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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, 1998
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)
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Delaware 87-0515089
(State or other jurisdiction (I.R.S. Employer
of incorporation) Identification 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
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 23, 1998 at a closing sale price of $4.88 as reported
by the Nasdaq National Market was approximately $26.2 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 23, 1998, the Registrant had 11,670,475 shares of Common
Stock outstanding.
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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 Fiscal 1998 Annual Meeting of Stockholders (the "Proxy Statement")
are incorporated by reference in Part III of this Annual Report of Form 10-K
(the "Form 10-K").
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NUTRACEUTICAL INTERNATIONAL CORPORATION
INDEX TO ANNUAL REPORT ON FORM 10-K
PART I
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Item 1 Business................................................................................. 1
Item 2 Properties............................................................................... 15
Item 3 Legal Proceedings........................................................................ 15
Item 4 Submission of Matters to a Vote of Security-Holders...................................... 15
Item 4A Executive Officers of the Registrant................................................ 16
PART II
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Item 5 Market for the Registrant's Common Equity and Related Stockholder Matters................ 17
Item 6 Selected Financial Data.................................................................. 18
Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations.... 19
Item 7A Quantitative and Qualitative Disclosure About Market Risk........................... 24
Item 8 Financial Statements and Supplementary Data.............................................. 24
Item 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure..... 24
PART III
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Item 10 Directors and Executive Officers of the Registrant....................................... 25
Item 11 Executive Compensation................................................................... 25
Item 12 Security Ownership of Certain Beneficial Owners and Management........................... 25
Item 13 Certain Relationships and Related Transactions........................................... 25
PART IV
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Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K.......................... 26
PART I
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Item 1. Business.
Unless the context otherwise requires, the terms "Company" and
"Nutraceutical" refer to Nutraceutical International Corporation and, as
applicable, its direct and indirect subsidiaries, Nutraceutical Corporation,
Solaray, Inc. ("Solaray"), Premier One Products, Inc. ("Premier One"), Makers of
KAL, Inc. and Makers of KAL, B.V. ("KAL"), NaturalMax, Inc. ("NaturalMax"),
Veglife, Inc. ("VegLife"), Action Labs, Inc. ("Action Labs"), Monarch
Nutritional Laboratories, Inc. ("Monarch Nutritional Laboratories"), Au Naturel,
Inc. ("Au Naturel") and NutraForce (Canada) International, Inc. ("NutraForce").
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 branded products under the Solaray, KAL, NaturalMax, VegLife, Premier
One, Solar Green and Natural Sport brand names directly to health food stores in
the United States. The Action Labs product line is sold to distributors and
health food stores in the United States. Internationally, the Company sells its
branded products primarily to distributors and retailers. The Company
manufactures and/or distributes one of the broadest branded product lines in the
industry with over 1600 stock keeping Units ("SKUs"), including approximately
200 SKUs exclusively sold internationally. With its new Natural Sport line
(introduced late in fiscal 1998), the Company introduced its all-natural sport
supplement line to health food stores. 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, the Company manufactures premium bulk
formulations for use by itself and for sale to other manufacturers and marketers
of nutritional supplements under the tradenames Monarch Nutritional Laboratories
and Great Basin Botanicals.
The Company was formed in 1993 by senior management and Bain Capital, Inc.
("Bain") to effect a consolidation strategy in the highly fragmented vitamin,
mineral, herbal and other nutritional supplements industry (the "VMS Industry").
Since its formation, the Company has successfully completed six acquisitions,
including Solaray, Premier One, KAL/NaturalMax, Monarch Nutritional
Laboratories, Action Labs and NutraForce. 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 rapid growth of the Healthy
Foods Channel. The Healthy Foods Channel consists of approximately 10,100
retailers including (i) independent health food stores, (ii) health food stores
affiliated with local, regional and national health food chains (including
healthy food supermarket chains, such as Whole Foods Market and Wild Oats
Markets) and (iii) GNC stores. The Healthy Foods Channel has historically
experienced strong growth based on the continued expansion of independent health
food stores and local, regional and national health food chains in response to
strong demand from consumers who desire product education, service and high
quality natural ingredients. The growth of the Healthy Foods Channel does not
appear to be currently 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 supermarkets), which 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 benefits from substantially greater customer
diversification than most of its larger competitors. The Company
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also benefits from product diversification.
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 90% of its products in fiscal 1998 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 over 150 new SKUs
in fiscal 1998.
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 historically has grown rapidly, generating
$6.5 billion in 1996 sales, as compared to $5.0 billion in 1994. The Company
believes that this growth was due to a number of factors, including (i)
increased interest in healthier lifestyles, (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. The
Company does not have reliable data for industry trends after calendar 1996.
Recently various publicly traded nutritional supplement companies have announced
that there appears to be a slow-down in sales of nutritional supplements which
the Company also experienced during the third and fourth fiscal quarters of
1998. The Company believes that this slow-down may be the result of, among other
things, the lack of any recent industry-wide "hit" products (such as St. John's
Wort in 1997).
Products
As of September 30, 1998, the Company sold over 1600 SKUs, including
approximately 200 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 tablets, capsules, softgels,
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
enhanced the strength of all of its brands since their respective acquisitions
by instituting appropriate business strategies in each case that have included
(i) consolidating sales forces and increasing the brands' 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, 1998, the Company's portfolio of established brand
names consisted of the following:
Solaray. Solaray began manufacturing and selling herbal products in 1973,
originally as a pioneer in formulating and marketing blended herbal products
that contain two or more herbs with complementary effects. From its inception,
Solaray focused on encapsulated products which 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
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. Three of the most
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popular products developed by Solaray include (i) Spectro, considered by many to
be the premier multivitamin/mineral supplement, (ii) CranActin, which the
Company believes is the best-selling cranberry supplement in the Healthy Foods
Channel, and (iii) Pygeum/Saw Palmetto, two ingredients intended to help
maintain a healthy prostate. 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. The KAL product line 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 allowed 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. More recently, KAL has been an innovator in introducing lipospray
products, a new delivery form that allows for quick absorption through a liquid
spray. 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. The NaturalMax brand began as a product line of the KAL brand
in approximately 1993, with a focus on diet products (with diet plans) as well
as energy and rest products. The NaturalMax brand uses tablets, softgels,
capsules and liquids, depending on the most desired form for the particular
product. After the acquisition of KAL/Natural Max, the Company established
NaturalMax as a separate brand in order to bring special focus to the NaturalMax
product line. The product line includes such innovative and popular products as
Super DietMax and Thin-Thin, a nutritional supplement and diet plan with natural
5-HTP derived from griffonia beans. The packaging of NaturalMax products always
includes the distinctive NaturalMax logo.
Premier One. The Premier One brand 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. Aside from Royal Jelly in Honey, 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 popular product which 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 is a relatively new brand which 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 will not consume any products which
include any animal-derived ingredients, including 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 cereal grasses (such as barley
and wheat grass). These products are currently offered in tablet forms. Solar
Green also introduced "green food" drink mixes which can be combined with juice
or water to create a nutritious beverage
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supplement. Solar Green's brand packaging includes a distinctive Solar Green
logo and a label with green borders and accents.
Action Labs. The Action Labs brand started in 1989 with a focus on men's
and women's specialty supplements and diet and energy products. The Company
acquired this brand late in fiscal 1998 and is in the process of bringing the
manufacturing of many Action Labs products in-house and updating some of the
labeling. The Action Labs brand has a relatively strong presence on the East
Coast and in GNC stores. The packaging of Action Labs products includes the
distinctive Action Labs logo and brightly colored text.
Natural Sport. Natural Sport was launched in September 1998 as the
Company's newest brand. The Natural Sport brand is focused on all-natural sport
supplements for not only serious athletes, but also for individuals who exercise
for fitness, health or to lose weight. As of September 30, 1998, the Natural
Sport line included two innovative sport beverage supplements, Pre-Burn (to be
taken prior to exercise to increase fat metabolism and endurance) and Post-Up
(to be taken after exercise to increase 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.
Research and Development; Quality Control
The Company has a strong 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) identify the active ingredients in current and potential
new products, (ii) test the safety, potency and efficacy of products, (iii)
develop more effective and efficient means of extracting ingredients for use in
products, (iv) develop testing methods for ensuring and verifying the
consistency of the dosage of ingredients included in the Company's products, (v)
develop new, more effective product delivery forms and (vi) 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
the use of any projects undertaken at the University facility. The Company also
conducts research and development in Company-owned laboratories. The Company
currently employs various professionals in its research and development and
quality control departments, including individuals with Ph.D. degrees.
Professionals employed by the Company have degrees in, among other things,
chemistry, botany, microbiology, nutrition 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. The Company's processing methods are
monitored closely to ensure that only quality ingredients are used and to ensure
product purity. The Company has been a leader in establishing industry product
quality guidelines.
Sales and Marketing
The Company promotes demand for its products by educating retailers, who in
turn educate consumers, as to the qualities 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 10,100 stores,
including (i) independent health food stores, (ii) health food stores affiliated
with local, regional and national health food chains (including healthy food
supermarket chains such as Whole Foods Market and Wild Oats Markets) 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
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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 the products.
The Company markets its products through a direct sales force dedicated to
the Healthy Foods Channel. The Company's sales representatives (including
independent, employee and sub-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 brand of products are sold principally
to distributors and through the Action Labs separate telephone marketing
organization.
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 a retailer seminar program which the Company believes has
made an important contribution to the growth of its brands. The Company also
sponsors seminars for consumers. 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 was formed in fiscal 1995 for the purpose of marketing the
Company's branded products internationally. During fiscal 1998, Au Naturel
marketed products to distributors and 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 standard and unique formulations that
must meet specific requirements of certain foreign countries, including minor
product formulation and labeling changes for Au Naturel's international
customers. Au Naturel uses specialized labels to meet the specific requirements
of each country.
During late fiscal 1998, the Company acquired all of the outstanding stock
of its Canadian distributor and shortly thereafter merged this entity into its
Canadian subsidiary, NutraForce (Canada) International, Inc.
Monarch Nutritional Laboratories and Great Basin Botanicals market premium
bulk formulations as well as bulk minerals and herbs in the United States
through its own sales force and internationally both directly to manufacturers
and through an independent sales representative and a distributor, both based in
Europe.
Manufacturing
The Company's manufacturing process generally consists of the following
operations (i) extracting the ingredients contained in a particular product from
a bulk source of such ingredient and measuring the ingredient for inclusion in
such product, (ii) blending the measured ingredients into a mixture with a
homogeneous consistency and
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(iii) encapsulating or tableting the blended mixture into the appropriate dosage
form using either automatic or semiautomatic equipment. The next step, bottling
and packaging, involves placing the encapsulated or tableted 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 90% of its products in fiscal 1998, 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.
Monarch Nutritional Laboratories and Great Basin Botanicals source raw
material components, provide contract grinding and milling services, manufacture
premium bulk formulations and supply these to the Company and other marketers of
nutritional supplements, including, in certain cases, competitors of the
Company. Monarch Nutritional Laboratories was acquired in September 1995, and
certain assets of Great Basin Botanicals were purchased in March 1997.
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 and allows for
inventory management. The Company believes that this system has improved
operating efficiencies and customer service. In addition, the Company has
installed an advanced telephone communication system which provides the platform
for computer-telephone integration and facilitates intra-company communication.
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Year 2000 Issue" for a discussion of concerns and
potential exposures related to the Company's computer systems vis-a-vis the
"Year 2000" issue.
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 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,
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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 U.S.
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.
The Company seeks to mitigate the risk of the shortage of certain raw
materials through its relationships with approximately 100 principal suppliers.
The Company also acquired Monarch Nutritional Laboratories, a manufacturer of
premium bulk formulations, which has purchased manufacturing equipment and hired
personnel 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. Shipments are generally made from the Company's primary
distribution facilities in Clearfield, Utah and Memphis, Tennessee. These
distribution facilities have been strategically located to reduce the Company's
expenses relating to outbound freight charges without sacrificing delivery
times. Certain of the Company's largest customers receive shipments directly
from the Company's central warehouse, located in a separate facility in
Clearfield, Utah, which also services the Company's two primary distribution
centers.
In fiscal 1998, the Company executed a short-term two year lease with
multiple two year renewal options for a facility formerly used by the Department
of Defense in the Ogden, Utah area ("DDO") in which it intends to consolidate
distribution and certain other operations which are currently being performed in
five different buildings and locations. This facility is currently under
renovation and has been designed to respond quickly to customer demands for the
Company's products and to assist the Company to reduce the risk of out-of-stocks
and to maintain appropriate levels of finished goods inventory. By integrating
the bulk product inventory distribution operation with the bottling and
packaging operation, the Company believes it will be able to bottle and package
finished goods on a more selective customer demand basis. The Company expects
that its Memphis, Tennessee facility will continue to operate for Eastern
distribution.
Government Regulation
The formulation, manufacturing, processing, packaging, labeling,
advertising, distribution and sale of nutritional supplements such as those sold
by the Company are subject to regulation by one or more federal agencies,
principally the FDA and the FTC, and to a lesser extent the Consumer Product
Safety Commission and 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 manufactured, distributed or
sold, as well as by governmental agencies in certain foreign countries in which
the Company's products are sold. Among other matters, regulation of the Company
by the FDA and FTC is concerned with claims made with respect to a product which
refer to the value of the product in treating or preventing 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 nutritional supplements
industry, including the imposition by federal agencies of civil penalties in the
millions of dollars against a few industry participants. In
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addition, certain product lines now manufactured by the Company had been the
subject of investigations prior to the acquisition of those product lines by the
Company, and the Company's bulk product subsidiary has been the subject of an
investigation by the FDA and by the Attorney General's Office of the State of
California during fiscal 1998. Although none of these investigations has had a
material adverse effect on the Company, there can be no assurance that future
regulatory action will not have such an effect. 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 nutritional supplements may result in increased regulatory scrutiny
of the nutritional supplements industry.
The Dietary Supplement Health and Education Act of 1994 (the "Act") was
enacted in October 1994, amending the Food, Drug and Cosmetic Act. The Company
believes this law is generally favorable to the dietary supplement industry. The
Act establishes a new statutory class of "dietary supplements," which provide
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 will not require the submission by the manufacturer or distributor of
evidence of a history of use or other evidence of safety establishing that the
supplement will reasonably be expected to be safe, but a dietary supplement
which contains 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, this law prevents the further regulation
of dietary ingredients as "food additives" and allows the use of statements of
nutritional support on product labels.
The FDA issued final dietary supplement labeling regulations in calendar
1997. These final regulations require the Company to revise most of its product
labels by March 1999. The Company has completed its first round of revisions,
but still expects to incur substantial increased costs related to these labeling
conversions, in part because many of the new labels are the more expensive "peel
off" variety. Applicable regulations also currently require the Company to
submit notification to the FDA of certain "statements of nutritional support"
made in labeling and advertising for the Company's products.
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 which 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. For example, Arkansas,
Hawaii, Missouri, Ohio, Florida and Texas have passed legislation or adopted
regulations regulating the over-the-counter sale of certain ephedra products or
are considering doing so. The Company believes that other states are considering
or will consider taking similar action and may take such action in the future.
The 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.
More recently, the DEA 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, 1998, 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 Company's customers, might be subject to registration and other
requirements, and it is possible such a regulation could have a material adverse
effect on the Company.
8
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/Max
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.
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 also may be in violation of a California law known as "Proposition
65" for failure to include required warning labels. Proposition 65 allows
private litigants or the California Attorney General to recover monetary
penalties or injunctive relief under certain circumstances. 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 for many months. 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 October 1997, the Company and a number of other suppliers, processors
and marketers of nutritional 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
Great Basin had processed 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 as 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.
On January 20, 1998, Monarch Nutritional Laboratories received a written
notice from an attorney representing a private party that alleged 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 product subsidiary with the assistance of
the Company and its outside counsel. The Company has not received any
correspondence or communications from the FDA regarding this matter for many
months. 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 as to the products in question and could have a material
adverse effect on the Company.
In September 1998, the Company received a letter written by the FDA to
all manufacturers and distributors of the supplement L-5-hydroxytryptophan,
warning that the FDA believed this supplement might be implicated in the
occurrence of a certain disorder known as EMS in a small subgroup of the general
population. The FDA asserted in this correspondence that it believed EMS might
be related to the presence of a contaminant or substance possibly found in L-5-
hydroxytryptophan which it labeled "Peak X." The FDA's letter described a
protocol for testing for "Peak X" and urged manufacturers, distributors and
marketers of these supplements to test for "Peak X" and to report adverse events
related to this supplement to the FDA. The Company has established its own
testing protocol for "Peak X" and is actively monitoring the product and any
potential adverse reactions.
9
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.
Governmental regulations in foreign countries where the Company plans to
commence or expand sales may prevent or delay entry into the market or prevent
or delay the introduction, or require the reformulation, of certain of the
Company's products. Compliance with such foreign governmental regulations is
generally the responsibility of the Company's distributors for those countries.
These distributors are independent contractors over whom the Company has limited
control.
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 not capable of reformulation, additional
recordkeeping, expanded documentation of the properties of certain products,
expanded or different labeling, and/or scientific substantiation. Any or all of
such requirements could have a material adverse effect on the Company's results
of operations and financial condition.
There can be no assurance that the foregoing proceedings or investigations,
or any future proceedings or investigations, will not have a material adverse
effect on the Company.
Competition
The nutritional supplements segment of the natural health food products
industry is highly competitive. The Company's principal competitors in the
Healthy Foods Channel include a limited number of large nationally known
manufacturers (such as Twinlab Corporation, Solgar and Nature's Way Products,
Inc.) 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 Market, Wild Oats Markets and most large health food stores
also sell a portion of their supplement offerings under their own private
labels.
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 advertising 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, premium
brand names, commitment to quality, ability to rapidly introduce innovative
products, competitive pricing, strong and effective sales force and distribution
strategy and sophisticated advertising 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, these product
offerings may affect sales in the Healthy Foods Channel. Several major
pharmaceutical companies have recently introduced herbal lines in the mass
market, including American Home Products (Centrum), Whitehall-Robins (Quanterra)
and Bayer (One-A-Day). Many of these companies have substantially greater
financial and other resources than the Company.
10
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 78 trademarks that have been registered with the United
States Patent and Trademark Office and has filed applications to register an
additional 55 trademarks. In addition, the Company claims domestic trademark
and servicemark rights in numerous additional marks used by the Company. The
Company owns a number of trademark registrations in foreign countries 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.
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 foreign
jurisdictions 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 the Solaray rainbow logo. The Company is vigorously defending the
suit and believes that its use of such logo does not infringe on the plaintiff's
registered trademark. See "Legal Proceedings."
Employees
At September 30, 1998, the Company and its subsidiaries employed over 410
full-time and over 50 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:
Government Regulation
The formulation, manufacturing, processing, packaging, labeling,
advertising, distribution and sale of nutritional supplements such as those sold
by the Company are subject to regulation by a number of federal, state and
foreign agencies, principally, the Food and Drug Administration ("FDA") and the
Federal Trade Commission ("FTC"). Among other matters, such regulation is
concerned with health 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 nutritional 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 nutritional 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. See
"Business--Government Regulation."
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
11
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.
Limited Availability of Conclusive Clinical Studies
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.
Competition
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 climactic 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 U.S.
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.
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, William T. Logan 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."
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."
12
Risks Associated with Acquisitions
The Company has completed six 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 assurances 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 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."
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 control.
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.
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."
Reliance on Independent Contractors
The Company places significant reliance on its independent contractors to
act as its primary sales force and sell its products to health food retailers.
As with any independent contractor, such contractors are not employed or
otherwise controlled by the Company and are generally free to conduct their
businesses at their own discretion. Although these contractors enter into
contracts with the Company, such contracts typically can be terminated at any
time by the Company or the independent contractor. The simultaneous loss of the
services of a number of these independent contractors could have a material
adverse effect on the Company.
Control by Existing Stockholders
Investment funds (the "Bain Capital Funds") controlled by Bain Capital
beneficially own approximately 40.1% of the outstanding Common Stock. By virtue
of such stock ownership, Bain Capital 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, three 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.
Computer Systems and Year 2000 Issues
The "Year 2000" issue concerns the potential exposures related to the
automated generation of business and financial misinformation resulting from the
application of computer programs which have been written using two digits,
rather than four, to define the applicable year of business transactions. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Year 2000 Issue." Failure of the Company or its software providers
to adequately address the Year 2000 issue could result in misstatement of
reported financial information or otherwise adversely affect the Company's
business operations.
13
Possible 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.
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.
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.
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." See also "Management's
Discussion and Analysis of Financial Condition and Results of Operations--
Forward-Looking Statements."
14
Item 2. Properties.
The following table describes the principal properties of the Company as of
September 30, 1998:
Square
Purpose Location Footage
------- --------------------- -------
DDO (proposed distribution, bottling and bulk material manufacturing). Ogden, Utah 297,200
Brand manufacturing+.................................................. Ogden, Utah 31,230
Finished goods warehouse*............................................. Clearfield, Utah 28,000
Western distribution*................................................. Clearfield, Utah 28,000
Raw material and bulk distribution*................................... Ogden, Utah 25,000
Eastern distribution.................................................. Memphis, Tennessee 22,400
Monarch manufacturing*................................................ Ogden, Utah 21,100
Brand marketing and product development............................... Park City, Utah 10,444
Printing facility..................................................... Las Vegas, Nevada 7,974
Administrative offices and customer service........................... Ogden, Utah 7,830
Action Labs sales and marketing....................................... Long Island, New York 7,300
Great Basin manufacturing*............................................ Clearfield, Utah 6,400
Executive offices and corporate sales and marketing................... Park City, Utah 6,103
Information systems and data management............................... Park City, Utah 3,228
Canadian distribution................................................. Langley, British 2,817
Columbia
Research, development and quality control............................. Ogden, Utah 1,813
- --------------------
+ 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 1998 and 2003, although
the Company has negotiated extension options in many cases.
* The operations currently housed in these facilities are expected to be
moved to the Company's proposed distribution, bottling and bulk material
manufacturing facility at DDO in Ogden, Utah.
Item 3. Legal Proceedings.
The Company is currently a party to various claims and legal actions which
arise in the ordinary course of business. The Company believes such claims and
legal actions, individually or in the aggregate, will not have a material
adverse effect on the business, financial condition or results of operations of
the Company. 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.
The Company has been sued by American Cyanimid, the manufacturer of the
Centrum line of vitamin/mineral supplements. American Cyanimid alleges that the
Solaray rainbow logo, as well as two KAL labels, infringe, or have infringed, on
the Centrum color spectrum logo. The Company is vigorously defending the
lawsuit. The case appears to be proceeding to trial, and although the Company
expects to prevail, there can be no assurance of this, nor any assurance that
the Company may not be required to pay damages or attorney fees and costs, and
change or abandon some of its labels and/or logos.
The Company is presently engaged in various other legal actions which arise
in the ordinary course of business. Although ultimate liability cannot be
determined at the present time, the Company believes that the amount of such
liability, if any, from these other actions, after taking into consideration the
Company's insurance coverage, will not have a material adverse effect on its
results of operations or financial condition.
Item 4. Submission of Matters to a Vote of Security-Holders.
No matters were submitted to a vote of the Company's security-holders in
the fourth quarter of fiscal 1998.
15
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.......... 53 Director, Chairman of the Board and Chief Executive Officer
Bruce R. Hough........... 44 Director, President
Jeffrey A. Hinrichs...... 41 Director, Chief Operating Officer and Executive Vice President
William T. Logan......... 56 Senior Vice President, Marketing and Sales
Leslie M. Brown, Jr...... 34 Senior Vice President, Finance and Chief Financial Officer
Stanley E. Soper......... 35 Vice President, Legal Affairs
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 has served as a member of the Board of Directors of the
Company since its inception and was made its President 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 Chief Operating Officer and Executive
Vice President 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.
William T. Logan has served as Senior Vice President, Marketing and Sales
since February 1995. Mr. Logan served as Senior Vice President of Makers of KAL,
Inc. ("Old KAL") from 1978 to January 1995. Prior to joining Old KAL, he held
several sales and marketing positions with Gillette.
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.
Stanley E. Soper has been Vice President, Legal Affairs for the Company
since July 1997. Mr. Soper graduated from Yale Law School in 1991, and was in
private law practice from 1991 to 1997, most recently with Holland & Hart LLP.
16
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
("Nasdaq") under the symbol "NUTR." The Common Stock commenced trading on
February 20, 1998. The following table sets forth the high and low prices per
share for the Common Stock as reported by the Nasdaq for the period indicated:
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 (through December 23, 1998)...... 7.69 4.88
Holders
As of the close of business on December 23, 1998, there were 68 holders of
record of Common Stock. The Company believes that it has a significantly larger
number of beneficial holders of Common Stock. A recent reported last sale price
of the Common Stock on the Nasdaq is set forth on the cover page of this report.
Dividends
Since its incorporation in 1993, the Company has not declared or 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. As a holding
company, the ability of the Company to pay dividends in the future is dependent
upon the receipt of dividends or other payments from its principal operating
subsidiary. Any future determination 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.
Recent Sales of Unregistered Securities
No securities of the Company that were not registered under the Securities
Act have been issued or sold by the Company within the period covered by this
report.
Use of Proceeds
The 3,829,500 shares of Common Stock registered and sold in the Company's
initial public offering on February 25, 1998 (the "Offering") were offered and
sold on behalf of the Company by Donaldson, Lufkin & Jenrette Securities
Corporation and Salomon Smith Barney (the "Underwriters"). The issuance of
2,144,618 primary shares resulted in gross proceeds to the Company of
$37,530,815 based on the price to the public of $17.50. The Company incurred the
following expenses in connection with the Offering: (i) underwriting discounts
and commissions of $2,627,157; (ii) non-accountable expenses to the Underwriter
of $55,000; and (iii) other expenses including, but not limited to, legal,
accounting and printing expenses of $2,041,718. From the effective date of the
Company's registration statement on February 11, 1998 until the end of the
Company's fiscal year on September 30, 1998, the Company applied approximately
$28,678,000 of net proceeds toward the repayment of indebtedness and $4,128,940
for other general corporate purposes.
17
Item 6. Selected Financial Data.
The selected financial data presented below were derived from the
consolidated financial statements of the Company. The consolidated financial
statements for each of the years in the five year period ended September 30,
1998 have been audited by PricewaterhouseCoopers LLP, independent accountants.
This selected financial data should be read in conjunction with "Management's
Discussion and Analysis of Results of Operations and Financial Condition" and
the Company's consolidated financial statements and the notes thereto.
Year Ended September 30,
---------------------------------------------------------------
1994(a) 1995 1996 1997 1998
---------- ---------- ----------- ------------ -----------
Consolidated Statement of Operations Data:
Net sales...................................... $ 26,083 $ 62,932 $ 83,923 $ 98,096 $ 104,688
Cost of sales.................................. 13,410 35,885 45,099 52,277 57,750
---------- ---------- ----------- ----------- -----------
Gross profit................................. 12,673 27,047 38,824 45,819 46,938
Operating expenses:
Selling, general and administrative.......... 8,116 21,140 27,308 28,879 31,233
Amortization of intangibles.................. 394 1,059 1,483 1,346 1,391
Non-recurring payments to management
advisors................................... 187 269 300 300 1,135
One-time payment to executive officer........ -- -- -- 1,700 --
---------- ---------- ----------- ----------- -----------
Income from operations......................... 3,976 4,579 9,733 13,594 13,179
Interest expense, net.......................... 1,820 4,478 7,126 6,572 3,971
---------- ---------- ----------- ----------- -----------
Income before provision for income taxes....... 2,156 101 2,607 7,022 9,208
Provision for income taxes..................... 848 23 1,056 2,774 3,509
---------- ---------- ----------- ----------- -----------
Net income before extraordinary loss........... 1,308 78 1,551 4,248 5,699
Extraordinary loss on early extinguishment of
debt, net of tax............................. -- (478) -- -- (3,129)
---------- ---------- ----------- ----------- -----------
Net income (loss).............................. $ 1,308 $ (400) $ 1,551 $ 4,248 $ 2,570
========== ========== =========== =========== ===========
Net income before extraordinary loss per common
share, basic................................. $ 0.18 $ 0.01 $ 0.17 $ 0.46 $ 0.53
Net income before extraordinary loss per
common share, diluted........................ $ 0.16 $ 0.01 $ 0.15 $ 0.40 $ 0.48
Net income per common share, basic............. $ 0.18 $ (0.05) $ 0.17 $ 0.46 $ 0.24
Net income per common share, diluted........... $ 0.16 $ (0.04) $ 0.15 $ 0.40 $ 0.22
Weighted average shares outstanding, basic..... 7,279,196 8,824,623 9,308,583 9,308,583 10,806,178
Weighted average shares outstanding, diluted... 8,198,261 9,878,693 10,421,667 10,502,749 11,902,348
Other Financial Data:
Adjusted EBITDA (b)............................ $ 5,724 $ 11,831 $ 13,118 $ 19,563 $ 19,410
Capital expenditures (excluding acquisitions).. 452 2,837 5,498 3,652 3,380
Cash flows provided by (used in):
Operating activities......................... 1,958 (64) 4,559 9,363 10,063
Investing activities......................... (10,065) (49,155) (5,498) (3,652) (17,815)
Financing activities......................... 8,341 49,645 2,600 (3,617) 5,309
Balance Sheet Data (at period end):
Cash........................................... $ 234 $ 660 $ 2,321 $ 4,415 $ 1,967
Working capital................................ 2,814 17,165 19,727 15,616 24,047
Total assets................................... 16,076 83,498 84,755 90,110 104,308
Total debt..................................... 8,769 60,881 63,657 60,259 37,133
Stockholders' equity........................... 3,738 10,512 12,091 16,354 51,622
- -----------------
(a) The Company's audited financial statements for the year ended September 30,
1994 primarily reflect operations after October 27, 1993, the date of the
Solaray acquisition. The Company's operations prior to such date were
immaterial.
(b) "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 of 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 positive trends in Adjusted EBITDA are used as the
18
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,
---------------------------------------------
1994 1995 1996 1997 1998
------ ------- ------- ------- -------
Net income before extraordinary
loss.............................. $1,308 $ 78 $ 1,551 $ 4,248 $ 5,699
Provision for income taxes.......... 848 23 1,056 2,774 3,509
Interest expense, net (1)........... 1,820 4,478 7,126 6,572 3,971
Depreciation and amortization (2)... 1,561 6,983 3,085 3,969 5,096
Non-recurring payments to management
advisors (3)...................... 187 269 300 300 1,135
One-time payment to executive
officer (4)....................... -- -- -- 1,700 --
------ ------- ------- ------- -------
Adjusted EBITDA................... $5,724 $11,831 $13,118 $19,563 $19,410
====== ======= ======= ======= =======
- -----------------
(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 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.
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 additional significant acquisitions: Premier One in
October 1994, KAL/NaturalMax in January 1995 and Monarch Nutritional
Laboratories in September 1995 (collectively, the "Fiscal 1995 Acquisitions").
In fiscal 1998, the Company completed two additional acquisitions: Action Labs
in July 1998 and NutraForce in August 1998 (collectively, the "Fiscal 1998
Acquisitions").
19
Results of Operations
The following table sets forth certain consolidated statement of operations
data as a percentage of net sales for the periods indicated:
Year Ended September 30,
------------------------
1996 1997 1998
----- ----- -----
Net sales............................................................ 100.0% 100.0% 100.0%
Cost of sales........................................................ 53.7 53.3 55.2
----- ----- -----
Gross profit......................................................... 46.3 46.7 44.8
Selling, general and administrative.................................. 32.5 29.4 29.8
Amortization of intangibles.......................................... 1.8 1.4 1.3
Non-recurring payments to management advisors........................ 0.4 0.3 1.1
One-time payment to executive officer................................ -- 1.7 --
----- ----- -----
Income from operations............................................... 11.6 13.9 12.6
Interest expense, net................................................ 8.5 6.7 3.8
----- ----- -----
Income before provision for income taxes............................. 3.1 7.2 8.8
Provision for income taxes........................................... 1.3 2.8 3.4
----- ----- -----
Net income before extraordinary loss................................. 1.8 4.4 5.4
Extraordinary loss on early extinguishment of debt, net of tax....... -- -- (2.9)
----- ----- -----
Net income........................................................... 1.8% 4.4% 2.5%
===== ===== =====
Comparison of Fiscal 1998 to Fiscal 1997
Net Sales. Net sales increased by $6.6 million, or 6.7%, to $104.7 million
for fiscal 1998 from $98.1 million for fiscal 1997. The increase in net sales
was primarily the result of increased sales volume. The Company believes that
the increased volume was primarily attributable to industry growth and the
success of new product introductions and, to a lesser extent, the Fiscal 1998
Acquisitions which occurred during the fourth fiscal quarter.
Gross Profit. Gross profit increased by $1.1 million, or 2.4%, to $46.9
million for fiscal 1998 from $45.8 million for fiscal 1997. This increase in
gross profit was primarily attributable to growth in sales volume. As a
percentage of net sales, gross profit decreased to 44.8% for fiscal 1998 from
46.7% for fiscal 1997. This decrease in gross profit as a percentage of net
sales was primarily attributable to higher packaging costs associated with label
and bottle conversions and additional discounting associated with certain
promotional programs during fiscal 1998. Label conversions are and were
necessitated by FDA regulations which become effective in March 1999. Bottle
costs increased as the Company moved from polystyrene to PET bottles.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased by $2.3 million, or 8.2%, to $31.2 million for
fiscal 1998 from $28.9 million for fiscal 1997. As a percentage of net sales,
selling, general and administrative expenses increased to 29.8% for fiscal 1998
from 29.4% for fiscal 1997. This increase in selling, general and
administrative expenses as a percentage of net sales was primarily attributable
to the Company's investment in information systems, including increased
amortization associated with prior year capital expenditures.
Amortization of Intangibles. Amortization of intangibles increased by $0.1
million, or 3.3%, to $1.4 million for fiscal 1998 from $1.3 million for fiscal
1997. As a percentage of net sales, amortization of intangibles decreased to
1.3% for fiscal 1998 from 1.4% for fiscal 1997. This increase in amortization of
$0.1 million was primarily attributable to the Fiscal 1998 Acquisitions. During
fiscal 1998, approximately two months of amortization expense related to these
acquisitions was incurred compared to no amortization expense for fiscal 1997.
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.
One-Time Payment to Executive Officer. One-time payment to executive
officer of $1.7 million for fiscal 1997 represents a payment to the Company's
Chief Executive Officer for successfully positioning the Company for the
Offering.
Interest Expense, Net. Interest expense decreased by $2.6 million, or
39.6%, to $4.0 million for fiscal 1998 from $6.6 million for fiscal 1997. As a
percentage of net sales, interest expense decreased to 3.8% for fiscal 1998 from
6.7% for fiscal 1997. This decrease in interest expense was primarily
attributable to decreased indebtedness associated with debt repayments made with
proceeds of the Offering.
20
Provision for Income Taxes. The Company's effective tax rate decreased to
38.1% for fiscal 1998 from 39.5% for fiscal 1997. In each fiscal year, the
effective tax rate is higher than statutory rates primarily due to the non-
deductibility for tax purposes of goodwill amortization arising from the
purchase of Solaray. The impact of Solaray goodwill on the effective tax rate
for fiscal 1998 decreased compared to fiscal 1997 as a result of the Company's
higher income before provision for taxes.
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 in connection with the Offering when new
financing (the "New Credit Agreement") was used to extinguish previous debt
arising from the Company's previous credit agreement (the "Senior Credit
Agreement").
Comparison of Fiscal 1997 to Fiscal 1996
Net Sales. Net sales increased by $14.2 million, or 16.9%, to $98.1
million for fiscal 1997 from $83.9 million for fiscal 1996. The increase in net
sales was primarily the result of increased sales volume and, to a lesser
extent, minimal increases in the prices of the Company's products. Such price
increases were immaterial to revenue growth. The Company believes that the
increased volume was primarily attributable to industry growth as well as to the
success of the Company's new growth-based incentive compensation structure for
independent sales representatives and the success of new product introductions.
Gross Profit. Gross profit increased by $7.0 million, or 18.0%, to $45.8
million for fiscal 1997 from $38.8 million for fiscal 1996. This increase in
gross profit was primarily attributable to growth in sales volume. As a
percentage of net sales, gross profit increased to 46.7% for fiscal 1997 from
46.3% for fiscal 1996. This increase in gross profit as a percentage of net
sales was primarily attributable to decreased material costs associated with new
vendor sourcing.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased by $1.6 million, or 5.8%, to $28.9 million for
fiscal 1997 from $27.3 million for fiscal 1996. As a percentage of net sales,
selling, general and administrative expenses decreased to 29.4% for fiscal 1997
from 32.5% for fiscal 1996. This decrease in selling, general and
administrative expenses as a percentage of net sales was primarily attributable
to the Company's efforts to implement new incentive and cost control programs.
Amortization of Intangibles. Amortization of intangibles decreased by $0.2
million, or 9.2%, to $1.3 million for fiscal 1997 from $1.5 million for fiscal
1996. As a percentage of net sales, amortization of intangibles decreased to
1.4% for fiscal 1997 from 1.8% for fiscal 1996. This decrease in amortization
of intangibles was primarily attributable to the use of the declining balance
method of amortization associated with certain non-compete covenants arising
from the Fiscal 1995 Acquisitions.
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.
One-Time Payment to Executive Officer. One-time payment to executive
officer of $1.7 million for fiscal 1997 represents a payment to the Company's
Chief Executive Officer for successfully positioning the Company for the
Offering.
Interest Expense, Net. Interest expense decreased by $0.5 million, or
7.8%, to $6.6 million for fiscal 1997 from $7.1 million for fiscal 1996. As a
percentage of net sales, interest expense decreased to 6.7% for fiscal 1997 from
8.5% for fiscal 1996. This decrease in interest expense was primarily
attributable to decreased indebtedness associated with the Senior Credit
Agreement.
Provision for Income Taxes. The Company's effective tax rate decreased to
39.5% for fiscal 1997 from 40.5% for fiscal 1996. In each fiscal year, the
effective tax rate is higher than statutory rates primarily due to the non-
deductibility for tax purposes of goodwill amortization arising from the
purchase of Solaray. The impact of Solaray goodwill on the effective tax rate
for fiscal 1997 decreased compared to fiscal 1996 as a result of the Company's
higher income before provision for taxes.
21
Selected Quarterly Financial Data; Seasonality
The following table sets forth certain quarterly financial date for fiscal
1997 and 1998. 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 of any future
period.
Fiscal 1997 Fiscal 1998
---------------------------------- ---------------------------------
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....................... $22,365 $25,120 $24,795 $25,815 $25,857 $27,799 $25,004 $26,027
Gross profit.................... 10,562 11,800 11,540 11,917 12,000 13,057 11,027 10,854
Net income before
extraordinary loss(a)......... 1,023 1,493 1,632 100 1,432 1,482 1,724 1,061
Net income (loss)............... 1,023 1,493 1,632 100 1,432 (1,647) 1,724 1,061
Earnings (loss) per
common share before
extraordinary loss:
Basic....................... $0.11 $0.16 $0.18 $0.01 $0.15 $0.14 $0.15 $0.09
Diluted..................... $0.10 $0.14 $0.16 $0.01 $0.14 $0.13 $0.14 $0.08
- ----------------
(a) During the second quarter of fiscal 1998, the Company incurred an
extraordinary loss of $3,129, net of tax, related to the early
extinguishment of debt in connection with the Offering.
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
sales volume during the second fiscal quarter due to increased interest in
health-related products among consumers following the holiday season and in
anticipation of the summer months. The Company does not believe that the impact
of seasonality on its results of operations is material. In addition, the
Company's sales of premium bulk formulations are characterized by periodic
shipments to certain customers and can vary significantly from quarter to
quarter.
Year 2000 Issue
Many existing computer programs use only two digits to identify years.
These programs were designed without consideration for the effect of the
upcoming change in century, and if not corrected, could fail or create erroneous
results by or at the year 2000. Essentially all the Company's information
technology based systems, as well as many non-information technology based
systems, are affected by the Year 2000 issue. Specific systems include
accounting, payroll, financial reporting, product formulation and development,
manufacturing, inventory tracking and control, business planning, tax, accounts
receivable, accounts payable, purchasing, distribution and numerous word
processing and similar applications. Non-information technology based systems
include equipment and services containing imbedded microprocessors, such as
manufacturing and bottling equipment, clocks, security systems and building
management systems. The Company also has relationships with numerous third
parties, including material suppliers, utility companies, transportation
companies, and banks and brokerage firms that may be affected by the Year 2000
issue.
Remediation plans have been established for all major systems potentially
affected by the Year 2000 issue. These remediation plans constitute an ongoing
process that the Company expects to adequately complete before the Year 2000.
Identification of areas of potential third party risk is currently in
process. Plans will be developed and implemented based on the results of such
identification and assessment. No areas of material risk have been identified to
date.
The Company is in the process of determining the risks it would face in the
event certain aspects of its Year 2000 remediation plan fail. It is also
developing contingency plans for all mission-critical processes. Under a "worst
case" scenario, the Company's manufacturing operations would be unable to build
and deliver products in a timely fashion due to internal system failures and/or
the inability of vendors to deliver raw materials and components. Alternative
suppliers are being identified (where possible) and inventory levels of certain
key components may be temporarily increased. While virtually all internal
systems can be replaced with manual systems on a temporary basis, the failure of
mission-critical systems would have at least a short-term negative affect on
operations. The failure of national and worldwide banking systems could result
in the inability of many businesses, including the Company, to conduct business.
Remediation, risk assessment and contingency plans are expected to be completed
in a timely enough manner before the Company experiences any material adverse
impact to its ongoing operations. The total cost to the Company of achieving
Year 2000 compliance is not expected to exceed $200,000, not including internal
resources. Spending to date totals approximately $20,000.
22
Liquidity and Capital Resources
For the fiscal year ended September 30, 1998, net cash provided by
operations was $10.1 million compared to $9.4 million for the year ended
September 30, 1997 and $4.6 million for the year ended September 30, 1996. The
increases in fiscal 1998 and 1997 were primarily attributable to higher net
income before extraordinary loss and reflect higher levels of accounts payable
and deferred income taxes, offset by higher accounts receivable and inventory
balances arising from higher sales volume.
Net cash used in investing activities was $17.8 million, $3.7 million and
$5.5 million for the years ended September 30, 1998, 1997 and 1996,
respectively. The Company's investing activities consist primarily of
acquisitions and, to a lesser extent, costs associated with capital
expenditures. The higher level of cash used in investing activities for fiscal
1998 reflects the Company's purchase of net assets related to the Fiscal 1998
Acquisitions. Capital expenditures during fiscal 1998, 1997 and 1996 related
primarily to manufacturing equipment and information systems required to expand
capacity and improve overall operating efficiency. 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 $5.3 million,
$(3.6) million and $2.6 million for the years ended September 30, 1998, 1997 and
1996, respectively. The Company's financing activities consist primarily of the
proceeds generated in connection with the Offering and, to a lesser extent,
borrowings and repayments under the Senior Credit Agreement and the New Credit
Agreement related to operating needs.
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. 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, 1998, the applicable interest rate was
5.88%. The Company is also required to pay a variable quarterly fee on the
unused balance under the New Credit Agreement. At September 30, 1998, the
applicable rate was 0.2%.
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 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 1999.
New Accounting Standards
The Financial Accounting Standards Board issued SFAS No. 130, Reporting
Comprehensive Income, which became effective for fiscal years beginning after
December 15, 1997 and established standards for the way that companies report
and display comprehensive income and its components in a full set of general
purpose financial statements. The Company is currently assessing the impact of
SFAS No. 130 on its financial statements.
The Financial Accounting Standards Board issued SFAS No. 131, Disclosures
about Segments of an Enterprise and Related Information, which became effective
for fiscal years beginning after December 15, 1997 and established standards for
the way that public business enterprises report information about operating
segments in annual and quarterly financial statements. SFAS No. 131 also
established standards for related disclosures about products and services,
geographic areas and major customers. The Company is currently assessing the
impact of SFAS No. 131 on its financial statements.
The American Institute of Certified Public Accountants issued SOP 98-1,
Accounting for the Costs of Computer Software Developed or Obtained for Internal
Use, which became effective for fiscal years beginning after December 15, 1997
and established standards for the way that public business enterprises account
for the costs of internal use computer software. The Company is currently
assessing the impact of SOP 98-1 on 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 form 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.
23
Forward-Looking Statements
Management's Discussion and Analysis of Financial Condition and Results of
Operations ("MD&A") contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended (the "Securities Act").
Such forward-looking statements are based on the beliefs of the Company's
management as well as on assumptions made by and information currently available
to the Company at the time such statements were made. When used in this MD&A,
the words "anticipate," "believe," "estimate," "expect," "intends," and similar
expressions, as they relate to the Company are intended to identify forward-
looking statements, which include statements relating to, among other things,
(i) the ability of the Company to continue to compete successfully in the
dietary supplements market; (ii) the anticipated benefits from new product
introductions; (iii) the continued effectiveness of the Company's sales and
marketing strategy; and (iv) the ability of the Company to continue to
successfully develop and launch new products. Actual results could differ
materially from those projected in the forward-looking statements as a result of
the matters discussed herein and certain economic and business factors, some of
which may be beyond the control of the Company.
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, 1998, the applicable interest rate
was 5.88% and the Company had total borrowings outstanding of $37.0 million. To
date, the Company has not obtained interest rate protection with respect to
these borrowings due to the recent stability of interest rates.
Item 8. Financial Statements and Supplementary Data.
The information required by Item 8 is set forth on pages F-1 through F-17
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.
24
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.
25
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
(b) Reports on Form 8-K.
The Company filed a Current Report on Form 8-K on July 21, 1998.
26
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, 1998.
NUTRACEUTICAL INTERNATIONAL CORPORATION
By: /s/ Frank W. Gay II
----------------------------
Name: Frank W. Gay II
Title: Chairman of the Board and Chief
Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1994, 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, 1998.
Signature Capacity
--------- --------
/s/ Frank W. Gay II Director, Chairman of the Board and Chief Executive
- -------------------------------- Officer
Frank W. Gay II
/s/ Bruce R. Hough
- --------------------------------
Bruce R. Hough Director, President
/s/ Jeffrey A. Hinrichs Director, Chief Operating Officer and Executive Vice
- -------------------------------- President
Jeffrey A. Hinrichs
/s/ Leslie M. Brown, Jr.
- --------------------------------
Leslie M. Brown, Jr. Senior Vice President, Finance and Chief Financial Officer
/s/ Alexander Gordon Bearn, M.D.
- --------------------------------
Alexander Gordon Bearn, M.D. Director
/s/ Robert C. Gay
- --------------------------------
Robert C. Gay Director
/s/ Matthew S. Levin
- --------------------------------
Matthew S. Levin Director
/s/ Geoffrey S. Rehnert
- --------------------------------
Geoffrey S. Rehnert Director
/s/ Jon Steven Young
- --------------------------------
Jon Steven Young Director
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*
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
23.1 Consent of PricewaterhouseCoopers LLP
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.
* 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.
NUTRACEUTICAL INTERNATIONAL CORPORATION
INDEX TO FINANCIAL STATEMENTS
PAGE
----
Financial Statements:
Report of Independent Accountants...................................... F-2
Consolidated Balance Sheets at September 30, 1997 and 1998............. F-3
Consolidated Statements of Operations for the years ended September 30,
1996, 1997 and 1998................................................... F-4
Consolidated Statements of Cash Flows for the years ended September 30,
1996, 1997 and 1998................................................... F-5
Consolidated Statements of Stockholders' Equity for the years ended
September 30, 1996, 1997 and 1998..................................... F-6
Notes to Consolidated Financial Statements............................. F-7
Financial Statement Schedules:
For each of the three years in the period ended September 30, 1998
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 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, 1997 and 1998, and the results of their operations and their cash
flows for each of the three years in the period ended September 30, 1998, in
conformity with generally accepted accounting principles. 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
generally accepted auditing standards 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 the opinion expressed
above.
/s/ PricewaterhouseCoopers LLP
Salt Lake City, Utah
November 17, 1998
F-2
NUTRACEUTICAL INTERNATIONAL CORPORATION
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except per share data)
SEPTEMBER 30,
-----------------
1997 1998
------- --------
ASSETS
- ------
Current assets:
Cash...................................................... $ 4,415 $ 1,967
Accountants receivable, net............................... 8,001 9,149
Inventories, net.......................................... 20,753 23,935
Prepaid expenses and other assets......................... 1,018 1,649
Deferred income taxes..................................... 897 1,101
------- --------
Total current assets.................................... 35,084 37,801
Property, plant and equipment, net.......................... 10,711 10,770
Goodwill, net............................................... 42,008 54,375
Other assets, net........................................... 2,307 1,362
------- --------
$90,110 $104,308
======= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Current liabilities:
Current portion of long-term debt......................... $ 7,085 $ --
Current portion of capital lease obligations.............. 181 53
Accounts payable.......................................... 6,932 9,614
Accrued expenses.......................................... 5,270 4,087
------- --------
Total current liabilities............................... 19,468 13,754
Long-term debt.............................................. 52,860 37,000
Capital lease obligations................................... 133 80
Deferred income taxes, net.................................. 1,295 1,852
------- --------
Total liabilities....................................... 73,756 52,686
------- --------
Commitments and contingencies (Notes 10, 13 and 16)
Stockholders' equity:
Common Stock, $.01 par value, 50,000,000 shares
authorized, 9,308,583 and 11,764,879 shares issued and
outstanding at September 30, 1997 and 1998,
respectively............................................. 93 118
Preferred Stock, $.01 par value, 5,000,000 shares
authorized, no shares issued and outstanding at September
30, 1997 and 1998........................................ -- --
Additional paid-in capital................................ 9,609 42,515
Subscriptions receivable.................................. (55) --
Retained earnings......................................... 6,707 9,277
Cumulative translation adjustment......................... -- 13
Treasury stock at cost, 41,800 shares at September 30,
1998..................................................... -- (301)
------- --------
Total stockholders' equity.............................. 16,354 51,622
------- --------
$90,110 $104,308
======= ========
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)
YEAR ENDED SEPTEMBER 30,
--------------------------------
1996 1997 1998
---------- ---------- ----------
Net sales................................... $ 83,923 $ 98,096 $ 104,688
Cost of sales............................... 45,099 52,277 57,750
---------- ---------- ----------
Gross profit............................ 38,824 45,819 46,938
---------- ---------- ----------
Operating expenses:
Selling, general and administrative....... 27,308 28,879 31,233
Amortization of intangibles............... 1,483 1,346 1,391
Non-recurring payments to management
advisors................................. 300 300 1,135
One-time payment to executive officer..... -- 1,700 --
---------- ---------- ----------
29,091 32,225 33,759
---------- ---------- ----------
Income from operations...................... 9,733 13,594 13,179
Interest expense, net....................... 7,126 6,572 3,971
---------- ---------- ----------
Income before provision for income taxes.... 2,607 7,022 9,208
Provision for income taxes.................. 1,056 2,774 3,509
---------- ---------- ----------
Net income before extraordinary loss........ 1,551 4,248 5,699
Extraordinary loss on early extinguishment
of debt, net of tax........................ -- -- (3,129)
---------- ---------- ----------
Net income.................................. $ 1,551 $ 4,248 $ 2,570
========== ========== ==========
Net income before extraordinary loss per
common share:
Basic..................................... $ 0.17 $ 0.46 $ 0.53
Diluted................................... $ 0.15 $ 0.40 $ 0.48
Extraordinary loss per common share:
Basic..................................... $ -- $ -- $ (0.29)
Diluted................................... $ -- $ -- $ (0.26)
Net income per common share:
Basic..................................... $ 0.17 $ 0.46 $ 0.24
Diluted................................... $ 0.15 $ 0.40 $ 0.22
Weighted average common shares outstanding:
Basic..................................... 9,308,583 9,308,583 10,806,178
Diluted................................... 10,421,667 10,502,749 11,902,348
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)
YEAR ENDED SEPTEMBER 30,
--------------------------
1996 1997 1998
------- ------- --------
Cash flows from operating activities:
Net income....................................... $ 1,551 $ 4,248 $ 2,570
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization (includes
amortization of inventory write-up of $381
during 1998).................................. 3,085 3,969 5,096
Amortization of debt issuance costs............ 785 817 468
Extraordinary loss on early extinguishment of
debt, net of tax.............................. -- -- 3,129
Loss on disposal of property, plant and
equipment..................................... -- -- 7
Changes in assets and liabilities, net of
effects from acquisitions:
Accounts receivable.......................... 3,932 (794) (456)
Inventories.................................. (1,491) (3,390) (2,460)
Prepaid expenses and other assets............ (358) 190 (453)
Deferred income taxes........................ 909 608 520
Other assets................................. (1) (3) (305)
Accounts payable............................. (2,838) 1,939 1,960
Accrued expenses............................. (1,015) 1,779 (13)
------- ------- --------
Net cash provided by operating activities.. 4,559 9,363 10,063
------- ------- --------
Cash flows from investing activities:
Purchases of property and equipment.............. (5,498) (3,652) (3,380)
Acquisitions, net of cash acquired............... -- -- (14,435)
------- ------- --------
Net cash used in investing activities...... (5,498) (3,652) (17,815)
------- ------- --------
Cash flows from financing activities:
Proceeds from long-term debt..................... 4,250 -- 46,450
Payments on long-term debt....................... (1,500) (3,450) (71,955)
Principal payments on capital lease obligations.. (178) (182) (181)
Payment of deferred financing fees............... -- -- (1,058)
Prepayment penalty and fees on early
extinguishment of debt.......................... -- -- (632)
Receipts of subscriptions receivable............. 28 15 55
Proceeds from issuance of common stock........... -- -- 32,931
Purchase of treasury shares...................... -- -- (301)
------- ------- --------
Net cash provided by (used in) financing
activities................................ 2,600 (3,617) 5,309
------- ------- --------
Effect of exchange rate changes on cash............. -- -- (5)
------- ------- --------
Net increase (decrease) in cash.................... 1,661 2,094 (2,448)
Cash at beginning of period........................ 660 2,321 4,415
------- ------- --------
Cash at end of period.............................. $ 2,321 $ 4,415 $ 1,967
======= ======= ========
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest....................................... $ 6,164 $ 5,924 $ 3,882
Income taxes................................... $ 513 $ 2,432 $ 874
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)
COMMON STOCK ADDITIONAL CUMULATIVE TOTAL
----------------- PAID-IN SUBSCRIPTIONS RETAINED TRANSLATION TREASURY STOCKHOLDERS'
SHARES AMOUNT CAPITAL RECEIVABLE EARNINGS ADJUSTMENT STOCK EQUITY
---------- ------ ---------- ------------- -------- ----------- -------- -------------
Balance at October 1,
1995................... 9,308,583 $ 93 $ 9,609 $(98) $ 908 $-- $ -- $10,512
Receipt of subscriptions
receivable............. -- -- -- 28 -- -- -- 28
Net income.............. -- -- -- -- 1,551 -- -- 1,551
---------- ---- ------- ---- ------ ---- ----- -------
Balance at September 30,
1996................... 9,308,583 93 9,609 (70) 2,459 -- -- 12,091
Receipt of subscriptions
receivable............. -- -- -- 15 -- -- -- 15
Net income.............. -- -- -- -- 4,248 -- -- 4,248
---------- ---- ------- ---- ------ ---- ----- -------
Balance at September 30,
1997................... 9,308,583 93 9,609 (55) 6,707 -- -- 16,354
Issuance of common
stock.................. 2,456,296 25 32,906 -- -- -- -- 32,931
Receipt of subscriptions
receivable............. -- -- -- 55 -- -- -- 55
Net income.............. -- -- -- -- 2,570 -- -- 2,570
Cumulative translation
adjustment............. -- -- -- -- -- 13 -- 13
Purchase of treasury
stock.................. -- -- -- -- -- -- (301) (301)
---------- ---- ------- ---- ------ ---- ----- -------
Balance at September 30,
1998................... 11,764,879 $118 $42,515 $-- $9,277 $ 13 $(301) $51,622
========== ==== ======= ==== ====== ==== ===== =======
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) develops, manufactures
and markets high quality branded vitamin, mineral, herbal and specialty dietary
supplements to domestic health food stores and international distributors under
the Solaray, Kal, NaturalMax, VegLife, Premier One, Solar Green, Natural Sport
and Action Labs brand names. The Company also produces chelated minerals and
processed herbs for its own use and sells these items to other manufacturers and
marketers in the dietary supplement industry. The Company's wholly-owned direct
and indirect subsidiaries consist of Nutraceutical Corporation; Solaray, Inc.
(Solaray); Premier One Products, Inc. (Premier One); Makers of KAL, Inc. and
Makers of KAL B.V. (KAL); NaturalMax, Inc. (NaturalMax); Monarch Nutritional
Laboratories, Inc. (Monarch Nutritional Laboratories); AuNaturel, Inc.; VegLife,
Inc.; Action Labs, Inc. (Action Labs) and Nutraforce (Canada) International,
Inc. (Nutraforce).
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation--The consolidated financial statements include the
accounts of the Company and its subsidiaries (Note 1). The acquired operations
of Action and Nutraforce 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 reporting periods. Estimates include reserves for obsolete and slow
moving inventory, customer returns and allowances and uncollectible accounts
receivable. Actual results could differ from these estimates.
Reclassification--Certain prior year amounts have been reclassified to conform
with the current year's presentation.
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, 1998. 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
period incurred.
Goodwill--The excess of the purchase price over the fair market values of the
assets acquired and liabilities assumed is classified as goodwill and is being
amortized using the straight-line method over periods ranging from 25 to 40
years. The Company periodically evaluates the recoverability of goodwill based
on undiscounted future cash flows. No impairments of goodwill have been recorded
as a result of these evaluations.
Non-Compete Agreements--Included in long-term other assets are capitalized
costs associated with non-compete agreements the Company entered into with
certain key executives associated with the Solaray, Premier One, KAL/NaturalMax
and Monarch Nutritional Laboratories acquisitions. These capitalized costs are
being amortized using the declining balance method over the lives of the
agreements which expire during fiscal 2000.
F-7
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(dollars in thousands, except per share data)
Deferred Financing Fees--The Company deferred certain debt issuance costs
related to the establishment of new financing loans (Note 9). These costs are
capitalized in long-term other assets and are being amortized using the
effective interest rate method over the life of the loans.
Interest Rate Cap Agreement--During fiscal 1995, the Company entered into an
interest rate cap agreement to hedge against the interest rate risk associated
with its variable rate debt obligations (Note 9). The effect of this interest
rate cap was to minimize the impact of interest rate fluctuations on the
Company's operating results. At September 30, 1997, the Company had an
outstanding interest rate cap agreement with a notional principal amount of
$26,000. This interest rate cap agreement was cancelled in connection with the
Offering.
Common Stock--On February 19, 1998, the Company completed the initial public
offering (the Offering) of its common stock (Common Stock), par value $0.01 per
share.
In connection with the Offering, the Company reclassified all of its
outstanding classes of capital stock (including accrued preference amounts) into
shares of Common Stock and authorized a single class of undesignated preferred
stock. Concurrently with the Offering, the Company effected a 7.5291-for-one
stock split of all outstanding shares of Common Stock and a corresponding
adjustment in the number of shares issuable upon the exercise of all outstanding
options and warrants. After giving effect to the reclassification and stock
split, the Company had 9,308,583 shares of Common Stock outstanding and no
shares of preferred stock outstanding. All periods presented have been
retroactively adjusted for the effect of the reclassification and stock split.
The Company sold 2,144,618 shares of Common Stock in the Offering and certain
selling stockholders sold an additional 1,684,882 shares of Common Stock
(including shares sold pursuant to the underwriters overallotment option). Of
the shares sold by the selling stockholders, 302,947 shares were issued in
connection with the Offering upon the exercise of outstanding warrants.
Immediately following the Offering, the Company had a total of 11,756,148 shares
of Common Stock outstanding. The net proceeds to the Company from the sale of
shares in the Offering of approximately $32,807 were primarily used to repay
existing indebtedness (Note 9). In addition, the Company recorded a one-time
payment related to the termination of a management advisory agreement and for
services rendered in connection with the Offering (Note 14).
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--Sales are recognized upon shipment of merchandise to a
customer. Provision is made for estimated customer returns, discounts and
allowances at the time of sale.
Research and Development--The Company expenses research and development costs
as incurred. For the years ended September 30, 1996, 1997 and 1998, the Company
incurred $837, $850 and $842, respectively, in research and development
expenditures. These costs are included in selling, 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 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.
F-8
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(dollars in thousands, except per share data)
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 the Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees, and will, when material, provide 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.
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, 1997 and 1998, 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, 1998.
3. ACQUISITIONS
Acquisitions--On July 20, 1998 and August 31, 1998, the Company acquired
substantially all of the assets and assumed certain liabilities of Action Labs
and Nutraforce, respectively (collectively referred to as the Acquired
Businesses or the Fiscal 1998 Acquisitions). 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 (Note 2). The consolidated statements of operations and statements of
cash flows presented herein include the activities of the Acquired Businesses
from their respective dates of acquisition.
The aggregate purchase price for the Fiscal 1998 Acquisitions totaled $14,683,
consisting of cash of $14,435, forgiveness of certain seller liabilities of $224
owed to the Company and a net payable to a seller of $24. The following reflects
the allocation of the aggregate purchase price for the Fiscal 1998 Acquisitions
to the aggregate assets acquired and the liabilities assumed:
FISCAL 1998
ACQUISITIONS
------------
Aggregate purchase price for Fiscal 1998 Acquisitions........ $14,683
=======
Aggregate assets acquired and liabilities assumed:
Current assets............................................. 2,022
Property, plant and equipment.............................. 12
Goodwill................................................... 13,665
Other assets............................................... 166
Current liabilities........................................ (1,182)
-------
Total.................................................... $14,683
=======
4. ACCOUNTS RECEIVABLE, NET
Accounts receivable, net, consist of the following:
SEPTEMBER 30,
---------------
1997 1998
------ -------
Accounts receivable...................................... $8,811 $10,173
Less allowances.......................................... (810) (1,024)
------ -------
$8,001 $ 9,149
====== =======
F-9
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(dollars in thousands, except per share data)
5. INVENTORIES, NET
Inventories, net of reserves for obsolete and slow moving inventory, are
comprised of the following:
SEPTEMBER 30,
---------------
1997 1998
------- -------
Raw materials............................................. $10,090 $ 8,562
Work-in-process........................................... 3,064 4,981
Finished goods............................................ 7,599 10,392
------- -------
$20,753 $23,935
======= =======
In connection with the Fiscal 1998 Acquisitions (Note 3), the inventories of
the Acquired Businesses were valued at net realizable value as of their
respective acquisition dates. The amount ascribed in excess of historical cost
(write-up) was $381 for the year ended September 30, 1998 and was charged to
cost of sales in the accompanying 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
USEFUL SEPTEMBER 30,
LIFE ----------------
(YEARS) 1997 1998
--------- ------- -------
Land........................................ -- $ 422 $ 422
Building and improvements................... 30 2,576 2,623
Furniture, fixtures and equipment........... 3-10 12,708 16,033
------- -------
15,706 19,078
Less accumulated depreciation and
amortization............................... (4,995) (8,308)
------- -------
$10,711 $10,770
======= =======
At September 30, 1997 and 1998, furniture, fixtures and equipment includes
$474 of leased equipment with an accumulated amortization balance of $304 and
$352, respectively. Certain property and equipment collateralize debt
obligations (Note 9).
Depreciation and amortization of property, plant and equipment totaled
$1,541, $2,561 and $3,324 for the years ended September 30, 1996, 1997 and
1998, respectively.
7. GOODWILL, NET
Goodwill, net, is comprised of the following:
SEPTEMBER 30,
----------------
1997 1998
------- -------
Goodwill................................................ $45,237 $58,902
Less accumulated amortization........................... (3,229) (4,527)
------- -------
$42,008 $54,375
======= =======
F-10
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(dollars in thousands, except per share data)
8. ACCRUED EXPENSES
Accrued expenses are comprised of the following:
SEPTEMBER 30,
----------------
1997 1998
------- -------
Employee payroll, benefits, taxes and performance
incentives.............................................. $ 2,009 $ 2,036
One-time payment to executive officer.................... 1,700 --
Other.................................................... 1,561 2,051
------- -------
$ 5,270 $ 4,087
======= =======
9. LONG-TERM DEBT
Long-term debt is comprised of the following:
SEPTEMBER 30,
----------------
1997 1998
------- -------
Note payable, payable in two installments as follows:
$500 in October 1997 and $765 in January 1998; interest
is payable with principal installments and accrues at
8% per annum........................................... $ 1,265 $ --
Senior Credit Agreement:
Revolving Credit Facility............................. 9,240 --
Term A Loan........................................... 37,000 --
Term B Loan, net of unamortized discount of $2,560.... 12,440
New Credit Agreement:
Revolving Credit Facility............................. -- 37,000
------- -------
Total long-term debt.................................... 59,945 37,000
Less current portion.................................... (7,085) --
------- -------
$52,860 $37,000
======= =======
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 the 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 fiscal 2001, 2002 and 2003,
respectively. 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, 1998, the applicable interest rate was 5.88%. The Company is
also required to pay a variable quarterly fee on the unused balance under the
New Credit Agreement. At September 30, 1998, the applicable rate was 0.2%.
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 January 2003.
Accordingly, the outstanding principal balance at September 30, 1998 was
classified as long-term debt.
F-11
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(dollars in thousands, except per share data)
10. LEASE COMMITMENTS AND OBLIGATIONS
The Company leases office and warehouse facilities under non-cancelable
operating leases expiring June of 2003. These operating leases require the
Company to pay all taxes, insurance and maintenance. The Company also leases
certain computer, manufacturing and laboratory equipment under capital leases.
The following summarizes future minimum lease payments required under
capital and operating leases:
YEAR ENDING CAPITALIZED OPERATING
SEPTEMBER 30, LEASES LEASES
------------- ----------- ---------
1999............................................. $ 63 $1,110
2000............................................. 63 656
2001............................................. 23 151
2002............................................. -- 126
2003............................................. -- 52
Thereafter....................................... -- --
---- ------
Future minimum lease payments.................... 149 $2,095
======
Less amounts representing interest............... (16)
====
Present value of future minimum lease payments... 133
Less amounts due within one year................. (53)
----
Amounts due after one year....................... $ 80
====
Total rent expense incurred by the Company under non-cancelable operating
leases for the years ended September 30, 1996, 1997 and 1998 was $898, $950
and $1,142, respectively.
11. INCOME TAXES
The provision for income taxes is comprised of the following:
YEAR ENDED
SEPTEMBER 30,
--------------------
1996 1997 1998
------ ------ ------
Current:
Federal............................................ $ 134 $2,058 $ 862
State.............................................. 13 197 133
Deferred:
Federal............................................ 830 508 647
State.............................................. 79 11 63
------ ------ ------
$1,056 $2,774 $1,705
====== ====== ======
The provision for income taxes for 1998 consists 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.
F-12
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(dollars in thousands, except per share data)
A summary of the composition of net deferred income tax assets and
liabilities is as follows:
SEPTEMBER 30,
-------------
1997 1998
------ ------
ASSETS
Inventory differences...................................... $ 108 $ 470
Accounts receivable reserves............................... 41 347
Accrued liabilities........................................ 748 273
Other...................................................... -- 11
------ ------
Current deferred income tax assets......................... $ 897 $1,101
====== ======
LIABILITIES
Amortization of intangibles................................ $1,131 $1,845
Depreciation............................................... 164 7
------ ------
Long-term deferred income tax liabilities, net............. $1,295 $1,852
====== ======
The differences between income taxes at the statutory federal income tax
rate and income taxes reported in the statements of operations are as follows:
YEAR ENDED
SEPTEMBER 30,
---------------------
1996 1997 1998
------ ------ ------
Tax at federal statutory rate...................... $ 886 $2,387 $1,454
State tax, net of federal benefit.................. 94 249 152
Non-deductible expenses............................ 86 102 113
Other.............................................. (10) 36 (14)
------ ------ ------
$1,056 $2,774 $1,705
====== ====== ======
12. CAPITAL STOCK
Description of Capital Stock -- At September 30, 1998, 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 Company has adopted Statement of Financial Accounting Standards No. 128,
Earnings per Share (SFAS 128). Under this statement, both "basic" earnings per
share and "diluted" earnings per share are presented on the face of the income
statement. As required under SFAS 128, both basic earnings per share and
diluted earnings per share for the years ended September 30, 1996 and 1997
have been calculated giving retroactive effect to the Company's stock
reclassification and stock split which occurred in conjunction with the
Offering (Note 2). The following table provides a reconciliation of both net
income and the number of common shares used in the computations of basic
earnings per share, which utilizes the weighted average number of common
shares outstanding without regard to potential common shares, and diluted
earnings per share which includes all such shares:
F-13
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(dollars in thousands, except per share data)
YEAR ENDED SEPTEMBER 30,
--------------------------------
1996 1997 1998
---------- ---------- ----------
Net income (Numerator):
Net income before extraordinary loss....... $ 1,551 $ 4,248 $ 5,699
Extraordinary loss on early extinguishment
of debt, net of tax....................... -- -- (3,129)
---------- ---------- ----------
Net income................................. $ 1,551 $ 4,248 $ 2,570
========== ========== ==========
Weighted average common shares (Denominator):
Basic weighted average common shares....... 9,308,583 9,308,583 10,806,178
Add: Dilutive effect of stock options and
warrants.................................. 1,113,084 1,194,166 1,096,170
---------- ---------- ----------
Diluted weighted average common shares..... 10,421,667 10,502,749 11,902,348
========== ========== ==========
Net income before extraordinary loss per
common share:
Basic...................................... $ 0.17 $ 0.46 $ 0.53
Diluted.................................... $ 0.15 $ 0.40 $ 0.48
Extraordinary loss per common share:
Basic...................................... -- -- $ (0.29)
Diluted.................................... -- -- $ (0.26)
Net income (loss) per common share:
Basic...................................... $ 0.17 $ 0.46 $ 0.24
Diluted.................................... $ 0.15 $ 0.40 $ 0.22
Stock Warrants--As part of the Solaray acquisition, the Company issued
detachable stock warrants which 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
value of these warrants on the date of issuance was $292. These warrants expire
October 28, 2003. As part of the Premier One and KAL 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 vest over a period of up to five years and expire no later than the
10th anniversary of the date of grant. As of September 30, 1998, 257,495 shares
were exercisable.
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 aggregate, 150,000
shares of Common Stock have been reserved for issuance under the Director
Option Plan.
F-14
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(dollars in thousands, except per share data)
The following table sets forth option grants 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, 1995...... -- $-- $ --
Granted........................... 190,486 5 936
Exercised......................... -- -- --
Canceled.......................... (15,246) 5 (75)
------- --- ------
Outstanding at September 30, 1996... 175,240 5 861
------- --- ------
Granted........................... 26,352 9 228
Exercised......................... -- -- --
Canceled.......................... (33,316) 5 (164)
------- --- ------
Outstanding at September 30, 1997... 168,276 5 925
------- --- ------
Granted........................... 314,074 16 5,105
Exercised......................... -- -- --
Canceled.......................... (20,580) 16 (336)
------- --- ------
Outstanding at September 30, 1998... 461,770 $12 $5,694
------- --- ------
These options were issued at exercise prices which represent management's
estimate of 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 Incentive
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.
F-15
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(dollars in thousands, except per share data)
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, 1998
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------- ---------------------------
RANGE OF WEIGHTED-AVERAGE WEIGHTED-AVERAGE
EXERCISE PRICES SHARES EXERCISE PRICE SHARES EXERCISE PRICE
- ---------------------- ------- ---------------- ------- ---------------
$ 4.91 - $ 4.91 140,042 $ 4.91 108,979 $ 4.91
(Avg. life: 6.5 years)
$ 8.63 - $13.38 92,881 $10.77 9,920 $10.23
(Avg. life: 9.4 years)
$17.50 - $17.50 228,847 $17.50 37,545 $17.50
(Avg. life: 9.3 years)
The weighted average fair value per share of options granted was $1.76 and
$10.13 for the years ended September 30, 1997 and 1998, respectively. The
Company's pro forma net income for the years ended September 30, 1997 and 1998
would have been $4,239 and $2,321, 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 fiscal years ended September 30, 1997 and
1998 would have been $0.46 and $0.21, respectively. The Company's pro forma
diluted net income per common share for the fiscal years ended September 30,
1997 and 1998 would have been $0.40 and $0.20, respectively.
The fair value of these options was estimated as of the date of grant using a
Black-Scholes option pricing model with the following assumptions for the years
ended September 30, 1997 and 1998, respectively: risk free interest rate of
6.15% and 5.52%; expected life of 5 years and 5 years; expected volatility of 1%
and 70%; and expected dividend yield of 0% and 0%. Because changes in the
subjective input assumptions can materially affect the fair value estimate,
management's opinion is 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 desiring
to do so a convenient means of purchasing shares of Common Stock through payroll
and lump-sum deductions. In aggregate, 750,000 shares of Common Stock have been
reserved for issuance under the Stock Purchase Plan.
Treasury Stock Repurchase Program--During the year ended September 30, 1998,
the Company's Board of Directors approved a treasury stock repurchase program to
repurchase 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 plan at an
aggregate price of $301.
F-16
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(dollars in thousands, except per share data)
13. EMPLOYEE BENEFIT PLANS
401(k) Plan--The Company has a 401(k) defined contribution profit sharing plan
which covers substantially all employees. Under the plan, employees can
contribute up to 15% of their compensation, not to exceed the prescribed annual
statutory limit ($10 for calendar 1998). The Company makes matching and
discretionary contributions to the plan which approximate 5% of all eligible
employees' salaries. The amounts contributed to the plan by the Company during
the years ended September 30, 1996, 1997 and 1998 were $254, $317 and $384,
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 $35 per year for each individual, while claims
exceeding $35 per individual, or $694 in the aggregate as of September 30,
1998, 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,
1996, 1997 and 1998 was $526, $770 and $898, respectively. At September 30,
1998, the Company had accrued $166 for claims incurred but not reported and
claims reported but not paid.
14. 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 connection with the Offering. For the years ended
September 30, 1996, 1997, and 1998, the Company incurred $339, $360 and
$1,185, respectively, in fees and out-of-pocket expenses for these certain
stockholders.
During fiscal 1994, the Company loaned $112 to certain stockholders for the
purchase of the Company's stock. The loans accrued interest at 6% per annum
and were payable in four annual installments commencing October 28, 1994 and
ending October 28, 1997. The amount outstanding under these loans at September
30, 1997 was $55 and was repaid in full during fiscal 1998.
15. SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES
As part of the Fiscal 1998 Acquisitions, the Company forgave $224 in certain
seller liabilities owed to the Company and incurred a net payable of $24 to a
seller.
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 and
the Federal Trade Commission and, to a lesser extent, the Consumer Product
Safety Commission and 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 foreign countries 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.
F-17
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(dollars in thousands, except per share data)
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 liabilities
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. 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-18
Nutraceutical International Corporation
Schedule II--Valuation and Qualifying Accounts
Balance at Charged Charged Balance at
Beginning to Costs and to Other End of
Description of Period Expenses Accounts Deductions Period
---------- ---------- ------------ -------- ---------- ----------
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
September 30 1997
Deducted from related asset account:
Allowance for sales returns.................... $ 456 $207 $ -- $243 $ 420
Allowance for doubtful accounts................ $ 355 $ 35 $ -- $ -- $ 390
Provision for inventory........................ $ 675 $492 $ -- $ -- $1,167
September 30 1996
Deducted from related asset account:
Allowance for sales returns.................... $ 412 $601 $ -- $557 $ 456
Allowance for doubtful accounts................ $ 420 $ -- $ -- $ 65 $ 355
Provision for inventory........................ $ 625 $ 50 $ -- $ -- $ 675