SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
for the Quarterly Period Ended June 30, 2006
Commission file number 000-23731
NUTRACEUTICAL INTERNATIONAL CORPORATION
(Exact name of registrant as specified in its charter)
Delaware | 87-0515089 |
(State of incorporation) | (IRS Employer Identification No.) |
1400 Kearns Boulevard, 2nd Floor, Park City, Utah | 84060 |
(Address of principal executive office) | (Zip code) |
(435) 655-6106 |
(Registrant’s telephone number, including area code) |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
YES x NO o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer as defined in Rule 12b-2 of the Exchange Act (check one):
Large accelerated filer o Accelerated filer x Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
YES o NO x
At July 27, 2006, the registrant had 11,250,667 shares of common stock outstanding.
NUTRACEUTICAL INTERNATIONAL CORPORATION
INDEX
2
PART I—FINANCIAL INFORMATION
Item 1. Financial Statements
NUTRACEUTICAL INTERNATIONAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
(dollars in thousands)
| | September 30, | | June 30, | |
| | 2005(1) | | 2006 | |
ASSETS | | | | | | | |
Current assets | | | | | | | |
Cash | | | $ | 3,371 | | | $ | 2,150 | |
Accounts receivable, net | | | 10,586 | | | 10,750 | |
Inventories, net | | | 25,434 | | | 30,669 | |
Prepaid expenses and other current assets | | | 2,060 | | | 1,601 | |
Deferred income taxes | | | 1,416 | | | 1,394 | |
Total current assets | | | 42,867 | | | 46,564 | |
Property, plant and equipment, net | | | 25,808 | | | 31,886 | |
Goodwill | | | 18,387 | | | 18,366 | |
Intangible assets, net | | | 7,016 | | | 6,750 | |
Other non-current assets, net | | | 616 | | | 468 | |
Deferred income taxes, net | | | 6,211 | | | 5,311 | |
| | | $ | 100,905 | | | $ | 109,345 | |
LIABILITIES AND STOCKHOLDERS’ EQUITY | | | | | | | |
Current liabilities | | | | | | | |
Accounts payable | | | $ | 10,733 | | | $ | 10,215 | |
Accrued expenses | | | 5,341 | | | 4,175 | |
Current portion of long-term debt | | | — | | | 3,500 | |
Total current liabilities | | | 16,074 | | | 17,890 | |
Long-term debt | | | 2,000 | | | — | |
Other non-current liabilities | | | 364 | | | 359 | |
Total liabilities | | | 18,438 | | | 18,249 | |
Stockholders’ equity | | | | | | | |
Common stock | | | 115 | | | 113 | |
Additional paid-in capital | | | 39,317 | | | 36,059 | |
Retained earnings | | | 42,900 | | | 54,754 | |
Accumulated other comprehensive income | | | 135 | | | 170 | |
Total stockholders’ equity | | | 82,467 | | | 91,096 | |
| | | $ | 100,905 | | | $ | 109,345 | |
(1) The condensed consolidated balance sheet as of September 30, 2005 has been prepared using information from the audited financial statements at that date.
The accompanying notes are an integral part of these condensed consolidated financial statements.
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NUTRACEUTICAL INTERNATIONAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME
(unaudited)
(dollars in thousands, except per share data)
| | Three months ended June 30, | | Nine months ended June 30, | |
| | 2005 | | 2006 | | 2005 | | 2006 | |
Net sales | | $ | 37,233 | | $ | 36,985 | | $ | 111,381 | | $ | 114,714 | |
Cost of sales | | 18,092 | | 17,414 | | 53,929 | | 54,246 | |
Gross profit | | 19,141 | | 19,571 | | 57,452 | | 60,468 | |
Operating expenses | | | | | | | | | |
Selling, general and administrative | | 13,676 | | 13,876 | | 41,188 | | 41,807 | |
Amortization of intangible assets | | 94 | | 92 | | 282 | | 280 | |
Income from operations | | 5,371 | | 5,603 | | 15,982 | | 18,381 | |
Interest and other (income)/expense, net | | 162 | | 138 | | 542 | | (893 | ) |
Income before provision for income taxes | | 5,209 | | 5,465 | | 15,440 | | 19,274 | |
Provision for income taxes | | 2,006 | | 2,104 | | 5,945 | | 7,420 | |
Net income | | $ | 3,203 | | $ | 3,361 | | $ | 9,495 | | $ | 11,854 | |
Other comprehensive income/(loss) | | | | | | | | | |
Foreign currency translation adjustment, net of tax | | (73 | ) | 40 | | (50 | ) | 35 | |
Comprehensive income | | $ | 3,130 | | $ | 3,401 | | $ | 9,445 | | $ | 11,889 | |
Net income per common share | | | | | | | | | |
Basic | | $ | 0.28 | | $ | 0.30 | | $ | 0.82 | | $ | 1.04 | |
Diluted | | 0.27 | | 0.29 | | 0.80 | | 1.02 | |
Weighted average common shares outstanding | | | | | | | | | |
Basic | | 11,560,503 | | 11,272,259 | | 11,539,643 | | 11,383,996 | |
Dilutive effect of stock options and warrants | | 199,073 | | 205,561 | | 264,315 | | 185,303 | |
Diluted | | 11,759,576 | | 11,477,820 | | 11,803,958 | | 11,569,299 | |
The accompanying notes are an integral part of these condensed consolidated financial statements.
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NUTRACEUTICAL INTERNATIONAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(dollars in thousands)
| | Nine months ended June 30, | |
| | 2005 | | 2006 | |
Cash flows from operating activities | | | | | | | | | |
Net income | | | $ | 9,495 | | | | $ | 11,854 | | |
Adjustments to reconcile net income to net cash provided by operating activities | | | | | | | | | |
Depreciation and amortization | | | 3,279 | | | | 3,476 | | |
Amortization of deferred financing fees | | | 137 | | | | 137 | | |
Losses/(gain) on disposals of property and equipment | | | 40 | | | | (1,099 | ) | |
Deferred income taxes | | | 1,003 | | | | 922 | | |
Tax benefit from stock option exercises | | | 333 | | | | 5 | | |
Changes in assets and liabilities, net of effects of acquisitions | | | | | | | | | |
Accounts receivable, net | | | 416 | | | | (164 | ) | |
Inventories, net | | | (387 | ) | | | (5,235 | ) | |
Prepaid expenses and other current assets | | | 1,311 | | | | 459 | | |
Other non-current assets, net | | | (18 | ) | | | (3 | ) | |
Accounts payable | | | (1,314 | ) | | | (518 | ) | |
Accrued expenses | | | (257 | ) | | | (803 | ) | |
Other non-current liabilities | | | (24 | ) | | | (5 | ) | |
Net cash provided by operating activities | | | 14,014 | | | | 9,026 | | |
Cash flows from investing activities | | | | | | | | | |
Acquisitions of businesses, net of cash acquired | | | (5,821 | ) | | | (95 | ) | |
Proceeds from sale of property and equipment | | | — | | | | 4,500 | | |
Purchases of property and equipment | | | (4,350 | ) | | | (12,675 | ) | |
Net cash used in investing activities | | | (10,171 | ) | | | (8,270 | ) | |
Cash flows from financing activities | | | | | | | | | |
Payments on other non-current liabilities | | | (225 | ) | | | (225 | ) | |
Proceeds from long-term debt | | | 5,500 | | | | 11,500 | | |
Payments on long-term debt | | | (7,000 | ) | | | (10,000 | ) | |
Proceeds from issuances of common stock | | | 831 | | | | 142 | | |
Purchases of common stock for treasury | | | (3,050 | ) | | | (3,414 | ) | |
Tax benefit from stock option exercises | | | — | | | | 7 | | |
Net cash used in financing activities | | | (3,944 | ) | | | (1,990 | ) | |
Effect of exchange rate changes on cash | | | (6 | ) | | | 13 | | |
Net decrease in cash | | | (107 | ) | | | (1,221 | ) | |
Cash at beginning of period | | | 2,134 | | | | 3,371 | | |
Cash at end of period | | | $ | 2,027 | | | | $ | 2,150 | | |
The accompanying notes are an integral part of these condensed consolidated financial statements.
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NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(dollars in thousands, except per share data)
1. INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
In the opinion of management, the accompanying unaudited condensed consolidated financial statements include all necessary adjustments (consisting of normal recurring accruals) to present fairly the consolidated financial position of Nutraceutical International Corporation and its subsidiaries (the “Company”) as of June 30, 2006, the results of their operations for the three months and nine months ended June 30, 2005 and 2006 and their cash flows for the nine months ended June 30, 2005 and 2006, in conformity with accounting principles generally accepted in the United States of America for interim financial information applied on a consistent basis. Results for the three and nine months ended June 30, 2006 are not necessarily indicative of the results to be expected for the full fiscal year.
Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted. Accordingly, these financial statements should be read in conjunction with the Company’s Form 10-K for the Fiscal Year Ended September 30, 2005, which was filed with the Securities and Exchange Commission on December 1, 2005.
2. ACCOUNTS RECEIVABLE, NET
Accounts receivable, net of allowances for sales returns and doubtful accounts, consisted of the following:
| | September 30, | | June 30, | |
| | 2005 | | 2006 | |
Accounts receivable | | | $ | 12,476 | | | $ | 12,738 | |
Less allowances | | | (1,890 | ) | | (1,988 | ) |
| | | $ | 10,586 | | | $ | 10,750 | |
3. INVENTORIES, NET
Inventories, net of reserves for slow moving, obsolete and/or damaged inventory, were comprised of the following:
| | September 30, | | June 30, | |
| | 2005 | | 2006 | |
Raw materials | | | $ | 9,495 | | | $ | 12,528 | |
Work-in-process | | | 6,800 | | | 6,746 | |
Finished goods | | | 11,123 | | | 13,203 | |
| | | 27,418 | | | 32,477 | |
Less reserves | | | (1,984 | ) | | (1,808 | ) |
| | | $ | 25,434 | | | $ | 30,669 | |
4. PROPERTY, PLANT AND EQUIPMENT
On January 20, 2006, the Company sold its 31,340 square foot building located in Park City, Utah for approximately $4,500 in cash. At the time of sale, the building had a book value of $3,395. A gain of $1,105
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NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)
(dollars in thousands, except per share data)
($680 after tax, or $0.06 per diluted share) was included in interest and other (income)/expense for the nine months ended June 30, 2006.
On March 31, 2006, the Company purchased the Rapid Response Center in Ogden, Utah, which (when fully converted) will provide approximately 410,000 square feet of gross building space located on approximately 19.2 acres, which includes available land for expansion, for $4,160 in cash. The Rapid Response Center is the central facility where the Company is, and has been, consolidating operations, including raw material warehousing, manufacturing, packaging, distribution and administrative offices. The Company was previously leasing most of this facility.
5. GOODWILL
The change in the carrying amount of goodwill from September 30, 2005 to June 30, 2006 was as follows:
| | Goodwill | |
Balance as of September 30, 2005 | | $ | 18,387 | |
Goodwill attributable to fiscal 2006 second quarter acquisition | | 95 | |
Purchase accounting adjustments related to prior acquisitions | | (116 | ) |
Balance as of June 30, 2006 | | $ | 18,366 | |
6. INTANGIBLE ASSETS
The carrying amounts of intangible assets at September 30, 2005 and June 30, 2006 were as follows:
| | September 30, 2005 | | June 30, 2006 | | Weighted- | |
| | Gross | | | | Net | | Gross | | | | Net | | Average | |
| | Carrying | | Accumulated | | Carrying | | Carrying | | Accumulated | | Carrying | | Amortization | |
| | Amount | | Amortization | | Amount | | Amount | | Amortization | | Amount | | Period (Years) | |
Intangible assets subject to amortization: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Non-compete agreements | | | $ | 1,000 | | | | $ | (750 | ) | | | $ | 250 | | | | $ | 1,000 | | | | $ | (1,000 | ) | | | $ | — | | | | 3 | | |
Trademarks/trade names/patents | | | 338 | | | | (250 | ) | | | 88 | | | | 352 | | | | (280 | ) | | | 72 | | | | 5 | | |
| | | 1,338 | | | | (1,000 | ) | | | 338 | | | | 1,352 | | | | (1,280 | ) | | | 72 | | | | | | |
Intangible assets not subject to amortization: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Trademarks/trade names/licenses | | | 6,678 | | | | — | | | | 6,678 | | | | 6,678 | | | | — | | | | 6,678 | | | | | | |
| | | $ | 8,016 | | | | $ | (1,000 | ) | | | $ | 7,016 | | | | $ | 8,030 | | | | $ | (1,280 | ) | | | $ | 6,750 | | | | | | |
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NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)
(dollars in thousands, except per share data)
Estimated future amortization expense related to the June 30, 2006 net carrying amount of $72 for intangible assets subject to amortization is as follows:
| | Estimated | |
| | Amortization | |
Year Ending September 30, | | | | Expense(1) | |
2006 | | | $ | 8 | | |
2007 | | | 26 | | |
2008 | | | 17 | | |
2009 | | | 13 | | |
2010 | | | 7 | | |
Thereafter | | | 1 | | |
| | | $ | 72 | | |
| | | | | | | | |
(1) Estimated amortization expense for the year ending September 30, 2006 includes only amortization to be recorded after June 30, 2006.
7. SHARE PURCHASES
During the three months ended June 30, 2006, the Company purchased 95,741 shares of common stock for an aggregate price of $1,445, which shares were held in treasury until being retired on June 28, 2006. During the nine months ended June 30, 2006, the Company purchased a total of 234,350 shares of common stock for an aggregate price of $3,414. As of June 30, 2006, the Company was permitted to purchase up to 150,428 additional shares under its approved purchase plan.
8. OPERATING 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 three and nine months ended June 30, 2005 and 2006 were as follows:
| | Three months ended
June 30, | | Nine months ended
June 30, | |
| | 2005 | | 2006 | | 2005 | | 2006 | |
United States | | $ | 33,815 | | $ | 32,698 | | $ | 101,683 | | $ | 103,041 | |
Foreign countries | | 3,418 | | 4,287 | | 9,698 | | 11,673 | |
| | $ | 37,233 | | $ | 36,985 | | $ | 111,381 | | $ | 114,714 | |
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
8
NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)
(dollars in thousands, except per share data)
foreign countries are sold to customers who in turn may sell such products to customers in the United States.
9. STOCK-BASED COMPENSATION
The Company adopted Statement of Financial Accounting Standards No. 123R, Share-Based Payment (“SFAS 123R”) effective October 1, 2005, using the modified prospective application method. SFAS 123R requires companies to record compensation expense for the value of all outstanding and unvested share-based payments, including employee stock options and similar awards. At the date of adoption, October 1, 2005, the Company had no outstanding and unvested share-based payments. On September 30, 2005, the Company terminated the 1995 Stock Option Plan, 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. As a result, the Company did not recognize any share-based compensation expense in its consolidated financial statements for the three and nine months ended June 30, 2006.
Prior to the adoption of SFAS 123R, the Company accounted for its stock-based employee compensation plans using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. No stock-based employee compensation cost was reflected in net income as all options granted under those stock-based employee compensation plans had exercise prices equal to the market values of the underlying common shares on the dates of grant. The following table illustrates the effect on net income and earnings per share as if the Company had applied the fair value recognition provisions of SFAS 123 to stock-based employee compensation.
| | Three months
ended June 30, | | Nine months
ended June 30, | |
| | 2005 | | 2006 | | 2005 | | 2006 | |
Net income, as reported | | $ | 3,203 | | $ | 3,361 | | $ | 9,495 | | $ | 11,854 | |
Deduct: Total stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax effects | | (124 | ) | — | | (371 | ) | — | |
Pro forma net income | | $ | 3,079 | | $ | 3,361 | | $ | 9,124 | | $ | 11,854 | |
Earnings per share | | | | | | | | | |
Basic—as reported | | $ | 0.28 | | $ | 0.30 | | $ | 0.82 | | $ | 1.04 | |
Diluted—as reported | | 0.27 | | 0.29 | | 0.80 | | 1.02 | |
Basic—pro forma | | $ | 0.27 | | $ | 0.30 | | $ | 0.79 | | $ | 1.04 | |
Diluted—pro forma | | 0.26 | | 0.29 | | 0.77 | | 1.02 | |
Stock options to purchase 836,897 and 875,836 shares of common stock were outstanding at June 30, 2005 and 2006, respectively. Of these outstanding stock options, 140,340 and 139,140 options to purchase common stock at June 30, 2005 and 2006, 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. Based on the application of the treasury stock method, the dilutive effect of stock options and warrants was 199,073
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NUTRACEUTICAL INTERNATIONAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)
(dollars in thousands, except per share data)
and 205,561 additional shares for the three months ended June 30, 2005 and 2006, respectively, and 264,315 and 185,303 additional shares for the nine months ended June 30, 2005 and 2006, respectively. No warrants were outstanding at June 30, 2005 and 2006.
The following table summarizes stock option activity during the nine months ended June 30, 2006:
| | | | Weighted-Average | |
| | Number of | | Exercise | |
| | Options | | Price | |
Options outstanding and exercisable at September 30, 2005 | | | 883,253 | | | | $ | 9.95 | | |
Exercised | | | (6,367 | ) | | | 9.44 | | |
Forfeited or expired | | | (1,050 | ) | | | 17.50 | | |
Options outstanding and exercisable at June 30, 2006 | | | 875,836 | | | | $ | 9.95 | | |
The weighted-average contractual life of stock options outstanding and exercisable at June 30, 2006 was 5.5 years. At June 30, 2006, the aggregate intrinsic value of stock options outstanding and exercisable was $4,712. 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 nine months ended June 30, 2005 and 2006, optionees realized aggregate gains of $865 and $31, respectively, from stock option exercises.
10. SUBSEQUENT EVENT
On July 26, 2006, the Company’s Board of Directors approved the addition of 1,000,000 shares to the Company’s previously approved share repurchase program, which means the Company is currently authorized to buy up to 1,150,428 total shares of its outstanding common stock. Under this approved share repurchase program, the Company 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 the Company’s shares and general market conditions.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
General
The following discussion and analysis should be read in conjunction with this report on Form 10-Q, including Part I, Item 1.
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, from beginning to end, the manufacturing, marketing and distribution of branded nutritional supplement businesses in the natural products industry. 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 sell branded nutritional supplements and other natural products under the trademarks Solaray®, KAL®, Nature’s Life®, Natural Balance®, NaturalMax®, VegLife®, Premier One®, Pioneer®, Sunny Green®, Natural Sport®, FunFresh Foods™, ActiPet®, Action Labs®, Thompson®, Montana Big Sky™, Body Gold®, Healthway®, Living Flower Essences® and Monarch Nutritional Laboratories™. Under the name Woodland Publishing™, we publish, print and market a line of books and booklets to, among others, book distributors, national retail bookstores and health and natural food stores. We also distribute branded products of certain third parties.
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 Arizona Health Foods™, Granola’s™ and Pilgrim’s Natureway™.
We were formed in 1993 by senior management and Bain Capital, Inc. 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 the following acquisitions: Solaray, Inc., Premier One Products, Inc., Makers of KAL, Inc. and Makers of KAL, B.V., Monarch Nutritional Laboratories, Inc., Action Labs, Inc., NutraForce (Canada) International, Inc., Woodland Publishing, Inc. and Summit Graphics, Inc., Thompson Nutritionals, Inc., The Real Food Company, Inc., Thom’s Natural Foods, M.K. Health Food Distributors, Inc. (dba Nature’s Life), Arizona Health Foods, Inc., Natural Balance, Inc., Montana Naturals, Inc., Cornucopia Community Market, Inc., Pilgrim’s Natureway LLC, Pioneer Nutritional Formulas, Inc. and Living Flower Essences, LLC. 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.
Critical Accounting Policies
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 and obsolete and/or damaged inventory. Actual results may differ from these estimates.
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
11
presented and had no material impact on the consolidated financial statements as reported. Our critical accounting policies include the following:
Accounts Receivable—Provision is made for estimated bad debts based on 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 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 actual 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.
Goodwill and Intangible Assets—Statement of Financial Accounting Standards No. 141, Business Combinations, and Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (“SFAS 142”), require estimates and judgments in determining the initial recognition and measurement of goodwill and intangible assets, including factors and assumptions used in determining fair values and useful lives. Intangible assets with finite useful lives are amortized, while intangible assets with indefinite useful lives are not amortized. In addition, SFAS 142 requires ongoing, periodic impairment testing, which relies on such factors and assumptions as identified reporting units, as well as expected future net cash flows relative to recorded book values. If an asset impairment were identified, a loss would be recorded, which could have a material impact on the consolidated financial statements.
Revenue Recognition—Revenue is recognized in accordance with Staff Accounting Bulletin No. 104, Revenue Recognition, which states that revenue should be 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.
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Results of Operations
The following table sets forth certain consolidated statements of operations data as a percentage of net sales for the periods indicated:
| | Three months
ended June 30, | | Nine months
ended June 30, | |
| | 2005 | | 2006 | | 2005 | | 2006 | |
Net sales | | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % |
Cost of sales | | 48.6 | % | 47.1 | % | 48.4 | % | 47.3 | % |
Gross profit | | 51.4 | % | 52.9 | % | 51.6 | % | 52.7 | % |
Selling, general and administrative | | 36.7 | % | 37.5 | % | 37.0 | % | 36.5 | % |
Amortization of intangible assets | | 0.3 | % | 0.2 | % | 0.3 | % | 0.2 | % |
Income from operations | | 14.4 | % | 15.2 | % | 14.3 | % | 16.0 | % |
Interest and other (income)/expense, net | | 0.4 | % | 0.4 | % | 0.4 | % | (0.8 | )% |
Income before provision for income taxes | | 14.0 | % | 14.8 | % | 13.9 | % | 16.8 | % |
Provision for income taxes | | 5.4 | % | 5.7 | % | 5.4 | % | 6.5 | % |
Net income | | 8.6 | % | 9.1 | % | 8.5 | % | 10.3 | % |
EBITDA(1) | | 17.3 | % | 18.2 | % | 17.3 | % | 19.1 | % |
(1) See “—EBITDA.”
Comparison of the Three Months Ended June 30, 2006 to the Three Months Ended June 30, 2005
Net Sales. Net sales decreased by $0.2 million, or 0.7%, to $37.0 million for the three months ended June 30, 2006 (“third quarter of fiscal 2006”) from $37.2 million for the three months ended June 30, 2005 (“third quarter of fiscal 2005”). Net sales of branded nutritional supplements and other natural products were relatively flat at $32.6 million for the third quarter of fiscal 2006 compared to $32.7 million for the third quarter of fiscal 2005. Other net sales were also relatively flat at $4.4 million for the third quarter of fiscal 2006 compared to $4.5 million for the third quarter of fiscal 2005. Management believes that the VMS Industry continues to have low growth rates and remains very competitive.
Gross Profit. Gross profit increased by $0.5 million, or 2.2%, to $19.6 million for the third quarter of fiscal 2006 from $19.1 million for the third quarter of fiscal 2005. As a percentage of net sales, gross profit increased to 52.9% for the third quarter of fiscal 2006 compared to 51.4% for the third quarter of fiscal 2005. This increase in gross profit was primarily attributable to decreased material costs as a percentage of net sales.
Selling, General and Administrative. Selling, general and administrative expenses were relatively flat at $13.9 million for the third quarter of fiscal 2006 compared to $13.7 million for the third quarter of fiscal 2005.
Amortization of Intangibles. Amortization of intangibles was $0.1 million for the third quarter of fiscal 2006 and 2005. For each period, amortization expense was primarily related to intangible assets recorded in connection with acquisitions.
Interest and Other (Income)/Expense, Net. Net interest and other (income)/expense was $0.1 million for the third quarter of fiscal 2006 and $0.2 million for the third quarter of fiscal 2005 and primarily consisted of interest expense on indebtedness under our revolving credit facility.
Provision for Income Taxes. Our effective tax rate was 38.5% for the third quarter of fiscal 2006 and for the third quarter of fiscal 2005. In each period, our effective tax rate was higher than the federal statutory rate primarily due to state taxes.
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Comparison of the Nine Months Ended June 30, 2006 to the Nine Months Ended June 30, 2005
Net Sales. Net sales increased by $3.3 million, or 3.0%, to $114.7 million for the nine months ended June 30, 2006 from $111.4 million for the nine months ended June 30, 2005. Net sales of branded nutritional supplements and other natural products increased by $3.3 million, or 3.4%, to $101.6 million for the nine months ended June 30, 2006 from $98.3 million for the nine months ended June 30, 2005. This increase in net sales was primarily related to the integration of the March 2005 acquisition of the Pioneer® brand and to an increase in sales in certain brands and customers within health and natural food stores. Other net sales remained flat at $13.1 million for both the nine months ended June 30, 2006 and the nine months ended June 30, 2005, which included the benefit of the November 2004 acquisition of Pilgrim’s Natureway LLC.
Gross Profit. Gross profit increased by $3.0 million, or 5.2%, to $60.5 million for the nine months ended June 30, 2006 from $57.5 million for the nine months ended June 30, 2005. This increase in gross profit was primarily attributable to the increase in net sales. As a percentage of net sales, gross profit increased to 52.7% for the nine months ended June 30, 2006 compared to 51.6% for the nine months ended June 30, 2005. This increase in gross profit as a percentage of net sales was primarily attributable to decreased material costs as a percentage of net sales.
Selling, General and Administrative. Selling, general and administrative expenses remained relatively flat at $41.8 million for the nine months ended June 30, 2006 compared to $41.2 million for the nine months ended June 30, 2005. As a percentage of net sales, selling, general and administrative expenses decreased to 36.5% for the nine months ended June 30, 2006 from 37.0% for the nine months ended June 30, 2005. This decrease in selling, general and administrative expenses as a percentage of net sales was primarily attributable to the increase in net sales.
Amortization of Intangibles. Amortization of intangibles was $0.3 million for the nine months ended June 30, 2006 and 2005. For each period, amortization expense was primarily related to intangible assets recorded in connection with acquisitions.
Interest and Other (Income)/Expense, Net. Net interest and other (income)/expense for the nine months ended June 30, 2006 included other income of $1.1 million ($0.7 million after tax, or $0.06 per diluted share) related to the gain on the sale of our 31,340 square foot building located in Park City, Utah as well as $0.1 million for payments received as settlement of litigation to which we were a plaintiff. Exclusive of these items, net interest and other (income)/expense was $0.3 million for the nine months ended June 30, 2006 and $0.5 million for the nine months ended June 30, 2005 and primarily consisted of interest expense on indebtedness under our revolving credit facility.
Provision for Income Taxes. Our effective tax rate was 38.5% for the nine months ended June 30, 2006 and for the nine months ended June 30, 2005. In each period, our effective tax rate was higher than the federal statutory rate primarily due to state taxes.
EBITDA
EBITDA (a non-GAAP measure) is defined as earnings before net interest and other (income)/expense, taxes, depreciation and amortization. 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, 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 generally accepted accounting principles. Our use of EBITDA 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.
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· Our use of EBITDA as a measure of operating performance is not based on any belief about the reasonableness of excluding depreciation and amortization when measuring financial performance.
· Our use of EBITDA is supported by the importance of EBITDA to the following key stakeholders:
· Analysts—who estimate our projected 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 and other EBITDA-based metrics in their written evaluations and comparisons of companies within our industry; and
· Board of Directors and Executive Management—who use EBITDA as an essential metric 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 to our business strategy. Historically, we have recorded a monthly accrual for incentive compensation as a percentage of EBITDA, 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 to EBITDA for each period included herein:
| | Three months
ended June 30, | | Nine months
ended June 30, | |
| | 2005 | | 2006 | | 2005 | | 2006 | |
Net income | | $ | 3,203 | | $ | 3,361 | | $ | 9,495 | | $ | 11,854 | |
Provision for income taxes | | 2,006 | | 2,104 | | 5,945 | | 7,420 | |
Interest and other (income)/expense, net(1) | | 162 | | 138 | | 542 | | (893 | ) |
Depreciation and amortization | | 1,059 | | 1,138 | | 3,279 | | 3,476 | |
EBITDA | | $ | 6,430 | | $ | 6,741 | | $ | 19,261 | | $ | 21,857 | |
(1) Includes amortization of deferred financing fees and losses associated with fixed asset disposals. The nine months ended June 30, 2006 also includes a gain of $1,105 on the sale of a building, which gain was excluded in determining EBITDA.
Our EBITDA increased to $6.7 million for the third quarter of fiscal 2006 from $6.4 million for the third quarter of fiscal 2005. EBITDA as a percentage of net sales increased to 18.2% for the third quarter of fiscal 2006 from 17.3% for the third quarter of fiscal 2005.
Our EBITDA increased to $21.9 million for the nine months ended June 30, 2006 from $19.3 million for the nine months ended June 30, 2005. EBITDA as a percentage of net sales increased to19.1% for the nine months ended June 30, 2006 from 17.3% for the nine months ended June 30, 2005.
Seasonality
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 (January thru March) due to increased interest in health-related products among consumers following the holiday season.
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Liquidity and Capital Resources
We had working capital of $28.7 million as of June 30, 2006 compared to $26.8 million as of September 30, 2005. This increase in working capital was primarily the result of an increase in inventories and a decrease in accrued expenses, partially offset by a decrease in cash and an increase in the current portion of long-term debt.
Net cash provided by operating activities for the nine months ended June 30, 2006 was $9.0 million compared to $14.0 million for the comparable period in fiscal 2005. This decrease in net cash provided by operating activities for the nine months ended June 30, 2006 was primarily attributable to a decrease in cash provided by changes in assets and liabilities, net of effects of acquisitions, as well as the gain related to the sale of our building located in Park City, Utah, partially offset by an increase in net income.
Net cash used in investing activities was $8.3 million for the nine months ended June 30, 2006 compared to $10.2 million for the comparable period in fiscal 2005. Our investing activities during these periods consisted primarily of acquisitions of businesses, capital expenditures and for the nine months ended June 30, 2006, proceeds of $4.5 million related to the sale of our building. Capital expenditures during these periods related primarily to real estate, distribution and manufacturing equipment, building improvements related to facility consolidation efforts and information systems, including retail technology.
On March 31, 2006, we purchased the Rapid Response Center in Ogden, Utah, which (when fully converted) will provide us approximately 410,000 square feet of gross building space located on approximately 19.2 acres, which includes available land for expansion, for $4.2 million in cash. The Rapid Response Center is the central facility where we are, and have been, consolidating operations, including raw material warehousing, manufacturing, packaging, distribution and administrative offices. We were previously leasing most of this facility. We intend to finance anticipated capital expenditures through internally generated cash flow and, if necessary, through funds provided under our revolving credit facility.
Net cash used in financing activities was $2.0 million for the nine months ended June 30, 2006 compared to $3.9 million for the comparable period in fiscal 2005. During these periods, financing activities primarily related to borrowings and repayments under our revolving credit facility, purchases of common stock for treasury and proceeds from the issuance of common stock. During the nine months ended June 30, 2006, we purchased a total of 234,350 shares of our common stock for an aggregate price of $3.4 million.
On July 26, 2006, our Board of Directors approved the addition of 1 million shares to our previously approved share repurchase program, which means we are currently authorized to buy up to 1.15 million total shares of our outstanding common stock. 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.
Our current revolving credit facility had a total credit limit of $47.5 million at June 30, 2006. The total credit limit will be reduced by $1.25 million in September 2006. Borrowings under the revolving credit facility are collateralized by substantially all our assets. At our 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 June 30, 2006, the applicable weighted-average interest rate for borrowings was 6.66%. We are also required to pay a variable quarterly fee on the unused balance under the revolving credit facility. At June 30, 2006, the applicable rate was 0.25%. 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 revolving credit facility matures on January 28, 2007, and we are required to repay all principal outstanding under the revolving credit facility on such date. We are in the process of amending or replacing this credit facility.
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The revolving credit facility contains restrictive covenants, including restrictions on incurring other indebtedness, limitations on capital expenditures and requirements that we maintain certain financial ratios. As of June 30, 2006, we were in compliance with these restrictive covenants. Upon the occurrence of a 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 revolving credit facility.
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 or the issuance of additional stock. We believe that borrowings under our current revolving credit facility or a replacement credit facility, together with cash flows from operations, will be sufficient to make required payments under the current credit facility or a replacement credit facility, and to make anticipated capital expenditures and fund working capital needs for fiscal 2006.
Our significant non-cancelable contractual obligations as of June 30, 2006 were as follows:
| | Payments Due By Period | |
| | | | Less Than | | 1-3 | | 4-5 | | After | |
Contractual Obligations | | | | Total | | 1 Year | | Years | | Years | | 5 Years | |
| | (dollars in thousands) | |
Revolving credit facility | | $ | 3,500 | | | $ | 3,500 | | | $ | — | | $ | — | | | $ | — | | |
Interest on revolving credit facility(a) | | 217 | | | 217 | | | — | | — | | | — | | |
Operating leases | | 4,813 | | | 1,971 | | | 1,867 | | 872 | | | 103 | | |
Total | | $ | 8,530 | | | $ | 5,688 | | | $ | 1,867 | | $ | 872 | | | $ | 103 | | |
| | | | | | | | | | | | | | | | | | | | | | |
(a) Represents estimated interest obligations associated with our outstanding revolving credit facility balance of $3.5 million at June 30, 2006, assuming no principal payments are made before maturity, a weighted-average interest rate of 6.66% and an underutilization fee rate of 0.25%.
New Accounting Standards
We adopted Statement of Financial Accounting Standards No. 123R, Share-Based Payment (“SFAS 123R”) effective October 1, 2005, using the modified prospective application method. SFAS 123R requires companies to record compensation expense for the value of all outstanding and unvested share-based payments, including employee stock options and similar awards. As of October 1, 2005, we had no outstanding and unvested share-based payments. Also, on September 30, 2005, we terminated the 1995 Stock Option Plan, 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. As a result, we did not recognize any compensation expense related to share-based payments in our consolidated financial statements for the three and nine months ended June 30, 2006.
Based on our review of other new accounting standards released during the quarter ended June 30, 2006, we did not identify any standard requiring adoption that would have a significant impact on our consolidated financial statements for the periods reported.
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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.
Forward-Looking Statements
This Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements relate to our future plans, objectives, expectations, intentions and financial performance and the assumptions that underlie these statements. These statements involve known and unknown risks, uncertainties and other factors that may cause actual results, level of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these statements. We undertake no obligation to update forward-looking statements to reflect events or circumstances occurring after the date this Form 10-Q was first filed with the SEC. Important factors that may cause results to differ from these forward-looking statements include, but are not limited to, government regulations, product liability claims and litigation, insurance coverage issues, a decrease in or slowing of the growth rate of the vitamin, mineral and supplement market, the success of the healthy foods channel, consumer perception of the safety and quality of our products and similar products, competition, intellectual property rights of other parties, the loss of key personnel, disruptions from acquisitions, issues with obtaining raw materials of adequate quality or quantity, problems with information management systems, manufacturing efficiencies and operations, litigation generally, the volatility of the stock market generally and of our stock specifically, a general lack of adequate industry analyst coverage, and other factors indicated from time to time in our SEC reports, copies of which are available upon request from our investor relations group or which may be obtained at the SEC’s website (www.sec.gov).
Item 3. Quantitative and Qualitative Disclosures about Market Risk
At our election, borrowings under our revolving credit facility 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 June 30, 2006, the applicable weighted-average interest rate for borrowings was 6.66% and we had total borrowings outstanding of $3.5 million. To date, we have not obtained interest rate protection with respect to these borrowings.
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 because the majority of our net sales to foreign countries are transacted in U.S. dollars. To date, we have not hedged any of our potential foreign currency exposures.
Item 4. 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 Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to
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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 of possible controls and procedures.
As required by SEC Rule 13a-15(b), we carried out an evaluation, under the supervision of 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 period 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.
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.
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PART II—OTHER INFORMATION
Item 1. Legal Proceedings
As discussed in our other filings, we are subject to regulation by a number of federal, state and foreign agencies and are involved in various legal matters arising in the normal 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. However, our current liability policy excludes claims related to certain ingredients, including products containing ephedra.
In our opinion, 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, the individual regulatory and legal matters in which we are involved are not expected to have a material adverse effect on our financial position, results of operations or cash flows.
Item 1A. Risk Factors
There have been no material changes in our risk factors from those disclosed in our 2005 Annual Report on Form 10-K.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
We did not sell any unregistered equity securities during the period covered by this Form 10-Q for the Quarterly Period Ended June 30, 2006.
During fiscal 2000, our Board of Directors approved a share purchase program authorizing us to buy up to 1,500,000 shares of our common stock, of which 150,428 shares may yet be purchased as of June 30, 2006. Purchases under this program during the three months ended June 30, 2006 occurred in April and June as follows:
| | | | | | Total Number | | | |
| | | | | | of Shares | | Maximum | |
| | | | | | Purchased as | | Number of | |
| | | | | | Part of | | Shares that | |
| | Total Number | | Average Price | | Publicly | | May Yet Be | |
| | of Shares | | Paid Per | | Announced | | Purchased Under | |
Period | | | | Purchased | | Share | | Plan | | the Plan | |
4/1/06 to 4/30/06 | | | 80,000 | | | | $ | 15.09 | | | | 80,000 | | | | | | |
6/1/06 to 6/30/06 | | | 15,741 | | | | 15.10 | | | | 15,741 | | | | | | |
Total | | | 95,741 | | | | $ | 15.09 | | | | 95,741 | | | | 150,428 | | |
| | | | | | | | | | | | | | | | | | | | |
On July 26, 2006, our Board of Directors approved the addition of 1,000,000 shares to our previously approved share repurchase program, which means we are currently authorized to buy up to 1,150,428 total shares of our outstanding common stock. 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.
Item 6. Exhibits
31.1 | | Certifications Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
32.1 | | Certifications Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
NUTRACEUTICAL INTERNATIONAL CORPORATION |
(Registrant) |
Date: | July 27, 2006 | | By: | /s/ LESLIE M. BROWN, JR. |
| | Leslie M. Brown, Jr. |
| | Senior Vice President, Finance, Chief |
| | Financial Officer and Assistant Secretary |
| | (Principal Financial and Accounting Officer) |
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