ITEM 1. BUSINESS
Natural Alternatives International, Inc. and its subsidiaries (referred to collectively herein as the "Company") is engaged in the formulation and production of encapsulated and tablet vitamins and related nutrients including phytochemicals derived from botanicals and foods. The Company provides clinical studies assessment, assistance with international product registration, packaging and delivery system design, customer-specific nutritional product formulation and a host of other marketing related services for its clients. The Company seeks to further its customers' objectives by assisting them in expanding their market share through a variety of special programs and services. There are no fees charged or revenues generated from these marketing related services, which are generally provided before orders for product are obtained.
Management believes its technically advanced facilities, laboratory and quality control capabilities are a major factor in solidifying existing customer relationships and adding new customers. The recognized standards for manufacturing nutritional products should, in the opinion of management, assist the Company in serving its present and future customers. The United States Pharmacopeia compendia (USP) contain specifications for vitamin and mineral supplements. This USP monograph has long been the basis for determining the strength, quality, purity, packaging and labeling of drugs and related articles. The Company currently has the technical and quality control expertise to conform to all aspects of USP specifications. Conformance with USP specifications allows the Company to use the USP designation on products manufactured for its customers, which have the USP designation.
The Company's growth strategy is to introduce new products, attract and retain preferred customers, and enter new markets. The Company believes that it can successfully implement this growth strategy by continuing to capitalize on its operating strengths: science-based products; a strong research and development program; in-house manufacturing; and an experienced management team.
RECENT MANAGEMENT CHANGES
The Company experienced a significant change in its management during fiscal 1999. Mark LeDoux, founder and CEO of the Company, assumed the role of President in January 1999. David Lough was appointed Executive Vice President with responsibility for all corporate operations. Douglas E. Flaker was appointed Vice President of Marketing, Business Development and Strategic Planning. David K. Shunick was appointed Vice President of Operations.
William P. Spencer, who served as a Director, President and Chief Financial Officer of the Company, and Jane Schlosberg, formerly Director of Marketing and Corporate Relations are no longer employed by the Company. Mr. Spencer resigned as a director of the Company on June 29, 1999.
PRODUCTS AND MANUFACTURING
The Company is engaged in the research, design and manufacture of nutritional supplements for others engaged in commerce in a variety of distribution channels - - both domestic and international. The Company purchases raw materials in bulk from qualified vendors, and, after quality control testing, encapsulates or compresses them into solid dosage forms of either chewable wafers or tablets. The Company utilizes contract manufacturers, in accordance with the Company's specifications and standards, to package the product for shipment.
RESEARCH AND DEVELOPMENT
The primary emphasis of the Company's research and development activities is the development of new products and enhancement of existing products. In addition, the Company continuously produces pilot or sample runs of products to ensure stability or efficacy and to determine ingredient interaction and prospective customer acceptance. The Company has implemented stringent quality control procedures to verify that all products comply with established specifications and standards. Research of this type is a part of the operating expenses incurred by the Company, and the associated costs have not been significant.
PART I
ITEM 1. BUSINESS (continued)
COMPETITION AND BUSINESS RISKS
The Company's products are sold in domestic and foreign markets in competition with other companies. The vitamin and nutritional supplement industry is highly competitive, and competition continues to increase. Competition for the sale of vitamins and supplements comes from many sources, including companies which sell vitamins to supermarkets, large chain discount retailers, drug store chains and independent drug stores, health food stores, pharmaceutical companies and others which sell to wholesalers, mail order vendors and network marketing companies. The Company does not believe it is possible to accurately estimate the number or size of its many competitors since the vitamin industry is largely privately held.
The Company believes that competition among manufacturers of vitamin and supplement products is based, among other things, on price, timely delivery, product quality, safety, availability, product innovation and assistance in marketing and customer service. The competitive position of the Company will also depend upon continued acceptance of its products, its ability to attract and retain qualified personnel, future governmental regulations affecting vitamins and nutritional supplements, and publication of vitamin product safety and efficacy studies by the government and authoritative health and medical authorities.
The Company's operations are subject to the risks normally associated with manufacturing vitamins and nutritional products, including shortage of certain raw materials and damage to property or injury to persons.
SOURCE AND AVAILABILITY OF RAW MATERIALS
Raw materials used in the Company's products consist of nutrient powders, empty gelatin capsules, and necessary components for packaging and distribution of finished vitamin and nutritional supplement products. The nutrient powders and the empty gelatin capsules are purchased from manufacturers in the United States, including foreign entities, some of which have operations in the United States. To date, the Company has not experienced any difficulty in obtaining adequate sources of supply. Although there can be no assurance that the Company will continue to be able to obtain adequate sources in the future, the Company believes that it will be able to do so.
MAJOR CUSTOMERS
Nu Skin International, NSA International and Pharmavite together represented 71% of the Company's sales for the year ended June 30, 1999. Loss of any of these customers could have an adverse impact on the Company's revenues and earnings until the Company could replace these sales. If the Company was unable to replace the sales to any of these customers, it would have a material adverse impact on the business and operations of the Company. No other customer represented 10% or more of the Company's sales for the year ended June 30, 1999.
EMPLOYEES
The Company employs 121 individuals, with five employed in executive positions, eleven in the area of research, laboratory and quality control, eleven in sales and marketing, while the remaining employees are engaged in production and administration. The Company has never experienced a work stoppage, and none of its employees are currently represented by a union or any other form of collective bargaining unit. The Company believes its relations with its employees are excellent.
PART I
ITEM 1. BUSINESS (continued)
GOVERNMENT REGULATION
The formulation, manufacturing, packaging, labeling, advertising and distribution of the Company's products are subject to regulation by one or more federal agencies, including the Federal Drug Administration (FDA), the Federal Trade Commission (FTC), the Consumer Product Safety Commission (CPSC), the United States Department of Agriculture (DOA) and the Environmental Protection Agency (EPA). These activities are also regulated by various agencies of the states and localities in which the Company's products are sold, including without limitation the California Department of Health Services, Food and Drug branch. The FDA in particular regulates the advertising, labeling and sales of vitamin and mineral supplements and may take regulatory action concerning medical claims, misleading or untruthful advertising, and product safety issues. These regulations include the FDA's Good Manufacturing Practices (GMPs) for foods. Detailed dietary supplement GMPs have been proposed but no regulations have been adopted. Additional regulations for the implementation of the Dietary Supplement Health and Education Act of 1994 (DSHEA) requirements for dietary supplement labeling were adopted.
The Company may be subject, from time to time, to additional laws or regulations administered by the FDA or other Federal, State or foreign regulatory authorities, or more stringent interpretations of current laws or regulations in the future. The Company is unable to predict the nature of such future laws, regulations, interpretations or applications, nor can it predict what effect additional governmental regulations or administrative orders, when and if promulgated, would have on its business in the future. They could, however, require the Company to: reformulate certain products to meet new standards; recall or discontinue certain products not able to be reformulated; expand documentation of the properties of certain products; expand or provide different labeling and scientific substantiation; or, impose additional recordkeeping requirements. Any or all such requirements could have a material adverse effect on the Company's results of operations and financial position.
ITEM 2.
ITEM 2. PROPERTIES
The Company's corporate and manufacturing facilities consist of approximately 123,000 square feet and are located in San Marcos and Vista, California. Of this space, the Company owns approximately 29,500 square feet and leases the remaining space. Approximately 68,000 square feet is used for production related activities, 35,000 square feet is used for warehousing, 5,000 square feet is used for laboratory and product development, and 15,000 square feet is used for offices.
In August 1997, the Company entered into a 15-year lease agreement under which the lessor was to construct a build-to-suit 82,000 square foot office and manufacturing facility in Carlsbad, California. In March 1999, the Company made the decision to sublease, and not occupy, the partially completed facility. In the third quarter of fiscal 1999, the Company recorded a $2.3 million charge for impairment of leasehold assets and an accrual of $2.7 million representing the present value of the excess of future lease payments over estimated sub-lease income. The Company is seeking tenants for the facility.
The Company entered into two new lease agreements during fiscal year 1999 for two adjacent buildings located in Vista, California. The facilities are leased from an unaffiliated third party and consist of a total of approximately 74,000 square feet. The lease for the first building commenced in August 1998 under a 5-year lease agreement and consists of approximately 54,000 square feet to be utilized as a warehousing and blending facility. The lease for the second building commenced in March 1999 under a 3.5-year lease agreement for the rental of approximately 20,000 square feet to be utilized as a warehouse and packaging facility. The consolidation of warehousing space is expected to increase operating efficiencies to allow the Company to meet demand for its products. The Company will continue to utilize its facilities in San Marcos for production.
PART I
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, after consultation with its legal counsel, the ultimate disposition of these matters will not have a material adverse effect on the Company's consolidated financial position, results of operations or liquidity.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock trades on the Nasdaq National Market tier of The Nasdaq Stock Market under the Symbol: NAII. The common stock of the Company had previously been traded on the American Stock Exchange (AMEX) since November 17, 1992, under the stock symbol NAI. The table below sets forth the high and low sales prices of the Company's stock for fiscal 1999 and 1998.
As of June 30, 1999, the approximate number of holders of common stock was 4,000.
The Company has never paid a dividend on its common stock. It is the Company's present policy to retain all earnings to provide funds for the future growth of the Company.
PART II
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
Five-Year Summary (Not Covered by Independent Auditors' Report) - --------------------------------------------------------------------------------
PART II
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Form 10-K contains certain "forward-looking statements" as such term is defined in the Private Securities Litigation Reform Act of 1995 or by the Securities and Exchange Commission in its rules, regulations and releases. These statements represent the Company's expectations or beliefs, including, but not limited to, statements concerning future financial and operating results, anticipated growth in revenues and profit margins, improvements in management personnel, the impact of European operations, and the utilization of inventories and facilities, statements concerning industry performance, the Company's operations, economic performance, financial condition, growth and acquisition strategies, margins and growth in sales of the Company's products. For this purpose, any statements contained in this Report that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the generality of the foregoing, words such as "may", "will", "expect", "believe", "anticipate", "intend", "could", "estimate" or "continue" or the negative or other variations thereof or comparable terminology are intended to identify forward-looking statements. These statements by their nature involve substantial risks and uncertainties, certain of which are beyond the Company's control, and actual results may differ materially depending on a variety of important factors, including uncertainty related to government regulation, the effect of adverse publicity, litigation, the centralized location of the Company's manufacturing operations, availability of raw materials, risks associated with international operations, competition, product liability claims, volatility of stock price and those factors described in this and other Company filings with the Securities and Exchange Commission.
RESULTS OF OPERATIONS
FISCAL 1999 COMPARED TO FISCAL 1998
Net sales decreased 15.4% or $10.5 million to $57.4 million in fiscal 1999 from $67.9 million in 1998. Management believes the decrease in sales is attributable to increased product and price competition in the nutritional supplement market as well as increased competition for new distributors. In addition, sales growth was negatively impacted by the reduction in market demand for several herbal products, resulting in depressed market prices. The Company expects competition to remain strong for the foreseeable future.
Sales of products by our customers into international markets increased 18.8% to $17.7 million in 1999 from $14.9 million in 1998. The increase is primarily the result of existing customers continued expansion into Asian and European markets through their international distribution channels. Management believes that the expansion into international markets should continue and net sales to these markets should increase as a percentage of total net sales.
For the year ended June 30, 1999, the Company experienced an increase in cost of goods sold, as a percentage of sales, to 78.4% compared to 72.4% for the prior year. The increase was primarily due to liquidation of excess or slow moving inventories at or below cost and inventory write-downs to net realizable values, caused by depressed market prices due to reduced industry demand. The increase in cost of goods sold resulted in a reduction of gross profit margins to 21.6% in fiscal 1999 compared to 27.6% in fiscal 1998.
Selling, general and administrative expenses increased as a percentage of net sales to 21.4% in 1999 from 13.4% in 1998, increasing in absolute dollars to $12.3 million in fiscal 1999 from $9.1 million in 1998. The percentage increase was due primarily to the fixed nature of selling, general and administrative expenses and the decrease in net sales as noted above. The increase in absolute dollars was due to: upgrades in systems and computers related to Y2K compliance; expenses related to management restructuring; and higher rents in connection with entering into additional leases for new blending, warehousing and packaging facilities. Additionally, professional fees increased because of increased activity in seeking additional manufacturing agreements.
(continued)
PART II
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
RESULTS OF OPERATIONS
FISCAL 1999 COMPARED TO FISCAL 1998 (continued)
The Company recorded charges related to a lease obligation of approximately $5,000,000 during the fiscal year ended June 30, 1999. The expense relates to the Company's decision to sublease, and not occupy, a partially completed office and manufacturing facility in Carlsbad, California. In the third quarter of fiscal 1999, the Company recorded a $2.3 million charge for impairment of leasehold assets and an accrual of $2.7 million representing the present value of the excess of future lease payments over estimated sub-lease income. The Company is seeking tenants for the facility.
The Company's loss from operations was approximately $4.9 million compared to income from operations of $9.6 million in 1998. This was due to an approximate $6.3 million decrease in gross profit, approximately $3.2 million increase in selling, general and administrative expenses, and the approximate $5 million provision for loss on lease obligation and other expense.
The Company incurred a net loss for fiscal 1999 of approximately $2.9 million compared to net income of $5.9 million in fiscal 1998. This loss was due to the reasons described above. Diluted loss per common share was ($.50) in fiscal 1999 compared to diluted earnings per common share of $1.00 in 1998.
FISCAL 1998 COMPARED TO FISCAL 1997
Net sales increased 37.3% or $18.5 million to $67.9 million in fiscal 1998. The Company added several new customers in the latter part of fiscal 1997 and sales to these and other new customers was the primary reason for the increase. A decrease in sales to certain existing customers was offset by increases in international sales to other existing customers through their international distribution channels.
Sales of products into international markets increased to $14.9 million in 1998 from $1.9 million in 1997. The increase was primarily the result of existing customers expanding into Asian and European markets.
Income from operations increased 430% to $9.6 million in 1998. This was due to a $8.3 million increase in gross profit offset by a $.5 million increase in selling, general and administrative expenses.
Gross profit margins were 27.6% and 21.1% in fiscal 1998 and 1997, respectively. The 1997 gross profit margin was substantially below historical margins because of the following factors: shifts in product sales mix toward lower profit margin products, rising costs of certain raw materials, increased costs for subcontracted packaging, change in ownership of a customer that resulted in a substantial write-off of packaging materials, and the write-off of raw materials that became obsolete because of customer discontinuance of certain products. The 1998 gross profit margin was slightly higher than historical margins experienced before 1997. The increase is principally due to negotiated raw material savings and improved manufacturing cost efficiencies.
Selling, general and administrative expenses decreased as a percentage of sales to 13.4% in 1998 from 17.4% in 1997, while increasing in absolute dollars to approximately $9.1 million in fiscal 1998 from $8.6 million in 1997. The majority of this increase in selling, general and administrative expenses is due to an increase in employee benefits expense which increased because the defined benefit pension plan adopted as of January 1, 1997 was in effect for a full year in 1998. Additionally, professional fees increased in part because of increased activity in the registration of foreign products. These increases in selling, general and administrative expenses were partially offset by a decline in bad debt expense, which was attributable to a related party customer write-off in fiscal 1997, and a decline in royalty expense because the Company's agreement with the United States Olympic Committee expired in March 1997.
Net other income (expense) was approximately $44,000 in fiscal 1998 compared approximately $25,000 in fiscal 1997.
PART II
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
FISCAL 1998 COMPARED TO FISCAL 1997 (continued)
Net earnings increased by 424% or $4.8 million to $5.9 million in fiscal 1998. This increase was due primarily to the reasons given above and was partially offset by a higher effective income tax rate. The higher effective income tax rate, from 39.1% in 1997 to 39.3% in 1998, was the result of a smaller investment credit applicable to California franchise taxes.
Diluted earnings per share increased 400% to $1.00 per share in 1998 from $.20 per share in 1997.
YEAR 2000 ISSUES
The year 2000 issue ("Year 2000 Issue") is the result of computer programs being written using two digits rather than four digits to represent the year and affects both information technology (IT) and non-IT systems. Thus, computer software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in system failures or miscalculations causing disruptions of operations, including among others, a temporary inability to process certain data or engage in similar normal business activities.
STATUS: The Company's plan to resolve the Year 2000 Issue involved four phases: assessment, remediation, testing and implementation. The Company completed its assessment of its IT systems and implemented its new computer software system during the fourth quarter of its 1999 fiscal year. The manufacturer represents this system as Year 2000 compliant. The Company also completed its assessment of non-IT systems, most of which are equipment used in production. Systems identified as not being Year 2000 compliant were brought into compliance by upgrading either the software or hardware. The Company fully implemented these upgrades by the end of its 1999 fiscal year. The Company has determined that its production equipment and alarm, heating, and air-conditioning systems will not be affected by the Year 2000.
The Company's computer staff has queried its significant suppliers, vendors and other outside parties and none of the responses received thus far have indicated any significant deficiencies. The Company will continue to monitor their Year 2000 compliance status, but has no means of ensuring that suppliers, vendors and other outside parties will be Year 2000 ready. The Company's most likely worst case scenario is the inability of suppliers, vendors and other outside parties (including the government) to complete their Year 2000 resolution process in a timely fashion, which could materially impact the Company. The effect of non-compliance by suppliers, vendors and outside parties is not determinable.
COSTS: The Company incurred approximately $1 million in costs, of which approximately $150,000 was charged directly to expense in the 1999 fiscal year to replace its financial and manufacturing software systems and to remediate or replace embedded microprocessors in its production equipment. The Company funded its costs from current funds available from operations. If, however, additional unanticipated costs are incurred, this could have a material adverse effect on the Company's business, results of operations and financial condition.
RISKS: While management of the Company believes it effectively implemented its program to resolve the Year 2000 Issue in a timely manner, as noted above, disruptions in the economy generally resulting from Year 2000 Issues could also materially adversely effect the Company. The Company is unable to estimate if it has any potential liability or potential lost revenue at this time. There can be no assurance that the Company will not discover Year 2000 compliance issues that will have a material adverse effect on the Company's business, results of operations and financial condition.
PART II
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
LIQUIDITY AND CAPITAL RESOURCES
The Company has historically met its working capital and capital expenditure requirements, including funding for expansion of operations, mainly through net cash provided by operating activities. In addition, the Company has utilized revolving lines of credit and equipment financing and leases. Management plans to pursue additional financing during its fiscal year 2000 to provide the resources necessary to meet currently anticipated funding requirements. There can be no assurance such financing will be available or if it is, on what terms, and if obtained, that it will be adequate to provide resources necessary to meet current requirements.
At June 30, 1999, the Company had working capital of $14,098,000 and borrowings available under revolving lines of credit of $3,000,000. As of June 30, 1999, there were no borrowings under these lines.
In 1999, net cash provided by operating activities was approximately $3,148,000 compared to approximately $3,330,000 for 1998. The net loss was offset by the cumulative effect of a provision for loss on a lease obligation, a decrease in accounts receivable, and a decrease in inventories less the cumulative effect of an increase in deferred income taxes, an increase in tax refund receivable, and a decrease in accounts payable. Current maturities of long-term debt amounted to $50,000, which the Company expects to pay out of working capital.
The Company has revolving lines of credit permitting borrowings up to $3,000,000, which are secured by the Company's receivables, inventory, equipment, and vehicles and bear interest at the bank's prime rate. These agreements contain financial covenants concerning limitations on maintenance of debt, certain financial ratios and other matters. The lines of credit expire on January 19, 2000; management expects such lines to be renewed in the normal course of business. The Company received a waiver for certain debt covenants for which it was not compliant as of June 30, 1999.
Capital expenditures for 1999 amounted to approximately $5.7 million. These expenditures relate to building improvements for the Company's new warehouse and blending facility, the purchase of production and packaging equipment to expand the Company's output capacity, and leasehold improvements in the Carlsbad facility, which were written off in the third quarter. The Company anticipates capital expenditures of approximately $5.4 million during fiscal 2000. These expenditures are expected to be paid from a combination of cash holdings, net cash provided by operating activities in fiscal 2000, borrowings under the Company's lines of credit with its bank, and anticipated additional financings. If these financing alternatives become unavailable, the Company may be required to defer or restrict certain commercial activities or delay or eliminate expenditures for certain of its potential products and/or markets.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1999, the Company adopted Statement of Financial Accounting Standards No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits." This Statement standardizes the disclosure requirements for pensions and other postretirement benefits, requires additional information on changes in the benefit obligations and fair values of plan assets and eliminates certain disclosures. Prior years have been restated to conform to the new standard.
In fiscal 1999, the Company adopted Statements of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130") and No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("SFAS 131"). SFAS 130 establishes standards for the reporting and display of comprehensive income and its components in the financial statements. SFAS 131 establishes standards for the manner in which public business enterprises report information about operating segments and also establishes standards for related disclosures about products and services, geographic areas, and major customers.
PART II
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
NEW ACCOUNTING PRONOUNCEMENTS (continued)
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." The Statement establishes accounting and reporting standards requiring that derivative instruments be recorded in the balance sheet as either an asset or liability measured at its fair value and that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. SFAS No. 133, as amended, is effective for fiscal years beginning after June 15, 2000. The adoption of this Statement will not have a material effect on the Company's consolidated financial statements as the Company does not currently hold any derivative or hedging instruments.
In April, 1998, the American Institute of Certified Public Accountants issued Statement of Position ("SOP") 98-5, "Reporting on the Cost of Start-up Activities." This Statement requires that all start-up activities, including organizational costs, be expensed as incurred. The Company adopted SOP 98-5 for the year ended June 30, 1999. The effects of adopting this SOP did not have a material impact on consolidated financial position, results of operations or liquidity.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to risks relating to changes in interest rates and stock market fluctuations. At June 30, 1999, the Company maintains a portion of its cash and cash equivalents in financial instruments with original maturities of three months or less. These financial instruments, principally comprised of government backed money market funds, are subject to interest rate risk and will decline in value if interest rates increase. The Company also maintains a short-term investment portfolio containing common stocks that are subject to market risk. The Company has not used derivative financial instruments in its investment portfolio. The Company believes that its investment in market-risk-sensitive instruments is not material.
Market rate risk related to Long Term Debt is diminimus due to the fixed interest rate and fixed payment structure of the debt.
RISK FACTORS
GOVERNMENT REGULATION
The manufacturing, processing, formulation, packaging, labeling and advertising of the Company's products are subject to regulation by one or more federal agencies, including the United States Food and Drug Administration ("FDA"), the Federal Trade Commission ("FTC"), the Consumer Product Safety Commission, the United States Department of Agriculture, the United States Postal Service, the United States Environmental Protection Agency and the Occupational Safety and Health Administration. These activities are also regulated by various agencies of the states and localities in which the Company's products are sold. In particular, the FDA regulates the safety, labeling and distribution of dietary supplements, including vitamins, minerals, herbs food, OTC and prescription drugs and cosmetics. The regulations that are promulgated by the FDA relating to the manufacturing process are known as food products. In addition, the FTC has overlapping jurisdiction with the FDA to regulate the labeling, promotion and advertising of vitamins, OTC drugs, cosmetics and foods.
The Dietary Supplement Health and Education Act of 1994 ("DSHEA") was enacted on October 25, 1994. DSHEA amends the Federal Food, Drug and Cosmetic Act by defining dietary supplements which include vitamins, minerals, nutritional supplements and herbs, as a new category of food separate from conventional food. DSHEA provides a regulatory framework to ensure safe, quality dietary supplements and the dissemination of accurate information about such products. Under DSHEA, the FDA is generally prohibited from regulating the active ingredients in dietary supplements as drugs unless product claims, such as claims that a product may heal, mitigate, cure or prevent an illness, disease or malady, trigger drug status.
PART II
RISK FACTORS (continued)
DSHEA provides for specific nutritional labeling requirements for dietary supplements and the FDA's final regulations require that all dietary supplements must be labeled in compliance with the regulations by no later than March 23, 1999. DSHEA permits substantiated, truthful and non-misleading statements of nutritional support to be made in labeling, such as statements describing general well-being resulting from consumption of a dietary ingredient or the role of a nutrient or dietary ingredient in affecting or maintaining a structure or function of the body. The Company anticipates the FDA will finalize CGMPs that are specific to dietary supplements and require at least some of the quality control provisions contained in the CGMPs for drugs. The Company currently manufactures its vitamins and nutritional supplement products in compliance with the applicable food CGMPs.
The FDA has finalized some of its regulations, including those relating to nutritional labeling requirements. The FDA also has under development additional regulations to implement DSHEA. Final labeling regulations may require expanded or different labeling for the Company's vitamin and nutritional products. The Company cannot determine what effect such regulations, when fully implemented, will have on its business in the future. Such regulations could, among other things, require the recall, reformulation or discontinuance of certain products, additional recordkeeping, warnings, notification procedures and expanded documentation of the properties of certain products or scientific substantiation regarding ingredients, product claims, safety or efficacy. Failure to comply with applicable FDA requirements can result in sanctions being imposed on the Company or the manufacturers of its products, including warning letters, fines, product recalls and seizures.
Governmental regulations in foreign countries where the Company plans to commence or expand sales may prevent or delay entry into a market or prevent or delay the introduction, or require the reformulation of, certain of the Company's products. In addition, the Company cannot predict whether new domestic or foreign legislation regulating its activities will be enacted. Such new legislation could have a material adverse effect on the Company.
EFFECT OF ADVERSE PUBLICITY
The Company's products consist of vitamins, minerals, herbs and other ingredients that the Company regards as safe when taken as suggested by the Company. In addition, various scientific studies have suggested the ingredients in some of the Company's products may involve health benefits. The Company believes the growth in the vitamin product business of the last several years may be based on material media attention and various scientific research suggesting potential health benefits for the consumption of certain vitamin products. The Company is highly dependent upon its customers' and consumers' perception of the overall integrity of its business, as well as the safety and quality of its products and similar products distributed by other companies which may not adhere to the same quality standards as the Company. The Company could be adversely affected if any of the Company's products or any similar products distributed by other companies should prove or be asserted to be harmful to consumers or should scientific studies provide unfavorable findings regarding the effectiveness of products similar to those produced by the Company.
CENTRALIZED LOCATION OF MANUFACTURING OPERATIONS
The Company currently manufactures the vast majority of its products at its manufacturing facilities in San Marcos, California. Accordingly, any event resulting in the slowdown or stoppage of the Company's manufacturing operations or distribution facilities in San Marcos could have a material adverse effect on the Company. The Company maintains business interruption insurance. There can be no assurance, however, that such insurance will continue to be available at a reasonable cost or, if available, will be adequate to cover any losses that may be incurred from an interruption in the Company's manufacturing and distribution operations.
PART II
RISK FACTORS (continued)
RELIANCE ON CERTAIN CUSTOMERS AND CERTAIN PRODUCTS
In fiscal 1999, NuSkin International, NSA International and Pharmavite accounted for approximately 71% of the Company's sales. Each of the Company's other major customers accounted for less than 10% of the Company's sales for fiscal 1999. If one or more of the Company's major customers substantially reduced their volume of purchases from the Company, or if consumer's purchases of vitamins were substantially reduced, the Company's results of operations could be materially adversely affected.
DISTRIBUTION AND MANAGEMENT OF OPERATIONS
In fiscal 1999, the Company leased and initiated development of two additional facilities comprising 74,000 square feet in Vista, California, to be used as warehousing, mixing, blending and packaging facilities. The Company also elected to sublease and not occupy an 82,000 square foot building in Carlsbad, California, developed specifically for the Company. In addition, the Company organized a European subsidiary that leased and developed a 15,000 square foot manufacturing facility in Lugano, Switzerland. During fiscal 1999, the Company also implemented an entirely new software system to manage its materials and manufacturing operations. While the Company believes that these activities will increase the Company's manufacturing and distribution capabilities, there can be no assurance the expected operating improvements will be realized or that these efforts will result in improved sales profit margins or earnings. A significant, unexpected disruption during the implementation of these systems and facilities could have a material adverse effect on the Company's results of operations.
POTENTIAL FOR INCREASED COMPETITION
The market for the Company's products is highly competitive. The Company competes with other vitamin product and OTC pharmaceuticals manufacturers. Among other factors, competition among these manufacturers is based upon price. If one or more manufacturers significantly reduce their prices in an effort to gain market share, the Company's results of operations or market position could be adversely affected. Certain of the Company's competitors, particularly manufacturers of nationally advertised brand name products, are larger and have resources substantially greater than those of the Company. Much speculation has also been made about the potential for increased participation in these markets by major international pharmaceutical companies. In the future, one or more of these companies could seek to compete more directly with the Company by manufacturing and distributing their own or others products or by significantly lowering the prices of their national brand products.
The Company sells substantially all of its vitamin products to customers who sell and distribute the products. Although the Company does not currently participate significantly in other channels such as health food stores, direct mail, internet sales and direct sales, the Company may expand its operations and its products may face competition from such alternative channels as more customers utilize these channels of distribution to obtain vitamin products.
RELIANCE ON CERTAIN SUPPLIERS; AVAILABILITY AND COST OF PURCHASED MATERIALS
The Company purchases from third party suppliers raw materials and certain products that the Company does not manufacture. Although the Company currently has supply arrangements with several suppliers of these ingredients and products, and the Company's purchased materials are generally available from numerous sources, an unexpected interruption of supply could materially adversely affect the Company's results of operations.
PART II
RISK FACTORS (continued)
EXPOSURE TO PRODUCT LIABILITY CLAIMS
The Company, like other retailers, distributors and manufacturers of products that are ingested, faces a risk of exposure to product liability claims in the event that, among other things, the use of its products results in injury. The Company maintains product liability coverage in the amount of $25 million, including primary product liability and excess liability coverage with deductibles of $25,000 per claim. There can be no assurance product liability insurance will continue to be available at an economically reasonable cost or that the Company's insurance will be adequate to cover liability the Company incurs in respect to product liability claims. See also "Item 3. Legal Proceedings and Product Liability."
RELIANCE ON KEY MANAGEMENT
The operation of the Company requires managerial and operational expertise. The Company does not have long term employment contracts with any of its executives. If, for any reason, key personnel do not continue to be active in the Company management, operations could be adversely affected.
RISKS ASSOCIATED WITH INTERNATIONAL MARKETS
The Company's growth may be dependent in part upon its ability to expand its operations and those of its customers into new markets, including international markets. The Company may experience difficulty entering new international markets due to greater regulatory barriers, the necessity of adapting to new regulatory systems and problems related to entering new markets with different cultural bases and political systems. Operating in international markets exposes the Company to certain risks, including, among other things, (1) changes in or interpretations of foreign import, currency transfer and other restrictions and regulations that among other things may limit the Company's ability to sell certain products or repatriate profits to the United States, (2) exposure to currency fluctuations, (3) the potential imposition of trade or foreign exchange restrictions or increased tariffs, and (4) economic and political instability. As the Company continues to expand its international operations, these and other risks associated with international operations are likely to increase.
LITIGATION INVOLVING PRODUCTS CONTAINING CERTAIN RAW MATERIALS
There can be no assurance that the Company will not be named in actions in the future seeking damages for alleged personal injuries resulting from the ingestion of certain products, and result in the Company becoming a defendant in multiple actions and such an event could have a material adverse impact on the Company.
CONCENTRATION OF OWNERSHIP; CERTAIN ANTI-TAKEOVER CONSIDERATIONS
The Company's directors and executive officers beneficially own approximately 27% of the outstanding Common Stock. Accordingly, these shareholders will continue to have the ability to substantially influence the management, policies and business operations of the Company. The Company's Board of Directors has the authority to approve the issuance of 5,000,000 shares of preferred stock and to fix the rights, preferences, privileges and restrictions, including voting rights, of those shares without any further vote or action by the Company's shareholders. The rights of the holders of Common Stock will be subject to, and may be adversely affected by, the rights of holders of any preferred stock that may be issued in the future. Certain provisions of Delaware law, as well as the issuance of preferred stock, and other "anti-takeover" provisions in the Company's Articles and Bylaws, could delay or inhibit the removal of incumbent directors and could delay, defer, make more difficult or prevent a merger, tender offer or proxy contest, or any change in control involving the Company, as well as the removal of management, even if such events would be beneficial to the interests of the Company's shareholders, and may limit the price certain investors may be willing to pay in the future for shares of Common Stock.
PART II
RISK FACTORS (continued)
VOLATILITY OF STOCK PRICE
The Company's stock price has experienced significant volatility over the past two fiscal years. Moreover, the stock market has from time to time experienced extreme price and volume fluctuations that may be unrelated to the operating performance of particular companies. Market conditions in the vitamin and nutritional supplement industry and factors such as announcements of new products by the Company, its competitors or third parties, and changes in earnings estimates by analysts, may have a significant effect on the price of the Common Stock.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary data as required by this item are set forth on pages 19 through 43.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item is included under the caption "Directors and Executive Officers of the Registrant" in the Registrant's Proxy Statement for the 1999 Annual Meeting of Stockholders and is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is included under the caption "Executive Compensation" in the Registrant's Proxy Statement for the 1999 Annual Meeting of Stockholders and is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is included under the caption "Security Ownership of Certain Beneficial Owners and Management" in the Registrant's Proxy Statement for the 1999 Annual Meeting of Stockholders and is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is included under the caption "Certain Relationships and Related Transactions" in the Registrant's Proxy Statement for the 1999 Annual Meeting of Stockholders and is incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. FINANCIAL STATEMENTS
The financial statements listed in the accompanying index to consolidated financial statements are filed as part of this report.
2. FINANCIAL STATEMENT SCHEDULES
The financial statement schedule listed in the accompanying index to the consolidated financial statements is filed as part of this annual report. Schedules not included have been omitted because they are not applicable or the information required is included in the financial statements and notes thereto.
(b) EXHIBITS
Exhibit 23 Re: Consent of KPMG LLP Exhibit 27 Financial Data Schedule
(c) REPORTS FORM 8-K
Not Applicable
NATURAL ALTERNATIVES INTERNATIONAL, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE JUNE 30, 1999
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders NATURAL ALTERNATIVES INTERNATIONAL, INC.:
We have audited the consolidated financial statements of Natural Alternatives International, Inc. and subsidiaries as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we have also audited the financial statement schedule as listed in the accompanying index. These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Natural Alternatives International, Inc. and subsidiaries as of June 30, 1999 and 1998, and the consolidated results of their operations and their cash flows for each of the years in the three-year period ended June 30, 1999, in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
KPMG LLP
San Diego, California September 10, 1999
NATURAL ALTERNATIVES INTERNATIONAL, INC. CONSOLIDATED BALANCE SHEETS JUNE 30, 1999 AND 1998
ASSETS
(continued)
NATURAL ALTERNATIVES INTERNATIONAL, INC. CONSOLIDATED BALANCE SHEETS (continued) JUNE 30, 1999 AND 1998
LIABILITIES AND STOCKHOLDERS' EQUITY
See accompanying notes to consolidated financial statements.
NATURAL ALTERNATIVES INTERNATIONAL, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED JUNE 30, 1999, 1998 AND 1997
See accompanying notes to consolidated financial statements.
NATURAL ALTERNATIVES INTERNATIONAL, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED JUNE 30, 1999, 1998 AND 1997
See accompanying notes to consolidated financial statements.
NATURAL ALTERNATIVES INTERNATIONAL, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (continued) FOR THE YEARS ENDED JUNE 30, 1999, 1998 AND 1997
(continued)
See accompanying notes to consolidated financial statements.
NATURAL ALTERNATIVES INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
Natural Alternatives International, Inc., (the Company) manufactures vitamins, micronutrients and related nutritional supplements, and provides innovative private-label products for specialized corporate, institutional and commercial accounts worldwide. The Company operates as a single business segment.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiary, NAIE Natural Alternatives International Europe, SA. All significant intercompany accounts and transactions have been eliminated.
Cash and Cash Equivalents
The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. The carrying amount reported in the balance sheet for cash and cash equivalents approximates its fair value.
Inventories
Inventories are recorded at the lower of cost (first-in, first-out) or market (net realizable value). Such costs include raw materials, labor and production overhead.
Property and Equipment
Property and equipment are stated at cost. Property and equipment under capital leases are recorded at the lower of fair market value or the present value of future minimum lease payments and are amortized using the straight-line method over the shorter of the estimated useful life of the asset or the lease term. Depreciation of property and equipment is provided using the straight-line method over their estimated useful lives, generally ranging from 3 to 39 years. Leasehold improvements are amortized using the straight-line method over the shorter of the life of the improvement or the remaining term of the lease. Maintenance and repairs are expensed as incurred. Significant expenditures that increase useful lives are capitalized.
Impairment of Long-Lived Assets
The Company accounts for its long-lived assets in accordance with SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. This Statement requires that long-lived assets and certain identifiable intangibles be reviewed 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 net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceed the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. In 1999, the Company recorded a $2.3 million charge for the impairment of certain assets. See Note L for discussion.
(continued
NATURAL ALTERNATIVES INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Investments
The Company accounts for its investments in accordance with Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities." The Company's investments, which consist of equity securities, are classified as available for sale and are carried at fair value, with unrealized gains and losses excluded from net earnings and included in Accumulated Other Comprehensive Loss.
Revenue Recognition
Revenue from sales of product, and related cost of products sold, is recognized upon shipment of product at which time title passes to the customer. Customers generally do not have the right to return product unless damaged or defective.
Cost of Goods Sold
Cost of goods sold includes raw material, labor and overhead.
Marketing Costs
In order to attract and retain its customer base, the Company provides a wide range of marketing services to its customers. The Company does not generate fees or revenues from these services and the related costs are expensed as incurred.
Income Taxes
The Company accounts for income taxes using the asset and liability method in accordance with SFAS No. 109 "Accounting for Income Taxes." Under this 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 operations in the period that includes the enactment date.
Stock Option Plans
The Company accounts for its stock-based employee compensation for stock options using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees", and related interpretations, as allowed under SFAS 123. Accordingly, compensation cost is measured as the excess, if any, of the fair value of the Company's stock at the date of the grant over the price the employee must pay to acquire the stock.
Fair Value of Financial Instruments
The carrying amounts of certain of the Company's financial instruments, including cash and cash equivalents, accounts receivable, notes receivable, investments, and accounts approximates fair value due to the relatively short maturity of such instruments. The carrying amounts for long-term debt approximate fair value as the interest rates and terms are substantially similar to rates and terms that could be obtained currently for similar instruments.
(continued
NATURAL ALTERNATIVES INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Use of Estimates
Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities, revenue and expenses, and the disclosure of contingent assets and liabilities to prepare these consolidated financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates.
Net Earnings (Loss) per Share
The Company computes net earnings (loss) per share in accordance with Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS 128"). This statement requires the presentation of basic earnings (loss) per share, computed using the weighted average number of shares outstanding during the period, and diluted earnings (loss) per share, computed using the additional dilutive effect of all dilutive securities. The dilutive impact of stock options account for the additional weighted average shares of common stock outstanding for the Company's diluted earnings (loss) per share computation. Basic and diluted earnings (loss) per share have been calculated as follows:
Options totaling 142,147 shares were excluded from the calculation of diluted earnings (loss) per share for the year ended June 30, 1999 as the effect of their inclusion would be anti-dilutive.
(continued)
NATURAL ALTERNATIVES INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Concentrations of Credit Risk
Financial instruments that subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents and accounts receivable. The Company places its cash and cash equivalents with highly rated financial institutions. Credit risk with respect to receivables is concentrated with the Company's three largest customers (see Note M). These three customers' receivable balances collectively represent 55% of gross accounts receivable at June 30, 1999 and 57% at June 30, 1998. Concentrations of credit risk related to the remaining accounts receivable balance are limited due to the number of customers comprising the Company's remaining customer base.
Reclassifications
Certain amounts in prior years' consolidated financial statements have been reclassified to conform to the 1999 presentation.
B. INTERNATIONAL SUBSIDIARY
On January 22, 1999, NAIE Natural Alternatives International Europe, SA was incorporated as a wholly-owned subsidiary of the Company, which is based in Switzerland. Operations are expected to commence in the first quarter of fiscal 2000.
C. INVENTORIES
Inventories are comprised of the following at June 30:
NATURAL ALTERNATIVES INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
D. PROPERTY AND EQUIPMENT
The following is a summary of property and equipment at June 30:
At June 30, 1998 accumulated depreciation and amortization includes $477,532 of amortization of equipment under capital leases.
E. INVESTMENTS
Investments consist of marketable securities. Securities held at June 30, 1999 and 1998 are considered "available for sale securities." Securities are valued at $383,515 and $61,971 as of June 30, 1999 and 1998. The security portfolio includes gross unrealized losses, net of tax, of $59,564 and $48,141 at June 30, 1999 and 1998.
F. LINE OF CREDIT AGREEMENTS
The Company has revolving lines of credit agreements permitting borrowings up to $3,000,000, which are secured by the Company's receivables, inventories, equipment, and vehicles and bear interest at the bank's prime rate, which was 7.75% at June 30, 1999. Advances against the revolving lines of credit cannot exceed 70% of eligible receivables. These agreements contain financial covenants concerning limitations on maintenance of debt, certain financial ratios and other matters. The lines of credit expire on January 19, 2000; management expects such lines to be renewed in the normal course of business. There were no amounts outstanding under these credit agreements at June 30, 1999 and 1998, respectively. The Company received a waiver for certain debt covenants for which it was not compliant as of June 30, 1999.
NATURAL ALTERNATIVES INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
G. LONG-TERM DEBT
Long-term debt consisted of the following as of June 30:
Aggregate amounts of long-term debt maturities as of June 30, 1999 are as follows:
H. CAPITAL LEASE OBLIGATION
The Company leased certain equipment under a capital lease, which expired in fiscal year 1999. The present value of the future minimum capital lease payments as of June 30 are as follows:
NATURAL ALTERNATIVES INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
I. INCOME TAXES
Income taxes (benefit) for the year ended June 30 consist of the following:
The provision (benefit) for deferred income taxes for the year ended June 30 consists of the following:
NATURAL ALTERNATIVES INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
I. INCOME TAXES (continued)
Net deferred tax assets and deferred tax liabilities as of June 30 are as follows:
The valuation allowance for deferred tax assets was $36,000 at June 30, 1999 and 1998. 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. Management considers, among other things, the scheduled reversal of deferred tax liabilities, projected future taxable income, and other planning strategies. In making this assessment, management believes it is more likely than not that the Company will realize the benefit of the deferred tax asset, net of the existing valuation allowance, at June 30, 1999 and 1998.
(continued)
NATURAL ALTERNATIVES INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
I. INCOME TAXES (continued)
A reconciliation of income taxes computed by applying the statutory federal income tax rate of 34% to earnings before income taxes for the year ended June 30 is as follows:
J. EMPLOYEE BENEFIT PLANS
The Company has a profit sharing plan pursuant to Section 401(k) of the Internal Revenue Code, whereby participants may contribute a percentage of compensation, but not in excess of the maximum allowed under the Code. All employees with twelve months and at least one thousand hours of service during the twelve-month period are eligible to participate in the plan. The Company may make contributions at the discretion of its Board of Directors. The Company contributed and expensed $167,218, $146,277, and $114,206 in 1999, 1998 and 1997, respectively.
The Company has a "Cafeteria Plan" pursuant to Section 125 of the Internal Revenue Code, whereby health care benefits are provided for active employees through insurance companies. Substantially all active full-time employees are eligible for these benefits. The Company recognizes the cost of providing these benefits by expensing the annual premiums, which are based on benefits paid during the year. The premiums expensed for these benefits totaled $365,613, $241,815, and $228,805 for 1999, 1998 and 1997, respectively.
The Company sponsors a defined benefit pension plan (the "Plan"), which provides retirement benefits to employees based generally on years of service and compensation during the last five years before retirement. Effective June 21, 1999, the Company adopted an amendment to freeze benefit accruals of the participants of the Plan, resulting in the recognition of $97,606 of net curtailment gains in 1999. The gain resulted from the net decrease of the Company's benefit obligation. At June 30, 1999, the estimated amortized portion of the unfunded estimated accrued liability for prior service cost, using a 30-year funding period, amounted to $410,048. This amount has been accrued in the current period. The Company's policy is to fund the net pension cost accrued. However, the Company would not contribute an amount less than the minimum funding requirements of the Employee Retirement Income Security Act of 1974 or more than the maximum tax-deductible amount.
(continued)
NATURAL ALTERNATIVES INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
J. EMPLOYEE BENEFIT PLANS (continued)
Disclosure of Funded Status
The following table sets forth the Plan's funded status and amount recognized in the Company's consolidated balance sheets at June 30, after the effect of curtailment:
(continued)
NATURAL ALTERNATIVES INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
J. EMPLOYEE BENEFIT PLANS (continued)
Net Periodic Benefit Cost
The Net Periodic Benefit Cost for the fiscal years ending June 30 includes the following components:
Assumption and Method Disclosures
K. STOCKHOLDERS' EQUITY
Treasury Stock
In February 1999, the Board of Directors approved a repurchase program of up to 500,000 shares of the Company's common stock. As of June 30, 1999, 199,500 shares had been repurchased under this repurchase approval. In addition, the Company repurchased 13,000 from an officer of the Company, bringing the aggregate amount of repurchases to 212,500 shares of common stock for a total, net of broker fees, of $1,116,250.
Employee Stock Option Plans
Effective June 5, 1992, the Company adopted the 1992 Incentive Stock Option Plan for which 500,000 common shares have been reserved for issuance to officers, directors, and key employees of the Company. The plan provides that no option may be granted at an exercise price less than the fair market value of the common stock of the Company on the date of grant. On September 9, 1993, 200,000 options were granted with an exercise price equal to the fair market value price of $4.875 per share. On January 21, 1998, 300,000 options were granted with an exercise price equal to the fair market value price of $10.50 per share. During 1999, 188,250 of these options were forfeited, and on May 10, 1999 an additional 70,000 options were granted with an exercise price equal to the fair market value price of $3.78 per share.
(continued)
NATURAL ALTERNATIVES INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
K. STOCKHOLDERS' EQUITY (continued)
Also effective June 5, 1992, the Company adopted the 1992 Nonqualified Stock Option Plan and reserved a total of 250,000 common shares for issuance to officers, employees, and consultants of the Company. On September 9, 1993, 250,000 options were granted with an exercise price equal to the fair market value price of $4.875 per share. All remaining options under this plan were exercised as of June 30, 1999.
Effective December 9, 1994, the Board of Directors approved the 1994 Nonqualified Stock Option Plan for which 500,000 common shares were reserved for issuance to officers, employees, and consultants of the Company. On January 24, 1995, 500,000 options were granted with an exercise price equal to the fair market value price of $4.625 per share. During fiscal 1999, 125,000 of the unexercised options were forfeited.
All stock options under each of the plans have five-year terms and all options become fully vested within three years of their grant date.
Stock option activity during the periods indicated is summarized below:
The fair value of the option grants was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions for fiscal 1999: risk-free interest rate equal to 5.90% at the grant date; dividend yield of zero; expected life of three years; and volatility of 62.1%. The weighted average fair value of options granted during fiscal year 1999 was $1.74. The assumptions used for fiscal 1998 are as follows: risk-free interest rate equal to 5.33% at the grant date; dividend yield of zero; expected life of three years; and volatility of 53.4%. The weighted average fair value of options granted during fiscal year 1998 was $4.27.
(continued)
NATURAL ALTERNATIVES INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
K. STOCKHOLDERS' EQUITY (continued)
On May 10, 1999, the Board of Directors adopted the 1999 Omnibus Equity Incentive Plan ("1999 Plan") and reserved for issuance thereunder 500,000 shares of common stock for officers, directors, employees and consultants of the Company. The 1999 Plan is subject to shareholder approval which is currently scheduled to be requested at the Annual Meeting of Shareholders on December 6, 1999. No options have been granted under the 1999 Plan.
The Company applies APB Opinion No. 25 in accounting for its Plans and, accordingly, no compensation cost has been recognized for its stock option grants to employees in the financial statements. Had the Company determined compensation cost based on the fair value at the grant date for its stock options under SFAS No. 123, the Company's net earnings (loss) would have been the pro forma amounts indicated below:
Proforma net earnings (loss) reflect only options granted in fiscal years 1999 and 1998 as there were no options granted by the Company during fiscal year 1997 or 1996. The full impact of calculating compensation cost for stock options under Statement No. 123 is not reflected in the proforma net earnings (loss) amounts presented above because compensation cost is reflected over the options' vesting period and compensation cost for options granted prior to July 1, 1995 is not considered.
Other Stock Options
On January 24, 1995, the Board of Directors granted 100,000 options with an exercise price of $4.625 in exchange for consulting services and reserved 100,000 common shares. The options were exercised in January 1999.
On March 14, 1997, 45,000 options were granted pursuant to a consulting agreement at prices ranging from $9.00 to $15.00 per share. Consulting expense incurred as a result of these options was $84,000 for the year ended June 30, 1997. None of the options were exercised and all had expired as of June 30, 1999.
L. COMMITMENTS AND RELATED PARTY TRANSACTIONS
The Company leases part of its main facilities under leases that are classified as noncancelable operating leases. In August 1997, the Company entered into a 15-year lease agreement under which the lessor was to construct a build-to-suit office and manufacturing facility in Carlsbad, California. Monthly lease payments commenced in November, 1998, at $103,000 per month and are subject to annual inflation adjustments. In March 1999, the Company made the decision to sublease, and not occupy, the partially completed facility. In the third quarter of 1999, the Company recorded a $2.3 million charge for impairment of leasehold assets and an accrual of $2.7 million representing the present value of the excess of future lease payments over estimated sub-lease income. The Company has an option to acquire the facility during the sixth year of the lease.
(continued)
NATURAL ALTERNATIVES INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
L. COMMITMENTS AND RELATED PARTY TRANSACTIONS (continued)
The Company entered into two lease agreements during fiscal year 1999 for adjacent buildings located in Vista, California. The facilities are leased from an unaffiliated third party and consist of a total of approximately 74,000 square feet. The lease for the first building commenced in August 1998 under a 5-year lease agreement and consists of approximately 54,000 square feet to be utilized as a warehousing and blending facility. The lease for the second building commenced in March 1999 under a 3.5-year lease agreement for the rental of approximately 20,000 square feet to be utilized as a packaging facility.
Minimum rental commitments (exclusive of property tax, insurance and maintenance) under all noncancelable operating leases, including the leases agreements referred to above, (with initial or remaining lease terms in excess of one year) are set forth below:
Rental expense totaled $419,254, $193,018, and $169,079 for the years ended June 30, 1999, 1998 and 1997, respectively.
During 1997, the Company had sales of $14,812 to a company in which a key employee and beneficial owner of 1% of the stock of the Company was formerly the president and part owner. At June 30, 1997, the amount receivable from this company was $775,302, which was fully reserved because the Company had determined the account to be doubtful of collection. The Company recovered $263,400 in the year ended June 30, 1998 and $511,902 was written off in the year ended June 30, 1999.
The Company entered into an agreement with the father-in-law and mother-in-law of the Chief Executive Officer of the Company in December 1991, which provides commissions on sales to a particular customer. The agreement will expire in December 2001. The commission equals 5% of sales, and is capped at $25,000 per calendar quarter, effective January 1, 1993. Amounts paid under this agreement were $100,000 for each of the years ended June 30, 1999, 1998 and 1997. There were no amounts owed under the agreement at June 30, 1999 or 1998.
During fiscal year 1993, the Company entered into an agreement with an unrelated party that required future minimum royalty payments over the term of the contract, which expired December 31, 1996. Amounts paid under this agreement were $154,728 for the year ended June 30, 1997.
Included in notes receivable are notes with the Chief Executive Officer, the Vice President of Science and Technology, the Vice President of Marketing, Business Development and Strategic Management, and the Vice President of Operations. During fiscal 1999, the Company made 6% interest-bearing loans, which are secured by Company stock, for $20,000 each to the Vice President of Science and Technology, the Vice President of Marketing, Business Development and Strategic Management, and the Vice President of Operations. The balances of these notes as of June 30, including accrued interest, are shown below:
(continued)
NATURAL ALTERNATIVES INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
L. COMMITMENTS AND RELATED PARTY TRANSACTIONS (continued)
In addition, during the year ended June 30, 1999, the Company made a 5-1/2% interest-bearing loan to the Executive Vice President in the amount of $250,000. The loan, including accrued interest, was repaid in February 1999.
During the year ended June 30, 1999, the Company made noninterest-bearing loans to the Chairman of the Board and the former President in the amount of $50,000 and $6,901, respectively. Amounts owed on these loans, which are secured by proceeds from life insurance policies on their respective lives, were $250,000 and $200,000 for the Chairman of the Board and $0 and $82,815 for the former President at June 30, 1999 and 1998, respectively.
M. ECONOMIC DEPENDENCY
The Company had substantial sales to four separate customers during one or more of the periods shown in the following table. The loss of any of these customers could have an adverse impact on the Company's revenues and earnings in the short-term. Sales by customer, representing 10% or more of the respective year's total sales, are shown below:
(a) Percent of total sales (b) Sales for the year were less than 10% of total sales.
Accounts receivable from these customers totaled $4,396,947 and $7,834,849 at June 30, 1999 and 1998, respectively.
N. CONTINGENCIES
The Company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, based in part on the advice of counsel, the ultimate disposition of these matters will not have a material adverse effect on the Company's consolidated financial position, results of operations or liquidity.
NATURAL ALTERNATIVES INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
O. QUARTERLY DATA (unaudited)
The following is a summary of unaudited quarterly data:
SCHEDULE II
NATURAL ALTERNATIVES INTERNATIONAL, INC. VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED JUNE 30, 1999, 1998 AND 1997
(*) Accounts written off
See accompanying independent auditors report.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
NATURAL ALTERNATIVES INTERNATIONAL, INC. (Registrant)
Date: September 27, 1999 By: /s/ Mark A. Ledoux ---------------------------------------- (Mark A. LeDoux, Chief Executive Officer, President and Assistant Treasurer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.