Item 1. Business
We were incorporated in Delaware in 1993 and maintain our principal executive offices at 1400 Kearns Boulevard, 2nd Floor, Park City, Utah, 84060. For convenience in this report, the terms "Company," "Nutraceutical," "we" and "us" may be used to refer to Nutraceutical International Corporation and/or its subsidiaries, except where indicated otherwise. Our telephone number is (435) 655-6106.
General
We are an integrated manufacturer, marketer, distributor and retailer of branded nutritional supplements and other natural products sold primarily to and through domestic health and natural food stores. Internationally, we market and distribute branded nutritional supplements and other natural products to and through health and natural product distributors and retailers. Our core business strategy is to acquire, integrate and operate businesses in the natural products industry that manufacture, market and distribute branded nutritional supplements. We believe that the consolidation and integration of these acquired businesses provides ongoing financial synergies through increased scale and market penetration, as well as strengthened customer relationships.
We manufacture and sell nutritional supplements and other natural products under numerous brands including Solaray®, KAL®, Nature's Life®, LifeTime®, Natural Balance®, bioAllers®, Herbs for Kids™, NaturalCare®, Health from the Sun®, Life-flo®, Organix-South®, Pioneer® and Monarch Nutraceuticals™.
We own neighborhood natural food markets, which operate under the trade names The Real Food Company™, Thom's Natural Foods™ and Cornucopia Community Market™. We also own health food stores, which operate under the trade names Fresh Vitamins™ and Granola's™.
We manufacture and/or distribute one of the broadest branded product lines in the industry with over 5,500 individual stock keeping units (SKUs), including over 700 SKUs sold internationally. We believe that as a result of our emphasis on innovation, quality, loyalty, education and customer service, our brands are widely recognized in health and natural food stores and among their customers.
We were formed in 1993 to effect a consolidation strategy in the fragmented vitamin, mineral, herbal and other nutritional supplements industry (the "VMS Industry"). Since our formation, we have completed thirty acquisitions. As a result of these acquisitions, internal growth and cost management, we believe that we are well positioned to continue to capitalize on the consolidation that we believe is occurring in the VMS Industry.
Business Strategy
We target consumers searching for high quality nutritional and other natural products. We believe many of these consumers shop in sales channels that offer meaningful education, service and support to their customers.
The primary channel that offers this type of support to consumers in the United States has been health and natural food stores (the "Healthy Foods Channel"). Our primary focus has been and remains on this channel. This strategy has enabled us to benefit from the growth of the Healthy Foods Channel. The Healthy Foods Channel consists of more than 17,000 retailers, including (i) independent health and natural food stores, (ii) health and natural food stores affiliated with local, regional and national health and natural food chains (including health and natural food store chains, such as Whole Foods Markets, and vitamin store chains, such as Vitamin Shoppe and Vitamin World) and (iii) GNC stores. The Healthy Foods Channel principally caters to our primary target consumers: those who
desire product education, service and high quality nutritional supplements and other natural products. We believe there are significant differences between mass market retailers (such as supermarkets, drugstores and warehouse clubs) that typically offer a limited selection of discounted natural products and lower-potency nutritional supplements and the Healthy Foods Channel, where natural ingredients, quality, potency, selection and customer support are emphasized. The growth rate of the Healthy Foods Channel is not at (and may not return to) levels achieved in the mid-1990s.
We believe we are among the largest suppliers of nutritional supplements to the Healthy Foods Channel that develop, manufacture, market and directly distribute a majority of their own products. We manufactured approximately 70% of our branded products in fiscal 2010 and believe that the quality of our products is among the highest in the industry. We market our branded products through one of the industry's largest sales forces dedicated to the Healthy Foods Channel. We seek to be a market leader in the development of new and innovative products, introducing over 120 new SKUs in fiscal 2010. We believe that we benefit from greater customer and product diversification than most of our larger competitors.
We believe that consumers seeking high quality products are also purchasing them through other channels, such as products available through health care practitioners and direct to consumer channels and we continue to seek opportunities through acquisitions to explore reaching our target consumers through these and additional channels.
Industry
According to Nutrition Business Journal, the total retail natural products market (the "Natural Products Market") is highly fragmented and totaled approximately $108.3 billion in retail sales in calendar 2009. The Natural Products Market is comprised of the following submarkets (with estimated calendar 2009 sales indicated): (i) personal care, $10.4 billion, (ii) natural and organic foods, $33.7 billion, (iii) functional foods, $37.3 billion and (iv) vitamins, minerals and supplements, $26.9 billion. Historically, our primary focus has been on vitamins, minerals and supplements (the "VMS Market"), but recently we have increased our effort in other areas within the Natural Products Market.
The total retail VMS Market is highly fragmented with estimated sales of $26.9 billion in calendar 2009, $25.2 billion in calendar 2008 and $23.7 billion in calendar 2007. We believe that the VMS Market reached its present size due to a number of factors, including (i) interest in healthier lifestyles, living longer and living well, (ii) the publication of research findings supporting the positive health effects of certain nutritional supplements and (iii) the aging of the "Baby Boom" generation combined with the tendency of consumers to purchase more nutritional supplements and natural foods as they age. Over the last few years, some publicly-traded companies in the Natural Products Market and industry analysts have commented on slowing growth trends and/or ongoing softness in sales of some nutritional supplements. We believe this may be the result of, among other things, the lack of any recent industry-wide "hit" products, negative press releases regarding certain ingredients and companies in the VMS Market and increased market and pricing competition, as well as competition from food and pharmaceutical companies.
Products
We primarily manufacture and market nutritional supplements and also sell certain other natural products. As of September 30, 2010, we sold over 5,500 SKUs, including over 700 SKUs sold internationally, under approximately 45 different brands. Our products include: (i) vitamins and minerals, (ii) herbs, (iii) specialty formulas, (iv) personal care products, (v) homeopathics, (vi) functional foods and (vii) other products. To accommodate consumer preferences, our products
come in various formulations and delivery forms, including capsules, tablets, softgels, chewables, liquids, creams, sprays, powders and whole herbs.
We currently market our products through a multiple brand strategy to offer more customer choice and to encourage retailers to allocate additional shelf space to our brands. We have worked to enhance the strength of our brands by instituting business strategies that have included (i) consolidating or expanding our sales force in certain areas, as appropriate, to maximize each brand's geographic coverage, (ii) performance and growth-based incentives for sales representatives, (iii) introducing more sophisticated management information systems and (iv) periodic updating to brand packaging.
We also act as a distributor to the Healthy Foods Channel and to certain international markets for certain third-party brands.
Research and Development; Quality Control
We have a commitment to research and development and to introducing innovative products to correspond with consumer trends and scientific research. We believe that product quality and innovation are fundamental to our long-term growth and success. Through our research and development efforts, we seek to (i) test the safety, purity and potency of products, (ii) develop more effective and efficient means of producing ingredients for use in products, (iii) develop testing methods for ensuring and verifying the consistency of the dosage of ingredients included in our products, (iv) develop new, more effective product delivery forms and (v) develop new products either by combining existing ingredients used in nutritional supplements or identifying new ingredients that can be used in nutritional supplements. Our efforts are designed to lead not only to the development of new and improved products, but also to ensure effective manufacturing quality control measures. For the years ended September 30, 2008, 2009 and 2010, we incurred $1.1 million, $3.0 million and $3.9 million, respectively, in research and development expenditures.
We have entered into a cooperative arrangement with Weber State University in Ogden, Utah through which, among other things, the university provides us with access to certain laboratory space and equipment. We also conduct research and development in our own facilities. We currently employ various professionals in research and development and quality control with degrees in, among other things, chemistry, microbiology and engineering and, in many cases, these professionals have also received training in natural health food products. In addition, we retain the services of outside laboratories from time to time to validate our product standards and manufacturing protocols.
Our quality control program seeks to ensure the superior quality of our products and that they are manufactured in accordance with current Good Manufacturing Practices ("GMPs"). Our processing methods are monitored closely to ensure that only quality ingredients are used and to ensure product purity. Periodically, we retain the services of outside GMP audit and/or consulting firms to assist in our efforts to comply with GMPs.
Marketing and Sales
We believe our marketing and sales efforts help to promote demand for our products by educating retailers, who in turn educate their customers, as to the quality and attributes of our natural nutritional supplements and other products. Our branded products are currently sold in the United States primarily in the Healthy Foods Channel. We believe that our products are attractive to retailers in the Healthy Foods Channel due to factors such as the strength of our brand names, the breadth of our product offerings, the quality and potency of our products and the availability of service, sales support and educational materials. We have developed various Internet sites (including http://www.nutraceutical.com) that provide information about our branded lines and the various products within each brand. We have included our Internet site here and elsewhere only as an inactive textual
reference. The information contained on the Internet site is not incorporated by reference into this Annual Report on Form 10-K.
We employ a sales force dedicated to the Healthy Foods Channel. Our sales representatives regularly visit each assigned health and natural food store in their respective areas to assist in the solicitation of orders for products and provide related product sales assistance. We monitor and periodically update our payment structure for our sales force in order to ensure that appropriate incentives are provided for sales growth. We also sell products directly to certain retailers through our telephone customer service organization and certain products to both retailers and distributors. We have organized our marketing and sales force under a subsidiary company, NutraBrands, Inc.
Our marketing efforts are focused on product development, in-store marketing support and educating retailers to enhance their knowledge and awareness of our products and to enable them to then educate their customers about our products. Our marketing efforts are designed to foster relationships with our customers in the Healthy Foods Channel and to increase retailer and consumer awareness of our products.
Au Naturel, Inc., a subsidiary of Nutraceutical, was formed in fiscal 1995 for the purpose of marketing and/or selling our branded products internationally. During fiscal 2010, Au Naturel marketed products to distributors and other customers in over 60 countries. Au Naturel markets domestic branded products as well as custom labeled versions of its domestic branded products internationally; however, many of its products must be modified to meet the specific labeling requirements of the relevant foreign country. In most foreign markets, Au Naturel sells to local distributors. However, in certain foreign markets (including the United Kingdom, the Netherlands, Norway, Sweden and Japan), Au Naturel markets and sells its products directly to retailers. Au Naturel is not currently selling products in Canada.
Monarch Nutraceuticals, Inc., a subsidiary of Nutraceutical, markets branded bulk products and custom blends. Monarch conducts marketing and sales for bulk materials domestically through a separate sales force and internationally directly to manufacturers and through distributors.
Manufacturing
Our manufacturing process generally consists of the following operations: (i) sourcing ingredients for products, (ii) warehousing raw ingredients, (iii) measuring ingredients for inclusion in products, (iv) blending, grinding, and chilsonating ingredients into a mixture with a homogeneous consistency and (v) encapsulating, tableting, pouring, pouching, bagging or boxing the blended mixture into the appropriate dosage form using either automatic or semiautomatic equipment. The next step, bottling and packaging, involves placing the product in packaging with appropriate tamper-evident features and sending the packaged product to a distribution point for delivery to retailers. We place special emphasis on quality control, including raw material verification, homogeneity testing, weight deviation measurements and package quality sampling. See "Research and Development; Quality Control."
We manufactured approximately 70% of our branded products in fiscal 2010, based on net sales. By manufacturing the majority of our own products, we believe that we maintain better control over product quality and availability while also reducing production costs. Our manufacturing operations are performed primarily in our facilities located in the greater Ogden, Utah area, although we also have a cream manufacturing operation in Phoenix, Arizona. We have a working relationship with numerous outside manufacturers, including softgel manufacturers and packagers and utilize these outside sources from time to time. Manufacturing backlogs, to the extent they may exist from time to time, do not have a material impact on delivery time to the customer. We have organized our manufacturing operations under a subsidiary company, NutraPure, Inc.
Management Information and Communication Systems
We use customized computer software systems, as well as commercially packaged software, for handling order entry and invoicing, manufacturing, inventory management, shipping, warehouse operations, customer service inquiries, accounting operations and management information. We believe that these systems have improved operating efficiencies and customer service.
Materials and Suppliers
We employ a purchasing staff that works with marketing, product development, formulations and quality control personnel to source raw materials for products as well as other items purchased by us. Raw materials are sourced principally from the United States, Europe and China. Raw materials used by us are available from a variety of suppliers and no one supplier accounted for more than 6% of our total raw material purchases in fiscal 2010. We seek to mitigate the risk of a shortage of raw materials through our relationships with our principal suppliers, including identification of alternative suppliers for the same, or similar, raw materials where available. We also manufacture bulk branded products to allow more extensive vertical integration and to improve the quality and consistency of raw materials.
Government Regulation
The formulation, manufacturing, packaging, labeling, advertising, distribution and sale (hereafter, "sale" or "sold" may be used to signify all of these activities) of our products are subject to regulation by one or more federal agencies, principally the Food and Drug Administration ("FDA") and the Federal Trade Commission ("FTC"), and to a lesser extent the Consumer Product Safety Commission ("CPSC"), the United States Department of Agriculture and the Environmental Protection Agency. Our activities are also regulated by various governmental agencies for the states and localities in which our products are sold, as well as by governmental agencies in certain countries outside the United States in which our products are sold. Among other matters, regulation by the FDA and FTC is concerned with product safety and claims made with respect to a product's ability to provide health-related benefits. Specifically, the FDA, under the Federal Food, Drug, and Cosmetic Act ("FDCA"), regulates the formulation, manufacturing, packaging, labeling, distribution and sale of food, including dietary supplements, and over-the-counter drugs. The FTC regulates the advertising of these products. The National Advertising Division ("NAD") of the Council of Better Business Bureaus oversees an industry-sponsored self-regulatory system that permits competitors to resolve disputes over advertising claims. The NAD has no enforcement authority of its own, but may refer matters that appear to violate the Federal Trade Commission Act or FDCA to the FTC or FDA for further action, as appropriate.
Federal agencies, primarily the FDA and FTC, have a variety of procedures and enforcement remedies available to them, including initiating investigations, issuing warning letters and cease and desist orders, requiring corrective labeling or advertising, requiring consumer redress (for example, requiring that a company offer to repurchase products previously sold to consumers), seeking injunctive relief or product seizures, imposing civil penalties, or commencing criminal prosecution. In addition, certain state agencies have similar authority. These federal and state agencies have in the past used these remedies in regulating participants in the food, dietary supplement and over-the-counter drug industries, including the imposition of civil penalties in the millions of dollars against a few industry participants.
The Dietary Supplement Health and Education Act ("DSHEA") was enacted in 1994, amending the FDCA. We believe DSHEA is generally favorable to consumers and to the dietary supplement industry. DSHEA establishes a statutory class of "dietary supplements," which includes vitamins, minerals, herbs, amino acids and other dietary ingredients for human use to supplement the diet. Dietary ingredients marketed in the United States before October 15, 1994 may be marketed without the submission of a "new dietary ingredient" ("NDI") premarket notification to the FDA. Dietary
ingredients not marketed in the United States before October 15, 1994 may require the submission, at least 75 days before marketing, of an NDI notification containing information establishing that the ingredient is reasonably expected to be safe for its intended use. Among other things, DSHEA prevents the FDA from regulating dietary ingredients in dietary supplements as "food additives" and allows the use of statements of nutritional support on product labels and in labeling. The FDA has issued final regulations under DSHEA and has indicated that further guidance and regulations are forthcoming. Several bills to amend DSHEA in ways that would make this law less favorable to consumers and industry have been proposed in Congress.
Some of our products are regulated as foods under the Nutrition Labeling and Education Act of 1990 ("NLEA"). The NLEA established requirements for ingredient and nutrition labeling and labeling claims for foods. If the NLEA labeling requirements change at a future time, we may need to revise our product labeling. Most of our products are classified as dietary supplements.
On February 11, 2004, the FDA issued a final rule, effective on April 12, 2004, banning the sale of dietary supplement products containing ephedrine alkaloids and announcing a risk/benefit test that could potentially apply to other types of dietary supplements. We filed a lawsuit on May 3, 2004 in the Federal District Court in the State of Utah challenging the FDA over the final rule. This litigation ended in 2007 in two related decisions. Under one of these decisions, our petition for a writ of certiorari to the U.S. Supreme Court was denied on May 14, 2007. However, in a related decision on March 16, 2007 (which was not part of our petition for a writ of certiorari), the Federal District Court in Utah ruled in favor of the FDA but held that the risk-benefit test announced in the FDA's final rule only applied to dietary supplements containing ephedrine alkaloids. Neither we nor the FDA appealed this decision. We stopped shipping any products containing ephedrine alkaloids to our retail customers in April 2004. We do not currently manufacture any products containing ephedrine alkaloids.
On October 20, 2004, the FDA announced a new strategy initiative to enforce and implement DSHEA and held a public meeting on November 15, 2004. The FDA requested comments on its premarket notification program for new dietary ingredients from industry, consumers, and other interested members of the public concerning the content and format requirements for new dietary ingredient notifications made under the FDCA and the type, quantity, and quality of information that a notifier should provide in notifications under section 413 (a)(2) of the Act. The FDA has stated that the agency intends to issue guidance on new dietary ingredients, and it is possible that the FDA may make it more difficult for companies to market dietary supplement products that contain new dietary ingredients. The FDA's October 20, 2004 announcement also outlined other potential strategy and enforcement initiatives relating to dietary supplements.
The FDA issued a Final Rule on Good Manufacturing Practices ("GMPs") for dietary supplements on June 22, 2007. Since our manufacturing subsidiary has less than 500 employees, our effective compliance date was June 22, 2009. The GMPs cover manufacturers and holders of finished dietary supplement products, including dietary supplement products manufactured outside the United States that are imported for sale into the United States. Among other things, the new GMPs: (a) require identity testing on all incoming dietary ingredients, (b) call for a "scientifically valid system" for ensuring finished products meet all specifications, (c) include requirements related to process controls, including statistical sampling of finished batches for testing and requirements for written procedures and (d) require extensive recordkeeping. We have reviewed the GMPs and have taken steps to ensure compliance. While we believe we are in compliance, there can be no assurance that our operations or those of our suppliers will be in compliance in all respects at all times. Additionally, there is a potential risk of increased audits as the FDA and other regulators seek to ensure compliance with the GMPs.
The FTC and FDA have pursued a coordinated effort to challenge what they consider to be unsubstantiated and unsafe weight-loss products, and have also coordinated enforcement against dietary supplement claims in other areas, including children's products. Their efforts to date have focused on manufacturers and marketers as well as media outlets, and have resulted in a significant number of investigations and enforcement actions, some resulting in civil penalties under the Federal Trade Commission Act of several million dollars.
On December 22, 2006 Congress passed the Dietary Supplement and Nonprescription Drug Consumer Protection Act, which went into effect on December 22, 2007. The law requires, among other things, that companies that manufacture or distribute nonprescription drugs or dietary supplements report serious adverse events allegedly associated with their products to the FDA and institute recordkeeping requirements for all adverse events (serious and non-serious). There is a risk that consumers, the press and government regulators could misinterpret reported serious adverse events as evidence of causation by the ingredient or product complained of, which could lead to additional regulations, banned ingredients or products, increased insurance costs and a potential increase in product liability litigation, among other things.
The Food and Drug Administration Amendments Act of 2007 amended the FDCA to prohibit, with certain exceptions, the marketing of foods to which a drug or biological product has been added. The meaning of this new provision is unclear, and FDA has requested comments on it. This new provision could have an impact on the marketing of some of our products.
The Consumer Product Safety Improvement Act of 2008 ("CPSIA") primarily addresses children's product safety but also improves the administrative process of the Consumer Product Safety Commission. Among other things, the CPSIA requires testing and certification of certain products and enhances the CPSC's authority to order recalls.
The sale of our products in countries outside the United States is regulated by the governments of those countries. Our plans to commence or expand sales in those countries may be prevented or delayed or even suspended by such regulations or by regulators in those countries. In countries in which we have distributors, compliance with such regulations is generally undertaken by our distributors, but even in these cases we assist with such compliance and in many cases may be liable if a distributor fails to comply. These distributors are independent contractors over whom we have limited control. In certain countries, we distribute our products through our own subsidiary or branch; in these countries we retain responsibility for compliance with all applicable regulations. These countries currently include the United Kingdom, the Netherlands, Norway, Sweden and Japan.
Norway is our largest international market. Norway's regulatory environment is similar to other countries in the European Union. In some countries or areas, such as the European Union and Norway, there are new regulations or proposed regulations that may or will prohibit the sale of certain products or certain combination products (such as products containing both vitamins and botanicals) or the use of certain common ingredients, or levels above certain established limits.
As a result of our efforts to comply with applicable statutes and regulations, we have from time to time reformulated, eliminated or relabeled certain of our products and revised certain provisions of our marketing and sales program. We have also suspended or halted sales in certain cases.
Competition
The Natural Products Market and the VMS Market are highly competitive. Our principal competitors in the VMS Market that sell to the Healthy Foods Channel include a number of large, nationally known brands (such as Country Life, Enzymatic Therapy, Garden of Life, NBTY (including its Solgar brand), Natrol, Nature's Plus, Nature's Way, Now Foods, and New Chapter) and many smaller brands, manufacturers and distributors of nutritional supplements. We have recently begun to focus on the broader Natural Products Market within the Healthy Foods Channel and within that market there are a number of large, nationally known competitors, such as Hain Celestial. Because both the Natural Products Market and the VMS Market generally have low barriers to entry, additional competitors enter the market regularly.
Private label products of our customers also provide competition to our products. For example, a substantial portion of GNC's vitamin and mineral supplement offerings are offered under GNC's own private label. Whole Foods, Vitamin Shoppe and many health and natural food stores also sell a portion of their offerings under their own private labels. Private label products are often sold at a discount to branded products. We have positioned certain of our brands to meet the needs of our customers in this area of the VMS Market.
We believe that health and natural food stores are increasingly likely to align themselves with those companies that offer a wide variety of high quality products, have a loyal consumer base, support their brands with strong marketing and education programs and provide consistently high levels of customer service. We believe that we compete favorably with other nutritional supplement companies because of our comprehensive line of products and brands, premium brand names, commitment to quality, ability to rapidly introduce innovative products, competitive pricing, strong and effective sales force and distribution strategy and sophisticated marketing and promotional support. The wide variety and diversity of the forms, potencies and categories of our products are important points of differentiation between us and many of our competitors.
With regard to the mass market retail channel of distribution, our sales are focused primarily in limited SKUs in the Body Gold®, Sayge® and NaturalCare® lines. All of these lines were focused on the mass market channel when acquired. We do not consider this channel to be an area of primary focus. It is possible that as increasing numbers of companies sell nutritional supplement products and other natural products in the mass market channels (such as Nature Made, NBTY, Schiff and Hain Celestial), these product offerings may affect sales in the Healthy Foods Channel. We also compete with distributors that sell products to the Healthy Foods Channel as well as the mass market retail channel (such as Nature's Best, Select Nutrition and Tree of Life). In addition, several major pharmaceutical companies continue to offer nutritional supplement lines in the mass market, including Wyeth (Centrum) and Bayer (One-A-Day). Some of these nutritional supplements purport to use proprietary manufacturing techniques or delivery forms. Moreover, pharmaceutical companies offer prescription and over-the-counter products that are or may be competitive with nutritional supplements, particularly with regard to certain categories of products.
Intellectual Property
We own more than 250 trademarks that have been registered with the United States Patent and Trademark Office and have filed applications to register additional trademarks. In addition, we claim domestic trademark and service mark rights in numerous additional marks that we use. We own a number of trademark registrations in countries outside the United States. Federally registered trademarks in the United States have a perpetual life, as long as they are maintained and renewed on a timely basis and used properly as trademarks, subject to the rights of third parties to seek cancellation of the trademarks if they claim priority or confusion of usage. Most foreign trademark offices use similar trademark renewal processes. We regard our trademarks and other proprietary rights as
valuable assets and believe they make a significant positive contribution to the marketing of our products.
We protect our legal rights concerning our trademarks by appropriate legal action. We rely on common law trademark rights to protect our unregistered trademarks. Common law trademark rights do not provide us with the same level of protection as afforded by a United States federal registration of a trademark. In addition, common law trademark rights are limited to the geographic area in which the trademark is actually used. We have registered and intend to register certain trademarks in certain limited jurisdictions outside the United States where our products are sold, but we may not register all or even some of our trademarks in every country in which we conduct business or intend to conduct business.
We own six U.S. patents and have filed five additional patent applications but generally do not seek patent protection for our products. Our patents expire between July 2017 and December 2025. We sell a number of products that include patented ingredients. We purchase these ingredients from parties that we believe have the right to manufacture and sell those ingredients to us. However, there are a large number of patents that have been granted or applied for in the dietary supplement industry, and there may be an increased possibility that third parties will seek to compel us and our competitors to purchase their patented ingredients or file infringement actions. The cost of these patented ingredients is typically higher than the cost of non-patented ingredients.
We are currently involved in various patent and trademark cases that have arisen in the ordinary course of business. See "Legal Proceedings."
Employees
At September 30, 2010, we employed approximately 685 full-time and approximately 90 part-time employees. None of our employees is represented by a collective bargaining unit. We believe that we have a good relationship with our employees.
Available Information
The SEC maintains an Internet site (http://www.sec.gov) that contains reports, proxy and information statements, and other information regarding us. Our Annual Report on Form 10-K filed with the SEC includes all exhibits required to be filed with the SEC. We make available, free of charge, on our website, our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all amendments to these reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Such reports are available as soon as is reasonably practicable after we electronically file such materials with the SEC. Additionally, copies of this Annual Report on Form 10-K are available without charge upon request. Please contact us to request copies of this Annual Report on Form 10-K (435-655-6106).
Executive Officers
The following table sets forth certain information concerning our executive officers:
Frank W. Gay II has served as the Chairman of our Board of Directors since our inception and as Chief Executive Officer since 1994. Mr. Gay received a master's degree in business administration from Harvard Business School.
Bruce R. Hough was made our President in 1994. Prior to joining Nutraceutical, Mr. Hough acted as a consultant from 1991 to 1993 and as President of Keystone Communications, a telecommunications firm, from 1987 to 1991. Mr. Hough received an associate's degree from Ricks College.
Jeffrey A. Hinrichs has served as our Executive Vice President and Chief Operating Officer since 1994 and as a member of our Board of Directors since 1998. Prior to joining Nutraceutical, Mr. Hinrichs served as President of Solaray from 1993 to 1994 and as Chief Financial Officer, and in other management positions, with Solaray from 1984 to 1993. Mr. Hinrichs received a bachelor of science degree from Weber State University.
Gary M. Hume has served as our Executive Vice President since September 1999. Prior to joining Nutraceutical, Mr. Hume was President and CEO of Murdock Madaus Schwabe (Nature's Way) from 1995 to 1999. Prior to joining Nature's Way, Mr. Hume was President of Tree of Life's Southwest Division for over twenty years. Mr. Hume received a bachelor of arts from Southwestern Union College.
Stanley E. Soper joined Nutraceutical in 1997 as Vice President, Legal Affairs. From September 1999 until March 2001, Mr. Soper founded and was employed at a technology startup. He rejoined Nutraceutical in his previous position in March 2001. Mr. Soper was in private law practice from 1991 to 1997, most recently with Holland & Hart LLP. Mr. Soper received a J.D. from Yale Law School.
Cory J. McQueen joined Nutraceutical in March 1995 as Assistant Controller. Mr. McQueen became Controller in October 1997 and was appointed Vice President in February 2001. In April 2007, Mr. McQueen became Chief Financial Officer. Prior to joining Nutraceutical, he was employed by Price Waterhouse LLP. Mr. McQueen received a master's degree in accounting from the University of Utah and is a Certified Public Accountant.
Christopher B. Neuberger joined Nutraceutical in August 1995 as Director of Marketing for the Premier One brand. Mr. Neuberger left Nutraceutical from March 1997 to December 1997 while he was employed by Weider Nutrition International, Inc. Mr. Neuberger became President of NutraBrands, our marketing and sales subsidiary in March 1999 and was appointed as our Vice President, Marketing and Sales in April 2005. Mr. Neuberger was previously employed by Melaleuca, Inc. Mr. Neuberger received his master's degree in business administration from Thunderbird, The Garvin School of International Management.
Daren P. Peterson joined Nutraceutical in 1994 as Controller. Mr. Peterson served in other management positions prior to his appointment as Vice President, Operations in March 2009. Prior to joining Nutraceutical, Mr. Peterson served in various positions with Solaray from 1985 to 1994. Mr. Peterson received a master's degree in accounting from Weber State University.
Andrew W. Seelos joined Nutraceutical in March 1997 as Assistant Controller. Mr. Seelos was appointed Assistant Vice President and Controller in April 2007. Prior to joining Nutraceutical, he was employed by Price Waterhouse LLP. Mr. Seelos received a master's degree in accounting from Brigham Young University and is a Certified Public Accountant.
Item 1A.
Item 1A. Risk Factors
Our business routinely encounters and addresses risks, some of which may cause our future results to be different than we currently anticipate. The risk factors described below represent our current view of some of the most important risks facing our businesses and are important to understanding our business. The following information should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations and our Consolidated Financial Statements and related notes included in this Annual Report on Form 10-K. This discussion includes a number of forward-looking statements. You should refer to the description of the qualifications and limitations on forward-looking statements under "Special Note Regarding Forward-Looking Statements" above.
Regulatory, Product Liability and Insurance Risks
Our products are subject to government regulation, both in the United States and abroad, which could increase our costs significantly and limit or prevent the sale of our products. The manufacture, packaging, labeling, advertising, promotion, distribution, and sale of our products are subject to regulation by numerous national and local governmental agencies in the United States and other countries. The primary regulatory bodies in the United States are the FDA and FTC, and we are also subject to the Food Standards Agency and the Department of Health in the United Kingdom and similar regulators in Norway. Failure to comply with these regulatory requirements may result in various types of penalties or fines. These include injunctions, product withdrawals, recalls, product seizures, fines, and criminal prosecutions. Individual states also regulate nutritional supplements. A state may interpret claims or products presumptively valid under federal law as illegal under that state's regulations. In markets outside the United States, we are usually required to obtain approvals, licenses, or certifications from a country's ministry of health or comparable agency, as well as labeling and packaging regulations, all of which vary from country to country. Approvals or licensing may be conditioned on reformulation of products or may be unavailable with respect to certain products or product ingredients. Any of these government agencies, as well as legislative bodies, can change existing regulations, or impose new ones, or could take aggressive measures, causing or contributing to a variety of negative consequences, including:
•requirements for the reformulation of certain or all products to meet new standards,
•the recall or discontinuance of certain or all products,
•additional record keeping,
•expanded documentation of the properties of certain or all products,
•expanded or different labeling,
•adverse event tracking and reporting and
•additional scientific substantiation.
Any or all of these requirements could have a material adverse effect on us. There can be no assurance that the regulatory environment in which we operate will not change or that such regulatory environment, or any specific action taken against us, will not result in a material adverse effect on us.
If we experience product recalls, we may incur significant and unexpected costs, and our business reputation could be adversely affected. We may be exposed to product recalls and adverse public relations if our products are alleged to cause injury or illness, or if we are alleged to have violated governmental regulations. A product recall could result in substantial and unexpected expenditures, which would reduce operating profit and cash flow. In addition, a product recall may require significant management attention. Product recalls may hurt the value of our brands and lead to decreased demand for our products. Product recalls also may lead to increased scrutiny by federal, state or international regulatory agencies of our operations and increased litigation and could have a material adverse effect on our business, results of operations, financial condition and cash flows.
We may experience product liability claims and litigation to prosecute such claims, and although we maintain product liability insurance, which we believe to be adequate for our needs, there can be no assurance that our insurance coverage will be adequate or that we will be able to maintain adequate insurance coverage. As a manufacturer and a distributor of products for human consumption, we experience product liability claims and litigation to prosecute such claims. Additionally, the manufacture and sale of these products involves the risk of injury to consumers as a result of tampering by unauthorized third parties or product contamination. We carry insurance coverage in the types and amounts that we consider reasonably adequate to cover the risks we face. If insurance coverage is inadequate or unavailable or premium costs continue to rise, we may face additional claims not covered by insurance, and claims that exceed coverage limits or that are not covered could have a material adverse effect on us.
Market and Channel Risks
Our success is linked to the size and growth rate of the vitamin, mineral and supplement market and an adverse change in the size or growth rate of that market could have a material adverse effect on us. Some manufacturers in our industry have experienced a slow-down in sales of nutritional supplements. An adverse change in size or growth rate of the vitamin, mineral and supplement market could have a material adverse effect on us. Underlying market conditions are subject to change based on economic conditions, consumer preferences and other factors that are beyond our control, including media attention and scientific research, which may be positive or negative.
Because a substantial majority of our sales are to or through health food stores, we are dependent to a large degree upon the success of this channel as well as the success of specific retailers in the channel. Over 85% of our sales are in the United States. In this market, we sell our products primarily to or through health food stores. Because of this, we are dependent to a large degree upon the success of that channel as well as the success of specific retailers in the channel. There are some large chains of health food stores, such as Whole Foods and Vitamin Shoppe, but most health food stores are individual stores or very small chains. We rely on these health food stores to purchase, market, and sell our products. Our success is dependent, to a large degree, on the growth and success of the Healthy Foods Channel, which is outside our control. There can be no assurance that the Healthy Foods Channel will be able to grow or prosper as it faces price and service pressure from other channels, including the mass market. There can be no assurance that retailers in the Healthy Foods Channel, in the aggregate, will respond or continue to respond to our stated loyalty to this channel.
We are highly dependent upon consumers' perception of the safety and quality of our products as well as similar products distributed by other companies in our industry, and adverse publicity and negative public perception regarding particular ingredients or products or our industry in general could limit our ability to increase revenue and grow our business. Decisions about purchasing made by consumers of our products may be affected by adverse publicity or negative public perception regarding particular ingredients or
products or our industry in general. This negative public perception may include publicity regarding the legality or quality of particular ingredients or products in general or of other companies or our products or ingredients specifically. Negative public perception may also arise from regulatory investigations, regardless of whether those investigations involve us. We are highly dependent upon consumers' perception of the safety and quality of our products as well as similar products distributed by other companies. Thus, the mere publication of reports asserting that such products may be harmful could have a material adverse effect on us, regardless of whether these reports are scientifically supported. Publicity related to nutritional supplements may also result in increased regulatory scrutiny of our industry and/or the healthy foods channel. Adverse publicity may have a material adverse effect on our business, financial condition, and results of operations. There can be no assurance of future favorable scientific results and media attention or of the absence of unfavorable or inconsistent findings.
We face intense competition from competitors that are larger, more established and that possess greater resources than we do, and if we are unable to compete effectively, we may be unable to maintain sufficient market share to sustain profitability. Numerous manufacturers and retailers compete actively for consumers. There can be no assurance that we will be able to compete in this intensely competitive environment. In addition, nutritional supplements can be purchased in a wide variety of channels of distribution. These channels include mass market retail stores and the Internet. Because these markets generally have low barriers to entry, additional competitors could enter the market at any time. Private label products of our customers also provide competition to our products. Additional national or international companies may seek in the future to enter or to increase their presence in the healthy foods channel or the vitamin, mineral supplement market. Increased competition in either or both could have a material adverse effect on us.
The nutritional supplement industry increasingly relies on intellectual property rights and although we seek to ensure that we do not infringe the intellectual property rights of others, there can be no assurance that third parties will not assert intellectual property infringement claims against us, which claims may result in substantial costs and diversion of management and other resources and could have a material adverse effect on our business, financial condition, and operating results. Recently it has become more and more common for suppliers and competitors to apply for patents or develop proprietary technologies and processes. We seek to ensure that we do not infringe the intellectual property rights of others, but there can be no assurance that third parties will not assert intellectual property infringement claims against us. These developments could prevent us from offering or supplying competitive products or ingredients in the marketplace. They could also result in litigation or threatened litigation against us related to alleged or actual infringement of third-party rights. If an infringement claim is asserted or litigation is pursued, we may be required to obtain a license of rights, pay royalties on a retrospective or prospective basis, or terminate our manufacturing and marketing of our products that are alleged to have infringed. Litigation with respect to such matters could result in substantial costs and diversion of management and other resources and could have a material adverse effect on our business, financial condition, and operating results.
We may be affected adversely by increased utility and fuel costs. Increasing fuel costs may affect our results of operations adversely in that consumer traffic to health and natural food stores may be reduced and the costs of our sales may increase as we incur fuel costs in connection with our manufacturing operations and the transportation of goods from our warehouse and distribution facilities to health and natural food stores. Also, high oil costs can affect the cost of our raw materials and components and the competitive environment in which we operate may limit our ability to recover higher costs resulting from rising fuel prices.
Adverse economic conditions may harm our business. Inflation or other changes in economic conditions that affect demand for nutritional supplements could adversely affect our revenue.
Uncertainty about current global economic conditions poses a risk as consumers and businesses may postpone spending in response to tighter credit markets, negative financial news and/or declines in income or asset values, each of which could have a material negative effect on the demand for our products. Other factors that could influence demand include conditions in the residential real estate and mortgage markets, labor and healthcare costs, access to credit, consumer confidence, and other macroeconomic factors affecting consumer spending behavior. These and other economic factors could have a material adverse effect on demand for our products and on our financial condition and operating results.
Business Strategy and Operational Risks
If we are unable to retain key personnel, our ability to manage our business effectively and continue our growth could be negatively impacted. Key management employees include Frank W. Gay II, Bruce R. Hough, Jeffrey A. Hinrichs, Gary M. Hume, Stanley E. Soper, Cory J. McQueen, Christopher B. Neuberger, Daren P. Peterson, Andrew W. Seelos and certain other employees. These key management employees are primarily responsible for our day-to-day operations, and we believe our success depends in part on our ability to retain them and to continue to attract additional qualified individuals to our management team. We do not have employment agreements with any of our key management employees. The loss or limitation of the services of any of our key management employees or the inability to attract additional qualified management personnel could have a material adverse effect on our business, financial condition, and results of operations.
As a part of our business strategy, we have made and expect to continue to make acquisitions that could disrupt our operations and harm our operating results. An element of our strategy includes expanding our product offerings, gaining shelf-space and gaining access to new skills and other resources through strategic acquisitions when attractive opportunities arise. Acquiring additional businesses and the implementation of other elements of our business strategy are subject to various risks and uncertainties. Some of these factors are within our control and some are outside our control. These risks and uncertainties include, but are not limited to, the following:
•any acquisition may result in significant expenditures of cash, stock and/or management resources,
•acquired businesses may not perform in accordance with expectations,
•we may encounter difficulties and costs with the integration of the acquired businesses,
•management's attention may be diverted from other aspects of our business,
•we may face unexpected problems entering geographic and product markets in which we have limited or no direct prior experience,
•we may lose key employees of acquired or existing businesses,
•we may incur liabilities and claims arising out of acquired businesses,
•we may be unable to obtain financing and
•we may incur indebtedness or issue additional capital stock which could be dilutive to holders of our common stock.
There can be no assurance that attractive acquisition opportunities will be available to us, that we will be able to obtain financing for or otherwise consummate any acquisitions or that any acquisitions which are consummated will prove to be successful. There can be no assurance that we can successfully execute all aspects of our business strategy.
Because we depend on outside suppliers with whom we do not have long-term agreements for raw materials, we may be unable to obtain adequate supplies of raw materials for our products at favorable prices or at all, which could result in product shortages and back orders for our products, with a resulting loss of net sales and profitability. We acquire all of our raw materials for the manufacture of our products from third-party suppliers. We also rely on third-party co-packers for some of our products. We have few agreements for the continued supply of these materials and products. A number of our products contain one or more ingredients that may only be available from a single source or supplier. Any of our suppliers could discontinue selling to us at any time. Our suppliers or government regulators may interpret new regulations (including GMP regulations) in such a way as to cause a disruption in our supply chain as these parties undertake increased scrutiny of raw materials and components of raw materials and products, causing certain suppliers or us to discontinue, change or suspend the sale of certain ingredients or components. Although we believe that we could establish alternate sources for most of these materials, any delay in locating and establishing relationships with other sources could result in product shortages and back orders for the products, with a resulting loss of net sales and profitability. We are also subject to delays associated with raw materials. These can be caused by conditions not within our control, including:
•weather,
•crop conditions,
•transportation interruptions,
•strikes by supplier employees and
•natural disasters or other catastrophic events.
We acquire many ingredients from suppliers outside of the United States. Purchasing these ingredients is subject to the risks generally associated with importing raw materials from other countries, including, among other factors, delays in shipments, changes in economic and political conditions, quality assurance, tariffs, trade disputes and foreign currency fluctuations. These factors could result in a delay in or disruption of the supply of certain raw materials. Any significant delay in or disruption of the supply of raw materials could have a material adverse effect upon us.
Our success is dependent on the accuracy, reliability, and proper use of sophisticated and dependable information processing systems and management information technology and any interruption in these systems could have a material adverse effect on our business, financial condition and results of operations. Our success is dependent on the accuracy, reliability and proper use of sophisticated and dependable information processing systems and management information technology. Our information technology systems are designed and selected in order to facilitate order entry and customer billing, maintain customer records, accurately track purchases and incentive payments, manage accounting, finance and manufacturing operations, generate reports, and provide customer service and technical support. Any interruption in these systems could have a material adverse effect on our business, financial condition and results of operations.
Because we manufacture approximately 70% of our products, we are dependent upon the uninterrupted and efficient operation of our manufacturing facilities, which are subject to power failures, the breakdown, failure, or substandard performance of equipment, the improper installation or operation of equipment, natural or other disasters, and the need to comply with the requirements or directives of government agencies, including the FDA. We are dependent upon the uninterrupted and efficient operation of our manufacturing facilities in Ogden, Utah as well as Phoenix, Arizona. Those operations are subject to power failures, the breakdown, failure, or substandard performance of equipment, the improper installation or operation of equipment, natural or other disasters, and the need to comply with the requirements or directives of government agencies, including the FDA. There can be no assurance that
the occurrence of these or any other operational problems at our facility would not have a material adverse effect on our business, financial condition, and results of operations.
We are party to a number of lawsuits that arise in the ordinary course of business and may become party to others in the future. We are party to a number of lawsuits that arise in the ordinary course of business and may become party to others in the future. The possibility of such litigation, and its timing, is in large part outside our control. While none of the current lawsuits in which we are involved are reasonably estimable to be material as of the date of this filing, it is possible that future litigation could arise, or developments could occur in existing litigation, that could have material adverse effects on us.
If we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial results or prevent fraud, which could harm our business reputation and cause our stock price to decline. Effective internal controls are necessary for us to provide reliable financial reports and prevent fraud. Any failure to implement required new or improved controls, or difficulties encountered in their implementation, could harm our operating results or cause us to fail to meet our reporting obligations. Inadequate internal controls could also cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading price of our stock.
If our goodwill or amortizable intangible assets become impaired we may be required to record a significant charge to earnings. Under generally accepted accounting principles, we review our amortizable intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. Goodwill and non-amortizable intangible assets are tested for impairment at least annually. Factors that may indicate that the carrying value of our goodwill or intangible assets may not be recoverable, include a decline in stock price and market capitalization, reduced future cash flow estimates, and slower growth rates in our industry. Our results of operations may be materially impacted if we are required to record a significant charge due to an impairment of our goodwill or intangible assets.
We are dependent upon our lenders for financing to execute our business strategy and meet our liquidity needs and the lack of adequate financing could negatively impact our business. There is risk that any lenders, even those with strong balance sheets and sound lending practices, could fail or refuse to honor their legal commitments and obligations under existing credit commitments, including but not limited to: extending credit up to the maximum permitted by a credit facility, allowing access to additional credit features and otherwise accessing capital and/or honoring loan commitments. The lenders on our credit facility are Rabobank International and Wells Fargo. If our lenders failed to honor their legal commitments under our credit facility, it could be difficult in this environment to replace our credit facility on similar terms. Furthermore, we may be unable to renegotiate our existing credit facility or obtain replacement or additional financing.
Stock Market Risks
The market price for our common stock may be particularly volatile, and our stockholders may be unable to resell their shares at a profit. The trading price of our common stock has been subject to wide fluctuations and may continue to fluctuate in the future in response to a variety of factors, including:
•quarter-to-quarter variations in operating results,
•material announcements by us or our competitors,
•governmental regulatory action,
•negative or positive publicity involving us or the nutritional supplement industry generally,
•general economic downturns,
•announcements by official or unofficial health and medical authorities,
•consumer preferences generally or
•other events or factors, many of which are beyond our control.
In addition, the stock market has historically experienced significant price and volume fluctuations, which have particularly affected the market prices of many nutritional supplement companies and which have, in certain cases, not had a strong correlation to the operating performance of these companies. Stock markets experienced unprecedented volatility in connection with the recent credit crisis. General economic conditions, such as recession or interest rate or currency rate fluctuations in the United States or abroad, could negatively affect the market price of our common stock in the future. In addition, our operating results in future quarters may be below the expectations of securities analysts and investors. If that were to occur, the price of our common stock would likely decline, perhaps substantially. In the past, following periods of volatility in the market price of a company's securities, securities class action litigation has often been instituted against that company. Such litigation could result in substantial cost and a diversion of management's attention and resources.
Item 1B.
Item 1B. Unresolved Staff Comments
We do not have any unresolved comments from the SEC staff.
Item 2.
Item 2. Properties
The following table describes our principal properties as of November 15, 2010:
(1)The Rapid Response Center is the central facility where we are, and have been, consolidating operations. The Rapid Response Center currently includes raw materials, manufacturing, packaging, distribution and offices.
(2)We own these properties. We lease all other properties identified above.
(3)The lease for this transitional warehouse expires in May 2013, although we can terminate early on either 90 days or 6 months notice, depending on the leased space to be terminated.
In addition to these principal properties, we own or lease various other properties used in our operations.
Item 3.
Item 3. Legal Proceedings
As discussed in other filings and elsewhere in this Annual Report on Form 10-K, we are subject to regulation by a number of federal, state and foreign agencies and are involved in various legal matters arising in the ordinary course of business.
We carry insurance coverage in the types and amounts that we consider reasonably adequate to cover the risks we face in the industry in which we compete. See "Business-Risk Factors."
We are involved in various legal matters arising in the normal course of business. In the opinion of management, the outcomes of individual regulatory and legal matters in which we are presently involved are not probable and no estimate can be made of the range of potential gains or losses. While incapable of estimation, in the opinion of management, none of the regulatory and legal matters in which we are involved are individually expected to have a material adverse effect on our financial position, results of operations or cash flows. However, our aggregate liability arising from regulatory and legal proceedings related to these matters could have a material effect on our financial position, results of operations or cash flows.
PART II
Item 5.
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information
Our common stock is traded on the Nasdaq National Market under the symbol "NUTR." The common stock commenced trading on the Nasdaq National Market on February 20, 1998 upon completion of our initial public offering. The following table sets forth the high and low closing prices per share for the common stock:
Holders
As of the close of business on November 15, 2010, there were 180 holders of record of common stock and approximately 3,000 beneficial holders. The closing price of our common stock on November 15, 2010 as reported by the Nasdaq National Market was $16.56.
Dividends
Since our initial public offering, we have neither declared nor paid any cash or other dividends on our common stock and do not expect to pay dividends for the foreseeable future. Instead, we currently intend to retain earnings to support our growth strategy and reduce indebtedness. Any future
determination by us to pay dividends will be at the discretion of our Board of Directors and will depend upon, among other factors, our results of operations, financial condition, capital requirements and contractual restrictions, including restrictions specified in our amended credit agreement dated September 7, 2006.
Purchase of Equity Securities
Prior to fiscal 2010, our Board of Directors approved a share purchase program authorizing us to buy up to 3,500,000 shares of our common stock. As of September 30, 2010, 879,792 shares may yet be purchased under this program. Purchases under this program during the fiscal 2010 fourth quarter occurred in August and September as follows:
All shares purchased during the fiscal 2010 fourth quarter were retired on September 27, 2010.
Under this approved share repurchase program, we may purchase common stock from time to time on the open market and in individually negotiated transactions. The amount and timing of any purchases will be dependent upon a number of factors, including the price and availability of our shares and general market conditions.
Securities Authorized for Issuance under Equity Compensation Plans
The following table summarizes outstanding options as of September 30, 2010:
Although options are still outstanding, the previous equity compensation plans were all terminated on September 30, 2005 so no additional options can be granted under those plans.
Item 6.
Item 6. Selected Financial Data
The selected financial data presented below were derived from our Consolidated Financial Statements. This selected financial data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our consolidated financial statements and the notes thereto.
(1)During the year ended September 30, 2007, we recorded a non-cash intangible asset impairment charge of $450 ($279 after tax, or $0.02 per diluted share) related to the re-branding of certain health food stores. During the year ended September 30, 2008, we recorded a non-cash goodwill impairment charge of $2,875 ($1,811 after tax, or $0.16 per diluted share) related to our health food stores reporting unit. During the year
ended September 30, 2009, we recorded a non-cash goodwill impairment charge of $37,519 ($27,288 after tax, or $2.52 per diluted share) related to our branded and natural food markets reporting units.
(2)During the year ended September 30, 2006, we sold our 31,340 square foot building located in Park City, Utah for $4,500 in cash. At the time of sale, the building had a book value of $3,395. A gain of $1,105 ($680 after tax, or $0.06 per diluted share) was included in other income.
(3)"Adjusted EBITDA" (a non-GAAP measure) is defined as earnings before net interest and other (income) expense, taxes, depreciation, amortization and goodwill and intangible asset impairment. Adjusted EBITDA has some inherent limitations in measuring operating performance due to the exclusion of certain financial elements such as depreciation and amortization and is not necessarily comparable to other similarly titled captions of other companies due to potential inconsistencies in the method of calculation. Furthermore, Adjusted EBITDA is not intended to be a substitute for cash flows from operating activities, as a measure of liquidity, or an alternative to net income in determining our operating performance in accordance with United States generally accepted accounting principles. Our use of an EBITDA-based metric should be considered within the following context:
•We acknowledge that plant and equipment (while less important in our line of business due to outsourcing alternatives) are necessary to earn revenue based on our current business model.
•Our use of an EBITDA-based measure of operating performance is not based on any belief about the reasonableness of excluding depreciation when measuring financial performance.
•Our use of an EBITDA-based measure is supported by its importance to the following key stakeholders:
•Analysts-who estimate our projected Adjusted EBITDA and other EBITDA-based metrics in their independently developed financial models for investors;
•Creditors-who evaluate our operating performance based on compliance with certain EBITDA-based debt covenants;
•Investment Bankers-who use EBITDA-based metrics in their written evaluations and comparisons of companies within our industry; and
•Board of Directors and Executive Management-who use EBITDA-based metrics for evaluating management performance relative to our operating budget and bank covenant compliance, as well as our ability to service debt and raise capital for growth opportunities, including acquisitions, which are a critical component of our stated strategy. Historically, we have recorded a monthly accrual for incentive compensation as a percentage of Adjusted EBIDTA, which has been paid out to executive management, as well as other employees, upon completion of our annual audit.
The following table sets forth a reconciliation of net income (loss) to Adjusted EBITDA for each period included herein:
(1)Includes amortization of deferred financing fees.
(2)Includes other income of $1,105 for the year ended September 30, 2006 related to a gain on the sale of a building.
(3)For the year ended September 30, 2007, a non-cash intangible asset impairment charge of $450 was recorded related to the re-branding of certain health food stores. For the year ended September 30, 2008, a non-cash goodwill impairment charge of $2,875 was recorded related to our health food stores reporting unit. For the year ended September 30, 2009, a non-cash goodwill impairment charge of $37,519 was recorded related to our branded and natural food markets reporting units.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our audited Consolidated Financial Statements and accompanying notes thereto included elsewhere in this Annual Report on Form 10-K.
Overview
We are an integrated manufacturer, marketer, distributor and retailer of branded nutritional supplements and other natural products sold primarily to and through domestic health and natural food stores. Internationally, we market and distribute branded nutritional supplements and other natural products to and through health and natural product distributors and retailers. Our core business strategy is to acquire, integrate and operate businesses in the natural products industry that manufacture, market and distribute branded nutritional supplements. We believe that the consolidation and integration of these acquired businesses provides ongoing financial synergies through increased scale and market penetration, as well as strengthened customer relationships.
We manufacture and sell nutritional supplements and other natural products under numerous brands including Solaray®, KAL®, Nature's Life®, LifeTime®, Natural Balance®, bioAllers®, Herbs for Kids™, NaturalCare®, Health from the Sun®, Life-flo®, Organix-South®, Pioneer® and Monarch Nutraceuticals™.
We own neighborhood natural food markets, which operate under the trade names The Real Food Company™, Thom's Natural Foods™ and Cornucopia Community Market™. We also own health food stores, which operate under the trade names Fresh Vitamins™ and Granola's™.
We manufacture and/or distribute one of the broadest branded product lines in the industry with over 5,500 SKUs, including over 700 SKUs sold internationally. We believe that as a result of our emphasis on innovation, quality, loyalty, education and customer service, our brands are widely recognized in health and natural food stores and among their customers.
We were formed in 1993 to effect a consolidation strategy in the fragmented VMS Industry. Since our formation, we have completed thirty acquisitions. We believe that Nutraceutical is well positioned to continue to capitalize on the consolidation we believe is occurring in the VMS Industry.
Critical Accounting Policies and Estimates
The preparation of our financial statements in conformity with accounting principles generally accepted in the United States of America required us to make estimates and assumptions that affected the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of net sales and expenses during the reported periods. Significant estimates included values and lives assigned to acquired intangible assets, reserves for customer returns and allowances, uncollectible accounts receivable, slow moving, obsolete and/or damaged inventory and valuation and recoverability of long-lived assets. Actual results may differ from these estimates.
Our critical accounting policies and estimates include the following:
Accounts Receivable-Provision is made for estimated bad debts based on a periodic analysis of individual customer balances, including an evaluation of days sales outstanding, payment history, recent payment trends and perceived credit worthiness. If general economic conditions and/or customer financial condition were to change, additional provisions for bad debts may be required, which could have a material impact on the consolidated financial statements.
Inventories-Provision is made for slow moving, obsolete and/or damaged inventory based on a periodic analysis of individual inventory items, including an evaluation of historical usage and/or movement, age, expiration date and general condition. If market demand and/or consumer preferences are less favorable than historical trends or future expectations, additional provisions for slow moving, obsolete and/or damaged inventory may be required, which could have a material impact on the consolidated financial statements.
Property, Plant and Equipment-Depreciation and amortization expense is impacted by our judgments regarding the estimated useful lives of assets placed in service. If the estimated lives of assets are significantly less than expected, depreciation and amortization expense would be accelerated, which could have a material impact on the consolidated financial statements.
We evaluate the recoverability of property, plant and equipment which are reviewed for possible impairment whenever events or circumstances indicate that the carrying amount of an asset group may not be recoverable. We measure recoverability of the asset group by comparison of its carrying amount to the future undiscounted cash flows the asset group is expected to generate. If the asset group is considered to be impaired, the difference between the carrying amount and the fair value of the impaired asset group is recorded.
Goodwill and Intangible Assets-Goodwill and intangible assets require estimates and judgments in determining the initial recognition and measurement, including factors and assumptions used in determining fair value and useful lives. Intangible assets with finite useful lives are amortized, while intangible assets with indefinite useful lives are not amortized. Amortizable intangible assets are reviewed for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. Goodwill and non-amortizable intangible assets are tested annually for impairment and are tested for impairment between annual tests if an event occurs that would cause us to believe that value is impaired. We perform our annual impairment testing as of September 30 each year, which is the last day of our fiscal year.
A two step process is used to test for goodwill impairment. The first step is to determine if there is an indication of impairment by comparing the estimated fair value of each reporting unit to its carrying value, including existing goodwill. Goodwill is considered impaired if the carrying value of a reporting unit exceeds the estimated fair value. Upon an indication of impairment, a second step is performed to measure the amount of the impairment by comparing the implied fair value of the reporting unit's goodwill with its carrying value.
For fiscal 2009, we recorded a non-cash goodwill impairment charge of $37.5 million ($27.3 million after tax, or $2.52 per diluted share) related to our branded and natural food markets reporting units. For fiscal 2008, we recorded a non-cash goodwill impairment charge of $2.9 million ($1.8 million after tax, or $0.16 per diluted share) related to our health food stores reporting unit. The fiscal 2008 and 2009 non-cash goodwill impairment charges had no impact on our compliance with debt covenants, cash flows or available liquidity.
The ongoing uncertainty in general and economic conditions may continue to impact retail and consumer demand, as well as the market price of our common stock, and could negatively impact our future operating performance, cash flow and/or stock price and could result in additional goodwill
and/or intangible asset impairment charges being recorded in future periods which could materially impact our consolidated financial statements. There were no at-risk reporting units at September 30, 2010. The valuation of goodwill and intangible assets is subject to a high degree of judgment and complexity.
Revenue Recognition-Revenue is recognized when the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) the product has been shipped and the customer takes ownership and assumes the risk of loss; (3) the selling price is fixed or determinable; and (4) collection of the resulting receivable is reasonably assured. We believe that these criteria are satisfied upon shipment from our facilities or, in the case of our neighborhood natural food markets and health food stores, at the point of sale within these stores. Revenue is reduced by provisions for estimated returns and allowances, which are based on historical averages that have not varied significantly for the periods presented, as well as specific known claims, if any. No other significant deductions from revenue must be estimated at the point in time that revenue is recognized.
Other than our previous discussion of goodwill impairment, our estimates and judgments related to our critical accounting policies, including factors and assumptions considered in making these estimates and judgments, did not vary significantly for the periods presented and had no material impact on the consolidated financial statements as reported.
For additional information on our accounting policies, see Note 2 of the accompanying Consolidated Financial Statements.
Results of Operations
The following table sets forth certain Consolidated Statements of Operations data as a percentage of net sales for the periods indicated:
Comparison of Fiscal 2010 to Fiscal 2009
Net Sales. Net sales increased by $17.8 million, or 10.9%, to $180.1 million for fiscal 2010 from $162.3 million for fiscal 2009. Net sales of branded nutritional supplements and other natural products increased by $18.3 million, or 12.5%, to $164.6 million for fiscal 2010 compared to $146.3 million for fiscal 2009. The increase in net sales of branded nutritional supplements and other natural products was primarily related to the net sales contributions of the four fiscal 2010 acquisitions and the fiscal 2009 acquisition. The impact on net sales of branded products attributable to price changes was not
material. Other net sales decreased by $0.5 million, or 3.5%, to $15.5 million for fiscal 2010 compared to $16.0 million for fiscal 2009.
Gross Profit. Gross profit increased by $8.7 million, or 10.1%, to $93.9 million for fiscal 2010 from $85.2 million for fiscal 2009. This increase in gross profit was primarily attributable to the increase in net sales. As a percentage of net sales, gross profit decreased to 52.1% for fiscal 2010 from 52.5% for fiscal 2009. This decrease in gross profit percentage was primarily attributable to increased material costs related to changes in sales mix and, to a lesser extent, vendor price increases, partially offset by the increase in net sales, which allowed us to better leverage our manufacturing overhead costs.
Selling, General and Administrative Expenses. Selling, general and administrative expenses increased by $3.5 million, or 5.6%, to $65.7 million for fiscal 2010 from $62.2 million for fiscal 2009. This increase in selling, general and administrative expenses was primarily attributable to operational and transition costs related to the fiscal 2009 and the fiscal 2010 acquisitions. As a percentage of net sales, selling, general and administrative expenses decreased to 36.5% for fiscal 2010 compared to 38.3% for fiscal 2009. This decrease in selling, general and administrative expenses as a percentage of net sales was primarily attributable to the increase in net sales, which allowed us to better leverage our cost structure.
Amortization of Intangible Assets. Amortization of intangibles was $1.3 million for fiscal 2010 and $0.7 million for fiscal 2009. For each period, amortization expense was primarily related to intangible assets recorded in connection with acquisitions.
Impairment of Goodwill. During fiscal 2009, we recorded a non-cash goodwill impairment charge of $37.5 million ($27.3 million after tax, or $2.52 per diluted share) related to our branded and natural food markets reporting units.
Interest and Other (Income) Expense, Net. Net interest and other (income) expense was $0.6 million for fiscal 2010 and $1.1 million for fiscal 2009 and primarily consisted of interest expense on indebtedness under our revolving credit facility with the decrease being primarily related to a reduction in interest rates.
Provision (Benefit) for Income Taxes. Our effective tax rate was 37.8% for fiscal 2010 and (13.9%) for fiscal 2009. During the second quarter of fiscal 2009, we recorded a non-cash goodwill impairment charge of $37.5 million of which $11.0 million related to non-tax-deductible goodwill and reduced our effective tax rate from 37.5% to (13.9%) for fiscal 2009.
Comparison of Fiscal 2009 to Fiscal 2008
Net Sales. Net sales decreased by $4.6 million, or 2.7%, to $162.3 million for fiscal 2009 from $166.9 million for fiscal 2008. Net sales of branded nutritional supplements and other natural products decreased by $3.4 million, or 2.2%, to $146.3 million for fiscal 2009 from $149.7 million for fiscal 2008. The decrease in net sales of branded nutritional supplements and other natural products was primarily related to a decrease in sales volume of branded products to many customers due in large part to the U.S. and global economic recession, partially offset by the net sales contributions of the businesses acquired during fiscal 2008 and 2009. Net sales of branded products attributable to price increases were $5.9 million for fiscal 2009. Other net sales decreased $1.2 million, or 6.9%, to $16.0 million for fiscal 2009 compared to $17.2 million for fiscal 2008. The decrease in other net sales was primarily related to a decrease in sales volume due in large part to the U.S. economic recession as well as the closure of three health and natural food stores.
Gross Profit. Gross profit decreased by $5.6 million, or 6.1%, to $85.2 million for fiscal 2009 from $90.8 million for fiscal 2008. The dollar decrease in gross profit was primarily attributable to the decrease in net sales. As a percentage of net sales, gross profit decreased to 52.5% for fiscal 2009 from
54.4% for fiscal 2008. This decrease in gross profit percentage was primarily attributable to increased material costs, primarily related to vendor price increases, as well as an increase in overhead costs as a percentage of net sales.
Selling, General and Administrative Expenses. Selling, general and administrative expenses decreased by $4.8 million, or 7.1%, to $62.2 million for fiscal 2009 from $67.0 million for fiscal 2008. As a percentage of net sales, selling, general and administrative expenses decreased to 38.3% for fiscal 2009 from 40.1% for fiscal 2008. This decrease in selling, general and administrative expenses was primarily attributable to a reduction in operational and transitional costs related to businesses acquired in fiscal 2007 and fiscal 2008 as well as year-over-year cost improvements in many selling, general and administrative expense areas.
Amortization of Intangible Assets. Amortization of intangibles was $0.7 million for fiscal 2009 and fiscal 2008. For each period, amortization expense was primarily related to intangible assets recorded in connection with acquisitions.
Impairment of Goodwill. During fiscal 2009, we recorded a non-cash goodwill impairment charge of $37.5 million ($27.3 million after tax, or $2.52 per diluted share) related to our branded and natural food markets reporting units. During fiscal 2008, we recorded a non-cash goodwill impairment charge of $2.9 million ($1.8 million after tax, or $0.16 per diluted share) related to our health food stores reporting unit.
Interest and Other (Income) Expense, Net. Net interest and other (income) expense was $1.1 million for fiscal 2009 and $1.3 million for fiscal 2008 and primarily consisted of interest expense on indebtedness under our revolving credit facility.
Provision (Benefit) for Income Taxes. During the second quarter of fiscal 2009, we recorded a non-cash goodwill impairment charge of $37.5 million of which $11.0 million related to non-tax-deductible goodwill and reduced our effective tax rate from 37.5% to (13.9%) for fiscal 2009. As a result of this goodwill impairment charge, we recognized a deferred tax benefit of $10.2 million due to the impairment of $26.5 million of tax-deductible goodwill. Our effective tax rate was 37.0% for fiscal 2008.
Selected Quarterly Financial Data; Seasonality
The following table sets forth certain quarterly financial data for fiscal 2009 and 2010. This quarterly information is unaudited, has been prepared on the same basis as the annual financial statements and, in our opinion, reflects all normally recurring adjustments necessary for fair presentation of the information for the periods presented. Operating results for any quarter are not necessarily indicative of results for any future period.
We believe that our business is characterized by minor seasonality. However, sales to any particular customer can vary substantially from one quarter to the next based on such factors as industry trends, timing of promotional discounts, international economic conditions and acquisition-related activities. Excluding the effect of acquisitions, we have historically recorded higher branded products sales volume during the second fiscal quarter due to increased interest in health-related products among consumers following the holiday season. The fiscal 2009 acquisition was completed during the fourth quarter and the fiscal 2010 acquisitions were completed during the first, third and fourth quarters.
Liquidity and Capital Resources
As of September 30, 2010, we had cash of $3.7 million. Net cash provided by operating activities was $17.9 million, $27.8 million and $20.3 million for the years ended September 30, 2010, 2009, and 2008, respectively. The decrease in net cash provided by operating activities in fiscal 2010 was primarily attributable to a decrease in cash provided by changes in assets and liabilities, net of effects of acquisitions.
Net cash used in investing activities was $26.4 million, $13.8 million and $23.7 million for the years ended September 30, 2010, 2009, and 2008, respectively. Our investing activities during these periods primarily consisted of acquisitions of businesses and capital expenditures.
During the year ended September 30, 2010, we made four acquisitions. On October 9, 2009, we acquired from Nutritional Specialties, Inc. and its parent corporation, Baywood International, Inc., substantially all of the assets of the LifeTime Products nutritional supplement business excluding the ready to drink beverage business, which continued after closing under the company's new name, New Leaf Brands, Inc. On December 18, 2009, we acquired substantially all of the assets of Organix-South, Inc. On April 15, 2010, we acquired substantially all of the operating assets of Honey Gardens Apiaries, Inc. and Apitherapy, LLC. On July 16, 2010, we acquired substantially all of the operating assets of Nutritech Corporation. The aggregate purchase price of these acquisitions was $14.9 million in cash.
During the year ended September 30, 2009, we made one acquisition. On July 1, 2009, we acquired substantially all the operating assets of AJG Brands, Inc. ("Alan James Group"), a subsidiary of Interleukin Genetics, Inc., for $4.6 million in cash. Alan James Group products include Ginsana®, Ginkoba® and Venastat®.
The fiscal 2010 and fiscal 2009 acquisitions were financed primarily using borrowings under our revolving credit facility, as well as cash provided by operating activities. These acquisitions are in keeping with our business strategy of consolidating the fragmented industry where we compete and give us nutritional brands with products we currently do not sell. The expected long-term sales and expense synergies of acquired businesses are generally not realized immediately following acquisition as certain transition and integration matters must be completed.
Capital expenditures during the years ended September 30, 2010, 2009, and 2008 related primarily to building improvements related to facility consolidation efforts, distribution and manufacturing equipment and information systems. Also, on December 11, 2009, we purchased a facility for $2.8 million in cash to expand our Rapid Response Center in Ogden, Utah. This facility is adjacent to our existing facilities and will provide us approximately 105,000 square feet of additional gross building space located on 5.4 acres.
Net cash provided by (used in) financing activities was $6.4 million, $(13.3) million and $4.1 million for the years ended September 30, 2010, 2009 and 2008, respectively. Our financing activities during these periods consisted primarily of borrowings and repayments under our revolving credit facility related to operating needs, purchases of common stock for treasury and proceeds from the issuance of common stock.
In October 2007, we registered a direct stock purchase plan with the Securities and Exchange Commission. The purpose of this direct stock purchase plan is to provide a convenient way for existing stockholders, as well as new investors, to purchase shares of our common stock. A total of 1,500,000 shares of our common stock were registered under the plan with 32,075 and 22,981 shares purchased during the years ended September 30, 2010 and 2009, respectively.
On September 7, 2006, we amended our revolving credit facility (the "Credit Agreement"). The Credit Agreement extends the term of the credit facility to September 2011, resets the available credit borrowings to $60 million with no automatic reductions and provides an accordion feature which can increase the available credit borrowings to $90 million, subject to approval by the lenders and compliance with certain covenants and conditions. The lenders on this Credit Agreement are Rabobank International and Wells Fargo. To date, we have not experienced any difficulties in accessing the available funds under the Credit Agreement. Deferred financing fees of $205 thousand related to the Credit Agreement were deferred and are being amortized over the term of the Credit Agreement.
At September 30, 2010, we had outstanding revolving credit borrowings of $28.0 million under the Credit Agreement. Borrowings under the Credit Agreement are collateralized by substantially all our assets and bear interest at the applicable Eurodollar Rate plus a variable margin or at a base rate, which is the higher of the Federal Funds Rate plus 0.5% or the Prime Lending Rate, plus a variable margin. At September 30, 2010, the applicable weighted-average interest rate for outstanding borrowings was 1.16%. We are also required to pay a variable quarterly fee on the unused balance under the Credit Agreement. At September 30, 2010, the applicable rate was 0.18%. Accrued interest on Eurodollar Rate borrowings is payable based on elected intervals of one, two or three months. Accrued interest on base rate borrowings is payable quarterly. The Credit Agreement matures on September 7, 2011, at which time we are required to repay all principal and interest outstanding under the Credit Agreement. Since the Credit Agreement matures within one year, the balance outstanding has been classified in current liabilities at September 30, 2010. We are currently in discussions with our lenders and expect to replace the existing credit facility with a similar credit facility prior to the maturity date; however, there can be no assurance that we will be successful in doing so. Should we be unable to replace the existing credit facility or secure other financing alternatives, we expect to be able to repay the outstanding revolving credit facility balance utilizing cash flows generated from operations and, if necessary, by reducing discretionary capital and other expenditures.
The Credit Agreement contains restrictive covenants, including restrictions on incurring other indebtedness and requirements that we maintain certain financial ratios. As of September 30, 2010, we were in compliance with these restrictive covenants. Upon the occurrence of a default or an event of default, the lender has various remedies or rights, which may include proceeding against the collateral or requiring us to repay all amounts outstanding under the Credit Agreement.
On August 10, 2008, we entered into a one-year interest rate swap agreement covering $15.0 million of our outstanding revolving credit borrowings. The interest rate swap had an all-in average interest rate of 4.06% and was not designated as a hedge. For the year ended September 30, 2009, the interest rate swap had an unfavorable change in fair value of $192 thousand, which was included as a component of interest and other (income) expense in the Consolidated Statements of Operations. This swap expired on August 11, 2009 and was not renewed.
A key component of our business strategy is to seek to make additional acquisitions, which may require that we obtain additional financing, which could include the incurrence of substantial additional indebtedness. We believe that borrowings under the Credit Agreement or a replacement credit facility, together with cash flows from operations, will be sufficient to make required payments under the Credit Agreement or any such replacement facility, and to make anticipated capital expenditures and fund working capital needs for fiscal 2011.
Our significant non-cancelable contractual obligations and other commitments as of September 30, 2010 were as follows:
(a)Represents estimated interest obligations associated with our outstanding revolving credit facility balance of $28.0 million at September 30, 2010, assuming no principal payments are made before maturity, a weighted-average interest rate of 1.16% and an underutilization fee rate of 0.18%.
New Accounting Standards
In September 2006, the Financial Accounting Standards Board ("FASB") issued authoritative guidance which is included in Accounting Standards Codification ("ASC") 820, "Fair Value Measurements and Disclosures." This guidance defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. The guidance does not require any new fair value measurements but rather eliminates inconsistencies in guidance found in prior accounting pronouncements. In November 2007, the FASB decided to postpone for one year the effective date of this guidance for assets and liabilities measured at fair value on a non-recurring basis. We adopted the provisions of this guidance as of October 1, 2008 for assets and liabilities measured at fair value on a recurring basis. On October 1, 2009, we adopted the guidance for assets and liabilities measured at fair value on a non-recurring basis. The adoption of this guidance did not have a material impact on our Consolidated Financial Statements.
In December 2007, the FASB issued authoritative guidance included in ASC 805, "Business Combinations," which addresses fair value accounting and the related disclosure for assets and liabilities acquired in a business combination and generally requires acquisition-related costs to be expensed as incurred. This guidance was effective for us as of October 1, 2009 and did not have a material impact on the four acquisitions completed during fiscal 2010 but may have a material impact on future acquisitions depending on the nature of the acquisition.
In December 2007, the FASB issued authoritative guidance included in ASC 810, "Consolidation," which changes the accounting and reporting for the noncontrolling interests in a subsidiary in consolidated financial statements. The guidance recharacterizes minority interests as noncontrolling interests and requires noncontrolling interests to be classified as a component of stockholders' equity. This guidance was effective for us as of October 1, 2009 and did not have a material impact on our Consolidated Financial Statements.
In April 2008, the FASB issued authoritative guidance included in ASC 350, "Intangibles-Goodwill and Other," which amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. This guidance was effective for us as of October 1, 2009 and did not have a material impact on our Consolidated Financial Statements.
We periodically review new accounting standards that are issued. Although some of these accounting standards may be applicable to us, we have not identified any other new standards that we
believe merit further discussion, and we expect that none would have a significant impact on our Consolidated Financial Statements.
Inflation
Inflation affects the cost of raw materials, goods and services used by us. In recent years, inflation has been modest. The competitive environment somewhat limits our ability to recover higher costs resulting from inflation by raising prices. We seek to mitigate the adverse effects of inflation primarily through improved productivity and cost containment programs. We do not believe that inflation has had a material impact on our results of operations for the periods presented, except with respect to increased costs in manufacturing, packaging and distribution resulting from increased fuel and other petrochemical costs, as well as payroll-related costs, insurance premiums, and other costs arising from or related to government imposed regulations.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Borrowings under the Credit Agreement bear interest at the applicable Eurodollar Rate plus a variable margin or at a base rate, which is the higher of the Federal Funds Rate plus 0.5% or the Prime Lending Rate, plus a variable margin. At September 30, 2010, the applicable weighted average interest rate for borrowings was 1.16% and we had total borrowings outstanding of $28.0 million. On August 10, 2008, we entered into a one-year interest rate swap agreement covering $15.0 million of our outstanding revolving credit borrowings. The interest rate swap had an all-in average interest rate of 4.06%. It expired on August 11, 2009 and was not renewed.
With respect to our international operations, we are subject to currency fluctuations; however, we do not believe that these fluctuations would have a material adverse impact on our financial position or results of operations because the majority of our net sales to foreign countries are transacted in U.S. dollars. Net sales to foreign countries not transacted in U.S. dollars included sales to customers in Norway, Sweden, the U.K., the Netherlands and Japan. To date, we have not hedged any of our potential foreign currency exposures.
Item 8.
Item 8. Financial Statements and Supplementary Data
The information required by Item 8 is set forth on pages through of this Annual Report on Form 10-K. The supplemental financial information required by Item 302 of Regulation S-K is set forth in "Management's Discussion and Analysis of Financial Condition and Results of Operations-Selected Quarterly Financial Data; Seasonality."
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
There have been no changes in our independent registered public accounting firm, PricewaterhouseCoopers LLP, or disagreements with our accountants on matters of accounting and financial disclosure.
Item 9A.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures. We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms and that such information is accumulated and communicated to our management, including our principal executive and principal financial officers, as appropriate, to allow for timely decisions regarding required disclosure.
In designing and evaluating the disclosure controls and procedures, we recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and we are required to apply our judgment in evaluating the cost-benefit relationship with respect to possible controls and procedures.
As required by SEC Rule 13a-15(b), we carried out an evaluation, under the supervision and with the participation of our management, including our principal executive and principal financial officers, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the fiscal year covered by this report. Based on the foregoing, our principal executive and principal financial officers have concluded that our disclosure controls and procedures were effective.
Management's Report on Internal Control Over Financial Reporting. We are responsible for establishing and maintaining adequate internal control over financial reporting as such term is defined in Exchange Act Rule 13a-15(f). In order to evaluate the effectiveness of internal control over financial reporting, we conducted an assessment, based on the criteria in Internal Control-Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Based on our evaluation, management concluded that we maintained effective internal control over financial reporting as of September 30, 2010, based on the criteria in Internal Control-Integrated Framework issued by the COSO. Our internal control over financial reporting as of September 30, 2010 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which is included herein.
Changes in Internal Control Over Financial Reporting. There were no changes in our internal control over financial reporting that occurred during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
Information required by this item with respect to our directors, our audit committee, our audit committee financial expert and procedures by which stockholders may recommend nominees to the board of directors is set forth under the heading "The Board of Directors" in our definitive Proxy Statement for the 2011 Annual Meeting of Stockholders (the "Proxy Statement"), to be filed with the SEC within 120 days of the end of our fiscal year, which information is incorporated herein by reference. Information required by this item regarding our executive officers is included in Part I of this Annual Report on Form 10-K under the heading "Business-Executive Officers." Information required by this item with respect to Section 16(a) beneficial ownership reporting compliance is set forth in the Proxy Statement under the heading "Section 16(a) Beneficial Ownership Reporting Compliance," which information is incorporated herein by reference.
Code of Ethics
We have adopted a Code of Ethics within the meaning of Item 406(b) of Regulation S-K under the Exchange Act. This Code of Ethics applies to all our directors, officers and employees. The Code of Ethics is available on our website: www.nutraceutical.com. Additionally, we will provide to any person, without charge, upon request, a copy of the Code of Ethics. A person may request a copy by writing to Nutraceutical International Corporation, Attn.: Investor Relations, 1500 Kearns Boulevard, Suite B-200, Park City, Utah 84060 or by telephoning us at (435) 655-6106.
Item 11.
Item 11. Executive Compensation
Information required by this item is set forth in the Proxy Statement under the heading "Executive Compensation," which information is incorporated herein by reference (except for the Compensation Committee Report).
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Information required by this item is set forth in the Proxy Statement under the heading "Principal Stockholders," which information is incorporated herein by reference.
Item 13.
Item 13. Certain Relationships, Related Transactions and Director Independence
Information required by this item is set forth in the Proxy Statement under the headings "The Board of Directors-Compensation Committee Interlocks and Insider Participation" and "The Board of Directors-Certain Relationships, Related Transactions and Director Independence," which information is incorporated herein by reference.
Item 14.
Item 14. Principal Accounting Fees and Services
Information required by this item appears in the Proxy Statement under the heading "Fees Paid to PricewaterhouseCoopers LLP" and is incorporated herein by reference.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a) The following documents are filed as part of this report:
1.All Financial Statements:
Consolidated Financial Statements, as set forth on the attached Index to Consolidated Financial Statements.
2.Financial Statement Schedules:
Schedule II-Valuation and Qualifying Accounts.
3.Exhibits:
Reference is made to the attached Exhibit Index.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on this 23rd day of November 2010.
NUTRACEUTICAL INTERNATIONAL CORPORATION
By:
/s/ FRANK W. GAY II
Frank W. Gay II
Chairman of the Board
and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities indicated on this 23rd day of November 2010.
Signature
Capacity
/s/ FRANK W. GAY II
Frank W. Gay II
Director, Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
/s/ JEFFREY A. HINRICHS
Jeffrey A. Hinrichs
Director, Executive Vice President,
Chief Operating Officer and Secretary
/s/ CORY J. MCQUEEN
Cory J. McQueen
Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
/s/ GREGORY M. BENSON
Gregory M. Benson
Director
/s/ MICHAEL D. BURKE
Michael D. Burke
Director
/s/ J. KIMO ESPLIN
J. Kimo Esplin
Director
/s/ JAMES D. STICE
James D. Stice
Director
Nutraceutical International Corporation
Index to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders
Of Nutraceutical International Corporation:
In our opinion, the consolidated balance sheets and the related consolidated statements of operations, stockholders' equity and comprehensive income (loss) and cash flows present fairly, in all material respects, the financial position of Nutraceutical International Corporation and its subsidiaries at September 30, 2010 and 2009, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 2010 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of September 30, 2010, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management's Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company's internal control over financial reporting based on our integrated audits. 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 audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ PricewaterhouseCoopers LLP
Salt Lake City, UT
November 23, 2010
NUTRACEUTICAL INTERNATIONAL CORPORATION
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except per share data)
The accompanying notes are an integral part of these consolidated financial statements.
NUTRACEUTICAL INTERNATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands, except per share data)
The accompanying notes are an integral part of these consolidated financial statements.
NUTRACEUTICAL INTERNATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
NUTRACEUTICAL INTERNATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND
COMPREHENSIVE INCOME (LOSS)
(dollars in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
1. Description of Business
Nutraceutical International Corporation (the "Company") is an integrated manufacturer, marketer, distributor and retailer of branded nutritional supplements and other natural products sold primarily to and through domestic health and natural food stores. Internationally, the Company markets and distributes branded nutritional supplements and other natural products to and through health and natural product distributors and retailers. The Company's core business strategy is to acquire, integrate and operate businesses in the natural products industry that manufacture, market and distribute branded nutritional supplements. The Company believes that the consolidation and integration of these acquired businesses provides ongoing financial synergies through increased scale and market penetration, as well as strengthened customer relationships.
The Company manufactures and sells nutritional supplements and other natural products under numerous brands including Solaray®, KAL®, Nature's Life®, LifeTime®, Natural Balance®, bioAllers®, Herbs for Kids™, NaturalCare®, Health from the Sun®, Life-flo®, Organix South®, Pioneer® and Monarch Nutraceuticals™.
The Company owns neighborhood natural food markets, which operate under the trade names The Real Food Company™, Thom's Natural Foods™ and Cornucopia Community Market™. The Company also owns health food stores, which operate under the trade names Fresh Vitamins™ and Granola's™.
2. Summary of Significant Accounting Policies
Principles of Consolidation-The Consolidated Financial Statements include the accounts of the Company and its subsidiaries. All significant intercompany transactions and balances were eliminated.
Use of Estimates-The preparation of these financial statements in conformity with accounting principles generally accepted in the United States of America required management to make estimates and assumptions that affected the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of net sales and expenses during the reported periods. Significant estimates included values and lives assigned to acquired intangible assets, reserves for customer returns and allowances, uncollectible accounts receivable, slow moving, obsolete and/or damaged inventory and valuation and recoverability of long-lived assets. Actual results may differ from these estimates.
Fair Value of Financial Instruments-The Company believes that the fair values of financial instruments, including cash and cash equivalents, accounts receivable, accounts payable and debt, approximated their respective book values at September 30, 2009 and 2010.
Cash and Cash Equivalents-Cash and cash equivalents consist of cash on hand and marketable securities with original maturities of three months or less. The majority of the Company's cash and cash equivalents were held by one bank at September 30, 2010. As a result of this concentration, the Company's cash and cash equivalents balances frequently exceed federally insured limits. The Company does not believe it is subject to any other unusual risks as a result of this concentration other than those normally associated with commercial banking relationships.
Accounts Receivable-Provision is made for estimated bad debts based on a periodic analysis of individual customer balances, including an evaluation of days sales outstanding, payment history, recent payment trends and perceived credit worthiness.
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(dollars in thousands, except per share data)
2. Summary of Significant Accounting Policies (Continued)
Inventories-Branded inventories included freight-in, materials, labor and overhead costs and were stated at the lower of cost or market, cost being determined by a moving weighted average. Retail inventories were accounted for using the retail method. Provision is made for slow moving, obsolete and/or damaged inventory based on a periodic analysis of individual inventory items, including an evaluation of historical usage and/or movement, age, expiration date and general condition.
Property, Plant and Equipment-Property, plant and equipment were stated at cost, less accumulated depreciation and amortization. Depreciation and amortization were provided using the straight-line method over the estimated useful lives of the respective assets. Expenditures for renewals and betterments were capitalized, while maintenance and repairs were charged to operations in the periods incurred. Upon sale or disposal of an asset, the historical cost and related accumulated depreciation or amortization of such asset were removed from their respective accounts and any gain or loss was recorded in the Consolidated Statements of Operations.
The Company evaluates the recoverability of property, plant and equipment which are reviewed for possible impairment whenever events or circumstances indicate that the carrying amount of an asset group may not be recoverable. The Company measures recoverability of the asset group by comparison of its carrying amount to the future undiscounted cash flows the asset group is expected to generate. If the asset group is considered to be impaired, the difference between the carrying amount and the fair value of the impaired asset group is recorded.
Goodwill and Intangible Assets-The excess of purchase price over fair value of assets acquired and liabilities assumed in purchase transactions was classified as goodwill. Intangible assets with finite useful lives are amortized while intangible assets with indefinite useful lives are not amortized. Amortizable intangible assets are reviewed for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. Goodwill and non-amortizable intangible assets are tested annually for impairment and are tested for impairment between annual tests if an event occurs that would cause the Company to believe that value is impaired. The Company performs its annual impairment testing as of September 30 each year, which is the last day of the Company's fiscal year.
Derivative Instruments-Accounting Standards Codification ("ASC") 815, "Derivatives and Hedging," requires derivative instruments to be recognized as either assets or liabilities in the balance sheet at fair value. The accounting for changes in the fair value of derivative instruments depends on their intended use and resulting hedge designation. For derivative instruments designated as hedges, the changes in fair value are recorded in the balance sheet as a component of accumulated other comprehensive income. Changes in the fair value of derivative instruments not designated as hedges are recorded in the Consolidated Statements of Operations, generally as a component of interest and other (income) expense. At September 30, 2009 and 2010, the Company had no derivative instruments.
Deferred Financing Fees-The Company deferred certain debt issuance costs, including bank, legal, accounting and other fees, related to the establishment of a credit agreement (Note 10). These costs were capitalized as deferred financing fees and were amortized using the straight-line method, which approximated the effective interest rate method, based on the terms of the credit agreement.
Foreign Currency Translation-The functional currency of each of the Company's foreign subsidiaries is the local currency. All assets and liabilities of foreign subsidiaries were translated into
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(dollars in thousands, except per share data)
2. Summary of Significant Accounting Policies (Continued)
U.S. Dollars at fiscal year-end exchange rates. Income and expense items were translated at average exchange rates prevailing during the year. The resulting translation adjustments, net of income taxes, were recorded in accumulated other comprehensive income, which is a component of stockholders' equity.
Revenue Recognition-Revenue is recognized when the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) the product has been shipped and the customer takes ownership and assumes the risk of loss; (3) the selling price is fixed or determinable; and (4) collection of the resulting receivable is reasonably assured. The Company believes that these criteria are satisfied upon shipment from its facilities or, in the case of the Company's neighborhood natural food markets and health food stores, at the point of sale within these stores. Revenue is reduced by provisions for estimated returns and allowances, which are based on historical averages that have not varied significantly for the periods presented, as well as specific known claims, if any.
Shipping and Handling Costs-The Company incurred shipping and handling costs related to third-party freight charges, as well as internal warehousing and order fulfillment costs. These costs were classified as selling, general and administrative expenses and totaled $9,177, $8,446 and $10,502 for the years ended September 30, 2008, 2009 and 2010, respectively.
Research and Development-The Company expensed research and development costs as incurred. For the years ended September 30, 2008, 2009 and 2010, the Company incurred $1,088, $3,022 and $3,938, respectively, in research and development expenditures.
Advertising-The Company expensed advertising costs the first time the respective advertising took place. These costs were included in selling, general and administrative expenses.
Income Taxes-The Company accounted for income taxes using the asset and liability method which required the Company to record deferred tax assets and liabilities for the differences between the financial statement and tax bases of assets and liabilities using the expected applicable future tax rates.
The Company accounted for uncertain tax positions taken or expected to be taken in a tax return including the related financial statement recognition, measurement, reporting and disclosure (Note 12).
Concentrations of Credit Risk-In the normal course of business, the Company provided credit terms to its customers; however, collateral was not required. Accordingly, the Company performed credit evaluations of its customers and maintained allowances for possible losses which, when realized, were within the range of management's expectations. From time to time, a higher concentration of credit risk existed on outstanding accounts receivable for a select number of customers due to individual buying patterns.
New Accounting Standards-In September 2006, the Financial Accounting Standards Board ("FASB") issued authoritative guidance which is included in ASC 820, "Fair Value Measurements and Disclosures." This guidance defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. The guidance does not require any new fair value measurements but rather eliminates inconsistencies in guidance found in prior accounting pronouncements. In November 2007, the FASB decided to postpone
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(dollars in thousands, except per share data)
2. Summary of Significant Accounting Policies (Continued)
for one year the effective date of this guidance for assets and liabilities measured at fair value on a non-recurring basis. The Company adopted the provisions of this guidance as of October 1, 2008 for assets and liabilities measured at fair value on a recurring basis. On October 1, 2009, the Company adopted the guidance for assets and liabilities measured at fair value on a non-recurring basis. The adoption of this guidance did not have a material impact on the Company's Consolidated Financial Statements.
In December 2007, the FASB issued authoritative guidance included in ASC 805, "Business Combinations," which addresses fair value accounting and the related disclosure for assets and liabilities acquired in a business combination and generally requires acquisition-related costs to be expensed as incurred. This guidance was effective for the Company as of October 1, 2009 and did not have a material impact on the four acquisitions completed during fiscal 2010 but may have a material impact on future acquisitions depending on the nature of the acquisition.
In December 2007, the FASB issued authoritative guidance included in ASC 810, "Consolidation," which changes the accounting and reporting for the noncontrolling interests in a subsidiary in consolidated financial statements. The guidance recharacterizes minority interests as noncontrolling interests and requires noncontrolling interests to be classified as a component of stockholders' equity. This guidance was effective for the Company as of October 1, 2009 and did not have a material impact on the Company's Consolidated Financial Statements.
In April 2008, the FASB issued authoritative guidance included in ASC 350, "Intangibles-Goodwill and Other," which amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. This guidance was effective for the Company as of October 1, 2009 and did not have a material impact on the Company's Consolidated Financial Statements.
The Company periodically reviews new accounting standards that are issued. Although some of these accounting standards may be applicable to the Company, the Company has not identified any other new standards that it believes merit further discussion, and the Company expects that none would have a significant impact on its Consolidated Financial Statements.
3. Acquisitions
During the year ended September 30, 2009, the Company made one acquisition. On July 1, 2009, the Company acquired substantially all the operating assets of AJG Brands, Inc. ("Alan James Group"), a subsidiary of Interleukin Genetics, Inc., for $4,624 in cash. Alan James Group products include Ginsana®, Ginkoba® and Venastat®.
During the year ended September 30, 2010, the Company made four acquisitions. On October 9, 2009, the Company acquired from Nutritional Specialties, Inc. and its parent corporation, Baywood International, Inc., substantially all of the operating assets of the LifeTime Products nutritional supplement business excluding the ready to drink beverage business, which continued after closing under the company's new name, New Leaf Brands, Inc. On December 18, 2009, the Company acquired substantially all of the operating assets of Organix-South, Inc. On April 15, 2010, the Company acquired substantially all of the operating assets of Honey Gardens Apiaries, Inc. and Apitherapy, LLC.
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(dollars in thousands, except per share data)
3. Acquisitions (Continued)
On July 16, 2010, the Company acquired substantially all of the operating assets of Nutritech Corporation. The aggregate purchase price of these acquisitions was $14,905 in cash.
These acquisitions are in keeping with the Company's business strategy of consolidating the fragmented industry where it competes. These acquisitions were accounted for using the acquisition method of accounting. Accordingly, the aggregate purchase price was assigned to the assets acquired and liabilities assumed based on their fair market values at the respective dates of acquisition. The excess of aggregate purchase price over the fair market values of the assets acquired and liabilities assumed was classified as goodwill (Note 7). The Consolidated Statements of Operations and Consolidated Statements of Cash Flows presented herein include the activities of these acquired businesses from their respective dates of acquisition. The following reflects the allocation of the aggregate purchase prices for the fiscal 2009 and 2010 acquisitions to the aggregate assets acquired and liabilities assumed:
The fiscal 2009 and fiscal 2010 acquired intangible assets included trademarks and tradenames totaling $850 and $2,910, respectively, which have indefinite lives and are not subject to amortization for financial statement purposes, as well as intangible assets totaling $1,110 and $3,610, respectively, related to trademarks, tradenames and customer relationships, which are being amortized over a period of 3 to 9 years for financial statement purposes. Acquired intangible assets of $1,960 related to the fiscal 2009 acquisition and $6,520 related to the fiscal 2010 acquisitions are expected to be deductible for tax purposes over fifteen years. Goodwill, which is not subject to amortization for financial statement purposes, of $845 related to the fiscal 2009 acquisition and $4,211 related to the fiscal 2010 acquisitions is expected to be deductible for tax purposes over fifteen years.
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(dollars in thousands, except per share data)
4. Accounts Receivable, net
Accounts receivable, net of allowances for sales returns and doubtful accounts, consisted of the following:
5. Inventories, net
Inventories, net of reserves for slow moving, obsolete and/or damaged inventory, were comprised of the following:
6. Property, Plant and Equipment, net
Property, plant and equipment, net, were comprised of the following:
At September 30, 2009 and 2010, the Company had no equipment under capital leases. Substantially all property, plant and equipment of the Company collateralized its debt obligations (Note 10).
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(dollars in thousands, except per share data)
6. Property, Plant and Equipment, net (Continued)
Depreciation and amortization of property, plant and equipment totaled $5,158, $5,934 and $6,075 for the years ended September 30, 2008, 2009 and 2010, respectively.
7. Goodwill and Intangible Assets
Goodwill and non-amortizable intangible assets are tested annually for impairment and are tested for impairment between annual tests if an event occurs that would cause the Company to believe that value is impaired. The Company performs its annual impairment testing as of September 30 each year, which is the last day of the Company's fiscal year. Amortizable intangible assets are reviewed for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. There were no at-risk reporting units at September 30, 2010.
During the year ended September 30, 2009, the Company recorded a non-cash goodwill impairment charge of $37,519 ($27,288 after tax, or $2.52 per diluted share) related to the Company's branded and natural food markets reporting units. During the year ended September 30, 2008, the Company recorded a non-cash goodwill impairment charge of $2,875 ($1,811 after tax, or $0.16 per diluted share) related to the Company's health food stores reporting unit. The fiscal 2008 and 2009 non-cash goodwill impairment charges had no impact on the Company's compliance with debt covenants, cash flows or available liquidity.
The changes in the carrying amount of goodwill for the years ended September 30, 2009 and 2010 were as follows:
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(dollars in thousands, except per share data)
7. Goodwill and Intangible Assets (Continued)
The carrying amounts of intangible assets at September 30, 2009 and 2010 were as follows:
(1)Amounts include the impact of foreign currency translation adjustments.
Aggregate amortization expense related to intangible assets subject to amortization totaled $701, $697 and $1,299 for the years ended September 30, 2008, 2009 and 2010, respectively.
Estimated amortization expense related to intangible assets subject to amortization is as follows:
The ongoing uncertainty in general and economic conditions may continue to impact retail and consumer demand, as well as the market price of the Company's common stock, and could negatively impact the Company's future operating performance, cash flow and/or stock price and could result in additional goodwill and/or intangible asset impairment charges being recorded in future periods which could materially impact the Company's Consolidated Financial Statements. The valuation of goodwill and intangible assets is subject to a high degree of judgment and complexity.
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(dollars in thousands, except per share data)
8. Fair Value of Financial Instruments
The Company measures at fair value certain financial assets, including cash equivalents, using a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company's own assumptions. The following fair value hierarchy prioritizes the inputs into three broad levels:
•Level 1-Quoted prices for identical instruments in active markets;
•Level 2-Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets; and
•Level 3-Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.
This hierarchy requires the Company to minimize the use of unobservable inputs and to use observable market data, if available, when determining fair value. The company had no assets requiring fair value measurement at September 30, 2010. The fair value of the Company's financial assets at September 30, 2009 was determined using the following level of input:
The fair value of the money market fund, classified as Level 1, was obtained from a quoted market price.
During fiscal 2009, the Company had one derivative financial instrument, an interest rate swap, to manage its exposure to interest rate risks. This swap expired August 11, 2009 and was not renewed. The Company does not use derivatives for trading or speculative purposes and is not a party to leveraged derivatives.
9. Accrued Expenses
Accrued expenses were comprised of the following:
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(dollars in thousands, except per share data)
10. Debt
Debt was comprised of the following:
On September 7, 2006, the Company amended its revolving credit facility (the "Credit Agreement"). The Credit Agreement extends the term of the credit facility to September 2011, resets the available credit borrowings to $60,000 with no automatic reductions and provides an accordion feature which can increase the available credit borrowings to $90,000 subject to approval by the lenders and compliance with certain covenants and conditions. The lenders on this Credit Agreement are Rabobank International and Wells Fargo. To date, the Company has not experienced any difficulties in accessing the available funds under the Credit Agreement. Deferred financing fees of $205 related to the Credit Agreement were deferred and are being amortized over the term of the Credit Agreement.
At September 30, 2010, the Company had outstanding revolving credit borrowings of $28,000 under the Credit Agreement. Borrowings under the Credit Agreement are collateralized by substantially all assets of the Company. At the Company's election, borrowings bear interest at the applicable Eurodollar Rate plus a variable margin or at a base rate, which is the higher of the Federal Funds Rate plus 0.5% or the Prime Lending Rate, plus a variable margin. At September 30, 2010, the applicable weighted-average interest rate for outstanding borrowings was 1.16%. The Company is also required to pay a variable quarterly fee on the unused balance under the Credit Agreement. At September 30, 2010, the applicable rate was 0.18%. Accrued interest on Eurodollar Rate borrowings is payable based on elected intervals of one, two or three months. Accrued interest on base rate borrowings is payable quarterly. The Credit Agreement matures on September 7, 2011, at which time the Company is required to repay all principal and interest outstanding under the Credit Agreement. Since the Credit Agreement matures within one year, the balance outstanding has been classified in current liabilities at September 30, 2010. The Company is currently in discussions with its lenders and expects to replace the existing credit facility with a similar credit facility prior to the maturity date; however, there can be no assurance that the Company will be successful in doing so. Should the Company be unable to replace the existing credit facility or secure other financing alternatives, the Company expects to be able to repay the outstanding revolving credit facility balance utilizing cash flows generated from operations and, if necessary, by reducing discretionary capital and other expenditures.
The Credit Agreement contains restrictive covenants, including restrictions on incurring other indebtedness and requirements that the Company maintain certain financial ratios. Upon the occurrence of a default or an event of default, the lender has various remedies or rights, which may include proceeding against the collateral or requiring the Company to repay all amounts outstanding under the Credit Agreement.
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(dollars in thousands, except per share data)
10. Debt (Continued)
On August 10, 2008, the Company entered into a one-year interest rate swap agreement covering $15,000 of the Company's outstanding revolving credit borrowings. The interest rate swap had an all-in interest rate of 4.06% and was not designated as a hedge. For the year ended September 30, 2009, the interest rate swap had an unfavorable change in fair value of $192, which was included as a component of interest and other (income) expense in the Consolidated Statements of Operations. This swap expired on August 11, 2009 and was not renewed.
11. Lease Commitments and Obligations
The Company leases retail, office, storage and warehouse space under non-cancelable operating leases, the last of which expires during fiscal 2017; however, the Company has negotiated extension options in many cases. These operating leases require the Company to pay all taxes, insurance and maintenance.
The following summarizes future minimum lease payments required under the Company's significant non-cancelable operating leases:
Total rent expense incurred by the Company under significant non-cancelable operating leases was $3,062, $3,151 and $3,337 for the years ended September 30, 2008, 2009 and 2010, respectively.
12. Income Taxes
The provision (benefit) for income taxes was comprised of the following:
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(dollars in thousands, except per share data)
12. Income Taxes (Continued)
A summary of the composition of net deferred income tax assets and liabilities was as follows:
The differences between income taxes (benefit) at the statutory federal income tax rate and income taxes (benefit) reported in the Consolidated Statements of Operations were as follows:
On October 1, 2007, the Company adopted authoritative guidance included in ASC 740, "Income Taxes," related to the accounting for uncertain tax positions. As a result of the adoption of this guidance, the Company recognized a $33 decrease in the liability for unrecognized tax benefits, which was recorded as an increase to the October 1, 2007 balance of retained earnings.
As of September 30, 2009, the Company's liability related to unrecognized tax benefits was $167. As of September 30, 2010, the Company's liability related to unrecognized tax benefits was $128 of which $119 would impact the Company's effective tax rate if recognized. The liability related to unrecognized tax benefits was recorded as a component of other non-current liabilities in the Company's Consolidated Balance Sheets. Interest and penalties related to unrecognized tax benefits are recorded as a component of interest and other (income) expense in the Company's Consolidated Statements of Operations. For the years ended September 30, 2009 and 2010, the Company recorded a net expense of $1 and a net benefit of $2, respectively, for interest related to unrecognized tax benefits. At September 30, 2010, the Company had $8 in accrued interest related to unrecognized tax benefits.
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(dollars in thousands, except per share data)
12. Income Taxes (Continued)
The Company does not anticipate any significant changes in unrecognized tax benefits during the next twelve months.
During fiscal 2009 and fiscal 2010, the aggregate changes in the balance of unrecognized tax benefits were as follows:
The Company files income tax returns in the United States federal jurisdiction, various U.S. state jurisdictions and certain foreign jurisdictions. The Company is no longer subject to U.S. federal tax examinations for fiscal years before 2007. The Company is no longer subject to examination in any U.S. state jurisdiction or foreign jurisdiction for fiscal years prior to 2005.
13. Capital Stock
Description of Capital Stock-At September 30, 2009 and 2010, the Company had two authorized classes of stock: Common Stock and Preferred Stock, each with a par value of $0.01 per share. At September 30, 2009 and 2010, 5,000,000 shares of Preferred Stock were authorized with no shares issued or outstanding.
Stock Option Plans-During the year ended September 30, 1998, the Company's Board of Directors adopted the 1998 Stock Incentive Plan. This plan provided for granting options to purchase Common Stock to executives, employees and consultants of the Company and its subsidiaries. Grants under this plan vested over a period of two to four years and expire no later than the tenth anniversary of the date of grant. In aggregate, 1,050,000 shares of Common Stock were reserved for issuance under this plan. As of September 30, 2010, options to purchase 371,688 shares of Common Stock were issued, outstanding and exercisable under this plan.
During the year ended September 30, 1998, the Company's Board of Directors adopted the 1998 Non-Employee Director Stock Option Plan. This plan provided for granting options to purchase Common Stock to non-employee directors of the Company. Grants under this plan vested over a period of three years and expire no later than the tenth anniversary of the date of grant. In aggregate, 150,000 shares of Common Stock were reserved for issuance under this plan. As of September 30, 2010, options to purchase 20,000 shares of Common Stock were issued, outstanding and exercisable under this plan.
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(dollars in thousands, except per share data)
13. Capital Stock (Continued)
On September 30, 2005, the Company terminated the 1998 Stock Incentive Plan and the 1998 Non-Employee Director Stock Option Plan. After September 30, 2005, no new awards of any kind will be granted under any of these plans. However, the termination of these plans did not have any effect on outstanding options. Outstanding, vested options may be exercised any time prior to the expiration date of such award to the same extent such award would have been exercisable had the plans not been terminated.
As of September 30, 2010, options to purchase an aggregate 391,688 shares of Common Stock were issued, outstanding and exercisable. The following table sets forth option activity under the 1998 Stock Incentive Plan and the 1998 Non-Employee Director Stock Option Plan for the years ended September 30, 2008, 2009 and 2010:
Options granted were issued at exercise prices that represented the quoted market price of Common Stock at the respective grant dates. For the years ended September 30, 2008, 2009 and 2010, options to purchase 232,800, 272,175 and 71,325 shares of common stock, respectively, were excluded from the computation of diluted earnings per share because the exercise prices of these stock options were greater than the average share price of the Company's common stock and, therefore, the effect would have been antidilutive.
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(dollars in thousands, except per share data)
13. Capital Stock (Continued)
The following table sets forth data related to exercise prices and lives for all issued, outstanding and exercisable options as of September 30, 2010, which include grants made under the 1998 Stock Incentive Plan and the 1998 Non-Employee Director Stock Option Plan:
At September 30, 2010, the aggregate intrinsic value of stock options outstanding and exercisable was $2,370. The intrinsic value is the amount by which the market value of the underlying common stock exceeds the exercise price of the respective stock option.
During the years ended September 30, 2008, 2009 and 2010, the Company received proceeds of $314, $318 and $278, respectively, related to the exercise of stock options and optionees realized aggregate pre-tax gains of $163, $323 and $683, respectively, from these stock option exercises.
Share Purchase Program-Prior to fiscal 2010, the Company's Board of Directors approved a share purchase program authorizing the Company to buy up to 3,500,000 shares of Common Stock of the Company. During fiscal 2008, the Company purchased 349,150 shares at an aggregate price of $4,469. All shares of Common Stock held in treasury during fiscal 2008 were retired prior to September 30, 2008. During fiscal 2009, the Company purchased 356,775 shares at an aggregate price of $4,407. All shares of Common Stock held in treasury during fiscal 2009 were retired prior to September 30, 2009. During fiscal 2010, the Company purchased 327,348 shares at an aggregate price of $3,995. All shares of Common Stock held in treasury during fiscal 2010 were retired prior to September 30, 2010. As of September 30, 2010, the Company was permitted to purchase up to 879,792 additional shares under its approved share purchase program. The shares available for repurchase at September 30, 2010 have no expiration date. The Company accounts for treasury shares using the cost method.
Direct Stock Purchase Plan-In October 2007, the Company registered a direct stock purchase plan with the Securities and Exchange Commission. The purpose of this direct stock purchase plan is to provide a convenient way for existing stockholders, as well as new investors, to purchase shares of the Company's Common Stock. A total of 1,500,000 shares of the Company's Common Stock were registered under the plan with 22,981 and 32,075 shares purchased for the years ended September 30, 2009 and 2010, respectively.
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(dollars in thousands, except per share data)
14. Segments
Segment identification and selection is consistent with the management structure used by the Company to evaluate performance and make decisions regarding resource allocation, as well as the materiality of financial results consistent with that structure. Based on the Company's management structure and method of internal reporting, the Company has one operating segment. The Company does not review operating results on a disaggregated basis; rather, management reviews operating results on an aggregate basis.
Net sales attributed to customers in the United States and foreign countries for the years ended September 30, 2008, 2009 and 2010 were as follows:
Certain net sales attributed to customers in the United States are sold to customers who in turn may sell such products to customers in foreign countries while certain net sales attributed to customers in foreign countries are sold to customers who in turn may sell such products to customers in the United States.
The Company's net sales by product group for the years ended September 30, 2008, 2009 and 2010 were as follows:
(1)Nets sales for any other product or group of similar products are less than 10% of consolidated net sales.
15. Employee Benefit Plans
401(k) Plan-The Company has a 401(k) defined contribution profit sharing plan that covers substantially all employees. Under the plan, employees may contribute up to 15% of their compensation subject to certain exceptions and limitations. In addition, employees who meet certain age requirements may contribute additional amounts permitted by law under the plan. The Company makes matching contributions to the plan up to the first 4% of employee contributions and is permitted to make discretionary contributions under the plan. The amounts contributed to the plan by the Company were $756, $760 and $800 for the years ended September 30, 2008, 2009 and 2010, respectively.
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(dollars in thousands, except per share data)
16. Supplemental Disclosure of Cash Flow Items
Cash paid by the Company for interest was $1,457, $1,178 and $430 for the years ended September 30, 2008, 2009 and 2010, respectively. Cash paid by the Company for taxes was $6,053, $5,711 and $7,575 for the years ended September 30, 2008, 2009 and 2010, respectively.
17. Commitments and Contingencies
The formulation, manufacturing, processing, packaging, labeling, advertising, distribution and sale of nutritional supplements (including vitamins, amino acids, minerals, herbs, other botanicals and other dietary ingredients), such as those sold by the Company, are subject to regulation by one or more federal agencies, principally the Food and Drug Administration (the "FDA") and the Federal Trade Commission and, to a lesser extent, the Consumer Product Safety Commission and the United States Department of Agriculture. These activities are also regulated by various governmental agencies for the states and localities in which the Company's products are sold, as well as by governmental agencies in certain countries in which the Company's products are sold outside the United States.
Although management believes that the Company is in material compliance with the statutes, laws, rules and regulations of every jurisdiction in which it operates, no assurance can be given that the Company's compliance with applicable statutes, laws, rules and regulations will not be challenged by governing authorities or private parties or that such challenges will not have a material adverse effect on the Company's financial position, results of operations or cash flows.
The Company, like any other retailer, distributor or manufacturer of products that are designed to be ingested, also faces inherent risk of exposure to product liability claims in the event that the use of its products results in injury. With respect to product liability claims, the Company has liability insurance; however, liability policies contain exclusions (such as those related to specific ingredients or types of claims) and there can be no assurance that such insurance will be adequate to cover all potential liabilities. In the event that the Company does not have adequate insurance or contractual indemnification from parties supplying raw materials or marketing its products, product liability related to defective products could have a material adverse effect on the Company.
The Company is involved in various legal matters arising in the normal course of business. In the opinion of management, the outcomes of individual regulatory and legal matters in which the Company is presently involved are not probable and no estimate can be made of the range of potential gains or losses. While incapable of estimation, in the opinion of management, the individual regulatory and legal matters in which it is involved are not expected to have a material adverse effect on the Company's financial position, results of operations or cash flows. However, the aggregate liability of the Company arising from regulatory and legal proceedings related to these matters could have a material effect on the Company's financial position, results of operations or cash flows.
18. Subsequent Events
On October 7, 2010, the Company acquired certain operating assets of TRC Nutritional Labs, Inc. On October 14, 2010, the Company acquired certain operating assets of The Heritage Store, Inc. The primary assets acquired in these acquisitions included accounts receivable, inventory, equipment, a building, trademarks/tradenames, customer relationships and goodwill. The aggregate purchase price of these acquisitions was approximately $7,200 in cash. As of the date of these financial statements, the Company is determining the fair value of the acquired assets and the related allocations of the purchase prices but deemed it impracticable to disclose the allocations due to the short time frame between the acquisition dates and this filing.
NUTRACEUTICAL INTERNATIONAL CORPORATION
SCHEDULE II-VALUATION AND QUALIFYING ACCOUNTS
EXHIBIT INDEX
(1)Incorporated herein by reference to the applicable exhibit to our Registration Statement on Form S-1/A, Registration No. 333-41909.
(2)Filed as an exhibit to our Form 8-K filed on October 3, 2005 and incorporated herein by reference.
(3)Filed as an exhibit to our Form 8-K filed on September 8, 2006 and incorporated herein by reference.
(4)Filed herewith.