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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended: December 31, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 0 - 20330
WHOLESOME & HEARTY FOODS, INC.
(Exact name of registrant as specified in its charter)
OREGON 93-0886359
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
1411 SW MORRISON STREET, SUITE 400, PORTLAND, OREGON 97205
(Address of principal executive offices)
Registrant's telephone number, including area code: (503)-205-1500
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, NO PAR VALUE
(Title of Class)
_______________
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 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 the voting stock held by non-affiliates of the
Registrant is $48,259,402 as of February 28, 1997 based upon the last closing
price as reported by the Nasdaq National Market System ($6.75).
The number of shares outstanding of the Registrant's Common Stock as of February
28, 1997 was 8,566,456 shares.
The index to exhibits appears on page 19 of this document.
_______________
DOCUMENTS INCORPORATED BY REFERENCE
The Registrant has incorporated into Part III of Form 10-K by reference portions
of its Proxy Statement, dated March 20, 1997. Portions of the Registrant's
Annual Report to Shareholders for the fiscal year ended December 31, 1996, are
incorporated by reference in Parts II and IV of Form 10-K.
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WHOLESOME & HEARTY FOODS, INC.
1996 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
Page
----
PART I
Item 1. Business 2
Item 2. Properties 8
Item 3. Legal Proceedings 9
Item 4. Submission of Matters to a Vote of Security Holders 9
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters 9
Item 6. Selected Financial Data 10
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations 10
Item 8. Financial Statements and Supplementary Data 15
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure 16
PART III
Item 10. Directors and Executive Officers of the Registrant 17
Item 11. Executive Compensation 17
Item 12. Security Ownership of Certain Beneficial Owners and Management 17
Item 13. Certain Relationships and Related Transactions 17
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 18
Signatures 21
1
PART I
ITEM 1. BUSINESS
INTRODUCTION
Wholesome & Hearty Foods, Inc. (the "Company" ) was organized in 1985 to provide
a line of food products in response to the public's awareness of the importance
of diet to overall health and fitness. Toward this end, the Company developed
and now produces and distributes products which include a variety of frozen,
meatless items that are low in cholesterol and low in fat. One such product, the
Gardenburger-Registered Trademark- Veggie Patty, contains approximately one-
sixth of the fat and two-thirds of the calories contained in a similar-sized
ground beef patty. In addition, the Company distributes and is continuing to
develop and perfect the GardenDog-Registered Trademark-, a meatless, all natural
hot dog like product made primarily from vital wheat gluten. The Company
divested itself of the AlmondMylk-TM- and AlmondCheeze-TM- products at the
beginning of 1996 and no longer sells these products. The Company registered
its common stock with the Securities and Exchange Commission and completed its
initial public offering in 1992.
PRODUCTS
The Company offers its meatless items, primarily patties, under the trade names
Gardenburger-Registered Trademark-, Gardenburger-Registered Trademark- Zesty
Bean, Gardenburger-Registered Trademark- Veggie Medley, Gardenburger
Sub-Registered Trademark-, GardenSausage-Registered Trademark-, and GardenVegan
- -Registered Trademark-. The patties range in various sizes from 2.5 ounces to
3.4 ounces. The recipes although proprietary, contain commonly known
ingredients including fresh mushrooms, brown rice, onions, rolled oats, low-fat
cheeses, bulgur wheat, egg whites, natural seasonings and spices, are soy-free
and do not contain artificial additives.
The Gardenburger contains the commonly known ingredients mentioned above.
The 1/4 pound Gardenburger-Registered Trademark- patty, is 130 calories, 3 grams
of fat, 19 grams of carbohydrate and 6 grams of protein.
The Gardenburger-Registered Trademark- Zesty Bean contains black beans,
Anaheim chilies, red and yellow bell pepper and cilantro in addition to the
common ingredients which provide a spicy, Mexican flavor and additional protein
and fiber from the beans. A 1/4 pound patty is 120 calories, 2.5 grams of fat,
18 grams of carbohydrate and 6 grams of protein.
The Gardenburger-Registered Trademark- Veggie Medley contains soy cheese in
lieu of low fat dairy cheeses, broccoli, carrots, and red and yellow bell
peppers in addition to the common ingredients. A 1/4 pound patty is 100
calories, zero grams of fat, 17 grams of carbohydrate and 6 grams of protein.
The 3.1 ounce Gardenburger Sub-Registered Trademark-, is 170 calories, 3
grams of fat, 26 grams of carbohydrate and 10 grams of protein. It is oval
shaped to accommodate sub sandwich style buns.
GardenSausage-Registered Trademark- contains maple syrup and natural
seasonings in addition to the common ingredients which provides a light and
fresh breakfast sausage flavor. A 2.5 ounce patty is 140 calories, 2.5 grams of
fat, 20 grams of carbohydrate and 7 grams of protein.
2
The GardenVegan-TM- contains water, brown rice, vital wheat gluten, bulgur
wheat, onions, mushrooms, and natural spices. A 1/4 pound patty is 140
calories, zero grams of fat, 23 grams of carbohydrate and 11 grams of protein.
The GardenDog-Registered Trademark- is a meatless, all natural hot dog like
product with approximately one sixth the fat content of a typical meat hot dog
and no preservatives or additives. The primary ingredients in a GardenDog-
Registered Trademark- are water, vital wheat gluten, nutritional yeast, natural
flavors, spices and color.
The Company is currently developing several new products also made from vital
wheat gluten, including analog chicken, beef and pepperoni products.
The Company produces it line of GardenProducts-TM- at its plant in Portland,
Oregon. The Company has also entered into selective co-packing agreements under
which its products are produced by third parties, although no such agreements
are currently in place. The production process involves cleaning, chopping and
mixing ingredients, forming, baking, and quick freezing patties, then packaging.
Products are then shipped fully cooked, frozen and packaged via temperature
controlled truck to distributors throughout North America, and by temperature
controlled container to Europe.
The Company's products may be purchased in restaurants and from other
institutional food preparers throughout the United States, Canada, Mexico and in
selected European food service outlets. Products may also be purchased for home
consumption from grocery stores, natural foods stores, club stores and specialty
food stores in the United States, Canada and the United Kingdom.
ACQUISITION OF GORILLA FOODS, INC. AND WHOLE FOODS MARKETING
In January 1996 the Company completed the acquisition of Ojai, California-based
Gorilla Foods, a privately held developer and manufacturer of wheat protein-
based, meatless food products, including the GardenDog-Registered Trademark-.
The transaction provided for the exchange of 240,000 shares of the Company's
common stock for all outstanding common shares of Gorilla Foods, and $68,750 in
cash. In addition, up to an additional 200,000 certain contingent shares of the
Company could be issued in 50,000 share increments based on sales performance of
wheat protein-based products over the next five years. This transaction has
enabled the Company to broaden its product line by owning the recipe for the
GardenDog-Registered Trademark- and future wheat gluten protein-based products
to be developed for the meat analog product market.
In a separate transaction in January 1996, the Company completed the acquisition
of the assets, for $350,000 in cash, of Whole Food Marketing, a Southern
California-based food broker of the Company's and Gorilla Foods' products, that
was partly owned by Gorilla Foods' executives.
COMPETITION
At present, competing products are sold by Worthington Foods, Inc., Pillsbury's
Green Giant Division which is marketing Archer-Daniels-Midland's meatless patty
products, Boca Burger, Fantastic Foods and Imagine Foods. The Company also
expects to see some additional competition from extreme low-fat meat based
products such as ConAgra's Healthy Choice 96 percent Extra Lean Ground Beef
burger and chicken/turkey based
3
patties. Large competitors are positioned to take advantage of their existing
resources, which are substantially greater than the Company's, especially
distribution and marketing resources in order to penetrate the market quickly,
to increase the potential market and to potentially occupy a significant share
of the market.
To the best of the Company's knowledge, the main competing meatless patty
products come from: Worthington Foods, Inc. distributing "Morningstar Farms"
and other products through institutional food service, and distributing
"Morningstar Farms" and "Natural Touch" patties to retail stores; Pillsbury,
distributing "Green Giant Harvest Burgers" for Archer-Daniels-Midland into
institutional food service and retail sectors; Boca Burger, distributing a
growing line of soy-based meat analog burgers in both the food service and
retail sectors; Imagine Foods, Inc. distributing "Ken & Robert's" burgers into
institutional and retail sectors; and a variety of patties and meat substitutes
which bear names such as the "New York Veggie Burger" and come primarily from
smaller health or natural foods producers. The foregoing are believed to be
representative but not inclusive of all existing and potentially competing
products.
The Company believes that its products compare favorably to those offered by
competitors based on taste, quality of its natural ingredients, ease of
preparation, availability and value. Some competing patty products, meat
substitutes, and meat substitute mixes use ingredients and processing methods,
soy for example, which tend to be less expensive and blend into textures and
appearances that are much more uniform and "meat-like" than the Company's
products. The Company believes that its ingredients and processes, although
slightly more costly, tend to produce products in which the major ingredients
are more discernible, and, therefore, more appealing to the consumer. Some
competitors, including Worthington Foods, Inc., are introducing products which
appear to be following the Company's approach but use different ingredients and,
presumably, different processing methods. The Company cannot readily assess the
immediate impact of such products or product introductions.
The Company believes, but cannot assure, that the Gardenburger's-Registered
Trademark- taste and texture are superior to that of soy or tofu-based burgers.
The calorie and fat content of the Gardenburger-Registered Trademark- is
generally equivalent to that of other meatless burger products. While
Gardenburgers-Registered Trademark- generally sell for a slightly higher price
than other meatless patty products, management feels that the higher price
reflects the value of higher quality ingredients and a "premium" product. A
possible competitive risk facing the Company is that others may attempt to copy
or imitate the Company's products using the same or similar ingredients or
methods as the Company. Management cannot assess the likelihood or the impact
of such efforts.
The Company feels that "low fat" meat products compete with meatless patties in
general and, as a result, with the Gardenburger-Registered Trademark- and its
variations. The Company is not able to quantify the specific trade-offs
involved as to when a consumer might choose between meat, "low-fat" meat, "meat-
like" (meat "analog"), non-meat protein concentrate, or non-meat "natural foods"
alternatives in selecting a patty or a meat substitute either over the long run
or at a specific time. However, based on sales over the past few years,
consumers are actively seeking alternatives to meat products.
In a broader sense, the Company competes with frozen, mass produced entrees and
distributed low calorie/low fat national consumer brands such as Healthy Choice,
LeMenu
4
and Weight Watchers whose name recognition, advertising budgets and resources
are significantly greater than those of the Company's.
DISTRIBUTION
The Company sells its products in North America and in certain European and
South American markets through sixty independent, commissioned food brokers and
through five hundred active distributors. The Company's line of frozen
GardenProducts-Registered Trade Mark- is shipped by temperature controlled
truck and inventoried for distributors in cold storage warehouses in principal
cities in the United States, Canada and Europe.
The Company's product distribution activities and sales in 1996 were primarily
focused on the west coast of the United States. Approximately 50 percent of net
sales were delivered on the West Coast, 20 percent in the Northeast, 10 percent
in the Southeast, 10 percent in the Midwest and 7 percent in the Southwest. The
remaining 3 percent were shipped outside of the United States, primarily Canada
and some parts of Europe.
The Company's Gardenburger-Registered Trademark- is the most significant product
sold by the Company in terms of both volume and net sales, comprising over 80
percent of each. Variations on the Gardenburger-Registered Trademark- are the
second largest product sales group, comprising approximately 18 percent of net
sales in 1996.
The Company is pursuing expanded European distribution through demonstrating its
products at food shows, exploring strategic partnerships and building a broker
network. At present this "developmental" activity is negligible to the overall
business.
SALES AND MARKETING
The Company's sales objective is to position the original Gardenburger-
Registered Trademark- and its flavor variants, the Zesty Bean and Veggie Medley,
as the number #1 veggie burger in both the retail grocery and food service
distribution channels. The Company intends to aggressively pursue national chain
restaurant accounts and to leverage the sales force with distributor sales
representatives who are educated regarding the unique benefits and features of
our healthy food choices. During 1997 and future years the company also intends
to aggressively expand its distribution in the retail grocery channel. At the
beginning of 1996 the Company's penetration in this channel was less than 30
percent of U.S. retail grocery outlets. It's goal is to penetrate up to 80
percent of the retail grocery channel in the U.S. during 1997 and also to expand
its presence in club stores. The costs of entry and maintenance in these
distribution channels are typically higher than in the food service channel, and
the Company plans to invest heavily in securing additional retail grocery
distribution and follow-up promotional activities during 1997. The Company
believes, but cannot assure, that additional investment in marketing, promotion
and merchandising will increase sales.
Sales activities are organized under an institutional sales division and a
retail sales division. Institutional customers include more than 30,000 food
service outlets such as restaurants, corporate and industrial cafeterias, hotel
chains, colleges, hospitals, airlines and sports stadiums. Retail outlets
include approximately 10,000 grocery and other specialty food stores and over
4,000 natural foods stores. Although complete and accurate meatless patty sales
data is not publicly available at this time, industry analysts have estimated
Wholesome & Hearty Foods has over a fifty percent share of the food service
5
meatless patty market and a ten percent share of the supermarket grocery and
natural food meatless patty retail market.
The Company will continue to build its natural foods store base while, as
mentioned above, it continues to seek new opportunities in national chain
restaurants, club stores, school food service and retail grocery distribution.
During 1996 the Company hired additional sales and marketing personnel and will
continue to add personnel as needed in order to promote the Company and its
products and relations with distributors, brokers and customers.
Marketing objectives include increasing market penetration, building brand
awareness and loyalty and establishing a position of leadership in the category
of meatless food choices. Programs are being created and pursued to encourage
the use of the Gardenburger-Registered Trademark- brand in broadcast and print
media, to encourage the use of the Company's other product names, such as
GardenSausage-Registered Trademark-, on restaurant menus and point of sale
displays, to introduce new meatless products and to expand distribution
geographically and into new channels.
In addition to increased promotional activities, the Company will utilize a
variety of methods to solidify and build its business. The Company's
promotional materials and packaging re-design include a complete reformatting to
comply with the Food and Drug Administration nutrition information and label
regulations. The updated materials build brand awareness by providing more
cohesive and consistent visual images across the Company's entire line of
products and communicate to consumers, at the point of purchase, the heart smart
nutritional benefits (less than 30% of calories from fat) of Wholesome & Hearty
products.
In 1996, the Company's advertising and promotional expenses focused primarily on
print ads in food service trade publications, trade shows, off-invoice
promotions with distributors and radio advertising. The Company spent
approximately $1,539,000 in 1996 for advertising and promotions, $871,000 in
1995 and $670,000 in 1994.
RESEARCH AND DEVELOPMENT
The Company's research and development activities include development of new
products, the improvement of existing products and process development. The
GardenDog continues to be sold through the Company's natural foods product
channel while product and process improvements continue to be made to improve
consumer acceptance. In the fourth quarter of 1996 the Company hired a new Vice
President of Research and Development with a significant background in healthy,
frozen food products. Other employees, outside consultants and experts are also
involved on an as needed basis depending on the specific projects at hand. The
Company's research and development resources are focused on creating great
tasting, convenient, healthy center-of-the-plate entrees. Recipes and processes
are being developed for meatless alternatives to chicken, beef and pepperoni.
Development activity is done at the Company's development and production
facilities in Portland, Oregon. In 1996, the Company spent approximately $1.0
million on such activities, including $612,000 of acquired in-process research
and development. The amount spent on such activities during 1995 and 1994 was
immaterial.
6
EMPLOYEES
The Company has approximately 147 full-time equivalent employees. The Company
also utilizes a temporary workforce during peak seasonal demand periods that
averages 70 employees. The Company's employees are not represented by a labor
union, and the Company believes its relations with employees are satisfactory.
TRADEMARKS
The Company has registered the trademarks "Gardenburger-Registered Trademark-",
"Wholesome & Hearty Foods, Inc.-Registered Trademark-", "GardenDog-Registered
Trademark-", "GardenSausage-Registered Trademark-", "Gardenburger Sub-Registered
Trademark-", "Gardenburger-Registered Trademark- Veggie Medley" and
"Gardenburger-Registered Trademark- Zesty Bean" with the United States Patent
and Trademark Office. These trademarks expire at different times after the turn
of the century. The Gardenburger-Registered Trademark- trademark has also been
registered in the United Kingdom, Australia, Canada, Germany and Switzerland.
The Company has applied to register the Gardenburger-Registered Trademark- in
Argentina, China, Japan, Mexico, The Philippines and Columbia. The Company has
also applied for various other trademarks in the U.S. related to its wheat-
gluten based products.
The Company is not aware of any significant claims of infringement or other
challenges to any of its trademarks, logos or trademark applications. The
Company did successfully settle such a claim with Worthington Foods during 1996.
SIGNIFICANT CUSTOMERS AND CONCENTRATIONS OF CREDIT RISK
For the fiscal year ended December 31, 1996 one customer accounted for
approximately 22.9 percent of revenue and 32.3 percent of the accounts
receivable balance at December 31, 1996. Another customer accounted for
approximately 11.5 percent of revenue for the year ended December 31, 1996 and
12.7 percent of the accounts receivable balance at December 31, 1996.
For the fiscal year ended December 31, 1995 one customer accounted for
approximately 22.9 percent of revenue and 24.3 percent of the accounts
receivable balance at December 31, 1995. Another customer accounted for 11.5
percent of revenue for the year ended December 31, 1995 and 7.9 percent of the
accounts receivable balance at December 31, 1995.
For the year ended December 31, 1994 one customer accounted for 13.3 percent of
revenue and 10.4 percent of the accounts receivable balance at December 31,
1994. Another customer accounted for 13.0 percent of revenue for the year ended
December 31, 1994 and 29.0 percent of accounts receivable balance at December
31, 1994.
Historically, the Company has not incurred significant losses related to its
accounts receivable.
SOURCES OF SUPPLY
The Company uses natural ingredients such as mushrooms, oats, rice, onions, and
egg whites. These are common agricultural items typically available in most
parts of the United States. In addition, the Company uses packaging and
materials which are common in the food industry. As a result, the Company
believes, but cannot assure, that its sources of supply are reasonably reliable
and that the Company is at no greater risk on supply matters than other similar
food processors and producers.
7
SEASONALITY
The Company believes that its industry is seasonal due to the seasonal nature of
consumer demand for its type of products. Historically, the fourth and first
quarters have a decrease in sales from the preceding second and third quarters
due to such seasonality. The Company believes such seasonal variations may be
reflected in future quarterly patterns of its revenues and earnings.
ITEM 2. PROPERTIES
The Company leases 19,000 square feet of administrative office space at 1411 SW
Morrison, Suite 400, Portland, Oregon 97205, pursuant to a two year lease which
terminates on December 31, 1998. The Company also leases 6,600 square feet of
former administrative office space at 975 S.E. Sandy Boulevard, Portland, Oregon
97214, pursuant to a 5-year lease which terminates on June 1, 1999. The Company
is currently seeking to sub-let this space to another tenant.
The Company also leases approximately 20,000 square feet of pre-production,
storage and distribution space at 10264 SE Jennifer, Clackamas, Oregon under a
one-year lease that expires on November 1, 1997, and 15,000 square feet of
distribution space at 215 SE Stark, Portland, Oregon under a one-year lease that
expires on March 14, 1997, with an option to extend the lease for an additional
six months which the Company intends to exercise.
The Company leases additional space for research and development and production
at 1416 S.E. Eighth Avenue in Portland, Oregon. The facility is leased from
Paul F. Wenner, the Company's Chief Creative Officer and Frank S. Card, a
shareholder of the Company, at a rental rate of $1,700 per month, which the
Company considers to be reasonable rent, consistent with rental rates charged by
unaffiliated property owners in the same market area.
The Company owns 40,000 square feet of production facilities at 1005 S.E.
Washington Street, Portland, Oregon, and a 1,200 square foot annex at the same
location.
The Company is actively seeking and planning for additional manufacturing
capacity in the next 12-24 months. Capacity expansion alternatives include:
adding additional equipment to existing facilities, constructing a new plant, or
retrofitting a plant, expanding co-packing (outsourcing production to qualified
food processors), and licensing others to produce and/or distribute the
Company's products. In the event the Company elects to construct a new plant in
Portland, Oregon, an investment estimated currently to be fifteen to twenty
million dollars, including production equipment, would be required. The Company
owns a 16.6 acre parcel of real estate close to Portland International Airport
and intends to build such a facility. Currently, the company is exploring
financing alternatives ranging from working capital, conventional long-term debt
and leasing. However, no firm commitments on such financing have been made at
this date.
8
ITEM 3. LEGAL PROCEEDINGS
There are currently no material pending legal proceedings to which the Company
or its subsidiaries are a party. From time to time, the Company becomes
involved in ordinary, routine or regulatory legal proceedings incidental to the
business of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company did not submit any matters to a vote of security holders during the
quarter ended December 31, 1996.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock trades on The Nasdaq National Market System under the
symbol WHFI. The high and low sales prices for the two years in the period
ended December 31, 1996 were as follows:
1996 High Low
---------------------------- ------ ------
Quarter 4 $ 8.25 $ 6.00
Quarter 3 8.38 6.38
Quarter 2 9.38 7.13
Quarter 1 9.50 6.50
1995 High Low
---------------------------- ------ ------
Quarter 4 $10.88 $ 7.13
Quarter 3 14.06 10.69
Quarter 2 13.75 10.00
Quarter 1 13.25 10.44
The approximate number of shareholders of record and beneficial shareholders at
December 31, 1996 was 745.
There were no cash dividends declared or paid in 1996 or 1995. The Company does
not anticipate declaring cash dividends in the foreseeable future.
Except for 240,000 shares issued and 200,000 shares put into escrow in
connection with the Gorilla Foods acquisition, there were no sales of
unregistered securities by the Company during the year ended December 31, 1996.
The 440,000 shares were issued in reliance on Rule 505 of Regulation D under the
Securities Act of 1933.
9
ITEM 6. SELECTED FINANCIAL DATA
IN THOUSANDS:
EXCEPT SHARE AND PER SHARE AMOUNTS 1996 (1) 1995 1994 1993 1992
---------- ---------- ----------- ---------- ----------
STATEMENT OF OPERATIONS DATA
Net sales $ 39,254 $ 35,754 $ 23,736 $ 12,952 $ 6,946
Gross margin 19,348 17,656 12,345 6,817 3,346
Operating expenses 17,885 13,958 8,754 4,158 2,277
Operating income 1,463 3,698 3,591 2,659 1,069
Net income $ 1,063 $ 2,510 $ 2,391 $ 1,532 $ 575
Net income per share $ 0.12 $ 0.29 $ 0.28 $ 0.19 $ 0.10
Shares used in per share calculations 9,065,969 8,638,691 8,577,907 8,177,222 6,190,341
BALANCE SHEET DATA
Working capital $ 13,393 $ 11,978 $ 11,037 $ 6,710 $ 2,495
Total assets 24,934 19,325 15,320 10,363 5,857
Long-term liabilities - - - - 697
Shareholders' equity 20,979 16,955 14,028 9,151 4,298
GROWTH INDICATORS (UNAUDITED)
Net sales growth 10% 51% 83% 86% 116%
Operating income growth (60%) 3% 35% 149% 64%
Net income growth (58%) 5% 56% 166% 55%
Net income per share growth (59%) 4% 47% 90% (17%)
(1) Operating expenses in 1996 include a $612,000 one-time charge for acquired
in-process research and development related to the Gorilla Foods
acquisition.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION
GENERAL
The following discussion should be read in conjunction with the financial
statements and related notes which follow. The Company's future operating
results are likely to be affected by trends and factors which are beyond the
Company's control. These include, among other factors, unexpected changes in
food manufacturing technology, uncertain business conditions that impact the
general food manufacturing industry, government regulation and general economic
conditions.
The Company's manufacturing processes use certain raw ingredients, including
mushrooms, onions and cheese, supplied from outside sources. Any reduction in
supply or change in costs of these ingredients may affect the Company's ability
to meet customer demand. The Company is not currently aware of any such changes
in supply or costs of its raw material ingredients, other than cheese. During
1996, the prices of cheese were volatile and such volatility may continue in
1997.
10
During 1996 the Company continued to broaden its product distribution into new
geographic locations and new sales channels to increase its national presence
and to provide direct sales and support interface with customers. There can be
no assurance that this strategy will be effective or successful or that the
service and support needed to ensure the success of the Company's expansion into
new territories or new sales channels can be achieved cost effectively.
The market price of the Company's Common Stock has been, and is likely to
continue to be, volatile. Many factors, including events affecting the stock
market generally, quarterly fluctuations in the Company's operating results and
general conditions in the economy may affect the price of the Company's stock.
Any shortfall in revenue or earnings from the level anticipated by securities
analysts could have an immediate and adverse impact on the trading price of the
Company's Common Stock in any given period.
Because of all the foregoing factors, as well as other variables, past financial
performance should not be considered a reliable indicator of future performance
and management believes that historical trends should not be relied on to
anticipate results or trends in future periods.
ACQUISITION OF GORILLA FOODS, INC. AND WHOLE FOOD MARKETING
In January 1996 the Company completed the acquisition of Ojai, California-based
Gorilla Foods, Inc., a privately held developer and manufacturer of wheat
protein-based, meatless food products, including the GardenDog. The transaction
provided for the issuance of 240,000 shares of the Company's Common Stock in
exchange for all outstanding common shares of Gorilla Foods, and $68,750 in
cash. In addition, up to an additional 200,000 certain contingent shares of the
Company could be issued in 50,000 share increments contingent upon the Company
achieving certain sales performance levels of wheat protein-based products over
the next five years. This transaction has enabled the Company to broaden its
product line by owning the recipe for the GardenDog and other future wheat
gluten protein-based products to be developed for the meat analog product
market. The Company incurred a one-time charge of $612,000 in the first quarter
of 1996 as a result of the acquisition of in process research and development
associated with this acquisition, with the remainder of the purchase price
principally allocated to goodwill. Pro forma financial information has not been
provided as the pro forma results are not materially different from actual
results.
In a separate transaction in January 1996, the Company completed the acquisition
of the assets of Whole Food Marketing, Inc., a Southern California-based food
broker of the Company's and Gorilla Foods' products. The Company paid $350,000
for the assets of Whole Food Marketing, Inc., all of which was allocated to
goodwill.
11
RESULTS OF OPERATIONS
The following table is derived from the Company's Statements of Operations for
the periods indicated and presents the results of operations as a percentage of
net sales.
Fiscal year ended December 31, 1996 December 31, 1995 December 31, 1994
- -------------------------------------------- ----------------- ----------------- -----------------
Net sales 100.0% 100.0% 100.0%
Cost of goods sold 50.7 50.6 48.0
----------------- ----------------- -----------------
Gross margin 49.3 49.4 52.0
Sales and marketing expense 31.4 28.2 26.8
General and administrative expense 12.6 10.8 10.1
Acquired in-process research and development 1.6 -- --
----------------- ----------------- -----------------
Operating income 3.7 10.4 15.1
Other income (expense) 0.9 0.4 1.1
----------------- ----------------- -----------------
Income before income taxes 4.6 10.8 16.2
Income taxes 1.9 3.8 6.1
----------------- ----------------- -----------------
Net income 2.7 7.0 10.1
----------------- ----------------- -----------------
----------------- ----------------- -----------------
1996 COMPARED TO 1995
NET SALES. Net sales for 1996 increased 9.8 percent to $39.3 million from $35.8
million for 1995. The Company has increased its sales levels in each of its
major channels, including food service, retail and club stores, such as
PriceCostco. Such increases are primarily a result of increased marketing and
public relations activities which have increased awareness of the Company's
products throughout its channels of distribution. At the beginning of the
second quarter of 1996, the Company started selling to additional large retail
chains in Southern California. In January 1996, the Company discontinued
selling its almond beverage and almond cheese products, which resulted in
natural foods sales declining approximately $1.0 million from the prior year.
GROSS MARGIN. Gross margin increased 9.6 percent to $19.3 million (49.3 percent
of net sales) for 1996 from $17.7 million (49.4 percent of net sales) for 1995.
Gross margin as a percentage of net sales remained constant primarily as a
result of continued upward pressures on pricing in certain raw materials, offset
by process improvements at the Company's manufacturing plant, increased food
service sales, which have higher margins, and start-up costs associated with a
new food service product-type in 1995 that were not duplicated in 1996.
SALES AND MARKETING EXPENSE. Sales and marketing expenses increased to $12.3
million (31.4 percent of net sales) for 1996 from $10.1 million (28.2 percent of
net sales) for 1995. The increase is primarily attributable to increased
expenditures during 1996 related to the promotion of sales for additional retail
chains that the Company began selling to during the first half of 1996,
increased headcount as a result of hiring additional field sales people, costs
associated with the Company's plan to aggressively grow its retail grocery
business in 1997 and increased promotional activities in general to support and
promote the growth of the Company.
12
GENERAL AND ADMINISTRATIVE EXPENSE. General and administrative expense
increased to $5.0 million (12.6 percent of net sales) for 1996 from $3.9 million
(10.8 percent of net sales) for 1995. The increase is primarily a result of non-
recurring costs to defend litigation which was settled in the third quarter of
1996, relocation and recruiting expense in connection with the hiring of
personnel to support the growth of the Company, approximately $400,000 for
management transition costs during the second quarter of 1996 and ongoing costs
related to the overall growth of the Company, including an improved support
infrastructure.
ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT. In connection with the
acquisition of Gorilla Foods, Inc., the Company recorded a one-time pretax
charge of $612,000 ($386,000 net of taxes) related to acquired in-process
research and development costs. The value assigned to the in-process research
and development was determined by an appraisal and represents those efforts in
process at the acquisition date that had not yet established feasibility and
that had no alternative future uses. Accounting rules require that such costs
be charged to expense as incurred. The Company currently believes that these
research and development efforts will result in commercially viable products
over the next several years.
OPERATING INCOME. Operating income (without the one-time charge for purchased
in-process research and development) decreased to $2.1 million (5.3 percent of
net sales) for 1996 compared to $3.7 million (10.4 percent of net sales) for
1995 as a result of the individual line item changes discussed above.
OTHER INCOME (EXPENSE). Other income increased to $327,000 in 1996 from
$153,000 in 1995 primarily as a result of increased cash balances and therefore
increased interest income.
INCOME TAXES. The Company's income tax rate for 1996 was 40.6 percent compared
to 34.8 percent for 1995. The increase from the 34.8 percent rate achieved for
fiscal 1995 is primarily a result of non-deductible goodwill expenditures in
1996, adjustments in 1996 relating to prior years and a one-time tax benefit
received in 1995 from the State of Oregon.
NET INCOME. Net income decreased to $1.1 million (2.7 percent of net sales)
for 1996 compared to $2.5 million (7.0 percent of net sales) for 1995 as a
result of the individual line item changes discussed above. The Company
believes that the impact of inflation on net income was minimal for fiscal years
1996 and 1995.
1995 COMPARED TO 1994
NET SALES. Net sales for 1995 increased 51 percent to $35.8 million from $23.7
million for 1994. The increase was primarily attributable to increased
penetration in the Company's food service distribution channels and in club
stores, such as PriceCostco, and increased marketing and public relations
activities which have increased awareness of the Company's products throughout
its channels of distribution.
13
GROSS MARGIN. Gross margin increased 43 percent to $17.7 million (49 percent of
net sales) for 1995 from $12.3 million (52 percent of net sales) for 1994. The
decrease as a percentage of net sales primarily resulted from increasing club
store sales, both in absolute dollars and as a percentage of the total sales
mix. In addition, greater promotional discounts due to increased competition
and start-up costs associated with new food service products impacted margins.
SALES AND MARKETING EXPENSE. Sales and marketing expenses increased to $10.1
million (28.2 percent of net sales) for 1995 from $6.4 million (26.8 percent of
net sales) for 1994. The increase is primarily attributable to growth of the
Company and increased marketing efforts which included more product
demonstrations, coupon and other media activities and a new marketing campaign
aimed at the Company's institutional business.
GENERAL AND ADMINISTRATIVE EXPENSE. General and administrative expense
increased to $3.9 million (10.8 percent of net sales) for 1995 from $2.4 million
(10.1 percent of net sales) for 1994. The increase is primarily attributable to
growth of the Company, $281,000 to defend current litigation and a company wide
profit sharing plan that was implemented in 1995, offset by cost containment
measures put into place in the third quarter of 1995.
OPERATING INCOME. 1995 operating income remained relatively constant at $3.7
million (10.3 percent of net sales) compared to $3.6 million (15.1 percent of
net sales) for 1994 as a result of the individual line item changes discussed
above.
OTHER INCOME (EXPENSE). Other income decreased to $153,000 in 1995 from
$262,000 in 1994 primarily as a result of increased cash balances and therefore
increased interest income, offset by a $52,000 loss on the sale of fixed assets
in 1995 compared to a gain on sale of fixed assets of $85,000 in 1994.
INCOME TAXES. The Company's income tax rate for 1995 was 34.8 percent compared
to 37.9 percent for 1994. The decrease from 1994 was primarily attributable to
tax exempt interest and dividends received on investments and slightly lower
effective state tax rates in 1995 as a result of a one-time benefit from the
state of Oregon.
NET INCOME. Net income remained relatively constant at $2.5 million (7.0
percent of net sales) for 1995 compared to $2.4 million (10.1 percent of net
sales) for 1994 as a result of the individual line item changes discussed above.
The Company believes that the impact of inflation on net income was minimal for
fiscal years 1995 and 1994.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1996, the Company had working capital of $13.4 million, which
included $7.8 million of cash and cash equivalents as compared to $12.0 in
working capital at December 31, 1995 and approximately $9.2 million of cash and
cash equivalents at December 31, 1995. The decrease in cash and cash
equivalents is primarily a result of $0.5 million used in operations, including
the building of inventories in anticipation of increased growth in 1997, $2.4
million for the purchase of property and equipment and $0.4 million for the
purchase of Gorilla Foods and Whole Food Marketing, offset by $2.0 million
provided from the exercise of Common Stock options and the income tax benefit of
non-qualified option exercises and disqualifying dispositions.
14
Accounts receivable decreased $141,000 to $2.8 million at December 31, 1996 from
$2.9 million at December 31, 1995. Days sales outstanding have decreased to
32.0 at December 31, 1996 from 34.6 at December 31, 1995 (calculated based on
average sales per day in the fourth quarter of each respective year). Accounts
80 days or more past due represent less than 2 percent of accounts receivable at
December 31, 1996.
Inventory levels at December 31, 1996 increased $3.2 million to $4.8 million at
December 31, 1996 from $1.6 million at December 31, 1995, due primarily to the
building of finished goods to ensure the Company's ability to meet anticipated
sales demand during the first half of 1997. Inventory turns have decreased to
approximately 5.1 times for the year ended December 31, 1996 from approximately
8.0 times for the year ended December 31, 1995.
Income taxes receivable were $653,000 at December 31, 1996 compared to a payable
of $269,000 at December 31, 1995 primarily as a result of a $1.4 million
benefit which resulted from the exercise of non-qualified stock options and
payments made during 1996.
Accounts payable increased to $2.2 million at December 31, 1996 from $1.0
million at December 31, 1995 primarily as a result of increased inventory
purchases to support an anticipated increase in the Company's sales growth rate
beginning in the first half of 1997.
Capital expenditures of $2.4 million during 1996 primarily resulted from the
purchase of packaging equipment to streamline the Company's retail manufacturing
process, equipment to increase the Company's manufacturing capacity at current
locations and improvements to the Company's information systems infrastructure.
Future capital requirements, other than normal operating expenses, could
include, among other things, the possible construction of a new manufacturing
facility, the purchase of manufacturing equipment to equip such a new facility
or a co-packing facility, the funding of regional or national marketing
campaigns and the implementation of a new information systems infrastructure.
If the Company obtains a new manufacturing facility, it would expect such a
facility to cost between $15 and $20 million, including all production
equipment. The Company is currently researching funding options including
various combinations of cash, conventional debt and lease financings. At
December 31, 1996, the Company had firm obligations of $120,000 related to such
facility. The Company has incurred approximately $468,000 in expenditures to
date on its information systems project and expects the entire project to cost
approximately $550,000, all of which is expected to be paid out of existing cash
balances.
Management believes that the Company's existing working capital, in combination
with cash flow from operations and funds available under credit and capital
lease facilities, should be sufficient to support working capital requirements
over the next year.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and notes thereto required by this item are included on
pages F-1 through F-15 as listed in Item 14 of Part IV of this document.
15
Unaudited quarterly financial data for each of the eight quarters in the two
year period ended December 31, 1996 is as follows:
IN THOUSANDS, EXCEPT PER SHARE DATA 1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER
- ----------------------------------- ----------- ----------- ----------- -----------
1996
Net sales $ 9,164 $ 11,005 $ 11,042 $ 8,043
Gross margin 4,523 5,532 5,434 3,859
Net income 58 (1) 521 778 (294)
Net income per share 0.01 0.06 0.09 (0.03)
1995
Net sales $ 8,281 $ 9,453 $ 10,195 $ 7,825
Gross margin 4,008 4,958 5,067 3,623
Net income 652 746 860 252
Net income per share 0.08 0.09 0.10 0.03
(1) Operating expenses in 1996 include a $612,000 one-time charge for acquired
in-process research and development related to the Gorilla Foods
acquisition.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On April 13, 1995, Wholesome & Hearty Foods, Inc. (the "Company") dismissed its
independent accountant, Grant Thornton LLP ("Grant Thornton"). Such dismissal
was recommended and approved by the Board of Directors of the Company. Grant
Thornton's report on the Company's financial statements for the fiscal year
ending December 31, 1994 contained no adverse opinion or disclaimer of opinion
and was not qualified or modified as to uncertainty, audit scope or accounting
principles. There were no disagreements with Grant Thornton on any matter of
accounting principles or practices, financial statement disclosure or auditing
scope or procedure during this one year period nor in any subsequent period
preceding the dismissal. In addition, there were no such events as described
under Item 304(a)(1)(v)(A) through (D) of Regulation S-K during the two most
recent fiscal years or the subsequent period through April 13, 1995.
Also as of April 13, 1995, the Company engaged Arthur Andersen LLP to be its
independent accountant. Except on a limited basis as disclosed below, at no
time during the two most recent fiscal years or subsequent period prior to
engagement has the Company consulted with Arthur Andersen LLP as to (i) the
application of accounting principles to a specified transaction, either
completed or proposed, (ii) the type of audit opinion that might be rendered on
its financial statements or (iii) any matter that was the subject of a
disagreement (as defined in Item 304(a)(1)(iv) of Regulation S-K) or a
reportable event (as described in Item 304(a)(1)(v) of Regulation S-K). In
anticipation of engaging Arthur Andersen LLP, the Company had limited
discussions with Arthur Andersen LLP regarding the accounting for the proposed
acquisition of Gorilla Foods. Arthur Andersen LLP expressed orally to the
Company that based on the preliminary facts and circumstances the proposed
transaction should be accounted for as a purchase. The Company has also
discussed the proposed transaction with Grant Thornton who also believes the
transaction should be accounted for as a purchase. It is the Company's
understanding that Arthur Andersen LLP has also consulted with Grant Thornton in
the process of reaching their conclusion.
16
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information required by this item is included under the captions ELECTION OF
DIRECTORS, EXECUTIVE OFFICERS AND COMPLIANCE WITH SECTION 16(a) OF THE
SECURITIES EXCHANGE ACT OF 1934, respectively, in the Company's Proxy Statement
for its 1997 Annual Meeting of Shareholders and is incorporated herein by
reference.
ITEM 11. EXECUTIVE COMPENSATION
Information required by this item is included under the caption EXECUTIVE
COMPENSATION in the Company's Proxy Statement for its 1997 Annual Meeting of
Shareholders and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is included under the caption SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT in the Company's Proxy
Statement for its 1997 Annual Meeting of Shareholders and is incorporated herein
by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is included under the caption CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS in the Company's Proxy Statement for its
1997 Annual Meeting of Shareholders and is incorporated herein by reference.
17
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) (1) FINANCIAL STATEMENTS
The Financial Statements, together with the reports thereon of Arthur Andersen
LLP and Grant Thornton LLP, are included on the pages indicated below :
Page
----
Report of Arthur Andersen LLP F-1
Report of Grant Thornton LLP F-2
Balance Sheets - December 31, 1996 and 1995 F-3
Statements of Operations for the years ended December 31, 1996,
1995 and 1994 F-4
Statements of Shareholders' Equity - December 31, 1996, 1995 and 1994 F-5
Statements of Cash Flows for the years ended December 31, 1996, 1995 and
1994 F-6
Notes to Financial Statements F-7
FINANCIAL STATEMENT SCHEDULES
The following schedule and report thereon is filed herewith:
Page
----
Report of Independent Public Accountants on Financial Statement Schedule F-16
Schedule II Valuation and Qualifying Accounts F-17
18
(a) (3) EXHIBITS INCLUDED HEREIN:
Exhibit No.
- -----------
3a Restated Articles of Incorporation (3) ----
3b Amendment No. 1 to Restated Articles of Incorporation (1) ----
3c Amendment No. 2 to Restated Articles of Incorporation (6) ----
3d 1995 Restated Bylaws (7) ----
4 Instruments defining the rights of security holders.
See Article II, Sections 3, 4 and 5 of Restated
Articles of Incorporation and Article I of 1995
Restated Bylaws (3) (7) ----
10a Business Loan Agreement with Bank of America re: Lines
of Credit, dated March 22, 1996 (6) ----
10b Plant Lease-1416 S.E. 8th, Portland, Oregon (1) ----
10c Office Lease-975 S.E. Sandy Blvd., Portland, Oregon (4) ----
10d Consent to Assignment and Option to purchase 1005 S.E.
Washington, Portland, Oregon (1) ----
10e Morrison Plaza Office Lease, dated October 29, 1996.
10f Purchase and Sale Agreement and Receipt For Earnest
Money Between the Iseli Family Partnership, an Oregon
Partnership (Seller) and the Company (Buyer), as
amended, dated May 8, 1995 (6) ----
10g 1992 Employee Incentive Stock Option Plan (1) ----
10h 1992 First Amended and Restated Combination Stock
Option Plan (4) ----
10i Lyle Hubbard employment agreement, dated April 14, 1996.
10j Employment Agreement and Amendment thereto-Mr. Wenner (1) ----
10k Paul F. Wenner Stock Option Agreement (2) ----
10l Executive Officer Termination Agreement
10m Form of indemnification Agreement between the Company
and its Officers and Directors (3) ----
10n Plan and Agreement of Reorganization by Exchange by
the Company of Its Voting Stock for Substantially All
The Properties of Gorilla Foods, Inc., dated
January 31, 1996 (6) ----
19
Exhibit No.
- -----------
10o 1997 Executive Bonus Plan
10p Consulting agreement between the Company and E. Kay
Stepp, dated November 1, 1996.
10q Rights Agreement between the Company and First Chicago
Trust Company of New York, dated April 25, 1996 (8) ----
11 Statement regarding computation of per share earnings
16 Letter re: change in certifying accountant (5) ----
23a Consent of Arthur Andersen LLP
23b Consent of Grant Thornton LLP
24a Power of attorney of Thomas D. Henrion
24b Power of attorney of Ralph M. Kovel
24c Power of attorney of Mary O. McWilliams
24d Power of attorney of Michael L. Ray
24e Power of attorney of E. Kay Stepp
24f Power of attorney of Michael D. Wagoner
24g Power of attorney of Paul F. Wenner
27 Financial Data Schedule
(1) Incorporated by reference to the Company's Form S-1 Registration Statement
(Commission File No. 33-46623) as filed with the Securities and Exchange
Commission on May 6, 1992.
(2) Incorporated by reference to the Company's fiscal year ended December 26,
1992 Form 10-K Annual Report as filed with the Securities and Exchange
Commission on March 23, 1993.
(3) Incorporated by reference to the Company's fiscal year ended December 25,
1993 Form 10-K Annual Report as filed with the Securities and Exchange
Commission on March 23, 1994.
(4) Incorporated by reference to the Company's fiscal year ended December 31
1994 Form 10-K Annual Report as filed with the Securities and Exchange
Commission on March 30, 1995.
(5) Incorporated by reference to the Company's Form 8-K/A dated April 13, 1995
as filed with the Securities and Exchange Commission on May 5, 1995.
(6) Incorporated by reference to the Company's fiscal year ended December 31,
1995 Form 10-K Annual Report as filed with the Securities and Exchange
Commission on March 29, 1996.
(7) Incorporated by reference to the Company's Form 10-Q for the quarter ended
September 30, 1996, as filed with the Securities and Exchange Commission on
November 4, 1996.
(8) Incorporated by reference to the Company's Form 8-K, as filed with the
Securities and Exchange Commission on May 8, 1996.
(b) REPORTS ON FORM 8-K.
No reports on Form 8-K were filed during the quarter ended December 31,
1996.
20
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Date: March 17, 1997
--------------
WHOLESOME & HEARTY FOODS, INC.
By:/s/ LYLE G. HUBBARD
-------------------
Lyle G. Hubbard
Director, President 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 and
in the capacities on March 17, 1997.
Signature Title
/s/ LYLE G. HUBBARD Director, President and Chief Executive Officer
- ------------------------- (Principal Executive Officer)
Lyle G. Hubbard
/s/ RICHARD C. DIETZ Executive Vice President,
- ------------------------- Chief Financial Officer, Treasurer and Secretary
Richard C. Dietz (Principal Financial and Accounting Officer)
* THOMAS D. HENRION Director
- -------------------------
Thomas D. Henrion
* RALPH M. KOVEL Director
- -------------------------
Ralph M. Kovel
* MARY O. MCWILLIAMS Director
- -------------------------
Mary O. McWilliams
* MICHAEL L. RAY Director
- -------------------------
Michael L. Ray
* E. KAY STEPP Chairman of the Board
- -------------------------
E. Kay Stepp
* MICHAEL D. WAGONER Director
- -------------------------
Michael D. Wagoner
* PAUL F. WENNER Founder, Senior Chairman of the Board
- ------------------------- and Chief Creative Officer
Paul F. Wenner
* BY:/s/ RICHARD C. DIETZ
- -------------------------
Richard C. Dietz, Attorney-in-fact
21
Report of Independent Public Accountants
To the Board of Directors and Shareholders of
Wholesome & Hearty Foods, Inc.:
We have audited the accompanying balance sheets of Wholesome & Hearty Foods,
Inc. (an Oregon corporation) as of December 31, 1996 and 1995 and the related
statements of operations, shareholders' equity and cash flows for each of the
two years in the period ended December 31, 1996. 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. The
financial statements of Wholesome & Hearty Foods, Inc. for the year ended
December 31, 1994 were audited by other auditors whose report dated February 20,
1995 expressed an unqualified opinion.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits 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. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Wholesome & Hearty Foods, Inc.
as of December 31, 1996 and 1995, and the results of its operations and its cash
flows for each of the two years in the period ended December 31, 1996, in
conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Portland, Oregon,
February 7, 1997
F-1
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors
Wholesome & Hearty Foods, Inc.
We have audited the accompanying statements of operations, shareholders' equity
and cash flows of Wholesome & Hearty Foods, Inc. (an Oregon corporation) for the
year ended December 31, 1994. 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 audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards 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. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the results of operations and cash flows of Wholesome &
Hearty Foods, Inc. for the year ended December 31, 1994, in conformity with
generally accepted accounting principles.
GRANT THORNTON LLP
Portland, Oregon
February 20, 1995
F-2
WHOLESOME AND HEARTY FOODS, INC.
BALANCE SHEETS
December 31, December 31,
1996 1995
------------ ------------
ASSETS
Current Assets:
Cash and cash equivalents (Note 1) $ 7,755,000 $ 9,247,000
Accounts receivable, net of allowances of
$177,000 and $120,000 (Note 1) 2,800,000 2,941,000
Inventories, net (Notes 1 and 2) 4,790,000 1,562,000
Prepaid expenses 378,000 197,000
Income taxes receivable 653,000 -
Deferred income tax benefit (Note 6) 470,000 156,000
------------ ------------
Total Current Assets 16,846,000 14,103,000
Property, Plant and Equipment, net of accumulated
depreciation of $1,220,000 and $828,000 (Note 3) 6,814,000 4,937,000
Other Assets, net of accumulated amoritization of
$122,000 and zero 1,274,000 285,000
------------ ------------
Total Assets $ 24,934,000 $ 19,325,000
------------ ------------
------------ ------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Income taxes payable (Note 6) $ - $ 269,000
Accounts payable 2,173,000 1,039,000
Payroll and related liabilities payable 458,000 408,000
Accrued employee bonuses 221,000 112,000
Accrued relocation 178,000 -
Accrued brokers' commissions 199,000 205,000
Other current liabilities 224,000 92,000
------------ ------------
Total Current Liabilities 3,453,000 2,125,000
Deferred Income Taxes (Note 6) 502,000 245,000
Commitments and Contingencies (Notes 5 and 12)
Shareholders' Equity:
Preferred Stock, no par value, 5,000,000 shares authorized;
none issued (Note 9) - -
Series A Junior Participating Preferred Stock, no par value,
250,000 shares authorized; none issued (Note 9) - -
Common Stock, no par value, 25,000,000 shares authorized;
shares issued and outstanding: 8,566,456 and 7,701,456 8,468,000 7,603,000
Additional paid-in capital 4,139,000 2,053,000
Retained earnings 8,372,000 7,299,000
------------ ------------
Total Shareholders' Equity 20,979,000 16,955,000
------------ ------------
Total Liabilities and Shareholders' Equity $ 24,934,000 $ 19,325,000
------------ ------------
------------ ------------
The accompanying notes are an integral part of these balance sheets.
F-3
WHOLESOME AND HEARTY FOODS, INC.
STATEMENTS OF OPERATIONS
For the Year Ended December 31,
1996 1995 1994
------------- ------------- -------------
Net sales $ 39,254,000 $ 35,754,000 $ 23,736,000
Cost of goods sold 19,906,000 18,098,000 11,391,000
------------- ------------- -------------
Gross margin 19,348,000 17,656,000 12,345,000
Operating expenses:
Sales and marketing 12,310,000 10,087,000 6,357,000
General and administrative 4,963,000 3,871,000 2,397,000
Acquired in-process research & development 612,000 - -
------------- ------------- -------------
------------- ------------- -------------
17,885,000 13,958,000 8,754,000
------------- ------------- -------------
Operating income 1,463,000 3,698,000 3,591,000
Other income (expense):
Interest income 365,000 284,000 164,000
Interest expense - (1,000) (1,000)
------------- ------------- -------------
------------- ------------- -------------
Other, net (38,000) (130,000) 99,000
327,000 153,000 262,000
------------- ------------- -------------
Income before provision for income taxes 1,790,000 3,851,000 3,853,000
Provision for income taxes 727,000 1,341,000 1,462,000
------------- ------------- -------------
Net income $ 1,063,000 $ 2,510,000 $ 2,391,000
------------- ------------- -------------
------------- ------------- -------------
Net income per share $ 0.12 $ 0.29 $ 0.28
------------- ------------- -------------
------------- ------------- -------------
Shares used in per share calculations 9,065,969 8,638,691 8,577,907
------------- ------------- -------------
------------- ------------- -------------
The accompanying notes are an integral part of these statements.
F-4
WHOLESOME AND HEARTY FOODS, INC.
STATEMENTS OF SHAREHOLDERS' EQUITY
For the Years Ended December 31, 1996, 1995 and 1994
Common Stock Additional Total
------------------------ Paid-In Retained Shareholders'
Shares Amount Capital Earnings Equity
--------- ------------ ------------ ------------ -------------
Balance at December 25, 1993 4,887,858 $ 6,743,000 $ 10,000 $ 2,398,000 $ 9,151,000
Three-for-two stock split 2,443,929 - - - -
--------- ------------ ------------ ------------ -------------
Adjusted Balances, December 25, 1993 7,331,787 6,743,000 10,000 2,398,000 9,151,000
Exercise of Common Stock Options 220,335 394,000 - - 394,000
Exercise of Common Stock Warrants 90,000 175,000 - - 175,000
Income tax benefit of non-qualified stock
option exercises and disqualifying
dispositions - - 1,917,000 - 1,917,000
Net income - - - 2,391,000 2,391,000
--------- ------------ ------------ ------------ -------------
Balance at December 31, 1994 7,642,122 7,312,000 1,927,000 4,789,000 14,028,000
Exercise of Common Stock Options 59,334 291,000 - - 291,000
Income tax benefit of non-qualified stock
option exercises and disqualifying
dispositions - - 126,000 - 126,000
Net income - - - 2,510,000 2,510,000
--------- ------------ ------------ ------------ -------------
Balance at December 31, 1995 7,701,456 7,603,000 2,053,000 7,299,000 16,955,000
Exercise of Common Stock Options 625,000 625,000 - - 625,000
Income tax benefit of non-qualified stock
option exercises and disqualifying
dispositions - - 1,336,000 - 1,336,000
Issuance of shares for acquisition
of Gorilla Foods, Inc. 240,000 240,000 750,000 - 990,000
Foreign currency translation - - - 10,000 10,000
Net income - - - 1,063,000 1,063,000
--------- ------------ ------------ ------------ -------------
Balance at December 31, 1996 8,566,456 $ 8,468,000 $ 4,139,000 $ 8,372,000 $ 20,979,000
--------- ------------ ------------ ------------ -------------
--------- ------------ ------------ ------------ -------------
The accompanying notes are an integral part of these statements.
F-5
WHOLESOME AND HEARTY FOODS, INC.
STATEMENTS OF CASH FLOWS
For the Year Ended December 31,
1996 1995 1994
------------ ------------ ------------
Cash flows from operating activities:
Net income $ 1,063,000 $ 2,510,000 $ 2,391,000
Effect of exchange rate on operating accounts 10,000 - -
Adjustments to reconcile net income to net cash flows
provided by (used in) operating activities:
Depreciation and amortization 594,000 334,000 190,000
Acquired in-process research and development, net of tax 386,000 - -
(Gain) loss on sale of fixed assets 52,000 52,000 (85,000)
Deferred income taxes (57,000) (154,000) 107,000
(Increase) decrease in:
Investments - 507,000 1,734,000
Accounts receivable, net 141,000 (519,000) (1,172,000)
Inventories, net (3,228,000) 1,398,000 (1,850,000)
Prepaid expenses (181,000) (60,000) (93,000)
Income taxes receivable, net (922,000) 2,559,000 (2,805,000)
Increase (decrease) in:
Accounts payable 1,134,000 409,000 473,000
Payroll and related liabilities 50,000 178,000 81,000
Other accrued liabilities 413,000 239,000 48,000
------------ ------------ ------------
Net cash provided by (used in) operating activities (545,000) 7,453,000 (981,000)
Cash flows from investing activities:
Payments for purchase of property and equipment (2,428,000) (2,219,000) (851,000)
Proceeds from sale of equipment 26,000 1,000 214,000
Cash paid for Gorilla Foods and Whole Food Marketing (419,000) - -
Other assets, net (87,000) (137,000) (110,000)
------------ ------------ ------------
Net cash used in investing activities (2,908,000) (2,355,000) (747,000)
Cash flows from financing activities:
Payment on equipment option - - (100,000)
Proceeds from exercise of common stock options and warrants 625,000 291,000 569,000
Income tax benefit of non-qualified stock option
exercises and disqualifying dispositions 1,336,000 126,000 1,917,000
------------ ------------ ------------
Net cash provided by financing activities 1,961,000 417,000 2,386,000
Increase (decrease) in cash and cash equivalents (1,492,000) 5,515,000 658,000
Cash and cash equivalents:
Beginning of period 9,247,000 3,732,000 3,074,000
------------ ------------ ------------
End of period $ 7,755,000 $ 9,247,000 $ 3,732,000
------------ ------------ ------------
------------ ------------ ------------
The accompanying notes are an integral part of these statements.
F-6
WHOLESOME & HEARTY FOODS, INC.
NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND NATURE OF OPERATIONS
Wholesome & Hearty Foods, Inc. was incorporated in Oregon in 1985 to provide a
line of food products in response to the public's awareness of the importance of
diet to overall health and fitness. Toward this end, the Company developed and
now produces and distributes products which include a variety of frozen,
meatless items that are generally low in cholesterol and fat. The Company's
products are principally sold to retail and institutional customers throughout
the United States.
REPORTING PERIOD
In January 1995 the Company changed from a 52-53 week year for reporting
purposes to a calendar year. The year ended December 31, 1994 consists of 53
weeks.
ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from those estimates. Management believes that the estimates used
are reasonable.
CASH EQUIVALENTS
Cash equivalents consist of highly liquid investments with maturities at the
date of purchase of 90 days or less.
INVENTORIES
Inventories are valued at standard cost, which approximates the lower of cost
(using the first-in, first-out (FIFO) method), or market, and include materials,
labor and manufacturing overhead.
GOODWILL
Goodwill is being amortized using the straight line method over ten years.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are stated at cost. Depreciation and amortization
are provided using straight-line and accelerated methods over the estimated
useful lives of the assets. Leasehold improvements are amortized over the lease
term or the estimated useful life of the asset, whichever is shorter. Estimated
useful lives are as follows:
BUILDING AND IMPROVEMENTS 3 - 40 YEARS
OFFICE FURNITURE AND EQUIPMENT 3 - 10 YEARS
MACHINERY AND EQUIPMENT 7 - 30 YEARS
VEHICLES 5 YEARS
F-7
CONCENTRATIONS OF CREDIT RISK AND SIGNIFICANT CUSTOMERS
The Company invests its excess cash with high credit quality financial
institutions which bear minimal risk and, by policy, limits the amount of credit
exposure to any one financial institution.
For the year ended December 31, 1996, two customers accounted for approximately
23 percent and 12 percent of revenue and 32 percent and 13 percent of the
accounts receivable balance at December 31, 1996, respectively.
For the year ended December 31, 1995, two customers accounted for approximately
23 and 12 percent of revenue and 24 and 8 percent of the accounts receivable
balance at December 31, 1995, respectively.
For the year ended December 31, 1994, two customers accounted for approximately
13 and 13 percent of revenue and 10 and 29 percent of the accounts receivable
balance at December 31, 1994. Historically, the Company has not incurred
significant losses related to its accounts receivable.
REVENUE RECOGNITION
Revenue from the sale of products is generally recognized at time of shipment to
the customer. Promotional and other discounts are accrued for at time of
shipment based on historical experience.
ADVERTISING COSTS
Advertising costs are expensed as incurred. Advertising expense was
approximately $1,539,000, $871,000 and $670,000 in 1996, 1995 and 1994,
respectively.
SLOTTING FEES
Slotting costs associated with new products or new territories are deferred and
amortized over the twelve month period following the initial introductions.
RESEARCH AND DEVELOPMENT COSTS
Research and development costs are expensed as incurred. Research and
development expense was approximately $1.0 million in 1996, which includes a
one-time charge of $612,000 of in-process research and development in
conjunction with the acquisition of Gorilla Foods (see Note 7). The amount spent
on such activities during 1995 and 1994 was immaterial.
NET INCOME PER SHARE
Net income per share is computed using the weighted average number of common and
dilutive common equivalent shares outstanding. Fully diluted earnings per share
is not significantly different from primary earnings per share for the periods
presented.
RECLASSIFICATIONS
Certain amounts in the prior year financial statements have been reclassified to
conform to the current year presentation.
F-8
2. INVENTORIES
Detail of inventory at December 31, 1996 and 1995 is as follows:
December 31, 1996 1995
- --------------------------------------------- ----------- -----------
Raw materials $ 670,000 $ 391,000
Packaging and supplies 243,000 171,000
Finished goods 3,877,000 1,000,000
----------- -----------
$ 4,790,000 $ 1,562,000
----------- -----------
----------- -----------
3. PROPERTY, PLANT AND EQUIPMENT
December 31, 1996 1995
- --------------------------------------------- ----------- -----------
Land $ 787,000 $ 787,000
Building and improvements 1,968,000 1,175,000
Machinery and equipment 3,825,000 2,809,000
Vehicles 49,000 47,000
Office furniture and equipment 1,405,000 947,000
----------- -----------
8,034,000 5,765,000
Less accumulated depreciation (1,220,000) (828,000)
----------- -----------
$ 6,814,000 $ 4,937,000
----------- -----------
----------- -----------
4. LINE-OF-CREDIT
The Company has a $5,000,000 unsecured line-of-credit agreement with a
commercial bank with interest at the bank's reference rate or, at the Company's
election, LIBOR plus 1.0 percent on amounts of $500,000 or more. This line-of-
credit expires on July 1, 1997. At December 31, 1996, the bank's reference rate
was 8.25 percent. There was no balance outstanding under this line at
December 31, 1996.
5. LEASE COMMITMENTS
Future minimum lease payments at December 31, 1996 were as follows:
Year Ended December 31,
- ---------------------------------------------
1997 $ 498,000
1998 338,000
1999 66,000
-----------
Total $ 902,000
Rental expense for the years ended December 31, 1996, 1995 and 1994 was
$257,000, $180,000 and $80,000, respectively.
F-9
6. INCOME TAXES
The Company accounts for income taxes under Statement of Financial Accounting
Standards 109, ACCOUNTING FOR INCOME TAXES. The Company realizes tax benefits
as a result of the exercise of nonqualified stock options and the exercise and
subsequent sale of certain incentive stock options (disqualifying dispositions).
For financial reporting purposes, any reduction in income tax obligations as a
result of these tax benefits is credited to paid-in capital. Tax benefits of
$1,336,000, $126,000 and $1,917,000 were credited to paid-in capital in 1996,
1995 and 1994, respectively.
The provision for income taxes is as follows:
December 31, 1996 1995 1994
- ----------------------------------- --------- ----------- -----------
CURRENT:
Federal $ 616,000 $ 1,309,000 $ 1,061,000
State 168,000 186,000 294,000
--------- ----------- -----------
784,000 1,495,000 1,355,000
DEFERRED (57,000) (154,000) 107,000
--------- ----------- -----------
$ 727,000 $ 1,341,000 $ 1,462,000
--------- ----------- -----------
--------- ----------- -----------
Total deferred income tax assets were $507,000 and $342,000 and liabilities were
$539,000 and $431,000, at December 31, 1996 and 1995, respectively.
Individually significant temporary differences include inventory reserves and
UniCap which are booked as deferred tax assets of $105,000 and $133,000 at
December 31, 1996, respectively and book/tax depreciation differences which are
recorded as deferred liabilities of $517,000 and $356,000 at December 31, 1996
and 1995, respectively. There are no other individually significant temporary
differences at December 31, 1996 or 1995. The Company's deferred tax assets are
realizable as a result of past income and available income tax carrybacks.
The reconciliation between the effective tax rate and the statutory federal
income tax rate is as follows:
December 31, 1996 1995 1994
- ---------------------------------------------- ---- ---- ----
Statutory federal income tax rate 34.0% 34.0% 34.0%
State taxes, net of federal income tax benefit 5.9 3.4 4.0
Tax exempt interest and dividends (4.0) (2.3) (1.4)
Trademark and goodwill amortization 2.0 -- --
Revision of prior year estimates 2.0 -- --
Other 0.7 (0.3) 1.3
---- ---- ----
Effective tax rate 40.6% 34.8% 37.9%
---- ---- ----
---- ---- ----
F-10
7. ACQUISITIONS
In January 1996 the Company completed the acquisition of Ojai, California based
Gorilla Foods, Inc., a privately held developer and manufacturer of wheat
protein-based, meatless food products, including the GardenDog. The
transaction, accounted for under the purchase method, provided for the issuance
of 240,000 shares of the Company's Common Stock in exchange for all outstanding
common shares of Gorilla Foods, and $68,750 in cash. In addition, up to an
additional 200,000 certain contingent shares of the Company could be issued in
50,000 share increments contingent upon meeting certain sales performance levels
of wheat protein-based products over the next five years. This transaction has
enabled the Company to broaden its product line by owning the recipe for the
GardenDog and other future wheat gluten protein-based products to be developed
for the meat analog, whole food product market. Prior to the acquisition of
Gorilla Foods, the Company purchased the GardenDog directly from Gorilla Foods.
The Company incurred a one-time charge of $612,000 in the first quarter of 1996
as a result of the acquisition of in process research and development associated
with this acquisition, with the remainder of the purchase price principally
allocated to goodwill.
In a separate transaction, the Company completed the acquisition of the assets
of Whole Food Marketing, Inc., a Southern California-based food broker of the
Company's and Gorilla Foods' products. The Company paid $350,000 for the assets
of Whole Food Marketing, Inc., all of which was allocated to goodwill. This
acquisition was accounted for under the purchase method.
Pro forma financial information has not been provided for these acquisitions as
the pro forma results are not materially different from actual results.
8. RELATED PARTY TRANSACTIONS
The Company leases its S.E. 8th Avenue plant facility from the Company's Chief
Creative Officer and one other shareholder. This lease agreement provides for a
$1,700 monthly payment. The lease provides for cancellation, without penalty,
by either party with a 60-day notice.
9. SHAREHOLDERS' EQUITY
PREFERRED STOCK
The Company has authorized 5,000,000 shares of preferred stock. Such stock may
be issued by the Board of Directors in one or more series, with the preferences,
limitations and rights of each series to be determined by the Board of
Directors.
PREFERRED SHARE PURCHASE RIGHTS
In April 1996, the Company declared a dividend distribution of one preferred
share purchase right on each outstanding share of the Company's Common Stock.
Each right will entitle shareholders to buy one one-hundredth of a share of
newly created Series A Junior Participating Preferred Stock of the Company at an
exercise price of $47. The rights will be exercisable if a person or group
acquires 15 percent or more of the
F-11
Company's Common Stock or announces a tender offer for 15 percent or more of the
Common Stock. The Company's Board of Directors is entitled to redeem the rights
at $.01 per right at any time before a person has acquired 15 percent or more of
the outstanding Common Stock.
COMMON STOCK SPLITS
On February 18, 1994, the Company effected a three-for-two Common Stock split.
All share and per share amounts have been retroactively adjusted to reflect the
stock splits.
STOCK OPTIONS AND WARRANTS
On March 10, 1992, the Company granted a non-statutory stock option to its Chief
Executive Officer exercisable for 1,650,000 shares of the Company's Common
Stock. Such option is exercisable for a period of ten years from the date of
grant at an exercise price of $1.00 per share, the fair market value of the
Company's Common Stock on the date of grant. At December 31, 1996, an option to
purchase 1,025,000 shares of Common Stock was outstanding, all of which was
exercisable. At December 31, 1996, 1,025,000 shares of the Company's Common
Stock were reserved for issuance under this option grant.
Also in 1992, the Company granted a non-statutory stock option to a consultant
of the Company exercisable for 150,000 shares of the Company's Common Stock at
$1.50 per share, the fair market value of the Company's Common Stock on the date
of grant. Such option was exercised in full in 1994.
In addition, the Company has a 1992 First Amended and Restated Combination Stock
Option Plan (the "Plan") which provides for the issuance of incentive stock
options ("ISOs") to employees and officers of the Company and non-statutory
stock options ("NSOs") to employees, officers, directors and consultants of the
Company. Under the Plan, the exercise price of an ISO cannot be less than the
fair market value on the date of grant and the exercise price of an NSO cannot
be less than 85 percent of fair market value on the date of grant. Options
granted under the Plan generally vest three to five years from the date of grant
and generally expire ten years from the date of grant. At December 31, 1996,
the Company had 2,132,817 shares of Common Stock reserved for issuance under the
Plan. At December 31, 1996, 549,580 shares were exercisable.
Activity under the Plan is summarized as follows:
Shares Available Shares Subject Exercise Price Per
for Grant to Options Share
---------------- -------------- ------------------
Balances, December 25, 1993 549,997 212,461 $ 1.00 - 6.87
Options granted (125,800) 125,800 11.00 - 13.25
Options canceled 35,200 (35,200) 4.16 - 5.25
Options exercised -- (70,307) 1.00 - 5.25
---------- ---------- ---------------
Balances December 31, 1994 459,397 232,754 $ 1.00 - 13.25
Additional shares reserved 1,500,000 -- --
Options granted (326,066) 326,066 9.56 - 13.13
Options canceled 13,337 (13,337) 1.00 - 11.75
Options exercised -- (59,334) 1.00 - 11.75
---------- ---------- ---------------
Balances, December 31, 1995 1,646,668 486,149 $ 1.50 - 13.25
Options granted (886,300) 886,300 6.50 - 8.69
Options canceled 15,333 (15,333) 11.50 - 11.75
Options exercised -- -- --
---------- ---------- ---------------
Balances, December 31, 1996 775,701 1,357,116 $ 1.50 - 13.25
---------- ---------- ---------------
---------- ---------- ---------------
F-12
The 1,200,000 units sold in the initial public offering (IPO) each included two
shares of Common Stock and one warrant to purchase one share of Common Stock at
$2.25 per share. Also included in the IPO were warrants issued to the
underwriters that provided for the purchase of 120,000 units at $3.60 per unit.
During 1994, the remaining 90,000 warrants were exercised at prices ranging from
$1.80 to $2.25 per share. There were no other warrant transactions during the
three year period ended December 31, 1996 and no warrants were outstanding at
December 31, 1996.
STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 123
During 1995, the Financial Accounting Standards Board issued SFAS 123 which
defines a fair value based method of accounting for an employee stock option and
similar equity instruments and encourages all entities to adopt that method of
accounting for all of their employee stock compensation plans. However, it also
allows an entity to continue to measure compensation cost for those plans using
the method of accounting prescribed by APB 25. Entities electing to remain with
the accounting in APB 25 must make pro forma disclosures of net income and, if
presented, earnings per share, as if the fair value based method of accounting
defined in SFAS 123 had been adopted.
The Company has elected to account for its stock-based compensation plans under
APB 25; however, the Company has computed, for pro forma disclosure purposes,
the value of all options granted during 1996 and 1995 using the Black-Scholes
option pricing model as prescribed by SFAS 123 using the following weighted
average assumptions for grants:
For the Year Ended December 31, 1996 1995
------- -------
Risk-free interest rate 6.0% 6.0%
Expected dividend yield 0% 0%
Expected lives 8 years 8 years
Expected volatility 60.94% 64.51%
Using the Black-Scholes methodology, the total value of options granted during
1996 and 1995 was $4,762,000 and $2,721,000, respectively, which would be
amortized on a pro forma basis over the vesting period of the options (typically
four years). The weighted average fair value of options granted during 1996 and
1995 was $5.42 and $8.34, respectively. If the Company had accounted for its
stock-based compensation plans in accordance with SFAS 123, the Company's net
income and net income per share would approximate the pro forma disclosures
below:
For the Year Ended December 31, 1996 1995
-------------------- ----------------------
As Pro As Pro
Reported Forma Reported Forma
---------- --------- ---------- ---------
Net income (loss) $1,063,000 $(299,000) $2,510,000 $1,046,000
Net income (loss) per share $ 0.12 $ (0.04) $ 0.29 $ 0.12
F-13
The effects of applying SFAS 123 in this pro forma disclosure are not indicative
of future amounts. SFAS 123 does not apply to awards prior to January 1, 1995,
and additional awards are anticipated in future years.
The following table summarizes information about stock options outstanding at
December 31, 1996:
Options Outstanding Options Exercisable
- ---------------------------------------------------------------- -------------------------
Weighted
Average Weighted Number of Weighted
Range of Number Remaining Average Shares Average
Exercise Outstanding Contractual Exercise Exercisable Exercise
Prices at 12/31/96 Life Price at 12/31/96 Price
- --------------- ----------- ----------- --------- ----------- --------
$ 1.00 - 1.50 1,047,500 5.0 $ 1.01 1,047,500 $ 1.01
3.08 - 5.00 18,450 6.2 3.76 18,450 3.76
6.51 - 8.69 898,300 9.2 7.89 176,094 7.57
9.56 - 11.75 362,866 7.8 11.58 278,202 11.54
11.76 - 13.25 55,000 8.2 13.00 54,334 13.00
-------------- --------- --- ------ --------- ------
$ 1.00 - 13.25 2,382,116 6.9 $ 5.51 1,574,580 $ 4.05
-------------- --------- --- ------ --------- ------
-------------- --------- --- ------ --------- ------
10. 401(k) PLAN
The Company has a 401(k) Salary Deferral Plan which covers all employees who
have reached the age of 18. The covered employees may elect to have an amount
deducted from their wages for investment in a retirement plan. The Company
matches 100 percent of employee contributions up to two percent. The Company's
contribution to this plan was approximately $74,000 in 1996, $51,000 in 1995 and
$22,000 in 1994.
11. SUPPLEMENTAL CASH FLOW INFORMATION
Supplemental disclosure of cash flow information is as follows:
1996 1995 1994
- --------------------------------------------- ---------- ------- ----------
Cash paid during the period for interest $ -- $ 1,000 $ 5,000
Cash paid during the period for income taxes 1,062,000 96,000 2,266,000
Issuance of Common Stock in exchange for
the assets of Gorilla Foods, Inc. 990,000 -- --
F-14
12. COMMITMENTS AND CONTINGENCIES
NEW FACILITY
During 1995, the Company purchased a 16.6 acre parcel of real estate in
proximity to Portland International Airport with the intent of building a new
facility that would house both production and administrative functions.
Currently, the company is exploring the feasibility of building such a facility
and financing alternatives ranging from working capital, conventional long-term
debt and leasing. However, no firm commitments on such financing have been made
at this date. The Company had firm purchase commitments of $120,000 related to
such facility at December 31, 1996.
LITIGATION
During the third quarter of 1996, the Company announced the settlement of a
lawsuit brought by a former sales executive, that alleged numerous claims
relating to his employment at the Company. This employee alleged damages of
more than $21 million but settled for $85,000, a substantial portion of which
was paid by the Company's officer and director liability insurance policy. The
Company is currently seeking recovery of its costs incurred in defending the
litigation from its insurance carrier. All defense costs have been expensed as
incurred in the accompanying statement of operations. No anticipated recoveries
have been reflected in the accompanying financial statements given uncertainty
as to the ultimate outcome.
F-15
Report of Independent Public Accountants
on Financial Statement Schedule
We have audited in accordance with generally accepted auditing standards, the
financial statements included in Wholesome & Hearty Foods, Inc.'s Form 10-K, and
have issued our report thereon dated February 7, 1997. Our audit was made for
the purpose of forming an opinion on those statements taken as a whole. The
schedule listed on page 15 is the responsibility of the Company's management and
is presented for purposes of complying with the Securities and Exchange
Commission's rules and is not part of the basic financial statements. This
schedule has been subjected to the auditing procedures applied in our audit of
the basic financial statements and, in our opinion, fairly states, in all
material respects, the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Portland, Oregon,
February 7, 1997
F-16
Column A Column B Column C Column D Column E
- --------------------------------------------- ------------ -------------------------------- ------------ ---------
Balance Charged Charged to Balance
at Beginning to Costs and Other Accounts - Deductions - at End
Description of Period Expenses Describe Describe (b) of Period
- --------------------------------------------- ------------ ------------ ---------------- ------------ ---------
Year Ended December 31, 1995 (a):
Reserves deducted from asset accounts:
Allowance for uncollectible accounts $ 50,000 $ 72,000 $ - $ 2,000 $ 120,000
Year Ended December 31, 1996:
Reserves deducted from asset accounts:
Allowance for uncollectible accounts $ 120,000 $ 70,000 $ - $ 13,000 $ 177,000
(a) Balances and amounts charged to and deducted from such account were not
material for the year ended December 31, 1994.
(b) Charges to the account included in this column are for the purposes for
which the reserve was created.
F-17