WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended June 30, 2004
OR
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the transition period from          to
Commission File Number 001-31788
NBTY, INC.
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE			11-2228617
(State or Other Jurisdiction of Incorporation or Organization)			(IRS Employer Identification No.)
90 Orville Drive Bohemia, New York 11716
(Address of Principal Executive Offices, Including Zip Code)
(631) 567-9500
(Registrant’s Telephone Number, Including Area Code)

 

 

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  ý  NO  o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES  ý  NO  o

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

 

 

 

NBTY, INC. and SUBSIDIARIES

FORM 10-Q

FISCAL QUARTER ENDED JUNE 30, 2004

INDEX

 

PART I.	Financial Information
ITEM 1.	Financial Statements (Unaudited)
	Condensed Consolidated Balance Sheets
	Condensed Consolidated Statements of Income
	Condensed Consolidated Statements of Stockholders’ Equity and Comprehensive Income
	Condensed Consolidated Statements of Cash Flows
	Notes to Condensed Consolidated Financial Statements
ITEM 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
ITEM 3.	Qualitative and Quantitative Disclosures about Market Risk
ITEM 4.	Controls and Procedures
PART II.	Other Information
ITEM 1.	Legal Proceedings
ITEM 6.	Exhibits and Reports on Form 8-K
Signatures
Exhibits

 

 

PART I.  Financial Information

 

ITEM 1: Financial Statements

 

NBTY, INC. and SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

(Dollars and shares in thousands)

 

		June 30, 2004			September 30, 2003
Assets
Current assets:
Cash and cash equivalents		$	50,185		$	49,349
Investments in bonds		—			4,158
Accounts receivable, less allowance for doubtful accounts of $7,560 at June 30, 2004 and $7,100 at September 30, 2003		87,367			80,829
Inventories		353,381			314,091
Deferred income taxes		37,021			37,021
Prepaid expenses and other current assets		51,715			44,736
Total current assets		579,669			530,184
Property, plant and equipment, net		283,612			298,344
Goodwill		217,287			213,362
Intangible assets, net		138,968			137,469
Other assets		15,816			16,423
Total assets		$	1,235,352		$	1,195,782
Liabilities and Stockholders’ Equity
Current liabilities:
Current portion of long-term debt and capital lease obligations		$	3,247		$	12,841
Accounts payable		96,965			87,039
Accrued expenses and other current liabilities		149,768			116,029
Total current liabilities		249,980			215,909
Long-term debt		307,112			413,989
Deferred income taxes		53,609			40,213
Other liabilities		6,188			10,872
Total liabilities		616,889			680,983
Commitments and contingencies
Stockholders’ equity:
Common stock, $.008 par; authorized 175,000 shares; issued and outstanding 66,870 shares at June 30, 2004 and 66,620 shares at September 30, 2003		535			533
Capital in excess of par		134,023			130,208
Retained earnings		460,257			369,453
		594,815			500,194
Accumulated other comprehensive income		23,648			14,605
Total stockholders’ equity		618,463			514,799
Total liabilities and stockholders’ equity		$	1,235,352		$	1,195,782

 

See accompanying notes to condensed consolidated financial statements.

 

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NBTY, INC. and SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

 

(Dollars and shares in thousands, except per share amounts)

 

		For the three months ended June 30,						For the nine months ended June 30,
		2004			2003			2004			2003
Net sales		$	399,913		$	308,474		$	1,224,559		$	827,701
Costs and expenses:
Cost of sales		197,228			141,196			603,362			372,555
Discontinued product charge		—			—			—			6,000
Catalog printing, postage and promotion		21,651			15,378			61,109			46,015
Selling, general and administrative		139,905			110,924			408,569			303,470
		358,784			267,498			1,073,040			728,040
Income from operations		41,129			40,976			151,519			99,661
Other income (expense):
Interest		(5,569		)	(3,890		)	(19,132		)	(11,709		)
Miscellaneous, net		1,096			2,023			3,142			5,536
		(4,473		)	(1,867		)	(15,990		)	(6,173		)
Income before provision for income taxes		36,656			39,109			135,529			93,488
Provision for income taxes		10,754			9,641			44,725			27,786
Net income		$	25,902		$	29,468		$	90,804		$	65,702
Net income per share:
Basic		$	0.39		$	0.44		$	1.36		$	0.99
Diluted		$	0.37		$	0.43		$	1.31		$	0.96
Weighted average common shares outstanding:
Basic		66,803			66,263			66,724			66,232
Diluted		69,207			68,287			69,107			68,233

 

See accompanying notes to condensed consolidated financial statements.

 

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NBTY, INC. and SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME

FOR THE YEAR ENDED SEPTEMBER 30, 2003 AND

NINE MONTHS ENDED JUNE 30, 2004

(Unaudited)

 

(Dollars and shares in thousands)

 

		Common Stock					Capital						Accumulated Other			Total			Total
		Number of Shares		Amount			in Excess of Par			Retained Earnings			Comprehensive Income			Stockholders’ Equity			Comprehensive Income
Balance, September 30, 2002		66,322		$	529		$	126,283		$	287,868		$	4,577		$	419,257
Components of comprehensive income
Net income										81,585						81,585			$	81,585
Foreign currency translation adjustment													9,980			9,980			9,980
Change in net unrealized gain on available-for-sale investments													48			48			48
																			$	91,613
Shares issued and contributed to ESOP		100		1			1,710									1,711
Exercise of stock options		198		3			1,143									1,146
Tax benefit from exercise of stock options							1,072									1,072
Balance, September 30, 2003		66,620		533			130,208			369,453			14,605			514,799
Components of comprehensive income
Net income										90,804						90,804			$	90,804
Foreign currency translation adjustment, net of taxes													9,043			9,043			9,043
																			$	99,847
Shares issued and contributed to ESOP		100		1			2,472									2,473
Exercise of stock options		150		1			806									807
Tax benefit from exercise of stock options							537									537
Balance, June 30, 2004		66,870		$	535		$	134,023		$	460,257		$	23,648		$	618,463

 

See accompanying notes to condensed consolidated financial statements.

 

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NBTY, INC. and SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

(Dollars in thousands)

 

		For the nine months ended June 30,
		2004			2003
Cash flows from operating activities:
Net income		$	90,804		$	65,702
Adjustments to reconcile net income to net cash provided by operating activities:
Loss / (gain) on disposal/sale of property, plant and equipment		496			(843		)
Depreciation and amortization		46,848			32,539
Foreign currency transaction gain		(679		)	(970		)
Amortization of deferred financing costs		2,337			591
Amortization of bond discount		93			93
Allowance for doubtful accounts		460			43
Compensation expense for ESOP		4,176			1,283
Tax benefit from exercise of stock options		537			113
Deferred income taxes		—			(1,000		)
Discontinued product charge		—			6,000
Changes in assets and liabilities:
Accounts receivable		(6,651		)	(12,998		)
Inventories		(35,536		)	(13,323		)
Prepaid expenses and other current assets		7,135			(17,201		)
Other assets		1,377			(1,209		)
Accounts payable		6,372			5,743
Accrued expenses and other liabilities		19,638			15,013
Net cash provided by operating activities		137,407			79,576
Cash flows from investing activities:
Purchase of property, plant and equipment		(32,087		)	(24,852		)
Proceeds from sale of property, plant and equipment		1,092			1,454
Proceeds from sale of investment in bonds		4,158			—
Cash paid for acquisitions, net of cash acquired		—			(32,049		)
Release of cash held in escrow		—			2,403
Net cash used in investing activities		(26,837		)	(53,044		)
Cash flows from financing activities:
Principal payments under long-term debt agreements and capital leases		(116,563		)	(17,510		)
Payments for debt issuance costs		(500		)	—
Proceeds from stock options exercised		807			176
Net cash used in financing activities		(116,256		)	(17,334		)
Effect of exchange rate changes on cash and cash equivalents		6,522			3,032
Net increase in cash and cash equivalents		836			12,230
Cash and cash equivalents at beginning of period		49,349			26,229
Cash and cash equivalents at end of period		$	50,185		$	38,459
Supplemental disclosure of cash flow information:
Cash paid during the period for interest		$	13,592		$	8,656
Cash paid during the period for income taxes		$	22,356		$	21,035

 

See accompanying notes to condensed consolidated financial statements.

 

4

 

NBTY, INC. and SUBSIDIARIES

NOTES to CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

(In thousands, except per share amounts, number of stores and amortization periods)

 

1.              Principles of consolidation and basis of presentation

 

The accompanying unaudited condensed consolidated financial statements as of June 30, 2004 and September 30, 2003 and for the three and nine months ended June 30, 2004 and June 30, 2003 include the accounts of NBTY, Inc. and Subsidiaries (collectively, “NBTY” or the “Company”) after elimination of all significant intercompany accounts and transactions.  These financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments considered necessary for fair presentation have been included.

 

Operating results for the three and nine months ended June 30, 2004 and 2003 are not necessarily indicative of the results that may be expected for a full year.  The financial statements included herein should be read in conjunction with the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2003 (“10-K”) and the Company’s filings with the Securities and Exchange Commission (“SEC”).

 

Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted  in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period.  The most significant estimates include the valuation of inventories, the allowance for doubtful accounts receivable and returns and discounts, income taxes, litigation reserves and the recoverability of long-lived assets.  Actual results could significantly differ from those estimates.

 

Stock-based compensation

 

The Company has elected to continue to measure compensation for stock options issued to its employees and outside directors pursuant to APB No. 25 under the intrinsic value method.  The Company has adopted the disclosure requirements of SFAS No. 123 and SFAS No. 148.  The adoption of SFAS No. 148, during fiscal 2003, did not have a material impact on the Company’s consolidated financial position or results of operations.  There were no stock option grants during the nine months ended June 30, 2004 or June 30, 2003, and all previously issued options are fully vested; therefore, the pro forma and actual net income and related earnings per share are the same as amounts reported.

 

Foreign currency

 

The financial statements of international subsidiaries are translated into U.S. dollars using the exchange rate at each balance sheet date for assets and liabilities and an average exchange rate for each period for revenues, expenses, gains and losses.  Foreign currency transaction gains and losses are charged or credited to income as incurred. Where the local currency is the functional currency, translation adjustments are recorded as a separate component of stockholders’ equity.

 

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Reclassifications

 

Certain reclassifications have been made to conform prior year amounts to the current year presentation.

 

New accounting developments

 

In December 2003, the SEC issued Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition.”  SAB 104, which was effective upon issuance, updates portions of the interpretive  guidance  included in Topic 13 of the codification  of  Staff   Accounting   Bulletins and revises or rescinds portions of the interpretative guidance included in SAB 101 in  order  to  make  this interpretive guidance consistent with current authoritative  accounting and auditing guidance and SEC rules and regulations. The principal revisions relate to the incorporation of certain sections of the staff’s Frequently Asked Question (“FAQ”) document on revenue recognition into Topic 13.   SAB 101, “Revenue Recognition in Financial Statements,” which was issued in December 1999, provides guidance to SEC registrants on the recognition, presentation and disclosure of revenues in the financial statements.  Since the Company has already adopted all such standards upon issuance, the application of this revised guidance did not impact its consolidated financial position, results of operations, or disclosure requirements.

 

In January 2003, the Financial Accounting Standards Board (“FASB”) issued Financial Interpretation Notice (“FIN”) No. 46, “Consolidation of Variable Interest Entities.” FIN No. 46 provides guidance for identifying a controlling interest in a variable interest entity (“VIE”) established by means other than voting interests. FIN No. 46 also requires consolidation of a VIE by an enterprise that holds such a controlling interest. On December 24, 2003, the FASB completed deliberations of the proposed modifications to FIN No. 46 (“Revised Interpretation”); the decisions reached include:

 

(1)          Deferral of the effective date;

(2)          Provisions for additional scope exceptions for certain other variable interests; and

(3)          Clarification of the impact of troubled debt restructurings on the requirement with respect to VIEs.

 

The Company adopted the revised interpretations of FIN No. 46 during the quarter ended March 31, 2004.  The Company did not have to consolidate any entities as a result of adopting this revised Interpretation.  Therefore the adoption of this Interpretation did not impact its consolidated financial position, results of operations, or disclosure requirements.

 

2.              Acquisitions

 

Fiscal 2003 Acquisitions

 

Rexall

 

On July 25, 2003, NBTY acquired all of the issued and outstanding capital stock of Rexall Sundown, Inc. (“Rexall”) for $250,000 in cash (subject to adjustment based upon finalization of working capital balances at date of closing) from Numico USA, Inc., an indirect subsidiary of Royal Numico N.V., through the acquisition of certain partnership and limited liability company interests.  The

 

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acquisition was financed by a senior credit facility (see Note 8).  The Company also incurred approximately $7,000 of direct transaction costs for a total purchase price of approximately $257,000.  Additionally, related financing costs of approximately $7,500 were paid to secure the financing for this acquisition which will be amortized until its maturity, which approximates six years.

 

The Company has retained essential Rexall employees consisting of product development, sales and service personnel. Management believes the transaction complements NBTY’s existing wholesale products and provides NBTY with an enhanced sales infrastructure and additional manufacturing capacity.  Rexall’s portfolio of nutritional supplement brands includes Rexall®, Sundown®, Osteo Bi-Flex®, Carb Solutions®, MET-Rx® and WORLDWIDE Sport Nutrition®.  Rexall brands contributed $67,687 and $224,345 in net sales to NBTY’s wholesale segment during the three and nine months ended June 30, 2004, respectively.

 

The Company accounted for the acquisition under the purchase method of accounting in accordance with SFAS No. 141, Business Combinations.  Under the purchase method of accounting, the total purchase price was allocated to the tangible and intangible assets acquired and the liabilities assumed based on their estimated fair values. The excess of the purchase price over those fair values was recorded as goodwill. The fair value assigned to the tangible and intangible assets acquired and liabilities assumed were based on estimates and assumptions provided by management, and other information compiled by management, including a valuation prepared by an independent valuation specialist that utilized established valuation techniques appropriate for the industry.   The total goodwill recognized in connection with this acquisition was $36,630, all of which relates to the wholesale segment.  None of this goodwill is expected to be deductible for income tax purposes.

 

Although management believes that the preliminary allocation of the estimated purchase price is reasonable, the final allocation (resulting from the finalization of working capital balances and finalization of the determination of the fair values of assets acquired and liabilities assumed) may differ significantly from the amounts reflected in the accompanying unaudited condensed consolidated financial statements.

 

The acquisition gave rise to the consolidation and elimination of certain Rexall personnel positions. The Company provided certain balance sheet adjustments for the same in accordance with EITF No. 95-3, Recognition of Liabilities in Connection with a Purchase Business Combination.  At the closing of the acquisition, the Company anticipated headcount reductions across all areas of Rexall and, as such, included an estimated accrual for workforce reductions of approximately $12,000 comprised of severance and employee benefits. A summary of the workforce reduction accrual is outlined as follows:

 

		July 25, 2003 Accrual			Payments through June 30, 2004			Reserve Adjustments			June 30, 2004 Accrual
Workforce reductions		$	12,000		$	(9,800	)	$	(1,700	)	$	500

 

The following unaudited condensed pro forma information presents a summary of consolidated results of operations of the Company and Rexall as if the acquisition had occurred at the beginning of fiscal 2003, with pro forma adjustments to give effect to the amortization of definite lived intangibles, adjustments in depreciation, interest expense on acquisition debt, elimination of impairment charges on intangibles recorded by Rexall, as well as the elimination of the cumulative effect of accounting change resulting from the adoption of SFAS No. 142, elimination of trademark

 

7

 

fees, and certain other adjustments, together with related income tax effects.  The unaudited pro forma condensed consolidated financial information is based on estimates and assumptions and includes intercompany charges paid to Rexall’s former parent company, Royal Numico N.V.  The pro forma information does not give effect to anticipated intercompany product sales, or any incremental direct costs or adjustments for liabilities resulting from integration plans that may be recorded in connection with the acquisition, or potential cost savings, which may result from the consolidation of certain operations of NBTY and Rexall.

 

The unaudited pro forma condensed consolidated statement of operations data for the three and nine months ended June 30, 2003 has been derived by combining the unaudited historical consolidated statement of operations of NBTY for the three and nine months ended June 30, 2003 with the unaudited historical consolidated statement of operations of Rexall for the three and nine months ended June 30, 2003.

 

		Three months ended June 30,						Nine months ended June 30,
		2004 Actual Consolidated			2003 Pro Forma Consolidated			2004 Actual Consolidated			2003 Pro Forma Consolidated
Net sales		$	399,913		$	422,380		$	1,224,559		$	1,146,517
Net income		$	25,902		$	28,549		$	90,804		$	22,733
Net income per share:
Basic		$	0.39		$	0.43		$	1.36		$	0.34
Diluted		$	0.37		$	0.42		$	1.31		$	0.33
Weighted average common shares outstanding:
Basic		66,803			66,263			66,724			66,232
Diluted		69,207			68,287			69,107			68,233

 

Included in Rexall’s pro forma income from operations for the three and nine months ended June 30, 2003 were non-recurring pre-tax expenses of $13,382 ($10,077 after-tax or $0.15 per diluted share) and $70,999 ($49,912 after-tax or $0.73 per diluted share), respectively. These expenses relate to charges incurred for litigation settlements and inter-company expenses for such items as product mark-ups and management stock purchase plan expenses.

 

During the fiscal third quarter of 2004, the Company entered into a contract with a real estate broker to facilitate the sale of a Rexall building acquired in the 2003 acquisition. The building was classified as an asset held for sale in June 2004 and has been included in “Prepaid expenses and other current assets” in the condensed consolidated balance sheet at June 30, 2004.  The estimated  fair  value  less  selling  costs exceeds the building’s carrying value of approximately $10,508 and, as such, no adjustment has been recorded for the three months ended June 30, 2004. There were no assets classified as held for sale at September 30, 2003.

 

De Tuinen

 

On May 20, 2003, the Company acquired the De Tuinen chain of retail stores from Royal Ahold N.V.  At the time of the acquisition, the De Tuinen chain consisted of  41 company owned stores and 24 franchised stores located throughout the Netherlands. This operation had been a wholly-owned subsidiary of the Ahold group of companies since 1991. The purchase price for this business was

 

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approximately $14,551 in cash.  This acquisition contributed $11,176 and $31,846 in net sales for the three and nine months ended June 30, 2004, respectively.  This acquisition also contributed pre-tax operating income of $231 for the three months ended June 30, 2004 and a pre-tax operating loss of $1,041 for the nine months ended June 30, 2004.  At June 30, 2004, 66 DeTuinen stores in the Netherlands were in operation.

 

Health & Diet Group (“GNC (UK)”) and FSC Wholesale (“FSC”)

 

On March 10, 2003, the Company acquired GNC (UK) and the FSC wholesale business from Royal Numico N.V.  At the time of the acquisition, GNC (UK) owned and operated 49 GNC stores in the U.K.  FSC is a Manchester, U.K.-based wholesale operation whose products are sold to health food stores and pharmacies.  The FSC branded products include comprehensive ranges of multivitamins, single vitamins and minerals, herbal formulas, and tinctures.  The purchase price for these businesses was approximately $16,759 in cash.   This transaction stipulates adjustments to the purchase price for agreed upon working capital requirements and inventory valuation procedures to be performed.  This acquisition contributed $11,700 and $34,194 in net sales for the three and nine months ended June 30, 2004, respectively.  GNC (UK) contributed a small profit, while FSC contributed a small loss during the three and nine months ended June 30, 2004.   At June 30, 2004, 47 GNC stores in the U.K. were in operation.

 

3.              Comprehensive income

 

Total comprehensive income for the Company includes net income, the effects of foreign currency translation and unrealized losses on available-for-sale securities, which are charged or credited to the accumulated other comprehensive income account within stockholders’ equity. Total comprehensive income for the three and nine month periods ended June 30, 2004 and 2003 is as follows:

 

		For the three months ended June 30,						For the nine months ended June 30,
		2004			2003			2004			2003
Net income		$	25,902		$	29,468		$	90,804		$	65,702
Changes in:
Unrealized holding losses		—			(1,821		)	—			(2,003		)
Foreign currency translation adjustments		(2,828		)	10,794			9,043			8,923
Total comprehensive income		$	23,074		$	38,441		$	99,847		$	72,622

 

 

Accumulated other comprehensive income, which is classified as a separate component of stockholders’ equity, is comprised of net gains on foreign currency translation of $23,648 and $14,605 at June 30, 2004 and September 30, 2003, respectively.

 

Prior to January 1, 2004, the Company had not recorded a deferred income tax liability relating to accumulated other comprehensive income.   During the nine months ended June 30, 2004, the Company recorded a deferred income tax liability of $13,476 relating to accumulated other

 

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comprehensive income at June 30, 2004.   Amounts relating to prior periods were not considered material.

 

4.              Investments in bonds

 

The Company classified its investments in bonds as available for sale and reported them at fair market value (based on then current quoted market prices), with net unrealized gains or losses on the securities recorded as accumulated other comprehensive income in stockholders’ equity.  The Company reviewed marketable securities for impairment based on criteria that include the extent to which cost exceeds market value, the duration of the market decline, and the financial condition and near-term prospects for the issuer.  As a result, the Company recorded an impairment charge of $4,084 in the results of operations during the fourth quarter of fiscal 2003.   The Company sold all of its investment in bonds during the 2004 fiscal first quarter at no further gain or loss.

 

5.              Inventories

 

The components of inventories are as follows:

 

		June 30, 2004			September 30, 2003
Raw materials		$	135,810		$	118,371
Work-in-process		13,154			9,555
Finished goods		204,417			186,165
		$	353,381		$	314,091

 

6.              Earnings per share (EPS)

 

Basic EPS computations are based on the weighted average number of common shares outstanding during the three and nine month periods ended June 30, 2004 and June 30, 2003.  Diluted EPS includes the dilutive effect of outstanding stock options, as if exercised.  The following is a reconciliation between basic and diluted EPS:

 

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		For the three months ended June 30,						For the nine months ended June 30,
		2004			2003			2004			2003
Numerator:
Numerator for basic EPS - income available to common stockholders		$	25,902		$	29,468		$	90,804		$	65,702
Numerator for diluted EPS - income available to common stockholders		$	25,902		$	29,468		$	90,804		$	65,702
Denominator:
Denominator for basic EPS - weighted-average shares		66,803			66,263			66,724			66,232
Effect of dilutive securities - Stock options		2,404			2,024			2,383			2,001
Denominator for diluted EPS - weighted-average shares		69,207			68,287			69,107			68,233
Net EPS:
Basic EPS		$	0.39		$	0.44		$	1.36		$	0.99
Diluted EPS		$	0.37		$	0.43		$	1.31		$	0.96

 

7.  Goodwill and Intangible Assets

 

Goodwill represents the excess of purchase price over the fair value of identifiable net assets of companies acquired.  Goodwill and intangible assets with indefinite useful lives are no longer amortized, but instead are tested for impairment at least annually.  The Company measures impairment based on a projected discounted cash flow method using a discount rate determined by management to be commensurate with the risk inherent in its current business model or another valuation technique.  Other definite lived intangibles are amortized on a straight-line basis over periods not exceeding 20 years.  The carrying amount of acquired intangible assets as of June 30, 2004 and September 30, 2003 is as follows:

 

		June 30, 2004						September 30, 2003
		Gross carrying amount			Accumulated amortization			Gross carrying amount			Accumulated amortization			Amortization period (years)
Definite lived intangible assets
Brands		$	79,088		$	3,575		$	78,000		$	650		10 - 20
Customer lists		61,912			23,217			61,368			19,843			2 - 15
Private label relationships		11,500			527			11,500			96			20
Trademarks and licenses		14,828			3,055			2,414			2,399			2 - 20
Patents		—			—			5,000			44			19
Covenants not to compete		2,605			2,391			2,605			2,186			3 - 5
		169,933			32,765			160,887			25,218
Indefinite lived intangible asset
Trademark		1,800			—			1,800			—
Total intangible assets		$	171,733		$	32,765		$	162,687		$	25,218

 

11

 

The changes in the carrying amount of goodwill by segment for the nine month period ended June 30, 2004, are as follows:

 

		Wholesale			Retail/ United States			Retail/ Europe			Direct Response/ Puritan’s Pride			Consolidated
Balance at September 30, 2003		$	38,929		$	7,588		$	151,648		$	15,197		$	213,362
Adjustments during period		2,592			—			(11,773		)	—			(9,181		)
Foreign currency translation		—			—			13,106			—			13,106
Balance at June 30, 2004		$	41,521		$	7,588		$	152,981		$	15,197		$	217,287

 

The goodwill associated with the acquisitions during the prior twelve months is subject to revision based on the finalization of working capital balances and the finalization of the determination of the fair values of assets acquired and liabilities assumed.  Goodwill adjustments during the first nine months of fiscal 2004 relate to re-allocations of net excess purchase price to assets acquired and liabilities assumed in connection with the fiscal 2003 acquisitions.  The decrease in the Retail Europe segment includes adjustments to the fair value of intangibles of $14,301, partially offset by re-allocations of net excess purchase price to tangible assets acquired and liabilities assumed of approximately $2,528.  The increase in the Wholesale segment’s goodwill includes net adjustments for re-allocations of net excess purchase price to tangible assets acquired and liabilities assumed of approximately $7,642 (which includes a $1,700 severance accrual reduction), adjustments to the fair value of intangibles of $4,781 and additional direct costs paid of $469, partially offset by adjustments to the fair value of insurance costs of $5,200 and adjustments to the fair value of other liabilities of $5,100.

 

Aggregate amortization expense of definite lived intangible assets for the nine months ended June 30, 2004 and 2003 was approximately $8,070 and $3,549, respectively.

 

Estimated amortization expense, assuming  no changes in the Company’s intangible assets, for each of the five succeeding fiscal years, beginning with fiscal 2004, is $9,917 (2004), $9,379 (2005), $9,205 (2006), $8,971 (2007) and $8,922 (2008).

 

8.              Debt

 

On July 25, 2003, the Company entered into a new Credit and Guarantee Agreement (“CGA”) comprised of $375,000 Senior Secured Credit Facilities. This CGA consisted of a $100,000 Revolving Credit Facility, a $50,000 Term Loan A and a $225,000 Term Loan B. Terms of the new CGA were in many instances similar to the previous credit agreement. On December 19, 2003, the Company refinanced $224,000 of Term B loans outstanding under its July 2003 credit agreement with a new class of Term C loans on more favorable terms of LIBOR plus 2%.  Costs of approximately $500 were paid on December 19, 2003, in connection with this debt refinancing, which will be amortized until Term C’s maturity of approximately six years.  By March 31, 2004, the Company had fully repaid Term Loan A.  Therefore, at June 30, 2004, existing outstanding facilities of the CGA consisted of a revolving credit facility which the Company has not drawn upon to date and $155,923 of Term Loan C.  Interest rates charged on borrowings can vary depending on the interest rate option utilized. Options for the rate can either be the Alternate Base Rate or LIBOR plus applicable margin.  At June 30, 2004 the annual borrowing rate for Term Loan C approximated 3.3125%.

 

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9.              Income Taxes

 

The Company’s income tax expense is impacted by a number of factors, including federal taxes, its international tax structure, state tax rates in the jurisdictions where the Company conducts business, and the Company’s ability to utilize state tax credits that will begin to expire in 2013. The effective income tax rate for the three months ended June 30, 2004 was 29.3%, compared to 24.7% in the fiscal third quarter ended June 30, 2003 and the effective income tax rate for the nine months ended June 30, 2004 was 33.0%, compared to 29.7% for the prior comparable period.  The prior year effective income tax rates were lower than the current year principally due to the Company recording a $4,000 after-tax benefit in the fiscal third quarter of 2003 to record foreign tax credits.  The effective income tax rates were less than the U.S. federal statutory tax rate primarily due to the enhanced tax structure of foreign subsidiaries.   This tax structure should also continue to impact future fiscal years. Therefore the Company’s overall effective income tax rate should vary.

 

10.  Segment Information

 

The Company is organized by sales segments on a worldwide basis.  The Company’s management reporting system evaluates performance based on a number of factors; however, the primary measures of performance are the sales and pre-tax operating income or loss (prior to corporate allocations) of each segment, as this is the key performance indicator reviewed by management.  Operating income or loss for each segment does not include corporate general and administrative expenses, interest expense and other miscellaneous income/expense items.  Such unallocated expenses remain within corporate.  Corporate also includes the manufacturing assets of the Company and, accordingly, items associated with these activities, such as the discontinued product charge (recorded during the nine months ended June 30, 2003) remains unallocated in the corporate segment.  The European Retail operation does not include the impact of any intercompany transfer pricing. The accounting policies of all of the operating segments are the same as those described in the summary of significant accounting policies in Note 1 to the consolidated financial statements included in the 10-K.

 

The Company reports four segments: Wholesale; Retail: United States; Retail: Europe; and Direct Response/Puritan’s Pride.  All of the Company’s products fall into one of these four segments. The Wholesale segment is comprised of several divisions each targeting specific market groups which include wholesalers, distributors, chains, pharmacies, health food stores, bulk and international customers. The Retail: United States segment generates revenue through the sales in its 552 owned and operated Vitamin World stores of proprietary brand and third-party products.  The Retail: Europe segment generates revenue through its 574 Company-operated stores and 25 franchise stores.  Such revenue consists of sales of proprietary brand and third-party products as well as franchise fees.  The Direct Response/Puritan’s Pride segment generates revenue through the sale of proprietary brand and third-party products primarily through mail order catalog and the Internet. Catalogs are strategically mailed to customers who order by mail, internet, or by phoning customer service representatives in New York, Illinois and the United Kingdom.

 

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The following table represents key financial information of the Company’s business segments:

 

		For the three months ended June 30,						For the nine months ended June 30,
		2004			2003			2004			2003
Wholesale:
Revenue		$	171,598		$	93,939		$	540,217		$	252,906
Income from operations		26,919			21,630			97,926			53,784
Depreciation and amortization		2,493			290			7,935			741
Identifiable assets, at end of period		335,079			45,039			335,079			45,039
Capital expenditures		682			213			1,300			367
Retail:
United States
Revenue		$	53,452		$	54,423		$	162,963		$	158,242
Income (loss) from operations		(1,147		)	902			243			340
Depreciation and amortization		2,323			2,639			8,509			8,576
Identifiable assets, at end of period		62,380			63,732			62,380			63,732
Capital expenditures		2,219			549			5,896			1,660
Locations open at end of period		552			536			552			536
Europe
Revenue		$	122,320		$	99,202		$	362,787		$	268,903
Income from operations		28,247			19,182			84,229			64,542
Depreciation and amortization		3,983			2,708			9,881			7,247
Identifiable assets, at end of period		374,180			326,690			374,180			326,690
Capital expenditures		3,697			3,261			12,761			7,028
Locations open at end of period		599			593			599			593
Direct Response/Puritan’s Pride:
Revenue		$	52,543		$	60,910		$	158,592		$	147,650
Income from operations		16,294			19,771			48,980			44,744
Depreciation and amortization		1,294			1,413			4,102			4,350
Identifiable assets, at end of period		81,990			82,020			81,990			82,020
Capital expenditures		26			138			80			632
Corporate:
Corporate expenses		$	(29,184	)	$	(20,509	)	$	(79,859	)	$	(57,749	)
Discontinued product charge		—			—			—			(6,000		)
Depreciation and amortization - manufacturing		3,922			2,504			11,665			7,707
Depreciation and amortization - other		1,575			1,233			4,756			3,918
Corporate manufacturing identifiable assets, at end of period		381,723			322,520			381,723			322,520
Capital expenditures - manufacturing		1,866			1,028			4,732			2,792
Capital expenditures - other		1,682			1,977			7,318			12,373
Consolidated totals:
Revenue		$	399,913		$	308,474		$	1,224,559		$	827,701
Income from operations		41,129			40,976			151,519			99,661
Depreciation and amortization		15,590			10,787			46,848			32,539
Identifiable assets, at end of period		1,235,352			840,001			1,235,352			840,001
Capital expenditures		10,172			7,166			32,087			24,852

 

14

 

Foreign subsidiaries accounted for approximately 31% of net revenues for the nine months ended June 30, 2004 and 30% of total assets and 12% of total liabilities as of June 30, 2004.  Foreign subsidiaries accounted for approximately 33% of net revenues for the nine months ended June 30, 2003 and  38% of total assets and 19% of total liabilities as of June 30, 2003.

 

11.  Discontinued Product Charge

 

Effective March 15, 2003, the Company voluntarily discontinued sales of products that contain ephedra.  Income from operations during the nine months ended June 30, 2003 include a one-time charge of approximately $6,000 ($3,996 or $0.06 basic and diluted earnings per share, after tax) associated with such discontinued sales.

 

12.  Litigation

 

The Company settled a previously announced civil complaint arising out of the Company’s sales of pseudoephedrine products (now discontinued) for a payment of $950.  The settlement, without any admission of wrongdoing by the Company, was entered into to avoid the uncertainty inherent in litigation as well as the considerable expense involved in litigating such an issue.

 

Since June 2004, several shareholder class action lawsuits have been filed in the United States District Court for the Eastern District of New York against the Company and certain of its officers and directors on behalf of shareholders of the Company who purchased shares of the Company’s stock during certain periods of time.  The complaints generally allege that defendants violated federal securities laws by issuing false and misleading statements and by failing to disclose material facts concerning the Company’s financial results that allegedly caused declines in the price of the Company’s stock.  In addition to the shareholder class actions, a derivative claim based on the same allegations has been filed in the Eastern

 

15

 

District of New York against individual directors of the Company.  The Company and the named officers and directors deny all claims of wrongdoing and intend to vigorously defend these actions.  However, given the early stages of the proceedings, no determination can be made at this time as to the final outcome.  The Company maintains policies of directors and officers professional liability insurance.

 

Also, a shareholder of the Company has recently served a demand that the Board of Directors of the Company commence a civil action against certain officers and directors of the Company based on the allegations described above.

 

As discussed in the 10-K, Rexall is involved in a California state class action involving Rexall’s nutrition bars.  The August 2, 2004 trial date in this case has been vacated.  No new date has yet been set for the trial in this matter.  The Company believes that this case is without merit and intends to vigorously defend against the claims asserted.  However, no determination can be made as to the case’s final outcome.

 

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ITEM 2:

 

NBTY, INC. and SUBSIDIARIES

MANAGEMENT’S DISCUSSION and ANALYSIS of FINANCIAL

CONDITION and RESULTS of OPERATIONS

 

(In thousands, except per share amounts and number of stores)

 

Readers are cautioned that certain statements contained herein are forward-looking statements and should be read in conjunction with the Company’s disclosures under the heading “Forward Looking Statements” below. The following discussion should also be read in conjunction with the Condensed Consolidated Financial Statements of the Company and the notes thereto included elsewhere herein and the 10K.

 

NBTY is a leading vertically integrated U.S. manufacturer and distributor of a broad line of high-quality, value-priced nutritional supplements in the United States and throughout the world. The Company markets approximately 1,500 products under several brands, including Nature’s Bounty®, Vitamin World®, Puritan’s Pride®, Holland & Barrett®, Rexall®, Sundown®, Carb Solutions®, MET-Rx®, WORLDWIDE Sport Nutrition®, GNC (UK)®, DeTuinen®, CarbWise™ and American Health®.

 

NBTY markets its products through four distribution channels: (i) Wholesale: wholesale distribution to drug store chains, supermarkets, discounters, independent pharmacies, and health food stores, (ii) U.S. Retail: Vitamin World and Nutrition Warehouse retail stores in the U.S., (iii) European Retail: Holland & Barrett, Nature’s Way, GNC (UK), and DeTuinen retail stores in the U.K., Ireland, and the Netherlands, and (iv) Direct Response: Puritan’s Pride sales via catalogs and Internet. During the fiscal third quarter of 2004, Vitamin World opened 10 new stores, closed 3 stores and at the end of the quarter operated 552 stores.  During the same period, the Company’s European retail division opened 3 new stores, closed 3 stores and at the end of the quarter 599 stores in the UK, Ireland and the Netherlands were in operation.

 

The Company recognizes revenues from products delivered when risk of loss and title transfers to its customers, and with respect to its own retail stores, upon the sale of products. Net sales are net of all discounts, allowances, returns and credits. Cost of sales includes the cost of raw materials and all labor and overhead associated with the manufacturing and packaging of the products. Gross margins are affected by, among other things, changes in the relative sales mix among the Company’s four distribution channels, as well as gross margins of acquired entities. Historically, gross margins from the Company’s direct response/e-commerce and retail sales have typically been higher than gross margins from wholesale sales.

 

Forward Looking Statements:

 

Information contained in this form 10-Q contains certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 with respect to our financial condition, results of operations and business. All of these forward-looking statements, which can be identified by the use of terminology such as “subject to,” “believe,” “expects,” “may,” “will,” “should,” “can,” or “anticipates,” or the negative thereof, or variations thereon, or comparable terminology, or by discussions of strategy which, although believed to be reasonable, are inherently uncertain. Factors which may materially affect such forward-looking statements include: (i) slow or negative growth in the nutritional supplement industry; (ii) interruption of business or negative impact on sales and earnings due to acts of war, terrorism, bio-terrorism, civil unrest or disruption of mail service; (iii) adverse publicity regarding nutritional supplements; (iv) inability to retain customers of companies (or mailing lists) recently acquired; (v) increased competition; (vi) increased costs; (vii) loss or retirement of key members of management; (viii) increases in the cost of borrowings and unavailability of additional debt or equity capital; (ix) unavailability of, or inability to consummate, advantageous acquisitions in the future, including those that may be subject to bankruptcy approval or the inability of NBTY to integrate acquisitions into the mainstream of its business; (x) changes in general worldwide economic and political conditions in the markets in which NBTY may compete from time to time; (xi) the inability of NBTY to gain and/or hold market share of its wholesale and/or retail customers anywhere in the world; (xii) unavailability of electricity in certain geographical areas; (xiii) the inability of NBTY to obtain and/or renew insurance; (xiv) exposure to and expense of defending and resolving, product liability claims and other litigation; (xv) the ability of NBTY to successfully implement its business strategy; (xvi) the inability of NBTY to manage its retail, wholesale, manufacturing

 

17

 

and other operations efficiently; (xvii) consumer acceptance of NBTY’s products; (xviii) the inability of NBTY to renew leases on its retail locations; (xix) inability of NBTY’s retail stores to attain or maintain profitability; (xx) the absence of clinical trials for many of NBTY’s products; (xxi) sales and earnings volatility and/or trends; (xxii) the efficacy of NBTY’s Internet and on-line sales and marketing; (xxiii) fluctuations in foreign currencies, including the British Pound; (xxiv) import-export controls on sales to foreign countries; (xxv) the inability of NBTY to secure favorable new sites for, and delays in opening, new retail locations; (xxvi) introduction of new federal, state, local or foreign legislation or regulation or adverse determinations by regulators anywhere in the world (including the banning of products) and more particularly the Food Supplements Directive and the Traditional Herbal Medicinal Products Directive in Europe; (xxvii) the mix of NBTY’s products and the profit margins thereon; (xxviii) the availability and pricing of raw materials; (xxix) risk factors discussed in NBTY’s filings with the U.S. Securities and Exchange Commission; (xxx) adverse effects on NBTY as a result of increased gasoline prices and potentially reduced traffic flow to NBTY’s retail locations; and (xxxi) other factors beyond NBTY’s control.

 

Consequently, such forward-looking statements should be regarded solely as the Company’s current plans, estimates and beliefs.

 

Readers are cautioned not to place undue reliance on forward-looking statements. The Company cannot guarantee future results, events, and levels of activity, performance or achievements. The Company does not undertake and specifically declines any obligation to update, republish or revise forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrences of unanticipated events.

 

Industry data used throughout this Report was obtained from industry publications and internal Company estimates. While the Company believes such information to be reliable, its accuracy has not been independently verified and cannot be guaranteed.

 

Critical Accounting Policies and Estimates:

 

The Company’s significant accounting policies are described in Note 1 of the Notes to Consolidated Financial Statements included in its Annual Report on Form 10-K for the fiscal year ended September 30, 2003. A discussion of the Company’s critical accounting policies, and the related estimates, are included in Management’s Discussion and Analysis of Results of Operations and Financial Condition in its Annual Report on Form 10-K for the fiscal year ended September 30, 2003.  Management has discussed the development and selection of these policies with the Audit Committee of the Company’s Board of Directors, and the Audit Committee of the Board of Directors has reviewed its disclosures relating to them.  There have been no significant changes in the Company’s existing accounting policies or estimates since its fiscal year ended September 30, 2003.

 

General:

 

Operating results in all periods presented reflect the impact of acquisitions.  The timing of those acquisitions and the changing mix of businesses as acquired companies are integrated into the Company may affect the comparability of results from one period to another.

 

18

 

Results of Operations:

 

The following table sets forth income statement data of the Company and its percentage of net sales for the periods indicated:

 

		For the three months ended June 30,					For the three months ended June 30,
		2004			% of net sales		2003			% of net sales		Change
Net sales		$	399,913		100	%	$	308,474		100	%	$	91,439
Costs and expenses:
Cost of sales		197,228			49.3	%	141,196			45.8	%	56,032
Catalog printing, postage and promotion		21,651			5.4	%	15,378			5.0	%	6,273
Selling, general and administrative		139,905			35.0	%	110,924			36.0	%	28,981
		358,784			89.7	%	267,498			86.8	%	91,286
Income from operations		41,129			10.3	%	40,976			13.2	%	153
Other income (expense):
Interest		(5,569		)	-1.4	%	(3,890		)	-1.3	%	(1,679		)
Miscellaneous, net		1,096			0.3	%	2,023			0.7	%	(927		)
		(4,473		)	-1.1	%	(1,867		)	-0.6	%	(2,606		)
Income before provision for income taxes		36,656			9.2	%	39,109			12.6	%	(2,453		)
Provision for income taxes		10,754			2.7	%	9,641			3.1	%	1,113
Net income		$	25,902		6.5	%	$	29,468		9.5	%	$	(3,566	)

 

For the three month period ended June 30, 2004 compared to the three month period ended June 30, 2003:

 

Net sales.   Net sales in the fiscal third quarter ended June 30, 2004 were $399,913, compared with $308,474 for the prior comparable period, an increase of $91,439 or 29.6%. The $91,439 increase is comprised of the following:

 

19

 

		Three months ended June 30,						Dollar Increase (Decrease)			Percent Increase (Decrease)
		2004			2003			2004 vs. 2003			2004 vs. 2003
Wholesale		$	171,598		$	93,939		$	77,659		82.7	%
U.S. Retail / Vitamin World		53,452			54,423			(971		)	-1.8	%
European Retail / Holland & Barrett / GNC (UK)		122,320			99,202			23,118			23.3	%
Direct Response / Puritan’s Pride		52,543			60,910			(8,367		)	-13.7	%
Total		$	399,913		$	308,474		$	91,439		29.6	%

 

The US Nutrition wholesale division, which operates Nature’s Bounty and Rexall brands, increased its net sales primarily due to the acquisition of the Rexall product lines ($67,687).  The Company continues to adjust shelf space allocation between the Nature’s Bounty brand and Rexall brands to provide the best overall product mix.  These efforts have strengthened US Nutrition’s position in the mass market.  Additionally, wholesale net sales increases resulted from increased promotional programs offered to the mass market, drug chains and supermarkets.  Through the Company’s well-known brands, it continues to strengthen its leading market position and increase its wholesale presence in the nutritional supplement marketplace.  Consumer sales information obtained from the Company’s Vitamin World retail stores and Puritan’s Pride direct-response/e-commerce operations are used to provide its mass-market customers with timely and vital data and analyses to drive mass market sales.  The Company continues to respond to consumer preferences and to monitor the market for trends and ideas, and these efforts have translated into increased sales.  For the fiscal third quarter ended June 30, 2004, one customer of the wholesale division represented more than 10% of the wholesale segment’s net sales.  For the fiscal third quarter ended June 30, 2003, two customers of the wholesale division represented, individually, more than 10% of the wholesale segment’s net sales.  While no one customer represented, individually, more than 10% of the Company’s consolidated net sales, the loss of either of these two customers could have a material adverse effect on the wholesale segment if the Company is unable to replace such customer(s).

 

U.S. retail net sales decreased due to a general sales slow down across the entire specialty market.  In addition, as US Nutrition introduces more new products directly to the mass market, the specialty retail market’s ability to capitalize on market trends and new products is restricted. The Company expects this trend to continue in the near future.  Same store sales for stores open more than one year decreased 3.6% (or $1,910), reflecting vulnerability in this specialty retail market.  During the fiscal third quarter of 2004, Vitamin World opened 10 new stores, closed 3 stores and at the end of the quarter operated 552 stores. The Company operated 536 stores in the U.S. as of June 30, 2003.

 

European retail net sales increases were directly attributable to (1) the De Tuinen acquisition (increase of $6,890) that the Company completed in May 2003 (66 DeTuinen stores in the Netherlands were in operation  at June 30, 2004); and (2) an increase in Holland & Barrett’s/GNC (UK)’s same store sales for stores open more than one year of 13.8% (or $12,917). Without foreign exchange, the increase in same store sales (for stores open more than one year) was 2.9%.  During the fiscal third quarter of 2004, the Company’s European retail division opened 3 new stores, closed 3 stores and at the end of the quarter

 

20

 

599 stores in the UK, Ireland and the Netherlands were in operation. At June 30, 2003, 593 stores in the UK, Ireland and the Netherlands were in operation.

 

Direct Response/ Puritan’s Pride net sales decreased primarily due to the change in the timing of promotional catalog mailings which was not comparable to the fiscal third quarter a year ago.  However, the Company continues to target market its customer base to maximize sales.  The five-for-two sales catalog which ran from April through June 2003 will be running from mid-June through July 2004.  Also, the prior period’s fiscal third quarter net sales included two historically best performing catalogs, whereas the current fiscal third quarter’s net sales include only portions of such catalogs’ advertising campaigns.   During the current fiscal third quarter, the Company shipped 91,250 fewer orders than in the prior like quarter, though the average order size remained relatively unchanged.   Conversely, Internet orders continue to increase as compared to prior like periods.  Puritan’s Pride on-line net sales increased 7.8% for the fiscal third quarter and comprised 20.9% of the Direct Response’s segment net sales for this fiscal third quarter.  The Company continues to increase the number of products available via its catalog and websites.

 

Cost of sales.   Cost of sales in the fiscal third quarter ended June 30, 2004 were $197,228 or 49.3% as a percentage of net sales, compared to $141,196, or 45.8% for the prior comparable period.  Overall, gross profit as a percentage of net sales decreased 3.5% to 50.7% in the fiscal third quarter ended June 30, 2004 as compared to 54.2% for the prior comparable period.  Gross profit as a percentage of sales by segment is as follows:

 

GROSS PROFIT BY SEGMENT

 

		Three months ended June 30,				Percent Change
		2004		2003		2004 vs. 2003
Wholesale		36.1	%	40.8	%	-4.7	%
U.S. Retail / Vitamin World		58.1	%	59.4	%	-1.3	%
European Retail / Holland & Barrett / GNC (UK)		63.4	%	59.6	%	3.8	%
Direct Response / Puritan’s Pride		61.1	%	61.5	%	-0.4	%
Total		50.7	%	54.2	%	-3.5	%

 

The US Nutrition wholesale segment’s gross profit decreased 4.7% to 36.1% from 40.8% as a percentage of net sales, primarily due to lower gross profit contributions from Rexall’s product lines (32.1%), and by changes in product mix.  US Nutrition experienced an increased demand for its private label business, which typically has a lower gross profit margin than the branded products offered.  Gross margins were also affected by an increase in sales incentives and promotion costs which are classified as reductions to gross sales this quarter as compared to the prior like period. The U.S. retail gross profit decreased 1.3% to 58.1% from 59.4% as a percentage of net sales, primarily due to product mix.  The European retail gross profit increased 3.8% to 63.4% from 59.6%, as a percentage of net sales, primarily due to different promotional programs in effect this current fiscal quarter as compared to the prior comparable period. Without the newly-acquired operations of GNC (UK) and De Tuinen, gross profit as a percentage of net sales would have increased 3.3% to 66.0%

 

21

 

from 62.7% for the prior comparable period.   Additionally, the recent acquisitions of GNC (UK) and De Tuinen impacted this segments’ gross profit since such businesses have historically experienced lower gross profit margins.  These operations reported gross profit of 46.6% and 54.5%, respectively, during the current three month period while such operations reported gross profit of 42.8% and 39.8%, respectively, during the prior comparable three month period.   Direct Response/ Puritan’s Pride gross profit decreased 0.4% to 61.1% from 61.5% as a percentage of net sales primarily due to product mix. The Company’s overall strategy is to improve margins by introducing new products which traditionally have a higher gross profit as well as continuing to increase in-house manufacturing.

 

Catalog printing, postage, and promotion.  Catalog printing, postage, and promotion expenses were $21,651 in the fiscal third quarter ended June 30, 2004, compared with $15,378 in the prior comparable period, an increase of $6,273. Such advertising expenses as a percentage of net sales were 5.4% for the fiscal third quarter ended June 30, 2004 as compared to 5.0% for the prior comparable period. Of the $6,273 increase, $5,118 was attributable to the increase in promotions for products, mainly via television, magazines, newspapers and mailing programs and $1,155 attributable to an increase in catalog printing costs. The wholesale segment promotion and media increased $7,505 primarily due to advertising expenses incurred for Rexall related products ($7,706) partially offset by decreases in television advertising on other US Nutrition related products ($201). Other segments’ advertising variances are as follows: U.S. retail advertising expenses increased $307 offset by decreases in European retail promotion and media expense ($788) and Puritan’s Pride/Direct Response advertising expenses ($751).   Investments in additional advertising and sales promotions are part of the Company’s strategic effort to increase long-term growth.

 

Selling, general and administrative expenses.   Selling, general and administrative expenses were $139,905 in the fiscal third quarter ended June 30, 2004, an increase of $28,981 as compared with $110,924 for the prior comparable period.   As a percentage of net sales, selling, general and administrative expenses were 35.0% for the fiscal third quarter ended June 30, 2004 and 36.0% for the prior comparable period.   Of the $28,981 increase, $9,652 was attributable to increased payroll costs mainly associated with business acquisitions and general salary increases, $5,222 to increased rent expense and additional European retail stores, $3,390 to increased depreciation and amortization expense as a result of acquisitions and an increase in capital expenditures,  $2,344 to increased freight costs mainly resulting from the increase in sales and the Company’s efforts to generate faster product delivery to customers, $1,837 to increased insurance costs mainly associated with an increase in general insurance rates and $3,390 to increased professional and legal fees.  Of the $28,981 increase in selling, general and administrative cost, $4,211 was attributed to the foreign exchange translation.  The increase in the selling, general and administrative expenses by segment are as follows: Wholesale $10,777, European retail $10,197, U.S. retail $494 and an increase in unallocated corporate expenses of $8,680 partially offset by a decrease in Puritan’s Pride/Direct Response $1,167.

 

Interest expense.  The major components of interest expense are interest on Senior Subordinated Notes, and interest on the Credit and Guarantee Agreement (“CGA”) used for acquisitions, capital expenditures and other working capital needs.  Interest expense was $5,569 in the fiscal third quarter ended June 30, 2004, an increase of $1,679 compared with interest expense of $3,890 for the prior comparable period. Interest expense increased due to increased borrowings under a new credit agreement entered into by the Company in conjunction with the Rexall acquisition.   On July 25, 2003, the Company entered into a new CGA comprised of $375,000 Senior Secured Credit Facilities. This CGA consisted of a $100,000 Revolving Credit Facility, a $50,000 Term Loan A and a $225,000 Term Loan B. Terms of the new CGA were in many instances similar to the previous credit agreement. On December 19, 2003,

 

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