EXHIBIT 13
SELECTED FINANCIAL DATA
Years ended June 30, all amounts in thousands except per share data.
| 1997 | 1998 | 1999(1) | 2000(2) | 2001(3) | |||||||||||||||||
| Revenues | $ | 365,134 | $ | 352,249 | $ | 320,952 | $ | 290,985 | $ | 283,552 | |||||||||||
| Operating income (loss) | 11,840 | 2,040 | (2,784 | ) | (12,871 | ) | (2,711 | ) | |||||||||||||
| Income (loss) before cumulative effect of accounting change | 8,332 | 2,126 | (672 | ) | (7,092 | ) | (19,345 | ) | |||||||||||||
| Per share amounts: | |||||||||||||||||||||
| Income (loss) before cumulative effect of accounting change, basic | .40 | .10 | (.03 | ) | (.34 | ) | (.94 | ) | |||||||||||||
| Net income (loss), basic | .04 | .10 | (.03 | ) | (.34 | ) | (.94 | ) | |||||||||||||
| Income (loss) before cumulative effect of accounting change, diluted | .40 | .10 | (.03 | ) | (.34 | ) | (.94 | ) | |||||||||||||
| Net income (loss), diluted | .04 | .10 | (.03 | ) | (.34 | ) | (.94 | ) | |||||||||||||
| Total assets | 112,297 | 106,245 | 112,614 | 106,517 | 85,637 | ||||||||||||||||
| Note payable and obligation under capital lease | 5,716 | 5,526 | 5,336 | 6,879 | 6,005 | ||||||||||||||||
| Shares outstanding | 20,688 | 20,689 | 20,689 | 20,689 | 20,689 | ||||||||||||||||
| (1) | Operating results for 1999 include a pre-tax charge of $8,203,000 for a litigation judgment. See Note 8 of Notes to Consolidated Financial Statements. |
| (2) | Operating results for 2000 include a pre-tax restructuring charge of $6,910,000. See Note 10 of Notes to Consolidated Financial Statements. |
| (3) | In 2001, the Company recorded a non-cash charge of $18,598,000 to provide a full valuation allowance for the United States deferred tax assets. See Note 5 of Notes to Consolidated Financial Statements. |
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
Forward-Looking Statements
Information provided in this Annual Report may contain, and the Company may from time to time disseminate material and make statements which may contain “forward-looking” information, as that term is defined by the Private Securities Litigation Reform Act of 1995 (the “Act”). These cautionary statements are being made pursuant to the provisions of the Act and with the intention of obtaining the benefit of “safe harbor” provisions of the Act. The reader is cautioned that all forward-looking statements are necessarily speculative. The reader should carefully review the cautionary statements contained in the Company’s Annual Report on Form 10-K for the year ended June 30, 2001, which identify important factors that could cause actual results to differ materially from those in the forward-looking statements, as well as the risk factors which may also be identified by the Company from time to time in other filings with the Securities and Exchange Commission, press releases and other communications.
The following table gives certain key statistics regarding the Company during the past five years ended June 30:
| 1997 | 1998 | 1999 | 2000 | 2001 | |||||||||||||||||||
Centres Open at End of Year: | |||||||||||||||||||||||
| Company-owned | |||||||||||||||||||||||
| United States | 542 | 533 | 524 | 437 | 431 | ||||||||||||||||||
| Foreign | 106 | 110 | 110 | 113 | 115 | ||||||||||||||||||
| 648 | 643 | 634 | 550 | 546 | |||||||||||||||||||
| Franchise | |||||||||||||||||||||||
| United States | 113 | 101 | 86 | 72 | 73 | ||||||||||||||||||
| Foreign | 36 | 37 | 37 | 38 | 38 | ||||||||||||||||||
| 149 | 138 | 123 | 110 | 111 | |||||||||||||||||||
| Total | 797 | 781 | 757 | 660 | 657 | ||||||||||||||||||
Average Revenue Per Centre in Thousands: | |||||||||||||||||||||||
| Company-owned | |||||||||||||||||||||||
| United States | $ | 538 | 502 | 463 | 466 | 517 | |||||||||||||||||
| Foreign | 483 | 447 | 461 | 445 | 338 | ||||||||||||||||||
| Franchise | |||||||||||||||||||||||
| United States | 517 | 510 | 487 | 476 | 515 | ||||||||||||||||||
| Foreign | 452 | 438 | 450 | 438 | 325 | ||||||||||||||||||
The decrease in United States Company-owned centres in 2000 reflects the Company’s closure of 100 centres, principally comprised of the closure of 86 centres in November 1999 in connection with a restructuring plan implemented by the Company. Also during fiscal 2000, the Company acquired 17 centres from five franchisees, and sold four centres to a franchisee in the United States.
The decrease in United States Company-owned centres in 1999 reflects the Company’s acquisition of six centres from a franchisee and the closure of 15 centres. The decrease in United States franchise centres reflects the Company’s acquisition of the six centres from a franchisee and the net closure of nine franchise centres.
The decrease in United States Company-owned centres in 1998 reflects the Company’s acquisition of eight centres from two franchisees and the net closure of 17 centres.
See Note 14 of Notes to Consolidated Financial Statements for additional information regarding United States and foreign operations.
5
Year Ended June 30, 2001 as Compared to Year Ended June 30, 2000
The following table presents selected operating results for United States Company-owned operations and foreign Company-owned operations for fiscal 2001 and fiscal 2000 (U.S. $ in thousands):
| Foreign Company Owned | ||||||||||||||||||||||||
| U.S. Company Owned Operations | Operations(1) | |||||||||||||||||||||||
| 2000 | 2001 | % Change | 2000 | 2001 | % Change | |||||||||||||||||||
| Product sales | $ | 204,864 | $ | 209,024 | 2 | % | $ | 45,982 | $ | 35,806 | -22 | % | ||||||||||||
| Service revenue | 13,213 | 14,900 | 13 | % | 3,721 | 2,672 | -28 | % | ||||||||||||||||
| Total | 218,077 | 223,924 | 3 | % | 49,703 | 38,478 | -23 | % | ||||||||||||||||
| Costs and expenses | 214,527 | 214,071 | 0 | % | 40,158 | 33,964 | -15 | % | ||||||||||||||||
| General and administrative | 17,692 | 15,873 | -10 | % | 2,907 | 2,573 | -11 | % | ||||||||||||||||
| Litigation judgment | 1,446 | 876 | — | — | — | — | ||||||||||||||||||
| Restructuring charge | 6,910 | — | — | — | — | — | ||||||||||||||||||
| Operating income (loss) | $ | (22,498 | ) | $ | (6,896 | ) | — | $ | 6,638 | $ | 1,941 | -71 | % | |||||||||||
| Average number of centres | 468 | 433 | -7 | % | 112 | 114 | 2 | % | ||||||||||||||||
| (1) | Foreign Company-owned operations reflect the Company’s 87 centres in Australia and 28 centres (26 centres in 2000) in Canada, with the Canadian centres generating revenues of $10,478,000 and $11,324,000 in 2000 and 2001, respectively, and an operating loss of $161,000 in 2000 and operating income of $2,600 in 2001. |
Revenues from United States Company-owned operations increased 3% in 2001 compared to 2000 principally due to an increase in product sales at United States Company-owned centres, which represented 79% of the worldwide Company-owned centres at June 30, 2001. There was an 7% decrease in the average number of United States Company-owned centres in operation between the years, principally reflecting the closure of 86 centres in November 1999 in connection with a restructuring plan implemented by the Company. Product sales, which consists primarily of food products, from United States Company-owned operations increased 2%, principally due to an increase in the average dollar amount of food products purchased per participant. The increase in the average dollar amount of food products purchased per participant resulted from the Company’s emphasis on improving participant’s adherence to the program, the implementation of an approximate 3% price increase on food items in May 2001, and the introduction of the Ultimate Choice program, also in May 2001. The Ultimate Choice program allows the participant more flexibility in selecting their individual food items, which the Company believes has resulted in many participants choosing products which they find more appealing and that have higher retail prices. The 13% increase in service revenues from United States Company-owned operations was primarily due to an increase in the average service fee charged per new participant enrolled in the program between the years.
Revenues from foreign Company-owned operations, which is derived from 87 centres in Australia and 28 centres (26 centres in 2000) in Canada, decreased 23% in 2001 compared to 2000, principally due to reduced demand at the Company’s Australian centres. The Company believes that the introduction of Xenical, a prescription drug for the treatment of obesity, in May 2000 and a new goods and services tax in the Australian market have contributed to the revenue decline. There was a 12% weighted average decrease in the Australian and Canadian currencies in relation to the U.S. dollar between the years.
The Company has experienced reduced demand over the past several years. The Company believes that increased competition from various sources, including prescription and non-prescription pills, best selling diet books, and other “do it yourself” methods have contributed to the Company’s downward trend. Many of these competitors claim to provide “quick” and “easy” weight loss or other aggressive claims about the efficacy of their methods, are supported by a high level of advertising, and are less expensive than the Company’s program. The Company cannot predict whether the current trend will continue in the future.
Costs and expenses of United States Company-owned operations decreased less than 1% in 2001 compared to 2000. Fiscal 2000 included a charge of $3,068,000 for obsolete inventory related to the
6
In November 1999, the Company implemented a restructuring plan to reduce annual operating expenses. Of the revised charge of $6,910,000 in connection with this restructuring, approximately $5,766,000 requires cash payments and $1,144,000 represents the non-cash write-off of fixed assets. As of June 30, 2001, the Company had made cash payments of $3,157,000 for lease termination costs, $1,432,000 for severance to 110 terminated employees, $112,000 for refunds to program participants, and $697,000 for other closure costs. The Company estimates that the remaining cash payments of approximately $368,000 will be substantially incurred by December 31, 2001. With respect to the impact of the restructuring on future results of operations, the 86 closed centres had revenues of $4,526,000 and direct operating expenses of $5,339,000 for the quarter ended September 30, 1999, which was the final full quarter of operating results for these 86 centres. The Company estimates that annual pre-tax savings of approximately $4,000,000 will be achieved with the elimination of the infrastructure of the 86 centres together with the reduced corporate staff, of which approximately $2,900,000 will represent cash savings and $1,100,000 will be a reduction of depreciation and amortization expense.
After including the allocable portion of general and administrative expenses, United States Company-owned operations had an operating loss of $6,896,000 in 2001 compared to an operating loss of $22,498,000 in 2000, which includes the above described charge of $3,068,000 for obsolete inventory and the $6,910,000 restructuring charge.
Costs and expenses of foreign Company-owned operations decreased 15% in 2001 compared to 2000 principally due to the decreased variable costs associated with the reduced level of Australian operations and the 12% decrease in the Australian and Canadian currencies in relation to the U.S. dollar between the years. After including the allocable portion of general and administrative expenses, operating income from foreign Company-owned operations, primarily reflecting the Company’s Australian operations, declined 71% from $6,638,000 in 2000 to $1,941,000 in 2001.
The Company’s gross margins were relatively stable between the years, with the gross margin on product sales from Company-owned operations increasing from 3% in 2000 to 4% in 2001, and its gross margin on service revenues decreasing from 30% in 2000 to 29% in 2001. Costs and expenses of Company-owned operations, other than direct product costs, are allocated between product and service based upon the respective percentage of total revenue from Company-owned operations derived from product sales and service revenue. The combined increase in gross margins in 2001 compared to 2000 resulted principally from the absence in the current year of the charge of $3,068,000 for obsolete inventory recorded in 2000.
Revenues from franchise operations decreased 9% from $23,205,000 in 2000 to $21,150,000 in 2001. This decline was principally due to a 5% decrease in the average number of franchise centres in operation between the periods and a decrease in revenues at foreign franchised centres which resulted in reduced product sales and royalties for the Company. The decrease in the average number of franchise centres reflects the Company’s net acquisition of 11 centres from franchisees between the years. As of June 30, 2001 there were 111 franchised centres in operation, of which 73 were in the United States and 38 were in foreign countries, principally Australia and New Zealand.
Costs and expenses of franchise operations, which consist primarily of product costs, decreased 5% from $15,954,000 in 2000 to $15,121,000 in 2001 principally because of the reduced level of franchise operations. Franchise costs and expenses as a percentage of franchise revenues remained relatively constant between the years.
General and administrative expenses decreased 11% from $24,861,000 in 2000 to $22,231,000 in 2001 and decreased from 8.5% to 7.8% of total revenues in 2000 and 2001, respectively. The decrease in general and administrative expenses is principally due to reduced corporate compensation and professional expenses.
7
A charge of $876,000 was recorded in the accompanying consolidated statement of operations for 2001 with respect to the previously disclosed litigation judgment arising out of the dispute concerning the lease at the Company’s former headquarters location. This charge consists of interest accrued on the judgment pending the appeal which has been filed seeking to overturn the judgment. In 2000, $1,446,000, comprised of attorney fees awarded to the plaintiff and interest accrued on the judgment, was expensed related to this matter. At June 30, 2001 the total amount accrued for this litigation judgment was $10,525,000.
The elements discussed above combined to result in an operating loss of $2,711,000 in 2001 compared to an operating loss of $12,871,000 in 2000.
Other income, net, principally interest, increased 52% from $1,432,000 in 2000 to $2,173,000 in 2001 principally due to licensing royalties which commenced in January 2001. The licensing royalties are pursuant to a trademark license agreement entered into with Balance Bar Company (subsequently acquired by Kraft Foods) and are based upon the retail sales of certain products bearing the Company’s brand.
Income taxes (benefit) for the year ended June 30, 2001 includes income taxes at an effective rate of 37% on the Company’s foreign taxable income, but does not reflect any benefit for the net operating loss incurred by the Company’s United States operations. During 2001, the Company concluded that the deferred tax asset valuation allowance should be increased due to the uncertainty of realizing certain tax loss carryforwards and other deferred tax assets in accordance with Statement of Financial Accounting Standards No. 109 “Accounting for Income Taxes”. Accordingly, the Company recorded a non-cash charge of $18,598,000 to provide a full valuation allowance for the balance of the U.S. net deferred tax asset. Management’s assessment was based principally on the losses experienced by the Company in the U.S. for the first six months of fiscal 2001, together with less than expected operating results in January 2001, following two consecutive profitable quarters ended March 31, 2000 and June 30, 2000. This increase to the deferred tax asset valuation allowance is the reason for the decrease in the deferred tax assets on the accompanying consolidated balance sheet at June 30, 2001.
For 2001, the net loss, reflecting the above described non-cash charge of $18,598,000, was $19,345,000, or $.94 per share, compared to a net loss of $7,092,000, or $.34 per share, in 2000.
In May 2001, the Company retained the investment banking firm Koffler & Company to advise the Company on strategic alternatives to maximize shareholder value, including a possible sale of the Company.
The Company is a defendant in a litigation in the Superior Court of California, Alameda County. The action was commenced in March 2001 by certain named plaintiffs on behalf of themselves and on behalf of the general public. The complaint alleges that the Company’s service contracts used in California with its clients do not comply with the requirements of certain California consumer protection statutes. The plaintiff contends these contracts are misleading and constitute deceptive practices. The complaint requests an order declaring the Company’s practices and conduct with respect to its California service agreements unlawful, refund of membership amounts paid by clients who choose to cancel their service agreement, treble damages and attorney’s fees. The proceeding has not progressed sufficiently for the Company to estimate a range of possible loss. The Company intends to defend the matter vigorously.
8
| Year Ended June 30, 2000 as Compared to Year Ended June 30, 1999 |
The following table presents selected operating results for United States Company-owned operations and foreign Company-owned operations for fiscal 2000 and fiscal 1999 (U.S. $ in thousands):
| Foreign Company Owned | ||||||||||||||||||||||||
| U.S. Company Owned Operations | Operations(1) | |||||||||||||||||||||||
| 1999 | 2000 | % Change | 1999 | 2000 | % Change | |||||||||||||||||||
| Product sales | $ | 231,196 | 204,864 | (11 | )% | 47,676 | 45,982 | (4 | )% | |||||||||||||||
| Service revenue | 13,107 | 13,213 | 1 | % | 3,023 | 3,721 | 23 | % | ||||||||||||||||
| Total | 244,303 | 218,077 | (11 | )% | 50,699 | 49,703 | (2 | )% | ||||||||||||||||
| Costs and expenses | 231,621 | 214,527 | (7 | )% | 40,531 | 40,158 | (1 | )% | ||||||||||||||||
| General and administrative | 18,492 | 17,692 | (4 | )% | 2,765 | 2,907 | 5 | % | ||||||||||||||||
| Litigation judgment | 8,203 | 1,446 | — | — | — | — | ||||||||||||||||||
| Restructuring charge | — | 6,910 | — | — | — | — | ||||||||||||||||||
| Operating income (loss) | $ | (14,013 | ) | (22,498 | ) | (61 | )% | 7,403 | 6,638 | (10 | )% | |||||||||||||
| Average number of centres | 528 | 468 | (11 | )% | 110 | 112 | 2 | % | ||||||||||||||||
| (1) | Foreign Company-owned operations reflect the Company’s 87 centres in Australia and 26 centres in Canada, with the Canadian centres generating revenues of $10,333,000 and $10,478,000 in 1999 and 2000, respectively, and an operating loss of $544,000 and $183,000 in 1999 and 2000, respectively. |
Revenues from United States Company-owned operations decreased 11% in 2000 compared to 1999, reflecting reduced demand for the Company’s products and services at United States Company-owned centres, which represented 79% of the worldwide Company-owned centres at June 30, 2000. The overall 11% decrease in revenues from United States Company-owned operations was principally the result of an 11% decrease in the average number of United States Company-owned centres in operation. The decrease in the number of United States Company-owned centres reflects the closure of 100 centres between the years, principally comprised of the closure of 86 centres in November 1999 in connection with a restructuring plan implemented by the Company. Product sales, which consists primarily of food products, from United States Company-owned operations decreased 11%, principally due to a 19% decrease in the number of active participants in the program between the years (which reflects the 11% decrease in the average number of centres), offset, in part, by an increase in the average amount of products purchased per active participant. The average amount of products purchased per active participant last year was below historical levels as a result of a program called “On-the-Go” which offered lower priced products and which has since been discontinued. The 1% increase in service revenues from United States Company-owned operations was primarily due to an increase in the average service fee charged per new participant, offset, in part, by a decrease in the number of new participants enrolled in the program between the years.
Revenues from foreign Company-owned operations, which is derived from 87 centres in Australia and 26 centres in Canada, decreased 2% in 2000 compared to 1999, principally due to reduced demand at the Company’s Australian centres. Revenues at the Company’s Australian centres deteriorated during the latter part of fiscal 2000 and have continued at significantly reduced levels for the first two months of fiscal 2001, with revenues down 34% for that two month period compared to the same period last year. The Company believes that the introduction of Xenical (a prescription drug for the treatment of obesity) in May 2000 and a new goods and services tax in the Australian market have contributed to the revenue decline. There was a 1% weighted average increase in the Australian and Canadian currencies in relation to the U.S. dollar between the years.
Costs and expenses of United States Company-owned operations decreased 7% in 2000 compared to 1999, principally due to the reduced variable costs associated with the decreased revenues and the decreased fixed costs associated with the decrease in the number of United States Company-owned centres in operation, offset, in part, by a charge of $3,068,000 for obsolete inventory related to the discontinued On-the-Go program. Costs and expenses of United States Company-owned operations as a percentage of United States
9
In November 1999, the Company implemented a restructuring plan to reduce annual operating expenses. The plan included the closure of 86 underperforming Company-owned centres in the United States, which represented 16% of the total United States Company-owned centres, and a staff reduction of approximately 15% at the Company’s corporate headquarters. All employees were notified in early November and the centres were closed by November 30, 1999. A charge of $7,512,000 was recorded in the quarter ended December 31, 1999 in connection with this restructuring. The charge was comprised of $3,882,000 for lease termination costs at the 86 centres, $1,563,000 for severance payments to terminated employees, $1,303,000 for the write-off of fixed assets at the closed centres, $291,000 for refunds to program participants at the closed centres, and $473,000 for other closure costs which includes the removal of signs and leasehold improvements. In June 2000, the Company reversed $602,000 of the originally estimated $7,512,000 restructuring charge because actual costs were less than the costs projected when the restructuring was implemented. The $602,000 reversal was comprised of $289,000 in lease termination costs, $19,000 in severance costs, $159,000 in fixed asset write-offs, and $182,000 in refunds to program participants, offset, in part, by $47,000 of additional other closure costs. Of the total revised charge of $6,910,000, approximately $5,766,000 requires cash payments and $1,144,000 represents the non-cash write-off of fixed assets. As of June 30, 2000, the Company had made cash payments of $2,214,000 for lease termination costs, $1,014,000 for severance to terminated employees, $109,000 for refunds to program participants, and $622,000 for other closure costs. The Company estimates that the remaining cash payments of approximately $1,807,000, which is included in accrued liabilities on the accompanying balance sheet at June 30, 2000, will be substantially incurred by December 31, 2000.
Costs and expenses of foreign Company-owned operations decreased 1% in 2000 compared to 1999 principally due to the 2% decrease in revenues between the years.
Operating income from foreign Company-owned operations, primarily reflecting the Company’s Australian operations, declined 10% from $7,403,000 to $6,638,000 in 1999 and 2000, respectively, compared to an operating loss from United States Company-owned operations of $14,013,000 and $22,498,000 in 1999 and 2000, respectively. The Company believes that the favorable results achieved by its Australian operations in 1999 and 2000 compared to its United States operations were attributable principally to a less competitive marketplace for commercial weight loss programs and lower operating costs in Australia. In addition, the Company believes that its advertising more effectively reached its target audience in Australia as a result of the favorable audience demographics of certain magazines and broadcast media in Australia. However, as previously discussed, revenues at the Company’s Australian centres deteriorated during the latter part of fiscal 2000 and have continued at significantly reduced levels for the first two months of fiscal 2001, with the result that Australian operating income was only slightly above breakeven for that two month period.
The Company’s gross margin on product sales from Company-owned operations decreased from 6% in 1999 to 3% in 2000, and its gross margin on service revenues decreased from 31% in 1999 to 30% in 2000. Costs and expenses of Company-owned operations, other than direct product costs, are allocated between product and service based upon the respective percentage of total revenue from Company-owned operations derived from product sales and service revenue. The decrease in gross margins in 2000 compared to 1999 resulted principally from the charge for obsolete inventory and the higher proportion of fixed costs when compared to the reduced level of revenues.
Revenues from franchise operations decreased 11% from $25,950,000 in 1999 to $23,205,000 in 2000. This decline was principally due to an 11% decrease in the average number of franchise centres in operation and a decrease in the number of new participants enrolled in the program at franchise centres, resulting in reduced product sales and royalties. The decrease in the number of franchise centres reflects the Company’s acquisition of 17 centres from five franchisees and the Company’s sale of four centres to a franchisee in the United States.
Costs and expenses of franchise operations, which consist primarily of product costs, decreased 11% from $17,944,000 in 1999 to $15,954,000 in 2000 principally because of the reduced level of franchise operations.
10
General and administrative expenses decreased 2% from $25,437,000 in 1999 to $24,861,000 in 2000 but increased from 7.9% to 8.5% of total revenues in 1999 and 2000, respectively. The decrease in general and administrative expenses in 2000 was primarily due to reduced compensation expenses resulting from the restructuring plan implemented in November 1999.
In June 1999, a jury of the California Superior Court found that the Company breached the terms of a commercial lease agreement related to its former headquarters location in Del Mar, California. The jury awarded the Company’s former landlord $2,261,000 in compensatory contract and tort damages and $5,942,000 in punitive damages, or $8,203,000 in aggregate, which was recorded as a charge in the accompanying consolidated statement of operations for the year ended June 30, 1999 and is accrued in the accompanying consolidated balance sheet at June 30, 1999 and 2000. An additional $1,446,000 was recorded in the year ended June 30, 2000 for attorney fees awarded to the plaintiff and interest accrued on the judgment, pending the appeal which has been filed seeking to overturn the judgment.
The elements discussed above combined to result in an operating loss of $12,871,000 in 2000 compared to an operating loss of $2,784,000 in 1999.
Other income, net, principally interest, decreased 16% from $1,700,000 in 1999 to $1,432,000 in 2000 principally due to a decrease in the average balance of cash investments between the periods.
For 2000, the net loss was $7,092,000, or $.34 per share, compared to a net loss of $672,000, or $.03 per share, in 1999.
Liquidity and Capital Resources
The Company has historically financed its operations through cash flow from operations, supplemented by a note payable obtained in 1996 to partially finance the Company’s purchase of its corporate office building and by a capital lease for computer equipment related to Y2K remediation in 2000.
At June 30, 2001, the Company had cash, cash equivalents, and short-term investments of $38,433,000 compared to $35,635,000 at June 30, 2000, reflecting an increase of $2,798,000 during the year ended June 30, 2001. This increase was principally due to the net cash provided by operating activities, offset, in part, by capital expenditures, debt service, and the effect of foreign currency exchange rate changes.
The Company’s principal cash commitments at June 30, 2001 are as follows:
| • | Operating lease payments on premises from which the Company’s centre operations are conducted totaling approximately $29,439,000, of which approximately $15,044,000 is payable in the twelve months ending June 30, 2002 and approximately $8,705,000 is payable in the twelve months ending June 30, 2003. Management expects that in the normal course of business, leases that expire will be renewed or replaced by other leases. | |
| • | The litigation judgment of $10,525,000 which the Company is appealing. | |
| • | Debt service with respect to the capital lease totaling $1,882,000. See Note 15 “Subsequent Event” of Notes to Consolidated Financial Statements for information regarding the payoff of the note payable on July 13, 2001 in connection with the sale of the Company’s corporate headquarters building. | |
| • | Remaining payments of approximately $368,000 related to the restructuring implemented in November 1999 described above. | |
| • | In the normal course of its business the Company acquires property and equipment, including replacing assets which are no longer useful. This may include moving the location of a centre or remodeling existing centres. |
The Company believes that its available cash and cash equivalents, together with its cash flow from operations, are adequate for its needs in the foreseeable future.
11
Effects of Recent Accounting Pronouncements
In July 2001, the Financial Accounting Standards Board issued Statement No. 141,Business Combinations, and Statement No. 142,Goodwill and Other Intangible Assets. Statement 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001 as well as all purchase method business combinations completed after June 30, 2001. Statement 142 will require that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment at least annually in accordance with the provisions of Statement 142. Statement 142 will also require that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with SFAS No. 121,Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.
The Company is required to adopt the provisions of Statement 141 immediately, and Statement 142 is required for fiscal years beginning after December 15, 2001. Goodwill and intangible assets acquired in business combinations completed before July 1, 2001 will continue to be amortized prior to the adoption of Statement 142.
Statement 141 will require, upon adoption of Statement 142, that the Company evaluate its existing intangible assets and goodwill that were acquired in a prior purchase business combination, and to make any necessary reclassifications in order to conform with the new criteria in Statement 141 for recognition apart from goodwill. Upon adoption of Statement 142, the Company will be required to reassess the useful lives and residual values of all intangible assets acquired in purchase business combinations, and make any necessary amortization period adjustments by the end of the first interim period after adoption. In addition, to the extent an intangible asset is identified as having an indefinite useful life, the Company will be required to test the intangible asset for impairment in accordance with the provisions of Statement 142 within the first interim period. Any impairment loss will be measured as of the date of adoption and recognized as the cumulative effect of a change in accounting principle in the first interim period.
In connection with the transitional goodwill impairment evaluation, Statement 142 will require the Company to perform an assessment of whether there is an indication that goodwill is impaired as of the date of adoption. Any transitional impairment loss will be recognized as the cumulative effect of a change in accounting principle in the Company’s consolidated statement of operations.
Because of the extensive effort needed to comply with adopting Statements 141 and 142, it is not practicable to reasonably estimate the impact of adopting these Statements on the Company’s financial statements at the date of this report, including whether any transitional impairment losses will be required to be recognized as the cumulative effect of a change in accounting principle.
Quantitative and Qualitative Disclosures About Market Risk
The Company is exposed to a variety of risks, including changes in interest rates affecting the return on its investments and the cost of its debt, and foreign currency fluctuations.
At June 30, 2001, the Company maintains a portion of its cash and cash equivalents in financial instruments with original maturities of three months or less. The Company also, at times, maintains a short-term investment portfolio containing financial instruments with original maturities of greater than three months but less than twelve months. These financial instruments, principally comprised of high quality commercial paper, are subject to interest rate risk and will decline in value if interest rates increase. Due to the short duration of these financial instruments, an immediate 10% increase in interest rates would not have a material effect on the Company’s financial condition or results of operations. The Company has not used derivative financial instruments in its investment portfolio.
The Company’s long-term debt at June 30, 2001 is comprised of a note payable to a bank, secured by the Company’s corporate office building, with a total balance of $5,147,000 (which was paid in full on July 13, 2001 in connection with the sale of the Company’s corporate headquarters building) and a capital lease agreement covering certain computer hardware with a total balance of $1,732,000. The note payable bears interest at the London Interbank Offered Rate plus one percent, with quarterly interest rate adjustments, and
12
Approximately 16% of the Company’s revenues for the year ended June 30, 2001 were generated from foreign operations, located principally in Australia and Canada. In fiscal 2001, the Company was subjected to a 12% weighted average decrease in the Australian and Canadian currencies in relation to the U.S. dollar compared to fiscal 2000. Currently, the Company does not enter into forward exchange contracts or other financial instruments with respect to foreign currency.
13
JENNY CRAIG, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
| 2000 | 2001 | |||||||||
| Cash and cash equivalents | $ | 34,710 | $ | 38,433 | ||||||
| Short-term investments | 925 | — | ||||||||
| Accounts receivable, net | 2,271 | 2,076 | ||||||||
| Inventories | 11,785 | 11,427 | ||||||||
| Prepaid expenses and other assets | 5,625 | 3,441 | ||||||||
| Deferred tax assets | 864 | — | ||||||||
| Total current assets | 56,180 | 55,377 | ||||||||
| Deferred tax assets | 16,696 | 125 | ||||||||
| Cost of reacquired area franchise rights and other intangibles, net | 8,658 | 7,460 | ||||||||
| Property and equipment, net | 25,797 | 22,216 | ||||||||
| Other assets | 630 | 459 | ||||||||
| $ | 107,961 | $ | 85,637 | |||||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||||
| Accounts payable | $ | 13,473 | $ | 15,255 | ||||||
| Accrued liabilities | 15,515 | 15,420 | ||||||||
| Current installments of obligation under capital lease | 642 | 684 | ||||||||
| Accrual for litigation judgment | 9,649 | 10,525 | ||||||||
| Deferred service revenue | 10,175 | 10,423 | ||||||||
| Total current liabilities | 49,454 | 52,307 | ||||||||
| Note payable, excluding current installments | 5,147 | 4,957 | ||||||||
| Obligation under capital lease, excluding current installments | 1,732 | 1,048 | ||||||||
| Total liabilities | 56,333 | 58,312 | ||||||||
| Stockholders’ equity: | ||||||||||
| Common stock, $.000000005 par value, 100,000,000 shares authorized; issued: 2000 and 2001 — 27,580,260 shares; outstanding: 2000 and 2001 — 20,688,971 shares | — | — | ||||||||
| Additional paid-in capital | 71,622 | 71,622 | ||||||||
| Retained earnings | 49,415 | 30,070 | ||||||||
| Accumulated other comprehensive income | 5,353 | 395 | ||||||||
| Treasury stock, at cost: 2000 and 2001 — 6,891,289 shares | (74,762 | ) | (74,762 | ) | ||||||
| Total stockholders’ equity | 51,628 | 27,325 | ||||||||
| Commitments and contingencies | ||||||||||
| $ | 107,961 | $ | 85,637 | |||||||
See accompanying notes to consolidated financial statements.
14
JENNY CRAIG, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
| 1999 | 2000 | 2001 | |||||||||||||
| Revenues: | |||||||||||||||
| Company-owned operations: | |||||||||||||||
| Product sales | $ | 278,872 | 250,846 | 244,830 | |||||||||||
| Service revenue | 16,130 | 16,934 | 17,572 | ||||||||||||
| 295,002 | 267,780 | 262,402 | |||||||||||||
| Franchise operations: | |||||||||||||||
| Product sales | 22,248 | 19,935 | 17,901 | ||||||||||||
| Royalties | 3,697 | 3,235 | 3,044 | ||||||||||||
| Initial franchise fees | 5 | 35 | 205 | ||||||||||||
| 25,950 | 23,205 | 21,150 | |||||||||||||
| Total revenues | 320,952 | 290,985 | 283,552 | ||||||||||||
| Costs and expenses: | |||||||||||||||
| Company-owned operations: | |||||||||||||||
| Product | 261,090 | 242,908 | 235,499 | ||||||||||||
| Service | 11,062 | 11,777 | 12,536 | ||||||||||||
| 272,152 | 254,685 | 248,035 | |||||||||||||
| Franchise operations: | |||||||||||||||
| Product | 15,761 | 14,746 | 13,819 | ||||||||||||
| Other | 2,183 | 1,208 | 1,302 | ||||||||||||
| 17,944 | 15,954 | 15,121 | |||||||||||||
| 30,856 | 20,346 | 20,396 | |||||||||||||
| General and administrative expenses | 25,437 | 24,861 | 22,231 | ||||||||||||
| Litigation judgment | 8,203 | 1,446 | 876 | ||||||||||||
| Restructuring charge | — | 6,910 | — | ||||||||||||
| Operating loss | (2,784 | ) | (12,871 | ) | (2,711 | ) | |||||||||
| Other income, net, principally interest | 1,700 | 1,432 | 2,173 | ||||||||||||
| Loss before taxes | (1,084 | ) | (11,439 | ) | (538 | ) | |||||||||
| Income taxes (benefit) | (412 | ) | (4,347 | ) | 18,807 | ||||||||||
| Net loss | $ | (672 | ) | (7,092 | ) | (19,345 | ) | ||||||||
| Basic and diluted net loss per share | $ | (0.03 | ) | (0.34 | ) | (0.94 | ) | ||||||||
See accompanying notes to consolidated financial statements.
15
JENNY CRAIG, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
| Accumulated | |||||||||||||||||||||||||
| Additional | other | Total | |||||||||||||||||||||||
| Common | paid-in | Retained | comprehensive | Treasury | stockholders’ | ||||||||||||||||||||
| stock | capital | earnings | income | stock | equity | ||||||||||||||||||||
| Balance at June 30, 1998 | — | $ | 71,622 | 57,179 | 1,747 | (74,762 | ) | 55,786 | |||||||||||||||||
| Comprehensive income: | |||||||||||||||||||||||||
| Net loss | — | — | (672 | ) | — | — | (672 | ) | |||||||||||||||||
| Translation adjustment | — | — | — | 2,383 | — | 2,383 | |||||||||||||||||||
| Balance at June 30, 1999 | — | 71,622 | 56,507 | 4,130 | (74,762 | ) | 57,497 | ||||||||||||||||||
| Comprehensive loss: | |||||||||||||||||||||||||
| Net loss | — | — | (7,092 | ) | — | — | (7,092 | ) | |||||||||||||||||
| Translation adjustment | — | — | — | 1,223 | — | 1,223 | |||||||||||||||||||
| Balance at June 30, 2000 | — | 71,622 | 49,415 | 5,353 | (74,762 | ) | 51,628 | ||||||||||||||||||
| Comprehensive loss: | |||||||||||||||||||||||||
| Net loss | — | — | (19,345 | ) | — | — | (19,345 | ) | |||||||||||||||||
| Translation adjustment | — | — | — | (4,958 | ) | — | (4,958 | ) | |||||||||||||||||
| Balance at June 30, 2001 | — | $ | 71,622 | 30,070 | 395 | (74,762 | ) | 27,325 | |||||||||||||||||
See accompanying notes to consolidated financial statements.
16
JENNY CRAIG, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
| 1999 | 2000 | 2001 | ||||||||||||||
| Cash flows from operating activities: | ||||||||||||||||
| Net loss | $ | (672 | ) | (7,092 | ) | (19,345 | ) | |||||||||
| Adjustments to reconcile net loss to net cash provided by (used in) operating activities: | ||||||||||||||||
| Depreciation and amortization | 5,854 | 5,769 | 6,053 | |||||||||||||
| Provision for (benefit from) deferred income taxes | (5,543 | ) | (4,154 | ) | 17,925 | |||||||||||
| Provision for doubtful accounts | 500 | 85 | 100 | |||||||||||||
| Provision for centre closures | — | 1,144 | — | |||||||||||||
| Loss on disposal of property and equipment | 579 | 178 | 26 | |||||||||||||
| Loss on write-off of cost of reacquired area franchise rights | — | 94 | 432 | |||||||||||||
| (Increase) decrease in: | ||||||||||||||||
| Accounts receivable | (88 | ) | (278 | ) | 95 | |||||||||||
| Inventories | (3,531 | ) | 6,293 | 364 | ||||||||||||
| Prepaid expenses and other assets | (98 | ) | (1,460 | ) | 2,355 | |||||||||||
| Increase (decrease) in: | ||||||||||||||||
| Accounts payable | 1,137 | (2,920 | ) | 1,782 | ||||||||||||
| Accrued liabilities | (4,289 | ) | 405 | (585 | ) | |||||||||||
| Accrual for litigation judgment | 8,203 | 1,446 | 876 | |||||||||||||
| Deferred service revenue | (203 | ) | 100 | 248 | ||||||||||||
| Net cash provided by (used in) operating activities | 1,849 | (390 | ) | 10,326 | ||||||||||||
| Cash flows from investing activities: | ||||||||||||||||
| Purchase of property and equipment | (5,073 | ) | (4,747 | ) | (1,961 | ) | ||||||||||
| Purchase of short-term investments | (7,883 | ) | (4,200 | ) | — | |||||||||||
| Proceeds from maturity of short-term investments | 5,969 | 6,425 | 925 | |||||||||||||
| Payments for acquisition of franchise centres | (320 | ) | (1,923 | ) | (225 | ) | ||||||||||
| Net cash used in investing activities | (7,307 | ) | (4,445 | ) | (1,261 | ) | ||||||||||
| Cash flows from financing activities — | ||||||||||||||||
| Principal payments on note payable and capital lease | (190 | ) | (542 | ) | (832 | ) | ||||||||||
| Effect of exchange rate changes on cash and cash equivalents | 2,388 | 1,223 | (4,510 | ) | ||||||||||||
| Net increase (decrease) in cash and cash equivalents | (3,260 | ) | (4,154 | ) | 3,723 | |||||||||||
| Cash and cash equivalents at beginning of year | 42,124 | 38,864 | 34,710 | |||||||||||||
| Cash and cash equivalents at end of year | $ | 38,864 | 34,710 | 38,433 | ||||||||||||
| Supplemental disclosure of cash flow information: | ||||||||||||||||
| Income taxes paid | $ | 3,972 | 728 | 1,659 | ||||||||||||
| Interest paid | 360 | 538 | 513 | |||||||||||||
| Supplemental disclosure of noncash investing and financing activities: | ||||||||||||||||
| Acquisition of franchise centres: | ||||||||||||||||
| Fair value of assets acquired | $ | 600 | 2,462 | 332 | ||||||||||||
| Cancellation of accounts receivable | (280 | ) | (539 | ) | (107 | ) | ||||||||||
| Cash paid for acquisitions | $ | 320 | 1,923 | 225 | ||||||||||||
| Property and equipment acquired through capital lease | $ | — | 2,726 | — | ||||||||||||
See accompanying notes to consolidated financial statements.
17
JENNY CRAIG, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) The Company and Summary of Significant Accounting Policies
(a) The Company
Jenny Craig, Inc., through its wholly owned subsidiaries, operates and franchises centres offering weight management programs to the general public in the United States, Australia, New Zealand, Canada and Puerto Rico.
(b) Basis of Consolidation
The consolidated financial statements include the accounts of Jenny Craig, Inc. and its wholly owned subsidiaries (the Company). All material intercompany accounts and transactions have been eliminated in consolidation.
(c) Cash Equivalents
Cash equivalents consist principally of money market funds and other highly liquid interest-bearing instruments with original maturities of three months or less.
(d) Short-Term Investments
Short-term investments consist principally of commercial paper. The Company classifies its securities as held-to-maturity. Held-to-maturity securities are those investments in which the Company has the ability and intent to hold the security until maturity. Held-to-maturity securities are recorded at amortized cost, which approximates market value. All investments mature within a 12-month period. Dividend and interest income are recognized in the period earned.
(e) Inventories
Inventories, which consist primarily of food products held for sale, are stated at the lower of cost (determined using the first-in, first-out method) or market.
(f) Property and Equipment
Property and equipment are stated at cost, net of accumulated depreciation and amortization. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets, predominantly five years. Leasehold improvements are amortized over the shorter of their useful life or related lease term, predominantly five years. The Company’s corporate headquarters building, purchased in 1997, is being depreciated using the straight-line method over 30 years.
(g) Reacquired Area Franchise Rights and Other Intangibles
The Company has acquired, from time to time, centres which were previously owned by franchisees. The excess cost over net assets acquired is being amortized using the straight-line method over the then remaining term of the acquired franchise territorial rights, which averages 13 years. Amortization expense was $805,000, $815,000 and $937,000 for the years ended June 30, 1999, 2000 and 2001, respectively. Accumulated amortization was $6,753,000 and $7,056,000 at June 30, 2000 and 2001, respectively.
| (h) Impairment of Long-Lived Assets |
The Company reviews long-lived assets and certain identifiable intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted cash flows expected to be generated by the asset. If such assets are considered to be
18
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Reacquired area franchise rights are evaluated for recoverability on an individual area franchise basis. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.
| (i) Revenue Recognition |
Revenue from product sales, which is substantially comprised of food products, whether sold to participants at Company-owned centres or sold to franchisees, is recognized upon receipt of the product by the customer. Product sales are non-returnable.
Service revenues are derived from the sale of weight loss and maintenance programs under contracts which entitle the customer to participate in the program. All service fees collected are deferred and recognized as revenue on a straight-line basis over the 14-month period of expected customer attendance at the centres. Service revenue not recognized in income is recorded as deferred service revenue in the accompanying consolidated balance sheets.
Certain weight loss programs enable the customer to receive a refund of a portion of the service fee if certain criteria are met. The Company records a liability at the time of sale for the estimated portion of the service fee to refunded based upon historical experience.
The Company grants franchises in exchange for an initial franchise fee which is recorded as revenue when substantially all services have been performed and the franchisee commences operations. Costs associated with such sales, substantially all of which are incurred prior to the franchisee commencing operations, are expensed as incurred. Franchise royalties are calculated as a percentage of franchisees’ revenue in accordance with the franchise agreements.
The Company’s allowance for doubtful accounts amounted to $1,572,000 and $1,416,000 at June 30, 2000 and 2001, respectively.
| (j) Advertising Costs |
Advertising costs are charged to expense as incurred.
| (k) Translation of Foreign Currency Financial Statements |
Assets and liabilities of foreign operations where the functional currency is other than the U.S. dollar are translated at fiscal year-end rates of exchange, and the related revenue and expense amounts are translated at the average rates of exchange in effect for the fiscal year. Gains or losses resulting from translating foreign currency financial statements are recorded in accumulated other comprehensive income.
| (l) Fair Value of Financial Instruments |
The carrying amounts of cash and cash equivalents, short-term investments, accounts receivable, accounts payable and accrued liabilities approximate their fair value because of the short-term nature of those instruments. The carrying amount of the note payable approximates fair value because the interest rate is reset each quarter to reflect current market rates, and the other terms are comparable to those currently available in the marketplace.
| (m) Stock-Based Compensation |
The Company adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123,Accounting for Stock-Based Compensation(SFAS 123). Accordingly, the Company continues to account for stock-based compensation under APB Opinion No. 25,Accounting for Stock Issued to Employees,
19
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
and related interpretations. As such, compensation expense for employee stock option grants is recorded on the date of grant only if the current market price of the Company’s stock exceeds the exercise price. Stock options issued to non-employees in exchange for goods or services received are recorded at the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measurable.
| (n) Earnings per Share |
The consolidated financial statements are presented in accordance with Statement of Financial Accounting Standards No. 128,Earnings per Share (SFAS 128). Basic net income (loss) per common share is computed using the weighted-average number of shares outstanding during the period. Diluted net income per share incorporates the incremental shares issuable upon the assumed exercise of stock options.
Net loss and weighted-average common shares used to compute net loss per share, basic and diluted, are presented below ($ in thousands):
| 1999 | 2000 | 2001 | ||||||||||
| Net loss | $ | (672 | ) | (7,092 | ) | (19,345 | ) | |||||
| Common shares, basic and diluted | 20,689 | 20,689 | 20,689 | |||||||||
For the years ended June 30, 1999, 2000 and 2001, stock options representing 2,167,500, 2,527,100 and 2,290,100 common shares respectively, were not included in the computation of diluted net loss per share because to do so would have been antidilutive.
| (o) Reclassification |
Certain prior year balances have been classified to conform with the current year presentation.
(p) Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
(2) Prepaid Expenses and Other Assets
Prepaid expenses and other assets at June 30 are summarized as follows ($ in thousands):
| 2000 | 2001 | |||||||
| Prepaid income taxes | $ | 3,000 | 1,584 | |||||
| Other | 2,625 | 1,857 | ||||||
| $ | 5,625 | 3,441 | ||||||
20
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(3) Property and Equipment
Property and equipment at June 30 is summarized as follows ($ in thousands):
| 2000 | 2001 | |||||||
| Land | $ | 2,000 | 2,000 | |||||
| Building | 7,048 | 7,048 | ||||||
| Furniture and equipment | 30,682 | 30,027 | ||||||
| Leasehold improvements | 21,034 | 21,402 | ||||||
| 60,764 | 60,477 | |||||||
| Less accumulated depreciation and amortization | (34,967 | ) | (38,261 | ) | ||||
| $ | 25,797 | 22,216 | ||||||
See Note 15 “Subsequent Event” for information regarding the sale of the land and building on July 13, 2001.
(4) Accrued Liabilities
Accrued liabilities at June 30 are summarized as follows ($ in thousands):
| 2000 | 2001 | |||||||
| Accrued salaries, wages and benefits | $ | 8,210 | 9,690 | |||||
| Restructuring accrual | 1,807 | 368 | ||||||
| Deferred tax liability | — | 490 | ||||||
| Other accruals | 5,498 | 4,872 | ||||||
| $ | 15,515 | 15,420 | ||||||
(5) Income Taxes
The Company and its United States subsidiaries file consolidated federal and combined or separate state income tax returns. Jenny Craig Weight Loss Centres, Pty. Ltd. and Jenny Craig Weight Loss Centres (Canada) Company, both wholly owned foreign subsidiaries, are subject to income tax in foreign jurisdictions.
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards.
Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
The components of loss before taxes are as follows ($ in thousands):
| 1999 | 2000 | 2001 | ||||||||||
| United States | $ | (11,256 | ) | (17,383 | ) | (1,686 | ) | |||||
| Foreign | 10,172 | 5,944 | 1,148 | |||||||||
| $ | (1,084 | ) | (11,439 | ) | (538 | ) | ||||||
21
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following summarizes income taxes (benefit) ($ in thousands):
| 1999 | 2000 | 2001 | ||||||||||||
| Current: | ||||||||||||||
| Federal | $ | 2,250 | (1,060 | ) | 200 | |||||||||
| State | 153 | 26 | 28 | |||||||||||
| Foreign | 2,728 | 841 | 654 | |||||||||||
| Total current | 5,131 | (193 | ) | 882 | ||||||||||
| Deferred: | ||||||||||||||
| Federal | (2,775 | ) | (5,546 | ) | 16,483 | |||||||||
| State | (429 | ) | 79 | 1,400 | ||||||||||
| Foreign | (2,339 | ) | 1,313 | 42 | ||||||||||
| Total deferred | (5,543 | ) | (4,154 | ) | 17,925 | |||||||||
| Total income taxes (benefit) | $ | (412 | ) | (4,347 | ) | 18,807 | ||||||||
Deferred income taxes result from the temporary differences between the tax basis of an asset or a liability and its reported amount in the consolidated balance sheets. The components that comprise deferred tax assets and liabilities at June 30, 2000 and 2001 are as follows ($ in thousands):
| 2000 | 2001 | |||||||||
| Deferred tax assets: | ||||||||||
| Employee benefits | $ | 898 | 812 | |||||||
| Allowance for doubtful accounts | 648 | 501 | ||||||||
| Depreciation and amortization | 1,674 | 1,980 | ||||||||
| Inventories | 216 | 159 | ||||||||
| Deferred service revenue | 2,603 | 2,626 | ||||||||
| Net operating losses | 6,021 | 7,365 | ||||||||
| Tax credits | 1,630 | 919 | ||||||||
| Accrual for litigation judgment | 3,497 | 3,997 | ||||||||
| Other accruals | 1,876 | 1,735 | ||||||||
| Total gross deferred tax assets | 19,063 | 20,094 | ||||||||
| Less valuation allowance | (700 | ) | (19,298 | ) | ||||||
| Net deferred tax assets | 18,363 | 796 | ||||||||
| Deferred tax liabilities: | ||||||||||
| Receivable from foreign subsidiary | (326 | ) | (331 | ) | ||||||
| Foreign operations | (323 | ) | (365 | ) | ||||||
| Other | (154 | ) | (465 | ) | ||||||
| Total deferred tax liabilities | (803 | ) | (1,161 | ) | ||||||
| Net deferred tax asset (liability) | $ | 17,560 | (365 | ) | ||||||
The valuation allowance for deferred tax assets as of July 1, 1999 and 2000 was $700,000. There was no change in the valuation allowance for the year ended June 30, 2000 and there was an increase of $18,598,000 in the valuation allowance for the year ended June 30, 2001. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. During 2001, the Company concluded that the deferred tax
22
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
asset valuation allowance should be increased due to the uncertainty of realizing certain tax loss carryforwards and other deferred tax assets in accordance with Statement of Financial Accounting Standards No. 109 “Accounting for Income Taxes”. Accordingly, the Company recorded a non-cash charge of $18,598,000 to provide a full valuation allowance for the balance of the U.S. net deferred tax asset. Management’s assessment was based principally on the losses experienced by the Company in the U.S. for the first six months of fiscal 2001, together with less than expected operating results in January 2001, following two consecutive profitable quarters ended March 31, 2000 and June 30, 2000.
Income taxes (benefit) for the years ended June 30, 1999, 2000 and 2001 differed from the amounts expected by applying the U.S. federal income tax rate of 34% to income (loss) before taxes as follows ($ in thousands):
| 1999 | 2000 | 2001 | ||||||||||
| Computed income tax benefit | $ | (369 | ) | (3,889 | ) | (183 | ) | |||||
| State taxes, net of federal benefit | (183 | ) | 69 | 1,333 | ||||||||
| Permanent differences | 70 | 84 | (155 | ) | ||||||||
| Foreign taxes | — | — | 445 | |||||||||
| Change in Federal valuation allowance | — | — | 16,982 | |||||||||
| Other | 70 | (611 | ) | 385 | ||||||||
| $ | (412 | ) | (4,347 | ) | 18,807 | |||||||
(6) Note Payable
In October 1996, the Company borrowed $6,000,000 from a bank, secured by the Company’s corporate office building. The note bears interest at the London Interbank Offered Rate plus 1% (5.375% at June 30, 2001). The current portion of the note, amounting to $190,000, is included in accrued liabilities at June 30, 2000 and 2001.
See Note 15 “Subsequent Event” for information regarding the repayment in full of the note payable on July 13, 2001.
(7) Leases
The Company’s centre operations are conducted from premises leased under noncancelable operating leases, generally for terms of five years with renewal options for like periods. The Company’s rent expense under such noncancelable operating leases amounted to $24,226,000, $23,159,000 and $21,605,000 for the years ended June 30, 1999, 2000 and 2001, respectively. Management expects that in the normal course of business, leases that expire will be renewed or replaced by other leases. A majority of the leases provide for the payment of taxes, maintenance, insurance, and certain other expenses applicable to the leased premises.
The Company is obligated under a capital lease for computer equipment that expires in November 2003. The gross amount of computer equipment and related accumulated amortization recorded under capital leases at June 30 is as follows ($ in thousands):
| 2000 | 2001 | |||||||
| Computer equipment | $ | 2,726 | 2,702 | |||||
| Less accumulated amortization | (586 | ) | (1,209 | ) | ||||
| $ | 2,140 | 1,493 | ||||||
Amortization of assets held under capital leases is included with depreciation expense.
23
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
As of June 30, 2001, the scheduled minimum annual rental payments, excluding renewal provisions under noncancelable operating leases and future minimum capital lease payments are as follows ($ in thousands):
| Capital | Operating | |||||||
| leases | leases | |||||||
| 2002 | $ | 783 | $ | 15,044 | ||||
| 2003 | 783 | 8,705 | ||||||
| 2004 | 316 | 4,247 | ||||||
| 2005 | — | 1,147 | ||||||
| 2006 | — | 296 | ||||||
| Minimum lease payments | 1,882 | $ | 29,439 | |||||
| Less amount representing interest (at rates ranging from 6% to 8.5%) | (150 | ) | ||||||
| Present value of minimum capital lease payments | 1,732 | |||||||
| Less current installments of obligations under capital lease | (684 | ) | ||||||
| Obligations under capital lease excluding current installments | $ | 1,048 | ||||||
(8) Litigation Judgment
In June 1999, a jury of the California Superior Court found that the Company breached the terms of a commercial lease agreement related to its former headquarters location in Del Mar, California. The jury awarded the Company’s former landlord $2,261,000 in compensatory contract and tort damages and $5,942,000 in punitive damages, or $8,203,000 in aggregate, which was recorded as a charge in the accompanying consolidated statement of operations for the year ended June 30, 1999 and is accrued in the accompanying consolidated balance sheet at June 30, 2000 and 2001. An additional $1,446,000 and $876,000 were recorded as charges in the accompanying consolidated statement of operations for the years ended June 30, 2000 and 2001, respectively, for attorney fees awarded to the plaintiff and interest accrued on the judgment, pending the appeal which has been filed seeking to overturn the judgment.
| (9) | Related Party Transactions |
The beneficial owners of a majority of the outstanding stock of the Company own the franchise operations in New Zealand. The Company’s revenue derived from these operations was $4,174,000, $4,978,000 and $3,733,000 for the years ended June 30, 1999, 2000 and 2001, respectively. A director and officer of the Company is a partner in a law firm which provided certain legal services to the Company. Legal fees incurred with such firm were $568,000, $1,726,000 and $1,486,000 in 1999, 2000 and 2001, respectively.
In March 1999, the Company entered into an agreement, which was subsequently terminated in August 2000, with Denise Altholz, the daughter of Jenny Craig, under which Ms. Altholz appeared in certain of the Company’s commercials and performed related public relations services for the Company. The agreement specified a monthly retainer of $5,000 plus a fee of $5,000 per day while appearing on behalf of the Company. The agreement also provided for travel and expense reimbursement to Ms. Altholz. Payments made to Ms. Altholz in accordance with this agreement totaled $98,000, $70,000 and $10,000 in 1999, 2000 and 2001, respectively.
Since May 1, 2001, Marvin Sears, a director of the Company, has provided consulting services to the Company in addition to his duties as a director. Payments of $20,000 were made to Mr. Sears in 2001 for such consulting services.
24
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
| (10) | Restructuring Charge |
In November 1999, the Company implemented a restructuring plan to reduce annual operating expenses. The plan included the closure of 86 underperforming Company-owned centres in the United States, which represented 16% of the total United States Company-owned centres, and a staff reduction of approximately 15% at the Company’s corporate headquarters. A charge of $7,512,000 was recorded in the quarter ended December 31, 1999 in connection with this restructuring. In June 2000, the Company reversed $602,000 of the originally estimated $7,512,000 restructuring charge because actual costs were less than the costs projected when the restructuring was implemented. The revised charge of $6,910,000 was comprised of $3,593,000 for lease termination costs, $1,544,000 for severance payments to 110 terminated employees, $1,144,000 for the write-off of fixed assets, $109,000 for refunds to program participants and $520,000 for other closure costs. None of the fixed assets subject to the write-off remained in use after the November 1999 centre closures. Of the revised charge of $6,910,000, approximately $5,766,000 requires cash payments and $1,144,000 represents the non-cash write-off of fixed assets. As of June 30, 2001, the Company had made cash payments of $3,157,000 for lease termination costs, $1,432,000 for severance to terminated employees, $112,000 for refunds to program participants, and $697,000 for other closure costs. The company estimates that the remaining cash payments of approximately $368,000 will be substantially incurred by December 31, 2001.
(11) Employee Benefits
In 1996, the Company adopted a 401(k) Retirement Plan which allows all employees with one or more years of service to participate. The Company currently matches 25% of an employee’s voluntary contribution up to a maximum of 6% of eligible compensation. The Company recorded expense of $348,000, $279,000 and $247,000 in 1999, 2000 and 2001, respectively, in connection with this plan.
In 1991, the Company adopted a management deferred bonus plan covering certain members of the Company’s management group. The bonus pool, which is determined by the Board of Directors following each fiscal year, cannot exceed 1% of operating income for the fiscal year plus a percentage of the increase, if any, in operating income over the prior fiscal year. Participants receive 25% of their allocated portion of the bonus pool approximately 90 days after the end of each fiscal year. Payment of the remaining 75% is deferred for five years and is subject to vesting at the rate of 20% per year. The unvested portion is forfeited if the participant terminates employment for any reason other than retirement after attainment of age 65 and completion of 10 years of participation in the management plan. There were no amounts expensed under this plan in 1999, 2000 or 2001, respectively.
(12) Stock Option Plan
The Company’s Stock Option Plan (the Option Plan) was adopted in October 1991 and provides for the grant of incentive stock options to key employees and of nonqualified stock options to key employees, consultants, directors, and Medical Advisory Board members. A total of 3,000,000 shares of common stock have been reserved for issuance under the Option Plan, of which 630,240 shares remain available for future grant at June 30, 2001. The exercise price of the options may not be less than the fair market value of the common stock on the date of grant. Additionally, no options may be exercisable more than ten years after the date of grant and, with certain exceptions, no option may become exercisable prior to the expiration of six months from the date of grant. The options granted to employees generally become exercisable over three to five years.
The Company applies APB Opinion No. 25 in accounting for the Option Plan and accordingly, no compensation cost has been recognized for stock option grants to employees and directors in the consolidated financial statements. Had the Company determined compensation cost based on the fair value at the grant
25
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
date for its stock options under SFAS 123, the Company’s net loss and net loss per share would have been increased to the pro forma amounts as follows ($ in thousands, except per share amounts):
| 1999 | 2000 | 2001 | |||||||||||
| Net loss — as reported | $ | (672 | ) | (7,092 | ) | (19,345 | ) | ||||||
| Net loss — pro forma | (1,352 | ) | (7,590 | ) | (20,142 | ) | |||||||
| Per share amounts: | |||||||||||||
| Basic and diluted, as reported | (.03 | ) | (.34 | ) | (.94 | ) | |||||||
| Basic and diluted, pro forma | (.07 | ) | (.37 | ) | (.97 | ) | |||||||
The per share weighted-average fair value of stock options granted during 1999, 2000 and 2001 was $2.64, $0.98 and $1.24 respectively, on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions: expected life of four years; expected volatility of 49%, 56% and 83% in 1999, 2000 and 2001, respectively; no dividends; and risk-free interest rate of 5%.
The following summarizes the status of the Option Plan:
| Weighted- | |||||||||||||
| average | |||||||||||||
| Number of | Range of | exercise | |||||||||||
| options | exercise prices | price | |||||||||||
| Outstanding at June 30, 1998 | 1,932,200 | $ | 4.63 to 15.32 | $ | 5.96 | ||||||||
| Granted | 547,000 | 2.88 to 6.79 | 5.98 | ||||||||||
| Canceled | (311,700 | ) | 5.63 to 15.32 | 6.54 | |||||||||
| Outstanding at June 30, 1999 | 2,167,500 | 2.88 to 6.79 | 5.88 | ||||||||||
| Granted | 1,188,000 | 1.97 to 2.94 | 2.05 | ||||||||||
| Canceled | (828,400 | ) | 5.63 to 6.79 | 6.01 | |||||||||
| Outstanding at June 30, 2000 | 2,527,100 | 1.97 to 6.07 | 4.04 | ||||||||||
| Granted | 342,000 | 1.48 to 2.94 | 1.95 | ||||||||||
| Canceled | (579,000 | ) | 5.63 to 5.94 | 5.89 | |||||||||
| Outstanding at June 30, 2001 | 2,290,100 | 1.48 to 6.07 | 3.26 | ||||||||||
| Exercisable at June 30, 2001 | 1,029,605 | 1.69 to 6.07 | 4.35 | ||||||||||
26
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Information with respect to options outstanding and exercisable by exercise price range at June 30, 2001 is as follows:
Options Outstanding
| Weighted- | ||||||||||||||
| average | Weighted- | |||||||||||||
| remaining | average | |||||||||||||
| Range of | Number | contractual life | exercise | |||||||||||
| exercise prices | outstanding | (in years) | price | |||||||||||
| $ | 1.48 to 2.13 | 1,528,000 | 8.7 | $ | 2.03 | |||||||||
| 2.25 to 2.94 | 27,000 | 7.8 | 2.86 | |||||||||||
| 4.63 to 6.07 | 735,000 | 6.5 | 5.83 | |||||||||||
| 1.48 to 6.07 | 2,290,100 | 8.0 | 3.26 | |||||||||||
Options Exercisable
| Weighted- | ||||||||||
| average | ||||||||||
| Range of | Number | exercise | ||||||||
| exercise prices | exercisable | price | ||||||||
| $ | 1.69 to 2.13 | 390,380 | 2.05 | |||||||
| 2.25 to 2.94 | 14,500 | 2.84 | ||||||||
| 4.63 to 6.07 | 624,725 | 5.83 | ||||||||
| 1.69 to 6.07 | 1,029,605 | 4.35 | ||||||||
(13) Contingencies
Because of the nature of its activities, the Company is, at times, subject to pending and threatened legal actions which arise out of the normal course of business. In the opinion of management, based in part upon advice of legal counsel, the disposition of such matters will not have a material effect on the consolidated financial statements.
The Company is a defendant in a litigation in the Superior Court of California, Alameda County. The action was commenced in March 2001 by certain named plaintiffs on behalf of themselves and on behalf of the general public. The complaint alleges that the Company’s service contracts used in California with its clients do not comply with the requirements of certain California consumer protection statutes. The plaintiff contends these contracts are misleading and constitute deceptive practices. The complaint requests an order declaring the Company’s practices and conduct with respect to its California service agreements unlawful, refund of membership amounts paid by clients who choose to cancel their service agreement, treble damages and attorney’s fees. The proceeding has not progressed sufficiently for the Company to estimate a range of possible loss. The Company intends to defend the matter vigorously.
27
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(14) Business Segments and Geographic Information
The Company operates in the weight management industry. Substantially all revenue results from the sale of weight management products and services, whether the centre is operated by the Company or its franchisees. The Company’s reportable segments consist of Company-owned operations and franchise operations, further segmented by geographic area. The following presents information about the respective reportable segments ($ in thousands):
| 1999 | 2000 | 2001 | ||||||||||||
| Revenue: | ||||||||||||||
| Company-owned operations: | ||||||||||||||
| United States | $ | 244,303 | 218,077 | 223,924 | ||||||||||
| Foreign | 50,699 | 49,703 | 38,478 | |||||||||||
| Franchise operations: | ||||||||||||||
| United States | 18,237 | 14,716 | 14,915 | |||||||||||
| Foreign | 7,713 | 8,489 | 6,235 | |||||||||||
| Operating income (loss): | ||||||||||||||
| Company-owned operations: | ||||||||||||||
| United States | (14,013 | ) | (22,498 | ) | (6,896 | ) | ||||||||
| Foreign | 7,403 | 6,638 | 1,941 | |||||||||||
| Franchise operations: | ||||||||||||||
| United States | 1,436 | 121 | 367 | |||||||||||
| Foreign | 2,390 | 2,868 | 1,877 | |||||||||||
| Identifiable assets: | ||||||||||||||
| United States | 99,965 | 92,503 | 72,529 | |||||||||||
| Foreign | 12,649 | 15,458 | 13,108 | |||||||||||
The operating loss for the United States Company-owned operations in 2000 includes a restructuring charge totaling $6,910,000. See Note 10 “Restructuring Charge.”
The operating loss for United States Company-owned operations in 1999 includes a litigation judgment totaling $8,230,000. See Note 8 “Litigation Judgment.”
(15) Subsequent Event
On July 13, 2001, the Company completed the sale of its corporate headquarters building for $21,000,000. Concurrent with the sale, the note payable totaling $5,147,000 was paid in full. After repayment of the note payable and expenses of the sale, the Company received net cash proceeds of $15,154,000.
28
INDEPENDENT AUDITORS’ REPORT
The Stockholders and Board of Directors
We have audited the accompanying consolidated balance sheets of Jenny Craig, Inc. and subsidiaries as of June 30, 2000 and 2001, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the years in the three-year period ended June 30, 2001. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Jenny Craig, Inc. and subsidiaries as of June 30, 2000 and 2001, and the results of their operations and their cash flows for each of the years in the three-year period ended June 30, 2001, in conformity with accounting principles generally accepted in the United States of America.
| KPMG LLP |
San Diego, California
29
JENNY CRAIG, INC. AND SUBSIDIARIES
SELECTED QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
The following is a summary of the unaudited quarterly results of operations ($ in thousands, except per share data):
| Three-Month Period Ended | ||||||||||||||||||||
| September 30, | December 31, | March 31, | June 30, | Total | ||||||||||||||||
| Current Year | 2000 | 2000 | 2001 | 2001 | year | |||||||||||||||
| Total revenues | $ | 66,393 | 60,684 | 76,840 | 79,635 | 283,552 | ||||||||||||||
| Operating income (loss) | (1,927 | ) | (3,971 | ) | (931 | ) | 4,118 | (2,711 | ) | |||||||||||
| Net income (loss) | (1,736 | ) | (21,612 | ) | (477 | ) | 4,480 | (19,345 | ) | |||||||||||
| Basic and diluted net income (loss) per share | (.08 | ) | (1.04 | ) | (.02 | ) | .22 | (.94 | ) | |||||||||||
The quarter ended December 31, 2000 includes a non-cash charge of $17,721,000 to provide a full valuation allowance for the United States deferred tax assets. See Note 5 “Income Taxes”.
| Three-Month Period Ended | ||||||||||||||||||||
| September 30, | December 31, | March 31, | June 30, | Total | ||||||||||||||||
| Prior Year | 1999 | 1999 | 2000 | 2000 | year | |||||||||||||||
| Total revenues | $ | 71,511 | 62,157 | 80,777 | 76,540 | 290,985 | ||||||||||||||
| Operating income (loss) | (6,488 | ) | (12,585 | ) | 2,559 | 3,643 | (12,871 | ) | ||||||||||||
| Net income (loss) | (3,782 | ) | (7,610 | ) | 1,727 | 2,573 | (7,092 | ) | ||||||||||||
| Basic and diluted net income (loss) per share | (.18 | ) | (.37 | ) | .08 | .12 | (.34 | ) | ||||||||||||
The quarter ended December 31, 1999 includes a pretax charge of $7,512,000 for a restructuring charge and the quarter ended June 30, 2000 includes a reversal of $602,000 of the originally estimated $7,512,000 restructuring charge because actual costs were less than the costs projected when the restructuring was implemented.
The net income (loss) per share computed for each quarter and the year are separate calculations.
30
JENNY CRAIG, INC. AND SUBSIDIARIES
COMMON STOCK DATA
At September 1, 2001, there were approximately 2,300 holders of the Company’s common stock. On August 16, 2001, the Company’s common stock was de-listed from the New York Stock Exchange (NYSE), where it had been listed under the symbol JC, because the Company was below the NYSE’s continued listing criteria requiring total market capitalization of not less than $50,000,000 and total stockholders’ equity of not less than $50,000,000. Subsequent to August 16, 2001, the Company’s common stock has traded on the NASD Bulletin Board system under the symbol JCGI. The following table reflects the range of high and low sales prices as reported by the NYSE for the indicated periods.
| 2000 | 2001 | |||||||||||||||
| High | Low | High | Low | |||||||||||||
| First quarter ended September 30 | 3.375 | 2.312 | 3.375 | 1.630 | ||||||||||||
| Second quarter ended December 31 | 3.875 | 2.000 | 2.000 | 1.250 | ||||||||||||
| Third quarter ended March 31 | 3.750 | 2.000 | 1.500 | 1.010 | ||||||||||||
| Fourth quarter ended June 30 | 3.437 | 1.437 | 1.730 | 1.020 | ||||||||||||
The Company did not pay any cash dividends in 2000 and 2001. The Company currently believes that its stockholders are best served by directing cash resources to the Company’s marketing efforts and improvement of its business.
31
