<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JULY 14, 1998
REGISTRATION NO. 333-52109
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
PRE-EFFECTIVE AMENDMENT NO. 3 TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------
NATROL, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C> <C>
DELAWARE 2833 95-3560780
(State or Other Jurisdiction (Primary Standard Industrial (I.R.S. Employer
of Incorporation or Classification Code Number) Identification
Organization) No.)
</TABLE>
21411 PRAIRIE STREET
CHATSWORTH, CALIFORNIA 91311
(818) 739-6000
(Address, including zip code, and telephone number, including area code, of
Registrant's principal executive offices)
ELLIOTT BALBERT
CHAIRMAN, CHIEF EXECUTIVE OFFICER AND PRESIDENT
NATROL, INC.
21411 Prairie Street
Chatsworth, California 91311
(818) 739-6000
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
------------------------------
COPIES TO:
JOHN R. LECLAIRE, P.C. JOHN A. BURGESS, ESQ.
ANDREW F. VILES, ESQ. VIRGINIA K. KAPNER, ESQ.
Goodwin, Procter & Hoar LLP Hale and Dorr LLP
Exchange Place 60 State Street
Boston, Massachusetts 02109-2881 Boston, Massachusetts 02109
(617) 570-1000 (617) 526-6000
------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after this Registration Statement becomes effective.
------------------------------
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. / /
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act of 1933, please check the
following box and list the Securities Act registration statement number of the
earlier effective registration statement for the same offering. / / 333-
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act of 1933, check the following box and list the
Securities Act registration statement number of the earlier effective
registration statement for the same offering. / / 333-
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / /
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. / /
------------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SECTION 8(A), MAY
DETERMINE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
SUBJECT TO COMPLETION, DATED JULY 14, 1998
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES
IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR
TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.
<PAGE>
3,940,000 SHARES
[LOGO]
COMMON STOCK
------------------
Of the 3,940,000 shares of Common Stock offered hereby, 3,200,000 shares are
being sold by the Company and 740,000 shares are being sold by the Selling
Stockholders. See "Principal and Selling Stockholders." The Company will not
receive any of the proceeds from the sale of the shares by the Selling
Stockholders.
Prior to this offering, there has been no public market for the Common Stock
of the Company. It is currently estimated that the initial public offering price
will be between $12.00 and $14.00 per share. See "Underwriting" for a discussion
of the factors to be considered in determining the initial public offering
price. The Common Stock has been approved for quotation on the Nasdaq National
Market upon completion of this offering under the symbol "NTOL."
SEE "RISK FACTORS" COMMENCING ON PAGE 6 FOR A DISCUSSION OF CERTAIN FACTORS
THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE COMMON STOCK OFFERED
HEREBY.
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
PRICE UNDERWRITING PROCEEDS PROCEEDS
TO DISCOUNTS AND TO TO SELLING
PUBLIC COMMISSIONS (1) COMPANY (2)(3) STOCKHOLDERS (3)
<S> <C> <C> <C> <C>
Per Share..................... $ $ $ $
Total (3)..................... $ $ $ $
</TABLE>
(1) The Company and the Selling Stockholders have agreed to indemnify the
Underwriters against certain liabilities under the Securities Act of 1933,
as amended. See "Underwriting."
(2) Before deducting expenses payable by the Company estimated at $1,050,000.
(3) The Company and the Selling Stockholders have granted to the Underwriters a
30-day option to purchase up to 295,500 and 295,500, respectively,
additional shares of Common Stock solely to cover over-allotments, if any.
If such option is exercised in full, the total Price to Public, Underwriting
Discounts and Commissions, Proceeds to Company and Proceeds to Selling
Stockholders will be $ , $ , $ and $ , respectively. See
"Underwriting."
------------------------------
The shares of Common Stock are offered by the several Underwriters subject
to receipt and acceptance by them and subject to their right to reject any order
in whole or in part. It is expected that delivery of the shares of Common Stock
will be made at the offices of Adams, Harkness & Hill, Inc., Boston,
Massachusetts, on or about , 1998.
Adams, Harkness & Hill, Inc.
NationsBanc Montgomery Securities LLC
Piper Jaffray Inc.
The date of this Prospectus is , 1998.
<PAGE>
[A photographic display of certain of the Company's products set against a
graphic background with the Company's name and leaf logo prominently displayed
at the top of the page and the text "Quality Dietary Supplements" directly below
the logo.]
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK,
INCLUDING OVER-ALLOTMENT, STABILIZING AND SHORT-COVERING TRANSACTIONS IN THESE
SECURITIES OR THE IMPOSITION OF PENALTY BIDS IN CONNECTION WITH THE OFFERING.
FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING."
Natrol-Registered Trademark-, Kavatrol-TM-, My Favorite
Multiple-Registered Trademark-, Mood Support-TM-,
Quintessence-Registered Trademark-, Highgar Farms-Registered Trademark-,
SAF-Registered Trademark-, Thera-C-TM-, Cravex-TM- and the Company's logo are
trademarks of the Company and are used throughout this document as such. All
other trademarks and trade names referred to in this Prospectus are the property
of their respective owners.
<PAGE>
PROSPECTUS SUMMARY
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY THE MORE DETAILED
INFORMATION AND THE CONSOLIDATED FINANCIAL STATEMENTS AND NOTES THERETO
APPEARING ELSEWHERE IN THIS PROSPECTUS. INVESTORS SHOULD CAREFULLY CONSIDER THE
RISK FACTORS CONTAINED IN THIS PROSPECTUS RELATED TO THE PURCHASE OF COMMON
STOCK OF THE COMPANY. SEE "RISK FACTORS."
THE COMPANY
Natrol, Inc. ("Natrol" or the "Company") manufactures and markets branded,
high-quality dietary supplements. The Company sells its products under the
Natrol brand name through multiple distribution channels throughout the United
States, including domestic health food stores and mass market drug, retail and
grocery store chains. The Company's select line of more than 145 products
consists of approximately 500 stock keeping units (i.e., units with different
unit counts or dosage strengths, or "SKUs") and includes vitamins, minerals,
herbs, specialty formulations, weight control products and hormones. The Company
recently strengthened its product categories through an acquisition which
included two brands of garlic products as well as a bulk ingredient business
which supplies dehydrated vegetable products to other manufacturers. The
Company's net sales have increased from $9.5 million in 1993 to $42.9 million in
1997.
The total United States retail market for dietary supplements is highly
fragmented and has experienced rapid growth, generating $6.5 billion in 1996
sales compared with $5.0 billion in 1994. The Company believes that this rapid
growth is due to a number of factors, including: (i) the aging of the "baby
boom" generation combined with consumers' tendency to purchase more dietary
supplements as they age; (ii) the publication of research findings supporting
the positive health effects of certain dietary supplements; (iii) increased
media attention on the use and efficacy of dietary supplements; (iv) the
nationwide trend toward preventive medicine in response to rising healthcare
costs; (v) increased consumer interest in herbs and herb-related supplements;
and (vi) increased interest in healthier lifestyles and the connection between
diet and health.
The Company has achieved growth within its industry by aggressively
promoting the Natrol brand and regularly introducing new products to meet
emerging trends and consumer demands. The Company uses a widespread multimedia
marketing and advertising strategy to build strong recognition of the Natrol
brand across multiple distribution channels. The Company invested 10.5%, 13.8%
and 16.2% of its annual net sales on marketing and advertising in 1995, 1996 and
1997, respectively, and seeks to invest approximately 15% of its annual net
sales on marketing and advertising on an ongoing basis. The Company's marketing
strategy focuses on national print, radio and television advertising as well as
cooperative advertising programs at the retail level. This strategy is designed
to create consumer demand, build strong relationships with the Company's
marketing partners and encourage retailers to carry more Natrol product
categories and a greater number of SKUs within those categories. Recent national
advertising initiatives include the "Natrol Health Minute," as heard on the
nationally syndicated Dr. Laura Schlessinger and Rush Limbaugh radio shows, and
commercials featured on the CNN/Turner Network.
Since its inception, the Company has emphasized the ongoing development and
marketing of new products in order to capitalize on and create market
opportunities. As a part of its product development efforts, the Company
introduced 34 new products with 53 SKUs in 1997 and 21 new products with 28 SKUs
in the three months ended March 31, 1998. Recent proprietary product
introductions include Kavatrol, Mood Support and the Natrol for Women product
line. Products introduced by the Company in 1997 accounted for $8.9 million, or
20.7%, of the Company's net sales in 1997. Net sales of these products together
with increased net sales of existing products enabled the Company to more than
offset substantial declines in net sales of Melatonin and DHEA.
The Company sells its products to health food stores through the leading
national distributors of dietary supplements, including United Natural Foods and
Tree of Life, as well as directly to GNC. The Company's mass market retail
customers include major drug and retail chains, including Walgreens, American
Drug Stores, Wal-Mart and Target, as well as grocery stores and supermarkets,
including Dominick's, Ralphs and Von's. The Company's products are also
available at a wide range of other distribution points, including mail order and
the Internet, airport shops, resort hotels and salons. The Company manufactures
substantially all of its products at its 90,000 square foot manufacturing
facility/headquarters located in Chatsworth, California. The Company believes
its manufacturing facility can support three times the Company's current sales
volume.
Natrol's objective is to manufacture and market high-quality dietary
supplements that are strongly identified with the Natrol brand. The Company
pursues this objective by: (i) continuing to build strong brand recognition;
(ii) expanding its presence and penetration in the health food store and mass
market distribution channels; (iii) continuing to develop new products; (iv)
expanding its bulk sales business; (v) developing additional distribution
channels such as mail order and the Internet, direct selling (multi-level
marketing as well as sales to health professionals), direct retail and
international; and (vi) pursuing strategic acquisitions that allow it to broaden
its product lines, increase the distribution channels it serves or otherwise
complement its business or further its strategic goals.
3
<PAGE>
THE OFFERING
<TABLE>
<S> <C>
Common Stock offered by:
The Company...................................... 3,200,000 shares
The Selling Stockholders......................... 740,000 shares
Common Stock to be outstanding after the offering
(1).............................................. 13,000,000 shares
Use of proceeds.................................... To repay existing indebtedness, to
redeem all outstanding shares of
Redeemable Preferred Stock, for capital
expenditures and for working capital
and other general corporate purposes,
including possible acquisitions. The
Company will not receive any of the
proceeds from the sale of shares of
Common Stock by the Selling
Stockholders. See "Use of Proceeds."
Proposed Nasdaq National Market symbol............. NTOL
</TABLE>
- ------------------------
(1) Excludes: (i) 720,000 shares of Common Stock issuable upon the exercise of
outstanding stock options at a weighted average exercise price of $5.87 per
share at June 30, 1998; and (ii) 750,000 and 225,000 additional shares of
Common Stock reserved for issuance under the Company's 1996 Stock Option and
Grant Plan, as amended (the "1996 Stock Plan"), and the Company's 1998
Employee Stock Purchase Plan (the "Purchase Plan"), respectively. Under the
terms of the 1996 Stock Plan, the sale of the 3,200,000 shares offered by
the Company hereby will result in the reservation for issuance of an
additional 480,000 shares of Common Stock under the 1996 Stock Plan. See
"Management--Employee Stock and Other Benefit Plans-- 1996 Stock Option and
Grant Plan" and "--1998 Employee Stock Purchase Plan."
SUMMARY CONSOLIDATED FINANCIAL DATA
<TABLE>
<CAPTION>
YEAR ENDED THREE MONTHS
DECEMBER ENDED
YEAR ENDED DECEMBER 31, 31, 1997 MARCH 31,
----------------------------------------------------- PRO --------------------
1993 1994 1995 1996 1997 FORMA(1) 1997 1998
--------- --------- --------- --------- --------- ----------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
(IN THOUSANDS, EXCEPT PER SHARE DATA)
CONSOLIDATED STATEMENT OF INCOME
DATA:
Net sales........................ $ 9,484 $ 12,214 $ 23,566 $ 40,802 $ 42,875 $ 51,583 $ 9,909 $ 13,116
Cost of goods sold............... 5,658 7,106 12,214 18,497 19,800 23,720 4,475 6,321
--------- --------- --------- --------- --------- ----------- --------- ---------
Gross profit................... 3,826 5,108 11,352 22,305 23,075 27,863 5,434 6,795
--------- --------- --------- --------- --------- ----------- --------- ---------
Selling and marketing expenses... 2,194 2,552 4,458 8,736 11,398 13,353 2,990 3,477
General and administrative
expenses....................... 1,197 1,739 3,378 5,431 4,450 7,632 1,055 1,230
--------- --------- --------- --------- --------- ----------- --------- ---------
Total operating expenses....... 3,391 4,291 7,836 14,167 15,848 20,985 4,045 4,707
--------- --------- --------- --------- --------- ----------- --------- ---------
Operating income................. 435 817 3,516 8,138 7,227 6,878 1,389 2,088
Interest income (expense), net... 33 (25) (19) 54 (220) (1,057) (35) (131)
--------- --------- --------- --------- --------- ----------- --------- ---------
Income before income tax
provision...................... 468 792 3,497 8,192 7,007 5,821 1,354 1,957
Income tax provision............. 189 301 1,453 2,299(3) 2,816 2,327 544 782
--------- --------- --------- --------- --------- ----------- --------- ---------
Net income....................... $ 279 $ 491 $ 2,044 $ 5,893 $ 4,191 $ 3,494 $ 810 $ 1,175
--------- --------- --------- --------- --------- ----------- --------- ---------
--------- --------- --------- --------- --------- ----------- --------- ---------
Basic earnings per share......... $ 0.05 $ 0.08 $ 0.34 $ 0.94 $ 0.59 $ 0.49 $ 0.11 $ 0.17
--------- --------- --------- --------- --------- ----------- --------- ---------
--------- --------- --------- --------- --------- ----------- --------- ---------
Diluted earnings per share....... $ 0.05 $ 0.08 $ 0.34 $ 0.83 $ 0.41 $ 0.34 $ 0.08 $ 0.11
--------- --------- --------- --------- --------- ----------- --------- ---------
--------- --------- --------- --------- --------- ----------- --------- ---------
Weighted average common shares
outstanding-basic.............. 6,000 6,000 6,000 6,275 7,100 7,100 7,100 7,100
--------- --------- --------- --------- --------- ----------- --------- ---------
--------- --------- --------- --------- --------- ----------- --------- ---------
Weighted average common shares
outstanding-diluted............ 6,000 6,000 6,000 7,065 10,273 10,273 10,262 10,273
--------- --------- --------- --------- --------- ----------- --------- ---------
--------- --------- --------- --------- --------- ----------- --------- ---------
<CAPTION>
THREE
MONTHS
ENDED MARCH
31, 1998
PRO
FORMA(2)
-----------
<S> <C>
CONSOLIDATED STATEMENT OF INCOME
DATA:
Net sales........................ $ 14,948
Cost of goods sold............... 7,168
-----------
Gross profit................... 7,780
-----------
Selling and marketing expenses... 4,002
General and administrative
expenses....................... 1,676
-----------
Total operating expenses....... 5,678
-----------
Operating income................. 2,102
Interest income (expense), net... (285)
-----------
Income before income tax
provision...................... 1,817
Income tax provision............. 727
-----------
Net income....................... $ 1,090
-----------
-----------
Basic earnings per share......... $ 0.15
-----------
-----------
Diluted earnings per share....... $ 0.11
-----------
-----------
Weighted average common shares
outstanding-basic.............. 7,100
-----------
-----------
Weighted average common shares
outstanding-diluted............ 10,273
-----------
-----------
</TABLE>
4
<PAGE>
<TABLE>
<CAPTION>
MARCH 31, 1998
-------------------------
<S> <C> <C>
ACTUAL AS ADJUSTED(4)
--------- --------------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents............................................................. $ 2,229 $ 22,042
Working capital....................................................................... 5,299 29,624
Total assets.......................................................................... 32,029 51,843
Long-term debt, less current maturities............................................... 7,375 --
Convertible participating preferred stock............................................. 12,000 --
Total stockholders' equity (deficit).................................................. (389) 43,311
</TABLE>
- ------------------------------
(1) Gives effect to the Company's acquisition on February 27, 1998 (the
"Pure-Gar Acquisition") of substantially all of the assets and assumption of
specified liabilities of Pure-Gar L.P. ("Pure-Gar") as if such transaction
had been completed on January 1, 1997. The pro forma consolidated statement
of income data has been adjusted for the combined operating results of
Natrol and Pure-Gar, amortization of goodwill associated with the Pure-Gar
Acquisition, interest expense on the term loan and line of credit used to
fund the Pure-Gar Acquisition, and related tax effects. The pro forma
consolidated statement of income data includes a non-recurring legal
settlement expense incurred by Pure-Gar of $733,000. See "Capitalization"
and "Management's Discussion and Analysis of Financial Condition and Results
of Operations."
(2) Gives effect to the Pure-Gar Acquisition as if such transaction had been
completed on January 1, 1998. The pro forma consolidated statement of income
data has been adjusted for the combined operating results of Natrol and
Pure-Gar, amortization of goodwill associated with the Pure-Gar Acquisition,
interest expense on the term loan and line of credit used to fund the
Pure-Gar Acquisition and related tax effects. See "Capitalization" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
(3) In 1996, the Company was taxed under Subchapter S of the Internal Revenue
Code of 1986, as amended (the "Code") for the period from July 1, 1996
through September 29, 1996, and was taxed under Subchapter C of the Code for
the period from January 1, 1996 through June 30, 1996 and for the period
from September 30, 1996 through December 31, 1996. Accordingly, the
provision for income taxes for the period in which the Company was taxed as
a Subchapter S corporation reflects primarily state income tax, if any. If
the Company had been subject to taxation under Subchapter C of the Code for
the entire year ended December 31, 1996, the pro forma provision for income
taxes would have been $3.2 million and pro forma basic earnings per share
and pro forma diluted earnings per share would have been $0.80 and $0.71,
respectively.
(4) Gives effect to (i) the sale of 3,200,000 shares of Common Stock offered by
the Company hereby at an assumed initial public offering price of $13.00 per
share and the receipt and application of the estimated net proceeds
therefrom as if such transaction had been completed on March 31, 1998 and
(ii) the conversion of all outstanding shares of the Company's Convertible
Participating Preferred Stock, par value $0.01 per share (the "Convertible
Preferred Stock"), into shares of Common Stock and shares of the Company's
Redeemable Preferred Stock, par value $0.01 per share (the "Redeemable
Preferred Stock"), concurrently with the completion of this offering and the
redemption of all shares of Redeemable Preferred Stock to be outstanding
immediately following such conversion for $6.0 million. See "Use of
Proceeds," "Capitalization" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
THE RESULTS FOR THE INTERIM PERIODS ARE NOT NECESSARILY INDICATIVE OF THE
RESULTS FOR THE FULL FISCAL YEAR. THE UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL
DATA SET FORTH ABOVE DO NOT PURPORT TO (I) REPRESENT WHAT THE CONSOLIDATED
RESULTS OF OPERATIONS OF THE COMPANY WOULD HAVE BEEN IF THE TRANSACTIONS
REFLECTED THEREIN HAD IN FACT OCCURRED AT THE ASSUMED DATES OR (II) PREDICT THE
FUTURE CONSOLIDATED RESULTS OF OPERATIONS OF THE COMPANY.
------------------------------
The Company was incorporated under the laws of Delaware on October 1, 1997.
The Company's predecessor was incorporated under the laws of California in 1980.
The Company's principal executive offices are located at 21411 Prairie Street,
Chatsworth, California 91311, and its telephone number is (818) 739-6000.
------------------------
EXCEPT AS OTHERWISE NOTED, ALL INFORMATION IN THIS PROSPECTUS ASSUMES NO
EXERCISE OF THE UNDERWRITERS' OVER-ALLOTMENT OPTION AND HAS BEEN ADJUSTED TO
REFLECT (I) A 1-FOR-10 REVERSE STOCK SPLIT OF ALL CLASSES OF THE COMPANY'S
CAPITAL STOCK EFFECTED ON JANUARY 15, 1998, (II) A 100-FOR-1 STOCK SPLIT OF THE
COMMON STOCK EFFECTED ON JUNE 19, 1998, (III) THE CONVERSION OF ALL OUTSTANDING
SHARES OF THE CONVERTIBLE PREFERRED STOCK INTO SHARES OF COMMON STOCK AND SHARES
OF THE REDEEMABLE PREFERRED STOCK CONCURRENTLY WITH THE COMPLETION OF THIS
OFFERING AND (IV) THE REDEMPTION OF ALL SHARES OF THE REDEEMABLE PREFERRED STOCK
TO BE OUTSTANDING IMMEDIATELY FOLLOWING SUCH CONVERSION OF THE CONVERTIBLE
PREFERRED STOCK. UNLESS THE CONTEXT OTHERWISE REQUIRES, ALL REFERENCES TO THE
"COMPANY" OR "NATROL" MEAN NATROL, INC., ITS PREDECESSOR AND ITS SUBSIDIARIES.
5
<PAGE>
RISK FACTORS
THE FOLLOWING RISK FACTORS SHOULD BE CAREFULLY CONSIDERED IN ADDITION TO THE
OTHER INFORMATION IN THIS PROSPECTUS BEFORE PURCHASING THE COMMON STOCK OFFERED
BY THIS PROSPECTUS. EXCEPT FOR THE HISTORICAL INFORMATION CONTAINED HEREIN, THE
DISCUSSION CONTAINED IN THIS PROSPECTUS CONTAINS "FORWARD-LOOKING STATEMENTS"
THAT INVOLVE RISK AND UNCERTAINTIES. THESE STATEMENTS MAY BE IDENTIFIED BY THE
USE OF FORWARD-LOOKING TERMINOLOGY SUCH AS "BELIEVES," "EXPECTS," "MAY," "WILL,"
"SHOULD" OR "ANTICIPATES" OR THE NEGATIVE THEREOF OR SIMILAR EXPRESSIONS OR BY
DISCUSSIONS OF STRATEGY. THE CAUTIONARY STATEMENTS MADE IN THIS PROSPECTUS
SHOULD BE READ AS BEING APPLICABLE TO ALL RELATED FORWARD-LOOKING STATEMENTS
WHEREVER THEY APPEAR IN THIS PROSPECTUS. THE COMPANY'S ACTUAL RESULTS COULD
DIFFER MATERIALLY FROM THOSE DISCUSSED IN THIS PROSPECTUS. IMPORTANT FACTORS
THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES INCLUDE THOSE DISCUSSED
BELOW, AS WELL AS THOSE DISCUSSED ELSEWHERE HEREIN.
EFFECT OF UNFAVORABLE PUBLICITY. The Company believes the dietary
supplement market is affected by national media attention regarding the
consumption of dietary supplements. Future scientific research or publicity may
not be favorable to the dietary supplement industry or to any particular
product, and may not be consistent with earlier favorable research or publicity.
Because of the
Company's dependence on consumers' perceptions, adverse publicity associated
with illness or other adverse effects resulting from the consumption of the
Company's products or any similar products distributed by other companies and
future reports of research that are perceived as less favorable or that question
earlier research could have a material adverse effect on the Company's business,
financial condition and results of operations. The Company is highly dependent
upon consumers' perceptions of the safety and quality of its products as well as
dietary supplements distributed by other companies. Thus, the mere publication
of reports asserting that such products may be harmful or questioning their
efficacy could have a material adverse effect on the Company's business,
financial condition and results of operations, regardless of whether such
reports are scientifically supported or whether the claimed harmful effects
would be present at the dosages recommended for such products. See "--Absence of
Conclusive Clinical Studies."
DEPENDENCE ON NEW PRODUCTS. The Company believes growth of its net sales is
substantially dependent upon its ability to introduce new products. The Company
seeks to introduce additional products each year. The success of new products is
dependent upon a number of factors, including the Company's ability to develop
products that will appeal to consumers and respond to market trends in a timely
manner. There can be no assurance that the Company's efforts to develop new
products will be successful or that consumers will accept the Company's new
products. In addition, products currently experiencing strong popularity and
rapid growth may not maintain their sales over time. For example, the Company's
net sales of DHEA, a specialty dietary supplement introduced by the Company in
March 1996, peaked at $4.6 million for the three months ended December 31, 1996
and accounted for 39.5% of the Company's net sales in such period. In
comparison, the Company's net sales of DHEA were only $273,000, or 2.1% of the
Company's net sales, for the three months ended March 31, 1998. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Business--Business Strategy."
GOVERNMENT REGULATION. The manufacture, packaging, labeling, advertising,
promotion, distribution and sale of the Company's products are subject to
regulation by numerous governmental agencies, the most active of which is the
U.S. Food and Drug Administration (the "FDA"), which regulates the Company's
products under the Federal Food, Drug and Cosmetic Act (the "FDCA") and
regulations promulgated thereunder. The Company's products are also subject to
regulation by, among other regulatory entities, the Consumer Product Safety
Commission (the "CPSC"), the U.S. Department of Agriculture (the "USDA") and the
Environmental Protection Agency (the "EPA"). Advertising and other forms of
promotion and methods of marketing of the Company's products are subject to
regulation by the U.S. Federal Trade Commission (the "FTC"), which regulates
these activities under the Federal Trade
6
<PAGE>
Commission Act (the "FTCA"). The manufacture, labeling and advertising of the
Company's products are also regulated by various state and local agencies as
well as those of each foreign country to which the Company distributes its
products.
The Company's products are generally regulated as dietary supplements under
the FDCA, and are, therefore, not subject to pre-market approval by the FDA.
However, these products are subject to extensive regulation by the FDA relating
to adulteration and misbranding. For instance, the Company is responsible for
ensuring that all dietary ingredients in a supplement are safe, and must notify
the FDA in advance of putting a product containing a new dietary ingredient
(i.e., an ingredient not marketed for use as a supplement before October 15,
1994) on the market and furnish adequate information to provide reasonable
assurance of the ingredient's safety. Further, if the Company makes statements
about the supplement's effects on the structure or function of the body, the
Company must, among other things, have substantiation that the statements are
truthful and not misleading. In addition, the Company's product labels must bear
proper ingredient and nutritional labeling and the Company's supplements must be
manufactured in accordance with current Good Manufacturing Practice regulations
("GMPs") for foods. The FDA has issued an advanced notice of proposed rulemaking
to consider whether to develop specific GMP regulations for dietary supplements
and dietary supplement ingredients. Such regulations, if promulgated, may be
significantly more rigorous than current requirements and contain quality
assurance requirements similar to GMPs for drug products. A product can be
removed from the market if it is shown to pose a significant or unreasonable
risk of illness or injury. Moreover, if the FDA determines that the "intended
use" of any of the Company's products is for the diagnosis, cure, mitigation,
treatment or prevention of disease, the product would meet the definition of a
drug and would require pre-market approval of safety and effectiveness prior to
its manufacture and distribution. Failure of the Company to comply with
applicable FDA regulatory requirements may result in, among other things,
injunctions, product withdrawals, recalls, product seizures, fines and criminal
prosecutions.
The Company's advertising of its dietary supplement products is subject to
regulation by the FTC under the FTCA. Section 5 of the FTCA prohibits unfair
methods of competition and unfair or deceptive acts or practices in or affecting
commerce. Section 12 of the FTCA provides that the dissemination or the causing
to be disseminated of any false advertisement pertaining to, among other things,
drugs or foods, which includes dietary supplements, is an unfair or deceptive
act or practice. Under the FTC's "substantiation doctrine," an advertiser is
required to have a "reasonable basis" for all product claims at the time the
claims are first used in advertising or other promotions. Failure to adequately
substantiate claims may be considered either as a deceptive or unfair practice.
Pursuant to this FTC requirement, the Company is required to have adequate
substantiation for all advertising claims made about its products. The type of
substantiation will be dependent upon the product claims made. For example, a
health claim normally would require competent and reliable scientific evidence,
while a taste claim would require only survey evidence.
In recent years the FTC has initiated numerous investigations of dietary
supplement and weight loss products and companies. The FTC is reexamining its
regulation of advertising for dietary supplements and has announced that it will
issue a guidance document to assist dietary supplement marketers in
understanding and complying with the substantiation requirement. Upon release of
this guidance document, Natrol will be required to evaluate its compliance with
the guideline and may be required to change its advertising and promotional
practices.
On two occasions, claims made by the Company have been the subject of
investigation by the FTC. In both matters, the FTC terminated its investigation
without further action or any formal findings. The Company is not currently a
party to any investigation, consent order or other decree of the FTC. The
Company may be subject to investigation by the FTC in the future. If the FTC has
reason to believe the law is being violated (e.g., the Company does not possess
adequate substantiation for product claims), it can initiate enforcement action.
The FTC has a variety of processes and remedies available to it for
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enforcement, both administratively and judicially, including compulsory process
authority, cease and desist orders and injunctions. FTC enforcement could result
in orders requiring, among other things, limits on advertising, consumer
redress, divestiture of assets, rescission of contracts and such other relief as
may be deemed necessary. Violation of such orders could result in substantial
financial or other penalties. Any such action by the FTC could materially
adversely affect the Company's ability to successfully market its products.
The Company manufactures certain products pursuant to contracts with
customers who distribute the products under their own or other trademarks. Such
private label customers are subject to government regulations in connection with
their purchase, marketing, distribution and sale of such products, and the
Company is subject to government regulations in connection with its manufacture,
packaging and labeling of such products. However, the Company's private label
customers are independent companies, and their labeling, marketing and
distribution of such products is beyond the Company's control. The failure of
these customers to comply with applicable laws or regulations could have a
material adverse effect on the Company's business, financial condition and
results of operations.
Governmental regulations in foreign countries where the Company plans to
commence or expand sales may prevent or delay entry into the market or prevent
or delay the introduction, or require the reformulation, of certain of the
Company's products. Compliance with such foreign governmental regulations is
generally the responsibility of the Company's distributors in those countries.
These distributors are independent contractors over whom the Company has limited
control.
The Company may be subject to additional laws or regulations by the FDA or
other federal, state or foreign regulatory authorities, the repeal of laws or
regulations which the Company considers favorable, such as the Dietary
Supplement Health and Education Act of 1994 ("DSHEA"), or more stringent
interpretations of current laws or regulations, from time to time 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
reformulation of certain products to meet new standards, the recall or
discontinuance of certain products that cannot be reformulated, imposition of
additional recordkeeping requirements, expanded documentation of the properties
of certain products, or expanded or different labeling or scientific
substantiation. Any or all of these requirements could have a material adverse
effect on the Company's business, financial condition and results of operations.
See "Business--Regulatory Matters."
PRODUCT LIABILITY. The Company, like other retailers, distributors and
manufacturers of products designed for human consumption, faces an inherent risk
of exposure to product liability claims in the event that the use of its
products results in injury. The Company may be subjected to various product
liability claims, including, among others, that its products include inadequate
instructions for use or inadequate warnings concerning possible side effects and
interactions with other substances. In addition, although the Company maintains
strict quality controls and procedures, including the quarantine and testing of
raw materials and qualitative and quantitative testing of selected finished
products, there can be no assurance that the Company's products will not contain
contaminated substances. In addition, in certain cases the Company relies on
third party manufacturers for its products. With respect to product liability
claims, the Company has $2.0 million in aggregate liability insurance. If such
claims should exceed $2.0 million, the Company has excess umbrella liability
insurance of up to $15.0 million. However, there can be no assurance that such
insurance will continue to be available at a reasonable cost, or, if available,
will be adequate to cover liabilities. The Company generally seeks to obtain
contractual indemnification from parties supplying raw materials for its
products or manufacturing or marketing its products, and to be added as an
additional insured under such parties' insurance policies. Any such
indemnification or insurance, however, is limited by its terms and any such
indemnification, as a practical matter, is limited to the creditworthiness of
the indemnifying party. In the event that the Company does not have adequate
insurance or contractual indemnification, product
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liabilities relating to its products could have a material adverse effect on the
Company's business, financial condition and results of operations. See
"Business--Legal Matters."
DEPENDENCE ON SIGNIFICANT CUSTOMERS. Net sales to Walgreens accounted for
15.3% of the Company's net sales for the three months ended March 31, 1998 and
17.7% and 12.6% of the Company's net sales in 1997 and 1996, respectively. Net
sales to Tree of Life accounted for 10.4% of the Company's net sales for the
three months ended March 31, 1998 and 11.6% and 10.2% of the Company's net sales
in 1997 and 1996, respectively. Net sales to GNC accounted for 3.0% of the
Company's net sales for the three months ended March 31, 1998 and 2.3% and 14.5%
of the Company's net sales in 1997 and 1996, respectively. The Company does not
have long-term contracts with any of its customers. There can be no assurance
that Walgreens, Tree of Life or the Company's other major customers will
continue as major customers of the Company. The loss of either Walgreens or Tree
of Life as a major customer, the loss of a significant number of other major
customers, or a significant reduction in purchase volume by or financial
difficulty of such customers, for any reason, could have a material adverse
effect on the Company's business, financial condition and results of operations.
See "Business--Sales and Distribution."
DEPENDENCE ON KEY PERSONNEL. The Company believes that its continued
success depends to a significant extent on the management and other skills of
Elliott Balbert, the Company's Chairman, Chief Executive Officer and President,
and its senior management team, as well as its ability to attract other skilled
personnel. Many of the Company's employees are not covered by a non-competition
agreement, and the ability of the Company to enforce such an agreement in
California, the state in which the Company's operations are principally located,
is limited and uncertain. The loss or unavailability of the services of Mr.
Balbert or the other members of the Company's senior management team or the
inability to attract other skilled personnel could have a material adverse
effect on the Company's business, financial condition and results of operations.
See "Management."
ABILITY TO MANAGE GROWTH. The Company believes that continued growth may
strain the Company's management, operations, sales and administrative personnel
and other resources. In order to serve the needs of its existing and future
customers, the Company has increased and intends to continue to increase its
workforce, which requires the Company to attract, train, motivate, manage and
retain qualified employees. The Company's ability to manage further growth
depends in part upon the Company's ability to expand its operating, management,
information and financial systems, and production capacity, which may
significantly increase its future operating expenses. No assurance can be given
that the Company's business will grow in the future or that the Company will be
able to effectively manage such growth. The Company's inability to manage its
growth successfully could have a material adverse effect on the Company's
business, financial condition and results of operations. See "Business--
Business Strategy."
RISKS ASSOCIATED WITH ACQUISITIONS. The Company recently completed its
first acquisition and expects to pursue additional acquisitions in the future as
a part of its business strategy. The Company faces significant competition for
acquisition opportunities from numerous companies, many of which have greater
financial resources than the Company. Accordingly, there can be no assurance
that attractive acquisition opportunities will be available to the Company.
There can be no assurance that the Company will be able to obtain financing for
or otherwise consummate any future acquisitions. Moreover, acquisitions involve
numerous risks, including the risk that the acquired business will not perform
in accordance with expectations, difficulties in the integration of the
operations and products of the acquired businesses with those of the Company,
the diversion of the Company's management's attention from other aspects of the
Company's business, the risks associated with entering geographic and product
markets in which the Company has limited or no direct prior experience and the
potential loss of key employees of the acquired business. The acquisition of
another business can also subject the Company to liabilities and claims arising
out of such business. Future acquisitions would likely require additional
financing, which would likely result in an increase in the Company's
indebtedness or the issuance of
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additional capital stock, which may be dilutive to the Company's stockholders,
including purchasers of shares offered hereby. In addition, to the extent the
Company has outstanding indebtedness under the Company's credit facility or is
required to incur indebtedness thereunder to consummate an acquisition, the
consent of the lender under the credit facility will be required prior to such
acquisition.
The Pure-Gar Acquisition resulted in a significant increase in the Company's
goodwill and any future acquisitions may result in additional goodwill and
related amortization expense. At March 31, 1998, goodwill on the Company's
balance sheet was $9.0 million, representing 28.0% of the Company's total assets
at that date. In the event of any sale or liquidation of the Company or a
portion of its assets, there can be no assurance that the value of the Company's
intangible assets will be realized. In addition, the Company continually
evaluates whether events and circumstances have occurred indicating that any
portion of the remaining balance of the amount allocable to the Company's
intangible assets may not be recoverable. When factors indicate that the amount
allocable to the Company's intangible assets should be evaluated for possible
impairment, the Company may be required to reduce the carrying value of such
assets. Any future determination requiring the write-off of a significant
portion of unamortized intangible assets could have a material adverse effect on
the Company's business, financial condition and operating results.
The Company regularly evaluates potential acquisitions of other businesses,
products and product lines and may hold discussions regarding such potential
acquisitions. As a general rule, the Company will publicly announce such
acquisitions only after a definitive agreement has been signed. See "Use of
Proceeds," "Management's Discussion and Analysis of Financial Condition and
Results of Operations-- Liquidity and Capital Resources" and "Business--Business
Strategy."
ABSENCE OF CONCLUSIVE CLINICAL STUDIES. Although many of the ingredients in
the Company's products are vitamins, minerals, herbs and other substances for
which there is a long history of human consumption, some of the Company's
products contain ingredients for which no such history exists. In addition,
although the Company believes all of its products are safe when taken as
directed by the Company, there is little long-term experience with human
consumption of certain of these product ingredients in concentrated form.
Accordingly, there can be no assurance that the Company's products, even when
used as directed, will have the effects intended or will not have harmful side
effects. Any such unintended effects may result in adverse publicity or product
liability claims which could have a material adverse effect on the Company's
business, financial condition and results of operations. See "--Effect of
Unfavorable Publicity" and "--Product Liability."
COMPETITION. The dietary supplement industry is highly competitive.
Numerous companies, many of which have greater size and financial, personnel,
distribution and other resources than the Company, compete with the Company in
the development, manufacture and marketing of dietary supplements. The Company's
principal competition in the health food store distribution channel comes from a
limited number of large nationally known manufacturers and many smaller
manufacturers of dietary supplements. In the mass market distribution channel,
the Company's principal competition comes from broadline manufacturers, major
private label manufacturers and other companies. In recent years, a number of
the Company's competitors have begun to market and sell their products under
different labels in both the health food store and the mass market distribution
channels. In addition, large pharmaceutical companies and packaged food and
beverage companies compete with the Company on a limited basis in the dietary
supplement market. With respect to Ester-C and the Company's Natrol Premium
category, the Company faces significant additional competition from large
pharmaceutical companies that market vitamins, multivitamins and minerals in the
mass market distribution channel. Increased competition from such companies
could have a material adverse effect on the Company because such companies have
greater financial and other resources available to them and possess
manufacturing, distribution and marketing capabilities far greater than those of
the Company. The Company also faces competition in both the health food store
and mass market distribution channels
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from private label dietary supplements and multivitamins offered by health and
natural food store chains, drugstore chains, mass merchandisers and supermarket
chains. See "Business--Competition."
RISKS ASSOCIATED WITH SUPPLY OF RAW MATERIALS. The Company obtains all of
its raw materials for the manufacture of its products from third-party
suppliers. Many of the raw materials used in the Company's products are
harvested internationally. With the exception of bulk garlic and
Ester-C-Registered Trademark-, the Company does not have contracts with any
suppliers committing such suppliers to provide the materials required for the
production of its products. In the last few years, natural vitamin E, beta
carotene and melatonin have had significant price fluctuations as a result of
short supply or increases in demand. The Company has experienced occasional
shortages of raw materials for a limited number of its products. There can be no
assurance that suppliers, including suppliers of bulk garlic and Ester-C, will
provide the raw materials needed by the Company in the quantities requested or
at a price the Company is willing pay. Because the Company does not control the
actual production of these raw materials, it is also subject to delays caused by
interruption in production of materials based on conditions not within its
control. Such conditions include job actions or strikes by employees of
suppliers, weather, crop conditions, transportation interruptions and natural
disasters or other catastrophic events. With respect to products that are sold
by the Company under the supplier's trademark, such as Ester-C and
Tonalin-Registered Trademark-, the Company is limited to that single supplier as
a source of raw material for that product. As a result, any shortage of raw
materials from that supplier would adversely affect the Company's ability to
manufacture that product. The inability of the Company to obtain adequate
supplies of raw materials for its products at favorable prices, or at all, could
have a material adverse effect on the Company's business, financial condition
and results of operations. See "Business--Manufacturing and Product Quality."
SALES AND EARNINGS VOLATILITY. The Company's sales and earnings continue to
be subject to volatility based upon, among other things: (i) trends and general
conditions in the dietary supplement industry and the ability of the Company to
recognize such trends and effectively introduce and market new products in
response to such trends; (ii) the introduction of new products by the Company or
its competitors; (iii) the loss of one or more significant customers; (iv)
increased media attention on the use and efficacy of dietary supplements; (v)
consumers' perceptions of the products and operations of the Company or its
competitors; and (vi) the availability of raw materials from suppliers. Sales
and earnings volatility as a result of the foregoing factors may affect the
Company's operating results from period to period which may adversely affect the
market price of the Common Stock. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
RISKS ASSOCIATED WITH MANUFACTURING. The Company's results of operations
are dependent upon the continued operation of its manufacturing facility in
Chatsworth, California, at its current levels. The operation of dietary
supplement manufacturing plants involves many risks, including the breakdown,
failure or substandard performance of equipment, natural and other disasters,
and the need to comply with the requirements of directives of government
agencies, including the FDA. In particular, the Company's manufacturing facility
is located in southern California, a geographic area that has historically been
prone to earthquakes, which in some cases have been catastrophic. Prior to the
Company's lease and build-out of the building in which its manufacturing
facility is located, the building was severely damaged in a major earthquake on
January 17, 1994, the epicenter of which was within five miles of the building.
Although the building was rebuilt with an enhanced ability to withstand
earthquakes and conforms to current local and state code requirements, the
Company's manufacturing facility could be damaged or destroyed in the event of
an earthquake. Any such damage or destruction would have a material adverse
effect on the Company's business, financial condition and results of operations.
The Company does not carry earthquake insurance because such insurance is
unobtainable on commercially reasonable terms in the Company's geographic
location. The Company's softgel and liquid products are manufactured by outside
contractors. The Company's profit margins on these products and its ability to
deliver these products on a timely basis are dependent on the ability of the
outside manufacturers to continue to supply products that meet the Company's
quality standards in a timely and cost-efficient
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manner. The occurrence of any of the foregoing or other material operational
problems could have a material adverse effect on the Company's business,
financial condition and results of operations during the period of such
operational difficulties. See "Business--Manufacturing and Product Quality."
RELIANCE ON INDEPENDENT BROKERS. The Company places significant reliance on
a network of independent brokers to act as its primary sales force to mass
market retailers. Although the Company employs management personnel, including
regional sales managers, to closely monitor the brokers, such brokers are not
employed or otherwise controlled by the Company and are generally free to
conduct their business at their own discretion. Although these brokers enter
into contracts with the Company, such contracts typically can be terminated upon
30 days notice by the Company or the independent broker. The simultaneous loss
of the services of a number of these independent brokers could have a material
adverse effect on the Company's business, financial condition and results of
operations. See "Business--Sales and Distribution."
NO ASSURANCE OF FUTURE INDUSTRY GROWTH. Market data referred to in this
Prospectus and otherwise available to prospective investors regarding the size
and projected growth rates of the market for dietary supplements generally
indicate that this market is large and growing. However, there can be no
assurance that such market is as large as reported or that such projected growth
will occur or continue. Market data and projections such as those presented in
this Prospectus are inherently uncertain, subject to change and generally not
available for 1997 and 1998. In addition, the underlying market conditions are
subject to change based on economic conditions, consumer preferences and other
factors that are beyond the Company's control. An adverse change in size or
growth rate of the market for dietary supplements is likely to have a material
adverse effect on the Company's business, financial condition and results of
operations.
INTELLECTUAL PROPERTY PROTECTION. The Company's policy is to pursue
registrations for all of the trademarks associated with its key products. The
Company relies on common law trademark rights to protect its unregistered
trademarks as well as its trade dress rights. Common law trademark rights
generally are limited to the geographic area in which the trademark is actually
used, while a United States federal registration of a trademark enables the
registrant to stop the unauthorized use of the trademark by any third party
anywhere in the United States. The Company intends to register its trademarks in
certain foreign jurisdictions where the Company's products are sold. However,
the protection available, if any, in such jurisdictions may not be as extensive
as the protection available to the Company in the United States.
Currently, the Company has received one United States patent for its
Kavatrol product, has a second United States patent application pending for a
method of using its Kavatrol product and has received two United States patents
on its amino acid products, SAF and SAF for Kids. To the extent the Company does
not have patents on its products, another company may replicate one or more of
the Company's products.
Although the Company seeks to ensure that it does not infringe the
intellectual property rights of others, there can be no assurance that third
parties will not assert intellectual property infringement claims against the
Company. Natrol was contacted in June 1997 by a third party that claimed
Natrol's marketing of melatonin infringed the third party's patents relating to
a method of using melatonin and sought to license such patents to Natrol. Since
Natrol does not believe its marketing of melatonin infringes the third party's
patent claims, Natrol has declined to enter into a license agreement with the
third party. Any infringement claims by third parties against the Company may
have a material adverse effect on the Company's business, financial condition
and results of operations. See "Business-- Trademarks and Patents."
MATERIAL BENEFIT TO INSIDERS. In September 1996, the Company and its
stockholders completed a series of transactions involving TA Associates, Inc., a
private equity firm based in Boston, Massachusetts, and the then current
stockholders of the Company (the "TA Transaction"). In connection with the TA
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Transaction, investment funds associated with TA Associates, Inc. (the "TA
Investors") purchased from the Company's then current stockholders and the
Company an aggregate of 27,000 shares of Convertible Preferred Stock of the
Company. Upon the completion of this offering, the Convertible Preferred Stock
will convert into 2,700,000 shares of Common Stock and 13,500 shares of
Redeemable Preferred Stock. As required by the terms of the Redeemable Preferred
Stock, the Company will immediately redeem all of the shares of the Redeemable
Preferred Stock upon issuance for $6.0 million, representing approximately 15.9%
of the estimated net proceeds to be received by the Company from this offering
at an assumed initial public offering price of $13.00 per share. See "Use of
Proceeds," "Certain Transactions" and "Principal and Selling Stockholders."
EFFECTIVE CONTROL BY PRINCIPAL STOCKHOLDERS. After giving effect to the
sale of the shares of Common Stock offered hereby, Elliott Balbert, the
Company's Chairman, Chief Executive Officer and President, and the TA Investors
will beneficially own in the aggregate approximately 48.7% (45.3% assuming
exercise of the Underwriters' over-allotment option in full) and 16.6% (16.2%
assuming exercise of the Underwriters' over-allotment option in full),
respectively, of the outstanding Common Stock. As a result, Mr. Balbert and the
TA Investors will be able to control or exert significant influence over the
outcome of fundamental corporate transactions requiring stockholder approval,
including, but not limited to mergers and sales of assets and the election of
the members of the Company's Board of Directors. See "Principal and Selling
Stockholders" and "Shares Eligible for Future Sale."
SHARES ELIGIBLE FOR FUTURE SALE. Sales of substantial amounts of Common
Stock in the public market after this offering could adversely affect the market
price of the Common Stock. In addition to the 3,940,000 shares of Common Stock
offered hereby, up to approximately 8,760,000 shares of Common Stock owned by
current stockholders of the Company will be eligible for sale in the public
market pursuant to Rule 144 under the Securities Act of 1933, as amended (the
"Securities Act"), beginning on the later of 90 days after the date of this
Prospectus, and 120,000 shares of Common Stock owned by a current stockholder of
the Company will be eligible for sale in the public market in accordance with
Rule 701 under the Securities Act beginning 90 days after the date of this
Prospectus. In addition 180,000 shares subject to sale under Rule 701 are
subject to vesting provisions and will become eligible for sale in the public
market at various times as they become vested. All executive officers and
directors, certain stockholders of the Company, who in the aggregate will hold
9,010,000 shares of Common Stock (after giving effect to the sale of 740,000
shares by the Selling Stockholders in the offering) and the holders of options
to purchase 685,000 shares of Common Stock, have agreed, pursuant to certain
Lock-up Agreements (the "Lock-up Agreements"), that until 180 days after the
date of this Prospectus, they will not, directly or indirectly, offer, sell,
assign, transfer, encumber, contract to sell, grant an option to purchase, make
a distribution of, or otherwise dispose of, any shares of Common Stock, or any
securities convertible into or exchangeable for shares of Common Stock,
otherwise than (i) as a bona fide gift or gifts, provided that the donee or
donees thereof agree in writing as a condition precedent to such gift or gifts
to be bound by the terms of the Lock-up Agreements, or (ii) with the prior
written consent of Adams, Harkness & Hill, Inc. Stockholders of the Company who
in the aggregate will hold 2,160,000 shares of Common Stock following the
offering have the right on any date after three months after this offering to
require the Company to register their shares under the Securities Act for resale
to the public (i) on Form S-1, if the anticipated net aggregate proceeds exceed
$10.0 million (provided that only one registration on Form S-1 is required) and
(ii) on Form S-3 if the anticipated net aggregate sale price of such registered
shares exceeds $500,000 (provided that only one registration on Form S-3 is
required in any 12 month period). All of such holders are subject to a Lock-up
Agreement. Sales of substantial amounts of Common Stock (including shares issued
in connection with future acquisitions which may be issued with registration
rights), or the availability of such shares for sale, may adversely affect the
prevailing market price for the Common Stock and could impair the Company's
ability to obtain additional capital through an offering of its equity
securities. See "Shares Eligible for Future Sale."
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ABSENCE OF A PUBLIC TRADING MARKET; OFFERING PRICE; POSSIBLE VOLATILITY OF
STOCK PRICE. Prior to this offering, there has been no public market for the
Common Stock, and there can be no assurance that an active market will develop
or be sustained following the consummation of this offering. Consequently, the
offering price of the Common Stock will be determined by negotiation between the
Company, the Selling Stockholders and the representatives of the several
Underwriters based on several factors and will not necessarily reflect the
market price of the Common Stock after this offering or the price at which the
Common Stock may be sold in the public market after this offering. See
"Underwriting" for a description of the factors to be considered in determining
the initial public offering price. Following the completion of this offering,
the trading price of the Common Stock could be subject to wide fluctuations in
response to quarter-to-quarter variations in the Company's operating results,
material announcements by the Company or its competitors, governmental
regulatory action, conditions in the dietary supplement industry, or other
events or factors, many of which are beyond the Company's control. In addition,
the stock market has historically experienced extreme price and volume
fluctuations which have particularly affected the market prices of many dietary
supplement companies and which often have been unrelated to the operating
performance of such companies. The Company's operating results in future
quarters may be below the expectations of securities analysts and investors. In
such event, the price of the Common Stock would likely decline, perhaps
substantially. See "Underwriting."
COMPUTER SYSTEMS AND YEAR 2000 ISSUES. Many existing computer programs and
databases use only two digits to identify a year in the date field (i.e., 98
would represent 1998). These programs and databases were designed and developed
without considering the impact of the upcoming millennium. If not corrected,
many computer systems could fail or create erroneous results relating to the
year 2000. The Company does not anticipate any significant costs, problems or
uncertainties associated with becoming Year 2000 compliant and is currently
developing a plan to ensure that its computer systems are modified to be
compliant on a timely basis. Failure of the Company, its software providers or
the Company's customers or suppliers to adequately address the Year 2000 issue
could result in misstatement of reported financial information or otherwise
adversely affect the Company's business, financial condition and results of
operations. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Year 2000 Compliance."
DIVIDEND POLICY. The Company has not declared cash dividends on its Common
Stock since it ceased to be an S-corporation on September 30, 1996 and the
Company does not anticipate paying cash dividends on its Common Stock in the
foreseeable future. Under Delaware law, the Company is permitted to pay
dividends only out of its surplus, or, if there is no surplus, out of its net
profits. Under the terms of the Company's credit facility, the Company is
required to utilize 25% of annual Excess Cash Flow (as defined in the Company's
credit facility) to prepay outstanding indebtedness thereunder, which may have
the effect of limiting the Company's ability to pay cash dividends. In addition,
the payment of cash dividends may be prohibited under agreements governing debt
which the Company may incur in the future. See "Dividend Policy" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."
ANTI-TAKEOVER PROVISIONS. Certain provisions of the Company's Amended and
Restated Certificate of Incorporation (the "Certificate") and By-laws (the
"By-laws"), certain sections of the Delaware General Corporation Law, and the
ability of the Board of Directors to issue shares of preferred stock and to
establish the voting rights, preferences and other terms thereof, may be deemed
to have an anti-takeover effect and may discourage takeover attempts not first
approved by the Board of Directors (including takeovers which stockholders may
deem to be in their best interests). Such provisions include, among other
things, a classified Board of Directors serving staggered three-year terms, the
elimination of stockholder voting by written consent, the removal of directors
only for cause, the vesting of exclusive authority in the Board of Directors to
determine the size of the Board of Directors and (subject to certain limited
exceptions) to fill vacancies thereon, the vesting of exclusive authority in the
Board of Directors (except as otherwise required by law) to call special
meetings of stockholders and certain advance notice
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requirements for stockholder proposals and nominations for election to the Board
of Directors. These provisions, and the ability of the Board of Directors to
issue preferred stock without further action by stockholders, could delay or
frustrate the removal of incumbent directors or the assumption of control by
stockholders and also could discourage or make more difficult a merger, tender
offer or proxy contest, even if such events would be beneficial to the interest
of stockholders. The Company will be subject to Section 203 of the Delaware
General Corporation Law which, in general, imposes restrictions upon certain
acquirors (including their affiliates and associates) of 15% or more of the
Company's Common Stock. See "Description of Capital Stock--Certain Provisions of
Certificate of Incorporation and By-Laws" and "--Statutory Business Combination
Provision."
IMMEDIATE AND SUBSTANTIAL DILUTION. Purchasers of the Common Stock in this
offering will incur immediate and substantial dilution in the net tangible book
value per share of Common Stock. At an assumed initial public offering price of
$13.00 per share (the midpoint of the range set forth on the cover page of this
Prospectus), investors in this offering will incur dilution of $10.36 per share.
See "Dilution."
15
<PAGE>
USE OF PROCEEDS
The net proceeds to the Company from the sale of the 3,200,000 shares of
Common Stock offered by the Company hereby at an assumed initial public offering
price of $13.00 per share, after deducting the estimated underwriting discounts
and estimated offering expenses payable by the Company, are estimated to be
$37.6 million ($41.2 million if the Underwriters' over-allotment option is
exercised in full). The Company expects to use the net proceeds as follows: (i)
approximately $8.5 million to repay all of the Company's outstanding
indebtedness under its existing bank credit facility with Wells Fargo Bank, N.A.
(the "Credit Facility"), including fees and accrued and unpaid interest; (ii)
$6.0 million to redeem all Redeemable Preferred Stock; (iii) approximately $1.0
million to fund additional capital expenditures related to the Company's
manufacturing facility; and (iv) the balance of approximately $22.1 million for
working capital and other general corporate purposes. The Company routinely
evaluates potential acquisitions of businesses and products that would
complement or expand the Company's business or further its strategic goals. The
Company may use a portion of the net proceeds from this offering for one or more
such transactions; however, it currently has no commitments or agreements with
respect to such transactions. Pending such use, the balance of the net proceeds
will be invested in short-term, investment grade, interest bearing obligations.
The Company will not receive any proceeds from the sale of shares of Common
Stock by the Selling Stockholders. See "Principal and Selling Stockholders."
The Credit Facility consists of a $9.0 million term loan (the "Term Loan")
and an $8.0 million revolving line of credit (the "Line of Credit"). The Term
Loan matures in February 2004 and the Line of Credit expires in May 2001. As of
June 30, 1998, the Company had no outstanding indebtedness under the Line of
Credit and the outstanding principal balance of the Term Loan was $8.5 million.
Amounts outstanding under the Credit Facility bear interest at variable rates
which are based upon either the prime rate or LIBOR, plus in either case a
margin which varies according to the Company's compliance with certain financial
ratios. The interest rate on such indebtedness at June 30, 1998 was 7.41% per
annum. The Company incurred $11.0 million in indebtedness under the Credit
Facility in connection with the Pure-Gar Acquisition in February 1998. See
"Capitalization" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources."
DIVIDEND POLICY
The Company has not declared any cash dividends on its Common Stock since it
ceased to be an S corporation on September 30, 1996. The Company currently
intends to retain its earnings for future growth and, therefore, does not
anticipate paying cash dividends in the foreseeable future. Under Delaware law,
the Company is permitted to pay dividends only out of its surplus, or, if there
is no surplus, out of its net profits. Under the terms of the Credit Facility,
the Company is required to utilize 25% of annual Excess Cash Flow (as defined in
the Credit Facility) to prepay outstanding indebtedness thereunder, which may
have the effect of limiting the Company's ability to pay cash dividends. In
addition, the payment of cash dividends may be prohibited under agreements
governing debt which the Company may incur in the future. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."
16
<PAGE>
CAPITALIZATION
The following table sets forth the capitalization of the Company as of March
31, 1998 (i) on an actual basis, (ii) on a pro forma basis to give effect to the
conversion of the Convertible Preferred Stock and (iii) as adjusted to give
effect to the sale of the 3,200,000 shares of Common Stock offered by the
Company hereby at an assumed initial public offering price of $13.00 per share
and the application of the estimated net proceeds therefrom as described in "Use
of Proceeds." This table should be read in conjunction with the Consolidated
Financial Statements of the Company and Notes thereto included elsewhere in this
Prospectus.
<TABLE>
<CAPTION>
MARCH 31, 1998
------------------------------------
<S> <C> <C> <C>
ACTUAL PRO FORMA AS ADJUSTED
--------- ----------- ------------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C> <C>
Current maturities of long-term debt(1).................................... $ 1,500 $ 1,500 $ --
--------- ----------- ------------
--------- ----------- ------------
Long-term debt, less current maturities(1)................................. $ 7,375 $ 7,375 $ --
--------- ----------- ------------
Convertible Participating Preferred Stock, $0.01 par value per share:
27,000 shares authorized; 27,000 shares issued and outstanding, actual;
no shares authorized, issued or outstanding on a pro forma basis and as
adjusted................................................................. 12,000 -- --
Redeemable Preferred Stock, $0.01 par value per share: 13,500 shares
authorized; no shares issued or outstanding, actual; 13,500 shares issued
and outstanding on a pro forma basis; no shares authorized, issued or
outstanding, as adjusted(2).............................................. -- 6,000 --
Stockholders' equity:
Preferred Stock, $0.01 par value per share: no shares authorized, issued
or outstanding, actual; 2,000,000 shares authorized, no shares issued
or outstanding on a pro forma basis and as adjusted.................... -- -- --
Common Stock, $0.01 par value per share: 10,550,000 shares authorized,
7,100,000 shares issued and outstanding, actual; 50,000,000 shares
authorized, and 9,800,000 shares issued and outstanding on a pro forma
basis; 50,000,000 shares authorized, 13,000,000 shares issued and
outstanding, as adjusted(3)............................................ 71 98 130
Additional paid-in capital................................................. 560 12,533 50,201
Retained earnings (deficit)(4)............................................. (457) (6,457) (6,457)
Receivable from stockholder................................................ (563) (563) (563)
--------- ----------- ------------
Total stockholders' equity (deficit)................................... (389) 5,611 43,311
--------- ----------- ------------
Total capitalization............................................... $ 18,986 $ 18,986 $ 43,311
--------- ----------- ------------
--------- ----------- ------------
</TABLE>
- ------------------------------
(1) See Notes 3 and 9 of Notes to Consolidated Financial Statements for
information concerning long-term debt obligations.
(2) Upon completion of this offering and as presented on a pro forma basis, the
outstanding shares of Convertible Preferred Stock will convert into an
aggregate of 2,700,000 shares of Common Stock and an aggregate of 13,500
shares of Redeemable Preferred Stock. All shares of Redeemable Preferred
Stock will be redeemed for an aggregate of $6.0 million in cash and retired
as presented on an as adjusted basis. See "Use of Proceeds" and "Certain
Transactions."
(3) Excludes: (i) 720,000 shares of Common Stock currently issuable upon
exercise of outstanding stock options, including options with respect to
320,000 shares of Common Stock granted subsequent to March 31, 1998; (ii)
750,000 additional shares of Common Stock available for future grants under
the 1996 Stock Plan as of June 30, 1998; and (iii) 225,000 additional shares
of Common Stock available for future sales under the Purchase Plan. Under
the terms of the 1996 Stock Plan, the sale of the 3,200,000 shares offered
by the Company hereby will result in the reservation for issuance of an
additional 480,000 shares of Common Stock under the 1996 Stock Plan. See
"Management--Employee Stock and Other Benefit Plans--1996 Stock Option and
Grant Plan" and "--1998 Employee Stock Purchase Plan."
(4) Reflects a decrease in retained earnings (deficit) for an aggregate of $6.0
million for the redemption of the Redeemable Preferred Stock. See "Use of
Proceeds" and "Certain Transactions."
17
<PAGE>
DILUTION
The pro forma net tangible book value of the Common Stock as of March 31,
1998 was $(9.4) million, or $(0.96) per share. Pro forma net tangible net book
value per share represents the amount of total tangible assets of the Company
less total liabilities of the Company divided by the number of Common Stock
outstanding, including all outstanding stock grants and excluding all
outstanding stock options.
After giving effect to the sale of the 3,200,000 shares of Common Stock
offered by the Company hereby at an assumed initial public offering price of
$13.00 per share the receipt and application by the Company of the estimated net
proceeds therefrom, the pro forma net tangible book value of the Common Stock as
of March 31, 1998 would have been $34.3 million, or $2.64 per share. This
represents an immediate increase in pro forma net tangible book value $3.60 per
share to existing stockholders and an immediate dilution to $10.36 per share to
purchasers of Common Stock in this offering. The following table illustrates
this per share dilution:
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share...................... $ 13.00
Pro forma net tangible book value per share at March 31, 1998.... $ (0.96)
Increase per share attributable to new stockholders.............. 3.60
---------
Pro forma net tangible book value per share after the offering....... 2.64
---------
Pro forma net tangible book value dilution per share to new
stockholders....................................................... $ 10.36
---------
---------
</TABLE>
The following table summarizes, on a pro forma basis as of March 31, 1998
after giving effect to the conversion of all outstanding shares of Convertible
Preferred Stock, the differences between existing stockholders and the new
stockholders with respect to the number of shares of Common Stock purchased from
the Company, the total consideration and the average price per share paid:
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
-------------------------- --------------------------- AVERAGE PRICE PAID
NUMBER PERCENT AMOUNT PERCENT PER SHARE
------------- ----------- -------------- ----------- -------------------
<S> <C> <C> <C> <C> <C>
Existing stockholders................. 9,800,000 75.4% $ 2,145,150 4.9% $ 0.22
New stockholders...................... 3,200,000 24.6 41,600,000 95.1 13.00
------------- ----- -------------- -----
Total............................. 13,000,000 100.0% $ 43,745,150 100.0%
------------- ----- -------------- -----
------------- ----- -------------- -----
</TABLE>
Other than as noted above, the foregoing computations assume no exercise of
any outstanding stock options after March 31, 1998 or the Underwriters'
over-allotment option. As of March 31, 1998, options to purchase 400,000 shares
of Common Stock were outstanding and subsequent to such date the Company granted
options to purchase an additional 320,000 shares of Common Stock. To the extent
any of these options or the Underwriters' over-allotment option is exercised,
there will be further dilution to new stockholders. See "Underwriting" for
information concerning the Underwriters' over-allotment option.
18
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated statement of income data for each of the
three years ended December 31, 1997 and consolidated balance sheet data at
December 31, 1996 and 1997 are derived from consolidated financial statements of
the Company which have been audited by Ernst & Young LLP, independent auditors,
and are included elsewhere herein. The balance sheet data at December 31, 1995,
is derived from audited financial statements not included herein. The selected
financial information for the years ended December 31, 1993 and 1994 are derived
from unaudited financial statements not included herein. The consolidated income
data for the three months ended March 31, 1997 and 1998 and the consolidated
balance sheet data at March 31, 1998 are derived from unaudited consolidated
financial statements also included elsewhere in the Prospectus. The unaudited
consolidated financial statements have been prepared by the Company on a basis
consistent with the Company's audited financial statements and, in the opinion
of management, include all adjustments, consisting only of normal recurring
accruals, necessary for a fair presentation of the Company's consolidated
financial position and results of operations for these periods. The consolidated
results of operations for the three months ended March 31, 1998 are not
necessarily indicative of results for the year ending December 31, 1998 or any
future period. The data set forth below should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Consolidated Financial Statements of the Company and Notes
thereto included herein.
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
----------------------------------------------------- ----------------------
1993 1994 1995 1996 1997 1997 1998(1)
--------- --------- --------- --------- --------- --------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
(IN THOUSANDS, EXCEPT PER SHARE DATA)
CONSOLIDATED STATEMENT OF INCOME DATA:
Net sales............................................ $ 9,484 $ 12,214 $ 23,566 $ 40,802 $ 42,875 $ 9,909 $ 13,116
Cost of goods sold................................... 5,658 7,106 12,214 18,497 19,800 4,475 6,321
--------- --------- --------- --------- --------- --------- -----------
Gross profit....................................... 3,826 5,108 11,352 22,305 23,075 5,434 6,795
--------- --------- --------- --------- --------- --------- -----------
Selling and marketing expenses....................... 2,194 2,552 4,458 8,736 11,398 2,990 3,477
General and administrative expenses.................. 1,197 1,739 3,378 5,431 4,450 1,055 1,230
--------- --------- --------- --------- --------- --------- -----------
Total operating expenses........................... 3,391 4,291 7,836 14,167 15,848 4,045 4,707
--------- --------- --------- --------- --------- --------- -----------
Operating income..................................... 435 817 3,516 8,138 7,227 1,389 2,088
Interest income (expense), net....................... 33 (25) (19) 54 (220) (35) (131)
--------- --------- --------- --------- --------- --------- -----------
Income before income tax provision................... 468 792 3,497 8,192 7,007 1,354 1,957
Income tax provision................................. 189 301 1,453 2,299(2) 2,816 544 782
--------- --------- --------- --------- --------- --------- -----------
Net income........................................... $ 279 $ 491 $ 2,044 $ 5,893 $ 4,191 $ 810 $ 1,175
--------- --------- --------- --------- --------- --------- -----------
--------- --------- --------- --------- --------- --------- -----------
Basic earnings per share............................. $ 0.05 $ 0.08 $ 0.34 $ 0.94 $ 0.59 $ 0.11 $ 0.17
--------- --------- --------- --------- --------- --------- -----------
--------- --------- --------- --------- --------- --------- -----------
Diluted earnings per share........................... $ 0.05 $ 0.08 $ 0.34 $ 0.83 $ 0.41 $ 0.08 $ 0.11
--------- --------- --------- --------- --------- --------- -----------
--------- --------- --------- --------- --------- --------- -----------
Weighted average common shares outstanding--basic.... 6,000 6,000 6,000 6,275 7,100 7,100 7,100
--------- --------- --------- --------- --------- --------- -----------
--------- --------- --------- --------- --------- --------- -----------
Weighted average common shares outstanding--diluted.. 6,000 6,000 6,000 7,065 10,273 10,262 10,273
--------- --------- --------- --------- --------- --------- -----------
--------- --------- --------- --------- --------- --------- -----------
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------------- MARCH 31,
1993 1994 1995 1996 1997 1998
--------- --------- --------- --------- --------- -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents.................................... $ -- $ 560 $ 515 $ 285 $ 1,800 $ 2,229
Working capital.............................................. 251 926 2,741 4,496 8,424 5,299
Total assets................................................. 1,689 3,972 7,608 11,345 19,716 32,029
Long-term debt, less current maturities...................... 84 84 67 405 2,606 7,375
Convertible participating preferred stock.................... -- -- -- 12,000 12,000 12,000
Total stockholders' equity (deficit)......................... 895 1,259 3,303 (5,755) (1,564) (389)
Cash dividend declared per common share...................... $ 0.00 $ 0.00 $ 0.00 $ 0.55 $ 0.00 $ 0.00
</TABLE>
- ------------------------
(1) The Consolidated Statement of Income Data for the three months ended March
31, 1998, includes the historical results of Pure-Gar for the period from
February 27, 1998 to the date of the Pure-Gar Acquisition through the end of
the period, which may affect the comparability of such data to the prior
period. See "Unaudited Pro Forma Consolidated Statements of Income."
(2) In 1996, the Company was taxed under Subchapter S of the Code for the period
from July 1, 1996 through September 29, 1996, and was taxed under Subchapter
C of the Code for the period from January 1, 1996 through June 30, 1996 and
for the period from September 30, 1996 through December 31, 1996.
Accordingly, the provision for income taxes for the period in which the
Company was taxed as a Subchapter S corporation reflects primarily state
income tax, if any. If the Company had been subject to taxation under
Subchapter C of the Code for the entire year ended December 31, 1996, the
pro forma provision for income taxes would have been $3.2 million and pro
forma basic earnings per share and pro forma diluted earnings per share
would have been $0.80 and $0.71, respectively.
19
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION OF THE RESULTS OF OPERATIONS AND FINANCIAL
CONDITION OF THE COMPANY SHOULD BE READ IN CONJUNCTION WITH THE CONSOLIDATED
FINANCIAL STATEMENTS OF THE COMPANY AND THE NOTES THERETO INCLUDED ELSEWHERE IN
THIS PROSPECTUS. EXCEPT FOR THE HISTORICAL INFORMATION CONTAINED HEREIN, THE
DISCUSSION CONTAINED IN THIS PROSPECTUS CONTAINS "FORWARD-LOOKING STATEMENTS"
THAT INVOLVE RISK AND UNCERTAINTIES. THESE STATEMENTS MAY BE IDENTIFIED BY THE
USE OF FORWARD-LOOKING TERMINOLOGY SUCH AS "BELIEVES," "EXPECTS," "MAY," "WILL,"
"SHOULD" OR "ANTICIPATES" OR THE NEGATIVE THEREOF OR SIMILAR EXPRESSIONS OR BY
DISCUSSIONS OF STRATEGY. THE CAUTIONARY STATEMENTS MADE IN THIS PROSPECTUS
SHOULD BE READ AS BEING APPLICABLE TO ALL RELATED FORWARD-LOOKING STATEMENTS
WHEREVER THEY APPEAR IN THIS PROSPECTUS. THE COMPANY'S ACTUAL RESULTS COULD
DIFFER MATERIALLY FROM THOSE DISCUSSED IN THIS PROSPECTUS. IMPORTANT FACTORS
THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES INCLUDE THOSE DISCUSSED UNDER
THE CAPTION ENTITLED "RISK FACTORS," AS WELL AS THOSE DISCUSSED ELSEWHERE
HEREIN.
OVERVIEW
Natrol manufactures and markets branded, high-quality dietary supplements.
The Company sells its products under the Natrol brand name through multiple
distribution channels throughout the United States, including domestic health
food stores and mass market drug, retail and grocery store chains. The Company
recently strengthened its product categories through an acquisition which
included two brands of garlic products, as well as a bulk ingredient business
which supplies dehydrated vegetable products to other manufacturers.
Natrol derives its net sales primarily from sales of dietary supplement
products to health food and mass market retailers and sales of bulk raw
materials. The Company's growth in net sales historically has been a result of
the introduction of new products on an ongoing basis and the expansion of sales
through additional channels of distribution. During the last three years, the
Company's net sales have been affected by the success of certain products,
including Melatonin and DHEA, which were introduced in 1995 and 1996,
respectively. During 1995 and 1996, these products gained substantial popularity
with the general public and generated net sales of $6.7 million in 1995 and
$22.9 million in 1996. However, during 1997 the net-sales volume of these two
products declined by an aggregate of $9.8 million, or 42.9%. When consumer
products experience heightened public popularity, it is not uncommon for them to
enjoy peaks of pipeline sales followed by declines. Accordingly, the Company
anticipated a decline in net sales of Melatonin and DHEA and introduced 34 new
products with 53 SKUs in 1997, which accounted for $8.9 million, or 20.7%, of
net sales in 1997. Growth in existing product lines added an additional $6.8
million to 1997 net sales. In the three months ended March 31, 1998, the largest
product category comprised 25.6% of net sales. A combination of new product
introductions, increases of existing product sales and increased penetration in
the mass market and health food channels of distribution contributed to the
Company's net sales growth during 1997 and the three months ended March 31,
1998. The Company believes that its future growth in net sales will depend on a
combination of these factors to a greater extent than on the rapid success of a
limited number of products. The Company's future results may be affected
significantly by the success or failure of individual products or product lines
that rapidly achieve or lose widespread popularity.
The Company has derived a significant portion of its net sales from certain
of its mass market and health food distribution customers. Net sales to
Walgreens accounted for 15.3% of the Company's net sales for the three months
ended March 31, 1998 and 17.7% and 12.6% of the Company's net sales in 1997 and
1996, respectively. Net sales to Tree of Life accounted for 10.4% of the
Company's net sales for the three months ended March 31, 1998 and 11.6% and
10.2% of the Company's net sales in 1997 and 1996, respectively. Net sales to
GNC accounted for 3.0% of the Company's net sales for the three months ended
March 31, 1998 and 2.3% and 14.5% of the Company's net sales in 1997 and 1996,
respectively.
20
<PAGE>
During 1997 the Company invested heavily in corporate infrastructure and the
building out and equipping of a 90,000 square foot manufacturing and
headquarters facility. The facility has improved manufacturing efficiency, and
management believes the facility provides the flexibility to service customers
more effectively and respond rapidly to increases in demand for particular
products. The Company also developed a dedicated employee sales force (22
employees as of June 1, 1998) during 1997 to service the health food channel of
distribution. Net sales within the health food channel of distribution grew
approximately 23% during 1997.
On February 27, 1998, the Company acquired substantially all of the assets
and certain liabilities of Pure-Gar. The acquisition involved the purchase of
two brands of garlic supplements, Quintessence and Highgar Farms, as well as a
bulk ingredient business. In connection with the acquisition, the Company
recorded $9.0 million of goodwill which will be amortized on a straight line
basis over 15 years, amounting to $600,000 of annual amortization expenses.
RESULTS OF OPERATIONS
The following table sets forth the percentages of net sales represented by
certain items reflected in the Company's statements of income. The information
that follows should be read in conjunction with the Consolidated Financial
Statements of the Company and Notes thereto included elsewhere in this
Prospectus.
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED DECEMBER 31, ENDED MARCH 31,
------------------------------- --------------------
<S> <C> <C> <C> <C> <C>
1995 1996 1997 1997 1998
--------- --------- --------- --------- ---------
Net sales........................................................ 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of goods sold............................................... 51.8 45.3 46.2 45.2 48.2
--------- --------- --------- --------- ---------
Gross profit................................................. 48.2 54.7 53.8 54.8 51.8
--------- --------- --------- --------- ---------
Selling and marketing expenses................................... 18.9 21.4 26.6 30.2 26.5
General and administrative expenses.............................. 14.3 13.3 10.4 10.6 9.4
--------- --------- --------- --------- ---------
Total operating expenses..................................... 33.2 34.7 37.0 40.8 35.9
--------- --------- --------- --------- ---------
Operating income................................................. 15.0 20.0 16.8 14.0 15.9
Interest income (expense), net................................... (0.1) 0.1 (0.6) (0.3) (1.0)
--------- --------- --------- --------- ---------
Income before income tax provision............................... 14.9 20.1 16.2 13.7 14.9
Income tax provision............................................. 6.2 5.6(1) 6.6 5.5 6.0
--------- --------- --------- --------- ---------
Net income....................................................... 8.7% 14.5% 9.6% 8.2% 8.9%
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
- ------------------------------
(1) In 1996, the Company was taxed under Subchapter S of the Code for the period
from July 1, 1996 through September 29, 1996, and was taxed under Subchapter
C of the Code for the period from January 1, 1996 through June 30, 1996 and
for the period from September 30, 1996 through December 31, 1996.
Accordingly, the provision for income taxes for the period in which the
Company was taxed as a Subchapter S corporation reflects primarily state
income tax, if any. If the Company had been subject to taxation under
Subchapter C of the Code for the entire year ended December 31, 1996, the
pro forma provision for income taxes would have been 7.7% of net sales.
THREE MONTHS ENDED MARCH 31, 1998 AND MARCH 31, 1997
NET SALES. Sales are recognized at the time product is shipped. Net sales
are net of discounts, allowances, and estimated returns and credits. Net sales
increased 32.4%, or $3.2 million, to $13.1 million for the three months ended
March 31, 1998 from $9.9 million for the three months ended March 31, 1997. Of
the $3.2 million increase, $1.2 million, or 37.5%, was attributable to net sales
of Pure-Gar, acquired in February 1998, with the remainder due to increases in
net sales of the Company's other dietary supplement products. The net sales of
Pure-Gar for the month of March 1998 were higher than
21
<PAGE>
anticipated due to a larger-than-usual bulk product purchase by an existing
customer. The $2.0 million increase in net sales of the Company's other dietary
supplement products was primarily due to a $3.7 million increase in net sales of
products introduced since the end of the first quarter of 1997 and a $1.0
million increase in sales of existing products, which was partially offset by a
$2.7 million decrease in net sales of products in the Company's specialty
dietary supplements category, primarily Melatonin and DHEA. The Company believes
that sales of Melatonin have stabilized although there can be no assurance that
sales of Melatonin will not decrease in future quarters, perhaps substantially.
GROSS PROFIT. Gross profit increased 23.5%, or $1.3 million, to $6.7
million for the three months ended March 31, 1998 from $5.4 million for the
three months ended March 31, 1997. Gross margin decreased to 51.1% for the three
months ended March 31, 1998 from 54.8% for the three months ended March 31,
1997. The decline was primarily due to a shift in product mix. Based on its
current product mix the Company expects that gross margins over the near term
will be generally consistent with the gross margins for the three months ended
March 31, 1998.
SELLING AND MARKETING EXPENSES. Selling and marketing expenses consist
primarily of advertising and promotional expenses, cost of distribution, and
related payroll expenses and commissions. Selling and marketing expenses
increased 16.3%, or $487,000, to $3.5 million for the three months ended March
31, 1998 from $3.0 million for the three months ended March 31, 1997. The
increase was primarily due to additional advertising, promotional and payroll
expenses to support increased net sales. As a percentage of net sales, selling
and marketing expenses decreased to 26.5% for the three months ended March 31,
1998 from 30.2% for the three months ended March 31, 1997.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
consist primarily of personnel costs related to general management functions,
finance, accounting and information systems, research and development expenses,
as well as professional fees related to legal, audit and tax matters and
depreciation and amortization. General and administrative expenses increased
16.6%, or $175,000, to $1.2 million for the three months ended March 31, 1998
from $1.0 million for the three months ended March 31, 1997. This increase was
primarily attributable to building the infrastructure to support and manage the
Company's growth, as well as $50,000 of amortization of goodwill associated with
the Pure-Gar Acquisition. The Company may incur additional amortization expense
as a result of any future acquisitions. As a percentage of net sales, general
and administrative expenses decreased to 9.4% for the three months ended March
31, 1998 from 10.6% for the three months ended March 31, 1997.
INTEREST INCOME (EXPENSE), NET. Interest expense increased $96,000 to
$131,000 for the three months ended March 31, 1998 from $35,000 for the three
months ended March 31, 1997. The increase was a result of increased outstanding
indebtedness relating to the financing of the Pure-Gar Acquisition and capital
expenditures. See "--Liquidity and Capital Resources."
YEARS ENDED DECEMBER 31, 1997 AND DECEMBER 31, 1996
NET SALES. Net sales increased 5.1%, or $2.1 million, to $42.9 million in
1997 from $40.8 million in 1996. The increase was due to net sales of $8.9
million attributable to products introduced in 1997 and a $3.0 million overall
increase in net sales of existing products, which more than offset a $9.8
million decrease in net sales of Melatonin and DHEA. The net increase in net
sales of new and existing products (other than Melatonin and DHEA ) was
primarily due to increased penetration and expanded presence in both the health
food store and mass market distribution channels.
GROSS PROFIT. Gross profit increased 3.5%, or $771,000, to $23.1 million in
1997 from $22.3 million in 1996. Gross margin decreased to 53.8% for 1997 from
54.7% for 1996. The decrease was primarily due to a shift in product mix as a
result of a decrease in sales in the Company's higher gross margin specialty
dietary supplements category, principally Melatonin and DHEA.
22
<PAGE>
SELLING AND MARKETING EXPENSES. Selling and marketing expenses increased
30.5%, or $2.7 million, to $11.4 million in 1997 from $8.7 million in 1996. As a
percentage of net sales, selling and marketing expenses increased to 26.6% in
1997 from 21.4% in 1996. The increase was primarily due to increases in spending
to support increased net sales, in particular increases in print, radio and
television advertising, and other promotional expenses and payroll expenses.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
decreased 18.2%, or $981,000, to $4.5 million in 1997 from $5.4 million in 1996.
As a percentage of net sales, general and administrative expenses decreased to
10.4% in 1997 from 13.3% in 1996. This decrease was primarily attributable to
increased payroll expenses as a result of significantly higher management
performance-based incentive bonuses in 1996.
INTEREST INCOME (EXPENSE), NET. Interest expense increased $274,000 to
$220,000 in 1997 from interest income of $54,000 in 1996. The increase net was
primarily due to increased borrowings to fund capital expenditures.
INCOME TAX PROVISION. Provision for income taxes increased 22.5%, or
$518,000, to $2.8 million in 1997 from $2.3 million in 1996. The effective tax
rate for 1997 was 40.2%, compared to 28.0% for 1996. The Company was taxed under
Subchapter S of the Code for the period from July 1, 1996 through September 30,
1996, at which time the Company ceased to qualify as an S corporation. As a
result, the Company paid no federal income taxes for the third calendar quarter
of 1996. If the Company had been required to pay federal income taxes during
such quarter, the provision for income taxes would have been $3.2 million and
the effective tax rate would have been 38.6%. The increase in the effective tax
rate in 1997 from the pro forma tax rate in 1996 was primarily due to the
differences in the various income tax rates in the states in which the Company
did business.
YEARS ENDED DECEMBER 31, 1996 AND DECEMBER 31, 1995
NET SALES. Net sales increased 73.1%, or $17.2 million, to $40.8 million in
1996 from $23.6 million in 1995. The increase was due almost entirely to
increased sales of Melatonin and DHEA. The Company's net sales of Melatonin
increased markedly as a result of favorable publicity regarding the use of
melatonin and the Company's aggressive promotional efforts. The Company also
introduced DHEA in 1996 and benefitted from substantial favorable publicity
regarding its use.
GROSS PROFIT. Gross profit increased 96.5%, or $11.0 million, to $22.3
million in 1996 from $11.4 million in 1995. Gross margin increased to 54.7% in
1996 from 48.2% in 1995. The increase was primarily due to a shift in product
mix to products with higher gross margins, most significantly Melatonin and
DHEA.
SELLING AND MARKETING EXPENSES. Selling and marketing expenses increased
96%, or $4.3 million, to $8.7 million in 1996 from $4.5 million in 1995. As a
percentage of net sales, selling and marketing expenses increased to 21.4% in
1996 from 18.9 % in 1995. The increase was primarily due to increases in
spending to support increased net sales, in particular increases in print, radio
and television advertising.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased 58.8%, or $2.0 million, to $5.4 million in 1996 from $3.4 million in
1995. This increase was primarily attributable to increased payroll expenses as
a result of significantly higher management performance-based incentive bonuses
in 1996. As a percentage of net sales, general and administrative expenses
decreased to 13.3% in 1996 from 14.3% in 1995.
INTEREST INCOME (EXPENSE), NET. Interest income increased $72,000 to
$54,000 in 1996 from interest expense of $19,000 in 1995. The increase was
primarily due to interest income on significantly higher cash balances as a
result of increased net sales in 1996.
23
<PAGE>
INCOME TAX PROVISION. Provision for income taxes increased 58.2%, or
$846,000, to $2.3 million in 1996 from $1.5 million in 1995. The effective tax
rate for 1996 was 28.0%, compared to 41.5% for 1995. The Company was taxed under
Subchapter S of the Code for the period from July 1, 1996 through September 30,
1996, at which time the Company ceased to qualify as an S corporation. As a
result, the Company paid no federal income taxes for the third calendar quarter
of 1996. If the Company had been required to pay federal income taxes during
such quarter, the provision for income taxes would have been $3.2 million and
the effective tax rate would have been 38.6%. The decrease in the pro forma tax
rate in 1996 from the effective tax rate in 1995 was primarily due to the
differences in the various income tax rates in the states in which the Company
did business.
QUARTERLY FINANCIAL INFORMATION; SEASONALITY
The following table sets forth unaudited quarterly operating results for
each of the Company's last nine quarters as well as certain of such data
expressed as a percentage of net sales for the periods indicated. This
information has been prepared by the Company on a basis consistent with the
Company's audited consolidated financial statements and includes all adjustments
(consisting only of normal recurring adjustments) that management considers
necessary for a fair presentation of the data. These quarterly results are not
necessarily indicative of future results of operations. This information should
be read in conjunction with the Consolidated Financial Statements of the Company
and Notes thereto included elsewhere in this Prospectus.
The Company believes that its business is characterized by mild seasonality.
Historically, the Company has recorded higher sales and profitability during the
third and fourth quarters of the year and the weaker sales and profitability
during the second quarter of the year. The Company does not believe that the
impact of seasonality on its results of operations is material. However, the
Company has experienced quarterly volatility in net sales as a result of, among
other things, trends and general conditions in the dietary supplement industry,
introduction of new products by the Company or its competitors and increased
media attention on the use and efficacy of dietary supplements. In addition,
advertising and marketing expenses have historically fluctuated from
quarter-to-quarter, which has in some cases contributed to quarterly variations
in the Company's operating income.
24
<PAGE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED
------------------------------------------------------------------------------------------------------
MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31,
1996 1996 1996 1996 1997 1997 1997 1997
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF
INCOME DATA:
Net sales................. $ 11,505 $ 7,369 $ 10,280 $ 11,648 $ 9,909 $ 8,191 $ 11,392 $ 13,382
Cost of goods sold........ 5,451 2,738 4,835 5,473 4,475 3,815 5,368 6,142
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
Gross profit............ 6,054 4,631 5,445 6,175 5,434 4,376 6,024 7,240
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
Selling and marketing
expenses................ 1,924 2,360 1,999 2,453 2,990 2,825 2,670 2,913
General and administrative
expenses................ 1,489 1,319 1,342 1,282 1,055 1,046 1,067 1,283
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
Total operating
expenses.............. 3,413 3,679 3,341 3,735 4,045 3,871 3,737 4,196
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
Operating income.......... 2,641 952 2,104 2,440 1,389 505 2,287 3,044
Interest income (expense),
net..................... (7) (11) 31 42 (35) (41) (74) (69)
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
Income before income tax
provision............... 2,634 941 2,135 2,482 1,354 464 2,213 2,975
Income tax provision...... 1,028 348 40(1) 882 544 187 889 1,196
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
Net income................ $ 1,606 $ 593 $ 2,095 $ 1,600 $ 810 $ 277 $ 1,324 $ 1,779
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
<CAPTION>
MAR. 31,
1998
-----------
<S> <C>
CONSOLIDATED STATEMENT OF
INCOME DATA:
Net sales................. $ 13,116
Cost of goods sold........ 6,321
-----------
Gross profit............ 6,795
-----------
Selling and marketing
expenses................ 3,477
General and administrative
expenses................ 1,230
-----------
Total operating
expenses.............. 4,707
-----------
Operating income.......... 2,088
Interest income (expense),
net..................... (131)
-----------
Income before income tax
provision............... 1,957
Income tax provision...... 782
-----------
Net income................ $ 1,175
-----------
-----------
</TABLE>
<TABLE>
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Basic earnings per
share................... $ 0.27 $ 0.10 $ 0.35 $ 0.23 $ 0.11 $ 0.04 $ 0.19 $ 0.25
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
Diluted earnings per
share................... $ 0.27 $ 0.10 $ 0.32 $ 0.16 $ 0.08 $ 0.03 $ 0.13 $ 0.17
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
Weighted average common
shares
outstanding-basic....... 6,000 6,000 6,012 7,100 7,100 7,100 7,100 7,100
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
Weighted average common
shares outstanding-
diluted................. 6,000 6,000 6,503 10,262 10,262 10,262 10,273 10,273
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
<CAPTION>
Basic earnings per
-----------
-----------
Diluted earnings per
share................... $ 0.11
-----------
-----------
Weighted average common
shares
outstanding-basic....... 7,100
-----------
-----------
Weighted average common
shares outstanding-
diluted................. 10,273
-----------
-----------
<CAPTION>
share................... $ 0.17
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED
------------------------------------------------------------------------------------------------------
MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31,
1996 1996 1996 1996 1997 1997 1997 1997
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
AS A PERCENTAGE OF NET
SALES:
Net sales................. 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of goods sold........ 47.4 37.2 47.0 47.0 45.2 46.6 47.1 45.9
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
Gross profit............ 52.6 62.8 53.0 53.0 54.8 53.4 52.9 54.1
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
Selling and marketing
expenses................ 16.7 32.0 19.4 21.1 30.2 34.5 23.4 21.8
General and administrative
expenses................ 12.9 17.9 13.1 11.0 10.7 12.8 9.4 9.6
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
Total operating
expenses.............. 29.6 49.9 32.5 32.1 40.9 47.3 32.8 31.4
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
Operating income.......... 23.0 12.9 20.5 20.9 13.9 6.1 20.1 22.7
Interest income (expense),
net..................... (0.1) (0.2) 0.3 0.4 (0.4) (0.5) (0.7) (0.5)
Income before income tax
provision............... 22.9 12.7 20.8 21.3 13.5 5.6 19.4 22.2
Income tax provision...... 8.9 4.7 0.4 7.6 5.5 2.3 7.8 8.9
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
Net income................ 14.0% 8.0% 20.4% 13.7% 8.0% 3.3% 11.6% 13.3%
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
<CAPTION>
MAR. 31,
1998
-----------
<S> <C>
AS A PERCENTAGE OF NET
SALES:
Net sales................. 100.0%
Cost of goods sold........ 48.2
-----------
Gross profit............ 51.8
-----------
Selling and marketing
expenses................ 26.5
General and administrative
expenses................ 9.4
-----------
Total operating
expenses.............. 35.9
-----------
Operating income.......... 15.9
Interest income (expense),
net..................... (1.0)
Income before income tax
provision............... 14.9
Income tax provision...... 6.0
-----------
Net income................ 8.9%
-----------
-----------
</TABLE>
- ------------------------------
(1) The Company was taxed under Subchapter S of the Code for the period from
July 1, 1996 through September 29, 1996. Accordingly, the provision for
income taxes for the period in which the Company was taxed as a Subchapter S
corporation reflects primarily state income tax. If the Company had been
subject to taxation under Subchapter C of the Code for the quarter ended
September 30, 1996, the pro forma provision for income taxes would have been
$862 and pro forma basic earnings per share and pro forma diluted earnings
per share would have been $0.21 and $0.20, respectively.
25
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
The Company has historically financed its operations and capital
requirements primarily through funds from operations and, to a lesser extent,
borrowings. At March 31, 1998, the Company had working capital of $5.3 million,
as compared to $8.4 million in working capital at December 31, 1997. The
decrease was primarily due to an increase in the current portion of long-term
debt as a result of increased borrowings due to the Pure-Gar Acquisition.
Net cash provided by operating activities was $3.4 million for the three
months ended March 31, 1998 and $2.1 million, $3.8 million and $409,000 in 1997,
1996 and 1995, respectively. The decrease in net cash provided by operating
activities in 1997 compared to 1996 was primarily due to a decrease in net
income and reflects higher levels of accounts receivable and inventory balances,
partially offset by higher levels of depreciation and amortization, provision
for reserves for doubtful accounts and other reserves and accounts payable. The
increase in inventory balances was primarily due to the purchase of larger
quantities of raw materials to obtain favorable volume discounts and the
purchase of raw materials for new products in anticipation of new product
introductions scheduled for 1998. The increase in accounts receivable was the
result of increased sales by the Company during such period to mass market
retailers from whom accounts receivable are on average outstanding for a longer
period of time. At March 31, 1998 the Company's average trade receivable aging
was under 45 days. The increase in net cash provided by operating activities in
1996 compared to 1995 was primarily due to an increase in net income and
reflected a decrease in accounts receivable which was only partially offset by
an increase in inventory balances.
Net cash used in investing activities was $11.2 million for the three months
ended March 31, 1998 and $3.2 million, $1.9 million and $409,000 in 1997, 1996
and 1995, respectively. Of the net cash used in investing activities in the
three months ended March 31, 1998, the Company used $11.1 million to consummate
the Pure-Gar Acquisition and invested $111,000 in property and equipment.
Substantially all net cash used in investing activities in 1997 and 1996
constituted capital expenditures made in connection with the build-out of the
Company's manufacturing facility/headquarters, which the Company began in 1996.
Net cash used in investing activities in 1995 consisted entirely of capital
expenditures.
Net cash provided by (used in) financing activities was $8.3 million for the
three months ended March 31, 1998 and $2.6 million, ($2.1 million) and ($44,000)
in 1997, 1996 and 1995, respectively. Net cash provided by financing activities
in the three months ended March 31, 1998 consisted entirely of borrowings to
finance in part the Pure-Gar Acquisition. Net cash provided by financing
activities in 1997 was comprised of net borrowings of $3.0 million to finance
capital expenditures made in connection with the build-out and equipping of the
Company's manufacturing facility, which was partially offset by $400,000 used to
pay dividends to stockholders declared in 1996. Net cash provided by financing
activities in 1996 was comprised of net borrowings of $415,000 used for capital
expenditures and proceeds of $854,000 from the sale by the Company to the TA
Investors of 1,921.9 shares of Convertible Preferred Stock. These amounts were
more than offset by $503,000 (net of $349,000 of compensation expense) used to
redeem shares of Common Stock from a stockholder and $2.9 million used to pay
dividends to stockholders. Net cash provided by financing activities in 1995 was
comprised entirely of net borrowings for working capital.
The Company's current Credit Facility consists of a $9.0 million term loan
and an $8.0 million revolving line of credit. The term loan matures in February
2004 and the line of credit expires in May 2001. As of March 31, 1998, the
Company had outstanding borrowings of $11.8 million under the Credit Facility.
The amounts outstanding under the Credit Facility bear interest at variable
rates which are based upon either the lender's base rate or LIBOR, plus, in
either case, a margin which varies according to the ratio of the Company's total
indebtedness to its earnings before interest, taxes, depreciation, and
amortization expenses for the relevant period. Furthermore, the Credit Facility
contains various financial
26
<PAGE>
covenants which are predicated on the Company's present and projected financial
condition. In the event that future operations differ materially from what is
expected, the Company may no longer be able to meet the tests set out in the
Credit Facility. Failure to meet these tests may result in a default by the
Company under the Credit Facility which may materially adversely affect the
Company's liquidity. The Credit Facility requires that the Company use 25% of
its net income after taxes, plus (i) depreciation and amortization expenses
minus (ii) unfinanced capital expenditures and scheduled principal debt and
capital lease payments, to repay outstanding indebtedness thereunder. The Credit
Facility restricts or prohibits the Company from incurring indebtedness,
incurring liens, disposing of assets or making investments or acquisitions,
without the consent of the lenders and requires the Company to maintain certain
financial ratios on an ongoing basis. As of June 1, 1998, the Company was in
compliance with the covenants and restrictions in the Credit Facility. The
Credit Facility is collateralized by pledges of all of the outstanding capital
stock of the Company's subsidiaries, and a lien on substantially all of the
assets of the Company.
The Company will use the net proceeds from this offering to repay all
outstanding indebtedness under the Credit Facility and to redeem for $6.0
million all Redeemable Preferred Stock to be issued upon the conversion of the
Company's Convertible Preferred Stock at the completion of this offering. The
Company believes that the remaining net proceeds from this offering, together
with cash generated from operations and borrowings under the Credit Facility,
will be sufficient to fund its anticipated working capital needs and capital
expenditures (other than financing necessary to complete future acquisitions, if
any) for at least the next 12 months. Future acquisitions, if any, could be
funded with cash from operations, the net proceeds of this offering, and
borrowings under the Credit Facility. There can be no assurance that attractive
acquisition opportunities will be available to the Company or will be available
at prices and upon such other terms that are attractive to the Company. To the
extent the Company has outstanding indebtedness under the Credit Facility or is
required to incur indebtedness thereunder to consummate an acquisition, the
consent of the lender under the Credit Facility will be required prior to such
acquisition. The Company regularly evaluates the potential acquisition of other
businesses, products and product lines and may hold discussions regarding such
potential acquisitions. As a general rule, the Company will publicly announce
such acquisitions only after a definitive agreement has been signed. The Company
currently has no commitments or agreements with respect to any acquisition. In
addition, in order to meet its long-term liquidity needs or consummate future
acquisitions, the Company may be required to incur additional indebtedness or
issue additional equity and debt securities, subject to market and other
conditions. There can be no assurance that such additional financing will be
available on terms acceptable to the Company or at all. The failure to raise the
funds necessary to finance its future cash requirements or consummate future
acquisitions could adversely affect the Company's ability to pursue its strategy
and could negatively affect its operations in future periods.
IMPACT OF INFLATION
Generally, the Company has been able to pass on inflation cost increases.
Consequently, inflation has not had a material impact on the Company's
historical operations or profitability.
YEAR 2000 COMPLIANCE
Many existing computer programs and databases use only two digits to
identify a year in the date field (i.e., 98 would represent 1998). These
programs and databases were designed and developed without considering the
impact of the upcoming millennium. If not corrected, many computer systems could
fail or create erroneous results relating to the year 2000. The Company does not
anticipate any significant costs, problems or uncertainties associated with
becoming Year 2000 compliant and is currently developing a plan to ensure that
its computer systems and other operations are modified to be compliant on a
timely basis.
27
<PAGE>
BUSINESS
OVERVIEW
Natrol, Inc. ("Natrol" or the "Company") manufactures and markets branded,
high-quality dietary supplements. The Company sells its products under the
Natrol brand name through multiple distribution channels throughout the United
States, including domestic health food stores and mass market drug, retail and
grocery store chains. Natrol's select line of more than 145 products consists of
approximately 500 SKUs and includes vitamins, minerals, herbs, speciality
formulations, weight control products and hormones. The Company's strategy
emphasizes building strong recognition of the Natrol brand across multiple
distribution channels through a widespread multimedia marketing and advertising
strategy. The Company recently strengthened its product categories through an
acquisition which included two brands of garlic products as well as a bulk
ingredient business which supplies dehydrated vegetable products to other
manufacturers.
INDUSTRY
Based on estimates in THE U.S. MARKET FOR VITAMINS, SUPPLEMENTS, AND
MINERALS, a 1997 market report prepared by Packaged Facts (the "Packaged Facts
Report"), an independent consumer marketing research firm, the retail market for
vitamins, minerals and other supplements (excluding sports nutrition and diet
products) has grown at a compound annual rate of 15% from $3.7 billion in 1992
to $6.5 billion in 1996. A large portion of this growth is attributable to an
increase in sales of other supplements (primarily herbal products), which grew
from $570 million in 1992 to $2.3 billion in 1996. Growth in this category has
been fueled by the popularity of such herbs as echinacea, garlic, ginseng,
ginkgo biloba and, more recently, saw palmetto and St. John's wort. The Packaged
Facts Report forecasts 13.6% compound annual growth in the market for vitamins,
minerals and other supplements (excluding sports nutrition and diet products),
including 25% compound annual growth in the market for other supplements,
through 2001. Compound annual growth rates from 1992 through 1996 for vitamins,
minerals and other supplements were 8.0%, 5.2% and 41.7%, respectively.
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
<TABLE>
<CAPTION>
RETAIL SALES AND GROWTH OF THE U.S. MARKET
<S> <C> <C> <C>
for Vitamins, Minerals and Other Supplements,
1992-1996
(dollars in billions)
Sales ($)
Other Supplements Vitamins Minerals
1992 0.6 2.6 0.6
1993 0.9 2.9 0.6
1994 1.3 3.1 0.6
1995 1.8 3.3 0.7
1996 2.3 3.5 0.7
</TABLE>
- ------------------------
Source: The Packaged Facts Report
The Company believes that growth in the dietary supplement industry has been
driven by: (i) the aging of the "baby boom" generation combined with consumers'
tendency to purchase more dietary supplements as they age; (ii) the publication
of research findings supporting the positive health effects of certain dietary
supplements; (iii) increased media attention on the use and efficacy of dietary
supplements; (iv) the nationwide trend toward preventive medicine in response to
rising healthcare
28
<PAGE>
costs; (v) increased consumer interest in herbs and herb-related supplements;
and (vi) increased interest in healthier lifestyles and the connection between
diet and health.
Dietary supplements are sold through several channels of distribution,
including health food stores, mass market retailers (drug store chains,
supermarkets and other mass merchandisers), and direct sales channels (including
network marketing and catalog distribution). In 1996, according to the Packaged
Facts Report, health food stores accounted for 38.2% of sales of vitamins,
minerals and other supplements, the mass market channel accounted for
approximately 45.8% of such sales and the remaining 16.0% of such sales were
generated through direct selling, mail order and the Internet.
The Company believes the United States health food store market is comprised
of over 9,500 stores, which are generally either independently owned or
associated with one of several regional or national chains, such as GNC, Wild
Oats Markets and Whole Foods Market. The health food store channel of
distribution has continued to experience growth in recent years as national
chains as well as other industry participants continue to add stores in new and
existing markets.
The United States mass market distribution channel consists of drug stores,
including chains such as Walgreens, American Drug Stores and Eckerd, mass
merchandisers such as Wal-Mart, Kmart, BJ's Wholesale Club and ShopKo, and food
stores, including national supermarket chains. In the mass market channel, sales
of vitamins, herbs and dietary supplements have generally grown in line with the
growth in all channels due to the proliferation of retail outlets and the
expansion of SKU's offered by these stores. According to the Packaged Facts
Report, in the mass market distribution channel, sales of vitamins, minerals and
other supplements have increased from approximately $2.3 billion in 1994 to
approximately $3.0 billion in 1996. Sales from herbal and other supplements have
shown the fastest rate of growth in the mass market distribution channel from
1994 to 1996. Within drug stores and mass merchandisers, sales from herbal and
other supplements increased as a percentage of total sales of dietary
supplements from an estimated 13.1% in 1994 to an estimated 20.9% in 1996.
Herbal and other supplements have begun to penetrate food stores as well,
increasing from 8% of total sales of dietary supplements in 1994 to 12% in 1996.
Total retail sales of vitamins, minerals and other supplements were $6.5
billion in 1996. The following chart sets forth the relative amount of total
sales in each channel of distribution in the dietary supplement industry in
1996:
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
<TABLE>
<CAPTION>
HEALTH AND NATURAL FOOD STORES 38.2%
<S> <C>
Drug Store Chains 20.2%
Mass Merchandisers 14.8%
Supermarkets 10.8%
Direct Selling 12.6%
Mail Order and the Internet 3.4%
</TABLE>
- ------------------------
Source: The Packaged Facts Report
29
<PAGE>
The dietary supplement industry is currently fragmented with hundreds of
manufacturers, marketers and distributors of vitamins, minerals and other
supplements in the various channels of distribution. Generally, most larger
companies sell multiple brands into each channel of distribution and smaller
companies generally target only one channel of distribution. The Company
believes that these industry dynamics present growth opportunities for a single
brand with strong brand recognition across multiple distribution channels.
BUSINESS STRATEGY
The Company's objective is to manufacture and market dietary supplements
that are strongly identified with the Natrol brand. Key elements of the
Company's strategy include the following:
- CONTINUE TO BUILD STRONG BRAND RECOGNITION. The Company's growth strategy
emphasizes building strong recognition of the Natrol brand across multiple
distribution channels. The Company consistently promotes the Natrol brand
through a widespread multimedia marketing and advertising strategy and
seeks to spend approximately 15% of its annual net sales on marketing and
advertising. The Company uses print, radio and television advertising to
reach millions of consumers each month throughout all of the nation's top
100 markets. Recent advertising initiatives include the "Natrol Health
Minute," as heard on the nationally syndicated Dr. Laura Schlessinger and
Rush Limbaugh radio shows, and commercials featured on the CNN/ Turner
Network.
- EXPAND PRESENCE AND PENETRATION IN THE HEALTH FOOD STORE AND MASS MARKET
DISTRIBUTION CHANNELS. The Company continually seeks to increase its
market penetration within both the health food store and mass market
distribution channels by gaining more shelf space within each store and
expanding the number of products and SKUs carried by retailers. Within the
health food store distribution channel, the Company's dedicated sales
force maintains direct and regular contact with key store personnel,
informing them of new product developments and industry trends, aiding
them in the design of store sets and creating merchandising programs which
promote brand and category awareness. Within the mass market distribution
channel, the Company's regional sales managers and network of independent
brokers work with corporate buyers, focusing on special promotional
activities and brand and category awareness. The number of the Company's
customers in the mass market distribution channel increased 35.2% in 1997
over 1996 and the average number of SKUs per customer in this channel
increased 34.3% in 1997 over 1996.
- CONTINUE TO DEVELOP NEW PRODUCTS. Since its inception, the Company has
focused on the ongoing development and marketing of new products in order
to capitalize on and create market opportunities. The Company has
established a focused process to anticipate consumer trends and to monitor
product developments within the dietary supplement industry. This process
includes communication with a panel of scientific advisors, the formal
review of periodicals, scientific research and use of on-line databases.
In addition, the Company develops proprietary products such as Kavatrol,
Mood Support and the Natrol for Women product line. The Company introduced
34 new products with 53 SKUs in 1997 and has introduced 21 new products
with 28 SKUs in the three months ended March 31, 1998.
- EXPAND BULK SALES BUSINESS. The Company believes that opportunities exist
for expansion of sales of bulk raw materials to other manufacturers,
distributors and marketers of dietary supplements. The Company's bulk
ingredient business currently involves the sale of dehydrated vegetable
products, primarily garlic, acquired from Basic Vegetable Products, L.P.
("BVP") pursuant to an exclusive, multi-year supply agreement. In the
future, the Company may seek to expand its bulk sales activities to
include sales of other bulk raw materials used in the manufacture of
dietary supplements.
30
<PAGE>
- DEVELOP ADDITIONAL DISTRIBUTION CHANNELS. The Company sells a substantial
majority of its products through the domestic health food stores and mass
market distribution channels. The Company believes that sales
opportunities exist in other distribution channels such as mail order and
the Internet, direct selling (multi-level marketing as well as sales to
health professionals), direct retail and international. Over time and as
the Company deems appropriate, the Company intends to enter or expand
these distribution channels either through internal growth or
acquisitions. The Company's products have been sold in Canada, China,
Turkey, Indonesia, Korea and a limited number of South American countries.
The Company believes that opportunities may develop as consumers in other
countries gain greater awareness of the benefits of dietary supplements.
- PURSUE STRATEGIC ACQUISITIONS. The Company believes that the dietary
supplement industry is currently fragmented and that attractive
acquisition opportunities may exist in the future. The Company intends to
pursue acquisition opportunities that will allow it to broaden its product
lines, increase the distribution channels it serves or otherwise
complement its business or further its strategic goals. The Company
completed its first acquisition, the Pure-Gar Acquisition, in February
1998. This acquisition involved the purchase of two well-known brands,
Quintessence and Highgar Farms, and enabled the Company to enter the
garlic supplement market and the bulk ingredient business from a position
of strength.
The Company intends to continue investing in its management team and
corporate infrastructure to support its business strategy. The Company has,
since January 1, 1997, hired a Director of Finance to support its Chief
Financial Officer, a Director of Administration, a product development manager,
a manager of information systems, a Director of International Sales, and a
number of mid-level managers and quality control and manufacturing personnel. In
addition, the Company has improved significantly its manufacturing capabilities
with its lease and build-out of a 90,000 square foot manufacturing/ headquarters
facility, which the Company occupied in March 1997. This facility has
substantial additional capacity and manufacturing flexibility which enables the
Company to bring products to market promptly in response to consumer demand and
to support increased sales volume.
PRODUCTS
The Company focuses on premium dietary supplement products that are in high
demand as well as specialty niche and proprietary formulations that have
potentially strong margins. The Company's products include vitamins, minerals,
herbs, specialty formulations, weight control products, hormones and various
nutrients. The Company positions Natrol as a premium brand of vitamins, minerals
and other supplements rather than a value brand. The Company manufactures and
sells more than 145 products packaged into approximately 500 SKUs. The Company's
consumer products are currently divided into seven product categories: Ester-C,
Herbals, Natrol Premium, Lifestyle Products, Garlic, Specialty Dietary
Supplements and Natural Diet Control. The Company also sells bulk raw materials.
The percentage of the Company's net sales represented by each of its product
categories fluctuates from period to period. For the three months ended March
31, 1998, the largest category accounted for 25.6% of net sales while the
smallest accounted for 3.6% of net sales and for 1997 the largest category
accounted for 29.4% of net sales while the smallest accounted for 3.5% of net
sales.
ESTER-C. Introduced in 1986, Ester-C is a buffered form of pH-neutral
Vitamin C and one of Natrol's cornerstone products. Although many Natrol
competitors sell Ester-C, according to Spence Information Services, Natrol's
Ester-C held approximately 25% of the Vitamin C market in health food stores in
1997. The Company has built its market share though heavy promotion, associating
Ester-C with the Natrol brand. The Company sells approximately 45 SKUs of
Ester-C, each offering a special potency, pill count, delivery system or
specialty combination, such as Ester-C with zinc.
HERBALS. Herbal supplements are popular in the health food store channel
and are becoming increasingly popular in the mass market distribution channel.
The Company's Herbals category consists
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of more than fifty herbal extracts. These include single herb products such as
St. John's wort, ginkgo biloba and kava kava, standardized extracts such as
bilberry, and specialty formulations that combine herbs designed to meet
particular consumer needs. Examples of the Company's specialty herb formulations
are Eye Support, Hair & Nail Formula, Liver Support and Mental Support.
LIFESTYLE PRODUCTS. This category is designed to meet particular lifestyle
needs. Product formulations are generally proprietary, and include Kavatrol, an
herbal kava formulation used as a calming aid, and Mood Support, a formulation
of St. John's wort and other herbs used for mood elevation. During the three
months ended March 31, 1998, the Company launched Natrol for Women, a line in
which each formulation is designed to meet nutritional needs specific to women.
The Company believes there is significant opportunity to expand the Lifestyle
Products category with formulations that are proprietary to the Natrol label.
NATROL PREMIUM. The Natrol Premium category includes My Favorite Multiple
(called the "Cadillac of vitamins" by the Center for Science in the Public
Interest) and the Company's core group of vitamins, minerals, anti-oxidants and
generic supplements. The Natrol Premium category, which contains approximately
80 SKUs and includes many widely consumed and popular vitamins, minerals and
other supplements, is important to Natrol's business as the Company seeks to
build broad-based consumer support and brand recognition.
GARLIC. The Company's Garlic category consists of two brands, Quintessence
and Highgar Farms, acquired in the Pure-Gar Acquisition. Quintessence is sold
through the health food store distribution channel while the Highgar Farms brand
is sold through the mass market distribution channel. Both brands have a solid
reputation for delivering high quality, high potency tablets and capsules. The
Company intends to integrate the Natrol name and logo into these brands.
SPECIALTY DIETARY SUPPLEMENTS. The Company's Specialty Dietary Supplements
category includes products such as Melatonin, DHEA and Pregnenolone. Melatonin
helped establish the Company's reputation within the mass market channel of
distribution. In 1996, the Company received the Rex Award for Market Maker of
the Year and the Rex Award for Best Nutritional Supplement, each from Drug Store
News, for its introduction of Melatonin into the chain drugstore distribution
channel. According to Information Resources, Inc., the Company ranked first in
net sales of Melatonin in the food, drug and mass trade class in the United
States in 1997.
NATURAL DIET CONTROL. The Company's Natural Diet Control category consists
of products sold for weight control or weight loss. The category includes
products such as Cravex, Tonalin, Absorbitol-Registered Trademark-, Chitosan,
Calcium Pyruvate and Citrimax-Registered Trademark-. Products within the natural
diet control category typically have a shorter life cycle than other dietary
supplement products, leading Natrol to be more aggressive with new product
development in this category.
The Company emphasizes the ongoing development and introduction of products
in response to emerging trends or scientific developments in the dietary
supplement market. The Company believes it has an excellent reputation among
retailers for introducing items at the front end of the consumer demand curve
and then working to develop brand loyalty after product introduction. Management
continually evaluates its product categories and SKUs for trends in sales and
profitability, de-emphasizing or dropping products when profitability or SKU
velocity lags and regularly introducing new products to replace slower moving
products, capitalize on market trends and diversify the Company's product
offerings. See "--Research and Product Development."
In its bulk ingredient business, the Company currently sells dehydrated
vegetable products, primarily garlic, to other manufacturers, distributors and
marketers of dietary supplements. The Company obtains bulk garlic from BVP
pursuant to a multi-year supply agreement that gives the Company the exclusive
right to sell BVP's vegetable powders in the dietary supplement industry. The
Company's future business may include sales of other bulk raw materials when, as
and if opportunities arise. See "--Manufacturing and Product Quality."
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MARKETING
The Company believes that its strategy of selling through both the health
food store and mass market channels of distribution under a single
label--Natrol--distinguishes the Company from its competition. Most of the
Company's competitors sell products into each channel using different brand
names, in some cases using a premium brand for the health channel and a value
brand for the mass market. The Company's core strategy is to continue to build
the Natrol brand name within multiple channels of distribution in order to
develop increased brand awareness and strong brand recognition among consumers
seeking products with a reputation for quality. The Company believes it can
leverage its reputation for high quality products developed within the health
food distribution channel in the mass market by positioning its products as a
premium, high quality brand rather than a value brand. By maintaining a single
brand identity, the Company believes it can also leverage its advertising budget
across multiple distribution channels.
The Company utilizes print, radio and television advertising. The Company
spent $2.1 million, or 16.0% of net sales on advertising and other marketing and
promotional activities in the three months ended March 31, 1998 and $6.9
million, or 16.2% of net sales, and $5.6 million, or 13.8% of net sales, in 1997
and 1996, respectively.
The Company generally uses targeted health-oriented magazines such as BETTER
NUTRITION, DELICIOUS and GREAT LIFE to support the health food store
distribution channel and uses mainstream publications such as PREVENTION,
HEALTH, USA TODAY, TV GUIDE, MCCALLS, FAMILY CIRCLE, WOMEN'S DAY and major
airline in-flight publications to support the mass market distribution channel.
The Company has utilized talk radio since 1991 when the Company first
advertised on the original LARRY KING LIVE SHOW. Throughout 1998, the Company's
"Natrol Health Minute," which features medical nutritional specialist Dr. Bruce
Hensel, will be heard on the nationally syndicated Dr. Laura Schlessinger and
Rush Limbaugh radio shows. The "Natrol Health Minute" campaign will feature
discussions about current health and nutrition issues. The campaign is intended
to make the Natrol name synonymous with good health.
In 1997, the Company first utilized television as part of its introductory
campaign for Kavatrol. Throughout 1998, the Company's commercials will be seen
on the CNN/Turner Network, including such programs as CNN HEADLINE NEWS, CNN
MORNING NEWS and BURDEN OF PROOF. In addition, the Natrol logo will appear on
HEADLINE WEATHER and HEADLINE SPORTS TICKER.
The Company also actively works to keep the news media aware of product
developments. In recent years the Company's products have appeared in
periodicals such as TIME, NEWSWEEK, THE WALL STREET JOURNAL and COSMOPOLITAN as
well as in television footage produced by programs such as 20/20, DATELINE, 48
HOURS and PRIME TIME LIVE.
SALES AND DISTRIBUTION
The Company distributes its products primarily to domestic health food
stores and mass market drug, retail and food stores. Net sales into these
distribution channels have historically accounted for a substantial majority of
the Company's total net sales. The Company's products are also available at a
wide range of other distribution points, including mail order and the Internet,
airport shops, resort hotels and salons.
The Company sells its products to health food stores through the leading
national distributors, including United Natural Foods and Tree of Life, as well
as directly to GNC. Natrol products are sold by health food store chains such as
Wild Oats Markets, Whole Foods Market, Hi-Health, Vitamin Cottage, Fred Meyer
Nutrition Centers and Vitamin Shoppes, as well as most independent health food
stores. The Company also distributes its products to domestic military
exchanges. During 1996 and 1997, in order to better develop retail business
within the health food store distribution channel, the Company converted
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from a sales network of independent brokers to a direct sales force of more than
22 employees under the supervision of three regional managers (at May 1, 1998).
The mass market distribution channel is managed by the Company's Vice
President of Sales and regional managers who work with a network of independent
brokers. The Company's employees service certain of its larger mass market
accounts directly while independent brokers service others in conjunction with
the Company's management. The Company sells its products to mass market
merchandisers either directly or through distributors of vitamins, minerals and
other supplement products such as Bergen Brunswick, McKesson and Cardinal. Some
of the Company's major mass market retail customers are Walgreens, CVS, American
Drug Stores, Rite Aid, Long's Drug, Drug Emporium, Eckerd, Snyders, Brooks Drug,
Wal-Mart, Kmart, Target, ShopKo and BJ's Wholesale Club. The Company also sells
its products in grocery stores and supermarkets, including Dominick's, Ralphs,
Von's, Cub Foods, Food For Less and Wegmans. The Company believes supermarket
and grocery stores present significant opportunities for growth in the dietary
supplement industry.
The Company provides retailers in both the health food store and the mass
market distribution channel with a wide array of comprehensive services tailored
to meet their individual needs. In the health food store channel, the Company's
dedicated sales force maintains direct and regular contact with key store
personnel, informing them of new product developments and industry trends,
aiding them in the design of store sets and creating merchandising programs that
promote brand and category awareness. The Company's regional sales managers and
independent brokers in the mass market distribution channel work with corporate
buyers focusing on special promotional activities and brand and category
awareness in order to gain more shelf space. The objective of these activities
is to build strong relationships with the Company's marketing partners and to
increase the number of stores carrying its products and the amount of space
allocated to, and the overall number of, the Company's products and SKUs within
each store.
Net sales to Walgreens accounted for 15.3% of the Company's net sales for
the three months ended March 31, 1998 and 17.7% and 12.6% of the Company's net
sales in 1997 and 1996, respectively. Net sales to Tree of Life accounted for
10.4% of the Company's net sales for the three months ended March 31, 1998 and
11.6% and 10.2% of the Company's net sales in 1997 and 1996, respectively. Net
sales to GNC accounted for 3.0% of the Company's net sales for the three months
ended March 31, 1998 and 2.3% and 14.5% of the Company's net sales in 1997 and
1996, respectively. The Company does not have long-term contracts with any of
its customers.
RESEARCH AND PRODUCT DEVELOPMENT
The Company emphasizes the ongoing development and introduction of products
in response to emerging trends in the dietary supplement market. The Company
believes it has an excellent reputation among retailers for introducing items at
the front end of the consumer demand curve and then working to develop brand
loyalty after product introduction. Management continually evaluates its product
categories and SKUs for trends in sales and profitability, de-emphasizing or
dropping products when profitability or SKU velocity lags and regularly
introducing new products to replace slower moving products, capitalize on market
trends and diversify the Company's product offerings. In addition, new products
often have higher gross margins than mature items. For these reasons, the
Company considers product development essential to maintaining growth and
profitability.
The Company believes it has developed a reputation among retailers for
consistently identifying new products with market potential. During 1996 and
1997 the Company was one of the first companies to market and promote broadly
melatonin, DHEA and St. John's wort. The Company has also introduced a number of
proprietary formulations including Kavatrol, Mood Support, Thera-C, and a line
of women's specialty products. As a result of its product development efforts,
the Company introduced 34 new products with 53 SKUs in 1997 and has introduced
21 products with 28 SKUs in the three months ended March 31, 1998.
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The Company has established a focused process to anticipate consumer
demands, monitor product developments within the dietary supplement industry,
and facilitate generation of new ideas for product introductions. In this
process, the Company's product development staff reviews periodicals, scientific
research and relevant clinical studies within medical journals and uses on-line
databases.
The Company also consults with a panel of scientific advisors to assist
members of its product development team. These advisors include: Dr. Terry
Willard, a recognized herbal expert, author and president of the Canadian
Association of Herbal Practitioners; Dr. Alexander Schauss, Director of the Life
Sciences Division, Natural and Medicinal Products Research of the American
Institute for Biosocial Research, Inc.; Dr. Ronald R. Watson, a scientist who
has published more than 150 articles relating to nutrition and immunology; and
Dr. Bruce Hensel, a physician and journalist. The Company also communicates with
other scientists on a regular basis regarding new product concepts.
The Company sponsors scientific research by independent researchers as a
part of its product development efforts. In order to implement its strategy of
consistently developing new products, in 1998 the Company is expanding its
budget for scientific research and product development. The Company is
sponsoring research by BVP which is focused on the development of functional
foods as well as the improvement of the potency of garlic and other dehydrated
vegetable products. The Company has agreed to pay BVP royalties with respect to
sales of products developed in connection with its research. The Company
recently sponsored a randomized, double-blind, placebo-controlled study at the
University of Virginia regarding the efficacy of the Company's proprietary
Kavatrol product, which produced favorable results. The Company has also
commissioned further independent research by the same researchers at the
University of Virginia on its proprietary Kavatrol product regarding dosage
levels.
MANUFACTURING AND PRODUCT QUALITY
The Company manufactures its products at its 90,000 square foot
manufacturing facility/ headquarters located in Chatsworth, California. At this
facility, the Company manufactures both tablets and two piece capsules which
accounted for more than 90% of the Company's net sales in 1997. The Company also
manufactures dietary supplement products pursuant to purchase orders with
customers who distribute and sell the products under their own brands and for
other customers as opportunities arise. The Company uses third party vendors to
produce its liquid products and softgels.
The Company places a strong emphasis on quality control because it believes
that quality standards play a critical factor in consumer purchasing decisions
and in differentiating the Natrol brand. The Company's products are manufactured
in accordance with current GMPs of the FDA for foods and the applicable
regulations of other agencies.
The Company's manufacturing facility includes an on-site laboratory which is
staffed by the director of quality assurance, bench chemists and other quality
control personnel. The Company's laboratory contains equipment for performing
testing procedures, including high performance liquid chromatography,
ultra-violet and infra-red spectrophotometry and thin layer chromatography. The
Company requires all raw materials or finished product produced by third party
vendors to be placed in quarantine upon receipt and tested by the Company's
quality control laboratory. The Company conducts sample testing, weight testing,
purity testing, dissolution testing and, where required, microbiological
testing. When raw materials are released from quarantine each lot is assigned a
unique lot number which is tracked throughout the manufacturing process.
Materials are blended, tested and then encapsulated or formed into pills which
may or may not be coated. The Company routinely performs qualitative and
quantitative quality control procedures on its finished products.
The Company obtains all of its raw materials for the manufacture of its
products from third-party suppliers. Many of the raw materials used in Company's
products are harvested internationally. With the exception of bulk garlic and
Ester-C, the Company does not have contracts with any suppliers committing such
suppliers to provide the materials required for the production of its products.
In the last few years, natural vitamin E, beta carotene and melatonin have had
significant price fluctuations as a result of short
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supply or increases in demand. The Company has experienced occasional shortages
of raw materials for a limited number of its products but to date has only
encountered short-term production interruptions as a result of such shortages.
No single supplier accounted for more than approximately 12.5% of the Company's
total purchases in 1997. There can be no assurance that suppliers, including
suppliers of bulk garlic and Ester-C, will provide the raw materials needed by
the Company in the quantities requested or at a price the Company is willing
pay. Because the Company does not control the actual production of these raw
materials, it is also subject to delays caused by interruption in production of
materials based on conditions not within its control. Such conditions include
job actions or strikes by employees of suppliers, weather, crop conditions,
transportation interruptions and natural disasters or other catastrophic events.
With respect to products that are sold by the Company under the supplier's
trademark, such as Ester-C and Tonalin, the Company is limited to that single
supplier as a source of raw materials for that product. As a result, any
shortage of raw materials from that supplier would adversely affect the
Company's ability to manufacture that product. The inability of the Company to
obtain adequate supplies of raw materials for its products at favorable prices,
or at all, could have a material adverse effect on the Company's business,
financial condition and results of operations.
The Company is a party to a multi-year Distributorship/Packager/Supply
Agreement (the "Inter-Cal Agreement") with Inter-Cal Corporation ("Inter-Cal"),
under which Inter-Cal is required to supply the Company with its requirements of
bulk Ester-C. The Inter-Cal Agreement requires the Company to use its best
efforts to promote and sell Ester-C vitamin products worldwide with the
exception of certain specified countries, including Australia and New Zealand
and certain European countries. The Inter-Cal Agreement may be terminated by
Inter-Cal immediately if the Company violates the terms of certain provisions
relating to distribution and packaging and may be terminated by either party
upon a default of the obligations of the other party if the default has not been
cured within 60 days. The Company is also a party to a multi-year Supply
Agreement (the "BVP Agreement") with BVP, which requires BVP to sell and the
Company to purchase specified amounts of certain vegetable, fruit, herbal and
botanical products (the "BVP Products") manufactured by BVP. The BVP Agreement
gives the Company the exclusive right to sell certain BVP Products in the
dietary supplement industry. The BVP Agreement may be terminated by either party
upon a material breach of the obligations of the other party, or certain other
specified conditions, if the breach is not cured within 60 days, or within 15
days in the case of non-payment by the Company.
The Company has the current manufacturing capability to produce four million
tablets and capsules per eight hour shift and 420,000 bottles per week per
shift. The Company, on average, operates its manufacturing facility one shift
per day, five to six days per week. At times certain of the Company's packaging
lines or capsule and tablet production lines run longer hours as demand
warrants. The Company believes it can triple current sales volumes without the
necessity of expanding the current facility. Such a tripling of production would
require additional space for warehousing and shipping operations but would not
require substantial capital investment.
The Company operates flexible manufacturing lines which enable it to shift
output efficiently among various pieces of equipment depending upon such factors
as batch size, tablets or capsule count, and labeling requirements. The Company
strives to fulfill and ship all orders within 48 hours.
The Company has a strong commitment to maintaining the quality of the
environment. Nearly all of the plastic or glass containers used by the Company
are recyclable. The Company does not use solvents in its manufacturing
processes. The Company believes it is in compliance with all applicable
environmental regulations.
COMPETITION
The dietary supplement industry is highly competitive. Numerous companies,
many of which have greater size and financial, personnel, distribution and other
resources than the Company, compete with the Company in the development,
manufacture and marketing of dietary supplements. The Company's
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principal competition in the health food store distribution channel comes from a
limited number of large nationally known manufacturers and many smaller
manufacturers of dietary supplements. In the mass market distribution channel,
the Company's principal competition comes from broadline manufacturers, major
private label manufacturers and other companies. In recent years, a number of
the Company's competitors have begun to market and sell their products under
different labels in both the health food store and the mass market distribution
channels. In addition, large pharmaceutical companies and packaged food and
beverage companies compete with the Company on a limited basis in the dietary
supplement market. With respect to Ester-C and the Company's Natrol Premium
category, the Company faces significant additional competition from large
pharmaceutical companies that market vitamins, multivitamins and minerals in the
mass market distribution channel. Increased competition from such companies
could have a material adverse effect on the Company because such companies have
greater financial and other resources available to them and possess
manufacturing, distribution and marketing capabilities far greater than those of
the Company. The Company also faces competition in both the health food store
and mass market distribution channels from private label dietary supplements and
multivitamins offered by health and natural food store chains, drugstore chains,
mass merchandisers and supermarket chains.
The Company competes on the basis of product quality, pricing, customer
service and marketing support. The Company believes that it competes favorably
with its competitors on the strength of the Company's strong brand recognition
across multiple distribution channels, ability to quickly develop new products
with market potential, sophisticated marketing, advertising and promotional
support, product quality, and strong and effective sales force and distribution
network.
REGULATORY MATTERS
The manufacture, packaging, labeling, advertising, promotion, distribution
and sale of the Company's products are subject to regulation by numerous
governmental agencies, the most active of which is the U.S. Food and Drug
Administration (the "FDA"), which regulates the Company's products under the
Federal Food, Drug and Cosmetic Act (the "FDCA") and regulations promulgated
thereunder. The Company's products are also subject to regulation by, among
other regulatory agencies, the Consumer Product Safety Commission, the U.S.
Department of Agriculture (the "USDA") and the Environmental Protection Agency
(the "EPA"). Advertising of the Company's products is subject to regulation by
the U.S. Federal Trade Commission (the "FTC"), which regulates the Company's
advertising under the Federal Trade Commission Act (the "FTCA"). The
manufacture, labeling and advertising of the Company's products are also
regulated by various state and local agencies as well as each foreign country to
which the Company distributes its products.
DSHEA revised the provisions of the FDCA concerning the regulation of
dietary supplements. In the judgment of the Company, the DSHEA is favorable to
the dietary supplement industry. The legislation for the first time defined
"dietary supplement." The term "dietary supplement" is defined as a product
intended to supplement the diet that contains one or more of certain dietary
ingredients, such as a vitamin, a mineral, an herb or botanical, an amino acid,
a dietary substance for use by man to supplement the diet by increasing the
total dietary intake, or a concentrate, metabolite, constituent, extract, or
combination of the preceding ingredients. The substantial majority of the
products marketed by the Company are regulated as dietary supplements under the
FDCA.
Under the current provisions of the FDCA there are four categories of claims
that pertain to the regulation of dietary supplements. Health claims are claims
that describe the relationship between a nutrient or dietary ingredient and a
disease or health related condition and can be made on the labeling of dietary
supplements if supported by significant scientific agreement and authorized by
FDA in advance via notice and comment rulemaking. Nutrient content claims
describe the nutritional value of the product and may be made if defined by the
FDA through notice and comment rulemaking and if one serving of the product
meets the definition. Health claims and nutrient content claims may also be made
if a scientific body of the U.S. government with official responsibility for the
public health has made an
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authoritative statement regarding the claim, the claim accurately reflects that
statement and the manufacturer, among other things, provides the FDA with notice
of and basis for the claim at least 120 days before the introduction of the
supplement with a label containing the claim into interstate commerce.
Statements of nutritional support or product performance, which are permitted on
labeling of dietary supplements without FDA pre-approval, are defined to include
statements that: (i) claim a benefit related to a classical nutrient deficiency
disease and discloses the prevalence of such disease in the United States; (ii)
describe the role of a nutrient or dietary ingredient intended to affect the
structure or function in humans; (iii) characterize the documented mechanism by
which a dietary ingredient acts to maintain such structure or function; or (iv)
describe general well-being from consumption of a nutrient or dietary
ingredient. In order to make a nutritional support claim the marketer must
possess substantiation to demonstrate that the claim is not false or misleading
and if the claim is for a dietary ingredient that does not provide traditional
nutritional value, prominent disclosure of the lack of FDA review of the
relevant statement and notification to the FDA of using the claim is required.
Drug claims are representations that a product is intended to diagnose,
mitigate, treat, cure or prevent a disease. Drug claims are prohibited from use
in the labeling of dietary supplements.
Claims made for the Company's dietary supplement products may include
statements of nutritional support and health and nutrient content claims when
authorized by the FDA or otherwise allowed by law. The FDA's interpretation of
what constitutes an acceptable statement of nutritional support may change in
the future thereby requiring that the Company revise its labeling. The FDA
recently issued a proposed rule on what constitutes permitted structure/function
claims as distinguished from prohibited disease claims. Although the Company
believes its product claims comply with the law, depending on the content of the
final regulation, it may need to revise its labeling. In addition, a dietary
supplement that contains a new dietary ingredient (i.e., one not on the market
before October 15, 1994) must have a history of use or other evidence of safety
establishing that it is reasonably expected to be safe. The manufacturer must
notify the FDA at least 75 days before marketing products containing new dietary
ingredients and provide the FDA the information upon which the manufacturer
based its conclusion that the product has a reasonable expectation of safety.
The FDA issued final dietary supplement labeling regulations in 1997 that
require a new format for product labels and will necessitate revising dietary
supplement product labels by March 23, 1999. All companies in the dietary
supplement industry are required to comply with these labeling regulations. The
FDA has also announced that it is considering promulgating new GMPs specific to
dietary supplements. Such GMPs, if promulgated, may be significantly more
rigorous than currently applicable GMP requirements and contain quality
assurance requirements similar to GMP requirements for drug products. Therefore,
the Company may be required to expend additional capital and resources on
manufacturing in the future in order to comply with the law.
The failure of the Company to comply with applicable FDA regulatory
requirements could result in, among other things, injunctions, product
withdrawals, recalls, product seizures, fines, and criminal prosecutions.
As a result of the Company's efforts to comply with applicable statutes and
regulations, the Company has from time to time reformulated, eliminated or
relabeled certain of its products and revised certain of its advertising claims.
The Company cannot predict the nature of any future laws, regulations,
interpretations or applications, nor can it determine 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
reformulation of certain products to meet new standards, the recall or
discontinuance of certain products not capable of reformulation, additional
recordkeeping, expanded documentation of the properties of certain products,
expanded or different labeling, and/or scientific substantiation. Any or all of
such requirements could have a material adverse effect on the Company's
business, financial condition and results of operations.
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The Company's advertising of its dietary supplement products is subject to
regulation by the FTC under the FTCA. Section 5 of the FTCA prohibits unfair
methods of competition and unfair or deceptive acts or practices in or affecting
commerce. Section 12 of the FTCA provides that the dissemination or the causing
to be disseminated of any false advertisement pertaining to drugs or foods,
which would include dietary supplements, is an unfair or deceptive act or
practice. Under the FTC's Substantiation Doctrine, an advertiser is required to
have a "reasonable basis" for all objective product claims before the claims are
made. Failure to adequately substantiate claims may be considered either
deceptive or unfair practices. Pursuant to this FTC requirement the Company is
required to have adequate substantiation for all material advertising claims
made for its products.
In recent years the FTC has initiated numerous investigations of dietary
supplement and weight loss products and companies. The FTC is reexamining its
regulation of advertising for dietary supplements and has announced that it will
issue a guidance document to assist supplement marketers in understanding and
complying with the substantiation requirement. Upon release of this guidance
document Natrol will be required to evaluate its compliance with the guideline
and may be required to change its advertising and promotional practices.
The FTC has a variety of processes and remedies available to it for
enforcement, both administratively and judicially, including compulsory process,
cease and desist orders, and injunctions. FTC enforcement can result in orders
requiring, among other things, limits on advertising, corrective advertising,
consumer redress, divestiture of assets, rescission of contracts and such other
relief as may be deemed necessary. A violation of such orders could have a
material adverse effect on the Company's business, financial condition and
results of operations.
Advertising and labeling for dietary supplements and conventional foods are
also regulated by states and local authorities. There can be no assurance that
state and local authorities will not commence regulatory action which could
restrict the permissible scope of the Company's product claims.
Governmental regulations in foreign countries where the Company plans to
commence or expand sales may prevent or delay entry into the market or prevent
or delay the introduction, or require the reformulation, of certain of the
Company's products. Compliance with such foreign governmental regulations is
generally the responsibility of the Company's distributors for those countries.
These distributors are independent contractors over whom the Company has limited
control.
In addition, the Company has in the past, from time to time, been the
subject of investigation by the FTC, however, the Company is not currently a
party to any consent order or other decree of the FTC. The Company may be the
subject of investigation in the future. The FTC may impose limitations on the
Company's advertising of its products. Any such limitations could materially
adversely affect the Company's ability to successfully market its products.
The Company manufactures certain products pursuant to contracts with
customers who distribute the products under their own or other trademarks. Such
private label customers are subject to government regulations in connection with
their purchase, marketing, distribution and sale of such products. The Company
is subject to government regulations in connection with its manufacture,
packaging and labeling of such products. However, the Company's private label
customers are independent companies, and their labeling, marketing and
distribution of such products is beyond the Company's control. The failure of
these customers to comply with applicable laws or regulations could have a
material adverse effect on the Company's business, financial condition and
results of operations.
The Company may be subject to additional laws or regulations by the FDA or
other federal, state or foreign regulatory authorities, the repeal of laws or
regulations which the Company considers favorable, such as the Dietary
Supplement Health and Education Act of 1994, or more stringent interpretations
of current laws or regulations, from time to time 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 reformulation of
certain products to meet new standards,
39
<PAGE>
the recall or discontinuance of certain products not able to be reformulated,
imposition of additional recordkeeping requirements, expanded documentation of
the properties of certain products, expanded or different labeling and
scientific substantiation. Any or all of such requirements could have a material
adverse affect on the Company's business, financial condition and results of
operations.
TRADEMARKS AND PATENTS
The Company regards its trademarks, patent applications and other
proprietary rights as valuable assets. The Company believes that protecting its
key trademarks is crucial to its business strategy of building strong brand name
recognition and that such trademarks have significant value in the marketing of
its products. The Company may in some cases seek to protect its research and
development efforts by filing patent applications for proprietary products.
The Company's policy is to pursue registrations for all of the trademarks
associated with its key products. The Company relies on common law trademark
rights to protect its unregistered trademarks as well as its trade dress rights.
Common law trademark rights generally are limited to the geographic area in
which the trademark is actually used, while a United States federal registration
of a trademark enables the registrant to stop the unauthorized use of the
trademark by any third party anywhere in the United States. Furthermore, the
protection available, if any, in foreign jurisdictions may not be as extensive
as the protection available to the Company in the United States.
Currently, the Company has received one United States patent for its
Kavatrol product, has a second United States patent application pending for a
method of using its Kavatrol product and has received two United States patents
on its amino acid products, SAF and SAF for Kids. To the extent the Company does
not have patents on its products, another company may replicate one or more of
the Company's products.
Although the Company seeks to ensure that it does not infringe the
intellectual property rights of others, there can be no assurance that third
parties will not assert intellectual property infringement claims against the
Company. Natrol was contacted in June 1997 by a third party that claimed
Natrol's marketing of melatonin infringed the third party's patents relating to
a method of using melatonin and sought to license such patents to Natrol. Since
Natrol does not believe its marketing of melatonin infringes the third party's
patent claims, Natrol has declined to enter into a license agreement with the
third party. Any infringement claims by third parties against the Company may
have a material adverse effect on the Company's business, financial condition
and results of operations.
LEGAL MATTERS
From time to time the Company is subject to litigation incidental to its
business including possible product liability claims. Such claims, if
successful, could exceed applicable insurance coverage.
The Company is not currently a party to any material legal proceedings.
EMPLOYEES
As of June 1, 1998, the Company had approximately 189 employees. Of such
employees, 36 were engaged in marketing and sales, 106 were devoted to
production and distribution and 47 were responsible for management and
administration. None of the Company's employees is covered by a collective
bargaining agreement. The Company considers its relations with its employees to
be good.
PROPERTIES
The Company leases a 90,000 square foot manufacturing, distribution and
office facility in Chatsworth, California. The Company has occupied this
facility since March 1997. The facility was designed and constructed to the
Company's specifications and includes areas for shipping and receiving,
quarantine of new materials, manufacture, quality control and laboratory
activities, research and development, packaging, warehousing and administrative
offices. The lease for the facility has a ten-year term (which expires in
October 2006). In 1997 the Company had total lease costs of $573,000 which
covered the manufacturing facility and other space.
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MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The executive officers and directors of the Company, and their ages as of
July 1, 1998, are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- --------------------------------- --- ------------------------------------------------------------------------
<S> <C> <C>
Elliott Balbert.................. 52 Chairman of the Board, Chief Executive Officer and President
Dennis R. Jolicoeur.............. 50 Chief Financial Officer, Treasurer, Executive Vice President and
Director
Cheryl A. Richitt................ 40 Vice President of Marketing
Gary P. DeMello.................. 44 Vice President of Operations
Jon J. Denis..................... 50 Vice President of Sales
Norman Kahn(1)(2)................ 67 Director
David Laufer(1)(2)............... 57 Director
P. Andrews McLane(1)(2).......... 50 Director
</TABLE>
- ------------------------
(1) Member of the Audit Committee.
(2) Member of the Compensation Committee.
Mr. Balbert founded the Company in 1980 and has served as the Company's
Chairman of the Board, Chief Executive Officer and President since its
inception.
Mr. Jolicoeur joined the Company as Chief Financial Officer, Treasurer and
Executive Vice President in July 1996 and has served as a director of the
Company since that date. From October 1993 to June 1996, Mr. Jolicoeur was a
principal of Gardiner & Rauen, Inc., an investment banking firm. In 1980 Mr.
Jolicoeur founded Lighthouse Press, Inc. ("Lighthouse"), and actively managed
Lighthouse until 1989. In 1993, Mr. Jolicoeur and other investors acquired
Naiman Printing, Inc. ("Naiman"). Mr. Jolicoeur became President of each of
Lighthouse and Naiman in August 1994 following the dismissal of the then-acting
President of each company. Naiman and Lighthouse filed voluntary petitions under
Chapters 7 and 11, respectively, of the federal bankruptcy code in September
1996.
Ms. Richitt joined the Company in September 1989 and has served as Vice
President of Marketing since 1992. Prior to joining the Company, Ms. Richitt
held sales and administrative positions with Vidal Sassoon and Rachel Perry,
Inc., a natural cosmetics company.
Mr. DeMello joined the Company in June 1992 and has been Vice President of
Operations since that time. Prior to joining the Company, Mr. DeMello was the
Director of Purchasing for Tree of Life, Inc.
Mr. Denis joined the Company as Vice President of Sales in August 1997.
Prior to joining the Company, Mr. Denis served as Vice President of Sales at
Conair Inc., a personal care and appliance products company, for 15 years,
preceded by eight years in various sales positions at Revlon, Inc.
Mr. Kahn has served as a director of the Company since April 1995. Mr. Kahn,
a private investor, was the Managing Director of the San Marino Financial Group,
an investment banking firm, from 1993 to 1996.
Mr. Laufer has served as a director of the Company since 1996. Since 1996,
Mr. Laufer has been a partner of Arter & Hadden LLP, a law firm. Prior to
joining Arter & Hadden LLP, Mr. Laufer was a partner or co-managing partner of
Kindel & Anderson LLP, a law firm, from 1986 to 1996.
Mr. McLane has served as a director of the Company since September 1996. He
has been at TA Associates, Inc. or its predecessor since 1979, where he is
Senior Managing Director and a member of the firm's Executive Committee. Mr.
McLane is also a director of Affiliated Managers Group, Inc., an
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investment management company, and several private companies, including Altamira
Management Ltd., a Canadian mutual fund company, and Eight-in-One Pet Products,
Inc.
BOARD OF DIRECTORS
The number of directors of the Company is currently fixed at five. Following
the offering, the Company's Board of Directors will be divided into three
classes, with the members of each class of directors serving for staggered
three-year terms. The Board will consist of two Class I Directors (Messrs.
Jolicoeur and Kahn), two Class II Directors (Messrs. Laufer and McLane) and one
Class III Director (Mr. Balbert), whose initial terms will expire at the 1999,
2000 and 2001 annual meetings of stockholders, respectively. Mr. McLane was
elected a director as the nominee of the holders of the Convertible Preferred
Stock.
The Board of Directors has established an Audit Committee (the "Audit
Committee") and a Compensation Committee (the "Compensation Committee"). The
Audit Committee recommends the firm to be appointed as independent accountants
to audit the Company's financial statements and to perform services related to
such audit, reviews the scope and results of such audit with the independent
accountants, reviews with management and the independent accountants the
Company's year-end operating results, considers the adequacy of the internal
accounting procedures and considers the effect of such procedures on the
accountants' independence. The Audit Committee currently consists of Messrs.
Kahn, Laufer and McLane, none of whom is an officer or an employee of the
Company. The Compensation Committee reviews and recommends the compensation
arrangements for officers and other senior level employees, reviews general
compensation levels for other employees as a group, determines the options or
stock to be granted to eligible persons under the 1996 Stock Plan and takes such
other action as may be required in connection with the Company's compensation
and incentive plans. The Compensation Committee currently consists of Messrs.
Kahn, Laufer and McLane. See "--Compensation Committee Interlocks and Insider
Participation" and "Certain Transactions."
On April 8, 1998, the Company granted options to purchase 25,000 shares of
Common Stock under the 1996 Stock Plan to Mr. Laufer, a non-employee director.
Such options vest as follows: 12,500 shares vested on the date of grant, 4,200
shares vest on each of April 8, 1999 and April 8, 2000 and 4,100 shares vest on
April 8, 2001 as long as he continues to serve as a director of the Company.
Directors receive such compensation for their services as the Board of
Directors may from time to time determine. Further, each director is reimbursed
for reasonable travel and other expenses incurred in attending meetings.
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<PAGE>
EXECUTIVE COMPENSATION
SUMMARY COMPENSATION. The following table sets forth information concerning
compensation for services rendered in all capacities awarded to, earned by or
paid to the Chief Executive Officer and the four other most highly compensated
executive officers of the Company for 1997 (the "Named Executive Officers").
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
---------------------------------------
ANNUAL COMPENSATION NUMBER OF SHARES
------------------------ UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION SALARY BONUS OPTIONS GRANTED(#) COMPENSATION(1)
- ---------------------------------------------------- ----------- ----------- -------------------- -----------------
<S> <C> <C> <C> <C>
Elliott Balbert..................................... $ 600,000 $ 400,000 -- $ 29,500
Chairman, Chief Executive Officer and President
Dennis R. Jolicoeur................................. 212,500 61,953 -- --
Chief Financial Officer
Cheryl R. Richitt................................... 128,786 62,274 100,000 --
Vice President of Marketing
Gary P. DeMello..................................... 112,180 44,234 -- --
Vice President of Operations
Jon J. Denis(2)..................................... 100,731 26,633 100,000 2,307
Vice President of Sales
</TABLE>
- ------------------------
(1) Mr. Balbert received $27,400 in life insurance benefits and $2,100 in
benefits for the use of a Company car. Mr. Denis received $2,307 in car
allowance.
(2) Mr. Denis joined the Company in August 1997.
OPTION GRANTS, EXERCISES AND HOLDINGS. The following table sets forth
information regarding stock options granted during 1997 to the Named Executive
Officers.
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
INDIVIDUAL GRANTS VALUE
----------------------------------------------------------------- AT ASSUMED ANNUAL
NUMBER OF PERCENT OF TOTAL RATES OF STOCK
SECURITIES OPTIONS PRICE APPRECIATION
UNDERLYING GRANTED TO EXERCISE FOR OPTION TERM(3)
OPTIONS EMPLOYEES IN OR BASE PRICE EXPIRATION ------------------------
NAME GRANTED(#)(1) FISCAL YEAR ($/SH)(2) DATE 5%($) 10%($)
- ------------------------------- -------------- --------------------- ------------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Cheryl R. Richitt.............. 100,000(4) 50% 2.10 7/29/07 132,067 334,686
Jon J. Denis................... 100,000(5) 50% 2.10 8/11/07 132,067 334,686
</TABLE>
- ------------------------------
(1) Vesting of options is subject to the continuation of such employee's service
relationship with the Company. The options terminate ten years after the
grant date, subject to earlier termination in accordance with the 1996 Stock
Plan and the applicable option agreement.
(2) The exercise price equals the fair market value of the stock as of the grant
date as determined by the Board of Directors after consideration of a number
of factors, including, but not limited to, the Company's financial
performance, the Company's status as a private company at the time of
grants, the minority interests represented by the option shares and the
price of shares of equity securities sold to or purchased by outside
investors.
(3) The amounts shown as potential realizable value illustrate what might be
realized upon exercise immediately prior to expiration of the option term
using the 5% and 10% appreciation rates established in regulations of the
Securities and Exchange Commission, compounded annually. The potential
realizable value of the options to each of Ms. Richitt and Mr. Denis using
the assumed initial public offering price of $13.00 per share is, in each
case, $1,907,563 at an assumed 5% appreciation rate and $3,161,865 at an
assumed 10% appreciation rate. The potential realizable value is not
intended to predict future appreciation of the price of the Common Stock.
The values shown do not consider nontransferability, vesting or termination
of the options upon termination of such employee's service relationship with
the Company.
(4) Options vest 6.25% on October 29, 1997 and then an additional 6.25% every
three months thereafter.
(5) Options vest in three equal annual installments commencing on the first
anniversary of the date of grant. These options were granted on August 11,
1997.
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<PAGE>
OPTION EXERCISES AND YEAR-END HOLDINGS. The following table sets forth
information concerning the number and value of unexercised options to purchase
Common Stock held by the Named Executive Officers. None of the Named Executive
Officers exercised any stock options during Fiscal 1997.
AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
OPTIONS AT FISCAL YEAR-END AT FISCAL YEAR-END ($)(1)
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ----------------------------------------------------- ----------- -------------- ------------- --------------
<S> <C> <C> <C> <C>
Cheryl R. Richitt.................................... 71,250 128,750 791,250 1,411,250
Gary P. DeMello...................................... 45,000 55,000 500,625 611,875
Jon J. Denis......................................... -- 100,000 -- 1,090,000
</TABLE>
- ------------------------
(1) There was no public trading market for the Common Stock as of December 31,
1997. Accordingly, these values have been calculated on the basis of the
assumed initial public offering price of $13.00 per share, less the
applicable exercise price.
MANAGEMENT BONUS PLAN. The Board of Directors has adopted an individualized
bonus plan for each Named Executive Officer for 1998 to be administered by the
Compensation Committee. Awards under the Plan are determined on the basis of the
Company's financial performance and certain individual goals, in each case as
established by the Compensation Committee at the beginning of 1998.
EMPLOYEE STOCK AND OTHER BENEFIT PLANS
1996 STOCK OPTION AND GRANT PLAN. The 1996 Stock Plan was initially adopted
by the Board of Directors and approved by the Company's stockholders in November
1996. The 1996 Stock Plan as amended and restated was approved by the Company's
Board of Directors and stockholders in June 1998. The 1996 Stock Plan permits
(i) the grant of Incentive Options, (ii) the grant of Non-Qualified Options,
(iii) the issuance or sale of Common Stock with or without vesting or other
restrictions ("Restricted Stock") or without restrictions ("Unrestricted Stock"
and collectively with Restricted Stock, "Stock Grants"), (iv) the grant of
Common Stock upon the attainment of specified performance goals ("Performance
Share Awards"), (v) the grant of the right to receive cash dividends with the
holders of the Common Stock as if the recipient held a specified number of
shares of the Common Stock ("Dividend Equivalent Rights") and (vi) the grant of
the right to receive the value of the excess of the fair market value of the
Common Stock over the exercise price of such rights ("Stock Appreciation Rights"
or "SARs"). These grants may be made to officers and other employees, directors,
advisors, consultants and other key persons of the Company and its subsidiaries.
The 1996 Stock Plan provides for the issuance of 1,770,000 shares of Common
Stock, which amount shall be increased as of each June 30 and December 31 by an
additional number of shares of Common Stock equal to fifteen percent (15%) of
the shares of stock issued by the Company in the previous six months. The sale
of 3,200,000 shares of Common Stock offered by the Company hereby will result in
an additional 480,000 shares of Common Stock being reserved for issuance under
the 1996 Stock Plan. Of the shares reserved for issuance under the 1996 Stock
Plan, (i) 720,000 shares were subject to outstanding options with a weighted
average exercise price of $5.87 per share as of June 30, 1998 and (ii) 300,000
shares were sold as restricted stock awards for an aggregate purchase price of
$562,800 in November 1996. On and after the date the 1996 Stock Plan becomes
subject to Section 162(m) of the Code, options with respect to no more than
150,000 shares of Common Stock may be granted to any one individual in any
calendar year.
The 1996 Stock Plan is administered by the Compensation Committee. Subject
to the provisions of the 1996 Stock Plan, the Compensation Committee has full
power to determine from among the persons eligible for grants under the 1996
Stock Plan the individuals to whom grants will be made, the combination of
grants to participants and the specific terms of each grant, including vesting.
Incentive Options may be made only to officers or other full-time employees of
the Company or its subsidiaries,
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<PAGE>
including members of the Board of Directors who are also full-time employees of
the Company or its subsidiaries. The Compensation Committee may delegate the
power to grant options to non-executive employees to the Company's Chief
Executive Officer.
The exercise price of options granted under the 1996 Stock Plan is
determined by the Compensation Committee. In the case of Incentive Options, the
exercise price may not be less than 100% of the fair market value of the
underlying shares on the date of grant. If any employee of the Company or any
subsidiary owns (or is deemed to own) at the date of grant shares of stock
representing in excess of 10% of the combined voting power of all classes of
stock of the Company or any parent or subsidiary, the option exercise price for
Incentive Options granted to such employee may not be less than 110% of the fair
market value of the underlying shares on that date. Non-Qualified Options may be
granted at prices which are less than the fair market value of the underlying
shares on the date granted. Options typically are subject to vesting schedules,
terminate 10 years from the date of grant and may be exercised for specified
periods subsequent to the termination of the optionee's employment or other
service relationship with the Company. At the discretion of the Compensation
Committee, any option may include a "reload" feature pursuant to which an
optionee exercising an option receives in addition to the number of shares of
Common Stock due on the exercise of such an option an additional option with an
exercise price equal to the fair market value of the Common Stock on the date
such additional option is granted. Upon the exercise of options, the option
exercise price must be paid in full either in cash or by certified or bank check
or other instrument acceptable to the Compensation Committee or, in the sole
discretion of the Compensation Committee, by delivery of shares of Common Stock
already owned by the optionee. The exercise price may also be delivered to the
Company by a broker pursuant to irrevocable instructions to the broker selling
the underlying shares from the optionee.
The 1996 Stock Plan also permits Stock Grants, Performance Share Awards,
grants of Dividend Equivalent Rights and SARs. Stock Grants may be made to
persons under the 1996 Stock Plan, subject to such conditions and restrictions
as the Compensation Committee may determine. Prior to the vesting of shares,
recipients of Stock Grants generally will have all the rights of a stockholder
with respect to the shares, including voting and dividend rights, subject only
to the conditions and restrictions set forth in the 1996 Stock Plan or in any
agreement. The Compensation Committee may also make Stock Grants in recognition
of past services or other valid consideration, or in lieu of cash compensation.
In the case of Performance Share Awards, the issuance of shares of Common Stock
will occur only after the conditions and restrictions set forth in the grant
agreement are satisfied. SARs may be granted in tandem with, or independently
of, Incentive Options or Non-Qualified Options. The Compensation Committee may
also grant Dividend Equivalent Rights in conjunction with any other grant made
pursuant to the 1996 Stock Plan or as a free standing grant. Dividend Equivalent
Rights may be paid currently or deemed to be reinvested in additional shares of
Common Stock, which may thereafter accrue further dividends.
The Compensation Committee may, in its sole discretion, accelerate or extend
the date or dates on which all or any particular award or awards granted under
the 1996 Stock Plan may be exercised or vest. Generally, upon a dissolution,
liquidation or sale of a majority of the outstanding voting stock or
substantially all of the assets of the Company, 50% of all unvested options,
SARs and other awards shall become vested as of the effective date of such
transaction, except as the Compensation Committee may otherwise specify with
respect to particular awards and except that 100% of unvested options held by
directors vest in such circumstances. To the extent not fully vested and
exercised, options granted under the 1996 Plan terminate upon the dissolution,
liquidation or sale of a majority of the outstanding voting stock or
substantially all of the assets of the Company, except as the parties to any
such transaction may otherwise agree in their discretion. Vesting of options
which remain in effect following a change-in-control generally accelerates in
the event the optionee's service relationship with the Company is terminated by
the Company without cause or by the optionee for good reason within 18 months
following the change-in-control transaction.
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<PAGE>
RESTRICTED STOCK GRANT. In November 1996 the Company sold 300,000 shares of
Restricted Stock to Dennis R. Jolicoeur under the 1996 Stock Plan for an
aggregate purchase price of $562,800. These shares of Restricted Stock vest in
equal three-month installments over four years beginning on July 1, 1997, with
unvested shares subject to repurchase at cost upon the termination of Mr.
Jolicoeur's employment with the Company for any reason. A total of 50% of Mr.
Jolicoeur's unvested shares would vest on any sale of a majority of the voting
stock or substantially all of the assets of the Company with unvested shares
subject to repurchase at cost in the event of any such transaction except to the
extent outstanding awards are assumed by the buyer in any such transaction. In
the event of such an assumption vesting would occur upon termination of Mr.
Jolicoeur's employment with the Company without cause or for good reason within
18 months following such a transaction. See "Certain Transactions."
1998 EMPLOYEE STOCK PURCHASE PLAN. The Purchase Plan was adopted by the
Board of Directors and subsequently approved by the Company's stockholders in
May 1998. Up to 225,000 shares of Common Stock may be issued under the Purchase
Plan. The Purchase Plan is administered by the Compensation Committee.
The first offering under the Purchase Plan will begin on September 1, 1998
and end on December 31, 1998. Subsequent offerings will commence on each January
1 and July 1 thereafter and will have a duration of six months. Generally, all
employees who are customarily employed for more than 20 hours per week as of the
first day of the applicable offering period are eligible to participate in the
Purchase Plan. An employee who owns or is deemed to own shares of stock
representing in excess of 5% of the combined voting power of all classes of
stock of the Company may not participate in the Purchase Plan.
During each offering, an employee may purchase shares under the Purchase
Plan by authorizing payroll deductions of up to 10% of his or her cash
compensation during the offering period. The maximum number of shares which may
be purchased by any participating employee during any offering period is limited
to 1,000 shares (as adjusted by the Compensation Committee from time to time).
Unless the employee has previously withdrawn from the offering, his accumulated
payroll deductions will be used to purchase Common Stock on the last business
day of the period at a price equal to 85% of the fair market value of the Common
Stock on the first or last day of the offering period, whichever is lower. Under
applicable tax rules, an employee may purchase no more than $25,000 worth of
Common Stock in any calendar year. No Common Stock has been issued to date under
the Purchase Plan.
AGREEMENTS WITH NAMED EXECUTIVE OFFICERS
In July 1997 the Company and Jon J. Denis entered into a letter agreement
pursuant to which the Company agreed to pay Mr. Denis an annual base salary of
$270,000 and provide certain incentive compensation based on sales and severance
benefits equal to six months base salary for the first six months of the term
and three months base salary thereafter. The Company's obligations under the
letter agreement terminate in August 1998.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The members of the Compensation Committee are Messrs. Kahn, Laufer and
McLane. None of these individuals is an executive officer of the Company. Mr.
Laufer is a partner of Arter & Hadden LLP, a law firm which provides services to
the Company. Mr. McLane is Senior Managing Director of TA Associates, Inc.
In September 1996, the TA Investors purchased from the Company 1,921.9
shares of Convertible Preferred Stock for $854,000. The Company used the
proceeds of this investment to redeem shares of Common Stock from Mr. Kahn. The
TA Investors also purchased 25,078.1 shares of Convertible Preferred Stock from
stockholders of the Company. The total consideration paid by the TA Investors
for the Convertible Preferred Stock was $12.0 million. Pursuant to this
transaction, the Company granted the TA
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<PAGE>
Investors (i) "piggy back" registration rights from the Company, (ii) certain
demand registration rights from the Company as described under "Shares Eligible
for Future Sale," (iii) certain rights (the "Co-Sale Rights") from the then
current stockholders to participate on a pro rata basis in certain resales of
Common Stock by such stockholders (who also agreed to restrictions on transfers
of their shares of Common Stock), and (iv) participation rights with respect to
certain future issuances of securities by the Company. In addition, the terms of
the Convertible Preferred Stock held by the TA Investors provide that the
holders thereof shall have the right to elect one director by a vote of a
majority of the holders of the outstanding shares thereof voting as a separate
class. As a condition to the purchase of the Convertible Preferred Stock by the
TA Investors, P. Andrews McLane, the nominee of the TA Investors as holders of
all of the outstanding shares of Convertible Preferred Stock, was elected as a
director of the Company. The Company also agreed to indemnify the TA Investors
and the controlling persons of the TA Investors (including Mr. McLane) against
claims and liabilities arising in connection with their investment in or
relating to the Company, including claims and liabilities under the securities
laws. Effective upon and subject to the completion of this offering, provisions
described above relating to the participation rights, the Co-Sale Rights, and
restrictions on transfers of shares will expire in accordance with their
original terms and, as a result of the conversion of all outstanding shares of
Convertible Preferred Stock upon completion of this offering and the retirement
of such class of stock, those stockholders who held shares of Convertible
Preferred Stock will no longer have the right to elect a director. The
registration rights and indemnification arrangements will remain in effect.
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<PAGE>
CERTAIN TRANSACTIONS
In September 1996, the TA Investors purchased from the Company 1,921.9
shares of Convertible Preferred Stock for $854,000. The Company used the
proceeds of this investment to redeem shares of Common Stock from Mr. Kahn. The
TA Investors also purchased 25,078.1 shares of Convertible Preferred Stock from
stockholders of the Company. The total consideration paid by the TA Investors
for the Convertible Preferred Stock was $12.0 million. Pursuant to this
transaction, the Company granted the TA Investors (i) "piggy back" registration
rights from the Company, (ii) certain demand registration rights from the
Company as described under "Shares Eligible for Future Sale," (iii) the Co-Sale
Rights from the then current stockholders (who also agreed to restrictions on
transfers of their shares of Common Stock), and (iv) participation rights with
respect to certain future issuances of securities by the Company. In addition,
the terms of the Convertible Preferred Stock held by the TA Investors provide
that the holders thereof shall have the right to elect one director by a vote of
a majority of the holders of the outstanding shares thereof voting as a separate
class. As a condition to the purchase of the Convertible Preferred Stock by the
TA Investors, P. Andrews McLane, the nominee of the TA Investors as holders of
all of the outstanding shares of Convertible Preferred Stock, was elected as a
director of the Company. The Company also agreed to indemnify the TA Investors
and the controlling persons of the TA Investors (including Mr. McLane) against
claims and liabilities arising in connection with their investment in or
relating to the Company, including claims and liabilities under the securities
laws. Effective upon and subject to the completion of this offering, provisions
described above relating to the participation rights, the Co-Sale Rights, and
restrictions on transfers of shares will expire in accordance with their
original terms and, as a result of the conversion of all outstanding shares of
Convertible Preferred Stock upon completion of the offering and the retirement
of such class of stock, those stockholders who held shares of Convertible
Preferred Stock will no longer have the right to elect one director. The
registration rights and indemnification arrangements will remain in effect.
In November 1996, the Company sold 300,000 shares of Restricted Stock to Mr.
Jolicoeur under the 1996 Stock Plan for an aggregate purchase price of $562,800.
Also in November 1996, the Company loaned Mr. Jolicoeur $562,500 and agreed to
pay Mr. Jolicoeur annual bonuses equal to the amount of interest on the loan
(computed at a rate of 6.6% per annum). The loan to Mr. Jolicoeur matures in
November 2004, is required to be prepaid to the extent of the after-tax net
proceeds realized from the sale of the Restricted Stock as such Restricted Stock
is sold, and is secured by a pledge of the Restricted Stock, with recourse to
Mr. Jolicoeur's personal assets limited to 25% of the principal and accrued and
unpaid interest thereon.
The Company has adopted a policy providing that all material transactions
between the Company and its officers, directors and other affiliates must (i) be
approved by a majority of the members of the Company's Board of Directors and by
a majority of the disinterested members of the Company's Board of Directors and
(ii) be on terms no less favorable to the Company than could be obtained from
unaffiliated third parties.
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<PAGE>
PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth certain information regarding beneficial
ownership of Common Stock as of July 1, 1998 (after giving effect to the
conversion of all of the Convertible Preferred Stock upon completion of this
offering) and as adjusted to reflect the sale of the shares of Common Stock
offered hereby of (i) each person known by the Company to own beneficially five
percent or more of the outstanding shares of Common Stock, (ii) each director
and Named Executive Officer of the Company, (iii) all directors and executive
officers of the Company as a group and (iv) each of the Selling Stockholders.
Unless otherwise indicated below, to the knowledge of the Company, all persons
listed below have sole voting and investment power with respect to their shares
of Common stock, except to the extent authority is shared by spouses under
applicable law.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY SHARES BENEFICIALLY
OWNED PRIOR TO OWNED AFTER THE
OFFERING(1) NUMBER OFFERING(1)(2)
---------------------- OF SHARES ----------------------
NAME OF BENEFICIAL OWNER(3) NUMBER PERCENT OFFERED(2) NUMBER PERCENT
- -------------------------------------- --------- ----------- ----------- --------- -----------
<S> <C> <C> <C> <C> <C>
Elliott Balbert (4)................... 6,325,000 64.5% -- 6,325,000 48.7%
TA Associates Group (5)............... 2,700,000 27.6 540,000 2,160,000 16.6
Dennis R. Jolicoeur (6)............... 300,000 3.1 -- 300,000 2.3
Cheryl R. Richitt (7)................. 130,000 1.3 -- 130,000 *
Gary P. DeMello (8)................... 60,000 * -- 60,000 *
Jon J. Denis (9)...................... -- -- -- -- --
Norman Kahn........................... 425,000 4.3 200,000 225,000 1.7
David Laufer(10)...................... 12,500 * -- 12,500 *
P. Andrews McLane (11)................ 4,607 * 921 3,686 *
All executive officers and directors
as a group (eight persons).......... 7,257,107 72.6 200,921 7,056,186 53.4
</TABLE>
- ------------------------------
* Less than 1%.
(1) All percentages have been determined as of July 1, 1998 in accordance with
Rule 13d-3 under the Securities Exchange Act of 1934, as amended (the
"Exchange Act"). For purposes of this table, a person or group of persons is
deemed to have "beneficial ownership" of any shares of Common Stock which
such person has the right to acquire within 60 days after the date of this
Prospectus. For purposes of computing the percentage of outstanding shares
of Common Stock held by each person or group of persons named above, any
security which such person or persons have the right to acquire within 60
days after the date of this Prospectus is deemed to be outstanding, but is
not deemed to be outstanding for the purpose of computing the percentage
ownership of any other person.
(2) Assumes no exercise of the Underwriters' over-allotment option.
(3) The address of the TA Associates Group is High Street Tower, Suite 2500, 125
High Street, Boston, MA 02110-2720. The address of Mr. McLane is c/o TA
Associates, Inc., High Street Tower, Suite 2500, 125 High Street, Boston, MA
02110-2720. The address of all other listed stockholders is c/o Natrol,
Inc., 21411 Prairie Street, Chatsworth, CA 91311.
(4) Includes 6,200,000 shares owned by the Balbert Family Trust, a revocable
trust of which Mr. Balbert and his wife, Cheryl Balbert, are trustees and of
which Mr. and Mrs. Balbert and other members of their family are the
beneficiaries. Also includes 125,000 shares of Common Stock owned by Mr.
Balbert's daughter, of which Mr. Balbert disclaims beneficial ownership. Mr.
Balbert has granted the Underwriters the right to purchase up to 295,500
shares of Common Stock solely to cover over-allotments. If the Underwriters'
over-allotment option is exercised in full, Mr Balbert will beneficially own
6,029,500 shares of Common Stock, or 45.3% of the outstanding shares of
Common Stock, upon completion of the offering, and all executive officers
and directors as a group will beneficially own 6,760,686 shares of Common
Stock, or 50.1% of the outstanding shares of Common Stock, upon completion
of the offering.
(5) Includes (i) 1,710,000 shares of Common Stock owned by Advent VII L.P., (ii)
787,500 shares of Common Stock owned by Advent Atlantic and Pacific III
L.P., (iii) 171,000 shares of Common Stock owned by Advent New York L.P.,
and (iv) 31,500 shares of Common Stock owned by TA Venture Investors L.P.
Advent VII L.P., Advent Atlantic and Pacific III L.P., Advent New York L.P.,
and TA Venture Investors L.P. are part of an affiliated group of investment
partnerships referred to, collectively, as the TA Associates Group. The
general partner of Advent VII L.P. is TA Associates VII L.P. The general
partner of Advent Atlantic and
49
<PAGE>
Pacific III L.P. is TA Associates AAP III Partners L.P. The general partner
of Advent New York L.P. is TA Associates VI L.P. The general partner of each
of TA Associates VII, L.P., TA Associates VI L.P. and TA Associates AAP III
Partners, L.P. is TA Associates, Inc. In such capacity, TA Associates, Inc.
exercises sole voting and investment power with respect to all of the shares
held of record by the named investment partnerships, with the exception of
those shares held by TA Venture Investors L.P.; individually, no
stockholder, director or officer of TA Associates, Inc. is deemed to have or
share such voting or investment power. Principals and employees of TA
Associates, Inc. (including Mr. McLane, a director of the Company) comprise
the general partners of TA Venture Investors L.P. In such capacity, Mr.
McLane may be deemed to share voting and investment power with respect to
the 31,500 shares held of record by TA Venture Investors L.P. Mr. McLane
disclaims beneficial ownership of all shares, except as to shares held by TA
Venture Investors L.P., as to which he holds a pecuniary interest. See Note
11.
(6) Constitutes shares of Restricted Stock held by Mr. Jolicoeur, of which
120,000 shares will be vested within 60 days of May 1, 1998 and 15,000
additional shares vest each calendar quarter thereafter, subject to
repurchase upon termination of Mr. Jolicoeur's employment with the Company
and in the event of a sale of a majority of the voting stock or
substantially all of the assets of the Company. See "Certain Transactions."
(7) Constitutes shares of Common Stock which may be purchased within 60 days of
May 1, 1998 upon the exercise of stock options. Excludes 70,000 shares of
Common Stock which may be acquired pursuant to unvested stock options, which
vest in quarterly installments through July 2001.
(8) Constitutes shares of Common Stock which may be purchased within 60 days of
May 1, 1998 upon the exercise of stock options. Excludes 140,000 shares of
Common Stock which may be acquired pursuant to unvested stock options, of
which 40,000 vest in quarterly installments through July 2000 and 100,000
vest in four annual installments commencing in April 1999.
(9) Mr. Denis may acquire 100,000 shares pursuant to unvested stock options
which vest in three annual installments commencing in August 1998.
(10) Constitutes shares of Common Stock which may be purchased within 60 days of
May 1, 1998 upon the exercise of stock options. Excludes 12,500 shares of
Common Stock which may be acquired pursuant to unvested stock options, which
vest in three annual installments commencing in April 1999.
(11) Constitutes shares of Common Stock beneficially owned by Mr. McLane through
TA Venture Investors Limited Partnership, all of which shares are included
in the 2,700,000 shares described in footnote (5) above. Does not include
any shares beneficially owned by Advent VII L.P., Advent Atlantic and
Pacific III L.P. or Advent New York L.P., of which Mr. McLane disclaims
beneficial ownership.
50
<PAGE>
DESCRIPTION OF CAPITAL STOCK
AUTHORIZED AND OUTSTANDING CAPITAL STOCK
Prior to the completion of this offering, there are 27,000 shares of
Convertible Preferred Stock outstanding and 7,100,000 shares of Common Stock
(including all outstanding stock grants) outstanding. In connection with and
subject to this offering, each share of Convertible Preferred Stock will convert
into one hundred shares of Common Stock and one-half of a share of Redeemable
Preferred Stock and will thereafter be retired. Pursuant to the terms of the
Redeemable Preferred Stock, all of the outstanding shares of Redeemable
Preferred Stock will be redeemed by the Company at the time of this offering for
$6.0 million.
Upon completion of this offering, the authorized capital stock of the
Company will consist of 50,000,000 shares of Common Stock, of which 13,000,000
shares will be issued and outstanding, and 2,000,000 shares of undesignated
preferred stock issuable in one or more series by the Board of Directors
("Preferred Stock"), of which no shares will be issued and outstanding.
COMMON STOCK. The holders of Common Stock are entitled to one vote per
share on all matters to be voted on by stockholders and are entitled to receive
such dividends, if any, as may be declared from time to time by the Board of
Directors from funds legally available therefor. Any issuance of Preferred Stock
with a dividend preference over Common Stock could adversely affect the dividend
rights of holders of Common Stock. Holders of Common Stock are not entitled to
cumulative voting rights. Therefore, the holders of a majority of the shares
voted in the election of directors can elect all of the directors then standing
for election, subject to any voting rights of the holders of any then
outstanding Preferred Stock. The holders of Common Stock have no preemptive or
other subscription rights, and there are no conversion rights or redemption or
sinking fund provisions with respect to the Common Stock. All outstanding shares
of Common Stock, including the shares offered hereby, are, or will be upon
completion of the offering, fully paid and non-assessable.
The Certificate and By-laws, which will be effective upon completion of this
offering provide, subject to the rights of the holders of any Preferred Stock
then outstanding, that the number of directors shall be fixed by the Board of
Directors. The directors, other than those who may be elected by the holders of
any Preferred Stock, are divided into three classes, as nearly equal in number
as possible, with each class serving for a three-year term. Subject to any
rights of the holders of any Preferred Stock to elect directors, and to remove
any director whom the holders of any Preferred Stock had the right to elect, any
director of the Company may be removed from office only with cause and by the
affirmative vote of at least two-thirds of the total votes which would be
eligible to be cast by stockholders in the election of such director.
UNDESIGNATED PREFERRED STOCK. The Board of Directors of the Company is
authorized, without further action of the stockholders, to issue up to 2,000,000
shares of Preferred Stock in one or more series and to fix the designations,
powers, preferences and the relative, participating, optional or other special
rights of the shares of each series and any qualifications, limitations and
restrictions thereon as set forth in the Certificate. Any such Preferred Stock
issued by the Company may rank prior to the Common Stock as to dividend rights,
liquidation preference or both, may have full or limited voting rights and may
be convertible into shares of Common Stock.
The issuance of Preferred Stock could have the effect of making it more
difficult for a third party to acquire, or of discouraging a third party from
acquiring or seeking to acquire, a significant portion of the outstanding Common
Stock.
CERTAIN PROVISIONS OF CERTIFICATE OF INCORPORATION AND BY-LAWS
A number of provisions of the Certificate and By-laws which will be
effective upon completion of this offering concern matters of corporate
governance and the rights of stockholders. Certain of these provisions, as well
as the ability of the Board of Directors to issue shares of Preferred Stock and
to set the
51
<PAGE>
voting rights, preferences and other terms thereof, may be deemed to have an
anti-takeover effect and may discourage takeover attempts not first approved by
the Board of Directors, including takeovers which stockholders may deem to be in
their best interests. To the extent takeover attempts are discouraged, temporary
fluctuations in the market price of the Common Stock, which may result from
actual or rumored takeover attempts, may be inhibited. These provisions,
together with the classified Board of Directors and the ability of the Board to
issue Preferred Stock without further stockholder action, also could delay or
frustrate the removal of incumbent directors or the assumption of control by
stockholders, even if such removal or assumption would be beneficial to
stockholders of Company. These provisions also could discourage or make more
difficult a merger, tender offer or proxy contest, even if favorable to the
interests of stockholders, and could depress the market price of the Common
Stock. The Board of Directors believes that these provisions are appropriate to
protect the interests of the Company and all of its stockholders. The Board of
Directors has no present plans to adopt any other measures or devices which may
be deemed to have an anti-takeover effect.
MEETINGS OF STOCKHOLDERS. The By-laws provide that a special meeting of
stockholders may be called only by the President or the Board of Directors
unless otherwise required by law. The By-laws provide that only those matters
set forth in the notice of the special meeting may be considered or acted upon
at that special meeting unless otherwise provided by law. In addition, the
By-laws set forth certain advance notice and informational requirements and time
limitations on any director nomination or any new proposal which a stockholder
wishes to make at an annual meeting of stockholders.
INDEMNIFICATION AND LIMITATION OF LIABILITY. The By-laws provide that
directors and officers of the Company shall be, and in the discretion of the
Board of Directors non-officer employees may be, indemnified by the Company to
the fullest extent authorized by Delaware law, as it now exists or may in the
future be amended, against all expenses and liabilities reasonably incurred in
connection with service for or on behalf of the Company. The By-laws also
provide that the right of directors and officers to indemnification shall be a
contract right and shall not be exclusive of any other right now possessed or
hereafter acquired under any by-law, agreement, vote of stockholders or
otherwise. The Certificate contains a provision permitted by Delaware law that
generally eliminates the personal liability of Directors for monetary damages
for breaches of their fiduciary duty, including breaches involving negligence or
gross negligence in business combinations, unless the director has breached his
or her duty of loyalty, failed to act in good faith, engaged in intentional
misconduct or a knowing violation of law, paid a dividend or approved a stock
repurchase in violation of the Delaware General Corporation Law or obtained an
improper personal benefit. This provision does not alter a director's liability
under the federal securities laws and does not affect the availability of
equitable remedies, such as an injunction or rescission, for breach of fiduciary
duty. The Company also entered into indemnification agreements with each of its
directors reflecting the foregoing and requiring the advancement of expenses in
proceedings involving the directors in most circumstances.
AMENDMENT OF THE CERTIFICATE. The Certificate provides that an amendment
thereof must first be approved by a majority of the Board of Directors and (with
certain exceptions) thereafter approved by a majority (or 80% in the case of any
proposed amendment to the provisions of the Certificate relating to the
composition of the Board or amendments of the Certificate) of the total votes
eligible to be cast by holders of voting stock with respect to such amendment.
AMENDMENT OF BY-LAWS. The Certificate provides that the By-laws may be
amended or repealed by the Board of Directors or by the stockholders. Such
action by the Board of Directors requires the affirmative vote of a majority of
the directors then in office. Such action by the stockholders requires the
affirmative vote of at least two-thirds of the total votes eligible to be cast
by holders of voting stock with respect to such amendment or repeal at an annual
meeting of stockholders or a special meeting called for such purpose, unless the
Board of Directors recommends that the stockholders approve such amendment or
repeal at such meeting, in which case such amendment or repeal shall only
require the
52
<PAGE>
affirmative vote of a majority of the total votes eligible to be cast by holders
of voting stock with respect to such amendment or repeal.
ABILITY TO ADOPT SHAREHOLDER RIGHTS PLAN. The Board of Directors may in the
future resolve to issue shares of Preferred Stock or rights to acquire such
shares to implement a shareholder rights plan. A shareholder rights plan
typically gives stockholders of the Company special rights which are intended to
discourage persons seeking to gain control of the Company by means of a merger,
tender offer, proxy contest or otherwise if such change in control is not in the
best interest of the Company and its stockholders. The Board of Directors has no
present intention of adopting a shareholder rights plan and is not aware of any
attempt to obtain control of the Company.
STATUTORY BUSINESS COMBINATION PROVISION
Upon completion of the offering, the Company will be subject to the
provisions of Section 203 of the Delaware General Corporation Law ("Section
203"). Section 203 provides, with certain exceptions, that a Delaware
corporation may not engage in any of a broad range of business combinations with
a person or affiliate, or associate of such person, who is an "interested
stockholder" for a period of three years from the date that such person became
an interested stockholder unless: (i) the transaction resulting in a person
becoming an interested stockholder, or the business combination, is approved by
the board of directors of the corporation before the person becomes an
interested stockholder; (ii) the interested stockholder acquired 85% or more of
the outstanding voting stock of the corporation in the same transaction that
makes it an interested stockholder (excluding shares owned by persons who are
both officers and directors of the corporation, and shares held by certain
employee stock ownership plans); or (iii) on or after the date the person
becomes an interested stockholder, the business combination is approved by the
corporation's board of directors and by the holders of at least 66 2/3% of the
corporation's outstanding voting stock at an annual or special meeting,
excluding shares owned by the interested stockholder. Under Section 203, an
"interested stockholder" is defined (with certain limited exceptions) as any
person that is (i) the owner of 15% or more of the outstanding voting stock of
the corporation or (ii) an affiliate or associate of the corporation and was the
owner of 15% or more of the outstanding voting stock of the corporation at any
time within the three-year period immediately prior to the date on which it is
sought to be determined whether such person is an interested stockholder.
A Delaware corporation may, at its option, exclude itself from the coverage
of Section 203 by amending its certificate of incorporation or by-laws by action
of its stockholders to exempt itself from coverage, provided that such by-law or
charter amendment shall not become effective until 12 months after the date it
is adopted. Neither the Certificate nor the By-laws contains any such exclusion.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the Common Stock is BankBoston, N.A.
53
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of this offering, the Company will have a total of
13,000,000 shares of Common Stock outstanding. Of these shares, the 3,940,000
shares of Common Stock offered hereby will be freely tradable without
restriction or registration under the Securities Act by persons other than
"affiliates" of the Company, as defined in the Securities Act, who would be
required to sell such shares under Rule 144 under the Securities Act. The
remaining 9,060,000 shares of Common Stock outstanding will be "restricted
securities" as that term is defined by Rule 144 (the "Restricted Shares"). The
Restricted Shares were issued and sold by the Company in private transactions in
reliance upon exemptions from registration under the Securities Act.
Of the Restricted Shares, 8,760,000 shares of Common Stock owned by current
stockholders of the Company will be eligible for sale in the public market
pursuant to Rule 144 under the Securities Act beginning 90 days after the date
of this Prospectus, and 120,000 shares of Common Stock owned by current
stockholders of the Company will be eligible for sale in the public market in
accordance with Rule 701 under the Securities Act beginning 90 days after the
date of this Prospectus. In addition 180,000 shares subject to sale under Rule
701 are subject to vesting provisions and will become eligible for sale in the
public market at various times as they become vested. In addition, shares
acquired upon exercise of vested options as described below are eligible for
resale under Rule 701 under the Securities Act beginning 90 days after the date
of this Prospectus.
In general, under Rule 144 as currently in effect, a person (or persons
whose shares are aggregated) who has beneficially owned restricted securities
for at least one year (including the holding period of any prior owner except an
affiliate), including persons who may be deemed "affiliates" of the Company,
would be entitled to sell within any three-month period a number of shares that
does not exceed the greater of one percent of the number of shares of Common
Stock then outstanding (approximately 130,000 shares upon completion of the
offering) or the average weekly trading volume of the Common Stock during the
four calendar weeks preceding the filing of a Form 144 with respect to such
sale. Sales under Rule 144 are also subject to certain manner of sale provisions
and notice requirements, and to the availability of current public information
about the Company. In addition, a person who is not deemed to have been an
affiliate of the Company at the time during 90 days preceding a sale, and who
has beneficially owned the shares proposed to be sold for at least two years
(including the holding period of any prior owner except an affiliate), would be
entitled to sell such shares under Rule 144(k) without regard to the
requirements described above. Rule 144 also provides that affiliates who are
selling shares that are not Restricted Shares must nonetheless comply with the
same restrictions applicable to Restricted Shares with the exception of the
holding period requirement.
Rule 701 promulgated under the Securities Act provides that shares of Common
Stock acquired pursuant to the exercise of options outstanding prior to this
offering or the grant of Common Stock prior to this offering pursuant to written
compensation plans or contracts may be resold by persons other than affiliates
beginning 90 days after the date of this Prospectus, subject only to the manner
of sale provisions of Rule 144, and by affiliates, beginning 90 days after the
date of this Prospectus, subject to all provisions of Rule 144 except its
one-year minimum holding period requirement.
The Company's executive officers and directors, certain stockholders, who in
the aggregate will hold 9,010,000 shares of Common Stock (after giving effect to
the sale of 740,000 shares by the Selling Stockholders in the offering) and the
holders of options to purchase 685,000 shares of Common Stock, have agreed,
pursuant to certain Lock-up Agreements, that until 180 days after the date of
this Prospectus, they will not, directly or indirectly, offer, sell, assign,
transfer, encumber, contract to sell, grant an option to purchase, make a
distribution of, or otherwise dispose of, any shares of Common Stock, or any
securities convertible into or exchangeable for shares of Common Stock,
otherwise than (i) as a bona fide gift or gifts, provided that the donee or
donees thereof agree in writing as a condition precedent to such gift or gifts
to be bound by the terms of the Lock-up Agreements, or (ii) with the prior
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<PAGE>
written consent of Adams, Harkness & Hill, Inc. In addition, the Company has
agreed that, without the prior written consent of Adams, Harkness & Hill, Inc.
on behalf of the Underwriters, the Company will not, directly or indirectly,
sell, offer, contract to sell, make any short sale, pledge, sell any option or
contract to purchase, purchase any option or contract to sell, grant any option,
right or warrant to purchase or otherwise transfer or dispose of any shares of
Common Stock or any securities, convertible into or exchangeable or exercisable
for or any rights to purchase or acquire Common Stock, or enter into any swap or
other agreement that transfers, in whole or in part any of the economic
consequences or ownership of Common Stock, during the 180-day period following
the date of this Prospectus, except that the Company may issue, and grant
options to purchase, shares of Common Stock under its current stock option and
purchase plans and may issue, and grant options to purchase, shares of Common
Stock under its current stock option and purchase plans and may issue shares of
Common Stock in connection with certain acquisition transactions, provided such
shares are subject to the 180-day Lock-up Agreement.
Upon completion of the offering, a total of (i) 2,250,000 shares of Common
Stock will be reserved for issuance under the 1996 Stock Plan, of which 720,000
shares will be issuable upon the exercise of outstanding stock options and
300,000 shares will have been granted as restricted stock, and (ii) 225,000
shares of Common Stock will be reserved for issuance under the Purchase Plan.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Management-- Employee Stock and Other Benefit Plans--1996 Stock
Option and Grant Plan" and "--1998 Employee Stock Purchase Plan." The Company
intends to file a registration statement on Form S-8 under the Securities Act to
register all shares of Common Stock issuable pursuant to the 1996 Stock Plan or
the Purchase Plan. The Company expects to file this registration statement
within approximately 90 days following the date of this Prospectus, and such
registration statement will become effective upon filing. Shares covered by this
registration statement will thereupon be eligible for sale in the public
markets, subject to Rule 144 limitations applicable to affiliates and the
Lock-up Agreements described above.
Stockholders of the Company who will own 2,160,000 shares of Common Stock
upon completion this offering have the right on any date three months after this
offering to require the Company to register their shares under the Securities
Act for resale to the public (i) on Form S-1, if the anticipated net aggregate
proceeds exceed $10.0 million (provided that only one registration on Form S-1
is required) and (ii) on Form S-3 if the anticipated net aggregate sale price of
such registered shares exceeds $500,000 (provided that only one registration on
Form S-3 is required in any 12 month period).
Prior to this offering, there has been no public market for the Common Stock
and no predictions can be made of the effect, if any, that the sale or
availability for sale of shares of additional Common Stock will have on the
market price of the Common Stock. Nevertheless, sales of substantial amounts of
such shares in the public market, or the perception that such sales could occur,
could materially and adversely affect the market price of the Common Stock and
could impair the Company's future ability to raise capital through an offering
of its equity securities.
55
<PAGE>
UNDERWRITING
Subject to the terms and conditions of the Underwriting Agreement, the
Company and the Selling Stockholders have agreed to sell to each of the
Underwriters named below, and each of such Underwriters, for whom Adams,
Harkness & Hill, Inc., NationsBanc Montgomery Securities LLC and Piper Jaffray
Inc. are acting as representatives (the "Representatives"), has severally agreed
to purchase from the Company and the Selling Stockholders, the respective number
of shares of Common Stock set forth opposite each Underwriter's name below:
<TABLE>
<CAPTION>
NUMBER OF
SHARES OF
UNDERWRITER COMMON STOCK
- ----------------------------------------------------------------------------- ---------------
<S> <C>
Adams, Harkness & Hill, Inc. ................................................
NationsBanc Montgomery Securities LLC........................................
Piper Jaffray Inc. ..........................................................
---------------
Total........................................................................ 3,940,000
---------------
---------------
</TABLE>
Under the terms and conditions of the Underwriting Agreement, the
Underwriters are committed to take and pay for all of the shares offered hereby,
if any are taken.
The Underwriters propose to offer the shares of Common Stock in part
directly to the public at the initial public offering price set forth on the
cover page of this Prospectus, and in part to certain securities dealers at such
price less a concession of not in excess of $ per share. The
Underwriters may allow, and such dealers may re-allow, a concession not in
excess of $ per share to certain brokers and dealers. After the shares
of Common Stock are released for sale to the public, the offering price and
other selling terms may from time to time be varied by the Representatives.
The Company and the Selling Stockholders have granted the Underwriters an
option exercisable for 30 days after the date of this Prospectus to purchase up
to an aggregate of 591,000 additional shares of Common Stock solely to cover
over-allotments, if any. If the Underwriters exercise their over-allotment
option, the Underwriters have severally agreed, subject to certain conditions,
to purchase approximately the same percentage thereof that the number of shares
to be purchased by each of them, as shown in the foregoing table, bears to the
shares of Common Stock offered hereby. The Underwriters may exercise such option
only to cover over-allotments, if any, in connection with the sale of the
3,940,000 shares of Common Stock offered hereby.
The Company has agreed not to offer, sell, contract to sell or otherwise
dispose of any shares of Common Stock for a period of 180 days after the date of
this Prospectus without the prior written consent of Adams, Harkness & Hill,
Inc., except for the shares of Common Stock offered hereby and except that the
Company may issue securities pursuant to the Company's stock plans, upon
exercise of outstanding options and warrants or in connection with certain
acquisition transactions, provided such shares are subject to the 180-day
Lock-up Agreement. In addition, the Company's executive officers and directors,
certain stockholders, who in the aggregate will hold 9,010,000 shares of Common
Stock (after giving effect to the sale of 740,000 shares by the Selling
Stockholders in the offering) and the holders of options to purchase 685,000
shares of Common Stock, have agreed, pursuant to certain Lock-up Agreements,
that until 180 days after the date of this Prospectus, they will not, directly
or indirectly, offer, sell, assign, transfer, encumber, contract to sell, grant
an option to purchase, make a distribution of, or otherwise dispose of, any
shares of Common Stock, or any securities convertible into or exchangeable for
shares of Common Stock, otherwise than (i) as a bona fide gift or gifts,
provided that the donee or donees thereof
56
<PAGE>
agree in writing as a condition precedent to such gift or gifts to be bound by
the terms of the Lock-up Agreements, or (ii) with the prior written consent of
Adams, Harkness & Hill, Inc.
The Representatives of the Underwriters have informed the Company that they
do not intend to confirm sales to any account over which they exercise
discretionary authority.
In connection with this offering, the Underwriters may purchase and sell the
Common Stock in the open market. These transactions may include over-allotment
and stabilizing transactions and purchases to cover syndicate short positions
created in connection with this offering. Stabilizing transactions consist of
certain bids or purchases made for the purpose of preventing or retarding a
decline in the market price of the Common Stock. Syndicate short positions
involve the sale by the Underwriters of a greater number of shares of Common
Stock than they are required to purchase from the Company in this offering. The
Underwriters also may impose a penalty bid, whereby the syndicate may reclaim
selling concessions allowed to syndicate members or other broker-dealers in
respect of the Common Stock sold in this offering for their account if the
syndicate repurchases the shares in stabilizing or covering transactions. These
activities may stabilize, maintain or otherwise affect the market price of the
Common Stock, which may as a result be higher than the price that might
otherwise prevail in the open market. These transactions may be affected on
Nasdaq, in the over-the-counter market or otherwise, and may, if commenced, be
discontinued at any time.
Prior to this offering, there has been no public market for the Common
Stock. The initial public offering price will be negotiated among the Company,
the Selling Stockholders and the Representatives. Among the factors to be
considered in determining the initial public offering price of the Common Stock,
in addition to prevailing market conditions, are the Company's historical
performance, estimates of the business potential and earnings prospects of the
Company, an assessment of the Company's management and the consideration of the
above factors in relation to market valuations of companies in related
businesses.
Application has been made to list the Common Stock for quotation and trading
on the Nasdaq National Market under the symbol "NTOL."
The Company and the Selling Stockholders have agreed to indemnify the
several Underwriters against or contribute to losses arising out of certain
liabilities, including liabilities under the Securities Act.
LEGAL MATTERS
The validity of the shares of Common Stock offered hereby will be passed
upon for the Company by Goodwin, Procter & Hoar LLP, Boston, Massachusetts.
Certain legal matters related to this offering will be passed upon for the
Underwriters by Hale and Dorr LLP, Boston, Massachusetts.
EXPERTS
The consolidated financial statements of the Company at December 31, 1996
and 1997, and for each of the three years in the period ended December 31, 1997,
appearing in this Prospectus and Registration Statement have been audited by
Ernst & Young LLP, independent auditors, as set forth in their report thereon
appearing elsewhere herein, and are included in reliance upon such report given
upon the authority of such firm as experts in accounting and auditing.
The financial statements of Pure-Gar as of and for the years ended December
31, 1996 and 1997 included in this Prospectus and elsewhere in this registration
statement have been audited by Farber & Hass LLP, independent public auditors,
as indicated in their reports with respect thereto, and are included herein in
reliance upon the authority of said firm as experts in giving said reports.
57
<PAGE>
ADDITIONAL INFORMATION
The Company has not previously been subject to the reporting requirements of
the Exchange Act. The Company has filed with the Commission a Registration
Statement (which term shall include any amendments thereto) on Form S-1 under
the Securities Act with respect to the Common Stock offered hereby. This
Prospectus, which constitutes a part of the Registration Statement, does not
contain all of the information set forth in the Registration Statement, certain
portions of which have been omitted as permitted by the rules and regulations of
the Commission. Statements contained in this Prospectus as to the contents of
any contract or other document are not necessarily complete, and in each
instance reference is made to the copy of such contract or other document filed
as an exhibit to the Registration Statement, each statement being qualified in
all respects by such reference. For further information with respect to the
Company and the Common Stock, reference is made to the Registration Statement,
including the exhibits and schedules thereto, copies of which may be examined
without charge at the Commission's principal office at 450 Fifth Street, N.W.,
Washington, D.C. 20549 and the regional offices of the Commission located at 7
World Trade Center, 13th Floor, New York, New York 10048 and Citicorp Center,
500 West Madison Street, 14th Floor, Chicago, Illinois 60661-2511. Copies of
such materials may be obtained from the Public Reference Section of the
Commission, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549 and
at its public reference facilities in New York, New York, and Chicago, Illinois,
at prescribed rates. The Commission also maintains a World Wide Web site that
contains reports, proxy and information statements and other information
regarding registrants (which, after this offering, will include the Company)
that file electronically with the Commission (at http://www.sec.gov).
Immediately following this offering, the Company will become subject to the
periodic reporting and other informational requirements of the Exchange Act. As
long as the Company is subject to such periodic reporting and information
requirements, it will file with the Commission all reports, proxy statements and
other information required thereby. The Company intends to furnish holders of
the Common Stock with annual reports containing financial statements audited by
an independent certified public accounting firm.
58
<PAGE>
NATROL, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
CONSOLIDATED FINANCIAL STATEMENTS OF NATROL, INC.
Report of Ernst & Young LLP, Independent Public Auditors.............................. F-2
Consolidated Balance Sheets as of December 31, 1996 and 1997 and March 31, 1998
(unaudited)......................................................................... F-3
Consolidated Statements of Income for the Years Ended December 31, 1995, 1996 and 1997
and the Three Months Ended March 31, 1997 and 1998 (unaudited)...................... F-4
Consolidated Statements of Stockholders' Equity (Deficit) for the Years Ended December
31, 1995, 1996 and 1997 and the Three Months Ended March 31, 1998 (unaudited)....... F-5
Consolidated Statements of Cash Flows for the Years Ended December 31, 1995, 1996 and
1997 and the Three Months Ended March 31, 1997 and 1998 (unaudited)................. F-6
Notes to Consolidated Financial Statements............................................ F-7
CONSOLIDATED FINANCIAL STATEMENTS OF PURE-GAR L.P. (A DIVISION OF BASIC VEGETABLE
PRODUCTS L.P.)
Report of Farber & Hass LLP, Independent Public Auditors.............................. F-19
Balance Sheets as of December 28, 1996 and December 27, 1997.......................... F-20
Statements of Income for the Years Ended December 28, 1996 and December 27, 1997...... F-21
Statements of Partners' Equity for the Years Ended December 28, 1996 and December 27,
1997................................................................................ F-22
Statements of Cash Flows for the Years Ended December 28, 1996 and December 27,
1997................................................................................ F-23
Notes to Financial Statements......................................................... F-24
UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
Unaudited Pro Forma Consolidated Statements of Income for the Year Ended December 31,
1997 and the Three Months Ended March 31, 1998...................................... F-27
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
Natrol, Inc.
We have audited the accompanying consolidated balance sheets of Natrol, Inc.
and subsidiaries as of December 31, 1996 and 1997, and the related consolidated
statements of income, stockholders' equity (deficit) and cash flows for each of
the years in the three year period ended December 31, 1997. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements 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 financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Natrol, Inc.
and subsidiaries at December 31, 1996 and 1997 and the consolidated results of
their operations and their cash flows for each of the years in the three year
period ended December 31, 1997, in conformity with generally accepted accounting
principles.
ERNST & YOUNG LLP
Woodland Hills, California
April 13, 1998, except with respect to Note 10, for which
the date is June 19, 1998
F-2
<PAGE>
NATROL, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, PRO FORMA
------------------------- MARCH 31, MARCH 31,
1996 1997 1998 1998
----------- ------------ ------------ --------------
(UNAUDITED)
<S> <C> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............................. $ 285,187 $ 1,800,202 $ 2,228,671
Accounts receivable, net of allowances of $160,000 in
1996 and $262,000 in 1997 and $307,000 at March
31,1998............................................. 3,999,124 5,396,625 7,649,634
Inventories........................................... 3,874,300 6,934,181 7,425,772
Deferred taxes........................................ 635,973 553,890 553,420
Income taxes receivable............................... 178,861 -- --
Prepaid expenses and other current assets............. 200,523 340,649 412,523
----------- ------------ ------------
Total current assets.................................... 9,173,968 15,025,547 18,270,020
Equipment and leasehold improvements:
Furniture and office equipment........................ 339,649 871,048 899,873
Machinery and equipment............................... 1,296,258 2,804,346 3,035,646
Leasehold improvements................................ 135,352 1,875,625 1,875,625
Construction in progress.............................. 1,193,546 -- --
----------- ------------ ------------
2,964,805 5,551,019 5,811,144
Accumulated depreciation and amortization............. (869,613) (922,839) (1,114,511)
----------- ------------ ------------
2,095,192 4,628,180 4,696,633
Other assets:
Deposits.............................................. 53,067 43,497 43,497
Trademarks and patents, net........................... 22,549 18,876 17,958
Goodwill.............................................. -- -- 9,001,229
----------- ------------ ------------
75,616 62,373 9,062,684
----------- ------------ ------------
Total assets............................................ $11,344,776 $ 19,716,100 $ 32,029,337
----------- ------------ ------------
----------- ------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Line of credit........................................ $ -- $ -- $ 3,000,000
Accounts payable...................................... 2,988,997 3,867,846 5,084,344
Accrued expenses...................................... 838,715 899,311 1,853,359
Accrued payroll and related liabilities............... 246,504 413,687 584,728
Income taxes payable.................................. -- 422,083 948,573
Dividends payable..................................... 400,000 -- --
Current portion of long-term debt..................... 204,167 998,611 1,500,000
----------- ------------ ------------
Total current liabilities............................... 4,678,383 6,601,538 12,971,004
Deferred income taxes, noncurrent....................... 16,694 72,774 72,314
Long-term debt, less current portion.................... 404,861 2,606,250 7,375,000
Convertible participating preferred stock, $0.01 par
value per share, 27,000 shares authorized, issued and
outstanding as of December 31, 1996 and 1997;
liquidation preference of $12,000,000; no shares
authorized, issued or outstanding on a pro forma
basis................................................. 12,000,000 12,000,000 12,000,000 $ --
Redeemable preferred stock, $0.01 par value per share,
13,500 shares authorized; none issued and outstanding;
13,500 shares issued and outstanding on a pro forma
basis................................................. -- -- -- 6,000,000
Commitments
Stockholders' equity (deficit):
Preferred stock, par value of $0.01 per share:
Authorized shares--2,000,000..........................
Issued and outstanding shares--none................... -- -- -- --
Common stock, par value of $0.01 per share:
Authorized shares -- 50,000,000.....................
Issued and outstanding shares -- 7,100,000;
9,800,000 on a pro forma basis.................... 71,000 71,000 71,000 98,000
Additional paid-in capital............................ 559,500 559,500 559,500 12,532,500
Retained earnings (deficit)........................... (5,823,162) (1,632,462) (456,981) (6,456,981)
----------- ------------ ------------ --------------
(5,192,662) (1,001,962) 173,519 6,173,519
Receivable from stockholder........................... (562,500) (562,500) (562,500) (562,500)
----------- ------------ ------------ --------------
Total stockholders' equity (deficit).................... (5,755,162) (1,564,462) (388,981) $ 5,611,019
----------- ------------ ------------ --------------
Total liabilities and stockholders' equity.............. $11,344,776 $ 19,716,100 $ 32,029,337
----------- ------------ ------------
----------- ------------ ------------
</TABLE>
See accompanying notes.
F-3
<PAGE>
NATROL, INC.
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
------------------------------------------- ------------------------------
1995 1996 1997 1997 1998
------------- ------------- ------------- -------------- --------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net sales.......................... $ 23,565,664 $ 40,802,352 $ 42,874,759 $ 9,908,946 $ 13,116,420
Cost of goods sold................. 12,214,148 18,497,818 19,799,712 4,474,497 6,320,642
------------- ------------- ------------- -------------- --------------
11,351,516 22,304,534 23,075,047 5,434,449 6,795,778
------------- ------------- ------------- -------------- --------------
Selling and marketing expenses..... 4,457,928 8,735,815 11,398,390 2,989,644 3,477,162
General and administrative
expenses......................... 3,378,175 5,431,368 4,450,244 1,055,038 1,230,300
------------- ------------- ------------- -------------- --------------
7,836,103 14,167,183 15,848,634 4,044,682 4,707,462
------------- ------------- ------------- -------------- --------------
Operating income................... 3,515,413 8,137,351 7,226,413 1,389,767 2,088,316
Interest income.................... 25,163 109,102 20,695 -- 21,146
Interest expense................... (43,891) (55,472) (240,250) (35,359) (152,481)
------------- ------------- ------------- -------------- --------------
Income before income tax
provision........................ 3,496,685 8,190,981 7,006,858 1,354,408 1,956,981
Income tax provision............... 1,452,670 2,298,593 2,816,158 544,355 781,500
------------- ------------- ------------- -------------- --------------
Net income......................... $ 2,044,015 $ 5,892,388 $ 4,190,700 $ 810,053 $ 1,175,481
------------- ------------- ------------- -------------- --------------
------------- ------------- ------------- -------------- --------------
Pro forma net income data (NOTE 4):
Income before provision for income
taxes............................ $ 3,496,685 $ 8,190,981 $ 7,006,858 $ 1,354,408 $ 1,956,981
Pro forma income tax provision
(actual for the years ended 1995
and 1997 and the three months
ended 1997 and 1998)............. 1,452,670 3,159,793 2,816,158 544,355 781,500
------------- ------------- ------------- -------------- --------------
Pro forma net income............... $ 2,044,015 $ 5,031,188 $ 4,190,700 $ 810,053 $ 1,175,481
------------- ------------- ------------- -------------- --------------
------------- ------------- ------------- -------------- --------------
Basic earnings per share........... $ 0.34 $ 0.94 $ 0.59 $ 0.11 $ 0.17
------------- ------------- ------------- -------------- --------------
------------- ------------- ------------- -------------- --------------
Diluted earnings per share......... $ 0.34 $ 0.83 $ 0.41 $ 0.08 $ 0.11
------------- ------------- ------------- -------------- --------------
------------- ------------- ------------- -------------- --------------
Weighted average shares
outstanding--basic............... 6,000,000 6,275,000 7,100,000 7,100,000 7,100,000
------------- ------------- ------------- -------------- --------------
------------- ------------- ------------- -------------- --------------
Weighted average shares
outstanding--diluted............. 6,000,000 7,065,385 10,272,859 10,261,538 10,272,859
------------- ------------- ------------- -------------- --------------
------------- ------------- ------------- -------------- --------------
</TABLE>
See accompanying notes.
F-4
<PAGE>
NATROL, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
ORIGINALLY ISSUED
COMMON STOCK COMMON STOCK ADDITIONAL RETAINED RECEIVABLE
--------------------- ---------------------- PAID-IN EARNINGS FROM
SHARES AMOUNT SHARES AMOUNT CAPITAL (DEFICIT) STOCKHOLDER
---------- --------- --------- ----------- ----------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1995............ 6,000,000 $ 10,000 -- $ -- $ 50,000 $ 1,199,435 $ --
Net income............................ -- -- -- -- -- 2,044,015 --
---------- --------- --------- ----------- ----------- ----------- ------------
Balance at December 31, 1995.......... 6,000,000 10,000 -- -- 50,000 3,243,450 --
Dividends, $0.55 per share............ -- -- -- -- -- (3,300,000) --
Exchanged shares in exchange for new
shares.............................. (6,000,000) (10,000) 7,027,780 70,278 (50,000) (13,250) --
Repurchase from stockholder........... -- -- (227,780) (2,278) -- (502,900) --
Restricted stock issued............... -- -- 300,000 3,000 559,500 -- (562,500)
Adjustment for redemption value of
convertible participating preferred
stock............................... -- -- -- -- -- (11,142,850) --
Net income............................ -- -- -- -- -- 5,892,388 --
---------- --------- --------- ----------- ----------- ----------- ------------
Balance at December 31, 1996.......... -- -- 7,100,000 71,000 559,500 (5,823,162) (562,500)
Net income............................ -- -- -- -- -- 4,190,700 --
---------- --------- --------- ----------- ----------- ----------- ------------
Balance at December 31, 1997.......... -- -- 7,100,000 71,000 559,500 (1,632,462) (562,500)
Net income (unaudited)................ -- -- -- -- -- 1,175,481 --
---------- --------- --------- ----------- ----------- ----------- ------------
Balance at March 31, 1998
(unaudited)......................... -- $ -- 7,100,000 $ 71,000 $ 559,500 $ (456,981) $ (562,500)
---------- --------- --------- ----------- ----------- ----------- ------------
---------- --------- --------- ----------- ----------- ----------- ------------
<CAPTION>
TOTAL
-----------
<S> <C>
Balance at January 1, 1995............ $ 1,259,435
Net income............................ 2,044,015
-----------
Balance at December 31, 1995.......... 3,303,450
Dividends, $0.55 per share............ (3,300,000)
Exchanged shares in exchange for new
shares.............................. (2,972)
Repurchase from stockholder........... (505,178)
Restricted stock issued............... --
Adjustment for redemption value of
convertible participating preferred
stock............................... (11,142,850)
Net income............................ 5,892,388
-----------
Balance at December 31, 1996.......... (5,755,162)
Net income............................ 4,190,700
-----------
Balance at December 31, 1997.......... (1,564,462)
Net income (unaudited)................ 1,175,481
-----------
Balance at March 31, 1998
(unaudited)......................... $ (388,981)
-----------
-----------
</TABLE>
See accompanying notes.
F-5
<PAGE>
NATROL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
---------------------------------------- ---------------------------
1995 1996 1997 1997 1998
------------ ------------ ------------ ------------ -------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net income................................ $ 2,044,015 $ 5,892,388 $ 4,190,700 $ 810,053 $ 1,175,481
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization........... 192,490 364,158 690,335 169,863 192,100
Amortization of goodwill................ -- -- -- -- 50,000
Provision for bad debts and returns..... 264,366 314,820 1,002,683 230,763 12,100
Deferred taxes.......................... (143,151) (397,461) 138,163 -- 10
Changes in operating assets and
liabilities:
Accounts receivable................... (3,155,866) (88,178) (1,440,220) (231,887) (204,393)
Inventories........................... (319,160) (1,770,548) (3,059,881) (236,721) 1,231,274
Income taxes receivable/payable....... 355,933 (1,031,246) 600,944 674,946 526,490
Deposits.............................. 5,450 (40,757) 9,570 -- --
Prepaid expenses and other current
assets.............................. 55,422 (52,632) (140,126) 46,473 (115,396)
Accounts payable...................... 710,906 549,052 878,849 (913,041) (638,117)
Accrued expenses...................... 187,210 (3,475) (899,368) 741,718 954,048
Accrued payroll and related
liabilities......................... 211,255 35,201 167,183 113,846 171,041
------------ ------------ ------------ ------------ -------------
Net cash provided by operating
activities.............................. 408,870 3,771,322 2,138,832 1,406,013 3,354,638
INVESTING ACTIVITIES
Assets purchased, net of liabilities
assumed in connection with Pure-Gar
acquisition............................. -- -- -- -- (11,085,736)
Purchases of equipment and leasehold
improvements............................ (409,354) (1,865,099) (3,219,650) (1,557,550) (110,572)
------------ ------------ ------------ ------------ -------------
Net cash used in investing activities..... (409,354) (1,865,099) (3,219,650) (1,557,550) (11,196,308)
FINANCING ACTIVITIES
Proceeds from long-term debt.............. 66,667 750,000 4,000,000 600,000 9,000,000
Repayments on long-term debt.............. (84,000) (207,639) (1,004,167) (51,041) (3,729,861)
Proceeds (repayments) on line of credit,
net..................................... (26,389) (127,778) -- -- 3,000,000
Convertible participating preferred stock
sold.................................... -- 854,178 -- -- --
Repurchase of common stock................ -- (505,178) -- -- --
Dividends paid to stockholders............ -- (2,900,000) (400,000) (400,000) --
------------ ------------ ------------ ------------ -------------
Net cash provided by (used in) financing
activities.............................. (43,722) (2,136,417) 2,595,833 148,959 8,270,139
------------ ------------ ------------ ------------ -------------
Net increase (decrease) in cash and cash
equivalents............................. (44,206) (230,194) 1,515,015 (2,578) 428,469
Cash and cash equivalents, beginning of
year.................................... 559,587 515,381 285,187 285,187 1,800,202
------------ ------------ ------------ ------------ -------------
Cash and cash equivalents, end of year.... $ 515,381 $ 285,187 $ 1,800,202 $ 282,609 $ 2,228,671
------------ ------------ ------------ ------------ -------------
------------ ------------ ------------ ------------ -------------
Supplemental disclosures of cash flow
information:
Cash paid during the year for:
Interest.............................. $ 43,891 $ 55,472 $ 240,250 $ 35,359 $ 152,481
Income taxes.......................... $ 916,990 $ 3,770,000 $ 2,215,000 $ -- $ --
</TABLE>
Supplemental non-cash transactions
During the year ended December 31, 1996, the Company adjusted retained earnings
(deficit) for $11,142,850, which increases the convertible participating
preferred stock to its redemption value.
See accompanying notes.
F-6
<PAGE>
NATROL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF THE BUSINESS
Natrol, Inc. (collectively with its subsidiaries, referred to as the
Company) manufactures and markets branded, high-quality dietary supplement
products, including vitamins, minerals, herbs and specialty formulations, weight
control products and hormones. The Company sells its products under the Natrol
brand name through multiple distribution channels throughout the United States,
including domestic health food stores and mass market drug, retail and grocery
store chains.
On July 1, 1996, the Company elected to be treated as an S Corporation for
federal income and California franchise tax purposes under Subchapter S of the
Internal Revenue Code and the corresponding provisions of the California
statute. Accordingly, the stockholders reported their equity in the earnings or
losses of the Company on their individual tax returns. In connection with this
election, the Company changed its year end from June 30 to a calendar year end.
On September 30, 1996, the Company filed an amendment to its charter whereby
all outstanding shares of common stock were split-up and converted to shares of
common stock and 25,078.1 shares of convertible participating preferred stock.
The original stockholders subsequently sold all of their convertible
participating preferred stock to unrelated third parties (the new stockholders).
The Company also sold an additional 1,921.9 shares of the convertible
participating preferred stock to the new stockholders. Upon completion of the
transactions, the new stockholders held 27,000 shares of convertible
participating preferred stock which were convertible into approximately 27% of
the then outstanding shares of Common Stock and 13,500 shares of redeemable
preferred stock.
Upon the creation and issuance of the convertible participating preferred
stock on September 30, 1996, the Company was required to change its status for
income tax purposes back to a C Corporation.
PRESENTATION
For purposes of comparability to the year ended December 31, 1997, the
consolidated financial information for the prior years has been restated to
include each of the twelve month periods ended December 31, 1995 and 1996. These
twelve month periods are referred to in the consolidated financial statements
and the following notes to the consolidated financial statements as the years
ended December 31, 1995 and 1996.
On January 15, 1998, the Company reincorporated itself in the State of
Delaware. Effective with the reincorporation, a ten-for-one reverse stock split
occurred affecting all classes of stock then outstanding. All references in the
accompanying consolidated financial statements to the number of shares and per
share amounts have been retroactively adjusted to reflect the reverse stock
split.
The pro forma March 31, 1998 unaudited information reflected in the
accompanying balance sheets reflect the conversion of the convertible
participating preferred stock into redeemable preferred stock and common stock.
Upon completion of the proposed initial public offering as described in Note 10
to the consolidated financial statements, the redeemable preferred stock will be
redeemed for $6,000,000.
The accompanying unaudited financial statements as of March 31, 1998 and for
the three months ended March 31, 1997 and 1998 have been prepared by the Company
pursuant to the rules and regulations of the Securities and Exchange Commission.
Accordingly, certain information and note disclosures normally included in
financial statements prepared in conformity with generally accepted accounting
principles have been condensed or omitted. In the opinion of the Company, all
adjustments,
F-7
<PAGE>
NATROL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
consisting of only normal recurring accruals, necessary to present fairly the
financial position, results of operations and cash flows for the periods
presented have been made.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts and operations of
Natrol, Inc. and its wholly owned subsidiaries. All significant intercompany
accounts have been eliminated in consolidation.
ESTIMATES AND ASSUMPTIONS
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts in the consolidated financial
statements and accompanying notes. Actual results could differ from those
estimates, although management does not believe that any differences would
materially affect the Company's consolidated financial position or results of
operations.
MAJOR CUSTOMERS
The Company had net sales to two customers which individually represented
17.2% and 10.0%, respectively, of total Company net sales during the year ended
December 31, 1995. The Company had net sales to three customers which
individually represented 14.5%, 12.6% and 10.2%, respectively, of total Company
net sales during the year ended December 31, 1996. The Company had net sales to
two customers which individually represented 17.8% and 11.6%, respectively, of
total Company net sales during the year ended December 31, 1997. The Company had
net sales to two customers which individually represented 14.8% and 11.1% and
15.3% and 10.4%, respectively, of total Company net sales during the three
months ended March 31, 1997 and 1998, respectively.
MAJOR PRODUCTS
The Company's sales of two products each comprised approximately 28.7% and
27.3%, respectively, of net sales during the year ended December 31, 1995. The
Company's sales of three products each comprised approximately 36.0%, 18.8% and
18.1%, respectively, of net sales during the year ended December 31, 1996. The
Company's sales of two products each comprised approximately 17.1% and 17.7%,
respectively, of net sales during the year ended December 31, 1997. The
Company's sales of three products each comprised approximately 23.7%, 20.7% and
20.0%, respectively, of net sales during the three months ended March 31, 1997.
The Company's sales of two products each comprised approximately 15.1% and
12.2%, respectively, of net sales during the three months ended March 31, 1998.
CONCENTRATION OF CREDIT RISK
Concentrations of credit risk with respect to trade receivables, other than
significant customers previously discussed, are limited, due to the distribution
of sales over a large customer base. The Company performs periodic credit
evaluations of its customers' financial conditions and generally does not
require collateral. Credit losses have been within management's expectations.
F-8
<PAGE>
NATROL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CASH EQUIVALENTS
The Company considers all highly liquid instruments with a maturity of three
months or less when purchased to be cash equivalents.
INVENTORIES
Inventories are carried at the lower of cost (first-in, first-out method) or
market.
EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Equipment and leasehold improvements are stated on the basis of cost.
Depreciation on furniture, machinery and equipment is computed using the
straight-line method over the estimated useful lives of the assets ranging from
five to ten years. Amortization on leasehold improvements is computed using the
straight-line method over the shorter of the estimated lives of the assets or
the lease terms.
TRADEMARKS AND PATENTS
Costs of obtaining trademarks and patents are capitalized and amortized
using the straight-line basis over the estimated useful life of eleven years.
Accumulated amortization was $17,951 and $21,624 at December 31, 1996 and 1997,
respectively. The costs of servicing the Company's patents and trademarks are
expensed as incurred.
REVENUE RECOGNITION
The Company sells its products to retail outlets through a direct salesforce
and a national broker network. Sales are recorded when products are shipped to
customers by the Company. Net sales represent products shipped, less estimated
returns and allowances for which provisions are made at the time of sale.
Generally the returns and allowances are limited to damaged goods and the
estimates recorded are based upon known claims and an estimate of additional
returns.
ADVERTISING COSTS
Advertising and promotional costs are expensed at first showing. In
addition, the Company advertises on a cooperative basis by accruing an
obligation to reimburse retailers for qualified advertising of Company products.
The Company provides for cooperative advertising obligations in the same period
as the related revenue is recognized. Advertising and promotional costs amounted
to $2,473,659, $5,638,500 and $6,944,454, respectively, for the years ended
December 31, 1995, 1996 and 1997 and $2,086,725 and $2,092,693 for the three
months ended March 31, 1997 and 1998, respectively.
RESEARCH AND DEVELOPMENT COSTS
The Company incurs research and development costs relating to the
development of its dietary supplement products. Research and development costs
are expensed as incurred and amounted to $106,848, $117,184 and $357,064 for the
years ended December 31, 1995, 1996 and 1997, respectively, and $64,414 and
$79,946 for the three months ended March 31, 1997 and 1998, respectively.
F-9
<PAGE>
NATROL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
STOCK-BASED COMPENSATION
Statement of Financial Accounting Standard (SFAS) No. 123, "Accounting for
Stock-Based Compensation" encourages, but does not require, companies to record
compensation cost for stock-based employee compensation plans at fair value. The
Company has chosen to continue to account for stock-based compensation using the
intrinsic value method prescribed in Accounting Principles Board Opinion (APB)
No. 25, "Accounting for Stock Issued to Employees."
EARNINGS PER SHARE
The Company calculates earnings per share in accordance with SFAS No. 128
"Earnings per Share." Pro forma basic earnings per share have been computed by
dividing pro forma net income by the pro forma weighted average number of common
shares outstanding. Pro forma diluted earnings per share have been computed by
dividing pro forma net income by securities or other contracts to issue common
stock as if these securities were exercised or converted to common stock.
The following table sets forth the calculation for basic and diluted
earnings per share for the periods indicated:
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED DECEMBER 31, ENDED MARCH 31,
-------------------------------------------- ---------------------------------
1995 1996 1997 1997 1998
------------- ------------- -------------- -------------- -----------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Earnings:
Net income...................... $ 2,044,015 $ 5,892,388 $ 4,190,700 $ 810,053 $ 1,175,481
------------- ------------- -------------- -------------- -----------------
------------- ------------- -------------- -------------- -----------------
Shares:
Weighted average shares for
basic earnings per share...... 6,000,000 6,275,000 7,100,000 7,100,000 7,100,000
Conversion of convertible
participating preferred
stock......................... -- 675,000 2,700,000 2,700,000 2,700,000
Share equivalent for redeemable
preferred stock............... -- 115,385 461,538 461,538 461,538
Stock options................... -- -- 11,321 -- 11,321
------------- ------------- -------------- -------------- -----------------
Weighted average shares for
diluted earnings per share.... 6,000,000 7,065,385 10,272,859 10,261,538 10,272,859
------------- ------------- -------------- -------------- -----------------
------------- ------------- -------------- -------------- -----------------
</TABLE>
As discussed further in Notes 1 and 4, the Company elected to be taxed as an
S Corporation for federal income and California franchise tax purposes for the
period from July 1, 1996 through September 29, 1996, and was taxed as a C
Corporation for all the other periods in the year ended December 31, 1996.
Accordingly, the provision for income taxes for the period in which the Company
was taxed as an S Corporation reflects primarily state income tax, if any. If
the Company had been subject to tax as a C Corporation for the entire year ended
December 31, 1996, pro forma basic and diluted earnings per share would have
been $0.80 and $0.71, respectively.
F-10
<PAGE>
NATROL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
LONG-LIVED ASSETS
The Company reviews for the impairment of long-lived assets and certain
identifiable intangibles whenever events or changes in circumstances indicate
that the carrying amount of any asset may not be recoverable. An impairment loss
would be recognized when the estimated undiscounted future cash flows expected
to result from the use of the asset and its eventual disposition is less than
the carrying amount. If an impairment is indicated, the amount of the loss to be
recorded is based upon an estimate of the difference between the carrying amount
and the fair value of the asset. Fair value is based upon discounted estimated
cash flows expected to result from the use of the asset and its eventual
disposition and other valuation methods. No such impairment losses have been
identified by the Company.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS
No. 130"). This statement establishes standards for reporting and display of
comprehensive income and its components. Components of comprehensive income are
net income and all other non-owner changes in equity such as unrealized gains on
available-for-sale securities that are not included in net income. This
statement requires that an enterprise: (a) classify items of other comprehensive
income by their nature in a financial statement and (b) display the accumulated
balance of other comprehensive income separately from retained earnings in the
equity section of the balance sheet. While SFAS No. 130 is effective for
financial statements issued for periods beginning after December 15, 1997, and
therefore was adopted in the year ended December 31, 1998, there were no items
of comprehensive income and no impact on the Company's results of operations or
related disclosures for the three months ended March 31, 1997 and 1998.
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," was issued in June 1997. SFAS No. 131 is effective for fiscal
years beginning subsequent to December 15, 1997, and therefore, will be adopted
by the Company for the year ended December 31, 1998. The Company does not expect
the adoption of SFAS No. 131 to result in any material changes in its disclosure
and this statement will have no impact on the Company's consolidated results of
operations, financial position or cash flows.
RECLASSIFICATIONS
Certain reclassifications have been made to the prior year consolidated
financial statements to conform to the presentation in 1997.
2. INVENTORIES
Inventories consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------
<S> <C> <C>
1996 1997
------------- -------------
Raw material and packaging supplies............................. $ 2,309,822 $ 3,837,856
Finished goods.................................................. 1,564,478 3,096,325
------------- -------------
$ 3,874,300 $ 6,934,181
------------- -------------
------------- -------------
</TABLE>
F-11
<PAGE>
NATROL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. FINANCING
Long-term debt consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
<S> <C> <C>
1996 1997
----------- -------------
Note payable to a bank, payable in monthly installments of $41,667, beginning October
31, 1997, plus interest at the prime rate plus 0.25%, due October 31, 2002.......... $ -- $ 1,875,000
Note payable to a bank, payable in monthly installments of $25,000, beginning June 30,
1997, plus interest at the prime rate plus 0.25%, due June 30, 2002................. -- 1,325,000
Note payable to a bank, payable in monthly installments of $11,458, beginning July 1,
1996, plus interest at the prime rate plus 0.75%, due June 1, 2000.................. 481,250 343,750
Note payable to a bank, payable in monthly installments of $5,556 plus interest at the
prime rate plus 0.75%, due November 1, 1998......................................... 127,778 61,111
----------- -------------
609,028 3,604,861
Less current portion.................................................................. 204,167 998,611
----------- -------------
$ 404,861 $ 2,606,250
----------- -------------
----------- -------------
</TABLE>
Future maturities of long-term debt at December 31 are as follows:
<TABLE>
<S> <C>
1998........................................................................... $ 998,611
1999........................................................................... 937,500
2000........................................................................... 868,750
2001........................................................................... 675,000
2002........................................................................... 125,000
----------
$3,604,861
----------
----------
</TABLE>
In addition to the term loans, the Company has an agreement with a bank
which provides for maximum borrowings on a revolving line of credit up to
$2,500,000, based on a formula, through December 1, 1998, with interest at the
prime rate plus 0.5% (prime rate was 8.50% at December 31, 1997). No amounts
were outstanding under this agreement at December 31, 1996 and 1997. The line of
credit and term loans are collateralized by substantially all of the Company's
assets and include requirements that the Company comply with certain financial
covenants. The agreement provides for a letter of credit up to a maximum of
$250,000, of which no amounts were outstanding at December 31, 1996 and 1997.
This agreement was subsequently replaced by the agreement described in Note 9 to
the consolidated financial statements.
4. INCOME TAXES
The Company accounts for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes." Under this method, deferred tax assets and
liabilities are determined based on differences between enacted rates and laws
that will be in effect when the differences are expected to reverse.
F-12
<PAGE>
NATROL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. INCOME TAXES (CONTINUED)
The income tax provision consists of the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------
<S> <C> <C> <C>
1995 1996 1997
------------- ------------- -------------
Current:
Federal............................................................ $ 1,260,351 $ 2,078,292 $ 2,161,400
State.............................................................. 335,470 617,762 516,595
------------- ------------- -------------
1,595,821 2,696,054 2,677,995
Deferred:
Federal............................................................ (133,574) (303,734) 72,202
State.............................................................. (9,577) (93,727) 65,961
------------- ------------- -------------
(143,151) (397,461) 138,163
------------- ------------- -------------
Total income tax provision........................................... $ 1,452,670 $ 2,298,593 $ 2,816,158
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
As described in Note 1 to the consolidated financial statements, in 1996 the
Company elected to be treated as an S Corporation for federal income and
California franchise tax purposes under Subchapter S of the Internal Revenue
Code and the corresponding provisions of the California statute. Upon the
creation and issuance of the convertible participating preferred stock as
discussed in Notes 1 and 6 to the consolidated financial statements, the Company
was required to change its status for income tax purposes back to a C
corporation. The following unaudited pro forma income tax information has been
determined as if the Company operated as a C corporation for the entire year
ended December 31, 1996. The pro forma information presented below represents
actual amounts for the years ended December 31, 1995 and 1997 as the Company was
operating as a C corporation during those periods.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------
<S> <C> <C> <C>
1995 1996 1997
------------- ------------- -------------
Federal tax provision................................................ $ 1,126,777 $ 2,599,860 $ 2,233,602
State income taxes net of federal benefit............................ 325,893 559,933 582,556
------------- ------------- -------------
Total pro forma income tax provision................................. $ 1,452,670 $ 3,159,793 $ 2,816,158
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
The difference between actual income tax expense and the U.S. Federal
statutory income tax rate is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
<S> <C> <C> <C>
1995 1996 1997
--------- --------- ---------
Statutory rate...................................................................... 34.0% 34.0% 34.0%
State tax provision................................................................. 6.0 4.0 6.0
S Corporation status................................................................ -- (10.0) --
Other............................................................................... 1.5 -- --
--- --------- ---
Effective tax rate.................................................................. 41.5% 28.0% 40.0%
--- --------- ---
--- --------- ---
</TABLE>
F-13
<PAGE>
NATROL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. INCOME TAXES (CONTINUED)
The significant components of the Company's deferred tax assets and
liabilities are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
<S> <C> <C>
1996 1997
----------- -----------
Deferred tax assets:
Accounts receivable reserves.......................................................... $ 334,712 $ 264,126
Inventory reserves.................................................................... 141,158 46,486
Various accrued liabilities........................................................... 93,938 120,626
State taxes........................................................................... 66,165 122,652
----------- -----------
635,973 553,890
Deferred tax liability:
Depreciation.......................................................................... (16,694) (72,774)
----------- -----------
$ 619,279 $ 481,116
----------- -----------
----------- -----------
</TABLE>
Deferred taxes arising from temporary differences that are not related to an
asset or liability are classified as current or noncurrent depending on the
periods in which the temporary differences are expected to reverse.
5. COMMITMENTS
The Company leases certain equipment and facilities under noncancelable
operating leases that expire in various years through 2001. Rent expense under
operating leases totaled $168,937, $406,446 and $641,731, for the years ended
December 31, 1995, 1996 and 1997, respectively, and $44,940 and $121,196 for the
three months ended March 31, 1997 and 1998, respectively. In August 1996, the
Company entered into a 120-month lease for an operating facility with an option
to extend the term of the lease for 60 months at 95% of the then market value
for similar space.
Future minimum lease payments under noncancelable operating leases with
initial terms of one year or more consisted of the following at December 31,
1997:
<TABLE>
<S> <C>
1998........................................................................... $ 503,720
1999........................................................................... 526,345
2000........................................................................... 520,811
2001........................................................................... 489,258
2002........................................................................... 448,085
Thereafter..................................................................... 1,711,430
----------
Total minimum lease payments................................................... $4,199,649
----------
----------
</TABLE>
6. STOCKHOLDERS' EQUITY
In September 1996, the shares of common stock held by the original
stockholders were split-up and converted into 7,027,780 shares of common stock
and 25,078.1 shares of convertible participating preferred stock. In addition,
the Company sold an additional 1,921.9 shares of its convertible participating
preferred stock to third party investors. The total of 27,000 shares of
convertible participating preferred stock purchased by the investors are
convertible into (i) approximately 27% of the then
F-14
<PAGE>
NATROL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. STOCKHOLDERS' EQUITY (CONTINUED)
outstanding shares of Common Stock of the Company on a fully diluted basis and
(ii) shares of redeemable preferred stock which are redeemable for a total of
$6.0 million. The total consideration paid by the investors for the convertible
participating preferred stock was $12.0 million.
Each share of convertible participating preferred stock is convertible based
on a formula upon the written election of not less than 66 2/3% of the
outstanding shares of convertible participating preferred stock such that each
outstanding share of convertible participating preferred stocks will convert
into one share of common stock (prior to giving effect the 100-for-1 stock split
described in Note 10) and one-half of one share of redeemable preferred stock,
subject to adjustment for stock splits, stock dividends, recapitalizations and
similar transactions. The convertible participating preferred stock has an
automatic conversion feature which provides for each share of convertible
participating preferred stock to be automatically converted into shares of
common stock and redeemable preferred stock based on the then effective
conversion price immediately upon the closing of the Company's first firm
commitment public offering pursuant to an effective registration statement under
the Securities Act of 1933, as amended, provided that such registration
statement covers the offer and sale of common stock of which the aggregate net
proceeds exceeds $15 million at a price per share reflecting a valuation of the
Company's equity of at least $50 million.
The convertible participating preferred stock contains a liquidation
preference of $444.445 per share, adjusted for any stock splits, stock
dividends, recapitalizations, plus any declared but unpaid dividends. The
convertible participating preferred stock contains voting rights equal to the
number of full shares of common stock they are convertible into.
Upon the occurrence of certain events on or after September 26, 2002, the
Company is required to redeem all of the outstanding shares of convertible
participating preferred stock at the liquidation preference value. Therefore, at
the time of the issuance of the convertible participating preferred stock, the
Company adjusted retained earnings (deficit) by $11,142,850, which represents
the difference between the proceeds received for the convertible participating
preferred stock by the Company and its redemption value. Thus, the convertible
participating preferred stock is recorded at its redemption value at December
31, 1996 and 1997.
RECEIVABLE FROM STOCKHOLDER
The receivable from stockholder represents an interest bearing note from a
stockholder in the amount of $562,500 issued by the stockholder to finance in
part the purchase of 300,000 shares of the Company's common stock. The note
bears interest at 6.60% per year with interest payments due annually. The note
is due within ten days of the receipt by the stockholder of proceeds from the
sale of the Company's common stock or November 14, 2006, whichever occurs first.
Included in interest income is $9,300 and $37,125 for the years ended December
31, 1996 and 1997, respectively, for interest from this stockholder.
STOCK OPTIONS
The Company has adopted the 1996 Stock Option and Grant Plan, as amended
(the Plan), which authorizes the Board of Directors of the Company to grant
incentive stock options or non-qualified stock options. Incentive stock options
may be granted only to employees of the Company. Non-qualified stock options may
be granted to officers and employees of the Company as well as to non-employees.
The
F-15
<PAGE>
NATROL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. STOCKHOLDERS' EQUITY (CONTINUED)
maximum number of shares of common stock to be issued under the Plan is
1,050,000 shares. All options granted under the Plan have been made at prices
not less than the estimated fair market value of the stock at the date of grant.
Generally the options granted under the Plan vest over 3-5 years. Options
granted under the plan have a term of not more than 10 years.
A summary of the Company's stock option activity, and related information is
as follows:
<TABLE>
<CAPTION>
OUTSTANDING STOCK OPTIONS
---------------------------------------------
<S> <C> <C> <C>
WEIGHTED
AVERAGE EXERCISE
NUMBER OF EXERCISE PRICE PRICE
OPTIONS PER SHARE PER SHARE
----------- -------------- ----------------
Outstanding at January 1, 1996.................................... -- $ -- $ --
Granted......................................................... 200,000 1.875 1.875
----------- ------- ----------------
Outstanding at December 31, 1996.................................. 200,000 1.875 1.875
Granted......................................................... 200,000 2.100 2.100
----------- ------- ----------------
Outstanding at December 31, 1997.................................. 400,000 $ 1.988 $ 1.875-2.100
----------- ------- ----------------
----------- ------- ----------------
Exercisable at:
December 31, 1996............................................... 70,000 $ 1.875 $ 1.875
December 31, 1997............................................... 116,250 $ 1.887 $ 1.875-$2.100
----------- ------- ----------------
----------- ------- ----------------
</TABLE>
At December 31, 1997, 350,000 shares were available for future grant.
Subsequent to year end through April 13, 1998, the Company granted 255,000
options under the Plan at exercise prices ranging from $10.40 to $13.00 per
share, which were determined to be not less than the estimated fair market value
of the stock at the date of grant. After these options were granted, 95,000
shares were available for future grant. The weighted average remaining
contractual life for the outstanding options in years was 10 and 9.38 at
December 31, 1996 and 1997, respectively.
If the Company had elected to recognize compensation expense based on the
fair value of the options granted at grant date for its stock-based compensation
plans consistent with the method prescribed by SFAS No. 123, the Company's net
income would have been reduced by approximately $100 and $4,900 for the years
ended December 31, 1996 and 1997, respectively, and there would have been no
effect on the reported earnings per share. The fair value of the options is
estimated using the Black-Scholes option-pricing model with the following
weighted average assumptions for grants in 1996 and 1997, respectively: dividend
yield of 6.0% and 3.0%; risk free interest rate of 6.3% and 6.0%; and expected
life of 6.0 years and 5.0 years.
7. PROFIT SHARING PLAN
The Company has a profit sharing 401(k) plan that covers substantially all
of its employees. Eligible employees may contribute up to 10% of their
compensation. Contributions are discretionary, however, the Company generally
matches 10% of the employees' contributions up to the maximum of 1% of eligible
compensation. Amounts recognized as expense were $5,055, $12,764 and $0 for the
years ended December 31, 1995, 1996 and 1997, respectively.
F-16
<PAGE>
NATROL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used by the Company in estimating
its fair value disclosures for financial instruments:
CASH AND CASH EQUIVALENTS: The carrying amount approximates fair value.
ACCOUNTS RECEIVABLE AND ACCOUNTS PAYABLE: The carrying amount approximates
fair value.
LONG-TERM DEBT: The fair values of the Company's long-term notes payable are
estimated using discounted cash flow analyses, based on the Company's current
incremental borrowing rates for similar types of borrowing arrangements. The
carrying amount of long-term notes payable approximate their fair value.
9. SUBSEQUENT EVENTS
ACQUISITIONS
On February 27, 1998, the Company purchased substantially all of the assets
and assumed certain liabilities of Pure-Gar L.P. (Pure-Gar), a distributor of
bulk dehydrated vegetable products and dietary supplements, for a total purchase
price of $11,085,736, which included $85,736 of deferred acquisition costs.
Assets purchased include accounts receivable of $2,060,716 and inventories of
$1,722,865, as well as fixed assets of $149,063 and intangible assets of the
business of $8,965,000. Liabilities assumed consisted primarily of trade
payables of $1,854,614. In addition, the Company entered into long-term supply
and royalty agreements with the seller. The supply agreement requires the seller
to sell and the Company to purchase specified amounts of certain vegetable,
fruit, herbal and botanical products (the "Products") manufactured by the
seller. The supply agreement gives the Company the exclusive right to sell
certain Products in the dietary supplement industry. The supply agreement may be
terminated by either party upon a material breach of the obligations of the
other party, or certain other specified conditions, if the breach is not cured
within 60 days, or 15 days in the case of non-payment by the Company. The
acquisition was accounted for using the purchase method, and accordingly, the
acquired assets and liabilities are recorded at their estimated fair values. The
excess of cost over the fair value of assets acquired will be amortized over
fifteen years. Amortization expense for the three months ended March 31, 1998
was $50,000 and is included in general and administrative expenses.
Pro forma revenues, net income, basic earnings per share and diluted
earnings per share would have been $51,583,312, $3,493,037, $0.23 and $0.16,
respectively, for the year ended December 31, 1997, if the acquisition of
Pure-Gar had taken place on January 1, 1997. Pro forma revenues, net income,
basic earnings per share and diluted earnings per share would have been
$14,948,264, $1,090,636, $0.09 and $0.06, respectively, for the three months
ended March 31, 1998, if the acquisition of Pure-Gar had taken place on January
1, 1998.
FINANCING
On February 27, 1998, the Company entered into an amended credit facility
(Loan Agreement) with a bank that provides for a revolving line of credit for
borrowings up to $8,000,000, based on a formula, through April 30, 2001. The
Loan Agreement amends and restates the previous revolving line of credit
agreement with the bank. Advances under the Loan Agreement bear interest at the
bank's adjusted LIBOR rate plus 1.25% or the bank's prime rate at the option of
the Company. The Loan Agreement also provides for a letter of credit up to a
maximum of $250,000. Proceeds from the initial funding under the Loan
F-17
<PAGE>
NATROL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. SUBSEQUENT EVENTS (CONTINUED)
Agreement were used to assist in the funding of the Pure-Gar acquisition and
further fundings are to be used for working capital requirements.
In addition to providing for the revolving loans, the Loan Agreement
provides for a term loan of $9,000,000 to be used for financing the acquisition
of Pure-Gar. The term loan calls for monthly installments of $125,000 during the
period March 1, 1998 through February 28, 2004 and bears interest at the bank's
adjusted LIBOR rate plus 1.25% or the bank's prime rate at the option of the
Company. Mandatory prepayments are required on the term loan based on excess
cash flows, as defined.
The Loan Agreement is collateralized by substantially all of the assets of
the Company and requires the Company to maintain certain minimum amounts and
ratios of net worth and other financial measurements.
10. PROPOSED INITIAL PUBLIC OFFERING
During May 1998, the Company's Board of Directors authorized the filing of a
registration statement with the Securities and Exchange Commission, relating to
an initial public offering of 3,200,000 shares of the Company's unissued common
stock and 740,000 shares to be sold by selling stockholders. If the initial
public offering is consummated under the terms anticipated, all of the
convertible participating preferred stock will convert into 2,700,000 shares of
common stock and 13,500 shares of redeemable preferred stock. The shares of
redeemable preferred stock are then required to be immediately redeemed by the
Company for $6,000,000 in cash.
In connection with the initial public offering, the Board of Directors
approved a one hundred-for-one-stock split of the Company's common stock which
became effective on June 19, 1998. All references in the accompanying
consolidated financial statements to the number of shares of common stock and
per common share amounts have been retroactively adjusted to reflect the stock
split. In addition, the Company's capital structure was changed effective June
19, 1998 to reflect 50,000,000 shares of common stock and will be further
changed prior to the registration statement going effective to authorize an
additional 2,000,000 shares of preferred stock. The Board of Directors has
authority to fix the rights, preferences, privileges and restrictions, including
voting rights, of these shares of preferred stock without any future vote or
action by the shareholders.
Subsequent to April 13, 1998, the Company granted a total of 65,000 stock
options under the Amended and Restated 1996 Stock Option and Grant Plan at
exercise prices ranging from $10.40 to $13.00 per share, which were determined
to be not less than the estimated fair market value of the stock at the date of
the grant.
F-18
<PAGE>
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Stockholders of Natrol, Inc.:
We have audited the accompanying balance sheets of Pure-Gar L.P. (a division
of Basic Vegetable Products, L.P.) (the "Partnership") as of December 28, 1996
and December 27, 1997 and the related statements of income, partners' equity and
cash flows for the years then ended. These financial statements are the
responsibility of the Partnership's management. Our responsibility is to express
an opinion on these financial statements 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 presentation of the financial
statements. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the accompanying financial statements present fairly, in all
material respects, the financial position of the Partnership at December 28,
1996 and December 27, 1997 and the results of its operations and its cash flows
for the years then ended in conformity with generally accepted accounting
principles.
Farber & Hass LLP
Oxnard, California
April 17, 1998
F-19
<PAGE>
PURE-GAR L.P.
(A DIVISION OF BASIC VEGETABLE PRODUCTS, L.P.)
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 28, DECEMBER 27,
1996 1997
-------------- --------------
<S> <C> <C>
ASSETS
Current assets:
Cash......................................................................... $ 465 $ 42,000
Accounts receivable (less allowance for doubtful accounts of $53,000 in 1996
and 1997).................................................................... 1,074,415 1,683,976
Inventories.................................................................. 2,684,242 1,922,753
Prepaid expenses and other current assets.................................... 169,431 66,684
-------------- --------------
Total current assets........................................................... 3,928,553 3,715,413
Property and equipment......................................................... 208,248 270,616
Less accumulated depreciation and amortization............................... (73,425) (113,497)
-------------- --------------
Property and equipment--net.................................................... 134,823 157,119
-------------- --------------
Total assets................................................................... $ 4,063,376 $ 3,872,532
-------------- --------------
-------------- --------------
LIABILITIES AND PARTNERS' EQUITY
Current liabilities:
Bank overdraft............................................................... $ 271,872 $ --
Accounts payable............................................................. 225,611 175,166
Accrued expenses............................................................. 313,090 234,458
Related party payable........................................................ 2,144,049 2,318,698
-------------- --------------
Total current liabilities...................................................... 2,954,622 2,728,322
-------------- --------------
Partners' equity:
Limited partner.............................................................. 1,097,666 1,132,768
General partner.............................................................. 11,088 11,442
-------------- --------------
Total partners' equity......................................................... 1,108,754 1,144,210
-------------- --------------
Total liabilities and partners' equity......................................... $ 4,063,376 $ 3,872,532
-------------- --------------
-------------- --------------
</TABLE>
See notes to financial statements.
F-20
<PAGE>
PURE-GAR L.P.
(A DIVISION OF BASIC VEGETABLE PRODUCTS, L.P.)
STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED
DECEMBER 28, DECEMBER 27,
1996 1997
-------------- --------------
<S> <C> <C>
Net sales...................................................................... $ 7,947,565 $ 8,708,553
Cost of goods sold............................................................. 3,802,207 3,920,226
-------------- --------------
Gross profit................................................................... 4,145,358 4,788,327
-------------- --------------
Operating expenses:
Selling and marketing expenses............................................... 1,900,559 1,954,543
General and administrative expenses.......................................... 1,924,024 1,849,161
Litigation settlement expense................................................ -- 733,120
-------------- --------------
Total operating expenses....................................................... 3,824,583 4,536,824
-------------- --------------
Income from operations......................................................... 320,775 251,503
Related party interest expense................................................. (177,785) (229,735)
Other income................................................................... 119,412 13,688
-------------- --------------
Net income..................................................................... $ 262,402 $ 35,456
-------------- --------------
-------------- --------------
Pro forma net income data:
Income before provision for income taxes....................................... $ 262,402 $ 35,456
Pro forma income taxes......................................................... 85,587 5,318
-------------- --------------
Pro forma net income........................................................... $ 176,815 $ 30,138
-------------- --------------
-------------- --------------
</TABLE>
See notes to financial statements.
F-21
<PAGE>
PURE-GAR L.P.
(A DIVISION OF BASIC VEGETABLE PRODUCTS, L.P.)
STATEMENTS OF PARTNERS' EQUITY
FOR THE YEARS ENDED DECEMBER 28, 1996 AND DECEMBER 27, 1997
<TABLE>
<CAPTION>
GENERAL LIMITED
PARTNER PARTNER TOTAL
--------- ------------- -------------
<S> <C> <C> <C>
Partners' equity at January 1, 1996..................................... $ 8,464 $ 837,888 $ 846,352
Net income for 1996..................................................... 2,624 259,778 262,402
--------- ------------- -------------
Partners' equity at December 28, 1996................................... 11,088 1,097,666 1,108,754
Net income for 1997..................................................... 354 35,102 35,456
--------- ------------- -------------
Partners' equity at December 27, 1997................................... $ 11,442 $ 1,132,768 $ 1,144,210
--------- ------------- -------------
--------- ------------- -------------
</TABLE>
See notes to financial statements.
F-22
<PAGE>
PURE-GAR L.P.
(A DIVISION OF BASIC VEGETABLE PRODUCTS, L.P.)
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED
DECEMBER 28, DECEMBER 27,
1996 1997
-------------- --------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income..................................................................... $ 262,402 $ 35,456
Adjustment to reconcile net income to net cash used in operating activities:
Depreciation and amortization................................................ 26,776 40,072
Changes in operating assets and liabilities:
Accounts receivable.......................................................... 71,028 (609,561)
Inventories.................................................................. (1,812,793) 761,489
Prepaid expenses............................................................. (133,426) 102,747
Accounts payable, accrued expenses and other liabilities..................... 350,953 (400,949)
-------------- --------------
Net cash used in operating activities.......................................... (1,235,060) (70,746)
-------------- --------------
CASH FLOWS USED BY INVESTING ACTIVITIES
Capital expenditures......................................................... (74,779) (62,368)
-------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net related party borrowings from limited partner............................ 1,303,186 174,649
-------------- --------------
NET INCREASE (DECREASE) IN CASH................................................ (6,653) 41,535
CASH, BEGINNING OF YEAR........................................................ 7,118 465
-------------- --------------
CASH, END OF YEAR.............................................................. $ 465 $ 42,000
-------------- --------------
-------------- --------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the year for:
Interest................................................................... $ -- $ --
Taxes...................................................................... $ -- $ --
</TABLE>
See notes to financial statements.
F-23
<PAGE>
PURE-GAR L.P.
(A DIVISION OF BASIC VEGETABLE PRODUCTS, L.P.)
NOTES TO FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS ACTIVITY
Pure-Gar L.P. (a division of Basic Vegetable Products, L.P.), a Delaware
Limited Partnership (the "Partnership"), is a distributor of dehydrated
vegetable products and dietary supplements. The Partnership utilizes the 52/53
week convention to report financial results.
CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Partnership to
significant concentrations of credit risk are principally trade accounts
receivable.
Concentrations of credit risk with respect to trade accounts receivable are
due to concentrations of sales to certain customers. At December 28, 1996, one
customer accounted for 24% of the Partnership's trade receivables. At December
27, 1997, two customers accounted for 17% and 16%, respectively, of the
Partnership's trade receivables. The Partnership performs ongoing credit
evaluations of its customers and normally does not require collateral to support
accounts receivable.
MAJOR CUSTOMERS
During the year ended December 28, 1996, two customers accounted for 35% and
24%, respectively, of the Partnership's net sales. During the year ended
December 27, 1997, two customers accounted for 22% and 20%, respectively, of the
Partnership's net sales.
MAJOR SUPPLIER
The Partnership purchases substantially all of its raw garlic from the
Partnership's limited partner, Basic Vegetable Products, L.P. ("BVP") (see Note
3). During the years ended December 28, 1996 and December 27, 1997, these
purchases amounted to approximately $2,979,000 and $2,748,000, respectively,
which includes a mark-up of approximately $687,000 and $634,000, respectively.
INVENTORIES
Inventories consist primarily of finished goods which are stated at the
lower of cost (first-in, first-out basis) or market. The net amount of
inventories at December 27, 1997 reflects an allowance for slow-moving and
obsolete inventories totalling $208,094.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. The Partnership uses the
straight-line method of depreciation.
The estimated useful lives are as follows:
<TABLE>
<S> <C>
Furniture and fixtures........................................ 5 years
Life of
Leasehold improvements........................................ Lease
</TABLE>
F-24
<PAGE>
PURE-GAR L.P.
(A DIVISION OF BASIC VEGETABLE PRODUCTS, L.P.)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
REVENUE RECOGNITION
The Partnership sells its products to retail outlets and food processors
through a direct sales force, sales representatives and a national broker
network. Sales are recorded when products are shipped to customers by the
Partnership. Net sales represents products shipped, less estimated returns and
allowances for which provisions are made at the time of sale.
RESEARCH AND DEVELOPMENT
Company-sponsored research and development costs related to both present and
future products are expensed as incurred.
INCOME TAXES
The Partnership is not subject to Federal and state income taxes. Instead,
each Partner's share of Partnership profit is reported on their separate income
tax return.
PRO FORMA NET INCOME DATA
The unaudited pro forma net income data included in the Statements of Income
was presented as if the Partnership operated as a C Corporation for the entire
years ended December 28, 1996 and December 27, 1997. The pro forma income taxes
represents only Federal taxes since there are no income taxes in the State of
Washington where its primary facility was located.
PERVASIVENESS OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Based on borrowing rates currently available to the Partnership for bank
loans with similar terms and maturities, the fair value of the Partnership's
related party debt approximates the carrying value. Furthermore, the carrying
value of all other financial instruments potentially subject to valuation risk
(principally consisting of accounts receivable and accounts payable) also
approximates fair value.
F-25
<PAGE>
PURE-GAR L.P.
(A DIVISION OF BASIC VEGETABLE PRODUCTS, L.P.)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
<TABLE>
<CAPTION>
1996 1997
----------- -----------
<S> <C> <C>
Furniture and fixtures.............................................. $ 135,806 $ 227,056
Leasehold improvements.............................................. 43,560 43,560
Construction in progress............................................ 28,882 --
----------- -----------
Total property and equipment........................................ $ 208,248 $ 270,616
----------- -----------
----------- -----------
</TABLE>
3. RELATED PARTY ACTIVITIES
The Partnership purchases substantially all of its raw garlic from the
Partnership's limited partner, BVP. In addition, BVP allocated certain operating
expenses to the Partnership based on BVP management's estimate of the
utilization of common occupancy and labor costs for its various operating
entities and divisions. Management believes the allocation methodology to be
reasonable. Total purchases and allocated operating expenses amounted to
$7,039,642 and $5,552,652 in the years ended December 28, 1996 and December 27,
1997, respectively. Borrowings from BVP are subject to interest at 8%.
Repayments are made to BVP as funds are available. The balance in the related
party payable at December 28, 1996 and December 27, 1997 represents borrowings
and accrued interest thereon.
4. LEASE COMMITMENTS
The Partnership leases office facilities and equipment under operating lease
agreements. Total lease expense was $50,445 and $101,823 in the years ended
December 28, 1996 and December 27, 1997, respectively. Future minimum payments
required under non-cancellable operating leases as of December 27, 1997 total
$29,538 for 1998.
5. LITIGATION SETTLEMENT
In March 1997, the Partnership settled a lawsuit with a supplier for
$733,120. Management does not anticipate any further liability to be incurred
related to this issue.
6. SUBSEQUENT EVENT (UNAUDITED)
In February 1998, the partners entered into an agreement with Natrol, Inc.
to sell substantially all of the Partnership's assets and certain specified
liabilities for approximately $11 million. In addition, the partners entered
into long-term supply and royalty agreements with the buyer. The financial
statements do not contain any adjustments to reflect the sale of the
Partnership's assets and liabilities.
F-26
<PAGE>
UNAUDITED PRO FORMA CONSOLIDATED STATEMENTS OF INCOME
The unaudited pro forma consolidated statements of income presented below
are based on the financial statements of the Company, giving effect to the
assumptions and adjustments set forth in the footnotes to the pro forma
consolidated statements of income. The pro forma statements of income have been
prepared by management based on the historical financial statements of the
Company and Pure-Gar L.P. (Pure-Gar) as of and for the years ended December 31,
1997 and December 27, 1997, respectively, and as of and for the three months
ended March 31, 1998, adjusted where necessary to reflect the acquisition of
Pure-Gar (which occured on February 27, 1998) and related operations as if the
acquisition had been consummated at the beginning of the periods presented. The
pro forma consolidated financial information is presented for illustrative
purposes and it does not purport to represent what the consolidated results of
the operations of the Company for the periods presented would have been had the
acquisition been consummated as of such dates and is not indicative of the
results of that may be obtained in the future.
<TABLE>
<CAPTION>
NATROL, INC. PURE-GAR L.P.
YEAR ENDED YEAR ENDED BUSINESS YEAR ENDED
DECEMBER 31, 1997, DECEMBER 27, 1997, COMBINATION DECEMBER 31, 1997,
ACTUAL ACTUAL ADJUSTMENTS PRO FORMA COMBINED
-------------------- -------------------- ------------- --------------------
<S> <C> <C> <C> <C>
Net sales.......................... $ 42,874,759 $ 8,708,553 $ 51,583,312
Cost of goods sold................. 19,799,712 3,920,226 23,719,938
-------------------- ----------- --------------------
Gross profit..................... 23,075,047 4,788,327 27,863,374
-------------------- ----------- --------------------
Selling and marketing expenses... 11,398,390 1,954,543 13,352,933
General and administrative
expenses....................... 4,450,244 2,582,281 600,000(1) 7,632,525(3)
-------------------- ----------- --------------------
Total expenses................... 15,848,634 4,536,824 20,985,458
-------------------- ----------- --------------------
Operating income................... 7,226,413 251,503 6,877,916
Interest income (expense), net..... (219,555) (216,047) (681,832)(2) (1,117,434)
-------------------- ----------- --------------------
Income before income tax
provision........................ 7,006,858 35,456 5,760,482
Income tax provision............... 2,816,158 -- (512,733)(4) 2,303,425
-------------------- ----------- --------------------
Net income......................... $ 4,190,700 $ 35,456 $ 3,457,057
-------------------- ----------- --------------------
-------------------- ----------- --------------------
Basic earnings per share........... $ 0.59 $ 0.49
-------------------- --------------------
-------------------- --------------------
Diluted earnings per share......... $ 0.41 $ 0.34
-------------------- --------------------
-------------------- --------------------
Weighted average common shares
outstanding--basic............... 7,100,000 7,100,000
-------------------- --------------------
-------------------- --------------------
Weighted average common shares
outstanding--diluted............. 10,272,859 10,272,859
-------------------- --------------------
-------------------- --------------------
</TABLE>
- ------------------------
(1) Gives effect to the amortization of goodwill of $600,000, as if the
acquisition of Pure-Gar L.P. (the "Pure-Gar Acquisition") had taken place on
January 1, 1997.
(2) Gives effect to pro forma interest expense of $1,151,817 offset by actual
interest expense of $469,985, as if the debt incurred in the Pure-Gar
Acquisition was made on January 1, 1997. Pro forma interest expense is based
on a term note (8.5% interest rate) and line of credit (8.5% to 7.69%
interest rate) with principal balances of $8,875,000 and $5,524,167,
respectively.
(3) Pro forma general and administrative expenses include a non-recurring legal
settlement expense incurred by Pure-Gar of $733,000.
(4) Gives effect to taxes for adjustments described in footnotes 1 and 2 such
that the pro forma income tax provision is at the statutory rate for the
period presented.
F-27
<PAGE>
<TABLE>
<CAPTION>
NATROL, INC. PURE-GAR L.P. THREE MONTHS
THREE MONTHS THREE MONTHS ENDED
ENDED ENDED BUSINESS MARCH 31, 1998,
MARCH 31, 1998, MARCH 31, 1998, COMBINATION PRO FORMA
ACTUAL ACTUAL ADJUSTMENTS COMBINED
---------------- ---------------- ------------- ----------------
<S> <C> <C> <C> <C>
Net sales.................................... $ 11,879,996 $ 3,068,268 -- $ 14,948,264
Cost of goods sold........................... 5,707,501 1,735,495 -- 7,442,996
---------------- ---------------- ----------------
Gross Profit............................... 6,172,495 1,332,773 -- 7,505,268
---------------- ---------------- ----------------
Selling expenses............................. 3,283,612 717,945 -- 4,001,557
General and administrative expenses.......... 1,198,943 377,134 100,000(1) 1,676,077
---------------- ---------------- ------------- ----------------
Total expenses............................. 4,482,555 1,095,079 -- 5,677,634
---------------- ---------------- ------------- ----------------
Operating income............................. 1,689,940 237,694 -- 1,827,634
Interest income (expense), net............... (63,207) (100,424) 136,276(2) (299,907)
---------------- ---------------- ------------- ----------------
Income before income tax provision........... 1,626,733 137,270 -- 1,527,727
Income tax provision......................... 650,694 -- 39,603(3) 611,091
---------------- ---------------- ------------- ----------------
Net income................................... $ 976,039 $ 137,270 -- $ 916,636
---------------- ---------------- ------------- ----------------
---------------- ---------------- ------------- ----------------
Basic earnings per share..................... $ 0.14 $ 0.15
---------------- ----------------
---------------- ----------------
Diluted earnings per share................... $ 0.10 $ 0.11
---------------- ----------------
---------------- ----------------
Weighted average common shares
outstanding--basic......................... 7,100,000 7,100,000
---------------- ----------------
---------------- ----------------
Weighted average common shares
outstanding--diluted....................... 10,272,859 10,272,859
---------------- ----------------
---------------- ----------------
</TABLE>
- ------------------------
(1) Gives effect to the amortization of goodwill of $150,000, as if the Pure-Gar
Acquisition had taken place on January 1, 1998, net of recorded goodwill
amortization.
(2) Gives effect to pro forma interest expense of $299,907 offset by actual
interest expense of $163,631, as if the debt incurred in the Pure-Gar
Acquisition was made on January 1, 1998. Pro forma interest expense is based
on a term note (8.5% interest rate) and line of credit (8.5% to 7.69%
interest rate) with principal balances of $8,875,000 and $5,524,167,
respectively.
(3) Gives effect to taxes for adjustments described in footnotes 1 and 2 such
that the pro forma income tax provision is at the statutory rate for the
period presented.
F-28
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
NO PERSON HAS BEEN AUTHORIZED IN CONNECTION WITH THE OFFERING MADE HEREBY TO
GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATION NOT CONTAINED IN THIS
PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE
RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR BY ANY UNDERWRITER. THIS
PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO
BUY ANY OF THE SECURITIES OFFERED HEREBY TO ANY PERSON OR BY ANYONE IN ANY
JURISDICTION IN WHICH IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION. NEITHER
THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY
CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THE INFORMATION CONTAINED HEREIN IS
CORRECT AS OF ANY DATE SUBSEQUENT TO THE DATE HEREOF.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary........................................................ 3
Risk Factors.............................................................. 6
Use of Proceeds........................................................... 16
Dividend Policy........................................................... 16
Capitalization............................................................ 17
Dilution.................................................................. 18
Selected Consolidated Financial Data...................................... 19
Management's Discussion and Analysis of Financial Condition and Results of
Operations.............................................................. 20
Business.................................................................. 28
Management................................................................ 41
Certain Transactions...................................................... 48
Principal and Selling Stockholders........................................ 49
Description of Capital Stock.............................................. 51
Shares Eligible for Future Sale........................................... 54
Underwriting.............................................................. 56
Legal Matters............................................................. 57
Experts................................................................... 57
Additional Information.................................................... 58
Index to Financial Statements............................................. F-1
</TABLE>
------------------------
UNTIL , 1998 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL DEALERS
EFFECTING TRANSACTIONS IN THE COMMON STOCK OFFERED HEREBY, WHETHER OR NOT
PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS.
THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN
ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR
SUBSCRIPTIONS.
3,940,000 SHARES
[LOGO]
COMMON STOCK
--------------
PROSPECTUS
--------------
Adams, Harkness & Hill, Inc.
NationsBanc Montgomery
Securities LLC
Piper Jaffray Inc.
, 1998
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION (1)
The following table sets forth the estimated expenses payable by the Company
in connection with this offering (excluding underwriting discounts and
commissions):
<TABLE>
<CAPTION>
NATURE OF EXPENSE AMOUNT
- ------------------------------------------------------------------------------- -------------
<S> <C>
SEC Registration Fee........................................................... $ 18,714
NASD Filing Fee................................................................ 6,844
Nasdaq Listing Fee............................................................. 84,875
Accounting Fees and Expenses................................................... 190,000
Legal Fees and Expenses........................................................ 450,000
Printing Expenses.............................................................. 175,000
Blue Sky Qualification Fees and Expenses....................................... 11,800
Transfer Agent's Fee........................................................... 10,500
Miscellaneous.................................................................. 102,267
-------------
TOTAL........................................................................ $ 1,050,000
</TABLE>
- ------------------------
(1) The amounts set forth above, except for the SEC, NASD and Nasdaq fees, are
in each case estimated.
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
In accordance with Section 145 of the General Corporation Law of the State
of Delaware (the "DGCL"), Article VIII of the Company's Amended and Restated
Certificate of Incorporation (the "Certificate") provides that no director of
the Company shall be personally liable to the Company or its stockholders for
monetary damages for breach of fiduciary duty as a director, except for
liability (i) for any breach of the director's duty of loyalty to the Company or
its stockholders, (ii) for acts or omissions not in good faith or which involve
intentional misconduct or a knowing violation of law, (iii) in respect of
certain unlawful dividend payments or stock redemptions or repurchases, or (iv)
for any transaction from which the director derived an improper personal
benefit. In addition, the Certificate provides that if the DGCL is amended to
authorize the further elimination or limitation of the liability of directors,
then the liability of a director of the Corporation shall be eliminated or
limited to the fullest extent permitted by the DGCL, as so amended.
Article V of the Company's Amended and Restated By-laws provides for
indemnification by the Company of its officers and certain non-officer employees
under certain circumstances against expenses (including attorneys fees,
judgments, fines and amounts paid in settlement) reasonably incurred in
connection with the defense or settlement of any threatened, pending or
completed legal proceeding in which any such person is involved by reason of the
fact that such person is or was an officer or employee of the Company if such
person acted in good faith and in a manner he or she reasonably believed to be
in or not opposed to the best interests of the Company, and, with respect to
criminal actions or proceedings, if such person had no reasonable cause to
believe his or her conduct was unlawful.
The Company has entered into indemnification agreements with each of its
directors reflecting the foregoing provisions of its By-laws and requiring the
advancement of expenses in proceedings involving such directors in most
circumstances.
The Stock Purchase and Shareholders Agreement, filed as Exhibit 2.1 hereto,
provides for indemnification by the Company of certain of its existing principal
stockholders and the controlling persons of
II-1
<PAGE>
such stockholders (one of whom is a director of the Company) against claims and
liabilities, including claims and liabilities arising under the securities laws.
Under Section 10 of the Underwriting Agreement filed as Exhibit 1.1 hereto,
the Underwriters have agreed to indemnify, under certain conditions, the
Company, its directors, certain officers and persons who control the Company
within the meaning of the Securities Act against certain liabilities.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
Set forth in chronological order below is information regarding the number
of share of capital stock issued by the Company for the past three years
beginning in May 1995. Further included is the consideration, if any, received
by the Company for such shares, and information relating to the section of the
Securities Act of 1933, as amended (the "Securities Act"), or rule of the
Securities and Exchange Commission under which exemption from registration was
claimed. The following transactions give effect to the Company's 100-to-1 stock
split of its Common Stock, effected on June 19, 1998.
(1) In September 1996, pursuant to a Stock Purchase and Shareholders'
Agreement, the Company and certain stockholders of the Company sold an
aggregate of 27,000 shares of the Company's Convertible Participating
Preferred Stock for an aggregate purchase price of $12.0 million to
Advent VII L.P., Advent Atlantic and Pacific III L.P., Advent New York
L.P., and TA Venture Investors Limited Partnership, in reliance upon the
exemption from registration under Regulation D of the Securities Act.
(2) In November 1996, pursuant to the Company's 1996 Stock Plan, the Company
sold 300,000 shares of restricted Common Stock for an aggregate purchase
price of $562,800 to an employee in reliance upon the exemption from
registration under Rule 701 promulgated under the Securities Act.
(3) In November 1996, pursuant to the Company's 1996 Stock Plan, the Company
granted options to purchase up to an aggregate of 200,000 shares of
Common Stock to two employees in reliance upon the exemption from
registration under Rule 701 promulgated under the Securities Act.
(4) In July 1997, pursuant to the Company's 1996 Stock Plan, the Company
granted an option to purchase up to 100,000 shares of Common Stock to an
employee in reliance upon the exemption from registration under Rule 701
promulgated under the Securities Act.
(5) In August 1997, pursuant to the Company's 1996 Stock Plan, the Company
granted an option to purchase up to 100,000 shares of Common Stock to an
employee in reliance upon the exemption from registration under Rule 701
promulgated under the Securities Act.
(6) In April 1998, pursuant to the Company's 1996 Stock Plan, the Company
granted options to purchase up to an aggregate of 225,000 shares of
Common Stock to eight employees in reliance upon the exemption from
registration under Rule 701 promulgated under the Securities Act.
(7) In April 1998, pursuant to the Company's 1996 Stock Plan, the Company
granted options to purchase up to an aggregate of 25,000 shares of Common
Stock to a director in reliance upon the exemption from registration
under Rule 701 promulgated under the Securities Act.
(8) In April 1998, pursuant to the Company's 1996 Stock Plan, the Company
granted an option to purchase up to 5,000 shares of Common Stock to a
consultant in reliance upon the exemption from registration under Rule
701 promulgated under the Securities Act.
(9) In May 1998, pursuant to the Company's 1996 Stock Plan, the Company
granted an option to purchase up to 25,000 shares of Common Stock to an
employee in reliance upon the exemption from registration under Rule 701
promulgated under the Securities Act.
II-2
<PAGE>
(10) In June 1998, pursuant to the Company's 1996 Stock Plan, the Company
granted an option to purchase up to 5,000 shares of Common Stock to an
employee in reliance upon the exemption from registration under Rule 701
promulgated under the Securities Act.
(11) In June 1998, pursuant to the Company's 1996 Stock Plan, the Company
granted options to purchase up to 35,000 shares of Common Stock to two
consultants in reliance upon the exemption from registration under Rule
701 promulgated under the Securities Act.
II-3
<PAGE>
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
<TABLE>
<CAPTION>
<C> <C> <S>
* 1.1 Form of Underwriting Agreement.
* 2.1 Stock Purchase and Shareholders' Agreement dated as of September 30, 1996 by and among the
Registrant and the Investors named therein (excluding schedules, which the Registrant agrees to
furnish supplementally to the Commission upon request).
* 3.1 Amended and Restated Certificate of Incorporation.
* 3.2 Amendment to Amended and Restated Certificate of Incorporation.
* 3.3 Form of Second Amended and Restated Certificate of Incorporation (to be filed immediately prior to
effectiveness of the Registration Statement).
* 3.4 Form of Third Amended and Restated Certificate of Incorporation (to be filed following the closing
of the Offering referred to in the Registration Statement).
* 3.5 By-Laws.
* 3.6 Form of Amended and Restated By-laws (to be effective upon effectiveness of the Registration
Statement).
* 4.1 Specimen certificate for shares of Common Stock, $.01 par value, of the Registrant.
* 5.1 Opinion of Goodwin, Procter & Hoar LLP as to the validity of the securities being offered.
* 10.1 Lease dated as of August 12, 1996, as amended by Amendment No. 1, between the Registrant and
Lincoln-Whitehall Pacific, L.L.C.
* 10.2 Amended and Restated 1996 Stock Option and Grant Plan of the Registrant.
* 10.3 1998 Employee Stock Purchase Plan of the Registrant.
* 10.4 Form of Indemnification Agreement between the Registrant and each of its directors.
* 10.5 Restricted Stock Agreement dated November 14, 1996 by and between the Registrant and Dennis R.
Jolicoeur.
* 10.6 Promissory Note of Dennis R. Jolicoeur dated November 14, 1996.
* 10.7 Pledge Agreement dated as of November 14, 1996 by and between the Registrant and Dennis R.
Jolicoeur.
* 10.8 Amended and Restated Credit Agreement with Wells Fargo Bank, N.A.
* 10.9 Form of Stock Option Agreement
*+ 10.10 Supply Agreement dated as of February 28, 1998, by and between the Registrant and Basic Vegetable
Products, L.P.
*+ 10.11 Distributorship/Packager/Supply Agreement dated as of January 1, 1995 by and between the Registrant
and Inter-Cal Corporation.
* 10.12 Letter Agreement dated July 18, 1997 between the Registrant and Jon J. Denis.
* 10.13 Description of salary and incentive bonus arrangements for Dennis R. Jolicoeur, Cheryl R. Richitt
and Gary P. DeMello.
* 21.1 Subsidiaries of the Registrant.
* 23.1 Consent of Goodwin, Procter & Hoar LLP (included in Exhibit 5.1 hereto).
23.2 Consent of Ernst & Young LLP.
23.3 Consent of Farber & Hass.
* 24.1 Powers of Attorney
* 27.1 Financial Data Schedule.
</TABLE>
- ------------------------
* Previously filed.
+ Portions of these Exhibits have been deleted from the publicly filed
documents and have been filed separately with the Commission pursuant to a
request for confidential treatment.
II-4
<PAGE>
(B) FINANCIAL STATEMENT SCHEDULES
Schedule II--Valuation and Qualifying Accounts
Schedules not listed above have been omitted because they are not required
or because the required information is given in the Financial Statements or
Notes thereto.
ITEM 17. UNDERTAKINGS
The undersigned registrant hereby undertakes to provide to the Underwriters
at the closing specified in the Underwriting Agreement certificates in such
denominations and registered in such names as required by the Underwriters to
permit prompt delivery to each purchaser.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Act, and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by the registrant of expenses incurred
or paid by a director, officer or controlling person of the registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Act and will be governed by the final adjudication of
such issue.
The undersigned registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act
of 1933, the information omitted from the form of prospectus filed as part
of this Registration Statement in reliance upon Rule 430A and contained in a
form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4)
or 497(h) under the Securities Act shall be deemed to be part of this
Registration Statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities
Act of 1933, each post-effective amendment that contains a form of
prospectus shall be deemed to be a new registration statement relating to
the securities offered therein, and the offering of such securities at that
time shall be deemed to be the initial bona fide offering thereof.
II-5
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant
has duly caused this Amendment No. 3 to the Registration Statement (File No.
333-52109) to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Chatsworth, State of California, on July 14, 1998.
<TABLE>
<S> <C>
NATROL,
INC.
By:
/S/
ELLIOTT
BALBERT
-
Elliott
Balbert
PRESIDENT
AND CHIEF
EXECUTIVE
OFFICER
</TABLE>
Pursuant to the requirements of the Securities Act of 1933, this Amendment
No. 3 to the Registration Statement has been signed below by the following
persons in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
- ------------------------------ -------------------------- -------------------
/S/ ELLIOTT BALBERT
- ------------------------------ Chairman of the Board, July 14, 1998
Elliott Balbert Chief Executive Officer,
President and Director
(Principal Executive
Officer)
/S/ DENNIS R. JOLICOEUR
- ------------------------------ Chief Financial Officer, July 14, 1998
Dennis R. Jolicoeur Executive Vice President
and Director (Principal
Financial Officer and
Principal Accounting
Officer)
*
- ------------------------------ Director July 14, 1998
Norman Kahn
*
- ------------------------------ Director July 14, 1998
David Laufer
*
- ------------------------------ Director July 14, 1998
P. Andrews McLane
*By: /S/ ELLIOTT BALBERT
--------------------------
Elliott Balbert,
Attorney-in-Fact
II-6
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
The Board of Directors
Natrol, Inc.
We have audited, in accordance with generally accepted auditing standards,
the consolidated financial statements of Natrol, Inc. and subsidiaries included
in this Registration Statement (Form S-1) and have issued our report dated April
13, 1998, except with respect to Note 10, for which the date is June 19, 1998.
Our audit also included the financial statement schedule of Natrol, Inc.
listed in Item 16(b). The schedule is the responsibility of the Company's
management. Our responsibility is to express an opinion on the schedule based on
our audits. In our opinion, the financial statement schedule referred to above,
when considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
ERNST & YOUNG LLP
Woodland Hills, California
April 13, 1998
S-1
<PAGE>
SCHEDULE II
NATROL, INC.
VALUATION AND QUALIFYING ACCOUNTS
SALES RETURN ACCRUAL
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
- -------------------------------------------- ----------- ------------------------ ----------- -----------
<S> <C> <C> <C> <C> <C>
BALANCE AT CHARGED TO CHARGED TO BALANCE
BEGINNING COSTS AND OTHER AT END
DESCRIPTION OF PERIOD EXPENSE ACCOUNTS DEDUCTIONS OF PERIOD
- -------------------------------------------- ----------- ----------- ----------- ----------- -----------
Year Ended December 31, 1997 $ 198,000 $ 801,000 -- $ 794,000(1) $ 205,000
Year Ended December 31, 1996 $ 200,000 $ 541,000 -- $ 543,000(1) $ 198,000
Year Ended December 31, 1995 $ 205,000 $ 244,000 -- $ 249,000(1) $ 200,000
</TABLE>
- ------------------------
(1) Represents actual returns of goods.
S-2
<PAGE>
EXHIBIT 23.2
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
We consent to the reference to our firm under the caption "Experts" and to
the use of our report dated April 13, 1998, except with respect to Note 10, for
which the date is June 19, 1998, in Amendment No. 3 to the Registration
Statement (Form S-1 No. 333-52109) and related Prospectus of Natrol, Inc. for
the registration of 3,940,000 shares of its common stock.
ERNST & YOUNG LLP
Woodland Hills, California
July 13, 1998
<PAGE>
EXHIBIT 23.3
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
We consent to the reference to our firm under the caption "Experts" and to
the use of our report dated April 17, 1998 in Amendment No. 3 to the
Registration Statement (Form S-1 No. 333-52109) and related Prospectus of
Natrol, Inc. for the registration of 3,940,000 shares of its common stock.
FARBER & HASS LLP
Oxnard, California
July 13, 1998
