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NUTR > SEC Filings for NUTR > Form 10-K on 21-Nov-2012All Recent SEC Filings

Show all filings for NUTRACEUTICAL INTERNATIONAL CORP

Form 10-K for NUTRACEUTICAL INTERNATIONAL CORP


21-Nov-2012

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our audited Consolidated Financial Statements and accompanying notes thereto included elsewhere in this Annual Report on Form 10-K.

Overview

We are an integrated manufacturer, marketer, distributor and retailer of branded nutritional supplements and other natural products sold primarily to and through domestic health and natural food stores. Internationally, we market and distribute branded nutritional supplements and other natural products to and through health and natural product distributors and retailers. Our core business strategy is to acquire, integrate and operate businesses in the natural products industry that manufacture, market and distribute branded nutritional supplements. We believe that the consolidation and integration of these acquired businesses provides ongoing financial synergies through increased scale and market penetration, as well as strengthened customer relationships.

We manufacture and sell nutritional supplements and other natural products under numerous brands including Solaray®, KAL®, Nature's Life®, LifeTime®, Natural Balance®, bioAllers®, Herbs for Kids™, NaturalCare®, Health from the Sun®, Life-flo®, Organix South®, Pioneer® and Monarch Nutraceuticals™.

We own neighborhood natural food markets, which operate under the trade names The Real Food Company™, Thom's Natural Foods™ and Cornucopia Community Market™. We also own health food stores, which operate under the trade names Fresh Vitamins™, Granola's™, Nature's Discount™ and Warehouse Vitamins™.


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We manufacture and/or distribute one of the broadest branded product lines in the industry with over 7,000 SKUs, including approximately 900 SKUs sold internationally. We believe that as a result of our emphasis on innovation, quality, loyalty, education and customer service, our brands are widely recognized in health and natural food stores and among their customers.

We were formed in 1993 to effect a consolidation strategy in the fragmented VMS Industry. Since our formation, we have completed numerous acquisitions of assets or stock. We believe that Nutraceutical is well positioned to continue to capitalize on the consolidation we believe is occurring in the VMS Industry.

Critical Accounting Policies and Estimates

The preparation of our financial statements in conformity with accounting principles generally accepted in the United States of America required us to make estimates and assumptions that affected the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of net sales and expenses during the reported periods. Significant estimates included values and lives assigned to acquired intangible assets, reserves for customer returns and allowances, uncollectible accounts receivable, valuation adjustments for slow moving, obsolete and/or damaged inventory and valuation and recoverability of long-lived assets. Actual results may differ from these estimates.

Our critical accounting policies and estimates include the following:

Accounts Receivable-Provision is made for estimated bad debts based on a periodic analysis of individual customer balances, including an evaluation of days sales outstanding, payment history, recent payment trends and perceived credit worthiness. If general economic conditions and/or customer financial condition were to change, additional provisions for bad debts may be required, which could have a material impact on the consolidated financial statements.

Inventories-Valuation adjustments are made for slow moving, obsolete and/or damaged inventory based on a periodic analysis of individual inventory items, including an evaluation of historical usage and/or movement, age, expiration date and general condition. If market demand and/or consumer preferences are less favorable than historical trends or future expectations, additional valuation adjustments for slow moving, obsolete and/or damaged inventory may be required, which could have a material impact on the consolidated financial statements.

Property, Plant and Equipment-Depreciation and amortization expense is impacted by our judgments regarding the estimated useful lives of assets placed in service. If the estimated lives of assets are significantly less than expected, depreciation and amortization expense would be accelerated, which could have a material impact on the consolidated financial statements.

We evaluate the recoverability of property, plant and equipment which are reviewed for possible impairment whenever events or circumstances indicate that the carrying amount of an asset group may not be recoverable. We measure recoverability of the asset group by comparison of its carrying amount to the future undiscounted cash flows the asset group is expected to generate. If the asset group is considered to be impaired, the difference between the carrying amount and the fair value of the impaired asset group is recorded.

Goodwill and Intangible Assets-Goodwill and intangible assets require estimates and judgments in determining the initial recognition and measurement, including factors and assumptions used in determining fair value and useful lives. Intangible assets with finite useful lives are amortized, while intangible assets with indefinite useful lives are not amortized. Amortizable intangible assets are reviewed for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. Goodwill and indefinite-lived intangible assets are tested annually for impairment and


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are tested for impairment between annual tests if an event occurs that would cause us to believe that value is impaired. The appropriateness of the indefinite-life classification of non-amortizable intangible assets is also reviewed as part of the annual testing or when circumstances warrant a change to a finite life. We perform our annual impairment testing as of September 30 each year, which is the last day of our fiscal year.

A two-step process is used to test for goodwill impairment. The first step is to determine if there is an indication of impairment by comparing the estimated fair value of each reporting unit to its carrying value, including existing goodwill. Reporting unit fair values are estimated using discounted cash flow models as well as considering market and other factors. Goodwill is considered impaired if the carrying value of a reporting unit exceeds the estimated fair value. Upon an indication of impairment, a second step is performed to measure the amount of the impairment by comparing the implied fair value of the reporting unit's goodwill with its carrying value.

Intangible assets with indefinite useful lives are tested for impairment at the individual tradename level by comparing the fair value of the indefinite-lived intangible asset to its carrying amount. If the carrying amount of an indefinite-lived intangible asset exceeds its fair value, an impairment charge is recognized. Fair values of indefinite-lived intangible assets are determined based on discounted cash flows.

Amortizable intangible assets are reviewed for recoverability by comparing an asset group's carrying amount to the future undiscounted cash flows the asset group is expected to generate. If the asset group is considered to be impaired, the difference between the carrying amount and the fair value of the impaired asset group is recorded.

For fiscal 2012, we recorded a non-cash intangible asset impairment charge of $0.9 million ($0.6 million after tax, or $0.06 per diluted share) related to the consolidation of certain brands. The fiscal 2012 non-cash intangible asset impairment charge had no impact on our compliance with debt covenants, cash flows or available liquidity.

The ongoing uncertainty in general and economic conditions may continue to impact retail and consumer demand, as well as the market price of our common stock, and could negatively impact our future operating performance, cash flow and/or stock price and could result in additional goodwill and/or intangible asset impairment charges being recorded in future periods. Also, we periodically review our brands to achieve marketing, sales and operational synergies. These reviews could result in additional brands being consolidated or discontinued and could result in additional intangible asset impairment charges being recorded in future periods. Additional goodwill and/or intangible asset impairment charges could materially impact our consolidated financial statements. There were no at-risk reporting units at September 30, 2012. The valuation of goodwill and intangible assets is subject to a high degree of judgment, uncertainty and complexity.

Revenue Recognition-Revenue is recognized when the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) the product has been shipped and the customer takes ownership and assumes the risk of loss; (3) the selling price is fixed or determinable; and (4) collection of the resulting receivable is reasonably assured. We believe that these criteria are satisfied upon shipment from our facilities or, in the case of our neighborhood natural food markets and health food stores, at the point of sale within these stores. Revenue is reduced by provisions for estimated returns and allowances, which are based on historical averages that have not varied significantly for the periods presented, as well as specific known claims, if any. No other significant deductions from revenue must be estimated at the point in time that revenue is recognized.

Other than our previous discussion of goodwill and intangible asset impairment, our estimates and judgments related to our critical accounting policies, including factors and assumptions considered in making these estimates and judgments, did not vary significantly for the periods presented and had no material impact on the consolidated financial statements as reported.


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For additional information on our accounting policies, see Note 2 of the accompanying Consolidated Financial Statements.

Results of Operations

The following table sets forth certain Consolidated Statements of Operations data as a percentage of net sales for the periods indicated:

                                                     Year Ended September 30,
                                                    2012         2011      2010
       Net sales                                      100.0 %     100.0 %   100.0 %
       Cost of sales                                   50.1        49.4      47.9

       Gross profit                                    49.9        50.6      52.1
       Selling, general and administrative             35.6        36.3      36.5
       Amortization of intangible assets                1.0         0.8       0.7
       Impairment of intangible asset                   0.5           -         -

       Income from operations                          12.8        13.5      14.9
       Interest and other expense, net                  0.7         0.6       0.3

       Income before provision for income taxes        12.1        12.9      14.6
       Provision for income taxes                       4.2         4.5       5.5

       Net income                                       7.9 %       8.4 %     9.1 %

Comparison of Fiscal 2012 to Fiscal 2011

Net Sales. Net sales increased by $12.3 million, or 6.5%, to $200.4 million for fiscal 2012 from $188.1 million for fiscal 2011. Net sales of branded nutritional supplements and other natural products increased by $9.6 million, or 5.5%, to $183.4 million for fiscal 2012 compared to $173.8 million for fiscal 2011. The increase in net sales of branded nutritional supplements and other natural products was primarily related to the net sales contributions of the fiscal 2011 and fiscal 2012 acquisitions and, to a lesser extent, an increase in sales volume of branded products to certain customers. The impact on net sales of branded products attributable to price changes was not material. Other net sales increased by $2.7 million, or 19.4%, to $17.0 million for fiscal 2012 compared to $14.3 million for fiscal 2011. The increase in other net sales was primarily related to the net sales contributions of the fiscal 2012 acquisitions, partially offset by the closure of three health food stores and one natural food market during fiscal 2011 and fiscal 2012.

Gross Profit. Gross profit increased by $4.8 million, or 5.0%, to $100.0 million for fiscal 2012 from $95.2 million for fiscal 2011. This increase in gross profit was primarily attributable to the increase in net sales. As a percentage of net sales, gross profit decreased to 49.9% for fiscal 2012 from 50.6% for fiscal 2011. This decrease in gross profit percentage was primarily attributable to increased material costs due to vendor price increases and, to a lesser extent, changes in sales mix and increased manufacturing overhead costs related to the expansion of our liquid manufacturing operations.

Selling, General and Administrative. Selling, general and administrative expenses increased by $3.2 million, or 4.7%, to $71.4 million for fiscal 2012 from $68.2 million for fiscal 2011. This increase in selling, general and administrative expenses was primarily attributable to operational and transition costs related to the fiscal 2011 and fiscal 2012 acquisitions. As a percentage of net sales, selling, general and administrative expenses decreased to 35.6% for fiscal 2012 compared to 36.3% for fiscal 2011. This decrease in selling, general and administrative expenses as a percentage of net sales was primarily attributable to the increase in net sales, which allowed us to better leverage our cost structure.


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Amortization of Intangible Assets. Amortization of intangible assets was $2.0 million for fiscal 2012 and $1.7 million for fiscal 2011. For each period, amortization expense was primarily related to intangible assets recorded in connection with acquisitions.

Impairment of Intangible Asset. During fiscal 2012, we recorded a non-cash intangible asset impairment charge of $0.9 million ($0.6 million after tax, or $0.06 per diluted share) related to the consolidation of our food, drug and mass ("FDM") brands. The charge represented the entire carrying amount of the Alan James Group™ ("AJG") brand. Existing products under the AJG brand were combined under our primary FDM Body Gold® brand. We believe this brand consolidation provides increased efficiencies and synergies for our FDM products and customers.

Interest and Other Expense, Net. Net interest and other expense was $1.5 million for fiscal 2012 and $1.1 million for fiscal 2011 and primarily consisted of interest expense on indebtedness under our revolving credit facility.

Provision for Income Taxes. Our effective tax rate was 34.8% for fiscal 2012 and 35.0% for fiscal 2011.

Comparison of Fiscal 2011 to Fiscal 2010

Net Sales. Net sales increased by $8.0 million, or 4.5%, to $188.1 million for fiscal 2011 from $180.1 million for fiscal 2010. Net sales of branded nutritional supplements and other natural products increased by $9.2 million, or 5.6%, to $173.8 million for fiscal 2011 compared to $164.6 million for fiscal 2010. The increase in net sales of branded nutritional supplements and other natural products was primarily related to the net sales contributions of the fiscal 2011 and fiscal 2010 acquisitions. The impact on net sales of branded products attributable to price changes was not material. Other net sales decreased by $1.2 million, or 7.7%, to $14.3 million for fiscal 2011 compared to $15.5 million for fiscal 2010. The decrease in other net sales was primarily related to the closure of two health food stores and one natural food market during fiscal 2011.

Gross Profit. Gross profit increased by $1.3 million, or 1.4%, to $95.2 million for fiscal 2011 from $93.9 million for fiscal 2010. This increase in gross profit was primarily attributable to the increase in net sales. As a percentage of net sales, gross profit decreased to 50.6% for fiscal 2011 from 52.1% for fiscal 2010. This decrease in gross profit percentage was primarily attributable to increased manufacturing overhead costs related to the expansion of our liquid manufacturing operations.

Selling, General and Administrative. Selling, general and administrative expenses increased by $2.5 million, or 3.9%, to $68.2 million for fiscal 2011 from $65.7 million for fiscal 2010. This increase in selling, general and administrative expenses was primarily attributable to operational and transition costs related to the fiscal 2011 acquisitions. As a percentage of net sales, selling, general and administrative expenses were 36.3% for fiscal 2011 compared to 36.5% for fiscal 2010.

Amortization of Intangible Assets. Amortization of intangible assets was $1.7 million for fiscal 2011 and $1.3 million for fiscal 2010. For each period, amortization expense was primarily related to intangible assets recorded in connection with acquisitions.

Interest and Other Expense, Net. Net interest and other expense was $1.1 million for fiscal 2011 and $0.6 million for fiscal 2010 and primarily consisted of interest expense on indebtedness under our revolving credit facility with the increase being primarily related to an increase in interest rates.

Provision for Income Taxes. Our effective tax rate was 35.0% for fiscal 2011 and 37.8% for fiscal 2010. The decrease in the effective tax rate was primarily due to an increase in the domestic production deduction rate. In each period, our effective tax rate was higher than the federal statutory rate primarily due to state taxes.


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Selected Quarterly Financial Data; Seasonality

    The following table sets forth certain quarterly financial data for fiscal
2012 and fiscal 2011. This quarterly information is unaudited, has been prepared
on the same basis as the annual financial statements and, in our opinion,
reflects all normally recurring adjustments necessary for fair presentation of
the information for the periods presented. Operating results for any quarter are
not necessarily indicative of results for any future period.

                                Fiscal 2012                                 Fiscal 2011
                  First      Second     Third      Fourth     First      Second     Third      Fourth
                 Quarter    Quarter    Quarter    Quarter    Quarter    Quarter    Quarter    Quarter
                               (dollars in thousands, except per share data: unaudited)
 Net sales       $ 46,628   $ 53,871   $ 49,607   $ 50,261   $ 45,243   $ 49,549   $ 47,453   $ 45,825
 Gross profit      23,258     26,988     24,729     24,979     23,462     25,414     23,907     22,410
 Net income         3,411      4,830      3,352      4,174      3,947      4,552      3,945      3,274
 Net income
 per common
 share:
 Basic           $   0.34   $   0.49   $   0.34   $   0.42   $   0.38   $   0.44   $   0.38   $   0.32
 Diluted         $   0.34   $   0.49   $   0.34   $   0.42   $   0.38   $   0.44   $   0.38   $   0.32

We believe that our business is characterized by minor seasonality. However, sales to any particular customer can vary substantially from one quarter to the next based on such factors as industry trends, timing of promotional discounts, international economic conditions and acquisition-related activities. Excluding the effect of acquisitions, we have historically recorded higher branded products sales volume during the second fiscal quarter due to increased interest in health-related products among consumers following the holiday season. The fiscal 2012 acquisitions were completed during the first, second and third quarters and the fiscal 2011 acquisitions were completed during the first, second, third and fourth quarters.

Liquidity and Capital Resources

As of September 30, 2012, we had cash of $4.8 million. Net cash provided by operating activities was $27.2 million, $26.3 million and $17.9 million for the years ended September 30, 2012, 2011 and 2010, respectively. The increase in net cash provided by operating activities in fiscal 2012 was primarily attributable to an increase in cash provided by changes in assets and liabilities, net of effects of acquisitions.

Net cash used in investing activities was $22.2 million, $27.2 million and $26.4 million for the years ended September 30, 2012, 2011 and 2010, respectively. Our investing activities during these periods consisted of acquisitions of businesses and capital expenditures.

During the year ended September 30, 2012, we made six acquisitions of businesses. On October 27, 2011, we acquired certain operating assets of Mia Rose Products, Inc. On November 22, 2011, we acquired certain operating assets of Collective Wellbeing, LLC. On January 16, 2012, we acquired certain operating assets of Nature's Discount, Inc. and Top Health. On January 27, 2012, we acquired certain operating assets of Your Crown and Glory, LLC. On March 2, 2012, we acquired certain operating assets of Treehouse Vitamins, LLC. On June 7, 2012, we acquired certain operating assets of Direct Access Network, Inc. The aggregate purchase price of these acquisitions was $12.2 million in cash.

During the year ended September 30, 2011, we made five acquisitions of businesses. On October 7, 2010, we acquired certain operating assets of TRC Nutritional Labs, Inc. On October 14, 2010, we acquired certain operating assets of The Heritage Store, Inc. On February 24, 2011, we acquired certain operating assets of SunFeather Natural Soap Company, Inc. On May 26, 2011, we acquired certain operating assets of Skin by Ann Webb, LLC. On September 15, 2011, we acquired certain operating


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assets of Transitions for Health, Inc., dba Emerita. The aggregate purchase price of these acquisitions was $14.8 million in cash.

The fiscal 2012 and fiscal 2011 acquisitions were financed primarily using borrowings under our revolving credit facility, as well as cash provided by operating activities. These acquisitions are in keeping with our business strategy of consolidating the fragmented industry where we compete and acquiring nutritional brands with products we currently do not sell. The expected long-term sales and expense synergies of acquired businesses are generally not realized immediately following acquisition as certain transition and integration matters must be completed.

Capital expenditures during the years ended September 30, 2012, 2011 and 2010 related primarily to buildings, building improvements related to facility consolidation efforts, distribution and manufacturing equipment and information systems.

Net cash provided by (used in) financing activities was $(2.6) million, $(0.5) million and $6.4 million for the years ended September 30, 2012, 2011 and 2010, respectively. Our financing activities during these periods consisted primarily of borrowings and repayments under our revolving credit facility related to operating needs, payments of deferred financing fees, purchases of common stock for treasury and proceeds from the issuance of common stock.

In October 2007, we registered a direct stock purchase plan with the Securities and Exchange Commission. The purpose of this direct stock purchase plan is to provide a convenient way for existing stockholders, as well as new investors, to purchase shares of our common stock. A total of 1,500,000 shares of our common stock were registered under the plan with 15,142 and 19,577 shares purchased during the years ended September 30, 2012 and 2011, respectively.

On December 17, 2010, we amended and restated our revolving credit facility (the "Restated Credit Agreement"). The Restated Credit Agreement extends the term of the credit facility to December 2015, resets the available credit borrowings to $90 million with no automatic reductions and provides an accordion feature which can increase the available credit borrowings to $120 million subject to approval by the lenders and compliance with certain covenants and conditions. The lenders under the Restated Credit Agreement are Rabobank International and Wells Fargo. To date, we have not experienced any difficulties in accessing the available funds under the Restated Credit Agreement. Deferred financing fees of $0.9 million related to the Restated Credit Agreement are being amortized over the term of the Restated Credit Agreement.

At September 30, 2012, we had outstanding revolving credit borrowings of $34.0 million under the Restated Credit Agreement. Borrowings under the Restated Credit Agreement are collateralized by substantially all of our assets. At our election, borrowings bear interest at the applicable Eurodollar Rate plus a variable margin or at a base rate, which is the higher of the Federal Funds Rate plus 0.5% or the Prime Lending Rate, plus a variable margin. At September 30, 2012, the applicable weighted-average interest rate for outstanding borrowings was 2.65%. We are also required to pay a quarterly fee of 0.50% on the unused balance under the Restated Credit Agreement. Accrued interest on Eurodollar Rate borrowings is payable based on elected intervals of one, two or three months. Accrued interest on base rate borrowings is payable quarterly. The Restated Credit Agreement matures on December 15, 2015, and we are required to repay all principal and interest outstanding under the Restated Credit Agreement on such date.

The Restated Credit Agreement contains restrictive covenants, including restrictions on incurring other indebtedness and requirements that we maintain certain financial ratios. As of September 30, 2012, we were in compliance with these restrictive covenants. Upon the occurrence of a default or an event of default, the lender has various remedies or rights, which may include proceeding against the collateral or requiring us to repay all amounts outstanding under the Restated Credit Agreement.


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A key component of our business strategy is to seek to make additional acquisitions, which may require that we obtain additional financing, which could include the incurrence of substantial additional indebtedness. We believe that borrowings under the Restated Credit Agreement or a replacement credit facility, together with cash flows from operations, will be sufficient to make required payments under the Restated Credit Agreement or any such replacement facility, and to make anticipated capital expenditures and fund working capital needs for fiscal 2013.

Our significant non-cancelable contractual obligations and other commitments as of September 30, 2012 were as follows:

                                                Payments Due By Period
      Contractual Obligations               Less Than     1 - 3     4 - 5       After
      and Other Commitments      Total       1 Year       Years     Years      5 Years
                                                (dollars in thousands)
      Debt                      $ 34,000    $        -   $     -   $ 34,000     $     -
. . .
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