fiscal 1999 Acquisitions. Net sales of bulk materials decreased by
$2.5 million, or 15.5%, to $13.8 million for fiscal 1999 from $16.3 million for
fiscal 1998. This decrease in net sales of bulk materials was primarily
attributable to reduced sales of certain commodity-based materials to key
customers.
GROSS PROFIT. Gross profit increased by $2.6 million, or 5.6%, to
$49.5 million for fiscal 1999 from $46.9 million for fiscal 1998. This increase
in gross profit was primarily attributable to growth in sales volume. As a
percentage of net sales, gross profit increased to 46.4% for fiscal 1999 from
44.8% for fiscal 1998. This increase in gross profit as a percentage of net
sales was primarily attributable to improvements in direct material pricing and,
to a lesser extent, a shift in sales mix to a higher proportion of branded
product sales, which have higher gross profit margins, relative to bulk material
sales, which have lower gross profit margins. During fiscal 1999, direct
material pricing improved due to new material sources, increased supplier
competition and reduced packaging costs, which were higher during fiscal 1998
due to bottle and label conversions associated with the Company's efforts to
enhance quality and to comply with new labeling laws mandated by the FDA.
23
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased by $5.4 million, or 17.3%, to $36.6 million
for fiscal 1999 from $31.2 million for fiscal 1998. As a percentage of net
sales, selling, general and administrative expenses increased to 34.3% for
fiscal 1999 from 29.8% for fiscal 1998. This increase in selling, general and
administrative expenses as a percentage of net sales was primarily attributable
to the Company's investment in the addition of certain executive and key
management personnel, facility consolidation, sales force expansion, new
business development and information systems, including increased amortization
associated with prior year capital expenditures.
AMORTIZATION OF INTANGIBLES. Amortization of intangibles increased by
$0.4 million, or 27.1%, to $1.8 million for fiscal 1999 from $1.4 million for
fiscal 1998. As a percentage of net sales, amortization of intangibles increased
to 1.7% for fiscal 1999 from 1.3% for fiscal 1998. This increase in amortization
of intangibles was primarily attributable to the Fiscal 1998 Acquisitions.
During fiscal 1999, twelve months of amortization expense related to these
acquisitions was incurred compared to approximately two months of amortization
expense for fiscal 1998.
NON-RECURRING PAYMENTS TO MANAGEMENT ADVISORS. Non-recurring payments to
management advisors represent payments pursuant to a management advisory
agreement which was terminated in connection with the Offering in fiscal 1998.
INTEREST EXPENSE, NET. Interest expense decreased by $1.5 million, or
37.2%, to $2.5 million for fiscal 1999 from $4.0 million for fiscal 1998. As a
percentage of net sales, interest expense decreased to 2.3% for fiscal 1999 from
3.8% for fiscal 1998. This decrease in interest expense was primarily
attributable to decreased indebtedness resulting from debt repayments made with
proceeds of the Offering, which occurred during the second quarter of fiscal
1998.
PROVISION FOR INCOME TAXES. The Company's effective tax rate increased to
39.0% for fiscal 1999 from 38.1% for fiscal 1998. In each fiscal year, the
effective tax rate is higher than statutory rates primarily due to state tax
considerations.
EXTRAORDINARY LOSS ON EARLY EXTINGUISHMENT OF DEBT. An extraordinary loss
on early extinguishment of debt of $3.1 million, net of tax, was recognized in
fiscal 1998. This loss was incurred at the time of the Offering in connection
with the New Credit Agreement, which was used to extinguish previous debt
arising from the Company's previous credit agreement (the "Senior Credit
Agreement").
SELECTED QUARTERLY FINANCIAL DATA; SEASONALITY
The following table sets forth certain quarterly financial data for fiscal
1999 and 2000. This quarterly information is unaudited, has been prepared on the
same basis as the annual financial statements and, in the opinion of the
Company's management, reflects all normally recurring adjustments necessary for
fair presentation of the information for the periods presented. Operating
results for any quarter are not necessarily indicative of results for any future
period.
FISCAL 1999 FISCAL 2000
----------------------------------------- -----------------------------------------
FIRST SECOND THIRD FOURTH FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER
-------- -------- -------- -------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA: UNAUDITED)
Net sales..................... $27,213 $27,234 $26,212 $26,150 $27,650 $28,674 $25,552 $24,937
Gross profit.................. 12,189 12,818 12,362 12,179 13,132 13,736 12,297 11,990
Net income.................... 1,813 1,740 936 784 1,608 1,735 1,212 1,046
Net income per common share:
Basic....................... $ 0.16 $ 0.15 $ 0.08 $ 0.07 $ 0.14 $ 0.15 $ 0.11 $ 0.10
Diluted..................... $ 0.15 $ 0.14 $ 0.07 $ 0.06 $ 0.13 $ 0.14 $ 0.10 $ 0.09
24
The Company believes that its business is characterized by minor
seasonality. Furthermore, sales to any particular customer can vary
substantially from one quarter to the next based on such factors as industry
trends, timing of promotional discounts, international economic conditions and
acquisition-related activities. Historically, the Company has recorded higher
branded products sales volume during the second fiscal quarter due to increased
interest in health-related products among consumers following the holiday
season. The Company does not believe that the impact of seasonality on its
results of operations is material. In addition, the Company's sales of bulk
materials are characterized by periodic shipments to certain customers and can
vary significantly from quarter to quarter.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operations was $15.6 million, $6.5 million and
$10.1 million for the years ended September 30, 2000, 1999 and 1998,
respectively. The increase in net cash provided by operations in fiscal 2000 was
primarily attributable to lower levels of inventories.
Net cash used in investing activities was $9.0 million, $9.1 million and
$17.8 million for the years ended September 30, 2000, 1999 and 1998,
respectively. The Company's investing activities consist primarily of capital
expenditures and acquisitions. Capital expenditures during the years ended
September 30, 2000, 1999 and 1998 related primarily to manufacturing equipment
and information systems and, to a lesser extent, distribution equipment required
to expand capacity and improve overall operating efficiency. In fiscal 2000 and
1999, expenditures were incurred related to leasehold improvements at the RRC
facility. The Company intends to finance anticipated capital expenditures
through internally generated cash flow and, if necessary, through funds provided
under the New Credit Agreement.
Net cash provided by (used in) financing activities was $(5.7) million,
$1.4 million and $5.3 million for the years ended September 30, 2000, 1999 and
1998, respectively. The Company's financing activities consist primarily of
borrowings and repayments under the Senior Credit Agreement and the New Credit
Agreement related to operating needs. In fiscal 2000, the Company's financing
activities were significantly impacted by purchases of common stock for treasury
and outstanding warrant rights. In fiscal 1998, the Company's financing
activities were significantly impacted by proceeds generated in connection with
the Offering.
The New Credit Agreement currently makes $70.0 million of revolving credit
borrowings available to the Company. The available revolving credit borrowings
are reduced to $65.0 million, $45.0 million and $37.5 million during fiscal
2001, 2002 and 2003, respectively. The reduction during fiscal 2001 occurs
quarterly beginning April 30, 2001 with reductions of $2.5 million per quarter
for two quarters. Borrowings under the New Credit Agreement are secured by
certain assets of the Company and bear interest at the applicable Eurodollar
Rate plus a variable margin or at the Federal Funds Rate plus 0.5% plus a
variable margin. At September 30, 2000, the applicable interest rate was 8.00%.
The Company is also required to pay a variable quarterly fee on the unused
balance under the New Credit Agreement. At September 30, 2000, the applicable
rate was 0.35%.
Accrued interest on Federal Funds Rate borrowings is payable quarterly.
Accrued interest on Eurodollar Rate borrowings is payable based on an elected
interval of one, two or three months. The Company is required to pay all
principal outstanding under the New Credit Agreement in January 2003.
The New Credit Agreement contains restrictive covenants, including
restrictions on incurring other indebtedness, limitations on capital
expenditures, requirements that the Company maintain a minimum level of
consolidated net worth, a minimum ratio of cash flow to fixed charges, a minimum
level of Adjusted EBITDA, and a maximum ratio of debt to Adjusted EBITDA. Upon
the occurrence of an event of default under the New Credit Agreement, the lender
may require the Company to repay all amounts borrowed thereunder and may proceed
against the collateral. The New Credit Agreement also
25
restricts the Company's ability to make certain payments, including the payment
of dividends on its Common Stock and payments with respect to certain capital
expenditures, without the approval of its lenders.
A key component of the Company's business strategy is to seek to make
additional acquisitions, which will likely require that the Company obtain
additional financing, which could include the incurrence of substantial
additional indebtedness. The Company believes that borrowings under the New
Credit Agreement or a replacement credit facility, together with cash flows from
operations, will be sufficient to make required payments under the New Credit
Agreement or any such replacement facility, and to make anticipated capital
expenditures and fund working capital needs for fiscal 2001.
NEW ACCOUNTING STANDARDS
The Securities and Exchange Commission issued Staff Accounting Bulletin 101,
REVENUE RECOGNITION IN FINANCIAL STATEMENTS ("SAB 101") effective for fiscal
years beginning after December 15, 1999. SAB 101 reaffirms and provides guidance
for standards of revenue recognition in financial statements. The Company does
not expect the adoption of this standard to have a significant impact on its
financial statements.
The Financial Accounting Standards Board issued FASB Interpretation No. 44,
ACCOUNTING FOR CERTAIN TRANSACTIONS INVOLVING STOCK COMPENSATION ("FIN 44")
effective July 1, 2000. FIN 44 provides guidance for certain transactions
involving stock compensation. The Company has adopted FIN 44 in its financial
statements.
INFLATION
Inflation affects the cost of raw materials, goods and services used by the
Company. In recent years, inflation has been modest. The competitive environment
somewhat limits the ability of the Company to recover higher costs resulting
from inflation by raising prices. Overall product prices have generally been
stable and the Company seeks to mitigate the adverse effects of inflation
primarily through improved productivity and cost containment programs. The
Company does not believe that inflation has had a material impact on its results
of operations for the periods presented, except with respect to payroll-related
costs.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
Borrowings under the New Credit Agreement bear interest at the applicable
Eurodollar Rate plus a variable margin or at the Federal Funds Rate plus 0.5%
plus a variable margin. At September 30, 2000, the applicable interest rate was
8.00% and the Company had total borrowings outstanding of $38.0 million. To
date, the Company has not obtained interest rate protection with respect to
these borrowings.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The information required by Item 8 is set forth on pages F-1 through F-19 of
this Form 10-K. The supplementary financial information required by Item 302 of
Regulation S-K is set forth in "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Selected Quarterly Financial
Data; Seasonality."
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
26
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Information with respect to Directors of the Company is set forth in the
Proxy Statement under the heading "The Board of Directors," which information is
incorporated herein by reference. Information regarding the executive officers
of the Company is included as Item 4A of Part I of the Form 10-K as permitted by
Instruction 3 to Item 401(b) of Regulation S-K. Information required by Item 405
of Regulation S-K is set forth in the Proxy Statement under the heading
"Section 16(a) Beneficial Ownership Reporting Compliance," which information is
incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION.
Information with respect to executive compensation is set forth in the Proxy
Statement under the heading "Executive Compensation," which information is
incorporated herein by reference (except for the Compensation Committee Report
and the Performance Graph).
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Information with respect to security ownership of certain beneficial owners
and management is set forth in the Proxy Statement under the heading "Principal
Stockholders," which information is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Information with respect to certain relationships and related transactions
is set forth in the Proxy Statements under the headings "The Board of
Directors--Compensation Committee Interlocks and Insider Participation" and "The
Board of Directors--Certain Relationships and Related Transactions," which
information is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) The following documents are filed as part of this report:
1. Financial Statements, as set forth on the attached Index to Financial
Statements.
2. Exhibits, as set forth on the attached Exhibit Index.
3. Financial Statement Schedules.
Schedule II--Valuation and Qualifying Accounts
27
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities and
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on this 29th day of
December 2000.
NUTRACEUTICAL INTERNATIONAL CORPORATION
By: /s/ FRANK W. GAY II
----------------------------------------
Frank W. Gay II
Chairman of the Board
and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant in the capacities indicated on this 29th day of December 2000.
SIGNATURE CAPACITY
--------- --------
/s/ FRANK W. GAY II
------------------------------------------- Director, Chairman of the Board and Chief
Frank W. Gay II Executive Officer
/s/ JEFFREY A. HINRICHS
------------------------------------------- Director, Executive Vice President, Chief
Jeffrey A. Hinrichs Operating Officer and Secretary
/s/ LESLIE M. BROWN, JR.
------------------------------------------- Senior Vice President, Finance, Chief
Leslie M. Brown, Jr. Financial Officer and Assistant Secretary
/s/ MICHAEL D. BURKE
------------------------------------------- Director
Michael D. Burke
/s/ ROBERT C. GAY
------------------------------------------- Director
Robert C. Gay
/s/ MATTHEW S. LEVIN
------------------------------------------- Director
Matthew S. Levin
/s/ JAMES D. STICE
------------------------------------------- Director
James D. Stice
/s/ J. STEVEN YOUNG
------------------------------------------- Director
J. Steven Young
28
EXHIBIT INDEX
NUMBER DESCRIPTION
- ------ ------------------------------------------------------------
3.1 Form of Amended and Restated Certificate of Incorporation of
the Registrant(1)
3.2 Form of By-laws of the Registrant(1)
4.1 Form of certificate representing Common Stock(1)
4.2 Amended and Restated Registration Agreement dated as of
January 31, 1995 among the Company and certain of its
stockholders(1)
4.3 Credit Agreement dated as of February 25, 1998 among the
Company and its lenders(2)
10.1 Nutraceutical International Corporation 1998 Stock Incentive
Plan(1)
10.2 Nutraceutical International Corporation 1998 Non-Employee
Director Stock Option Plan(1)
10.3 Nutraceutical International Corporation Employee Stock
Discount Purchase Plan(1)
10.4 Transaction Services Agreement between the Company and Bain
Capital(1)
10.5 Consultant Stock Agreement dated as of October 28, 1993
between the Company and Bruce R. Hough(1)
10.6 Executive Stock Agreement dated as of October 28, 1993
between the Company and Jeffrey A. Hinrichs(1)
10.7 Stock Option Agreement dated as of November 15, 1994 between
the Company and Jeffrey A. Hinrichs(1)
10.8 Stock Option Agreement dated as of November 15, 1994 between
the Company and Bruce R. Hough(1)
10.9 Stock Option Agreement dated as of November 15, 1994 between
the Company and Frank W. Gay II(1)
10.10 Form of Area Sales Consultant Agreement(1)
11.1 Computation of earnings per share
The information required by Exhibit 11.1 is set forth on
page F-14 of this Form 10-K.
21.1 Subsidiaries of the Company
27.1 Financial Data Schedule
- ------------------------
(1) Incorporated by reference to the applicable exhibit to the Registrant's
Registration Statement on Form S-1, Registration No. 333-41909.
(2) Incorporated by reference to the applicable exhibit to the Company's
Form 10-K filed on December 29, 1998. The Company agrees to furnish
supplementally to the Commission a copy of any omitted schedule or exhibit
to such agreement upon request by the Commission.
29
NUTRACEUTICAL INTERNATIONAL CORPORATION
INDEX TO FINANCIAL STATEMENTS
PAGE
--------
Financial Statements:
Report of Independent Accountants......................... F-2
Consolidated Balance Sheets at September 30, 1999 and
2000.................................................... F-3
Consolidated Statements of Operations for the years ended
September 30, 1998, 1999 and 2000....................... F-4
Consolidated Statements of Cash Flows for the years ended
September 30, 1998, 1999 and 2000....................... F-5
Consolidated Statements of Stockholders' Equity for the
years ended
September 30, 1998, 1999 and 2000....................... F-6
Notes to Consolidated Financial Statements................ F-7
Financial Statement Schedules:
For each of the three years in the period ended
September 30, 2000
Schedule II--Valuation and Qualifying Accounts
F-1
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
of Nutraceutical International Corporation:
In our opinion, the accompanying consolidated financial statements listed in
the accompanying index present fairly, in all material respects, the financial
position of Nutraceutical International Corporation and its subsidiaries at
September 30, 1999 and 2000, and the results of their operations and their cash
flows for each of the three years in the period ended September 30, 2000, in
conformity with accounting principles generally accepted in the United States of
America. 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 of these statements in
accordance with auditing standards generally accepted in the United States of
America, which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
Salt Lake City, Utah
November 15, 2000
F-2
NUTRACEUTICAL INTERNATIONAL CORPORATION
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
SEPTEMBER 30,
-------------------
1999 2000
-------- --------
ASSETS
Current assets:
Cash...................................................... $ 869 $ 1,773
Accounts receivable, net.................................. 9,010 9,551
Inventories, net.......................................... 26,863 24,083
Prepaid expenses and other current assets................. 1,397 976
Deferred income taxes..................................... 1,231 1,162
-------- --------
Total current assets.................................... 39,370 37,545
Property, plant and equipment, net.......................... 14,752 16,939
Goodwill, net............................................... 53,422 53,068
Other non-current assets, net............................... 1,100 777
-------- --------
$108,644 $108,329
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of capital lease obligations.............. $ 57 $ 22
Accounts payable.......................................... 6,879 6,418
Accrued expenses.......................................... 3,185 3,391
-------- --------
Total current liabilities............................... 10,121 9,831
Long-term debt.............................................. 38,750 38,000
Capital lease obligations................................... 23 --
Deferred income taxes, net.................................. 2,460 2,554
-------- --------
Total liabilities....................................... 51,354 50,385
-------- --------
Commitments and contingencies (Notes 10, 14 and 16)
Stockholders' equity:
Common Stock, $0.01 par value, 50,000,000 shares
authorized, 11,791,295 shares issued and outstanding at
September 30, 1999, 11,823,391 shares issued and
10,905,104 shares outstanding at September 30, 2000..... 118 118
Preferred Stock, $0.01 par value, 5,000,000 shares
authorized, no shares issued and outstanding at
September 30, 1999 and 2000............................. -- --
Additional paid-in capital................................ 42,637 41,012
Retained earnings......................................... 14,504 20,105
Cumulative translation adjustment......................... 31 18
Treasury stock at cost, 918,287 shares at September 30,
2000.................................................... -- (3,309)
-------- --------
Total stockholders' equity.............................. 57,290 57,944
-------- --------
$108,644 $108,329
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
NUTRACEUTICAL INTERNATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
YEARS ENDED
SEPTEMBER 30,
------------------------------------
1998 1999 2000
---------- ---------- ----------
Net sales................................................ $ 104,688 $ 106,809 $ 106,813
Cost of sales............................................ 57,750 57,261 55,658
---------- ---------- ----------
Gross profit........................................... 46,938 49,548 51,155
---------- ---------- ----------
Operating expenses:
Selling, general and administrative.................... 31,233 36,644 37,178
Amortization of intangibles............................ 1,391 1,768 1,735
Non-recurring payments to management advisors.......... 1,135 -- --
---------- ---------- ----------
33,759 38,412 38,913
---------- ---------- ----------
Income from operations................................... 13,179 11,136 12,242
Interest expense, net.................................... 3,971 2,493 3,060
---------- ---------- ----------
Income before provision for income taxes................. 9,208 8,643 9,182
Provision for income taxes............................... 3,509 3,370 3,581
---------- ---------- ----------
Net income before extraordinary loss..................... 5,699 5,273 5,601
Extraordinary loss on early extinguishment of debt, net
of tax................................................. (3,129) -- --
---------- ---------- ----------
Net income............................................... $ 2,570 $ 5,273 $ 5,601
========== ========== ==========
Net income before extraordinary loss per common share:
Basic.................................................. $ 0.53 $ 0.45 $ 0.49
Diluted................................................ $ 0.48 $ 0.42 $ 0.46
Extraordinary loss per common share:
Basic.................................................. $ (0.29) $ -- $ --
Diluted................................................ $ (0.26) $ -- $ --
Net income per common share:
Basic.................................................. $ 0.24 $ 0.45 $ 0.49
Diluted................................................ $ 0.22 $ 0.42 $ 0.46
Weighted average common shares outstanding:
Basic.................................................. 10,806,178 11,729,587 11,509,168
Diluted................................................ 11,902,348 12,494,179 12,204,945
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
NUTRACEUTICAL INTERNATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
YEARS ENDED
SEPTEMBER 30,
------------------------------
1998 1999 2000
-------- -------- --------
Cash flows from operating activities:
Net income................................................ $ 2,570 $5,273 $5,601
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization (includes amortization of
inventory write-up of $381 and $92 during 1998 and
1999, respectively)................................... 5,096 5,946 6,065
Amortization of debt issuance costs..................... 468 215 215
Extraordinary loss on early extinguishment of debt, net
of tax................................................ 3,129 -- --
Loss on disposal of property, plant and equipment....... 7 44 36
Changes in assets and liabilities, net of effects from
acquisitions:
Accounts receivable, net.............................. (456) 245 (541)
Inventories, net...................................... (2,460) (2,616) 3,723
Prepaid expenses and other current assets............. (453) 251 421
Deferred income taxes................................. 520 479 357
Other non-current assets.............................. (305) 468 90
Accounts payable...................................... 1,960 (2,852) (461)
Accrued expenses...................................... (13) (925) 98
------- ------ ------
Net cash provided by operating activities........... 10,063 6,528 15,604
------- ------ ------
Cash flows from investing activities:
Proceeds from the sale of property and equipment.......... -- 33 --
Purchases of property and equipment....................... (3,380) (7,904) (6,552)
Acquisitions of businesses................................ (14,435) (1,187) (2,401)
------- ------ ------
Net cash used in investing activities............... (17,815) (9,058) (8,953)
------- ------ ------
Cash flows from financing activities:
Proceeds from long-term debt.............................. 46,450 4,750 3,500
Payments on long-term debt................................ (71,955) (3,000) (4,250)
Principal payments on capital lease obligations........... (181) (53) (58)
Payment of deferred financing fees........................ (1,058) -- --
Prepayment penalty and fees on early extinguishment of
debt.................................................... (632) -- --
Receipts of subscriptions receivable...................... 55 -- --
Proceeds from issuances of common stock................... 32,931 117 101
Purchase of warrant rights................................ -- -- (1,726)
Purchases of common stock for treasury.................... (301) (391) (3,309)
------- ------ ------
Net cash provided by (used in) financing
activities........................................ 5,309 1,423 (5,742)
------- ------ ------
Effect of exchange rate changes on cash..................... (5) 9 (5)
------- ------ ------
Net increase (decrease) in cash............................. (2,448) (1,098) 904
Cash at beginning of period................................. 4,415 1,967 869
------- ------ ------
Cash at end of period....................................... $ 1,967 $ 869 $1,773
======= ====== ======
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest................................................ $ 3,882 $2,124 $3,318
Income taxes............................................ $ 874 $3,523 $3,251
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
NUTRACEUTICAL INTERNATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
ACCUMULATED
COMMON STOCK ADDITIONAL OTHER
--------------------- PAID-IN SUBSCRIPTIONS RETAINED COMPREHENSIVE TREASURY
SHARES AMOUNT CAPITAL RECEIVABLE EARNINGS INCOME STOCK
---------- -------- ---------- ------------- -------- ------------- --------
Balance at October 1, 1997........ 9,308,583 93 9,609 (55) 6,707 -- --
Net income........................ -- -- -- -- 2,570 -- --
Cumulative translation
adjustment...................... -- -- -- -- -- 13 --
Total comprehensive income........
Issuances of common stock......... 2,456,296 25 32,906 -- -- -- --
Receipts of subscriptions
receivable...................... -- -- -- 55 -- -- --
Purchases of common stock for
treasury........................ -- -- -- -- -- -- (301)
---------- ---- ------- --- ------- --- -------
Balance at September 30, 1998..... 11,764,879 118 42,515 -- 9,277 13 (301)
Net income........................ -- -- -- -- 5,273 -- --
Cumulative translation
adjustment...................... -- -- -- -- -- 18 --
Total comprehensive income........
Issuances of common stock......... 26,416 -- 122 -- -- -- --
Purchases of common stock for
treasury........................ -- -- -- -- -- -- (391)
Issuance of common stock from
treasury........................ -- -- -- -- (46) -- 692
---------- ---- ------- --- ------- --- -------
Balance at September 30, 1999..... 11,791,295 118 42,637 -- 14,504 31 --
Net income........................ -- -- -- -- 5,601 -- --
Cumulative translation
adjustment...................... -- -- -- -- -- (13) --
Total comprehensive income........
Issuances of common stock......... 32,096 -- 101 -- -- -- --
Purchases of common stock for
treasury........................ -- -- -- -- -- -- (3,309)
Purchase of warrant rights........ -- -- (1,726) -- -- -- --
---------- ---- ------- --- ------- --- -------
Balance at September 30, 2000..... 11,823,391 $118 $41,012 $-- $20,105 $18 $(3,309)
========== ==== ======= === ======= === =======
TOTAL
STOCKHOLDERS'
EQUITY
-------------
Balance at October 1, 1997........ 16,354
Net income........................ 2,570
Cumulative translation
adjustment...................... 13
-------
Total comprehensive income........ 2,583
Issuances of common stock......... 32,931
Receipts of subscriptions
receivable...................... 55
Purchases of common stock for
treasury........................ (301)
-------
Balance at September 30, 1998..... 51,622
-------
Net income........................ 5,273
Cumulative translation
adjustment...................... 18
-------
Total comprehensive income........ 5,291
Issuances of common stock......... 122
Purchases of common stock for
treasury........................ (391)
Issuance of common stock from
treasury........................ 646
-------
Balance at September 30, 1999..... 57,290
Net income........................ 5,601
Cumulative translation
adjustment...................... (13)
-------
Total comprehensive income........ 5,588
Issuances of common stock......... 101
Purchases of common stock for
treasury........................ (3,309)
Purchase of warrant rights........ (1,726)
-------
Balance at September 30, 2000..... $57,944
=======
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
1. DESCRIPTION OF BUSINESS
Nutraceutical International Corporation (the "Company") is a manufacturer
and marketer of quality branded products sold to health food stores. The Company
sells its branded products under the widely recognized
SOLARAY-Registered Trademark-, KAL-Registered Trademark-, NATURALMAX-TM-,
VEGLIFE-Registered Trademark-, PREMIER ONE-Registered Trademark-, SOLAR
GREEN-TM-, NATURAL SPORT-TM-, ACTIPET-TM-, ACTION LABS-Registered Trademark- and
THOMPSON-Registered Trademark- brand names to health food stores in the United
States, and to distributors and stores worldwide. Under the name Woodland, the
Company markets a line of books and booklets to, among others, book
distributors, national retail bookstores and health food stores. In addition to
branded products, Nutraceutical manufactures bulk materials for use in its own
products and for sale to other manufacturers and marketers in the nutritional
supplement industry.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION -- The consolidated financial statements include
the accounts of the Company and its subsidiaries. The operating results of
acquired businesses have been consolidated from their respective dates of
acquisition (Note 3). All significant intercompany transactions and balances
have been eliminated.
USE OF ESTIMATES -- The preparation of these financial statements in
conformity with generally accepted accounting principles required management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the dates of
the financial statements and the reported amounts of net sales and expenses
during the reported periods. Estimates include reserves for customer returns and
allowances, uncollectible accounts receivable and obsolete and slow moving
inventories. Actual results could differ from these estimates.
FAIR VALUE OF FINANCIAL INSTRUMENTS -- The fair value of financial
instruments, including cash, accounts receivable, other current assets, accounts
payable, accrued expenses and debt, approximates their respective book values.
CASH -- Substantially all of the Company's cash is held by one bank at
September 30, 2000. The Company does not believe that, as a result of this
concentration, it is subject to any unusual financial risk beyond the normal
risk associated with commercial banking relationships.
INVENTORIES -- Inventories include freight-in, materials, labor and overhead
costs and are stated at the lower of cost or market, cost being determined by a
moving weighted average under the first-in, first-out method.
PROPERTY, PLANT AND EQUIPMENT -- Property, plant and equipment are stated at
cost, less accumulated depreciation and amortization. Depreciation and
amortization are provided using the straight-line method over the estimated
useful lives of the respective assets. Expenditures for renewals and betterments
are capitalized while maintenance and repairs are charged to operations in the
periods incurred. Upon sale or disposal of any asset, the historical cost and
related accumulated depreciation of such asset are removed from their respective
accounts and any gain or loss is recorded in the Consolidated Statements of
Operations.
GOODWILL -- The excess of purchase price over fair market value of assets
acquired and liabilities assumed in acquisition transactions is classified as
goodwill and is being amortized using the straight-line method over periods
ranging from 20 to 40 years. The Company evaluates the
F-7
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
recoverability of goodwill using undiscounted future cash flows whenever events
or changes in circumstances indicate that the carrying amount of goodwill may
not be recoverable. The amount of goodwill impairment, if any, is measured based
on discounted future net cash flows using a discount rate reflecting the
Company's average cost of funds. To date, no impairments of goodwill have been
recorded as a result of these evaluations.
DEFERRED FINANCING FEES -- The Company deferred certain debt issuance costs
related to the establishment of a new credit agreement (Note 9). These costs are
capitalized in other non-current assets and are being amortized using the
effective interest rate method over the life of the agreement.
COMMON STOCK -- On February 19, 1998, the Company completed an initial
public offering (the "Offering") of its common stock ("Common Stock"), par value
$0.01 per share.
FOREIGN CURRENCY TRANSLATION -- All assets and liabilities of foreign
subsidiaries are translated into U.S. dollars at fiscal year-end exchange rates.
Income and expense items are translated at average exchange rates prevailing
during the fiscal year. The resulting translation adjustments are recorded as a
component of stockholders' equity.
REVENUE RECOGNITION -- A sale is recognized upon shipment of merchandise to
a customer. Provision is made for estimated customer returns and allowances at
the time of sale.
SHIPPING COSTS -- The cost of shipping merchandise to customers is
classified as a selling, general and administrative expense in the Consolidated
Statements of Operations.
RESEARCH AND DEVELOPMENT -- The Company expenses research and development
costs as incurred. For the years ended September 30, 1998, 1999 and 2000, the
Company incurred $842, $900 and $657, respectively, in research and development
expenditures. These costs are included in general and administrative expenses
for the respective periods.
ADVERTISING -- The Company expenses advertising costs as incurred. These
costs are included in selling, general and administrative expenses for the
respective periods in the Consolidated Statements of Operations.
INCOME TAXES -- The Company accounts for income taxes using the asset and
liability method as prescribed by Statement of Financial Accounting Standards
No. 109, ACCOUNTING FOR INCOME TAXES ("SFAS 109"). SFAS 109 requires the Company
to record deferred tax assets and liabilities for expected future tax
consequences of events that have been recognized in different periods for
financial statements versus tax returns.
ACCOUNTING FOR STOCK-BASED COMPENSATION -- The Company has adopted Statement
of Financial Accounting Standards No. 123, ACCOUNTING FOR STOCK-BASED
COMPENSATION ("SFAS 123"). The Company measures compensation expense for its
stock-based employee compensation plans using the intrinsic value method
prescribed by Accounting Principles Board Opinion No. 25, ACCOUNTING FOR STOCK
ISSUED TO EMPLOYEES, and provides pro forma disclosures of net income and net
income per share as if the fair value-based method prescribed by SFAS 123 had
been applied in measuring compensation expense (Note 12).
F-8
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CONCENTRATIONS OF CREDIT RISK -- In the normal course of business, the
Company provides credit terms to its customers; however, collateral is not
required. Accordingly, the Company performs ongoing credit evaluations of its
customers and maintains allowances for possible losses which, when realized,
have been within the range of management's expectations. From time to time, a
higher concentration of credit risk may exist on outstanding accounts receivable
for a select number of customers depending on individual buying patterns. At
September 30, 1999 and 2000, no customer accounted for more than 10 percent of
trade accounts receivable. Furthermore, no customer accounted for more than
10 percent of net sales in any of the three years ended September 30, 2000.
3. ACQUISITIONS
ACQUISITIONS -- On July 20, 1998, the Company acquired substantially all of
the assets and assumed certain liabilities of Action Labs, Inc. and on
August 31, 1998, the Company acquired all of the outstanding stock of Ahmed's
Sun Force International Products Inc., now known as NutraForce (Canada)
International, Inc. (collectively referred to as the "Fiscal 1998
Acquisitions"). On April 1, 1999, the Company acquired all of the outstanding
stock of Woodland Publishing, Inc. and acquired substantially all of the assets
and assumed certain liabilities of Summit Graphics, Inc. (collectively referred
to as the "Fiscal 1999 Acquisitions"). On May 26, 2000, the Company acquired
certain assets of Rexall Sundown, Inc.'s Thompson Nutritional Products business
(referred to as the "Fiscal 2000 Acquisition"). These acquisitions were
accounted for using the purchase method of accounting. Accordingly, the purchase
price assigned to the assets acquired and liabilities assumed was their fair
market values at their respective dates of acquisition. The excess of the
purchase price over the fair market values of the assets acquired and
liabilities assumed has been classified as goodwill and is being amortized using
the straight-line method. The Consolidated Statements of Operations and
Consolidated Statements of Cash Flows presented herein include the activities of
these acquired businesses from their respective dates of acquisition.
The aggregate purchase price for the Fiscal 1999 Acquisitions totaled
$1,837, consisting of cash of $1,187 and 100,000 shares of Common Stock. The
aggregate purchase price for the Fiscal 2000 Acquisition was $2,401 and was paid
in cash. The following reflects the allocation of the aggregate purchase price
for the Fiscal 1999 Acquisitions and the Fiscal 2000 Acquisition to the
aggregate assets acquired and the liabilities assumed:
FISCAL 1999 FISCAL 2000
ACQUISITIONS ACQUISITION
------------ -----------
Aggregate assets acquired and liabilities assumed:
Current assets, net................................. 509 1,273
Property, plant and equipment....................... 241 --
Goodwill............................................ 1,237 1,228
Current liabilities................................. (150) (100)
------ ------
Total................................................. $1,837 $2,401
====== ======
F-9
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
4. ACCOUNTS RECEIVABLE, NET
Accounts receivable, net, consist of the following:
SEPTEMBER 30,
-------------------
1999 2000
-------- --------
Accounts receivable....................................... $10,163 $10,807
Less allowances........................................... (1,153) (1,256)
------- -------
$ 9,010 $ 9,551
======= =======
5. INVENTORIES, NET
Inventories, net of reserves for obsolete and slow moving inventories, are
comprised of the following:
SEPTEMBER 30,
-------------------
1999 2000
-------- --------
Raw materials............................................. $ 7,491 $ 8,277
Work-in-process........................................... 7,151 4,242
Finished goods............................................ 12,221 11,564
------- -------
$26,863 $24,083
======= =======
In connection with the Fiscal 1999 Acquisitions and the Fiscal 2000
Acquisition (Note 3), acquired inventories were valued at fair market value to
reflect the net realizable value of these inventories as of their respective
acquisition dates. The amount ascribed in excess of historical cost (write-up)
was $92 and $0 for the years ended September 30, 1999 and 2000, respectively,
and was charged to cost of sales in the accompanying Consolidated Statements of
Operations as the inventories were sold.
6. PROPERTY, PLANT AND EQUIPMENT, NET
Property, plant and equipment, net, are comprised of the following:
ESTIMATED SEPTEMBER 30,
USEFUL LIFE -------------------
(YEARS) 1999 2000
----------- -------- --------
Land.......................................... -- $ 422 $ 422
Building...................................... 30 1,826 1,872
Leasehold improvements........................ 1-10 5,097 7,690
Furniture, fixtures and equipment............. 3-10 19,588 21,059
-------- --------
26,933 31,043
Less accumulated depreciation and
amortization................................ (12,181) (14,104)
-------- --------
$ 14,752 $ 16,939
======== ========
F-10
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
6. PROPERTY, PLANT AND EQUIPMENT, NET (CONTINUED)
At September 30, 1999 and 2000, furniture, fixtures and equipment included
$327 of leased equipment with an accumulated amortization balance of $252 and
$303, respectively. Certain property and equipment collateralize debt
obligations (Note 9).
Depreciation and amortization of property, plant and equipment totaled
$3,324, $4,086 and $4,330 for the years ended September 30, 1998, 1999 and 2000,
respectively.
7. GOODWILL, NET
Goodwill, net, is comprised of the following:
SEPTEMBER 30,
-------------------
1999 2000
-------- --------
Goodwill.................................................. $59,641 $61,005
Less accumulated amortization............................. (6,219) (7,937)
------- -------
$53,422 $53,068
======= =======
8. ACCRUED EXPENSES
Accrued expenses are comprised of the following:
SEPTEMBER 30,
-------------------
1999 2000
-------- --------
Employee payroll, taxes, benefits, and performance
incentives................................................ $2,050 $2,533
Other accrued expenses...................................... 1,135 858
------ ------
$3,185 $3,391
====== ======
9. LONG-TERM DEBT
Long-term debt is comprised of the following:
SEPTEMBER 30,
-------------------
1999 2000
-------- --------
Revolving Credit Facility................................. $38,750 $38,000
======= =======
DEBT TRANSACTIONS
On February 25, 1998, the Company replaced its senior credit agreement under
which the Company had outstanding borrowings of $60,178 (before unamortized
discount of $2,454), with a new credit agreement (the "New Credit Agreement").
The company realized an extraordinary loss on the early extinguishment of its
senior credit agreement of $3,129, net of tax of $1,804.
The New Credit Agreement currently makes $70,000 of revolving credit
borrowings available to the Company. The available revolving credit borrowings
are reduced to $65,000, $45,000 and $37,500 during
F-11
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
9. LONG-TERM DEBT (CONTINUED)
fiscal 2001, 2002 and 2003, respectively. The reduction during fiscal 2001
occurs quarterly beginning April 30, 2001 with reductions of $2.5 million per
quarter for two quarters. Borrowings under the New Credit Agreement are secured
by certain assets of the Company and bear interest at the applicable Eurodollar
Rate plus a variable margin or at the Federal Funds Rate plus 0.5% plus a
variable margin. At September 30, 2000, the applicable interest rate was 8.00%.
The Company is also required to pay a variable quarterly fee on the unused
balance under the New Credit Agreement. At September 30, 2000, the applicable
rate was 0.35%. Accrued interest on Federal Funds Rate borrowings is payable
quarterly. Accrued interest on Eurodollar Rate borrowings is payable based on an
elected interval of one, two or three months. The Company is required to repay
all principal outstanding under the New Credit Agreement in 2003. Accordingly,
the outstanding principal balance at September 30, 2000 was classified as
long-term debt.
The New Credit Agreement contains restrictive covenants, including
restrictions on incurring other indebtedness, limitations on capital
expenditures and requirements that the Company maintain certain financial ratios
and profitability measures. Upon the occurrence of an event of default, the
lender may require the Company to repay all amounts borrowed under the New
Credit Agreement and may proceed against the collateral.
10. LEASE COMMITMENTS AND OBLIGATIONS
The Company leases office and warehouse facilities under non-cancelable
operating leases ending between fiscal years 2001 and 2004, although the Company
has negotiated early termination and extension options in many cases. These
operating leases require the Company to pay all taxes, insurance and
maintenance. The Company also leases certain manufacturing and laboratory
equipment under capital leases.
The following summarizes future minimum lease payments required under
capital and non-cancelable operating leases:
CAPITALIZED OPERATING
YEAR ENDING SEPTEMBER 30, LEASES LEASES
- ------------------------- ----------- ---------
2001.................................................. $ 23 $ 836
2002.................................................. -- 515
2003.................................................. -- 56
2004.................................................. -- 32
2005.................................................. -- --
Thereafter............................................ -- --
---- ------
Future minimum lease payments........................... 23 $1,439
======
Less amounts representing interest...................... (1)
----
Present value of future minimum lease payments.......... 22
Less amounts due within one year........................ (22)
----
Amounts due after one year.............................. $ --
====
F-12
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
10. LEASE COMMITMENTS AND OBLIGATIONS (CONTINUED)
Total rent expense incurred by the Company under non-cancelable operating
leases for the years ended September 30, 1998, 1999 and 2000 was $1,142, $1,242
and $1,030, respectively.
11. INCOME TAXES
The provision for income taxes is comprised of the following:
YEARS ENDED
SEPTEMBER 30,
------------------------------
1998 1999 2000
-------- -------- --------
Current:
Federal................................................... $ 862 $2,682 $2,681
State..................................................... 133 385 614
Deferred:
Federal................................................... 647 276 261
State..................................................... 63 27 25
------ ------ ------
$1,705 $3,370 $3,581
====== ====== ======
The provision for income taxes for 1998 consisted of a provision of $3,509
resulting from income before provision for income taxes offset by a benefit of
$1,804 resulting from the extraordinary loss on early extinguishment of debt.
A summary of the composition of net deferred income tax assets and
liabilities is as follows:
SEPTEMBER 30,
-------------------
1999 2000
-------- --------
ASSETS
Inventory differences....................................... $ 669 $ 573
Accounts receivable reserves................................ 380 451
Accrued liabilities......................................... 180 138
Other....................................................... 2 --
------ ------
Current deferred income tax assets.......................... $1,231 $1,162
====== ======
LIABILITIES
Amortization of intangibles................................. $2,560 $3,168
Depreciation................................................ (100) (614)
------ ------
Long-term deferred income tax liabilities, net.............. $2,460 $2,554
====== ======
F-13
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
11. INCOME TAXES (CONTINUED)
The differences between income taxes at the statutory federal income tax
rate and income taxes reported in the Consolidated Statements of Operations are
as follows:
YEARS ENDED
SEPTEMBER 30,
------------------------------
1998 1999 2000
-------- -------- --------
Federal tax at statutory rate............................... $1,454 $2,939 $3,122
State tax, net of federal benefit........................... 152 280 460
Non-deductible expenses..................................... 113 150 155
Foreign sales corporation benefit........................... -- -- (156)
Other....................................................... (14) 1 --
------ ------ ------
$1,705 $3,370 $3,581
====== ====== ======
12. CAPITAL STOCK
DESCRIPTION OF CAPITAL STOCK -- At September 30, 2000, the Company had two
authorized classes of stock: Common Stock with a par value of $0.01 per share
and Preferred Stock with a par value of $0.01 per share.
The following table provides a reconciliation of basic common shares, which
represent the weighted average number of common shares outstanding without
regard to potential common shares, to diluted weighted average common shares,
which includes all such shares:
YEARS ENDED
SEPTEMBER 30,
------------------------------------
1998 1999 2000
---------- ---------- ----------
Net income (Numerator):
Net income before extraordinary loss................... $ 5,699 $ 5,273 $ 5,601
Extraordinary loss on early extinguishment of debt, net
of tax............................................... (3,129) -- --
---------- ---------- ----------
Net income............................................. $ 2,570 $ 5,273 $ 5,601
========== ========== ==========
Weighted average common shares (Denominator):
Basic weighted average common shares................... 10,806,178 11,729,587 11,509,168
Dilutive effect of stock options and warrants.......... 1,096,170 764,592 695,777
---------- ---------- ----------
Diluted weighted average common shares................. 11,902,348 12,494,179 12,204,945
========== ========== ==========
Net income before extraordinary loss per common share:
Basic.................................................. $ 0.53 $ 0.45 $ 0.49
Diluted................................................ $ 0.48 $ 0.42 $ 0.46
Extraordinary loss per common share:
Basic.................................................. $ (0.29) $ -- $ --
Diluted................................................ $ (0.26) $ -- $ --
Net income per common share:
Basic.................................................. $ 0.24 $ 0.45 $ 0.49
Diluted................................................ $ 0.22 $ 0.42 $ 0.46
F-14
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
12. CAPITAL STOCK (CONTINUED)
STOCK WARRANTS -- As part of the Solaray, Inc. acquisition, the Company
issued detachable stock warrants that entitle the holder to purchase 993,393
shares of Common Stock at an exercise price of $0.01 per share, of which 302,947
warrants were exercised in connection with the Offering. The aggregate estimated
fair market value of these warrants on the date of issuance was $292. On
September 28, 2000, the Company purchased and cancelled the remaining 690,446
warrants. As part of the Premier One Products, Inc. and Makers of KAL, Inc. and
Makers of KAL, B.V. acquisitions, the Company issued warrants to purchase
163,976 shares of Common Stock at exercise prices ranging from $4.86 to $4.91
per share, which were considered to be the estimated fair market values per
share of the Common Stock at the respective dates of issuance. These warrants
expire in January 2005.
STOCK OPTIONS -- During November 1994, the Company issued 301,164 options to
certain key executives at an exercise price of $3.45, which was considered to be
the estimated fair market value of the Company's stock at the date of grant.
These grants, which are fully vested and exercisable, expire no later than the
tenth anniversary of the date of grant.
STOCK OPTION PLANS -- During the year ended September 30, 1995, the
Company's Board of Directors adopted the 1995 Stock Option Plan (the "1995
Option Plan"). The 1995 Option Plan provides for granting options to executives
and key employees of the Company and its subsidiaries to purchase Common Stock.
In aggregate, 225,873 shares have been reserved for issuance under the 1995
Option Plan.
During the year ended September 30, 1998, the Company's Board of Directors
adopted the 1998 Stock Incentive Plan (the "1998 Stock Plan"). The 1998 Stock
Plan provides for granting options to executives and key employees of the
Company and its subsidiaries to purchase Common Stock. In aggregate, 1,050,000
shares of Common Stock have been reserved for issuance under the 1998 Stock
Plan.
During the year ended September 30, 1998, the Company's Board of Directors
adopted the 1998 Non-Employee Director Stock Option Plan (the "Director Option
Plan"). The Director Option Plan provides for granting options to non-employee
directors of the Company to purchase Common Stock. In aggregrate, 150,000 shares
of Common Stock have been reserved for issuance under the Director Option Plan.
F-15
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
12. CAPITAL STOCK (CONTINUED)
The following grants have been made under the 1995 Option Plan, the 1998
Stock Plan and the Director Option Plan:
NUMBER OF AVERAGE PRICE AGGREGATE
OPTIONS PER SHARE OPTION PRICE
--------- ------------- ------------
Outstanding at October 1, 1997............................ 168,276 $ 5 $ 925
Granted................................................... 314,074 16 5,105
Exercised................................................. -- -- --
Forfeited and/or Expired.................................. (20,580) 16 (336)
------- --- ------
Outstanding at September 30, 1998......................... 461,770 12 5,694
------- --- ------
Granted................................................... 161,550 5 770
Exercised................................................. -- -- --
Forfeited and/or Expired.................................. (49,660) 12 (611)
------- --- ------
Outstanding at September 30, 1999......................... 573,660 10 5,853
------- --- ------
Granted................................................... 26,400 4 95
Exercised................................................. -- -- --
Forfeited and/or Expired.................................. (29,934) 13 (390)
------- --- ------
Outstanding at September 30, 2000......................... 570,126 $10 $5,558
======= === ======
Options granted prior to the Offering were issued at exercise prices that
represented management's estimates of the fair market value per share of Common
Stock at the respective grant dates. Options granted since the Offering were
issued at exercise prices that represented the fair market value per share of
Common Stock at the respective grant dates. The 1995 Option Plan grants vest
over a period of four years and expire on the tenth anniversary of the date of
grant. The 1998 Stock Inventive Plan grants vest over a period of two to four
years and expire no later than the tenth anniversary of the date of grant. The
Director Option Plan grants vest over a period of approximately three years and
expire no later than the tenth anniversary of the date of grant. Grants that are
forfeited and/or expired are available for future issuance under these plans.
The following table sets forth data related to exercise prices and lives for
option grants made under the 1995 Option Plan, the 1998 Stock Plan and the
Director Option Plan:
SEPTEMBER 30, 2000
---------------------------------------------------------
OPTIONS OPTIONS
OUTSTANDING EXERCISABLE
--------------------------- ---------------------------
WEIGHTED-AVERAGE WEIGHTED-AVERAGE
RANGE OF EXERCISE PRICES SHARES EXERCISE PRICE SHARES EXERCISE PRICE
- ------------------------ -------- ---------------- -------- ----------------
$3.43 - $7.00................................ 312,532 $ 4.72 198,258 $ 4.85
(Avg. life: 6.7 years)
$8.63 - $13.38............................... 65,205 $10.98 50,689 $11.01
(Avg. life: 6.7 years)
$17.50....................................... 192,389 $17.50 134,361 $17.50
(Avg. life: 6.8 years)
F-16
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
12. CAPITAL STOCK (CONTINUED)
The weighted average fair value per share of options granted was $10.13,
$3.45 and $2.93 for the years ended September 30, 1998, 1999 and 2000,
respectively. The Company's pro forma net income for the years ended
September 30, 1998, 1999 and 2000 would have been $2,321, $4,874 and $5,204
respectively, if compensation cost had been measured under the fair value method
of SFAS 123. The Company's pro forma basic net income per common share for the
years ended September 30, 1998, 1999 and 2000 would have been $0.21, $0.42, and
$0.45, respectively. The Company's pro forma diluted net income per common share
for the years ended September 30, 1998, 1999 and 2000 would have been $0.20,
$0.39 and $0.43, respectively.
The fair value of these options was estimated as of the date of grant using
the Black-Scholes option pricing model with the following assumptions for the
years ended September 30, 1998, 1999 and 2000, respectively: risk free interest
rate of 5.52%, 4.98% and 6.65%; expected life of 5 years, 5 years and 7 years;
expected volatility of 70%, 90% and 90%; and expected dividend yield of 0%, 0%
and 0%. Because changes in the subjective input assumptions can materially
affect the fair value estimate, management believes that the existing valuation
models do not necessarily provide a reliable single measure of the fair value of
its employee stock options. The initial impact on pro forma net income may not
be representative of pro forma compensation expense in future years, depending
upon the amount of stock options awarded in the future and their related vesting
periods.
STOCK PURCHASE PLAN -- During the year ended September 30, 1998, the
Company's Board of Directors adopted the Employee Stock Discount Purchase Plan
(the "Stock Purchase Plan"). The Stock Purchase Plan is intended to give
employees a convenient means of purchasing shares of Common Stock through
payroll and lump-sum deductions. In aggregrate, 750,000 shares of Common Stock
have been reserved for issuance under the Stock Purchase Plan.
SHARE REPURCHASE PROGRAM -- During the year ended September 30, 1998, the
Company's Board of Directors approved a share repurchase program authorizing the
Company to buy up to 400,000 shares of Common Stock of the Company. As of
September 30, 1998, the Company had repurchased 41,800 shares under this program
at an aggregate price of $301. During fiscal 1999, the Company repurchased an
additional 57,500 shares at an aggregate price of $391. On April 1, 1999, all
99,300 shares of treasury stock previously repurchased by the Company were
reissued in connection with the Fiscal 1999 Acquisitions. During the year ended
September 30, 2000, the Company repurchased 400,000 shares under this existing
repurchase program. During fiscal 2000, the Company's Board of Directors
approved a new share repurchase program authorizing the Company to buy up to
1,500,000 shares of Common Stock of the Company. This repurchase program
superceded the previous repurchase program announced during fiscal 1998. Under
this new program, the Company repurchased a total of 518,287 shares and 690,446
warrants to purchase shares during fiscal 2000. The aggregate price of shares
repurchased during fiscal 2000 was $3,309.
13. OPERATING SEGMENTS
Based on the Company's method of internal reporting, the Company has two
reportable segments: branded products and bulk materials. The Company is a
manufacturer and marketer of quality branded products sold to health food stores
in the United States, and to distributors and stores worldwide. In
F-17
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
13. OPERATING SEGMENTS (CONTINUED)
addition to branded products, the Company manufactures bulk materials for use in
its own products and for sale to other manufacturers and marketers in the
nutritional supplement industry.
The accounting policies for these segments are the same as those described
in the summary of significant accounting policies (Note 2). The Company
evaluates the financial performance of its segments based on sales performance.
Other performance measures beyond net sales, as well as balance sheet
components, are not tracked to these segments.
Segment information for the years ended September 30, 1998, 1999 and 2000
was as follows:
YEARS ENDED
SEPTEMBER 30,
------------------------------
1998 1999 2000
-------- -------- --------
NET SALES:
Branded Products............................ $ 88,399 $ 93,052 $ 96,332
Bulk Materials.............................. 16,289 13,757 10,481
-------- -------- --------
Total..................................... $104,688 $106,809 $106,813
======== ======== ========
14. EMPLOYEE BENEFIT PLANS
401(K) PLAN -- The Company has a 401(k) defined contribution profit sharing
plan that covers substantially all employees. Under the plan, employees can
contribute up to 15% of their compensation. The Company makes matching and
discretionary contributions to the plan that approximate 4% of all plan
participants' eligible salaries and wages. The amounts contributed to the plan
by the Company during the years ended September 30, 1998, 1999 and 2000 were
$384, $465 and $419, respectively.
SELF-FUNDED HEALTH INSURANCE PLAN -- The Company has a self-insured health
care program for its employees and their dependents. Under the program, the
Company pays claims up to $40 per year for each individual, while claims
exceeding $40 per individual, or $1,315 in the aggregate as of September 30,
2000, are covered by a third party stop-loss insurance policy. Total health
insurance expense incurred by the Company, which includes claims, third party
insurance premiums and other related costs, for the years ended September 30,
1998, 1999 and 2000 was $898, $1,232 and $1,413, respectively. At September 30,
2000, the Company had accrued $302 for claims reported but not paid and claims
incurred but not reported. On November 1, 2000, the Company changed from a
self-insured health care program to a fully-insured health care program.
15. RELATED PARTY TRANSACTIONS
On January 31, 1995, the Company entered into a five-year management
agreement (the "Agreement") with certain stockholders of the Company. The
Agreement required the Company to pay a monthly management fee of $25 plus
out-of-pocket expenses payable on a quarterly basis in arrears commencing
March 31, 1995. The Agreement was terminated in conjunction with the Offering. A
fee of $1,012 was incurred related to the termination of the Agreement and other
services performed in
F-18
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
15. RELATED PARTY TRANSACTIONS (CONTINUED)
connection with the Offering. For the year ended September 30, 1998, the Company
incurred $1,185 in fees and out-of-pocket expenses for these certain
stockholders.
16. COMMITMENTS AND CONTINGENCIES
The formulation, manufacturing, processing, packaging, labeling,
advertising, distribution and sale of dietary supplements (consisting of
vitamins, amino acids, minerals, herbs, other botanicals and other dietary
ingredients) such as those sold by the Company are subject to regulation by one
or more federal agencies, principally the Food and Drug Administration (the
"FDA") and the Federal Trade Commission and, to a lesser extent, the Consumer
Product Safety Commission and the United States Department of Agriculture. These
activities are also regulated by various governmental agencies for the states
and localities in which the Company's products are sold, as well as by
governmental agencies in certain countries outside the United States in which
the Company's products are sold.
Although management believes that the Company is in compliance, in all
material respects, with the statutes, laws, rules and regulations of every
jurisdiction in which it operates, no assurance can be given that the Company's
compliance with applicable statutes, laws, rules and regulations will not be
challenged by governing authorities or that such challenges will not have a
material adverse effect on the Company's financial position or results of
operations or cash flows.
The Company, like any other retailer, distributor and manufacturer of
products that are designed to be ingested, also faces inherent risk of exposure
to product liability claims in the event that the use of its products results in
injury. With respect to product liability claims, the Company has liability
insurance; however, there can be no assurance that such insurance will be
adequate to cover potential liabilities. In the event that the Company does not
have adequate insurance or contractual indemnification from parties supplying
raw materials or marketing its products, product liability relating to defective
products could have a material adverse effect on the Company.
The Company is not currently a named defendant in any product liability
lawsuit. However, the Company is involved in various legal matters arising in
the normal course of business, including, but not limited to, an investigation
by the FDA regarding a January 20, 1998 Proposition 65 notice received by
Monarch Nutritional Laboratories, Inc. The Company has received grand jury
subpoenas for documents with respect to the investigation; the Company continues
to cooperate with the FDA and the United States Attorney's Office in the
investigation of these matters. In the opinion of management, the Company's
liability, if any, arising from legal proceedings related to these matters is
not expected to have a material adverse impact on the Company's financial
position.
F-19
NUTRACEUTICAL INTERNATIONAL CORPORATION
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
BALANCE AT CHARGED TO CHARGED TO BALANCE AT
BEGINNING OF COSTS AND OTHER END OF
DESCRIPTION PERIOD EXPENSES ACCOUNTS DEDUCTIONS PERIOD
- ----------- ------------ ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
SEPTEMBER 30, 2000
Deducted from related asset account:
Allowance for sales returns.............. $ 620 $ 124 $ -- $ 85 $ 659
Allowance for doubtful accounts.......... $ 533 $ 129 $ -- $ 65 $ 597
Provision for inventory.................. $1,855 $1,135 $1,135 $834 $3,291
SEPTEMBER 30, 1999
Deducted from related asset account:
Allowance for sales returns.............. $ 603 $ 371 $ 40 $394 $ 620
Allowance for doubtful accounts.......... $ 421 $ 181 $ 35 $104 $ 533
Provision for inventory.................. $1,121 $1,293 $ 40 $599 $1,855
SEPTEMBER 30, 1998
Deducted from related asset account:
Allowance for sales returns.............. $ 420 $ 313 $ 165 $295 $ 603
Allowance for doubtful accounts.......... $ 390 $ 223 $ 15 $207 $ 421
Provision for inventory.................. $1,167 $ 410 $ 164 $620 $1,121