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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For Fiscal Year ended June 30, 2004
[ ] 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 0-14983
NUTRITION 21, INC.
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(Exact Name of Registrant as Specified in its Charter)
New York 11-2653613
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(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
4 Manhattanville Road, Purchase, New York 10577-2197
(914) 701-4500
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 $.005 per share)
----------------------------------------
Title of Class
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding twelve (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 ninety (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
registrant's best 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. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes_____ No ___X___
Based on the last sale price as of December 31, 2003 (last business day of the
Registrant's most recently completed second quarter), the aggregate market value
of the voting stock held by non-affiliates of the registrant was $21,537,342.
As of September 17, 2004, there were 37,991,988 shares of common stock
outstanding.
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FORM 10-K REPORT INDEX
10-K Part
and Item No. Page No.
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PART I
Item 1 Overview of the Business 3
Item 2 Properties 15
Item 3 Legal Proceedings 15
Item 4 Submission of Matters to a Vote of Security Holders 16
PART II
Item 5 Market Price of Registrant's Common Equity and
Related Stockholder Matters 17
Item 6 Selected Financial Data 19
Item 7 Management's Discussion and Analysis of Financial
Condition and Results of Operations 20
Item 7A Quantitative and Qualitative Disclosures About Market Risk 25
Item 8 Financial Statements and Supplementary Data 26
Item 9 Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 26
Item 9A Controls and Procedures 26
PART III
Item 10 Directors and Executive Officers of the Registrant 27
Item 11 Executive Compensation 31
Item 12 Security Ownership of Certain Beneficial Owners
and Management 36
Item 13 Certain Relationships and Related Transactions 38
Item 14 Principal Accounting Fees and Services 39
PART IV
Item 15 Exhibits, Financial Statement Schedules, and
Reports on Form 8-K 40
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Disclosures in this Form 10-K contain certain forward-looking statements,
including without limitation, statements concerning the Company's operations,
economic performance and financial condition. These forward-looking statements
are made pursuant to the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995. The words "believe," "expect," "anticipate" and
other similar expressions generally identify forward-looking statements. Readers
are cautioned not to place undue reliance on these forward-looking statements,
which speak only as of their dates. These forward-looking statements are based
largely on the Company's current expectations and are subject to a number of
risks and uncertainties, including without limitation, changes in external
market factors, changes in the Company's business or growth strategy or an
inability to execute its strategy due to changes in its industry or the economy
generally, the emergence of new or growing competitors, various other
competitive factors and other risks and uncertainties indicated from time to
time in the Company's filings with the Securities and Exchange Commission.
Actual results could differ materially from the results referred to in the
forward-looking statements. In light of these risks and uncertainties, there can
be no assurance that the results referred to in the forward-looking statements
contained in this Form 10-K will in fact occur. The Company makes no commitment
to revise or update any forward looking statements in order to reflect events or
circumstances after the date any such statement is made.
PART I
ITEM 1. OVERVIEW OF THE BUSINESS
Nutrition 21 is a biosciences company dedicated to the research, development and
commercialization of innovative chromium-based nutrition products for use in
improving the structure or function of the body, and in the prevention and
treatment of metabolic diseases such as diabetes, insulin resistance, obesity,
depression and cardiovascular disease. Nutrition 21 holds 36 patents for
nutrition products, 22 for chromium compounds and their uses. Nutrition 21's
Chromax(R) chromium picolinate is a form of the essential mineral chromium
developed by the USDA and licensed to the Company. It is used as an ingredient
in many nutritional supplements.
The Company currently licenses chromium picolinate to vitamin and supplement
manufacturers and marketers for use in human and animal nutrition products at
doses typically between 50-400 mcg under its Chromax trademark. Finished
products that incorporate chromium picolinate are marketed to enable consumers
to meet their requirements for essential dietary chromium needs, and are
regulated by the FDA under the Dietary Supplement Health and Education Act.
The function of insulin, the body's master metabolic hormone, is in part
dependent on chromium that must be supplied through diet or supplementation.
Recognizing that a number of the signs and symptoms of diabetes are shared in
common with chromium deficiency, a 1999 Congressional mandate urged the National
Institutes of Health's Office of Dietary Supplements (ODS) and the USDA to
further evaluate the role of chromium in diabetes. An ODS November, 1999
Chromium and Diabetes Workshop Summary prioritized the research questions that
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had to be resolved in order to evaluate chromium's potential role in preventing
and/or mitigating diabetes management.
Since that time, Nutrition 21's core research and development program has
followed the ODS research guidelines with the goal of further commercializing
its chromium patent estate by expanding chromium use to therapeutic applications
in diabetes and other health conditions linked to insulin resistance. According
to the American Diabetes Association 18.2 million people suffer from diabetes;
it is the sixth leading cause of death in the US and one its mostly costly
health problems. Insulin resistance is thought to be a pre-cursor to diabetes
and is estimated to affect one in five Americans according to the Journal of
American Dietetic Association, February 2004.
In collaboration with both independent and sponsored academic researchers at
leading international institutions and government agencies, the Company's
research objectives are to:
o Firmly establish the safety of Chromax chromium picolinate
o Determine the mechanism of action of chromium picolinate in insulin
mediated glucose metabolism
o Confirm a relationship between low chromium status and an increased
risk of diabetes and other conditions linked to insulin resistance
o Use double-blind placebo-controlled trials to demonstrate the
potential of its chromium product(s) to safely prevent, mitigate or
treat diabetes
o Communicate the cost and health benefits of chromium-based
supplements to secure approval of its product(s) for use as a first
line therapy in diabetes management
o Identify other opportunities to expand the therapeutic use of its
chromium technology
With successful research outcomes, the Company plans to publicize these findings
to reposition its products and increase the demand for chromium picolinate use
in vitamin and supplement formulas. Additionally, Chromax chromium picolinate
has recently been affirmed as Generally Recognized as Safe (GRAS) for use in
nutritional bars and beverages, and the Company is actively marketing its
research findings to functional food manufacturers. This will be a new market
for the Company's product.
In addition to its core chromium research program, the Company has recently
begun to commercialize Diachrome, a newly patented combination of chromium
picolinate and biotin, as a nutritional complement to medical treatment for
people with type 2 diabetes. Diachrome will be sold as a finished consumer
product, initially available through direct distribution to health care
providers. Short term, small-scale, double-blind, placebo-controlled,
peer-reviewed trials have already shown that Diachrome can significantly improve
blood sugar and lipid profiles. The study outcomes compare favorably to drugs
but without their side effects. Through a strategic alliance with XLHealth, a
disease management company, the Company is currently conducting a large-scale
trial to confirm these findings. With favorable Diachrome study outcomes, the
Company hopes to have XLHealth incorporate Diachrome into its treatment
protocol. This will be a key step in the Company's longer term program to secure
government and health care approval of Diachrome as a reimbursed first line
medical nutrition therapy for all US patients diagnosed with type 2 diabetes.
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XLHealth, in partnership with Omnicare Inc., has been awarded funding by the
Centers for Medicare and Medicaid Services (CMS) to conduct a demonstration
project where they will provide disease management, counseling, monitoring and
education to 10,000 Medicare beneficiaries who are chronically ill with severe
diabetes, congestive heart failure and cardiovascular disease.
The Company holds patents for several other novel nutrition compounds and plans
to expand its licensing program to include them once the Chromax expansion and
Diachrome launch are underway.
HISTORY OF THE COMPANY
The Company is a New York corporation that was incorporated on June 29, 1983 as
Applied Microbiology, Inc. Prior to 1995 the Company focused on the development
and commercialization of antibacterial technologies for new drugs. The Company
subsequently licensed these technologies to third parties. Beginning in 1995,
the Company shifted its focus to developing and marketing nutrition products and
ingredients. In 1997 the Company acquired a comprehensive chromium-based patent
portfolio based on a picolinate form of chromium that was invented and
researched by the United States Department of Agriculture. In 1999, the Company
acquired the Lite Bites consumer product line from Optimum Lifestyles, Inc. In
August of 2003, the Company discontinued its investment in the Lite Bites
product line and recorded a $4.4 million charge relating to the discontinuance.
THE COMPANY'S PRODUCTS AND PROPOSED PRODUCTS
The Company's Existing Ingredients Business
Since 1997, the Company's primary business has been to develop and market
proprietary ingredients to the vitamin and supplement market for both human and
animal applications. Today, Chromax(R) chromium picolinate is the Company's
primary ingredients product.
The Company's ingredient customers distribute Chromax as a stand-alone chromium
supplement either under the Chromax name under license from the Company, or
under their own private labels. A license from the Company is required for all
chromium picolinate products that are sold in the US for glucose control and its
derivative benefits, including cholesterol control and improved body
composition.
The calendar 2003 annual US retail market for stand-alone chromium mineral
supplements is estimated to be $106 million based on retail sales data provided
by Nutrition Business Journal compared to $85 million for calendar 2002. Based
on SPINS and Information Resources, Inc. ("IRI") data, more than 80% of US
chromium supplements are formulated with the Company's Chromax chromium
picolinate, while the rest are manufactured using chloride, polynicotinate or
other forms.
The Company derives additional revenues from the sale and licensing of Chromax
to customers who incorporate it and other of the Company's ingredients into over
900 finished multi-ingredient products. These include vitamin/mineral formulas,
weight loss and sports nutrition supplements, baked goods, beverages and other
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products. These products are sold by the Company's customers under a variety of
brands throughout the world through natural/health food stores, supermarkets,
drug stores, and mass merchandisers, and also through direct sales and catalogue
sales.
Chromax chromium picolinate is also used for managing the health of breeding
sows and their offspring, where it has been shown to improve glucose control in
gestating swine. Research outcomes include improved fertility, productivity and
recovery for the sows, and stronger and more resilient offspring.
The Company's principal customers have entered into master license agreements
with the Company that cover purchases that they decide to make from the Company
from time to time. The Company has no long-term purchase or sale commitments
with its customers. The master license grants to these customers a license under
the Company's patents to sell chromium picolinate for the particular uses
covered by the patents. The fee for this license is bundled on an unallocated
basis with the price that the Company charges to its customers for products that
the Company sells to them. See "Supply and Manufacturing" for information on a
manufacturing agreement between the Company and the manufacturer of its
principal products.
During each of the fiscal years ended June 30, 2004, 2003 and 2002,
respectively, ingredient sales of chromium picolinate accounted for more than
83%, 74%, and 64% of the Company's total revenues. Sales of the Company's
Lite-Bite products during these three fiscal years accounted for more than 4%,
8%, and 27% of the Company's total revenues. One customer, Prince Agri
Products, Inc., accounted for 18%, 19%, and 13% of the Company's total revenues,
respectively, in the Company's 2004, 2003 and 2002 fiscal years.
In marketing its Chromax chromium picolinate, the Company must continue to
demonstrate the safety of this product. The following studies in the Company's
opinion demonstrate that chromium picolinate is safe.
The United States Government, acting through the National Institutes of
Health-National Toxicology Program ("NTP"), has independently evaluated
the safety of chromium picolinate with government approved tests. In 2002,
the NTP did not find any safety concerns with chromium picolinate, even at
high doses.
In 2002 a group of experts consisting of Richard Anderson, Ph.D. (senior
scientist, USDA chromium expert), Walter Glinsman, MD (former director
from the FDA), and Joseph Borzelleca, Ph.D. (professor emeritus of
pharmacology and toxicology from Virginia Commonwealth University)
reviewed all existing studies of chromium picolinate and found no safety
concerns.
In 1997 United States Department of Agriculture ("USDA") researchers
published results of a high dose chromium picolinate study, concluding
that chromium picolinate is safe.
However, several researchers have questioned the safety of chromium picolinate.
In 1995 and 2002 a research group headed by Dianne Stearns, Ph.D. (University of
Dartmouth College and Northern Arizona University) administered chromium
picolinate in a laboratory to Chinese hamster ovary cell lines, and in 2003
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another research group headed by John Vincent, Ph.D. (University of Alabama)
administered chromium picolinate to fruit flies. Both reported safety concerns.
The Company engaged an independent contract research organization, BioReliance
Corporation, and replicated the studies conducted by Stearns using Chromax
chromium picolinate following internationally accepted procedures. The Company
found its Chromax chromium picolinate to be safe. Experts have advised that
fruit fly studies do not predict results in humans.
The Company's Proposed Therapeutic Branded Products
The Company is positioning its first branded product, Diachrome(R), as an aid in
the dietary management of diabetes, and it expects to market this product with
the support of healthcare professionals. Diachrome is a patented combination of
Chromax chromium picolinate and biotin; these are nutritional ingredients that
work synergistically to enhance blood sugar control and improve blood
cholesterol profiles. Building on pre-clinical and early clinical research, the
Company has formed a strategic alliance with XLHealth, formerly known as
Diabetex Corporation, a leading diabetes disease management company, to validate
Diachrome's ability to significantly improve blood sugar control in people with
type 2 diabetes. Together, the companies are conducting a 400+ patient
double-blind placebo controlled trial aimed at demonstrating the
pharmacoeconomic and health benefits associated with the use of Diachrome as a
nutritional adjunct to current diabetes management protocols. The Diachrome
study is expected to complete by the end of calendar year 2004 and, assuming
positive results, Diachrome will be aggressively marketed to the diabetes
healthcare market under the Nutrition 21 label, as a first line medical
nutrition therapy for all patients diagnosed with type 2 diabetes.
XLHealth, in partnership with Omnicare Inc., has been awarded funding by the
Centers for Medicare and Medicaid Services (CMS) to conduct a demonstration
project where they will provide disease management, counseling, monitoring and
education to 10,000 Medicare beneficiaries who are chronically ill with severe
diabetes, congestive heart failure and cardiovascular disease. Through its
alliance with XLHealth, the Company will also seek to include Diachrome on the
Medicare formulary, and demonstrate the product's ability to improve patient
outcomes and lower the cost of care. The Company plans a targeted
direct-to-consumer marketing program to managed diabetic populations. The
Company plans to build consumer awareness for its products through a media
campaign that leverages research outcomes, in combination with consumer and
physician testimonials. Communication of scientific findings will be used to
build consensus within the healthcare community regarding the inherent value of
the Company's products.
The Company holds patents for several other novel nutrition compounds and plans
to expand its licensing program to include them once the Chromax expansion and
Diachrome launch are underway.
Pharmaceutical Products Licensed to Third Parties
In August 2000, the Company exclusively licensed to Biosynexus certain rights to
nisin and lysostaphin antibacterial technologies for development and marketing
of new drugs for human uses. The Company received a payment of $1.4 million, and
the license provides for milestone payments of up to $14 million, and royalties.
The Company also received warrants to acquire common stock of Biosynexus,
currently a privately held company.
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The Company also has infectious disease technology centered on nisin and
lysostaphin for the treatment of diseases in animals, including a moistened
towel using a nisin-based formulation for mastitis prevention that is used for
preparing dairy cows for milking. The Company launched the product under its
trademark Wipe Out(R) Dairy Wipes in April 1996. On December 30, 1999, the
Company sold its Wipe Out Dairy Wipes business to ImmuCell Corporation
("ImmuCell"). On April 12, 2000, the Company exclusively licensed to ImmuCell
worldwide rights to develop and market new antibacterial drugs for animals using
the Company's nisin technology.
RESEARCH AND DEVELOPMENT
During the fiscal years ended June 30, 2004, 2003 and 2002, the Company spent
approximately $2.4 million, $2.2 million, and $1.0 million, respectively, on
research and development. The Company's research and development program is
based on chromium and seeks to discover and substantiate the efficacy and safety
of ingredients and products that have a significant nutritional therapeutic
value to consumers. The primary research focus over the past few years has been
in the area of diabetes and cardiovascular health. Discovering the mechanism of
action of chromium picolinate and further confirming the beneficial effects of
chromium picolinate in people with diabetes have been critical objectives. The
Company is also researching therapeutic areas involving obesity, depression,
bone and joint health, and women's health.
This research effort has enabled the Company to identify patentable new
combinations of chromium and new uses for chromium, and new food systems that
can be enhanced by the inclusion of its ingredient systems.
Clinical Studies, Presentations and Publications
The Company from time to time provides funding for clinical studies of its
products to evaluate efficacy and mechanisms of action, and in other instances
supplies chromium picolinate for use in studies for which it provides no
funding. The Company believes that positive results in these studies, whether or
not funded by it, provide benefits to the Company by furthering acceptance of
its products. The Company also makes presentations at various meetings to gain
acceptance of its products. The following information summarizes certain of
these studies and details those studies that were funded by the Company. The
information also summarizes several recent presentations and publications that
relate to the Company's products. In no case is the Company required to provide
any further funding.
Studies in progress
Chromax
The Company has supplied its Chromax chromium picolinate to Yale School of
Medicine for a clinical study funded by National Institutes of Health that is
evaluating "Chromium Effects in Impaired Glucose Tolerance." This study focuses
on the effects of chromium picolinate on both measures of glucose tolerance
(glucose, insulin, OGTT) and brachial artery endothelial function, and is
8
designed to generate dietary chromium recommendations for reducing the risk of
diabetes and associated diseases.
The Company has supplied Chromax chromium picolinate to Pennington Biomedical
Research Center for a clinical study funded by National Institutes of Health
that is evaluating "Chromium and Insulin Action." This study focuses on the
effects of chromium picolinate on glucose homeostasis, and is designed to
generate dietary chromium recommendations for reducing the risk of diabetes and
associated diseases.
The Company supplied Chromax chromium picolinate to the University of
Pennsylvania for a clinical study funded by the National Institutes of Health
that is entitled "A Double Blind Randomized Controlled Clinical Trial of
Chromium Picolinate on Clinical and Biochemical Features of the Metabolic
Syndrome." This study is evaluating the effect of daily supplementation with
chromium picolinate on insulin sensitivity in individuals with metabolic
syndrome, and on glucose tolerance tests, HDL-C, triglycerides, body
composition, BMI and blood pressure. This study will also provide the first
human data on the effects of chromium picolinate supplementation on oxidative
stress and inflammation, which are major risk factors in the progression of
diabetes and cardiovascular disease.
Diachrome
The Company has supplied its Diachrome product (Chromax chromium picolinate and
biotin) and paid $700,000 to conduct a clinical study that is entitled "A
Randomized, Double Blinded, Placebo Controlled, Parallel Arm, Multicenter Study
To Evaluate The Improvement In Glycemic Control, Lipid Levels, Quality Of Life
And Healthcare Costs After Daily Administration Of Chromium Picolinate And
Biotin In Patients With Type 2 Diabetes." The study is designed to provide data
on the effects of Diachrome on diabetes risk factors, and is expected to reflect
improvements effected by Diachrome in beta cell function and the risk of insulin
resistance in type 2 diabetes patients. Any data that are positive should
support Diachrome as an alternative nutritional therapy for diabetes patients.
Studies Completed in 2004
Chromax
The Company gave a $900,000 research grant to Comprehensive Neuroscience Inc. to
conduct a clinical study on "The Effects of Chromium Picolinate in Atypical
Depression." The study was a double-blind placebo-controlled trial of Chromax
chromium picolinate in people with depression and symptoms that include
carbohydrate cravings, weight gain and tiredness. Results from this study
suggest that chromium picolinate exerts antidepressant effects in people with
carbohydrate cravings and reduces their carbohydrate cravings.
Presentations and Publications in 2004
A paper on "Determining The Safety Of Chromium Tripicolinate For Addition To
Foods As A Nutrient Supplement" was published in Food Chemical Toxicology. This
paper concluded that chromium picolinate is safe for addition to foods as a
supplement.
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A poster presentation entitled "Chromium Picolinate And Biotin Combination
Improves Blood Sugar Control In People With Type 2 Diabetes" was given at the
International Diabetes Federation. This presentation showed beneficial effects
of chromium picolinate and biotin combination (Diachrome) on lowering elevated
glycosylated hemoglobin (HbA1c) in people with type 2 diabetes.
A poster presentation entitled "Chromium With Biotin Combination Decreases
Fasting And Post Prandial Glucose Levels In People With Type 2 Diabetes
Mellitus" was given at the North American Association of Study of Obesity. This
presentation reported beneficial effects of chromium picolinate and biotin
combination (Diachrome) on lowering post prandial and fasting blood glucose
levels in people with type 2 diabetes.
A poster presentation entitled "Program Including Chromium Picolinate And Biotin
Helps To Improve Glycemic Control In Type 2 Diabetes" was given at the First
World Congress on Insulin Resistance Syndrome. This presentation reported
beneficial effects of chromium picolinate and biotin combination (Diachrome) on
improving glycemic control in people with type 2 diabetes.
A presentation entitled "Improvement in Fasting Blood Glucose with the
Combination of Chromium Picolinate and Biotin In Type 2 Diabetes Mellitus" was
given at the 64th Annual Scientific Meetings of American Diabetes Association.
This presentation reported reductions in fasting blood glucose levels and
fructosamine levels in people with type 2 diabetes.
A poster presentation entitled "Chromium Picolinate And Biotin Combination
Improves Coronary Risk Factors" was given at AHA Council on Arteriosclerosis,
Thrombosis and Vascular Biology 5th Annual Conference meeting. This presentation
reported reductions in coronary risk lipids and lipoprotein levels in people
with type 2 diabetes.
A poster presentation entitled "The Combination of Chromium Picolinate And
Biotin Improves Glycemic Control In Patients With Type 2 Diabetes Mellitus" was
given at a meeting of the at 64th Annual Scientific Meetings of American
Diabetes Association. This presentation discussed beneficial effects of chromium
picolinate and biotin combination (Diachrome) in reducing glycosylated
hemoglobin (HbA1c) in people with type 2 diabetes.
A presentation entitled "Chromium and Insulin Resistance" was given at a meeting
of the Federation of American Societies for Experimental Biology. This
presentation summarized several recent presentations and publications that
demonstrate chromium picolinate efficacy and safety.
Studies Completed in 2003
Chromax
The Company supplied its Chromax chromium picolinate to the University of
Vermont for a clinical study that was funded by the American Diabetes
Association. The study is entitled "Evaluation of the Effect of Chromium
Picolinate in People with Type 2 Diabetes," and is designed to evaluate the
effect of Chromax chromium picolinate on insulin sensitivity in people with type
2 diabetes. The study reported that chromium picolinate supplementation improved
glycemic control in people with type 2 diabetes through enhancement of insulin
action in cellular signaling.
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Presentations and Publications in 2003
An article on "Chromium and Cardiovascular Disease" was published in Advances in
Heart Failure (International Academy of Cardiology). This article reviewed the
significant beneficial effects of chromium picolinate on coronary heart disease
risk factors, such as lipids and lipoproteins, in both animal and human studies.
A poster presentation entitled "Glucose Uptake Of Chromium Picolinate, Chromium
Polynicotinate And Niacin" was presented at a meeting of the Federation of
American Societies for Experimental Biology. This presentation reported on
chromium picolinate enhancement of glucose uptake in skeletal muscle cells.
A poster presentation on "Chromium Picolinate Increases Skeletal Muscle PI3
Kinase Activity in Obese, Hyperinsulinemic JCR:LA Corpulent Rats" was presented
at the 63rd annual meeting and scientific sessions of the American Diabetes
Association. The presentation reported a mechanism of action by which chromium
picolinate enhances insulin activity.
Studies Completed in 2002
Diachrome
The Company gave a $200,000 research grant and supplied Diachrome to the Chicago
Center for Clinical Research to conduct a "Study On Chromium With Biotin
Decreases Coronary Risk Lipids And Lipoproteins In People With Type 2 Diabetes
Ingesting Moderate Carbohydrate Nutritional Beverages." Results from this trial
showed that chromium picolinate and biotin can significantly reduce elevations
in blood glucose levels and symptoms of fatigue in people with type 2 diabetes
that are consuming a carbohydrate-containing beverage. These findings were
presented at the Federation of American Societies for Experimental Biology, and
American College of Nutrition.
Chromax
The Company gave a $110,000 research grant and supplied Chromax to Duke
University to study the "Effectiveness of Chromium Picolinate in Atypical
Depression: A Placebo-Controlled Clinical Trial." Results from this study showed
that chromium picolinate helped reduce depression markers. In this study,
seventy percent (70%) of chromium picolinate group and zero percent (0%) of
placebo group responded to treatment. This study was published in Biological
Psychiatry.
Presentations and Publications in 2002
A paper entitled "Oral Chromium Picolinate Improves Carbohydrate And Lipid
Metabolism And Enhances Skeletal Muscle Glut-4 Translocation In Obese,
Hyperinsulinemic (JCR-LA Corpulent) Rats" was published in The Journal of
Nutrition 2002. This article reported that chromium picolinate helps in
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treatment of the insulin resistance syndrome. Chromium picolinate
supplementation was also shown to enhance insulin sensitivity, glucose
metabolism and blood lipids.
A poster presentation entitled "Antimutagenic Activity Of Chromium Picolinate In
The Salmonella Assay" was presented at XIV World Congress of Pharmacology. The
presentation reported that chromium picolinate is non-mutagenic.
GOVERNMENTAL REGULATION
The U.S. Food and Drug Administration ("FDA") regulates the labeling and
marketing of the Company's dietary supplements under the Dietary Supplement and
Health Education Act ("DSHEA"). Under DSHEA, dietary supplements that were first
marketed as dietary supplements after October 1994 require safety approval by
the FDA. The Company's products did not require FDA safety approval because they
were marketed as dietary supplements prior to October 1994. See "The Company's
Existing Ingredient Business" for further information on the safety of the
Company's products. Under DSHEA, the Company is required to submit for FDA
approval claims regarding the effect of its dietary supplements on the structure
or function of the body. DSHEA also requires an FDA approval for claims that
relate dietary supplements to disease prevention (so-called "health claims"). To
enhance its market applications, the Company has elected to seek FDA approval
for health claims that its products can prevent diabetes and possibly other
diseases.
The Federal Trade Commission ("FTC") regulates product-advertising claims and
requires that claims be supported by competent and reliable scientific evidence.
Prior to the Company's acquisition of a California limited partnership called
Nutrition 21 ("Nutrition 21 LP"), the FTC opened an inquiry into certain of the
claims that Nutrition 21 LP was making for chromium picolinate. The inquiry was
terminated by Nutrition 21 LP and the FTC entering into a consent decree that
requires that claims be supported by competent and reliable scientific evidence.
After the Company acquired Nutrition 21 LP, the Company undertook new clinical
studies to support the claims it intended to make for its products. The FTC has
subsequently audited the Company's chromium picolinate advertising and has not
found either a lack of competent and reliable scientific evidence or a failure
by the Company to comply with the consent decree. The FTC continues to monitor
the Company's advertising and could limit its advertising in ways that could
make marketing its products more difficult or result in lost sales.
PROPRIETARY RIGHTS
Trademarks
Chromax, Diachrome, Selenomax, SelenoPure, Zinmax, Zenergen, and Magnemax are
among the more well known trademarks owned by Nutrition 21: Chromax for chromium
picolinate; Diachrome for chromium picolinate and biotin; Selenomax for high
selenium yeast, SelenoPure for yeast-free selenium; Zinmax for zinc picolinate;
Zenergen for chromium picolinate and conjugated linoleic acid, and Magnemax for
manganese picolinate.
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Nutrition Patents
The Company presently has 36 issued US patents and 13 pending US patent
applications with foreign equivalents covering novel compositions and therapies
directed towards significant health conditions such as cardiovascular disease,
depression, polycystic ovary syndrome, both type 1 and type 2 diabetes, and
sports nutrition.
Of these patents, 24 U.S. patents and various foreign patents relate to
chromium, including composition of matter patents for novel chromium picolinate
complexes and their uses. Three of these patents relate to the accepted
essential nutritional uses of chromium picolinate for glucose control, for
managing cholesterol, and for increasing lean body mass and reducing body fat,
and are in force through 2009. Patents for improved chromium picolinate
complexes containing combinations of chromium and various nutrients for
enhancing the benefits of chromium picolinate, are in force into the year 2017.
More recently, the Company has secured patent rights to the uses of all forms of
chromium in the treatment of depression and other mood disorders, rights that
are in force through 2018.
The pending applications build upon the Company's expertise in technology areas
such as nutritional mineral supplements, and are directed towards the
synergistic effects of combining chromium with compounds such as biotin, alpha
lipoic acid, conjugated linoleic acid (CLA), and CLA isomers. These include
issued and pending patent applications covering the positive effects of chromium
and biotin on type 2 diabetes. Outside of the chromium area, the Company
continues to file patent applications in the area of arginine silicate, a
patented compound that has shown promise in therapies for bone and joint health,
cardiovascular disease, and glucose metabolism.
The Company maintains non-disclosure safeguards, including confidentiality
agreements, with employees and certain consultants. There can be no assurance,
however, that others may not independently develop similar technology or that
secrecy will not be breached despite any agreements that exist.
Although the Company holds exclusive rights to United States patents for the
nutritional uses for which chromium picolinate is sold, the Company is often
faced with competition from companies, including importers, that disregard its
patent rights. These companies take calculated risks that the Company will not
sue to enforce its patent rights against them. The Company determines whether to
file suit against an infringer by taking into consideration an estimate of
infringing sales and the cost of patent enforcement. While there is no guarantee
that the Company will be able to successfully enforce its patent rights against
these competitors, the Company continues to monitor industry practices.
The Company has initiated several patent infringement cases that it subsequently
settled. In 2003, the Company settled a patent dispute with Lonza Inc., in which
Lonza agreed to license the Company's glucose control patents for marketing
Lonza's proprietary combination of carnitine and chromium picolinate for swine
feed applications. No other rights were granted to Lonza to sell chromium
picolinate, alone or in other combinations, for human or other animal
applications.
13
Pharmaceutical Patents
The Company owns more than 200 patents relating to, among other things, the
expression and production of proteins by recombinant Bacillus strains; plasmid
vectors and methods of construction; expression and production of recombinant
lysostaphin; novel bacteriocin compositions and their use as broad spectrum
bactericides; the use of bacteriocin compositions to treat bovine mastitis; the
use of bacteriocin compositions in oral healthcare; the use of bacteriocin
compositions on skin for healthcare and hygiene; and the use of bacteriocin
compositions in gastrointestinal healthcare. These patents are licensed to
Biosynexus Incorporated, and ImmuCell Corporation as set forth under
"Pharmaceutical Products Licensed to Third Parties."
The Company maintains trade secret protection for bacterial strains, technical
know-how, and other information it considers proprietary and beneficial for the
manufacture, use, regulatory approval, and marketing of the Company's products.
COMPETITION
In considering its competitive position, the Company distinguishes between its
existing ingredients business, on the one hand, and its prospective therapeutic
branded products, on the other hand. The Company has a relatively strong
position for its current chromium sales where it believes that it has an
approximately 80% share of the market for stand alone sales, and it has a 15%
market share for sales of chromium into multi-ingredient products, based on
SPINS and IRI data reporting retail sales of chromium products. The Company's
major competitors in the chromium industry are Albion Labs, Kelatron, and
InterHealth Nutraceuticals Inc.
The Company's proposed therapeutic branded business will confront many large
established companies in a huge industry that serves the diabetes management
market. The Company's success in this arena will in large part depend on its
ability to obtain a scientific consensus that its supplement offer benefits that
are competitive with the numerous companies that participate in this business.
The nutritional product industry and the related drug industries are, of course,
intensely competitive. The great majority of these competitors have financial
and technical resources as well as production and marketing capabilities
substantially greater than the Company. In addition, many competitors have
significantly greater experience in the development and testing of new or
improved products.
SUPPLY AND MANUFACTURING
The Company has a manufacturing agreement with a third party for the manufacture
of the Company's principal products. There are numerous sources of supply for
the raw materials that the Company's manufacturers use to manufacture the
Company's products. The Company has never experienced a shortage of ingredient
products.
The Company keeps on hand an average of four months' inventory. The Company
believes that it has adequate inventory to accommodate a suspension in the
14
manufacture of any of its products by its current manufacturers, and that it
could in any event resort to other manufacturers with minimal disruption.
The Company plans to continue to outsource the manufacturing and packaging needs
as it expands its business to include its marketing and distribution of branded
therapeutic supplements.
EMPLOYEES
As of June 30, 2004, the Company had 28 full-time employees, of whom 3 were
executive employees, 8 were administrative, 12 were engaged in marketing and
sales, and 5 were involved in research, process and product development, and
manufacturing. The Company does not have a collective bargaining agreement with
any of its personnel and considers its relationship with its employees to be
satisfactory.
ITEM 2. PROPERTIES
Since September 1998, the Company maintains its headquarters pursuant to a seven
and one-half year lease at 4 Manhattanville Road, Purchase, New York 10577-2197
(Tel: 914-701-4500). In fiscal 2002, the Company's surrendered a portion of its
leased premises, and received a reduction in its annual rental for its
headquarters location from $589,420 to $370,443 which sum is due in monthly
installments. The rent is subject to annual increases over the term of the lease
based on increases in certain building operating expenses.
ITEM 3. LEGAL PROCEEDINGS
On March 19, 2003, Andrew Wertheim (a former Executive Officer) initiated an
arbitration with the American Arbitration Association against the Company in
connection with his termination of employment. On July 24, 2004, an arbitrator
awarded Mr. Wertheim (1) damages of $268,477 for salary and benefits, (2)
$708,750 related to stock options, and (3) interest of $92,151. The Company
believes that the arbitrator's award is in error. Accordingly, on August 3,
2004, the Company filed an action in the United States District Court for the
Southern District of New York against Mr. Wertheim seeking to vacate the
arbitration award. On August 16, 2004, the Company filed a Motion to Vacate the
part of the award that relates to the stock options, i.e. $708,750 plus
interest.
The Company and the Federal Trade Commission (FTC) are discussing whether the
Company should have any liability for weight loss advertising claims that were
made on QVC, Inc. for the Company's Lite Bites(R) products. On March 24, 2004,
the FTC sued QVC in the U.S. District Court for the Eastern District of
Pennsylvania for these claims and for claims made on QVC for other products. QVC
has in the same lawsuit filed on April 14, 2004, Third-Party Complaints for
damages against six parties including the Company (Third-Party Defendants). The
FTC and the Third-Party Defendants have filed Motions to Strike QVC's
Third-Party Complaints. The Company discontinued the Lite Bites product line in
fiscal year 2003. Neither the FTC nor QVC has set forth an amount being sought
as damages, nor can the Company estimate its exposure.
On September 3, 2004, QVC filed a suit against the Company alleging that QVC has
the right to return product to the Company and receive a payment of $551,715,
and for $5,706 for certain services QVC allegedly rendered to the Company. QVC's
purchase orders provide QVC the right to return product, provided the requests
15
for return are made within certain time periods. The Company has reviewed its
records and believes that QVC's requests for return were not timely. The Company
is unable to predict the outcome of this matter.
The Company in the ordinary course of its business has brought patent
infringement actions against companies that are selling chromium picolinate in
violation of the Company's patent rights. As of this date, no actions are
ongoing, and the Company, which intends to vigorously protect its proprietary
rights, is evaluating bringing other patent infringement actions. Various
actions have been terminated on terms that the Company believes will protect its
rights.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to the Company's shareholders during the fiscal
quarter ended June 30, 2004.
16
PART II
ITEM 5. MARKET PRICE OF REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS
Matters Relating to Common Stock
The Company's Common Stock trades on the Nasdaq SmallCap Market System under the
symbol "NXXI".
The Company has not paid a cash dividend to its public shareholders on its
Common Stock. The Company intends to retain all earnings, if any, for the
foreseeable future for use in the operation and expansion of its business and,
accordingly, the Company does not contemplate paying any cash dividends on its
Common Stock in the foreseeable future.
The following table sets forth the high and low sales prices as reported by the
Nasdaq Market for the Common Stock.
Common Stock
Fiscal Quarter Ended High Low
-------------------------------------------------------------
September 30, 2002 $0.40 $0.37
December 31, 2002 $0.64 $0.48
March 31, 2003 $0.38 $0.35
June 30, 2003 $0.48 $0.44
September 30, 2003 $1.66 $0.77
December 31, 2003 $1.25 $0.99
March 31, 2004 $1.03 $0.84
June 30, 2004 $1.31 $0.69
As of September 17, 2004, there were approximately 471 holders of record of the
Common Stock. The Company believes that the number of beneficial owners is
substantially greater than the number of record holders, because a large portion
of its Common Stock is held of record in broker "street names."
ADOPTION OF SHAREHOLDERS RIGHTS PLAN
The Company adopted a Shareholder Rights Plan on September 12, 2002. Under this
plan, the Company distributed, as a dividend, one preferred share purchase right
for each share of Common Stock of the Company held by stockholders of record as
of the close of business on September 25, 2002. The Rights Plan is designed to
deter coercive takeover tactics, including the accumulation of shares in the
17
open market or through private transactions, and to prevent an acquiror from
gaining control of the Company without offering a fair price to all of the
Company's stockholders. The Rights will expire on September 11, 2012.
Each Right entitles stockholders to buy one one-thousandth of a share of newly
created Series H Participating Preferred Stock of the Company for $3.00 per
share. Each one one-thousandth of a share of the Preferred Stock is designed to
be the functional equivalent of one share of Common Stock. The Rights will be
exercisable only if a person or group acquires beneficial ownership of 15% or
more of the Company's Common Stock (30% in the case of a person or group that is
currently a 15% holder) or commences a tender or exchange offer upon
consummation of which such person or group would beneficially own 15% or more of
the Company's Common Stock.
If any person or group (an "Acquiring Person") becomes the beneficial owner of
15% or more of the Company's Common Stock (30% in the case of a person that is
currently a 15% holder), then (1) the Rights become exercisable for Common Stock
instead of Preferred Stock, (2) the Rights held by the Acquiring Person and
certain affiliated parties become void, and (3) the Rights held by others are
converted into the right to acquire, at the purchase price specified in the
Right, shares of Common Stock of the Company having a value equal to twice such
purchase price. The Company will generally be entitled to redeem the Rights, at
$.001 per Right, until 10 days (subject to extension) following a public
announcement that an Acquiring Person has acquired a 15% position.
18
ITEM 6. SELECTED FINANCIAL DATA
The following tables summarize selected consolidated financial data that should
be read in conjunction the more detailed financial statements and related
footnotes and management's discussion and analysis of financial condition and
results of operations included herein. Figures are stated in thousands of
dollars, except per share amounts.
SELECTED STATEMENT OF YEAR ENDED JUNE 30,
- --------------------------------------------------------------------------------
OPERATIONS DATA: 2004 2003(2) 2002(1) 2001 2000
- --------------------------------------------------------------------------------
Total Revenues $10,232 $10,615 $14,668 $23,252 $32,814
Gross Profit 8,113 6,486 10,324 17,036 27,034
Operating (Loss) Income (5,854) (11,081) (7,789) (955) 7,041
(Loss) Income Before Taxes (5,833) (11,050) (6,011) 1,400 7,004
Income Taxes 68 (544) -- 335 523
Net (Loss) Income (5,901) (10,506) (6,011) 1,065 6,490
Diluted (Loss) Earnings per
Common Share (0.16) (0.32) (0.19) 0.03 0.20
AT JUNE 30,
- --------------------------------------------------------------------------------
SELECTED BALANCE SHEET DATA: 2004 2003 2002 2001 2000
- --------------------------------------------------------------------------------
Working Capital $ 3,413 $ 4,146 $ 8,002 $ 6,392 $ 6,486
Total Assets 16,367 18,920 28,100 38,887 41,085
Total Liabilities 3,734 3,484 2,151 6,495 10,430
Long-Term Obligations -- -- -- 122 1,278
Redeemable Preferred Stock -- -- -- 418 676
Stockholders' Equity 12,633 15,436 25,949 31,974 29,979
- ----------
(1) Consolidated Statements of Operations include a $7.1 million non-cash
charge for the impairment of goodwill.
(2) Consolidated Statements of Operations include a $4.4 million non-cash
charge for the impairment of intangibles.
19
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the Consolidated
Financial Statements and related notes thereto of the Company included elsewhere
herein.
OVERVIEW
The Company's revenues are primarily derived from the sale of proprietary
ingredients and the grant of patent licenses related to those ingredients to
manufacturers of vitamin and mineral supplements. The fee for the licenses is
bundled on an undifferentiated basis with the price that the Company charges for
its ingredients.
Cost of goods sold includes both direct and indirect manufacturing costs.
Research and development expenses include internal expenditures as well as
expenses associated with third party providers. Selling, general and
administrative expenses include salaries and overhead, third party fees and
expenses, royalty expenses for licenses and trademarks, and costs associated
with the selling of the Company's products. The Company capitalizes patent costs
and intangible asset costs, and amortizes them over periods of one to seventeen
years.
The following table sets forth items in the Consolidated Statements of
Operations as a percent of revenues:
Fiscal Year
Percent of Revenues
2004 2003 2002
---- ---- ----
Total Revenues 100.0% 100.0% 100.0%
Gross profit* 78.8 59.8 69.7
Selling, general and administrative expense 88.8 77.3 50.1
Research and development expense 23.3 21.0 6.9
Operating (loss) (57.2) (104.4) (53.1)
Net (loss) (57.7) (99.0) (41.0)
*Based upon percent of net sales
Results of Operations
1. Year ended June 30, 2004 vs. year ended June 30, 2003
Revenues
Net sales of $10.0 million for fiscal year 2004 declined $0.3 million when
compared to net sales of $10.3 million for fiscal year 2003.
The Company's decision to discontinue its investment in the Lite Bites product
line in fiscal year 2003 resulted in a $0.9 million decline in revenue in fiscal
year 2004. Partially offsetting the decline was a $0.6 million improvement in
net sales of its Chromax chromium picolinate products. Net sales were bolstered
by the positive effect of a price increase introduced in fiscal year 2003.
20
Other revenue from license fees for fiscal year 2004 was $0.2 million and $0.4
million in fiscal year 2003.
Cost of Goods Sold
Cost of goods sold in fiscal year 2004 of $2.1 million declined $2.0 million
when compared to $4.1 million in fiscal year 2003. The reduction in cost of
goods sold is directly related to the Company's decision to discontinue its
investment in the Lite Bites product line. Gross margin on product sales was
78.8% in fiscal year 2004 compared to 59.8% in fiscal year 2003. The improvement
is directly related to gross margins on nutritional products sales, which are
greater than gross margins on Lite Bites products.
Selling, General and Administrative
Selling, general and administrative expense (SG&A) of $9.1 million for fiscal
year 2004 increased $0.9 million when compared to $8.2 million in fiscal year
2003. Excluding a $1.1 million charge for termination benefits related to an
employment matter, SG&A decreased $0.2 million when compared to the comparable
period a year ago. Reduction in personnel and personnel related costs was the
primary reason for the improvement.
Research and Development
Research and development expense in fiscal year 2004 was $2.4 million compared
to $2.2 million in fiscal year 2003. The increase is due primarily to costs for
continued research for new chromium applications.
The Company's therapeutic strategy continues to include a commitment to spending
on research and development and is targeted at further validating earlier
findings focused on disease specific conditions in the areas of diabetes and
depression.
In fiscal year 2003, the Company entered into an agreement with XLHealth,
formerly known as Diabetex Corporation, a diabetes disease management company,
to fund a 400+ patient double blind placebo controlled trial to evaluate
Diachrome's effect as a nutritional adjunct to standard care for people with
diabetes. This Diachrome study is expected to be completed by the end of
calendar year 2004.
The Company expects to launch these products under the Dietary Supplement Health
and Education Act (DSHEA) regulatory pathway that is less costly and less time
consuming than that required for drug development. These large-scale studies are
being conducted to secure medical acceptance and adoption for the Company's
products as standard treatment protocols. The Company's spending in these areas
of new technology is discretionary and is subject to the availability of funds.
There can be no assurances that the Company's disease specific product
development efforts will be successfully completed or that the products will be
successfully manufactured or marketed.
21
Operating Loss
Operating loss for fiscal year 2004 was $5.9 million, an improvement of $5.2
million when compared to an operating loss of $11.1 million in fiscal year 2003.
Fiscal year 2003 included a $4.4 million non-cash charge for impairment of
long-lived assets. In addition, an increase in gross profit in fiscal year 2004
of $1.6 million when compared to fiscal year 2003 contributed to the reduction
in the company's operating loss. Partially offsetting the improvement was a net
increase of $0.8 million in operating expenses, due primarily to costs accrued
for termination benefits related to an employment matter.
2. Year ended June 30, 2003 vs. Year ended June 30, 2002
Revenues
Net sales of $10.3 million for fiscal year 2003 declined $4.0 million when
compared to net sales of $14.3 million for fiscal year 2002.
The decline in revenues primarily reflects unsatisfactory results in the
marketing of the Company's Lite Bites product line. Lower sales to the QVC
channel can be partially attributable to increased competition in the nutrition
bar category and a general decline in the weight-loss supplement market related
to negative press associated with the ephedra controversy. Softer sales resulted
in more limited airtime driving the Lite Bites business on QVC into further
decline. In parallel during fiscal year 2003, the Company continued to explore
alternative cost-effective channels of distribution for the Lite Bites brand
that, prior to this year, was by agreement sold exclusively through QVC. The
Company tested the proposition of taking Lite Bites into retail distribution
though an alliance with Leiner Health Products, one of the largest and most
reputable supplement distributors in the U.S. The resulting feedback indicated
that the brand would require a much larger investment in marketing than the
Company believed was justified. Therefore, the Company has made the decision to
discontinue the Lite Bites product line. As a result, the Company determined
that a $4.4 million non-cash charge associated with the long-lived assets
related to the Lite Bites product line was warranted. The Company will consider
a sale of the Lite Bites assets. Any returns realized will be reinvested in the
expansion of the Company's chromium-derived business opportunities.
Lower weight-loss and sports nutrition supplement sales have led to commensurate
reductions in revenues from ingredient sales.
Other revenue from license fees for fiscal year 2003 and fiscal year 2002 was
$0.4 million.
Cost of Goods Sold
Cost of goods sold in fiscal year 2003 of $4.1 million declined $0.2 million
when compared to $4.3 million in fiscal year 2002. A reduction in cost of goods
sold, which is directly related to lower sales in fiscal year 2003, was
partially offset by a charge of $0.2 million for slow-moving inventory of the
Lite Bites product line. Gross margin on product sales was 59.8% in fiscal year
2003, compared to 69.7% in fiscal year 2002. The decline was due primarily to
product mix and charges to cost of goods sold for slow-moving inventory.
22
Selling, General and Administrative
Selling, general and administrative expense for fiscal year 2003 of $8.2 million
increased $0.9 million when compared to $7.3 million for fiscal year 2002.
Marketing and related expenditures increased $0.5 million while personnel and
personnel-related costs associated with organizational expansion to support the
Company's planned launch of new chromium based therapeutic products increased
$0.4 million.
Research and Development
Research costs of $2.2 million for fiscal year 2003 increased $1.2 million when
compared to $1.0 million in fiscal year 2002. The increase is due primarily to
studies related to the Company's anti-depressant technology ($1.0 million) as
well as increased expenditures for its Diachrome studies ($0.2 million).
The Company's therapeutic strategy for the past year includes a larger
commitment to spending on research and development and is targeted at further
validating earlier findings focused on disease specific conditions in the areas
of diabetes and depression.
The Company entered into an agreement with XLHealth, formerly known as Diabetex
Corporation, a diabetes disease management company, and is funding a large-scale
trial in managed patient populations to evaluate Diachrome's effect as a
nutritional adjunct to standard care for people with diabetes.
The Company also entered into an agreement with Comprehensive NeuroSciences,
Inc., a contract research organization in the neurosciences field, to perform
studies related to the Company's anti-depressant technology. The Company expects
that the first phase of its study will be completed during fiscal year 2004.
The Company expects to launch these products under the Dietary Supplement Health
and Education Act (DSHEA) regulatory pathway that is less costly and less time
consuming than that required for drug development. These large-scale studies are
being conducted to secure medical acceptance and adoption for the Company's
products as standard treatment protocols. The Company's spending in these areas
of new technology is discretionary and is subject to the availability of funds.
There can be no assurances that the Company's disease specific product
development efforts will be successfully completed or that the products will be
successfully manufactured or marketed.
Impairment of Intangibles
In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." This statement supercedes FASB Statement No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of." The statement requires the Company to review its
long-lived assets whenever events or changes in circumstances indicate that
impairment might exist. During fiscal year 2003, the Company decided to
discontinue investing in its Lite Bites product line. As a result of a review of
current and forecasted operating cash flows and the profitability of this line,
the Company determined that a $4.4 million non-cash impairment charge was
warranted.
23
Operating Loss
Operating loss for fiscal year 2003 was $11.1 million, including a $4.4 million
non-cash charge for impairment of long-lived assets, compared to an operating
loss of $7.8 million in fiscal year 2002, which included a $7.1 million non-cash
charge for impairment of goodwill.
Income Taxes
The effective tax rate for fiscal year 2003 was a benefit of 5% compared to 0%
for fiscal year 2002. For fiscal year 2003, the benefit was recorded up to the
extent of the Company's net operating loss carryback. The difference between the
federal statutory rate of 34% and the actual rate is primarily due to changes in
the deferred tax asset valuation allowance.
Liquidity and Capital Resources
Cash and cash equivalents and short-term investments at June 30, 2004 of $4.2
million increased $0.1 million when compared to $4.1 million at June 30, 2003.
As of June 30, 2004, the Company had a working capital surplus of $3.4 million,
compared to a working capital surplus of $4.1 million at June 30, 2003. Changes
in working capital included an increase in trade receivables and a decrease in
other receivables of $0.2 million and $0.8 million, respectively, as well as an
increase of $0.2 million in accounts payable and accrued expenses.
Net cash used in operating activities for fiscal year 2004 was $2.5 million
compared to cash used in operating activities of $0.3 million in fiscal year
2003. Net increases in operating assets of $1.0 million and decreases in
accounts payable and accrual expenses of $1.1 million were the primary reasons
for the change.
Net cash used in investing activities for fiscal year 2004 was $2.4 million
compared to cash provided by investing activities of $0.5 million in fiscal year
2003. $2.0 million was invested in short-term instruments in fiscal year 2004
compared to the redemption of $1.0 million in short-term instruments in fiscal
year 2003.
Net cash provided by financing activities was $3.0 million for fiscal year 2004
compared to net cash used in financing activities of $58 thousand in fiscal year
2003. Net proceeds of $3.0 million from a private placement was the primary
reason for the change.
The Company's primary source of financing in fiscal year 2004 was proceeds from
a private placement. The Company believes that cash on hand will provide
sufficient liquidity in the short term. Long term liquidity is dependent upon
achieving future profitability or raising additional financing.
Future increases in marketing and research and development expenses over the
present levels and any acquisition activities will require additional funds. The
Company intends to seek any necessary additional funding through arrangements
with corporate collaborators, through public or private sales of its securities,
including equity securities, or through bank financing arrangements. The Company
does not currently have any specific arrangements for additional financing and
there can be no assurance that additional funding will be available at all or on
terms acceptable to the Company.
24
Critical Accounting Policies and Estimates
The preparation of the consolidated financial statements requires the Company to
make estimates and judgments that affect the reported amounts of assets,
liabilities and expenses. On an on-going basis, the Company evaluates its
estimates, including those related to uncollectible accounts receivable,
inventories, goodwill, intangibles and other long-lived assets. The Company
bases its estimates on historical experience and on various other assumptions
that are believed to be reasonable under the circumstances, the results of which
form the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results may
differ from these estimates under different assumptions or conditions.
The Company believes the following critical accounting policies affect its more
significant judgments and estimates used in the preparation of its consolidated
financial statements:
o The Company maintains allowances for uncollectible accounts
receivable for estimated losses resulting from the inability of its
customers to make required payments. If the financial condition of
the Company's customers were to deteriorate, resulting in an
impairment of their ability to make payments, additional allowances
may be required.
o The Company carries inventories at the lower of cost or estimated
net realizable value. If actual market conditions are less favorable
than those projected by management write-downs may be required.
o Property, plant and equipment, patents, trademarks and other
intangible assets owned by the Company are amortized, over their
estimated useful lives. Useful lives are based on management's
estimates over the period that such assets will generate revenue.
Intangible assets with definite lives are reviewed for impairment
whenever events or changes in circumstances indicate that the
carrying value of an asset may not be recoverable. Future adverse
changes in market conditions or poor operating results of underlying
capital investments or intangible assets could result in losses or
an inability to recover the carrying value of such assets, thereby
possibly requiring an impairment charge in the future.
Significant Accounting Pronouncements
In May 2003, the FASB issued SFAS No. 150, "Accounting for Financial Instruments
with Characteristics of both Liabilities and Equity." SFAS No. 150, establishes
standards for how an issuer classifies and measures certain financial
instruments with characteristics of both liabilities and equity. The Company
believes this pronouncement will have no effect on its operations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk represents the risk of changes in value of a financial instrument,
derivative or non-derivative, caused by fluctuations in interest rates, foreign
exchange rates and equity prices. The Company has no financial instruments that
give it exposure to foreign exchange rates or equity prices.
25
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements are included herein commencing on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
At a meeting held on July 29, 2003, the Audit Committee of the Board of
Directors of the Company approved the engagement of J. H. Cohn LLP as its
independent registered public accounting firm for the fiscal year ended June 30,
2003 to replace the firm of Ernst & Young LLP, who were dismissed as auditors of
the Company effective July 31, 2003.
The audit reports of Ernst & Young LLP on the consolidated financial statements
of Nutrition 21, Inc. as of and for the years ended June 30, 2002 and 2001, did
not contain an adverse opinion or a disclaimer of opinion and were not qualified
or modified as to uncertainty, audit scope, or accounting principles. There were
no disagreements between the Company and Ernst & Young LLP on any matter of
accounting principles or practices, financial statement disclosure or auditing
scope or procedure, which, if not resolved to Ernst & Young LLP's satisfaction,
would have caused Ernst & Young LLP to make reference to the subject matter of
such disagreements in connection with its report.
ITEM 9A. CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures designed to ensure that
information required to be disclosed in reports filed under the Securities
Exchange Act of 1934, as amended, is recorded, processed, summarized and
reported within the specified time periods. As of June 30, 2004, the Company's
Chief Executive Officer and Chief Financial Officer evaluated, with the
participation of the Company's management, the effectiveness of the Company's
disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e)
and 15d-15(e)). Based on the evaluation, which disclosed no significant
deficiencies or material weaknesses, the Company's Chief Executive Officer and
Chief Financial Officer concluded that the Company's disclosure controls and
procedures are effective. There were no significant changes in the Company's
internal controls over financial reporting that occurred during the Company's
most recent fiscal quarter that have materially affected or are reasonably
likely to materially affect the Company's internal control over financial
reporting.
26
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
OFFICERS AND DIRECTORS
The officers and directors of the Company are as follows:
Year Joined
Name and Age Company Position
- --------------------------------------------------------------------------------
Gail Montgomery (51) 1999 President, Chief
Executive Officer,
and Director
John H. Gutfreund (74) 2000 Chairman of the Board
P. George Benson, PhD (58) 1998 Director
Warren D. Cooper, MD (51) 2002 Director
Audrey T. Cross, PhD (59) 1995 Director
Paul Intlekofer (36) 2002 Chief Financial Officer and
Senior Vice President,
Corporate Development
Marvin Moser, MD (80) 1997 Director
Robert E. Pollack, PhD (64) 1995 Director
Benjamin T. Sporn (66) 1986 Senior Vice President,
General Counsel, and
Secretary
Gail Montgomery has been President, Chief Executive Officer and a Director of
the Company since September 29, 2000, when she succeeded Fredrick D. Price. From
July 1999 to September 2000, she served the Company's Nutrition 21 subsidiary in
various capacities, most recently as Vice President and General Manager. From
November 1998 to July 1999, Ms. Montgomery was President of Health Advantage
Consulting, a consulting firm, which provided strategic planning, new product
introduction, and market development services to the nutrition industry. From
1992 to 1998 she worked for Diet Workshop, a diet franchise network, most
recently as President and CEO. From 1979 to 1992, Ms. Montgomery has served in
various capacities in the health and fitness sector. She received a BA from
Douglas College of Rutgers University in communications.
P. George Benson, PhD, was elected a Director of the Company in July 1998. Dr.
Benson is Dean of the Terry College of Business and holds the Simon S. Selig,
Jr. Chair for Economic Growth at the University of Georgia. Dr. Benson was
previously the Dean of the Faculty of Management at Rutgers University and a
professor of decision sciences at the Carlson School of Management of the
University of Minnesota. In 1997, he was appointed by the U.S. Secretary of
Commerce to a three-year term as one of the nine judges for the Malcolm Baldrige
National Quality Award. In 1996, Business News New Jersey named Dr. Benson one
of New Jersey's "Top 100 Business People". He received a BS from Bucknell
University and a PhD in business from the University of Florida.
27
Warren D. Cooper, MD was elected a Director of the Company in April 2002. Dr.
Cooper is president and founder of Coalesence, Inc., a consultancy focused on
business and product development for the pharmaceutical and healthcare
industries. From 1995 to 1999, Dr. Cooper was the business unit leader of
Cardiovascular Business Operations at AstraZeneca Pharmaceuticals LP. For three
years before that he was executive director of the Medical Affairs & Drug
Development Operations in the Astra/Merck Group of Merck & Co. Over a five-year
period from 1987 to 1992, Dr. Cooper served as executive director for Worldwide
Clinical Research Operations and as senior director for Clinical Research
Operations (Europe) at Merck Research Laboratories. He was with Merck, Sharp &
Dohme, U.K., from 1980 to 1987, first as a clinical research physician and later
as director of medical affairs. Dr. Cooper is a member of the Medical Advisory
Board of Zargis Medical Corp. (a Siemens joint venture). He also holds
memberships in the American Association of Pharmaceutical Physicians, the
American Society of Hypertension and the International Society of Hypertension.
He received a B.Sc. in physiology and an M.B. B.S. (U.K. equivalent to U.S. MD)
form The London Hospital Medical College, University of London.
Audrey T. Cross, PhD, was elected a Director of the Company in January 1995. Dr.
Cross has been Associate Clinical Professor at the Institute of Human Nutrition
at the School of Public Health of Columbia University since 1988. She also works
as a consultant in the areas of nutrition and health policy. She has served as a
special assistant to the United States Secretary of Agriculture as Coordinator
for Human Nutrition Policy and has worked with both the United States Senate and
the California State Senate on nutrition policy matters. Dr. Cross received a BS
in dietetics, a Master of Public Health in nutrition and a PhD from the
University of California at Berkeley, and a JD from the Hastings College of Law
at the University of California at San Francisco.
John H. Gutfreund was elected a Director of the Company in February 2000 and
Chairman of the Board in September 2001. Mr. Gutfreund is Senior Managing
Director and Executive Committee Member of C. E. Unterberg, Towbin, investment
bankers, and President of Gutfreund & Company, Inc., a New York-based financial
consulting firm that specializes in advising select corporations and financial
institutions in the United States, Europe and Asia. He is the former chairman
and chief executive officer of Salomon Inc., and past vice chairman of the New
York Stock Exchange and a past board member of the Securities Industry
Association. Mr. Gutfreund is active in the management of various civic,
charitable, and philanthropic organizations, including the New York Public
Library, Montefiore Medical Center, The Brookings Institution, Council on
Foreign Relations, Honorary Trustee, Oberlin (Ohio) College, and Chairman of the
Aperture Foundation. Mr. Gutfreund is also a director of AccuWeather, Inc.,
Evercel Inc., LCA-Vision, Inc., Maxicare Health Plans, Inc., The LongChamp Core
Plus Fund Ltd., and The Universal Bond Fund. He received a BA from Oberlin
College.
Paul Intlekofer was elected Chief Financial Officer and Senior Vice President,
Corporate Development, on January 17, 2003. From June 2002 to January 2003, he
served the Company in varying capacities. From September 2001 to June 2002, Mr.
Intlekofer was Senior Vice President of Planit, Inc., which provided strategic
planning, capital formation, M&A, marketing and new product development services
to the healthcare and financial industries. From 1998 to 2001 he was Senior Vice
President of Corporate Development for Rdental LLC, the exclusive technology
alliance of the American Dental Association and oral health content provider of
WebMD. From 1995 to 1997 he was Director of Strategic Operations/Business
Development for Doctors Health, a practice management and health insurance
company. Early in his career, he practiced corporate and securities law for
28
Venable, Baetjer & Howard. Mr. Intlekofer received his MBA and Juris Doctor from
the University of Maryland and BA from the Johns Hopkins University.
Marvin Moser, MD was elected to the Board of Directors in October 1997. He is
clinical professor of medicine at Yale and senior medical consultant at the
National High Blood Pressure Education Program of the National Heart, Lung and
Blood Institute. Dr. Moser's work has focused on various approaches to the
prevention and treatment of hypertension and heart disease. He has published
extensively on this subject with over 400 publications. He has authored or
contributed to more than 30 books and numerous physician and patient education
programs. He is editor-in chief of the Journal of Clinical Hypertension. Dr.
Moser is also a member of the Board of The Third Avenue Value Funds and the
Trudeau Institute. Dr. Moser holds a BA from Cornell University and an MD from
Downstate University College of Medicine.
Robert E. Pollack, PhD, was elected a Director of the Company in January 1995.
Dr. Pollack has been a Professor of Biological Sciences at Columbia University
since 1978. In addition, from 1982 to 1989 he was Dean of Columbia College.
Prior thereto he was Professor of Microbiology at the State University of New
York School of Medicine at Stony Brook, Senior Scientist at Cold Spring Harbor
Laboratory, Special NIH fellow at the Weizmann Institute in Israel, and NIH
Fellow in the Department of Pathology at New York University School of Medicine.
He is the author of more than one hundred research papers on the molecular
biology of viral oncogenesis, a dozen articles in the popular press, and three
books. He received a BA in physics from Columbia University and a PhD in biology
from Brandeis University.
Benjamin T. Sporn has been legal counsel to the Company since 1990 and has
served as Secretary of the Company since 1986, and was appointed Senior Vice
President and General Counsel in February 1998. He was an attorney with AT&T
from 1964 until December 1989 when he retired from AT&T as a General Attorney
for Intellectual Property Matters. Mr. Sporn was a director of the Company from
1986 until 1994. He received a BSE degree from Rensselaer Polytechnic Institute
and a JD degree from American University.
The Directors serve for a term of one year and until their successors are duly
elected and qualified. Officers serve at the discretion of the Board of
Directors, subject to the provisions of the employment agreements described
below. Except for Mr. Paul Intlekofer, who is first cousin to Ms. Gail
Montgomery, there are no family relationships among directors or executive
officers.
Arrangements Regarding the Election of Directors
So long as Burns Philp & Company Limited owned at least 20% of the Company's
outstanding common stock, BP was entitled to nominate one member for election to
the Company's Board. On August 3, 2004, Burns Philp's ownership of the Company's
common stock fell below 20%. BP has not nominated and is no longer entitled to
nominate a member for election to the Company's Board. See Item 13. Certain
Relationships and Related Transactions.
Director Compensation
Non-management Directors each receive a quarterly director's fee of $1,800 and
the Chairman of the Board receives a quarterly director's fee of $3,600. Each
non-management Director also receives $500 for each meeting of the Board
attended in person, $250 for each meeting of the Board attended telephonically,
and each received options to acquire 15,000 shares of Common Stock during the
fiscal year ended June 30, 2004, at an exercise price of $1.02. For the fiscal
29
year ending June 30, 2005, each non-management Director is expected to receive
options to acquire 15,000 shares of Common Stock at the closing price on the
date of grant.
Committees of the Board of Directors
Audit Committee
The Company has a separately designated standing audit committee established in
accordance with Section 3(a)(58)(A) of the Exchange Act. Serving on the
Committee are P. George Benson, Warren. D. Cooper and John. H. Gutfreund. The
Board of Directors has determined that it has an audit committee financial
expert serving on the audit committee, John H. Gutfreund. Mr. Gutfreund is an
independent director as defined in Item 7(d)(3)(iv) of Schedule 14A.
Compensation Committee
The Board of Directors has a Compensation Committee which consists of
independent directors Audrey T. Cross, John H. Gutfreund, and Robert E. Pollack.
The Compensation Committee held one meeting during the fiscal year ended June
30, 2004.
Compensation Committee Interlocks and Insider Participation
The Board of Directors determines executive compensation taking into
consideration recommendations of the Compensation Committee. No member of the
Company's Board of Directors is an executive officer of a company whose
compensation committee or board of directors includes an executive officer of
the Company.
Code of Ethics
The Company has adopted (i) Standards of Business Conduct ("Standards") and (ii)
Business Conduct and Compliance Program ("Program") that includes its code of
ethics. The Standards and Program are posted on the Company website:
www.nutrition21.com. After accessing the Company's website, click on Investor
Relations and then on Shareholder Information. Any amendments or waivers will be
posted on the Company's website.
Compliance with Section 16(a) of the Securities Exchange Act of 1934
Section 16(a) of the Securities Exchange Act of 1934 requires the Company's
officers and directors, and persons who own more than ten percent of a
registered class of the Company's equity securities, to file reports of
ownership and changes in ownership with the Securities and Exchange Commission.
Officers, directors and greater than ten-percent shareholders are required by
SEC regulation to furnish the Company with copies of all Section 16(a) forms
they file.
Based solely on review of the copies of such forms furnished to the Company, or
written representations that no filings were required, the Company believes that
during the period from July 1, 2003 through June 30, 2004, all Section 16(a)
filing requirements applicable to its officers, directors and greater than
ten-percent beneficial owners were complied with.
30
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth the compensation paid or accrued by the Company
during the periods indicated for (i) the chief executive officer during fiscal
year 2004 and (ii) certain other persons that served as executive officers in
fiscal year 2004 whose total annual salary and bonus was in excess of $100,000.
SUMMARY COMPENSATION TABLE (1)(2)
=======================================================================================
NAME AND PRINCIPAL LONG-TERM ALL OTHER
POSITION ANNUAL COMPENSATION COMPENSATION COMPENSATION
-------------------------------------------------------------
PERIOD SALARY BONUS SECURITIES ($)
($) ($) UNDERLYING
OPTIONS/SARs
(#)
- ---------------------------------------------------------------------------------------
Gail Montgomery, 7/1/01 - 275,000 500,000
President, 6/30/02
Chief Executive Officer
and Director -------------------------------------------------------------
7/1/02 - 275,000 1,175,000
6/30/03
-------------------------------------------------------------
7/1/03 - 300,000(4)
6/30/04
- ---------------------------------------------------------------------------------------
Paul Intlekofer, Chief
Financial Officer and 7/1/02 - 190,731 1,050,000
Senior Vice President, 6/30/03 37,500(3)
Corporate Development
- ---------------------------------------------------------------------------------------
7/1/03 - 219,135
6/30/04
- ---------------------------------------------------------------------------------------
Benjamin T. Sporn, 7/1/01 - 207,500
Senior Vice President, 6/30/02
General Counsel and
Secretary -------------------------------------------------------------
7/1/02 - 207,500 225,000
6/30/03
-------------------------------------------------------------
7/1/03 - 194,808
6/30/04
=======================================================================================
(1) The above compensation does not include the use of an automobile and other
personal benefits, the total value of which do not exceed as to any named
officer or director, the lesser of $50,000 or 10% of such person's annual salary
and bonus.
(2) Pursuant to the regulations promulgated by the Securities and Exchange
Commission (the "Commission"), the table omits a number of columns reserved for
types of compensation not applicable to the Company.
(3) Fees earned in a consulting capacity during fiscal year 2003.
(4) Includes $25,000 of deferred compensation.
None of the individuals listed above received any long-term incentive plan
awards during the fiscal year.
31
EMPLOYMENT AND CONSULTING AGREEMENTS
The Company has entered into a three-year employment agreement with Gail
Montgomery as President and Chief Executive Officer, effective as of September
1, 2002. The agreement provides for an annual salary of $275,000, $300,000, and
$325,000 in the successive years under the agreement, and for performance
bonuses based on achieving defined revenue targets. Ms. Montgomery is also
entitled to additional payments equal to one year's salary plus an additional
month of salary for defined years of service, if her employment is terminated
without cause before the agreement expires, or if the Company fails to offer to
enter into a new one-year agreement upon expiration. If Ms. Montgomery's
employment is terminated or she resigns within six months after a change of
control (as defined) the Company will pay to her 2.99 times her annual salary
and previous year's bonus plus certain gross-ups, but these payments will be
reduced to the extent necessary to prevent the application of Section 280G of
the Internal Revenue Code.
Effective as of September 16, 2002 the Company entered into a three-year
employment agreement with Paul Intlekofer, who has served as Chief Financial
Officer and Senior Vice President, Corporate Development since January 17, 2003.
The agreement provides for an annual salary of $200,000, $225,000, and $250,000
in the successive years under the agreement, and for performance bonuses based
on achieving defined revenue targets. Mr. Intlekofer is also entitled to
additional payments equal to one year's salary, if his employment is terminated
without cause before the agreement expires. If Mr. Intlekofer's employment is
terminated or he resigns within six months after a change of control (as
defined) the Company will pay to him 2.99 times his annual salary and previous
year's bonus plus certain gross-ups, but these payments will be reduced to the
extent necessary to prevent the application of Section 280G of the Internal
Revenue Code.
The Company entered into a four-year agreement with Benjamin Sporn effective,
September 1, 2002, which provides for his services as Senior Vice President,
General Counsel, and Secretary as an employee during the first two years of the
term, and as General Counsel as a consultant during the balance of the term. Mr.
Sporn's salary and fees will be $207,500, $225,000, $150,000 and $100,000 in
successive years under the agreement, plus performance bonuses based on
achieving defined revenue targets. Mr. Sporn is also entitled to additional
payments equal to two years' salary if his employment is terminated without
cause before the agreement expires. If Mr. Sporn's employment is terminated or
he resigns within six months after a change of control (as defined) the Company
will pay to him 2.99 times his annual salary and previous year's bonus plus
certain gross-ups, but these payments will be reduced to the extent necessary to
prevent the application of Section 280G of the Internal Revenue Code.
The following tables set forth information with regard to options granted during
the fiscal year (i) to the Company's Chief Executive Officer, and (ii) to other
officers of the Company named in the Summary Compensation Table.
32
OPTION/SAR GRANTS IN LAST FISCAL YEAR
- --------------------------------------------------------------- ---------------------
Potential
Realizable Value At
Individual Grants Assumed Annual
Rates Of Stock
Price Appreciation
For Option Term
- -------------------------------------------------------------------------------------
Percent Of
Total
Number Of Options/SARs
Securities Granted To Exercise
Underlying Employees In Of Base
Name Options/SARs Fiscal Year Price Expiration
Granted (#) ($/Sh) Date 5% ($) 10% ($)
- -------------------------------------------------------------------------------------
Paul Intlekofer 0 0% -- -- -- --
- -------------------------------------------------------------------------------------
Gail Montgomery 0 0% -- -- -- --
- -------------------------------------------------------------------------------------
Benjamin T. Sporn 0 0% -- -- -- --
- -------------------------------------------------------------------------------------
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTION VALUES
- -------------------------------------------------------------------------------------
INDIVIDUAL GRANTS
- -------------------------------------------------------------------------------------
NAME SHARES VALUE NUMBER OF UNEXERCISED VALUE OF UNEXERCISED
ACQUIRED REALIZED OPTIONS/SARs AT FY-END IN-THE-MONEY
IN ($) (#) OPTIONS/SARs AT
EXERCISE FY-END
(#) ---------------------------------------------------
Exercisable Unexercisable Exercisable Unexercisable
- -------------------------------------------------------------------------------------
Paul Intlekofer 0 0 293,333 766,667 $68,967 $186,333
- -------------------------------------------------------------------------------------
Gail Montgomery 0 0 745,833 1,154,167 $35,874 $210,875
- -------------------------------------------------------------------------------------
Benjamin T. Sporn 0 0 349,000 148,500 $73,290 $ 73,290
- -------------------------------------------------------------------------------------
33
PENSION PLANS
Nutrition 21, Inc.
Eligible employees of the Company were entitled to participate in the Burns
Philp Inc. Retirement Plan for Non-Bargaining Unit Employees, a non-contributory
pension plan (the "Pension Plan") maintained by Burns Philp as long as Burns
Philp maintained the Pension Plan and owned at least 20% of the Company's
outstanding Common Stock. At June 30, 2004 and August 3, 2004, Burns Philp held
approximately 20.44% and 19.29%, respectively, of the Company's outstanding
Common Stock. Assuming retirement at age 65, the Pension Plan provides benefits
equal to the greater of (a) 1.1% of the employee's final average earnings
multiplied by the number of years of credited service plus 0.65% of the
employee's final average earnings in excess of the average of the contribution
and the benefit bases in effect under Section 230 of the Social Security Act for
each year in the 35-year period ending with the year in which the employee
attains the Social Security retirement age as calculated under Section
401(l)(5)(E) of the Code and Table I of IRS Notice 89-70, multiplied by the
employee's years of credited service up to 35, minus any predecessor plan
benefit in the case of an employee who participated in a predecessor plan or (b)
$24 multiplied by the number of years of credited service up to 25 years plus
$12 multiplied by the years of employment from 26-40 years, minus any
predecessor plan benefit in the case of an employee who participated in a
predecessor plan. The "final average earnings" are the average earnings during
the five highest-paid consecutive calendar years within the last ten calendar
years of credited service with the Company. Earnings include the salary and
bonus listed in the summary compensation table. Earnings, which may be
considered under the Pension Plan, are limited to $205,000 in 2004 subject to
annual cost of living adjustments as determined by the IRS.
On August 3, 2004, Burns Philp advised the Company that no further pension
benefits will be earned for services performed or compensation paid on or after
September 19, 2004. Service with the Company after September 19, 2004 will be
considered solely for purposes of vesting and for determining eligibility for
early retirement benefits.
The following table sets forth estimated annual benefits payable upon
retirement, assuming retirement at age 65 in 2004, according to years of
credited service and final average earnings. The benefits listed are not subject
to any deduction for Social Security or other offset amounts.
34
YEARS OF CREDITED SERVICE
Final average
earnings 15 20 25 30 35
- -----------------------------------------------------------------------------
$25,000 $4,320 $5,760 $7,200 $8,760 $9,600
$50,000 $8,520 $11,400 $14,280 $17,160 $20,040
$75,000 $15,120 $20,160 $25,200 $30,240 $35,400
$100,000 $21,720 $28,920 $36,120 $43,440 $50,640
$150,000 $34,800 $46,440 $58,080 $69,720 $81,240
$200,000 $47,880 $63,960 $79,920 $95,880 $111,960
and up
Paul Intlekofer, Gail Montgomery, and Benjamin T. Sporn each have 1.8, 4.9, and
12 years, respectively, of credited service under the Pension Plan as of June
30, 2004, respectively.
35
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of September 17, 2004, information regarding
the beneficial ownership of the Company's Common Stock based upon the most
recent information available to the Company for (i) each person known by the
Company to own beneficially more than five (5%) percent of the Company's
outstanding Common Stock, (ii) each of the Company's executive officers and
directors and (iii) all executive officers and directors of the Company as a
group. Unless otherwise indicated, each stockholder's address is c/o the
Company, 4 Manhattanville Road, Purchase, New York 10577-2197.
SHARES OWNED BENEFICIALLY AND OF RECORD (1)
NAME AND ADDRESS NO. OF SHARES % OF CLASS
P. George Benson (2) 100,000 *
Warren D. Cooper (3) 40,000 *
Audrey T. Cross (4) 124,000 *
John H. Gutfreund (5) 120,000 *
Paul Intlekofer (6) 658,716 1.70
Gail Montgomery (7) 1,306,303 3.33
Marvin Moser (8) 185,000 *
Robert E. Pollack (3) 130,000 *
Benjamin T. Sporn (9) 505,625 1.31
Wyeth (10) 3,478,261 9.16
5 Giralda Farms
Madison, NJ 07940
Burns Philp & Company Limited (11) 7,327,237 19.29
7 Bridge Street
Sydney, NSW 2000, Australia
All Executive Officers and Directors 3,169,644 7.75
as a Group (9 persons) (12)
- ----------
* Less than 1%
(1) Unless otherwise indicated, each person has sole investment and voting
power with respect to the shares indicated. For purposes of this table, a
36
person or group or group of persons is deemed to have "beneficial
ownership" of any shares as of a given date, which such person has the
right to acquire within 60 days after such date. For purposes of computing
the percentage of outstanding shares held by each person or group of
persons named above on a given date, any security which such person or
group of persons has the right to acquire within 60 days after such date
is deemed to be outstanding for the purposes of computing the percentage
ownership of such person or persons, but is not deemed to be outstanding
for the purpose of computing the percentage ownership of any other person.
(2) Includes 90,000 shares issuable upon exercise of currently exercisable
options under the Company's Stock Option Plans.
(3) Consists of shares issuable upon exercise of currently exercisable options
under the Company's Stock Option Plans.
(4) Includes 120,000 shares issuable upon exercise of currently exercisable
options under the Company's Stock Option Plans.
(5) Includes 70,000 shares issuable upon exercise of currently exercisable
options under the Company's Stock Option Plans.
(6) Includes 626,666 shares issuable upon exercise of currently exercisable
options under the Company's Stock Option Plans.
(7) Includes 1,181,666 shares issuable upon exercise of currently exercisable
options under the Company's Stock Option Plans.
(8) Includes 175,000 shares issuable upon exercise of currently exercisable
options under the Company's Stock Option Plans.
(9) Includes 471,500 shares issuable upon exercise of currently exercisable
options under the Company's Stock Option Plans.
(10) Formerly American Home Products Corporation.
(11) Consists of shares owned by subsidiaries.
(12) Includes 2,904,832 shares issuable upon exercise of currently exercisable
options under the Company's Stock Option Plans.
37
EQUITY COMPENSATION PLAN INFORMATION
The following table sets forth securities authorized for issuance under equity
compensation plans as of June 30, 2004.
EQUITY COMPENSATION PLAN INFORMATION
- --------------------------------------------------------------------------------
PLAN CATEGORY NUMBER OF
SECURITIES TO BE NUMBER OF SECURITIES
ISSUED UPON WEIGHTED-AVERAGE REMAINING AVAILABLE FOR
EXERCISE OF EXERCISE PRICE OF FUTURE ISSUANCE UNDER
OUTSTANDING OUTSTANDING EQUITY COMPENSATION PLANS
OPTIONS, WARRANTS OPTIONS, WARRANTS (EXCLUDING SECURITIES
AND RIGHTS AND RIGHTS REFLECTED IN COLUMN (a))
(a) (b) (c)
- --------------------------------------------------------------------------------
Equity
compensation
plans approved 3,205,052 $1.14 211,000
by security
holders
- --------------------------------------------------------------------------------
Equity
compensation (1) 2,049,734 $0.48 440,266
plans not (2) 0
approved by (3) 601,950 $0.95 2,500,000
security
holders
- --------------------------------------------------------------------------------
Total 5,856,736 3,151,266
- --------------------------------------------------------------------------------
(1) 2001 Stock Option Plan to provide non-executives, who render services to
the Company additional incentives to advance the interests of the Company.
Neither directors nor executive officers of the Company may be granted
Stock Options under the Plan (Exhibit 10.70).
(2) 2002 Inducement Stock Option Plan to inducement an individual to be come
an employee of the Company, and provide additional incentives to advance
the interests of the Company. Neither directors nor executive officers of
the Company may be granted Stock Options under the Plan (Exhibit 10.71).
(3) Warrants granted from time to time as an inducement to various persons or
entities to enter into transactions with the Company.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On December 12, 1996, the Company completed the sale of its UK-based food
ingredients subsidiary, Aplin & Barrett Limited ("A&B"), to Burns Philp &
Company Limited ("BP") for $13.5 million in cash and the return to the Company
of 2.42 million shares of the Company's Common Stock held by BP. The sale
included the Company's nisin-based food preservative business. In connection
with the transaction, the Company and A&B entered into two License Agreements.
Pursuant to the first License Agreement, the Company is exclusively licensed by
A&B for the use of nisin generally in pharmaceutical products and animal
healthcare products. Pursuant to the second License Agreement, A&B is
exclusively licensed by the Company generally for the use of nisin as a food
preservative and for food preservation. As long as BP owns at least 20% of the
Company's outstanding common stock, BP is entitled to nominate one member for
election to the Company's Board. BP has not nominated a member for election to
the Company's Board. The amount of consideration for the sale was arrived at
through arms-length negotiation and a fairness opinion was obtained. As of June
30, 2004, BP owned 7,763,837 shares of Common Stock, which amounted to 20.44% of
the outstanding common stock. As of August 3, 2004, BP owned 7,327,237 shares of
Common Stock, which amounted to 19.29% of the outstanding common stock, and is
no longer entitled to nominate a director.
In October 1998, the Company issued 3,478,261 shares of Common Stock to Wyeth
38
for $4.0 million. At June 30, 2004, Wyeth held approximately 9.16% of the
Company's outstanding Common Stock.
On July 1, 2000, the Company licensed its remaining rights to sell lysostaphin
for research purposes, to Benjamin T. Sporn, its senior vice president, for
$300,000, payable in cash over a three-year period. Payment of the $300,000 has
been made. The price and other terms of the transaction were established through
arms-length negotiations.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
AUDIT COMMITTEE PRE-APPROVAL POLICIES AND PROCEDURES.
The Audit Committee is directly and solely responsible for oversight, engagement
and termination of any independent registered public accounting firm employed by
the Company for the purpose of preparing or issuing an audit report or related
work.
The Committee (i) meets with the independent registered public accounting firm
prior to the audit and discusses the planning and staffing of the audit; (ii)
approves in advance the engagement of the independent registered public
accounting firm for all audit services and non-audit services and approves the
fees and other terms of any such engagement; (iii) obtains periodically from the
independent registered public accounting firm a formal written statement of the
matters required to be discussed by Statement of Auditing Standards No. 61, as
amended, and, in particular, describing all relationships between the auditor
and the Company; and (iv) discusses with the independent registered public
accounting firm any disclosed relationships or services that may impact auditor
objectivity and independence.
Information Concerning Fees Paid to Independent Registered Public Accounting
Firms for the fiscal years ended June 30, 2004 and 2003.
Set forth below is certain information concerning audit and related services
rendered to the Company by J.H. Cohn LLP and Ernst & Young LLP for the fiscal
years ended June 30, 2004 and 2003. As indicated below, in addition to reviewing
financial statements, J.H. Cohn LLP and Ernst & Young LLP provided other
services in the fiscal year ended June 30, 2004. The Audit Committee has
determined that the provision of these other services is compatible with
maintaining the independence of the firm.
Audit Fees. In the fiscal year ended June 30, 2004, J. H. Cohn LLP billed the
Company $95,000 for audit services. Ernst & Young LLP billed the Company for
aggregate fees of approximately $85,370 for audit services for the fiscal year
ended June 30, 2003, up to their dismissal on July 31, 2003.
Audit related fees. In the fiscal year ended June 30, 2004, J.H. Cohn LLP billed
the Company $9,000 and Ernst & Young LLP billed the company $12,500 for services
related to registration on Form S-3.
39
Tax Fees. In the fiscal year ended June 30, 2004, J. H. Cohn LLP billed the
Company $20,000 for tax compliance services. Ernst & Young LLP billed the
Company for aggregate fees of approximately $25,975 for other services rendered
in the fiscal year ended June 30, 2003, consisting primarily of tax compliance
fees.
All other fees. None
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
ON FORM 8-K
(a) 1. Financial Statements
The financial statements are listed in the Index to Consolidated
Financial Statements on page F-1 and are filed as part of this annual
report.
2. Financial Statement Schedules
The following financial statement schedule is included herein:
Schedule II - Valuation and Qualifying Accounts
All other schedules are not submitted because they are not applicable,
not required, or because the information is included in the
Consolidated Financial Statements.
3. Exhibits
The Index to Exhibits following the Signature Page indicates the
Exhibits, which are being filed herewith, and the Exhibits, which are
incorporated herein by reference.
(b) Reports on Form 8-K
The Company filed one Report on Form 8-K during the fiscal quarter
ended June 30, 2004.
1. Report dated April 30, 2004 furnishing a copy of a press release of
financial results for the fiscal quarter ended March 31, 2004.
40
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, Registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
NUTRITION 21, INC.
By: /s/ Gail Montgomery
----------------------------
Gail Montgomery, President,
CEO and Director
Dated: September 24, 2004
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below, as of September 24, 2004, by the following persons
on behalf of Registrant and in the capacities indicated.
/s/ Gail Montgomery
--------------------------------
Gail Montgomery, President,
CEO and Director
/s/ John H. Gutfreund
--------------------------------
John H. Gutfreund,
Chairman of the Board
/s/ P. George Benson
--------------------------------
P. George Benson, Director
/s/ Warren D. Cooper
--------------------------------
Warren D. Cooper Director
/s/ Audrey T Cross
--------------------------------
Audrey T. Cross, Director
/s/ Marvin Moser
--------------------------------
Marvin Moser, Director
/s/ Robert E. Pollack
--------------------------------
Robert E. Pollack, Director
/s/ Paul Intlekofer
--------------------------------
Paul Intlekofer, Chief
Financial Officer
41
EXHIBITS
3.01 Certificate of Incorporation (1)
3.01a Certificate of Amendment to the Certificate of Incorporation (2)
3.01b Certificate of Amendment to the Certificate of Incorporation (3)
3.01c Certificate of Amendment to the Certificate of Incorporation (11)
3.01d Certificate of Amendment to the Certificate of Incorporation (11)
3.01e Certificate of Amendment to the Certificate of Incorporation (12)
3.02 Amended and Restated By-laws (2)
10.01 Form of Incentive Stock Option Plan (8)
10.02 Form of Non-qualified Stock Option Plan (8)
10.02a Form of 1989 Stock Option Plan (1)
10.02b Form of 1991 Stock Option Plan (1)
10.02c Form of 1998 Stock Option Plan (15)
10.24 Exclusive Option and Collaborative Research Agreement dated July 1,
1988 between the Company and the University of Maryland (4)
10.25 License and License Option Agreement dated December 15, 1988 between
the Company and Babson Brothers Company (4)
10.36 Agreement, dated October 6, 1992 between the Company and PHRI (5)
10.47 Employment Agreement dated August 30, 1994 between the Company and
Fredric D. Price, as amended and restated (6)
10.48 Lease dated as of February 7, 1995, between the Company and Keren
Limited Partnership (7)
10.49 Share Purchase Agreement dated as of December 12, 1996, by and among
Applied Microbiology, Inc., Aplin & Barrett Limited and Burns Philp
(UK) plc. (9)
10.50 License Agreement dated as of December 12, 1996 between Licensee
Applied Microbiology, Inc. and Licensor Aplin & Barrett Limited. (9)
10.51 License Agreement dated as of December 12, 1996 between Licensee Aplin
& Barrett Limited and Licensor Applied Microbiology, Inc. (9)
10.52 Supply Agreement dated as of December 12, 1996 between Aplin & Barrett
Limited and Applied Microbiology, Inc. (9)
10.53 Investors' Rights Agreement dated as of December 12, 1996 between
Applied Microbiology, Inc. and Burns Philp Microbiology. Pty Limited.
(9)
42
10.54 Revolving Loan and Security Agreement dated as of December 12, 1996
between Burns Philp Inc. as Lender and Applied Microbiology, Inc. as
Borrower. (9)
10.55 Stock and Partnership Interest Purchase Agreement dated as of August
11, 1997, for the purchase of Nutrition 21. (10)
10.57 Sublease dated as of September 18, 1998, between the Company and
Abitibi Consolidated Sales Corporation (12)
10.58 Stock Purchase Agreement dated as of September 17, 1998 between
American Home Products Corporation and AMBI Inc. (13)*
10.59 License, Option, and Marketing Agreement dated as of September 17, 1998
between American Home Products, acting through its Whitehall-Robins
Healthcare division, and AMBI Inc. (13)*
10.60 Amended and Restated Revolving Credit and Term Loan Agreement dated as
of January 21, 1999 between State Street Bank & Trust Company as Lender
and the Company and Nutrition 21 as Borrower. (14)
10.61 Agreement of Purchase and Sale of Assets made as of January 19, 1999 by
and among Dean Radetsky and Cheryl Radetsky, Optimum Lifestyle, Inc.
and AMBI Inc. (14)
10.62 Strategic Alliance Agreement dated as of August 13, 1999 between AMBI
Inc. and QVC, Inc. (15)*
10.63 Asset Purchase Agreement made as of December 30, 1999, by and between
ImmuCell Corporation and AMBI Inc. (16)
10.64 License Agreement entered into as of August 2, 2000 between AMBI Inc.
and Biosynexus Incorporated. (17)*
10.65 License and Sublicense Agreement entered into as of August 2, 2000
between AMBI Inc. and Biosynexus Incorporated. (17)*
10.66 Amendment effective as of June 30, 2000, to the Amended and Restated
Revolving Credit and Term Loan Agreement dated as of January 21, 1999
between Citizens Bank of Massachusetts (successor in interest to loans
originally made by State Street Bank & Trust Company) as Lender and the
Company and Nutrition 21 as Borrower. (17)
10.67 Employment Agreement dated as of October 16, 2000 between AMBI Inc. and
Gail Montgomery. (18)
10.68 Consulting Agreement entered into as of September 29, 2000 between AMBI
Inc. and Fredrick D. Price. (19)
10.69 Amended and Restated By-laws, and Rights Agreement adopted September
12, 2002 (20)
10.70 Nutrition 21, Inc. 2001 Stock Option Plan. (21)
43
10.71 Nutrition 21, Inc. 2002 Inducement Stock Option Plan. (21)
10.72 Nutrition 21, Inc. Change of Control Policy adopted September 12, 2002.
(21)
10.73 Employment Agreement entered into as of September 1, 2002 between
Nutrition 21, Inc. and Gail Montgomery. (21)
10.74 Employment Agreement entered into as of August 5, 2002 between
Nutrition 21, Inc. and Andrew Wertheim. (21)
10.75 Employment Agreement entered into as of September 1, 2002 between
Nutrition 21, Inc. and Benjamin Sporn (21)
10.76 Employment Agreement entered into as of September 16, 2002 between
Nutrition 21, Inc. and Paul Intlekofer (22)
23.1 Consent of J.H. Cohn LLP (23)
23.2 Consent of Ernst & Young LLP (23)
31.1 Certification of President and Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002 (23)
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 (23)
32 Certification of President and Chief Executive Officer and Chief
Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
2002 (23)
- --------------------------------------
(1) Incorporated by reference to the Company's Report on Form 10-K for
1991.
(2) Incorporated by reference to the Company's Report on Form 8-K dated
September 4, 1992.
(3) Incorporated by reference to the Company's Registration Statement on
Form S-8 dated August 8, 1996, file No. 333-09801.
(4) Incorporated by reference to the Company's Report on Form 10-K for
1988.
(5) Incorporated by reference to the Company's Report on Form 10-K for the
fiscal period January 31, 1992 through August 31, 1992.
(6) Incorporated by reference to the Company's Report on Form 10-K for
1994.
(7) Incorporated by reference to the Company's Report on Form 10-K for
1995.
(8) Incorporated by reference to the Company's Registration Statement on
Form S-1 originally filed April 15, 1986, file No. 33-4822.
(9) Incorporated by reference to the Company's Report on Form 8-K dated
December 27, 1996.
44
(10) Incorporated by reference to the Company's Report on Form 8-K dated
August 25, 1997.
(11) Incorporated by reference to the Company's Report on Form 10-K/A2 for
1997.
(12) Incorporated by reference to the Company's Report on Form 10-K/A for
1998.
(13) Incorporated by reference to the Company's Report on Form 10-Q for the
quarter ended September 30. 1998.
(14) Incorporated by reference to the Company's Report on Form 8-K dated
February 3, 1999.
(15) Incorporated by reference to the Company's Report on Form 10-K for
1999.
(16) Incorporated by reference to ImmuCell Corporation's Report on Form 8-K
dated January 13, 2000.
(17) Incorporated by reference to the Company's Report on Form 10-K for
2000.
(18) Incorporated by reference to the Company's Report on Form 10-Q for the
quarter ended December 31. 2000.
(19) Incorporated by reference to the Company's Report on From 10-K for
2001.
(20) Incorporated by reference to the Company's Report on Form 8-K dated
September 18, 2002.
(21) Incorporated by reference to the Company's Report on From 10-K for
2002.
(22) Incorporated by reference to the Company's Report on Form 10-K/A for
2003.
(23) Filed herewith.
* Subject to an order by the Securities and Exchange Commission granting
confidential treatment. Specific portions of the document for which confidential
treatment has been granted have been blacked out. Such portions have been filed
separately with the Commission pursuant to the application for confidential
treatment.
45
NUTRITION 21, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
FILED WITH THE ANNUAL REPORT OF THE
COMPANY ON FORM 10-K
JUNE 30, 2004
PAGE
----
REPORTS OF INDEPENDENT REGISTERED PUBLIC
ACCOUNTING FIRMS F-2 & F-3
CONSOLIDATED BALANCE SHEETS AT JUNE 30, 2004 AND 2003 F-4
CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE
YEARS ENDED JUNE 30, 2004, 2003 AND 2002 F-6
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED JUNE 30, 2004, 2003 AND 2002 F-7
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE
YEARS ENDED JUNE 30, 2004, 2003 AND 2002 F-8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F-9
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Stockholders and Board of Directors
Nutrition 21, Inc.
We have audited the accompanying consolidated balance sheets of Nutrition 21,
Inc. and subsidiary as of June 30, 2004 and 2003, and the related consolidated
statements of operations, stockholders' equity and cash flows for the years then
ended. Our audit also included the 2004 and 2003 consolidated financial
statement schedule listed in the Index in Item 15(a). These consolidated
financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements and schedule based on our audit.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Nutrition 21, Inc. and subsidiary as of June 30, 2004 and 2003, and their
consolidated results of operations and cash flows for the years then ended, in
conformity with accounting principles generally accepted in the United States of
America. Also, in our opinion, the consolidated financial statement schedule,
when considered in relation to the basic consolidated financial statements taken
as a whole, presents fairly in all material respects the information set forth
therein.
/s/ J.H. Cohn LLP
Roseland, New Jersey
August 25, 2004, except for the
first paragraph of Note 14, which
is as of September 3, 2004
F-2
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Stockholders and Board of Directors
Nutrition 21, Inc.
We have audited the consolidated statements of operations, stockholders' equity,
and cash flows of Nutrition 21, Inc. (the "Company") for the year ended June 30,
2002. Our audit also included the related financial statement schedule for the
year ended June 30, 2002 listed in the Index at Item 15(a)(2). These financial
statements and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated results of operations and cash
flows of Nutrition 21, Inc. for the year ended June 30, 2002, in conformity with
U.S. generally accepted accounting principles. Also, in our opinion, the related
financial statement schedule for the year ended June 30, 2002, when considered
in relation to the basic financial statements taken as a whole, presents fairly
in all material respects the information set forth therein.
/s/ ERNST & YOUNG LLP
Stamford, Connecticut
August 16, 2002,
except for the first paragraph of Note 8,
Note 9 and the fourth and fifth
paragraphs of Note 14, as to which the
date is September 12, 2002
F-3
NUTRITION 21, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
June 30, June 30,
2004 2003
---- ----
ASSETS
Current assets:
Cash and cash equivalents $2,164 $4,059
Short-term investments 2,000 --
Accounts receivable (less allowance for doubtful
accounts and returns of $10 in 2004 and $430 in 2003) 1,342 1,140
Other receivables 257 1,100
Inventories 1,163 1,135
Prepaid expenses and other current assets 221 196
------- -------
Total current assets 7,147 7,630
Property and equipment, net 314 479
Patents, trademarks and other intangibles (net of
accumulated amortization of $15,444 in 2004 and $13,334
in 2003) 8,719 10,612
Other assets 187 199
------- -------
TOTAL ASSETS $16,367 $18,920
======= =======
See accompanying notes.
F-4
NUTRITION 21, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
JUNE 30, JUNE 30,
2004 2003
-------- --------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 3,687 $ 3,456
Contingent payments payable 47 26
Preferred dividends payable -- 2
-------- --------
TOTAL LIABILITIES 3,734 3,484
-------- --------
COMMITMENTS AND CONTINGENT LIABILITIES
STOCKHOLDERS' EQUITY
Preferred stock, $0.01 par value, authorized
5,000,000 shares Series G convertible preferred,
1,769 shares issued, 188 shares outstanding at
June 30, 2003 -- 188
Common stock, $0.005 par value, authorized
65,000,000 shares; 37,991,988 and 33,602,990
shares issued and outstanding at June 30, 2004
and 2003, respectively 190 168
Additional paid-in capital 67,367 64,103
Accumulated deficit (54,924) (49,023)
-------- --------
TOTAL STOCKHOLDERS' EQUITY 12,633 15,436
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 16,367 $ 18,920
======== ========
See accompanying notes.
F-5
NUTRITION 21, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)
YEAR ENDED JUNE 30,
--------------------------------------------
2004 2003 2002
------------ ------------ ------------
Net sales $ 9,990 $ 10,265 $ 14,314
Other revenues 242 350 354
------------ ------------ ------------
TOTAL REVENUES 10,232 10,615 14,668
Cost of goods sold 2,119 4,129 4,344
------------ ------------ ------------
GROSS PROFIT 8,113 6,486 10,324
Selling, general & administrative expense 9,088 8,201 7,349
Research & development expense 2,382 2,232 1,017
Depreciation & amortization expense 2,497 2,691 2,619
Charges for impairment of intangibles -- 4,443 7,128
------------ ------------ ------------
OPERATING (LOSS) (5,854) (11,081) (7,789)
Interest income 46 64 94
Interest (expense) (25) (33) (110)
Other income -- -- 1,794
------------ ------------ ------------
(LOSS) BEFORE INCOME TAXES (5,833) (11,050) (6,011)
Income taxes (benefit) 68 (544) --
------------ ------------ ------------
NET (LOSS) $ (5,901) $ (10,506) $ (6,011)
============ ============ ============
Basic and diluted (loss) per common share $ (0.16) $ (0.32) $ (0.19)
============ ============ ============
Weighted average number of common
shares - basic and diluted 36,767,826 33,309,371 32,621,918
============ ============ ============
See accompanying notes.
F-6
NUTRITION 21, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands, except share data)
Additional
Preferred Stock Paid-In Accumulated Treasury
Series G Common Stock Capital Deficit Stock Total
Shares $ Shares $ $ $ $ $
------ ------ ---------- ------- -------- --------- ------- --------
Balance at June 30, 2001 941 941 32,342,818 161 63,196 (32,324) -- 31,974
Conversion of Series E preferred
stock to common stock -- -- 155,605 1 193 -- -- 194
Issuance of warrants -- -- -- -- 80 -- -- 80
Preferred stock dividends declared -- -- -- -- -- (51) -- (51)
Premium on redemption of Series F
preferred stock -- -- -- -- -- (115) -- (115)
Conversion of Series G preferred
stock to common stock (470) (470) 686,232 3 467 -- -- --
Repurchase of common stock for
treasury -- -- (136,000) -- -- -- (122) (122)
Net loss for the year -- -- -- -- -- (6,011) -- (6,011)
------ ------ ---------- ------- -------- --------- ------- --------
Balance at June 30, 2002 471 471 33,048,655 165 63,936 (38,501) (122) 25,949
------ ------ ---------- ------- -------- --------- ------- --------
Preferred stock dividends declared -- -- -- -- -- (16) -- (16)
Issuance of warrants -- -- -- -- 47 -- -- 47
Conversion of Series G preferred
stock to common stock (283) (283) 654,335 4 279 -- -- --
Repurchase of common stock for
treasury -- -- (100,000) -- -- -- (38) (38)
Retirement of treasury stock -- -- -- (1) (159) -- 160 --
Net loss for the year -- -- -- -- -- (10,506) -- (10,506)
------ ------ ---------- ------- -------- --------- ------- --------
Balance at June 30, 2003 188 188 33,602,990 168 64,103 (49,023) -- 15,436
------ ------ ---------- ------- -------- --------- ------- --------
Charge for stock appreciation rights -- -- -- -- 35 -- -- 35
Exercise of stock options -- -- 10,000 -- 6 -- -- 6
Issuance of warrants to purchase
95,000 shares of common stock for
services -- -- -- -- 52 -- -- 52
Conversion of Series G preferred stock
to common stock (188) (188) 316,498 2 186 -- -- --
Private placement of common stock -- -- 4,062,500 20 2,985 -- -- 3,005
Net loss for the year -- -- -- -- -- (5,901) -- (5,901)
------ ------ ---------- ------- -------- --------- ------- --------
Balance at June 30, 2004 $ -- $ -- 37,991,988 $ 190 $ 67,367 $ (54,924) $ -- $ 12,633
====== ====== ========== ======= ======== ========= ======= ========
See accompanying notes.
F-7
NUTRITION 21, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
YEAR ENDED JUNE 30,
--------------------------------------
2004 2003 2002
-------- -------- --------
Cash flows from operating activities:
Net (loss) $ (5,901) $(10,506) $ (6,011)
Adjustments to reconcile net (loss) to net
cash (used in)/provided by operating
activities:
Depreciation and amortization 2,497 2,691 2,619
Impairment write-off -- 4,443 7,128
Deferred taxes -- -- (725)
(Gain) loss on disposal of equipment -- 7 (55)
Issuance of warrants for services 52 47 80
Charge for stock appreciation rights 35 -- --
Changes in operating assets and liabilities:
Accounts receivable (202) 1,079 1,744
Other receivables 843 (3) 710
Inventories (28) (60) 231
Prepaid expenses and other current assets (25) 591 26
Other assets 12 21 96
Accounts payable and accrued expenses 231 1,354 (1,391)
-------- -------- --------
Net cash (used in)/provided by
operating activities (2,486) (336) 4,452
-------- -------- --------
Cash flows from investing activities:
Contingent payments for acquisitions (143) (135) (2,770)
Purchases of property and equipment (12) (86) (274)
Payments for patents and trademarks (263) (350) (336)
Proceeds from sale of equipment -- 50 200
Redemption of investments available for sale 3,500 1,000 --
Purchase of investments available for sale (5,500) -- (1,000)
-------- -------- --------
Net cash (used in)/ provided by
investing activities (2,418) 479 (4,180)
-------- -------- --------
Cash flows from financing activities:
Debt repayments -- -- (1,125)
Purchase of common stock for treasury -- (38) (122)
Redemption of redeemable preferred stock -- -- (345)
Proceeds from stock option exercises 6 -- --
Preferred stock dividends paid (2) (20) (61)
Net proceeds from private placement 3,005 -- --
-------- -------- --------
Net cash provided by/(used in)
financing activities 3,009 (58) (1,653)
-------- -------- --------
Net (decrease) increase in cash and cash
equivalents (1,895) 85 (1,381)
Cash and cash equivalents at beginning of year 4,059 3,974 5,355
-------- -------- --------
Cash and cash equivalents at end of year $ 2,164 $ 4,059 $ 3,974
======== ======== ========
See accompanying notes.
F-8
NUTRITION 21, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1: NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
a) Nature of Operations
Nutrition 21, Inc. and its subsidiaries (collectively, the
"Company") is a nutritional bioscience company and the maker of
chromium-based supplements with health benefits substantiated by
clinical research. The Company markets Chromax chromium picolinate,
which is the most studied form of the essential mineral chromium.
The Company's operations related to the licensing of pharmaceutical
products have become less material. Accordingly, effective in fiscal
year 2004, the Company reports on the basis that it is one business
segment.
b) Consolidation
The consolidated financial statements include the accounts of
Nutrition 21, Inc., and its wholly owned subsidiaries. All
intercompany balances and transactions have been eliminated in
consolidation.
c) Use of Estimates
The preparation of the consolidated 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 and
liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements. Estimates also affect the
reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
d) Cash Equivalents and Short-Term Investments
The Company considers all liquid interest-earning investments with a
maturity of three months or less when acquired to be cash
equivalents. Investments with maturities beyond one year may be
classified as short-term based on their highly liquid nature and
because such marketable securities represent the investment in cash
that is available for current operations. All short-term investments
are classified as available for sale and are recorded at market
value. Realized gains and losses are determined using the specific
identification method. Unrealized gains and losses would be
reflected in Accumulated Other Comprehensive Income, if material.
Cash equivalents included in the accompanying financial statements
include money market accounts, bank overnight investments and
commercial paper.
e) Inventories
Inventories, which consist of finished goods, are carried at the
lower of cost (on a first-in, first-out method) or estimated net
realizable value.
f) Property and Equipment
Property and equipment are stated at cost less accumulated
depreciation. Depreciation is provided using the straight-line
method over the related assets' estimated useful lives. The
estimated useful lives are as follows:
Leasehold improvements -- Term of lease
Furniture and fixtures -- 7 years
Machinery and equipment -- 5 to 7 years
Office equipment -- 3 to 5 years
Computer equipment -- 3 to 5 years
g) Patents and Trademarks
The Company capitalizes certain patent and trademark costs. Patent
and trademark costs are amortized over their estimated useful lives,
ranging from 3 to 15 years.
F-9
NUTRITION 21, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1: NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(continued)
h) Revenue Recognition
Sales revenue is recognized when title transfers, upon delivery at
the customer site. There are no customer acceptance provisions to be
met before the recognition of any product revenue. Only revenue
where collectability of accounts receivable is probable is
recognized. Other revenues are comprised primarily of license and
royalty fees recognized as earned in accordance with agreements
entered into by the Company when there is no further involvement
required by the Company. The Company accrues for related product
returns based on historical activity.
i) Research and Development
Research and development costs are expensed as incurred.
j) Income taxes
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for future tax
consequences attributable to the temporary differences between the
financial statement carrying amounts of assets and liabilities and
their respective tax bases and operating loss and tax credit
carryforwards. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply in the years in which
those temporary differences are expected to be recovered or settled.
The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in the period that includes the enactment date.
Deferred tax assets are reduced by a valuation allowance when, in
the opinion of management, it is more likely than not that some
portion or all of the deferred tax assets will not be realized.
k) Stock-based Compensation
The Company continues to account for employee stock-based
compensation using the intrinsic value method prescribed in
Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees." Compensation cost for stock options, if any,
is measured as the excess of the quoted market price of the
Company's stock at the date of grant over the amount an employee
must pay to acquire the stock.
Statement of Financial Accounting Standards ("SFAS") No. 123,
"Accounting for Stock-Based Compensation," established accounting
and disclosure requirements using a fair-value method of accounting
for stock-based employee compensation plans. The Company has elected
to remain on its current method of accounting as described above,
and has adopted the disclosure requirements of SFAS No. 123 and SFAS
No. 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure."
The Company applies the intrinsic value method pursuant to APB
Opinion No. 25 in accounting for its employee stock option plans
and, accordingly, no compensation cost has been recognized in the
consolidated financial statements for its employee stock options,
which have an exercise price equal to the fair value of the stock on
the date of the grant. Had the Company determined compensation cost
based on the fair value at the grant date for its stock options
under SFAS No. 123 and amortized such costs over the vesting period,
the Company's net loss would have been increased to the pro forma
amounts indicated below (in thousands, except per share data):
F-10
NUTRITION 21, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1: NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(continued)
Year-ended
June 30,
2004 2003 2002
---- ---- ----
Net (loss) as reported $(5,901) $(10,506) $(6,011)
Deduct: total stock-based employee
compensation expense determined under
fair value based method for all awards (25) (256) (383)
------- -------- -------
Pro forma net (loss) $(5,926) $(10,762) $(6,394)
======= ======== =======
(Loss) per share
Basic - as reported $(0.16) $(0.32) $(0.19)
Basic - pro forma $(0.16) $(0.32) $(0.20)
Diluted - as reported $(0.16) $(0.32) $(0.19)
Diluted - pro forma $(0.16) $(0.32) $(0.20)
l) Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed
The Company reviews long-lived tangible assets and certain
intangible assets with definite useful lives for impairment whenever
events or changes in circumstances indicate that the carrying amount
of an asset may not be recoverable. Recoverability of assets to be
held and used is measured by a comparison of the carrying amount of
an asset to future undiscounted cash flows expected to be generated
by the asset. If such assets are considered to be impaired, the
impairment to be recognized is measured by the amount by which the
carrying amount of the assets exceeds the fair value. Assets to be
disposed of are reported at the lower of the carrying amount or fair
value less costs to sell.
m) Recently Issued Accounting Standards
In May 2003, the FASB issued SFAS No. 150, "Accounting for Financial
Instruments with Characteristics of Both Liabilities and Equity."
SFAS No. 150, establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both
liabilities and equity. The Company believes this pronouncement will
have no effect on its consolidated financial statements.
n) Advertising costs
Advertising costs are expensed as incurred. The amount charged to
expense during fiscal years 2004, 2003 and 2002 was $0.9 million,
$0.6 million and $0.4 million, respectively.
o) Reclassifications
Certain reclassifications have been made to prior years' financial
statement amounts to conform to the 2004 presentation.
F-11
NUTRITION 21, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2: SHORT-TERM INVESTMENTS
Short-term investments are as June 30,
follows (in thousands):
2004 2003
---- ----
Available for sale:
1.81% corporate bond, maturing 6/1/05 $1,000 $ --
2.03% corporate bond, maturing 12/22/05 1,000 --
------ ------
TOTAL $2,000 $ --
====== ======
The fair value of the short-term investments at June 30, 2004
approximates the carrying value of the investments.
Note 3: FINANCIAL INSTRUMENTS AND MAJOR CUSTOMERS
The fair value of cash and cash equivalents, short-term investments,
accounts receivable and accounts payable approximate carrying amounts
due to the short maturities of these instruments.
Financial instruments that potentially subject the Company to
significant concentrations of credit risk consist principally of cash
and cash equivalents and accounts receivable. Concentrations of credit
risk with respect to accounts receivable are limited as the Company
performs on-going credit evaluations of its customers and maintains
credit insurance on customers' balances. On a periodic basis, the
Company evaluates its accounts receivable and establishes an allowance
for doubtful accounts, based on a history of past write-offs and
collections and current credit considerations. Management does not
believe that significant credit risk exists at June 30, 2004. The
Company places its cash primarily in market interest rate accounts,
overnight investments and short-term investments. The Company had $0.4
million in overnight investments and $1.8 million invested in mutual
money market funds at June 30, 2004.
The Company sells its products to customers in the Americas. The Company
performs ongoing credit evaluations of its customer's financial
condition and limits the amount of credit extended as deemed
appropriate, but generally requires no collateral. The Company maintains
reserves for credit losses based on past write-offs, collections and
current credit evaluations, and, to date, such losses have been within
management's expectations.
In fiscal year 2004 and fiscal year 2003, two customers accounted for
approximately 35% and 27% of net sales, respectively. For fiscal year
2002, one customer accounted for 28% of net sales. In addition, three
customers accounted for 57% of accounts receivable, net at June 30,
2004, while two customers accounted for 40% of accounts receivable, net
at June 30, 2003.
Note 4: RELATED PARTY TRANSACTIONS
A former officer's employment with the Company terminated on September
29, 2000. Effective as of such date, the Company entered into a
consulting agreement with the former officer. The agreement was for the
period from October 1, 2000 through June 30, 2004, and provided for
payment of $206,250 for the period from October 1, 2000 through June 30,
2001, and a fee at an annual rate of $100,000 thereafter. All of the
former officer's stock options (900,000 shares) became fully vested and
became exercisable until June 30, 2004. As of June 30, 2004, no further
payments are required, and all stock options have expired.
F-12
NUTRITION 21, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 5: PROPERTY AND EQUIPMENT, NET
The components of property and equipment, net, at June 30, 2004 and 2003
are as follows (in thousands):
2004 2003
---- ----
Furniture and fixtures $422 $422
Machinery and equipment 135 135
Office equipment & leasehold improvements 542 542
Computer equipment 778 766
------ ------
1,877 1,865
Less: accumulated depreciation and
amortization (1,563) (1,386)
------ ------
Property and equipment, net $314 $479
====== ======
Note 6: PATENTS AND TRADEMARKS, NET
During fiscal years 2004, 2003 and 2002, changes in intangible assets
relate to the investment of $0.2 million, $.05 million and $1.0 million,
respectively, in existing patents, which will be amortized over the
remaining life of the patents, as well as in fiscal year 2003, a $4.4
million impairment charge relating to the discontinuance of the Lite
Bites product line. No significant residual value is estimated for these
intangible assets. Intangible asset amortization expense was $2.3
million for fiscal year 2004, $2.5 million for fiscal year 2003 and $2.4
million for fiscal year 2002. The components of intangible assets were
as follows (in thousands):
June 30,
2004 2003
---------------------- -----------------------
Gross Gross
Carrying Accumulated Carrying Accumulated
Amount Amortization Amount Amortization
-------- ------------ -------- ------------
Patents and licenses $ 8,468 $ (7,246) $ 8,659 $ (5,958)
Trademarks, trade names and
other Intangible assets 15,695 (8,198) 15,287 (7,376)
-------- -------- --------
$ 24,163 $(15,444) $ 23,946 $(13,334)
======== ======== ======== ========
Amortization expense for the net carrying amount of intangible assets at
June 30, 2004 is estimated to be approximately $2.1 million in fiscal
years 2005 through 2008, respectively.
Note 7: ACCOUNTS PAYABLE AND ACCRUED EXPENSES
The following items are included in accounts payable and accrued
expenses at June 30, 2004 and 2003 (in thousands):
2004 2003
------ ------
Accounts payable $1,130 $1,903
Consulting and professional fees payable 172 109
Accrued compensation and related expense 302 160
Accrued termination expense 1,069 --
Other accrued expenses 1,014 1,284
------ ------
$3,687 $3,456
====== ======
Note 8: STOCKHOLDERS' EQUITY
Inducement Plan
The Company adopted a 2002 Inducement Stock Option Plan (the "Inducement
Plan"). The Inducement Plan provides for the grant of options to
purchase shares of the Company's common stock to induce individuals to
become employed by the Company. The aggregate number of shares of common
stock, which may become subject to options shall not exceed 2,500,000.
Approximately 2,500,000 options remain available for grant under the
Inducement Plan at June 30, 2004.
F-13
NUTRITION 21, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 8: STOCKHOLDERS' EQUITY (continued)
Warrants
The Company, from time to time, issues warrants to purchase Common Stock
to non-employees for services rendered. Warrants are granted to purchase
the Company's Common Stock with exercise prices set at fair market value
on the date of grant. The terms of the warrants vary depending on the
circumstances, but generally expire in three to five years.
The Company had outstanding warrants for the purchase of its Common
Stock as follows:
Number of Exercise price
warrants per share
---------- --------------
Outstanding at June 30, 2001 1,132,137 $0.89-$6.30
Issued 160,000 $0.63-$0.74
Exercised -- --
Cancelled (482,137) $1.25-$6.30
--------
Outstanding at June 30, 2002 810,000 $0.63-$3.65
Issued 105,000 $0.40-$0.57
Exercised -- --
Cancelled (70,000) $2.59-$3.62
--------
Outstanding at June 30, 2003 845,000 $0.40-$3.65
Issued 216,950 $0.62-$1.11
Exercised -- --
Cancelled (460,000) $1.17-$3.65
--------
Outstanding at June 30, 2004 601,950 $0.40-$3.26
=======
The warrants expire between 2003 and 2012. Certain of the warrants
include anti-dilution clauses.
Warrants outstanding and exercisable at June 30, 2004 are as follows:
Warrants Outstanding Warrants Exercisable
---------------------------------- ---------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Range of Number Contractual Exercise Number Exercise
Exercise Prices Outstanding Life Price Exercisable Price
--------------- ----------- ----------- -------- ----------- --------
$0.40 - $0.89 400,000 2.47 $0.69 400,000 $0.69
$1.05 - $3.26 201,950 3.47 $1.46 201,950 $1.46
------- -------
601,950 601,950
======= =======
The Company recorded compensation expense associated with the issuance
of warrants to third parties of $52 thousand, $47 thousand and $80
thousand during fiscal years 2004, 2003 and 2002, respectively.
Options
In addition to the Inducement Plan, the Company had adopted five other
Stock Option Plans ("Plans") whereby options to purchase an aggregate of
8,750,000 shares of the Company's common stock may be granted to
employees, consultants and others who render services to the Company.
The exercise price per share for the options granted under these Plans
may not be less than the fair value of the Company's Common Stock on the
date of grant. The options issuable pursuant to the Plans expire between
2004 and 2011. Approximately 651,000 options remain available for grant
under these Plans at June 30, 2004.
F-14
NUTRITION 21, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 8: STOCKHOLDERS' EQUITY (continued)
A summary of stock option activity related to the Company's stock option
plans is as follows:
Number of Exercise price
options per share
--------- --------------
Outstanding at June 30, 2001 2,952,099 $0.81 - $7.56
Issued 1,230,000 $0.55 - $1.23
Exercised -- --
Cancelled (542,110) $0.69 - $7.56
---------
Outstanding at June 30, 2002 3,639,989 $0.55 - $5.63
Issued 3,466,000 $0.31 - $0.71
Exercised -- --
Cancelled (591,987) $0.37 - $3.50
---------
Outstanding at June 30, 2003 6,514,002 $0.31 - $5.63
Issued 632,400 $0.54 - $1.02
Exercised (10,000) $0.76 - $1.03
Cancelled (1,881,616) $0.38 - $5.19
----------
Outstanding at June 30, 2004 5,254,786 $0.31 - $5.63
=========
Each of these options is entitled to one share of common stock. Stock
options generally vest ratably over several years from the date of grant
and expire within ten years from the date of vesting.
Options outstanding and exercisable at June 30, 2004 are as follows:
Options Outstanding Options Exercisable
--------------------------------- ---------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Range of Number Contractual Exercise Number Exercise
Exercise Prices Outstanding Life Price Exercisable Price
--------------- ----------- ----------- -------- ----------- --------
$0.31 - $0.94 3,600,234 8.26 $0.49 1,181,242 $0.54
$1.00 - $1.44 1,043,352 6.89 $1.18 848,649 $1.19
$1.50 - $2.94 421,200 3.92 $2.23 370,700 $2.27
$3.00 - $5.63 190,000 2.61 $3.66 183,600 $3.50
--------- ---------
5,254,786 2,584,191
========= =========
The per share weighted-average fair value of stock options granted during
fiscal years 2004, 2003 and 2002 was $0.25, $0.06 and $0.15, respectively,
on the date of grant using the Black Scholes option-pricing model with the
following weighted-average assumptions:
2004 2003 2002
---- ---- ----
Risk-free interest rate 2.3% 2.2% 3.8%
Expected life-years 2.5 2.5 2.0
Expected volatility 125.5% 45.4% 45.6%
Expected dividend yield -- -- --
Note 9: SHAREHOLDER RIGHTS PLAN
The Company adopted a Shareholder Rights Plan on September 12, 2002.
Under this plan, the Company distributed, as a dividend, one preferred
share purchase right for each share of Common Stock of the Company held
by stockholders of record as of the close of business on September 25,
2002. The Rights Plan is designed to deter coercive takeover tactics,
including the accumulation of shares in the open market or through
private transactions, and to prevent an acquiror from gaining control of
the Company without offering a fair price to all of the Company's
stockholders. The Rights will expire on September 11, 2012.
F-15
NUTRITION 21, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Each Right entitles stockholders to buy one one-thousandth of a share of
newly created Series H Participating Preferred Stock of the Company for
$3.00 per share. Each one one-thousandth of a share of the Preferred
Stock is designed to be the functional equivalent of one share of Common
Stock. The Rights will be exercisable only if a person or group acquires
beneficial ownership of 15% or more of the Company's Common Stock (30%
in the case of a person or group that is currently a 15% holder) or
commences a tender or exchange offer upon consummation of which such
person or group would beneficially own 15% or more the Company's Common
Stock.
If any person or group (an "Acquiring Person") becomes the beneficial
owner of 15% or more of the Company's Common Stock (30% in the case of a
person that is currently a 15% holder), then (1) the Rights become
exercisable for Common Stock instead of Preferred Stock, (2) the Rights
held by the Acquiring Person and certain affiliated parties become void,
and (3) the Rights held by others are converted into the right to
acquire, at the purchase price specified in the Right, shares of Common
Stock of the Company having a value equal to twice such purchase price.
The Company will generally be entitled to redeem the Rights, at $.001
per right, until 10 days (subject to extension) following a public
announcement that an Acquiring Person has acquired a 15 % position.
Note 10: (LOSS) PER SHARE
The following table sets forth the computation of basic and diluted (
loss) per share for the periods indicated.
Year ended June 30,
------------------------------
2004 2003 2002
---- ---- ----
Basic and diluted (loss) per share:
Net (loss) $(5,901) $(10,506) $(6,011)
Less: Dividends on preferred shares -- (16) (51)
Premium on redemption of preferred
stock -- -- (115)
--------- ---------- -----
(Loss) applicable to common stockholders $(5,901) $(10,522) $(6,177)
======= ======== =======
Weighted average shares 36,767,826 33,309,371 32,621,918
========== ========== ==========
Basic and diluted (loss) per share $(0.16) $(0.32) $(0.19)
====== ====== ======
Diluted (loss) per share for the fiscal years ended June 30, 2003 and
2002, does not reflect the incremental shares from the assumed
conversion of preferred stock, options and warrants (505,693 and
396,586 shares respectivley) as the effect of such inclusion would be
anti-dilutive.
Note 11: GOODWILL
The Company adopted SFAS No. 142 effective July 1, 2001. Under SFAS No.
142, goodwill is no longer amortized but reviewed for impairment
annually, or more frequently if certain indicators arise. The Company
was required to complete the initial step of a transitional impairment
test within six months of adoption of SFAS No. 142 and to complete the
final step of the transitional impairment test by the end of the fiscal
year. The initial step was completed in the first quarter of fiscal
2002. In addition, the Company assesses the impairment of identifiable
intangible assets and goodwill whenever events or changes in
circumstances indicate that the carrying value of the relevant assets
may not be recoverable. Management's judgment regarding the existence of
impairment is based on factors such as significant changes in the manner
or the use of acquired assets or the Company's overall business
strategy; significant negative industry or economic trends; significant
declines in the Company's stock price for a sustained period and the
Company's market capitalization relative to book value. Upon adoption,
goodwill in the amount of $4.1 million which was included in patents and
trademarks since acquisition (although accounted for separately by the
Company and included therein because of its estimated economic life) was
reclassified in the accompanying balance sheets in accordance with the
requirements of SFAS No. 142. Due to declining market conditions, as
well as a change in business strategy, it was determined that a $7.1
million impairment charge was warranted in fiscal year 2002. The Company
used a discounted cash flow analysis for purposes of estimating the fair
value of its reporting unit.
F-16
NUTRITION 21, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 12: PENSION PLAN
Eligible employees of the Company are entitled to participate in the
Burns Philp Inc. Retirement Plan for Non-Bargaining Union Employees (the
"Pension Plan"), a defined benefit pension plan, as long as Burn Philp
maintains the Pension Plan and owns at least 20% of the Company's
outstanding Common Stock. At June 30, 2004, Burns Philp held
approximately 20% of the Company's outstanding Common Stock.
During fiscal years 2004, 2003, and 2002, the Company made contributions
to the Pension Plan of $239 thousand, $131 thousand and $106 thousand,
respectively. As of August 3, 2004, Burns Philp's ownership of the
Company's outstanding common stock fell below 20%. Burns Philp has
notified the Company that no further pension benefits will be earned for
services performed or compensation paid on or after September 19, 2004.
Service with the Company after September 19, 2004 will be considered
solely for purposes of vesting and for determining eligibility for early
retirement benefits.
Note 13: INCOME TAXES
The provisions for income taxes for the fiscal years ended June 30,
2004, 2003 and 2002 consist of the following (in thousands):
2004 2003 2002
---- ---- ----
Current $ 68 $(1,182) $ 725
Deferred -- 638 (725)
---- ------- -----
$ 68 $ (544) $ --
==== -====== =====
Income taxes attributed to pre-tax ( loss) income differed from the
amounts computed by applying the US federal statutory tax rate to
pre-tax income as a result of the following (in thousands):
2004 2003 2002
---- ---- ----
Income taxes at U.S. statutory rate $(1,983) $(3,757) $(2,044)
Increase/(reduction) in income taxes
resulting from:
Change in valuation allowance 1,983 4,184 1,607
Goodwill book basis in excess of tax -- -- 263
State taxes, net of federal 68 (663) (268)
Other items -- (308) 442
------- ------- -------
$ 68 $ (544) $ --
======= ======= =======
The tax effects of temporary differences that give rise to deferred taxes
and deferred tax assets and deferred tax liabilities at June 30, 2004 and
2003 are presented below (in thousands):
2004 2003
---- ----
Deferred tax assets:
Net operating loss carryforwards $ 4,392 $ 2,920
Accrued expenses 833 580
Inventory reserve 2 95
Intangible and fixed assets 4,886 2,188
Other 3 8
-------- -------
Total gross deferred tax assets 10,116 5,791
Less valuation allowance (10,116) (5,791)
-------- -------
Net deferred tax assets $ -- $ --
======== =======
F-17
NUTRITION 21, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 13: INCOME TAXES (continued)
At June 30, 2004, the Company has available, for federal and state
income tax purposes, net operating loss carry forwards of approximately
$10.7 million and $12.7 million, respectively, expiring through 2024.
Ultimate utilization of such net operating loss carryforwards may be
significantly curtailed if a significant change in ownership of the
Company were to occur. A valuation allowance is provided when it is more
likely than not that some portion or all of the deferred tax assets will
not be realized.
Note 14: COMMITMENTS AND CONTINGENT LIABILITIES
On September 3, 2004, QVC filed a suit against the Company alleging that
QVC has the right to return product to the Company and receive a payment
of $551,715, and for $5,706 for certain services QVC allegedly rendered
to the Company. QVC's purchase orders provide QVC the right to return
product, provided the requests for return are made within certain time
periods. The Company has reviewed its records and believes that QVC's
requests for return were not timely. The Company is unable to predict
the outcome of this matter.
The Company and the Federal Trade Commission (FTC) are discussing
whether the Company should have any liability for weight loss
advertising claims that were made on QVC, Inc. for the Company's Lite
Bites(R) products. On March 24, 2004, the FTC sued QVC in the U.S.
District Court for the Eastern District of Pennsylvania for these claims
and for claims made on QVC for other products. QVC has in the same
lawsuit filed on April 14, 2004, Third-Party Complaints for damages
against six parties including the Company (Third-Party Defendants). The
FTC and the Third-Party Defendants have filed Motions to Strike QVC's
Third-Party Complaints. The Company discontinued the Lite Bites product
line in fiscal year 2003. Neither the FTC nor QVC has set forth an
amount being sought as damages, nor can the Company estimate its
exposure.
On March 19, 2003, Andrew Wertheim (a former Executive Officer)
initiated an arbitration with the American Arbitration Association
against the Company in connection with his termination of employment. On
July 24, 2004, an arbitrator awarded Mr. Wertheim (1) damages of
$268,477 for salary and benefits, (2) $708,750 related to stock options,
and (3) interest of $92,151 (see Note 7). The Company believes that the
arbitrator's award is in error. Accordingly, on August 3, 2004, the
Company filed an action in the United States District Court for the
Southern District of New York against Mr. Wertheim seeking to vacate the
arbitration award. On August 16, 2004, the Company filed a Motion to
Vacate the part of the award that relates to the stock options, i.e.
$708,750 plus interest.
The Company entered into a three-year employment agreement with Gail
Montgomery as President and Chief Executive Officer, effective as of
September 1, 2002. The agreement provides for an annual salary of
$275,000, $300,000, and $325,000 in the successive years under the
agreement, and for performance bonuses based on achieving defined
revenue targets. Ms. Montgomery is also entitled to additional payments
equal to one year's salary plus an additional month of salary for
defined years of service, if her employment is terminated without cause
before the agreement expires, or if the Company fails to offer to enter
into a new one-year agreement upon expiration. If Ms. Montgomery's
employment is terminated or she resigns within six months after a change
of control (as defined) the Company will pay to her 2.99 times her
annual salary and previous year's bonus plus certain gross-ups, but
these payments will be reduced to the extent necessary to prevent the
application of Section 280G of the Internal Revenue Code. The Company in
July 2002 granted to Ms. Montgomery options to purchase an aggregate of
850,000 shares of common stock at $0.39 per share, and 325,000 stock
appreciation rights ("SAR") on the same general terms as the option
grant, except that upon exercise of the SAR the Company will pay to her
the SAR's in-the-money value in cash or common stock.
The Company entered into a four-year agreement with Benjamin Sporn
effective as of September 1, 2002, which provides for his services as
Senior Vice President, General Counsel, and Secretary as an employee
during the first two years of the term and as General Counsel as a
consultant during the balance of the term. Mr. Sporn's salary and fees
will be $207,500, $225,000, $150,000 and $100,000 in successive years
under the agreement, plus performance bonuses based on achieving defined
revenue targets. Mr. Sporn is also entitled to additional payments equal
to two years' salary if his employment is terminated without cause
before the agreement expires. If Mr. Sporn's employment is terminated or
he resigns within six months after a change of control (as defined) the
Company will pay to him 2.99 times his annual salary and previous year's
bonus plus certain gross-ups, but these payments will be reduced to the
F-18
NUTRITION 21, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 14: COMMITMENTS AND CONTINGENT LIABILITIES (continued)
extent necessary to prevent the application of Section 280G of the
Internal Revenue Code. The Company in July 2002 granted to Mr. Sporn
options to purchase an aggregate of 225,000 shares of the Company's
Common Stock at $0.39 per share.
Effective as of September 16, 2002, the Company entered into a
three-year employment agreement with Paul Intlekofer, who has served as
Chief Financial Officer and Senior Vice President, Corporate Development
since January 17, 2003. The agreement provides for an annual salary of
$200,000, $225,000, and $250,000 in the successive years under the
agreement, and for performance bonuses based on achieving defined
revenue targets. Mr. Intlekofer is also entitled to additional payments
equal to one year's salary if his employment is terminated without cause
before the agreement expires. If Mr. Intlekofer's employment is
terminated or he resigns within six months after a change of control (as
defined) the Company will pay to him 2.99 times his annual salary and
previous year's bonus plus certain gross-ups, but these payments will be
reduced to the extent necessary to prevent the application of Section
280G of the Internal Revenue Code. The Company, in accordance with the
agreement, granted to Mr. Paul Intlekofer options to purchase an
aggregate 550,000 shares of the Company's common stock at $0.40 per
share.
In October 1995, the Company entered into an exclusive license agreement
whereby the Company received a license to sell a patented salt
alternative in the United States. During the term of the license, the
Company agreed to pay a royalty of 4.5% of net sales of the salt
alternative. The Company is required to make royalty payments quarterly
through 2007. In connection with this agreement, the Company recorded
royalty expense of $2 thousand for the fiscal year ended June 30, 2004;
$2 thousand for the fiscal year ended June 30, 2003 and $0.2 million for
the fiscal year ended June 30, 2002.
The Company has entered into various research and license agreements
with certain universities to supplement the Company's research
activities and to obtain for the Company rights to certain technology.
The agreements generally require the Company to fund the research and to
pay royalties based upon a percentage of product sales.
The Company leases certain office space in the United States. The lease
expires in the year 2006. Rent expense under this operating lease was
approximately $0.4 million in fiscal year 2004, $0.4 million in fiscal
year 2003, and $0.5 million in fiscal year 2002. Future non-cancelable
minimum payments under this lease are as follows (in thousands):
Fiscal Year Amount
----------- ------
2005 370
2006 278
-----
Total $648
====
In connection with the Company's purchase agreement for Nutrition 21 on
August 11, 1997, the Company made cash payments in fiscal years 2004,
2003 and 2002 of $143 thousand, $135 thousand and $1.8 million,
respectively. In fiscal year 2002, the Company paid $1.0 million in
satisfaction of the contingent payment requirement to the owners of
Optimum Lifestyle, Inc.
Note 15: SUPPLEMENTAL CASH FLOW INFORMATION
Year ended June 30,
2004 2003 2002
---- ---- ----
Supplemental disclosure of cash flow information
(in thousands)
Cash paid for interest $ -- $33 $ 62
Cash paid for income taxes 2 41 504
Supplemental schedule of non-cash financing activities:
Obligation for Nutrition 21 contingent payment 21 26 369
Obligation for Lite Bites contingent payment -- -- 589
Issuance of common stock for Series G conversion 188 283 --
F-19
NUTRITION 21, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 16: QUARTERLY FINANCIAL INFORMATION (unaudited)
First Second Third Fourth
In thousands, except per share data Quarter Quarter Quarter Quarter (a)
----------------------------------- ------- ------- ------- -----------
Fiscal Year 2004
----------------
Revenues $2,358 $2,395 $2,648 $2,831
Gross Profit 1,795 1,813 2,197 2,308
(Loss) before income taxes (1,013) (1,248) (1,020) (2,552)
Net (Loss) (1,013) (1,248) (1,020) (2,620)
Net (Loss) per common share:
Basic $(0.03) $(0.03) $(0.03) $(0.07)
Diluted $(0.03) $(0.03) $(0.03) $(0.07)
Fiscal Year 2003
----------------
Revenues $3,315 $2,334 $3,132 $1,834
Gross Profit 2,506 1,352 2,115 513
(Loss) before income taxes (112) (2,270) (1,449) (7,219)
Net (Loss) (112) (2,270) (1,143) (6,981)
Net (Loss) per common share:
Basic $(0.00) $(0.07) $(0.03) $(0.22)
Diluted $(0.00) $(0.07) $(0.03) $(0.22)
(a) The fourth quarter of fiscal year 2003 includes $4.4 million of
non-cash charges for impairment of intangibles.
F-20
SCHEDULE II
NUTRITION 21, INC.
VALUATION AND QUALIFYING ACCOUNTS
Balance Charged Additions
Beginning to Cost Charged to Balance
of and Other End
Accounts Year Expense Accounts Deductions of Year
-------- --------- -------- ---------- ---------- -------
($ in thousands)
Year ended June 30, 2004
Allowance for Doubtful
Accounts 430 (411) -- (9) 10
Deferred Tax Valuation
Allowance 5,791 1,983 2,342*** -- 10,116
Allowance for returns and
allowances 1,060 -- (190) (354) 516*
Allowance for inventory
obsolescence 237 -- -- (231) 6
Year ended June 30, 2003
Allowance for Doubtful
Accounts 19 -- 411 -- 430
Deferred Tax Valuation
Allowance 1,607 4,184 -- -- 5,791
Allowance for returns and
allowances 140 920 1,060*
Allowance for inventory
obsolescence 1 236 -- -- 237
Year ended June 30, 2002
Allowance for Doubtful
Accounts 45 -- -- (26) 19
Deferred Tax Valuation
Allowance 1,360 1,607 (1,360)** -- 1,607
Allowance for returns and
allowances 117 23 0 140*
Allowance for inventory
obsolescence 31 (30) -- -- 1
* Included in accrued expenses in the consolidated balance sheets.
** Reclassified to reflect a deferred tax liability on acquired amortizable
intangibles basis differences.
*** Reclassification of deferred tax assets and related valuation allowance.
F-21