<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________ TO ______________
COMMISSION FILE NUMBER 0-18160
------------------------
IRWIN NATURALS/4HEALTH, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
UTAH 87-0468225
(State of incorporation) (I.R.S. Employer Identification No.)
</TABLE>
10549 WEST JEFFERSON BLVD.
CULVER CITY, CALIFORNIA 90232
(Address of principal executive offices)
Registrant's telephone number: (310) 253-5305
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, PAR VALUE $.01 PER SHARE
(TITLE OF CLASS)
------------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes: /X/ No: / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
As of April 9, 1999, 27,766,249 shares of the registrant's Common Stock, par
value $0.01, were outstanding. The aggregate market value of the Common Stock
held by non-affiliates of the registrant (i.e., excluding shares held by
executive officers, directors, and control persons as defined in Rule 405) on
that date was $20,766,380 (computed based upon the closing price for the Common
Stock on the Nasdaq National Market on that date.)
DOCUMENTS INCORPORATED BY REFERENCE
None
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
IRWIN NATURALS/4HEALTH, INC.
INDEX TO FORM 10-K
<TABLE>
<CAPTION>
PAGE
-----
<S> <C> <C>
PART I.
Item 1. Business...................................................................................... 3
Item 2. Properties.................................................................................... 11
Item 3. Legal Proceedings............................................................................. 11
Item 4. Submission of Matters to a Vote of Security Holders........................................... 11
PART II.
Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters...................... 11
Item 6. Selected Financial Data....................................................................... 12
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation.......... 14
Item 7A. Quantitative and Qualitative Disclosure about Market Risk..................................... 18
Item 8. Financial Statements and Supplementary Data................................................... 18
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.......... 18
PART III
Item 10. Directors and Executive Officers of the Registrant............................................ 19
Item 11. Executive Compensation........................................................................ 20
Item 12. Security Ownership of Certain Beneficial Owners and Management................................ 24
Item 13. Certain Relationships and Related Transactions................................................ 25
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.............................. 25
Exhibit Index................................................................................. 26
Index to Financial Statements................................................................. F-1
Financial Statements.......................................................................... F-2
Signature Page
</TABLE>
2
<PAGE>
PART I
THIS ANNUAL REPORT ON FORM 10-K INCLUDES "FORWARD-LOOKING STATEMENTS" WITHIN
THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED (THE
"SECURITIES ACT") AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS
AMENDED (THE "EXCHANGE ACT"). ALL STATEMENTS OTHER THAN STATEMENTS OF HISTORICAL
FACTS INCLUDED IN THIS ANNUAL REPORT, INCLUDING, WITHOUT LIMITATION, THOSE
REGARDING THE COMPANY'S FINANCIAL POSITION, BUSINESS, MARKETING AND PRODUCT
INTRODUCTION AND DEVELOPMENT PLANS AND OBJECTIVES OF MANAGEMENT FOR FUTURE
OPERATIONS, ARE FORWARD-LOOKING STATEMENTS. ALTHOUGH THE COMPANY BELIEVES THAT
THE EXPECTATIONS REFLECTED IN SUCH FORWARD-LOOKING STATEMENTS ARE REASONABLE, IT
CAN GIVE NO ASSURANCE THAT SUCH EXPECTATIONS WILL PROVE TO HAVE BEEN CORRECT.
IMPORTANT FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THE
COMPANY'S EXPECTATIONS ARE DISCLOSED UNDER "BUSINESS-RISKS RELATED TO THE
BUSINESS OF IRWIN NATURALS/4HEALTH," "MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS" AND ELSEWHERE IN THE ANNUAL
REPORT.
ITEM 1. BUSINESS
GENERAL
Irwin Naturals/4Health, Inc ("INH" or the "Company"), a Utah corporation,
formerly known as 4Health, Inc., is the surviving corporation of a merger (the
"Merger") of 4Health, Inc., a Utah corporation ("4Health") with Irwin Naturals,
Inc., a California corporation ("IN") consummated June 30, 1998. Pursuant to the
Merger, IN was merged with and into 4Health. Upon consummation of the Merger,
4Health changed its name to Irwin Naturals/4Health, Inc.
Prior to the Merger, 4Health was a supplier and formulator of vitamins and
nutritional supplements designed and formulated to address the dietary needs of
the general public. 4Health's products are produced solely from natural
ingredients and are formulated for the purposes of achieving specific dietary or
nutritional goals.
On July 16, 1996, 4Health emerged from an earlier merger between 4health
Inc., a California corporation ("Old 4health") and Surgical Technologies, Inc.,
a Utah corporation ("SGTI"). Subsequent to this merger, SGTI changed its name to
4Health, Inc. Old 4health was incorporated and commenced operations on February
17, 1993.
In mid-1997, 4Health began a search for a strategic partner. 4Health
management believed that its lack of experience in the food, drug and mass
market was limiting its future sales growth and reducing 4Health's ability to
generate significant economies of scale with respect to the cost of goods sold.
As a result of this search, 4Health agreed to merge with IN. IN was organized in
August 1995 and formulated and distributed nutritional supplements through the
food, drug and mass market, internationally and through health food stores.
4Health chose IN as a strategic partner because of IN's significant
international and mass market sales in comparison to other potential partners.
The Merger was accounted for under the "pooling-of-interests" method of
accounting, in accordance with generally accepted accounting principles. The
"pooling-of -interests" method is intended to present as a single interest the
4Health and IN common stockholder interests that were previously independent and
the combined rights and risks represented by those interests. This method
assumes that the stockholder groups neither withdraw nor invest assets but in
effect exchange voting common stock in a ratio that determines their respective
interests in the combined enterprise. The Merger resulted in the issued and
outstanding shares of common stock, no par value per share, of IN being
converted into an aggregate 15,750,000 shares of 4Health Common Stock.
PRODUCTS
The Company is a supplier and formulator of vitamins and nutritional
supplements that are manufactured primarily from natural herbs, botanicals and
nutrients. The Company has three broad categories of
3
<PAGE>
products including: (i) cleansing products to eradicate the toxins from the
body; (ii) building products, including 151 Bars that increase the body's energy
and stamina through restoring vital nutrients to the appropriate levels; and
(iii) specific solutions for selected organ and body systems to concentrate on
an individual's problem areas. The Company's top brand names are: Nature's
Secret-Registered Trademark- (31.9% of 1998 revenue), Diet Systems
6-Registered Trademark- (14.9%), and Irwin Naturals-Registered Trademark-
(13.4%).
With over 69 registered and pending trademarks worldwide, INH believes that
certain of its product formulas are proprietary and cannot be duplicated without
the master recipes, which are secured in safekeeping. The Company attempts to
protect its products and formulas with, among other things, "non-
disclosure/non-competition" agreements with its manufacturers and employees and
trademark protection. The formulations of INH's products were developed by the
Company's founders R. Lindsey Duncan, Chairman and a nutritionist certified by
the National Institute of Nutritional Education and Klee Irwin, Chief Executive
Officer. The Company trademarks all brand line names and most product names. The
Company further protects its trademarks by taking prompt action against
potential infringements.
MANUFACTURING AND SUPPLY SOURCES
All of the Company's products are manufactured by third party suppliers
pursuant to the Company's specifications and proprietary recipes. All of the
companies that manufacture for INH are required to meet strict manufacturing
standards required by the Food and Drug Administration ("FDA"). To date, the
Company has relied exclusively on domestic manufacturers in order to facilitate
quality assurance monitoring. Prior to selecting a manufacturer to produce its
products, INH reviews the manufacturer's raw material sources, quality assurance
procedures, and reliability to assure that the proposed manufacturer meets the
Company's criteria.
The Company places purchase orders with its suppliers for individual product
manufacturing lots. Delivery of packaged and labeled products are made to the
Company's distribution center in Culver City, California. The Company has no
long-term manufacturing agreements with any of its suppliers, but purchases
manufactured lots pursuant to individual purchase orders. Currently, the Company
utilizes eight different manufacturers and believes that there are other
qualified manufacturers that would meet quality assurance requirements if
alternative manufacturing sources were required. The Company maintains an
inventory of approximately 60 to 90 days of anticipated demand and to date has
not experienced material shortages of manufactured products for delivery. All
ingredients in the Company's products are generally available from a number of
alternative sources, although certain of the ingredients, such as those based on
agricultural products, are subject to seasonal availability to a limited degree.
MARKETING AND DISTRIBUTION
The Company utilizes its marketing expertise to position and sell its
portfolio of branded products. The Company is continuing to build its portfolio
of consumer brands. The Company aims to achieve brand growth through
advertising, attractive packaging and favorable shelf positioning. This process
may be augmented through targeted brand acquisitions. The sales, marketing and
distribution infrastructure is designed to integrate new brands with minor
incremental costs and synergistic potential. Historically, the Company has
distributed its products though three main segments: mass market retailers (47%
of sales in 1998), specialty health food stores (43%) and internationally (10%).
Through advertising, the Company is able to convey the effectiveness of its
products. The Company has established its reputation with retailers through
quality products, timely delivery and superior packaging. Through its ability to
position products in the marketplace and its strong reputation, the Company has
been able to secure favorable shelf spacing from most of its retail customers.
As a result of the Merger, INH is positioned to pursue a distribution
strategy of multiple brands within multiple retail channels. The Merger has
expanded the potential consumer base of 4Health
4
<PAGE>
significantly, as 4Health and IN offer products in distinct product categories.
Since the Merger, merchandising vehicles which feature products from both lines
have met with acceptance and the Company has instituted cross-branding
incentives for retailers.
In recognizing the need for strong operational management expertise, the
Company retained Louis Mancini, the former President of General Nutrition
Centers, as the President and Chief Operating Officer. Mr. Mancini began his
tenure at INH effective October of 1998.
SALES
Sales during 1998 were relatively flat compared to 1997 primarily due to the
fact that the Merger dissipated management energy and negatively impacted the
Company's ability to focus its attention upon the sales effort. As of December
31, 1998, the Company's backlog totaled $1,207,963 compared to $965,125 on
December 31, 1997.
Throughout 1998, the Company took several critical steps that it hopes will
strengthen its future position. The Company made strategic decisions to develop
new areas of business by launching a nutritional bar product and by pursuing the
addition of pain relief products to its portfolio.
CUSTOMERS CONCENTRATION
The Company's top ten customers represented approximately 36.8% of its 1998
total revenues. Management believes that its business is sufficiently
diversified among its customers and additional efforts are underway to further
diversify the Company's revenues along both distribution channels and among
specific customers.
COMPETITION
The industry in which the Company operates is highly competitive and
fragmented. It is estimated that nearly 900 companies are involved in the
manufacturing or wholesale of supplements to the mass markets. Of those 900,
eleven companies comprise 25% of the market with the remaining 75% comprised
mostly of companies generating less than $20 million in total annual sales.
The Company continues to be a leader in internal cleansing products and
intends to leverage this success to launch other products. INH's Nature's
Secret-Registered Trademark- and Harmony Formula-Registered Trademark- brand
lines have built strong brand loyalty with retailers, practitioners and
customers by delivering quality products, excellent customer service and an
emphasis on health through education.
In the food, drug and mass market, the Company faces increased competition
where many of its competitors are significantly larger and have greater
financial resources. The Company believes it will be able to compete
successfully in this mass market because of its unique formulations and
packaging, product quality, and good relationships with distributors and store
buyers.
EMPLOYEES
As of the end of 1998 INH had 109 employees including Chairman, CEO,
President, two senior managers and eight middle managers, 16 individuals in
general administration, 40 individuals in sales and marketing, 39 individuals in
distribution and one in research and development. The Company's employees are
not represented by a collective bargaining organization, and the Company is not
aware of any efforts to organize any such collective bargaining unit. INH has
not experienced any work stoppages or slow downs.
5
<PAGE>
RISKS RELATED TO THE BUSINESS OF IRWIN NATURALS/4HEALTH
EXPANSION OF DISTRIBUTION CHANNELS
The Company anticipates expanding current distribution channels, introducing
new products, entering new markets, and in general expanding its activities and
operations. Because of the nature of any such expansion, the accompanying
results of operations for previous periods may not necessarily be indicative of
the results of operations in the future. While INH has been successful in
expanding its markets and distributors to date there can be no assurance that it
will be able to successfully continue to expand in the future. Further, there
can be no assurance that expenditures of funds to expand current distribution
channels, introduce new products, enter new markets, and in general to expand
the Company's activities and operations will be successful in generating
incremental profitable revenue.
DIFFICULTY OF STRICT COMPLIANCE WITH GOVERNMENT REGULATIONS
The processing, formulation, packaging, labeling and advertising of the
Company's products are subject to regulation by more than one federal agency.
Congress has recognized the potential impact of dietary supplements in promoting
the health of US citizens by enacting the Dietary Supplement Health Education
Act of 1994 ("DSHEA"). Because of the broad language of certain sections of
DSHEA and the regulations which implement it, it is difficult for any company
manufacturing or making dietary supplements to remain in strict compliance.
On November 24, 1997, the Commission on Dietary Supplement Labels, a seven
member group appointed by the President of the United States (the "DSL
Commission"), issued an 84 page report (the "Report") which includes many
recommendations for the regulation of label claims and statements for dietary
supplements. The DSL Commission's conclusions and advice are in the form of a
series of Findings and Guidelines and its ultimate recommendations are called
Recommendations. Section 12 of DSHEA requires the FDA to publish in the Federal
Register "a notice of any recommendation of the Commission for changes in
regulations of the Secretary for the regulation of dietary supplements and shall
include in such notice a notice of proposed rulemaking on such changes together
with an opportunity to present views on such changes."
Based on the report, and pursuant to Section 12 of DSHEA, on April 29, 1998
the FDA published a proposed rule entitled "Regulations on Statements Made for
Dietary Supplements Concerning the Effect of the Product on the Structure or
Function of the Body" (the "S/F Rule"). This proposed rule, if made a final rule
(that is a regulation), would broaden what the FDA considers an impermissible
drug claim or disease claim for a dietary supplement. At the same time the S/F
Rule would restrict and narrow the permissible structure/function statements the
Company could make about the benefits of its products on the label and labeling
(brochures). Indirectly, this S/F rule would narrow the permissible claims the
Company could place in advertisements. The effective date of the regulation is
proposed as 30 days after the final rule is published in the Federal Register.
While there is no way the Company can predict the language of the resulting
regulation, based upon advice of their FDA counsel, the Company believes that
the S/F rule will not be issued in the form as published on April 29, 1998.
CONCENTRATION OF CUSTOMERS
INH received approximately 13.3% of its revenues from a single customer
(GNC) during 1998. The Company does not have any long-term contractual
relationship with this customer. The loss of this customer would have an adverse
impact on the business of INH.
RELIANCE ON LIMITED NUMBER OF PRODUCTS
The Company currently offers approximately 100 products and derived more
than 13% of its revenues during 1998 from the sale of one product, Ultimate
Cleanse-Registered Trademark-. As a result of the limited number of products
6
<PAGE>
from which the Company derives its revenue, the risks associated with INH's
business increase since a decline in market demand for one or more products, for
any reason, could have a significant adverse impact on the Company.
STRENGTH OF INH'S COMPETITORS
Competition in the nutritional supplement industry is vigorous with a large
number of businesses engaged in the industry. Operations in the food, drug and
mass market exposes the Company to increased competition from vitamin and other
health related products that compete for the same shelf space. Many of these
competitors have established reputations for successfully developing and
marketing nutritional supplement products. Many of these companies have greater
financial, managerial, and technical resources than INH, which may put the
Company at a competitive disadvantage. If the Company is not successful in
competing in those markets, it may not be able to realize its business
objectives.
DEPENDENCE ON MANAGEMENT
The Company is dependent on its management for substantially all of its
business activities, including the development of new products and the
advancement of INH's identity and recognition in the nutritional supplement
industry. The loss of the services of certain members of management such as the
Chairman of the Board or Chief Executive Officer could have a material effect on
the business, operations and financial condition of the Company. INH is required
to maintain a key-man life insurance policy on the lives of the Chairman of the
Board and Chief Executive Officer in the amount of $5,000,000. Except for an
employment, intellectual property and non-compete agreement with Messrs. Duncan
and Irwin and a three year employment agreement with Mr. Louis Mancini,
President, INH has no long-term agreement with any executive officer or key
employee.
NO LONG-TERM CONTRACTS WITH MANUFACTURERS OR DISTRIBUTORS
The Company purchases all of its products from third-party manufacturers
pursuant to purchase orders issued from time to time by INH but without any
long-term manufacturing agreements. In the event that a current manufacturer is
unable to meet the Company's manufacturing and delivery requirements at some
time in the future, the Company may suffer interruptions of delivery of certain
products while it establishes an alternative source. To limit the Company's
exposure to this type of interruption, for all large volume products, two
third-party manufacturers have been established. For smaller volume products,
the selection of alternative manufacturing sources may be delayed while the
Company completes a review of the proposed manufacturer's quality control, raw
material sources, and manufacturing and delivery capabilities. To help mitigate
any interruption, the Company maintains a 60-90 day inventory on most products.
CUSTOMER GUARANTY OF SATISFACTION; RIGHT OF RETURN
In an effort to build customer confidence and satisfaction, INH warrants
satisfaction and grants to its customers the right of return for full credit any
product that is unsatisfactory to the customer or that is shelf-worn or stale
merchandise. Although the Company has had this policy since its inception and
experienced product returns of only approximately 5% of gross sales in 1998,
there can be no assurance that such a policy will not result in additional
product returns in the future as the Company expands its product lines and
enters new markets.
POTENTIAL TRADEMARK INFRINGEMENT
The conduct of INH's business, in common with other sellers of branded
consumer products, may involve from time to time potential liability for
trademark infringement. The Company is engaged on a continuing basis in
developing brand names for its new products, securing trademark protection for
brand
7
<PAGE>
names and copyright protection for associated materials, policing its existing
marks, and enforcing its legal rights in cases of potential infringement by
third parties of its legally protected marks and copyrights. Prior to commencing
advertising and sales of products under a newly developed brand name, the
Company seeks to minimize the risks of potentially infringing the rights of
third parties by conducting trade and service mark searches and other inquiries
in addition to filing publicly for trademark protection of the brand name and
copyright protection for associated advertising materials and labeling. The
Company registers for its principal product lines as well as its principal
products. Notwithstanding such efforts, there can be no assurance that the
Company will not suffer adverse financial consequences as a result of legally
established third party claims to first use of trade or service marks used by
the Company.
YEAR 2000
THE Y2K PROBLEM.
INH has conducted a review of its respective computer systems to identify
the systems that could be affected by the Y2K issue. The Y2K problem is the
result of computer programs being written using two digits rather than four to
define the applicable year. Any of the Company's programs that have time-
sensitive software or equipment that has time-sensitive embedded components may
recognize a data using "00" as the year 1900 rather than the year 2000. This
could result in a major system failure or miscalculations.
While some upgrades will be necessary, the Company presently believes that
the Year 2000 problem will not pose significant operational problems for the
Company's computer systems. Additionally, the Y2K problem is not expected to
have a material effect on the cost of operation of the Company.
The Company also may be vulnerable to other companies' Y2K issues. The
Company's current estimates of the impact of the Y2K problem on its operations
and financial results do NOT include costs and time that may be incurred as a
result of any vendors' or customers' ("third-party") failure to become compliant
on a timely basis. The Company has initiated formal communications with its
significant vendors and customers with respect to such persons' Y2K compliance
programs and status. However, there can be no assurance that such other
companies will achieve Y2K compliance or that any conversions by such companies
to become Y2K compliant will be compatible with the Company's computer system.
The inability of the Company or any of its principal vendors or customers to
become Year 2000 compliant in a timely manner could have a material adverse
effect on the Company's financial condition or results of operations.
A Y2K task force has been established. The task force has not developed a
"Worst Case" scenario for an overall Y2K contingency plan and does not plan to
do so unless; as a result of its ongoing Y2K review, management believes such
plans are warranted. The only contingency plan to be developed and implemented
will be as a result of a comprehensive survey being conducted on suppliers and
key third parties of their IT systems, including computer applications,
operating systems, and all non-IT related systems, including embedded
applications and equipment. The focus of the survey is to ensure that key third
parties are Y2K compliant by the end of the year.
The Company has identified high risk applications that are critical to its
business, recognizing the fact that timely Year 2000 compliance of these systems
is crucial, and therefore, has designed its plan to address these systems first.
The Company's plan includes remediating certain existing software. The plan
is underway and the Company believes it will be completely in effect by the end
of October, 1999.
ADDRESSING THE PROBLEM.
The Company predicts a six-phase approach to resolving the Y2K issues that
are reasonably within its control. All of these efforts are being coordinated
through Company's Director of Information Systems
8
<PAGE>
(I.S.). The Director of I.S. reports to the Audit Review Committee comprised of
Daniel Martin, Chief Financial Officer and Louis Mancini, President, with
respect to the Company's Y2K efforts.
The Company's approach to, and the anticipated timing of each phase are
described below.
PHASE 1--INVENTORY. The first phase entails a corporate-wide inventory of
all hardware and software (including business and operational applications,
operating systems and third-party products) that may be at risk, and
identification of key third-party businesses whose Y2K failures might most
significantly impact the Company. The IT system inventory process has been
completed, and the inventories of key third-party businesses and of internal
non-IT systems are expected to be completed by April 30, 1999.
PHASE 2--ASSESSMENT. Once each at-risk system has been identified, the MIS
department assesses how critical the system is to business operations and the
potential impact of failure, in order to establish priorities for repair or
replacement. Systems are classified as "critical," "important" or
"non-critical." A "critical" system is one that, if not operational, would cause
the shutdown of all or a portion of a business unit within two weeks, while an
"important" system is one that would cause such a shutdown within two months.
This process has been completed for all IT systems. The assessment process for
internal non-IT systems and for key third-party businesses is expected to be
completed by June 1999. Systems that are known to be critical or important are
receiving top priority in assessment and remediation.
PHASE 3--STRATEGY. This phase involves the development of appropriate
remedial strategies for both IT and non-IT systems. These strategies may include
repairing, testing and certifying, replacing or abandoning particular systems
(as discussed under Phases 4 and 5 below). Selection of appropriate strategies
is based upon such factors as the assessments made in Phase 2, the type of
system, the availability of a Y2K-compliant replacement and cost. The strategy
phase has been completed for all IT systems. For some non-IT embedded systems,
strategy development is continuing. A strategy for addressing embedded systems
in office buildings currently occupied, and those anticipated to be occupied, is
being developed in concert with building managers and systems vendors and should
be completed by July 1999. The process of analysis, certification or replacement
or "workaround" for embedded systems in office buildings is expected to consume
the first half of 1999. Strategies for other embedded systems, such as satellite
communications systems, are being developed and are also expected to be complete
by mid-1999.
PHASE 4--REMEDIATION. The remediation phase involves creating detailed
project plans, marshalling necessary resources and executing the strategies
chosen. For IT systems, this phase is approximately 90% complete for critical
and important systems, and is expected to be completed (including certification)
by July 31, 1999. For non-critical systems, most corrections are expected to be
completed by October 31, 1999. For those systems that are not expected to be
reliably functional after January 1, 2000, detailed manual workaround plans will
be developed prior to the end of 1999.
PHASE 5--TESTING AND CERTIFICATION. This phase includes establishing a test
environment, performing systems testing (with third parties if necessary), and
certifying the results. The certification process entails having functional
experts review test results, computer screens and printouts against
pre-established criteria to ensure system compliance. The Company expects all
critical and important IT systems to be certified by September 30, 1999. Testing
for non-IT systems has been initiated; however, due to the Company's reliance on
many third-party vendors for these systems, the Company cannot estimate
precisely when this phase will be completed. The Company's target for all
critical and important non-IT systems is August 1999. The Company has initiated
written and telephonic communications with key third-party businesses, as well
as public and private providers of infrastructure services, to ascertain and
evaluate their efforts in addressing Y2K compliance. It is anticipated that the
majority of testing and certification with these entities will occur in 1999.
PHASE 6--CONTINGENCY PLANNING. This phase involves addressing any remaining
open issues expected in 1999 and early 2000. As a precautionary measure, the
Company is currently developing contingency
9
<PAGE>
plans for all systems that are not expected to be Y2K compliant by July 1999. A
variety of automated as well as manual fallback plans are under consideration,
including the use of electronic spreadsheets, resetting system dates to 1972, a
year in which the calendar coincides with that of 2000, and manual workarounds.
The Company estimates that all of these plans will be completed by December
1999.
COSTS.
The estimated additional costs to complete the project are currently
expected to be approximately $20,000. A significant portion of these costs will
not be incremental, but rather reflect redeployment of internal resources from
other activities. The Company does not expect these redeployments to have a
material adverse effect on other ongoing business operations of the Company,
although it is possible that certain maintenance and upgrading processes will be
delayed as the result of the priority being given to Y2K remediation. All of the
costs of the Y2K project are being borne out of the Company's operating cash
flow.
Based upon its efforts to date, the Company believes that the vast majority
of both its IT and its non-IT systems, including all critical and important
systems, will remain up and running after January 1, 2000. Accordingly, the
Company does not currently anticipate that internal systems failures will result
in any material adverse effect to its operations or financial condition. During
1999, the Company will also continue and expand its efforts to ensure that major
third-party businesses and public and private providers of infrastructure
services, such as utilities, communications services and transportation, will
also be prepared for the year 2000, and to develop contingency plans to address
any failures on their part to become Y2K compliant. At this time, the Company
believes that the most likely "worst-case" scenario involves potential
disruptions in areas in which the Company's operations must rely on such third
party vendors whose systems may not work properly after January 1, 2000. In
addition, the Company's international operations may be adversely affected by
failures of businesses in other parts of the world to take adequate steps to
address the Y2K problem. While such failures could affect important operations
of the Company, either directly or indirectly, in a significant manner, the
Company cannot at present estimate either the likelihood or the potential cost
of such failures.
The nature and focus of the Company's efforts to address the Year 2000
problem may be revised periodically as interim goals are achieved or new issues
are identified. In addition, it is important to note that the description of the
Company's efforts necessarily involves estimates and projections with respect to
activities required in the future. These estimates and projections are subject
to change as work continues, and such changes may be substantial.
Other than the cost of the new software and hardware to be implemented
corporate-wide, the Company has spent nominal amounts on the Y2K issue, and does
not expect any significant future expenditure. Although the task force expects
its cost estimates to be relatively accurate, it can not assure nor guarantee
that these costs will not increase or that the proposed solutions will be
installed on schedule by the date estimated.
10
<PAGE>
ITEM 2. PROPERTIES
The Company's principal offices are located at 10549 West Jefferson Blvd.,
Culver City, California, 90232 in a building and warehouse leased by the
Company. In addition, in 1998 the Company owned a building in Boulder Colorado
and leased warehouse space in Broomfield, Colorado.
<TABLE>
<CAPTION>
LOCATION SIZE FUNCTION
- ----------------------------------------------- -------------- --------------------------------------
<S> <C> <C>
Culver City, California........................ 13,328 sq. ft. Corporate Headquarters
Culver City, California........................ 24,000 sq. ft. Warehouse
Boulder, Colorado*............................. 28,000 sq. ft. Midwest Office
Broomfield, Colorado**......................... 22,600 sq. ft. Distribution center and warehouse
</TABLE>
- ------------------------
* The sale of the Boulder building was completed as of March 25, 1999.
** Warehousing activities for this location were relocated to Culver City in
October 1998.
ITEM 3. LEGAL PROCEEDINGS
From time to time the Company is a party to legal proceedings that it
considers routine litigation incidental to its business. Management believes
that the likely outcome of such litigation will not have a material adverse
effect on INH's business or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock commenced trading on the Nasdaq National Market
tier of The Nasdaq Stock Market under the stock symbol HHHH on July 17, 1996.
Prior to that date, the Company was known as Surgical Technologies, Inc. with
stock trading under the symbol SGTI.
The market price of Common Stock could be subject to significant
fluctuations in the future based on factors such as announcements of new
products by the Company or its competitors, quarterly fluctuations in the
Company's financial performance, the results of the Company's marketing and
sales efforts, general conditions in the dietary and nutritional supplements
industry, changes in analysts' estimates of the Company's financial performance,
conditions in the financial markets or other factors which are currently
unforeseen by management. There can be no assurance that the market price for
the Common Stock will not decline from current levels, or otherwise not be
subject to significant fluctuations in the future.
11
<PAGE>
The high and low closing bid prices reported for the period between January
1, 1997 and April 9, 1999 appear in the following table:
<TABLE>
<CAPTION>
FISCAL YEAR QUARTER HIGH LOW
- ----------------------------------------------------------------- ----------- --------- ---------
<S> <C> <C> <C>
1997............................................................. 1st $ 5.625 $ 5.250
1997............................................................. 2nd $ 6.188 $ 5.000
1997............................................................. 3rd $ 6.063 $ 3.250
1997............................................................. 4th $ 7.250 $ 4.250
1998............................................................. 1st $ 5.875 $ 4.500
1998............................................................. 2nd $ 9.500 $ 4.875
1998............................................................. 3rd $ 7.500 $ 2.750
1998............................................................. 4th $ 6.938 $ 3.000
1999............................................................. 1st $ 8.000 $ 3.438
Apr 1-9 1999..................................................... 2nd $ 3.625 $ 3.250
</TABLE>
As of April 9, 1999, there were approximately 204 stockholders of record of
the Company's Common Stock, exclusive of stockholders who hold title to their
shares in street name.
SALES OF UNRESTRICTED SECURITIES
In connection with the merger of IN with and into 4Health, the Company
issued 15,759,000 shares of common stock to Mr. & Mrs. Klee Irwin in a private
transaction intended to qualify for the exemption from registration afforded by
Section 4(2) of the Securities Act of 1933.
DIVIDEND POLICY
The Company has never paid dividends with respect to the INH Common Stock.
There are no restrictions on the declaration or payment of dividends in the
articles of incorporation or bylaws of the Company, however, for the foreseeable
future, the Board of Directors intends to retain all of the Company's earnings
for use in the expansion of the Company's business.
REGISTRAR AND TRANSFER AGENT
The registrar and transfer and warrant agent for the Company is American
Securities Transfer and Trust, 938 Quail Street, Suite 101, Lakewood, CO,
80215-5513, telephone number (303)234-5300.
ITEM 6. SELECTED FINANCIAL DATA
The following selected statements of operations data for the three years
ended December 31, 1996, 1997 and 1998 and the selected balance sheet data as of
December 31, 1997 and 1998 have been derived from the audited financial
statements of the Company included herein ("Financial Statements"). The selected
statements of operations data for the two years ended December 31, 1994 and 1995
and the selected balance sheet data as of December 31, 1994, 1995, and 1996 has
been derived from audited financial statements of the Company not included
elsewhere herein. The selected financial data set forth below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the Financial Statements and notes thereto
included elsewhere in this Form 10-K. Certain amounts in prior years have been
reclassified to conform to current year presentation.
12
<PAGE>
YEARS ENDING DECEMBER 31,
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
1994 1995 1996 1997 1998
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
Net sales................................................. $ 2,076 $ 12,824 $ 28,592 $ 29,353 $ 30,547
Gross profit.............................................. 1,332 7,620 16,266 15,790 17,602
Operating (loss) income................................... (131) 1,342 (1,298) (4,638) 1,827
Other income (expense), net............................... (5) (76) 101 (79) (209)
Income (loss) before provision for income taxes........... (136) 1,266 (1,197) (4,717) 1,618
Provision for income taxes................................ 2 360 594 -- 600
Net income (loss)......................................... $ (138) $ 906 $ (1,791) $ (4,717) $ 1,018
Pro forma provision for income taxes (unaudited).......... N/A 439 N/A 765 1,345
Pro forma net income (loss) (unaudited)................... N/A $ 827 N/A $ (5,482) $ 273
PER SHARE DATA:
Historical
Earnings (loss) per common share--Basic and diluted..... $ (0.02) $ 0.04 $ (0.07) $ (0.17) $ 0.04
Pro forma
Earnings (loss) per common share--Basic and diluted
(unaudited)........................................... N/A $ 0.03 N/A $ (.20) $ 0.01
Historical
Weighted average number of shares of common stock
outstanding--Basic.................................... 7,335 24,457 25,647 27,365 27,747
Weighted average number of shares of common stock
outstanding--Diluted.................................. 7,335 24,583 25,647 27,365 28,221
Pro forma
Weighted average number of shares of common stock
outstanding--Basic (unaudited)........................ N/A 24,457 N/A 27,365 27,747
Weighted average number of shares of common stock
outstanding--Diluted (unaudited)...................... N/A 24,583 N/A 27,365 28,221
</TABLE>
<TABLE>
<CAPTION>
YEARS ENDING DECEMBER 31
(IN THOUSANDS)
------------------------------------------
<S> <C> <C> <C> <C>
1995 1996 1997 1998
--------- --------- --------- ---------
BALANCE SHEET DATA:
Working capital............................................................ $ 2,385 $ 4,843 $ 3,588 $ 4,395
Total assets............................................................... 5,786 15,832 11,337 13,087
Long-term debt, net of current portion..................................... 1,296 1,276 1,298 1,423
Shareholders' equity....................................................... 3,205 10,256 5,387 5,869
</TABLE>
13
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
REFERENCE IS HEREBY MADE TO THE DISCLOSURE REGARDING "FORWARD-LOOKING"
STATEMENTS ON PAGE 3.
The following table sets forth, for years 1996, 1997 and 1998, certain items
from the Company's Statements of Operations included elsewhere herein, expressed
as a percentage of net sales.
<TABLE>
<CAPTION>
YEARS ENDING DECEMBER 31,
-------------------------------------
1996 1997 1998
----------- ----------- -----------
<S> <C> <C> <C>
Net Sales.............................................. 100.0 % 100.0 % 100.0 %
Cost of Sales.......................................... 43.1 % 46.2 % 42.4 %
----- ----- -----
Gross Profit........................................... 56.9 % 53.8 % 57.6 %
Selling, General and Administrative Expenses........... 61.4 % 58.7 % 51.6 %
Loss on write-off of Goodwill.......................... -- 10.9 % --
----- ----- -----
Income (loss) from operations.......................... (4.5)% (15.8)% 6.0 %
Other income (expense), net............................ 0.3 % (0.3)% (0.7)%
----- ----- -----
Income (loss) before provision for income taxes........ (4.2)% (16.1)% 5.3 %
Provision for income taxes............................. 2.1 % -- 2.0 %
----- ----- -----
Net income (loss)...................................... (6.3)% (16.1)% 3.3 %
----- ----- -----
----- ----- -----
</TABLE>
RESULTS OF OPERATIONS
1998 COMPARED TO 1997
Net Sales for the year ended December 31, 1998 rose to $30,547,000 from
$29,353,000, an increase of 4.1% when compared to 1997. Several products were
repositioned and remarketed after the merger as a result of new management's
focus on optimizing each product's potential. This repositioning resulted in a
one-time reduction of $387,000 (1.3%) in net sales. The improvement in net sales
between periods was due primarily to an increase in the Mass Market business,
with strong first quarter sales indicative of a high level of interest in
several major products introduced in the last half of 1997, greater market
penetration, and a strong focus on expanding into drug and discount chains in
the second, third, and fourth quarters. In addition, the last half of the year
saw the promising early signs of acceptance of the Company's newly introduced
Nutrition Bar. The relatively stable health food store sales are a reflection of
continued competitive pressures and an overall weakness in this sector of the
marketplace. International sales improved over 1997 as the newly installed
International Sales Division staff expanded strongly into several new strategic
markets.
Gross Profit Margins rose to $17,602,000 in 1998 from $15,790,000 in 1997,
an increase of 11.5%. The post-merger product repositionings resulted in a
one-time $172,000 (1.1%) decrease in Gross Margins. Gross Margin as a percentage
of net sales increased to 57.6% of net sales in 1998 from 53.8% of net sales in
1997. This increase was due primarily to an improved product sales mix, and
reflective of continued internal efforts to lower the cost of the core products.
Improved margins were particularly evident in the Nature's
Secret-Registered Trademark- and Harmony Formula-Registered Trademark- branded
products.
Total Selling, General & Administrative (SG&A) Expenses decreased by
$1,451,000 (8.4%) to $15,775,000 in 1998 from $17,226,000 in 1997. This
improvement was further reflected as SG&A Expenses decreased as a percentage of
net revenue to 51.6% in 1998 from 58.7% in 1997. Sales & Marketing Expense in
1998 accounted for $3,195,000 of the change as they decreased from $9,583,000 in
1997 to $6,388,000 in 1998, a 33.3% improvement. Much of the decrease in Sales &
Marketing expense was attributable to the synergies achieved as a result of the
merger. General and Administrative expense increased to $9,387,000 in 1998 from
$7,643,000 in 1997. The 1998 General & Administrative expenses, when adjusted
for merger related expenses of $1,614,000, were $7,773,000, a net increase of
$130,000
14
<PAGE>
compared to the 1997 General & Administrative expenses of $7,643,000. Included
in the 1997 General & Administrative expenses are Research & Development (R & D)
expenses of $418,000. R & D expenses decreased to $29,000 in 1998 as the Company
relied on existing, developed products. The increase of $519,000 in the other
General & Administrative expenses in 1998 compared to 1997 was due to the
Company's investment in infrastructure to support anticipated growth in 1999.
During 1997, the Company wrote off goodwill in the amount of $3,202,000 in
connection with the 1996 merger with SGTI. There was no similar expense in 1998.
1997 COMPARED TO 1996
Net Sales for the year ended December 31, 1997 rose to $29,353,000 from
$28,592,000 in 1996, an increase of 2.7%. Irwin Naturals net sales increased
from $11,240,000 in 1996 to $16,921,000 in 1997, an increase of 50.5% while
4Health net sales decreased from $17,352,000 in 1996 to $12,432,000 in 1997, a
decrease of 28.4%. A large one-time sale in 4Health of approximately $5,000,000
in 1996 was a contributing reason to the decline in 4Health sales from 1996 to
1997.
Gross Profit Margins declined to $15,790,000 in 1997 from $16,266,000 in
1996, a decrease of 2.9%. Gross Margins during this period increased at Irwin
Naturals from $5,839,000 in 1996 to $9,481,000 in 1997, a 62.4% increase.
4Health Gross Margins decreased during this same period from $10,427,000 in 1996
to $6,309,000, a decrease of 39.5%. Much of the decrease in 4Health Gross
Margins were due to the higher than normal margins in 1996 due to the large
one-time sale. Gross Margin as a percentage of net sales decreased to 53.8% of
net sales in 1997 from 56.9% of net sales in 1996. During this period Irwin
Gross Margins increased from 51.9% in 1996 to 56.0% in 1997, while 4Health Gross
Margins decreased from 60.1% in 1996 to 50.7% in 1997.
Total SG&A Expenses decreased by $338,000 (1.9%) to $17,226,000 in 1997 from
$17,564,000 in 1996. Sales and Marketing expenses improved to $9,583,000 in 1997
from $10,831,000 in 1996, an 11.5% decrease. This improvement was partially due
to non-recurring advertising expenses in 1996 as a result of a targeted
advertising campaign. General and Administrative expenses increased to
$7,643,000 in 1997 from $6,733,000 in 1996, an increase of 13.5%. This
difference was attributable to Irwin Naturals as they began to create
infrastructure to support their 50.5% growth.
The Company wrote off $3,202,000 of goodwill associated with SGTI during
1997.
1996 COMPARED TO 1995
Net Sales for the year ended December 31, 1996 rose to $28,592,000 from
$12,824,000 in 1995, an increase of $15,768,000, or 123.0%. Irwin Naturals
increased from $2,390,000 in 1995 to $11,240,000 in 1996, an improvement of
$8,850,000 (370.3%). Irwin's increase contributed 56.1% of the overall net sales
increase. Irwin started its operations in August 1995. 4Health net sales
improved from $10,434,000 in 1995 to $17,352,000 in 1996, an increase of
$6,918,000 (66.3%). 4Health contributed 43.9% of the overall net sales increase.
Nearly $5,000,000 increase from 1995 to 1996 for 4Health resulted from a
non-recurring sale to a single customer. The year-to-year increase in net sales
can be attributed to highly energized and focused sales and marketing efforts on
the part of both companies.
Gross Profit Margins improved to $16,266,000 in 1996 from $7,620,000 in
1995, an increase of $8,646,000 or 113.5%. Gross Margins during this period
increased at Irwin Naturals from $988,000 in 1995 to $5,839,000 in 1996, a 491%
increase. 4Health Gross Margins also increased during this same period from
$6,631,000 in 1995 to $10,427,000 in 1996, an increase of 57.2% in 1996. During
the same period, Gross Margin as a percentage of net sales decreased at 4Health
from 63.6% in 1995 to 60.1% of net sales in 1996.
Total SG&A Expenses increased by $11,286,000 (179.8%) to $17,564,000 in 1996
from $6,278,000 in 1995. Sales and Marketing expenses increased to $10,831,000
in 1996 from $4,225,000 in 1995, an increase of 156.4%. 4Health accounted for
the majority of the increase as it increased its advertising expenses with a
Television Advertising campaign, and built up the outside sales forces, sales
management, and marketing
15
<PAGE>
management for its brands. General and Administrative expenses increased to
$6,733,000 in 1996 from $2,052,000 in 1995, while both Irwin Naturals and
4Health invested heavily in building corporate infrastructure by adding
additional personnel, improving systems, and in the case of 4Health incurring
the additional expenses necessary to operate as a public company.
LIQUIDITY AND CAPITAL RESOURCES
During the past three years, the Company has financed its business growth
primarily through operations and short-term borrowings.
The Company's Cash position at December 31, 1998 was $426 thousand compared
to $637 thousand at December 31, 1997. As of December 31, 1998, the Company had
Working Capital of $4.395 million with a 1.8 to 1 Working Capital Ratio.
Accounts Receivable totaled $6.023 million at December 31, 1998 as compared
to $4.9 million on December 31, 1997, an increase of $1.23 million, or 22.9%.
This increase was due primarily to increased sales revenue overall, a
disproportionate number of large sales in November and December, and a longer
collection cycle in the Company's fastest growing market segment, the mass
market.
Inventories were valued at $2.855 million at December 31, 1998 as compared
to $2.162 million at December 31, 1997, which represents a 32.1% increase of
$.693 million. Management has concluded that Inventory levels at December 31,
1998 are at a level necessary to support the level of sales projected for the
fourth quarter of the year.
Capital Expenditures for the year ended December 31, 1998 were $350 thousand
compared to $216 thousand for the same period in 1997, reflecting the cost of
creating new infrastructure support capabilities, and improving capacity.
Other Assets have increased slightly from $648 thousand at December 31, 1997
to $749 thousand at December 31, 1998, an increase of $101 thousand, or 15.6%.
This increase stemmed primarily from a Note Receivable from Officer.
Accounts Payable and Accrued Liabilities decreased $363 thousand, or 10.6%,
to $3.795 million from $3.432 million. The primary reason for the increase in
overall Inventory levels of 32.1%.
As of December 31, 1998 the Company had a $1 million Line of Credit with
Alliance Bank, which had an outstanding balance of $1 million, and a $1.5
million Line of Credit with Norwest Bank, which had no outstanding borrowings.
The Company has generated an overall negative cash flow of $211 thousand for
the year ended December 31, 1998 compared to a negative cash flow of $731
thousand for the same period in 1997. The majority of this improvement was due
to improved profitability, offset slightly by increased Inventory levels.
The company's future capital requirements will depend on many factors,
including the nature and timing of orders from customers, collection of accounts
on trade sales, the expansion of sales and marketing efforts, costs associated
with entering into new channels of distribution, and the status of competitive
products.
At December 31, the Company was in active negotiations with Wells Fargo Bank
to develop the terms of a $5 million Secured Line of Credit. This Line was
established in February of 1999 and expires on June 30, 1999.
Subsequent to December 31, 1998, the Company entered into two acquisitions.
Effective February 15, 1999, the Company purchased the issued and outstanding
shares of Health & Vitamin Express, Inc. Although the purchase price of this
acquisition is to be paid in shares of Company stock, the Company is obligated
to invest or contribute to the acquired operations a minimum of $10 million
during the 36 months period subsequent the acquisition date, of which $4 million
must be invested or contributed within the first 18 months. Further, effective
March 10, 1999, the Company purchased certain assets and liabilities
16
<PAGE>
of Inholtra Investment Holding and Trading, N.V., Inholtra, Inc. and Inholtra
Natural, Ltd. for $13,250,000. Of this total purchase price, $3,250,000 was paid
in cash, and the remaining $10 million is payable through a promissory note due
on June 10, 1999 secured by the acquired assets. These acquisitions have
significantly increased the Company's funding requirements.
The Company is currently seeking to raise additional financing to meet the
increased funding requirements resulting from these acquisitions as well as to
satisfy anticipated sales growth and operational requirements. Management
believes that the Company will be able to successfully obtain the necessary
financing.
There can be no assurance, however, that the Company will not require
additional financing earlier than anticipated, or that any additional financing
will be available at acceptable terms, if at all. The inability to obtain such
financing could have a material adverse effect on the Company's business,
financial condition, and results of operations.
SEASONALITY AND QUARTERLY FLUCTUATIONS
The business is to some extent cyclical, but not necessarily seasonal.
The following table sets forth, certain unaudited results of operations for
each quarter during 1997 and 1998. The unaudited information has been prepared
on the same basis as the audited financial statements appearing elsewhere in
this report and includes all adjustments, consisting of normal recurring
adjustments, which management considers necessary for a fair presentation of the
financial data shown. The operating results for any quarter are not necessarily
indicative of the results to be attained for any future period.
<TABLE>
<CAPTION>
QUARTERS ENDED
1998
----------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
DECEMBER 31 SEPTEMBER 30 JUNE 30 MARCH 30 TOTAL
------------ ------------ ------------- ------------ -------------
Net sales............................... $7,743,000 $7,140,000 $ 6,918,000 $ 8,746,000 $ 30,547,000
Gross profit............................ 4,918,000 4,136,000 3,441,000 5,107,000 17,602,000
Income (loss) from operations........... 453,000 956,000 (1,192,000) 1,610,000 1,827,000
Other income (expense), net ............ (143,000) (32,000) (27,000) (7,000) (209,000)
------------ ------------ ------------- ------------ -------------
Income (loss) before provision (benefit)
for income taxes...................... 310,000 924,000 (1,219,000) 1,603,000 1,618,000
Provision (benefit) for income taxes.... 679,000 -- (45,000) (34,000) 600,000
------------ ------------ ------------- ------------ -------------
Net income (loss)....................... $ (369,000) $ 924,000 $ (1,174,000) $ 1,637,000 $ 1,018,000
------------ ------------ ------------- ------------ -------------
------------ ------------ ------------- ------------ -------------
Net earnings (loss) per common
share-Basic and Diluted............... $ (0.01) $ 0.03 $ (0.04) $ 0.06 $ 0.04
------------ ------------ ------------- ------------ -------------
------------ ------------ ------------- ------------ -------------
</TABLE>
<TABLE>
<CAPTION>
QUARTERS ENDED
1997
----------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
DECEMBER 31 SEPTEMBER 30 JUNE 30 MARCH 30 TOTAL
------------- ------------ ------------ ------------ -------------
Net sales............................... $ 8,679,000 $6,466,000 $ 6,999,000 $ 7,209,000 $ 29,353,000
Gross profit............................ 4,888,000 3,659,000 3,774,000 3,469,000 15,790,000
Loss from operations.................... (2,918,000) (477,000) (720,000) (523,000) (4,638,000)
Other (expense) income, net............. (95,000) (4,000) (12,000) 32,000 (79,000)
------------- ------------ ------------ ------------ -------------
(Loss) before provision (benefit) for
income taxes.......................... (3,013,000) (481,000) (732,000) (491,000) (4,717,000)
Provision (benefit) for income taxes.... (348,000) 13,000 119,000 216,000 --
------------- ------------ ------------ ------------ -------------
Net (loss).............................. $ (2,665,000) $ (494,000) $ (851,000) $ (707,000) $ (4,717,000)
------------- ------------ ------------ ------------ -------------
------------- ------------ ------------ ------------ -------------
Net (loss) per common share-- Basic and
Diluted............................... $ (0.10) $ (0.02) $ (0.03) $ (0.03) $ (0.17)
------------- ------------ ------------ ------------ -------------
------------- ------------ ------------ ------------ -------------
</TABLE>
17
<PAGE>
NEW AUTHORITATIVE PRONOUNCEMENTS
The Financial Accounting Standards Board has issued SFAS No. 132,
"Employer's Disclosure about Pensions and Other Postretirement Benefits" and
SFAS No. 133, "Accounting for Derivative and Hedging Activities." These new
accounting standards do not have any impact on the Company's financial
statements or financial reporting.
INFLATION
Management believes that the effect of inflation will not have a significant
impact on the Company's financial position or results of operations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company's primary market risk exposure is interest rate risk. As of
December 31, 1998, all of the Company's debt obligations were subject to fixed
interest rates. In February 1999, the Company obtained a $5,000,000 line of
credit amended to $6,400,000 in March 1999, subject to varying interest rates.
The Company will monitor the level of risk by keeping variable rate exposures at
acceptable levels.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following Financial Statements are filed with this Annual Report as
pages F-2 through F-22. The Index to Financial Statements appears on page F-1 of
this Annual Report.
Report of Independent Public Accountants
Balance Sheet
Statements of Operations
Statements of Shareholders' Equity
Statements of Cash Flows
Notes to Financial Statements
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
The Company has not made any changes in accountants. The Company does not
have any disagreement with its accountants regarding accounting or financial
disclosure.
18
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table lists the names, ages, and positions of the Company's
directors, executive officers and other significant employees who were employed
by INH in 1998.
<TABLE>
<CAPTION>
OFFICER DIRECTOR
NAME AGE SINCE SINCE POSITION
- ------------------------- --- ----------- ----------- --------------------------------------------------------------
<S> <C> <C> <C> <C>
R. Lindsey Duncan........ 36 1993 1993 Chairman of the Board
Klee Irwin............... 33 1998 1998 President and Chief Executive Officer and Director
Louis Mancini............ 53 1998 President and Chief Operating Officer
Daniel Martin............ 53 1998 Acting Chief Financial Officer
Jonathan Diamond......... 39 -- 1998 Director
James Jeffs.............. 45 -- 1998 Director
*Cheryl M. Wheeler....... 37 1993 1993 Secretary, Director, Marketing Manager
*Scott W. Lusk........... 40 1997 -- Director of Finance
*Rockwell D. Schutjer.... 51 1996 1996 Director, Manager, Surgical Technologies
*Steven B. Beckman....... 30 -- 1997 Director
</TABLE>
- ------------------------
* Served only from January 1, 1998 to June 30, 1998.
R. LINDSEY DUNCAN, the founder of 4Health, is a nutritionist certified by
the National Institute of Nutritional Education, an industry accrediting body.
Since the mid-1980s, he has owned, operated, and been the principal nutritionist
of Home Nutrition Clinic, Santa Monica, California. In January 1988, Mr. Duncan
began formulating his own nutritional supplements and in 1993, he organized
4health Inc. (a California corporation and a predecessor to the Company). Mr.
Duncan is a member of the National Nutritional Foods Association, the American
Herbal Products Association, and the Herb Research Foundation.
MR. KLEE IRWIN is the Chief Executive Officer of INH and was the founder of
Irwin Naturals, Inc. Mr. Irwin served as President and Chief Executive Officer
of IN from its formation in 1994 until the Merger in 1998.
MR. LOUIS MANCINI has served as President and Chief Operating Officer of INH
since October 1998. Previous to joining INH, Mr. Mancini was with General
Nutrition Centers, Inc. for over 21 years. His last position while with GNC was
as President of General Nutrition Centers. Mr. Mancini also has been a director
of Sports Club, Inc. since 1995.
MR. DANIEL MARTIN served as the Acting Chief Financial Officer of IN from
March of 1998 until the Merger, and continues to hold this position within INH.
From March 1995 until February 1997, Mr. Martin served as the Chief Financial
Officer of Bocchi Laboratories, a contract manufacturer in the skin and health
care industry. From January 1993 to March 1995, Mr. Martin was the Chief
Financial Officer of Westar Management, a diversified company involved in the
real estate, restaurant and gaming business.
MR. JONATHAN DIAMOND is the Vice Chairman of CDNOW, Inc., an online music
entertainment company based in New York City, New York. Prior to joining CDNOW,
Inc., Mr. Diamond was Chairman of NTK which has merged with CDNOW, Inc. Prior to
joining, NTK, Mr. Diamond was the founder of the J. Diamond Group, a media and
entertainment company involved in broadcast, film and television production and
multimedia projects.
MR. JAMES JEFFS is the Managing Director of the Whittier Trust Company, an
investment management firm based in Pasadena, California. Prior to joining the
Whittier Trust Company, Mr. Jeffs created the
19
<PAGE>
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (CONTINUED)
private capital management division at Trust Services of America (TSA) served as
its Chief Investment Officer and President of TSA Capital Management.
Prior to the Merger, the Company's Board of Directors was comprised of R.
Lindsey Duncan, Cheryl Wheeler, Rockwell D. Schutjer and Steven B. Beckman.
Subsequent to the Merger, the Board of Directors of the Company was comprised of
R. Lindsey Duncan, Klee Irwin, Jonathan Diamond, and James Jeffs. The Board of
Directors met six times during 1998 for regular Board of Directors meetings. All
directors attended 100% of the aggregate of (i) the total number of meetings of
the Board of Directors held while they were members and (ii) the total number of
meetings held by all Committees of the Board of Directors on which they served
as members. In addition, on several occasions, the Board of Directors gave their
unanimous written consent on issues involving normal corporate business. The
Board of Directors has three standing committees, the Audit Committee, the
Compensation Committee, and the Long-Term Stock Incentive Plan Administration
Committee ("LTSIP Administration Committee"). During 1998, the Audit Committee
and the LTSIP Administration Committee were composed of Messrs. Crosland and
Beckman prior to the Merger and Messrs. Diamond and Jeffs thereafter. The Audit
Committee did not meet during 1998, the functions of such committee being
performed by the Board of Directors as a whole. The LTSIP Administration
Committee met throughout 1998 as needed to grant stock options. The LTSIP
Administration Committee is responsible for overseeing 4Health's Long-Term Stock
Incentive Plan (the "LTSIP") including, subject to the express terms of the
LTSIP, making awards, interpreting the LTSIP, amending and rescinding rules and
other duties related to the proper implementation of the LTSIP. During 1998, the
Compensation Committee was composed of Messrs. Duncan and Irwin. The
Compensation Committee met once in 1998. The primary responsibility of the
Compensation Committee is to establish and review the compensation policies of
INH, including those for executives. During 1998, INH did not have a nominating
committee, the functions of such a committee being performed by the Board of
Directors as a whole.
The LTSIP provides that upon assuming office, each non-employee director
shall be granted a non-qualified option to acquire 5,000 shares of Common Stock
at an exercise price equal to 100% of the fair market value on the date of
grant. One-half of the grant shall become exercisable upon completion of one
year of service as a director and the remaining balance upon completion of two
years of service as a director. All options have a five year expiration term.
In addition, Messrs. Diamond and Jeffs were granted by the Board an
additional 20,000 shares each upon becoming directors. Half of these shares are
vested on June 30, 1999 and the other half on June 30, 2000.
Directors do not receive compensation for attending meetings of the Board of
Directors. Directors are reimbursed for their reasonable travel and lodging
expenses incurred attending meetings.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Pursuant to Section 16(a) of the Securities Exchange Act of 1934, executive
officers, directors and 10% shareholders of INH are required to file reports on
Form 3, 4 and 5 of their beneficial holdings and transactions in the INH Common
Stock. During 1998, all such reports were filed in a timely manner.
ITEM 11. EXECUTIVE COMPENSATION
The following table shows, for the year ended December 31, 1998, the cash
compensation paid by the Company, as well as certain other compensation paid or
accrued for the year, to Company's five most highly compensated executive
officers (the "Named Individuals") during 1998:
20
<PAGE>
ITEM 11. EXECUTIVE COMPENSATION (CONTINUED)
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM COMPENSATION
---------------------------
AWARDS
---------------------------
ANNUAL COMPENSATION SECURITIES
------------------------------------ RESTRICTED UNDERLYING
NAME AND POSITION YEAR SALARY BONUS OTHER STOCK AWARD OPTIONS
- ---------------------------------------- --------- ---------- ----------- ----------- --------------- ----------
<S> <C> <C> <C> <C> <C> <C>
R. Lindsey Duncan,...................... 1998 $ 192,219 $ 0 $ 0 $ 0 50,000
Chairman of the Board 1997 150,000 0 0 0 401,252
1996 84,023 0 0 0 331,034
*Klee Irwin,............................ 1998 175,000 0 0 0 50,000
Chief Executive Officer 1997 0 0 0 0 0
1996 0 0 0 0 0
Rockwell Schutjer,...................... 1998 122,163 0 0 0 0
Manger, Surgical Technologies 1997 80,000 0 0 0 0
1996 80,000 0 0 0 132,500
<CAPTION>
PAYOUTS
------------- ALL OTHER
NAME AND POSITION LTIP PAYOUTS COMPENSATION
- ---------------------------------------- ------------- -------------
<S> <C> <C>
R. Lindsey Duncan,...................... $ 0 $ 0
Chairman of the Board 0 0
0 0
*Klee Irwin,............................ 0 0
Chief Executive Officer 0 0
0 0
Rockwell Schutjer,...................... 0 0
Manger, Surgical Technologies 0 0
0 0
</TABLE>
- ------------------------
* This Named Individuals was not employed before July 1, 1998.
OPTION GRANTS IN 1998
The following table presents information with respect to the Named
Individuals concerning the exercise of options during 1998 and unexercised
options held as of December 31, 1998
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
-----------------------------------------------------------------------
NUMBER OF % OF TOTAL
SECURITIES OPTIONS/SARS
UNDERLYING GRANTED TO SEE (1) BELOW
OPTIONS/SARS EMPLOYEES IN EXERCISE STOCK PRICE EXPIRATION --------------------
NAME GRANTED FISCAL YEAR PRICE ON GRANT DATE DATE 0% 5%
<S> <C> <C> <C> <C> <C> <C> <C>
R. Lindsey Duncan.......... 50,000 3% $ 6.9375 $ 7.06 06/30/03 $ 6,125 $ 126,054
K. Irwin................... 50,000 3% 6.9375 $ 7.06 06/30/03 $ 6,125 $ 126,054
<CAPTION>
NAME 10%
<S> <C>
R. Lindsey Duncan.......... $ 278,361
K. Irwin................... $ 278,361
</TABLE>
- --------------------------
(1) Potential Realizable value at Assumed Annual Rates of Stock Price
Appreciation for Option term.
AGGREGATED OPTION EXERCISES AND YEAR END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF UNEXERCISED IN- VALUE OF UNEXERCISED
THE-MONEY OPTIONS AT OPTIONS AT DECEMBER 31,
DECEMBER 31, 1998 1998
VALUE -------------------------- --------------------------
NAME SHARES EXERCISED(#) REALIZED($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ------------------------------- ------------------- --------------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
R. Lindsey Duncan.............. 0 $ 0 436,363 0 $ 302,486(1) 0
K. Irwin....................... 0 0 50,000 0 0
</TABLE>
- ------------------------
(1) Based on the closing market price of $4.75 per share for INH's Common Stock
as of December 31, 1998.
21
<PAGE>
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
R. Lindsey Duncan, Chairman of the Board and Klee Irwin, Chief Executive
Officer, served on the Compensation Committee of the Board of Directors during
1998.
REPORT ON EXECUTIVE COMPENSATION
The Compensation Committee of the Board of Directors has responsibility for
making recommendations regarding compensation policy for INH, including
executives. The Compensation Committee's overall goal is to provide a strong
link among shareholder value, Company performance, and executive compensation.
An additional goal is to promote long-term growth and development for INH by
attracting and retaining qualified and talented executives. The following report
shall not be deemed incorporated by reference into any filing under the
Securities Exchange Act of 1933 or the Securities Exchange Act of 1934.
COMPENSATION COMMITTEE REPORT
INH uses various compensation surveys, including industry and regional
specific surveys, to develop its compensation strategy and plans. The
Compensation Committee also refers to such surveys for executive compensation,
including that of the Chairman of the Board and the Chief Executive Officer.
There is no set policy for adjusting base salary or bonuses subsequent to
initial employment. Such adjustments in the past have occurred due to changes in
job skills, performance, and competitive salary information.
INH's current stock option plan includes executives, managers and key
employees. Stock options are granted periodically by the LTSIP Administration
Committee of the Board of Directors. The Long-Term Stock Incentive Plan allows
the grant of options, both incentive and non-qualified. Historically, the LTSIP
Administration Committee has granted non-qualified options. For executives, the
options are usually granted with one third vesting after each year of service
with INH. Pricing of the options generally begins at the fair market price on
the date of grant for the options vested after one year and increases $1.00 per
share for each additional year of service.
The compensation given to INH's executives and senior officers for 1998 is
shown in the Summary Compensation table. The Compensation Committee believes
that the compensation awarded Messrs. Duncan and Irwin adequately reflects their
performance as INH's Chairman of the Board and Chief Executive Officer
respectively.
The Compensation Committee has reviewed INH's compensation plans with regard
to the deduction limitations under the Omnibus Budget Reconciliation Act of 1993
(the "Act") and the final regulations interpreting the Act which have recently
been adopted by the Internal Revenue Service and the Department of the Treasury.
Based on this review, the Committee has determined that INH's LTSIP, as
previously approved by shareholders, meets the requirements for deductibility
under the Act. The Committee believes that no tax deduction will be lost as a
result of Section 162(m) on compensation paid to Company executives in 1998.
R. Lindsey Duncan
CHAIRMAN OF THE BOARD
Klee Irwin
CHIEF EXECUTIVE OFFICER
22
<PAGE>
EMPLOYMENT AGREEMENTS
Upon the consummation of the Merger, both Mr. R. Lindsey Duncan and Mr. Klee
Irwin entered into substantially similar three year employment agreements with
the Company. Mr. Duncan is employed as Chairman of the Board and as a member of
the Executive Committee with all duties and responsibilities normally associated
with this position. Mr. Irwin is employed as the Chief Executive Officer and as
a member of the Executive Committee with all duties and responsibilities
normally associated with this position. In October of 1998, the Company entered
into an agreement to hire Mr. Louis Mancini as President and Chief Operating
Officer.
These employment agreements provide for: (i) annual salaries of $225,000,
$350,000 and $250,000 for Messrs. Duncan, Irwin and Mancini respectively; (ii)
the right for Messrs Duncan and Irwin to receive an annual bonus equal to 2% of
the consolidated earning before income taxes in excess of $6,000,000; and (iii)
the right to participate in all retirement and welfare, benefit, fringe,
perquisite and other plans and programs applicable generally to other key
executives in effect at any time. In addition, all the above are entitled to
reimbursement for their reasonable business expenses.
STOCK PERFORMANCE
The graph below presents a comparison of the cumulative shareholder return
of the Company's Common Stock over the period July 17, 1996 to December 31, 1998
with the cumulative total return over the same period for The Nasdaq Stock
Market--U.S. Companies Total Return Index and a peer group represented by the
Nasdaq Pharmaceutical Stocks Total Return Index (SIC code 283). Both indexes
were prepared for Nasdaq by the Center for Research in Security Prices. The
graph below compares the cumulative total return of INH's Common Stock over the
July 17, 1996 to December 31, 1998 period assuming a $100 investment on July 17,
1996 and assuming reinvestment of all dividends. (INH's Common Stock commenced
trading on the Nasdaq National Market tier of The Nasdaq Stock Market under the
stock symbol HHHH on July 17, 1996. Prior to that date, 4Health was known as
Surgical Technologies, Inc. with stock trading under the symbol SGTI. The prior
market performance history of SGTI has not been included herein because it does
not reflect the results of 4Health Inc. and Surgical Technologies, Inc. (the
"Surgical Merger") or the changed nature of the Company's business since the
Surgical Merger. The graph is based on daily total return figures from July 17,
1996 and month-end figures from July 30, 1996 through December 31, 1998).
23
<PAGE>
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
<TABLE>
<CAPTION>
NASDAQ PHARMACEUTICAL INDEX INH NASDAQ US INDEX
<S> <C> <C> <C> <C> <C> <C>
7/17/96 $100.00 $100.00 $100.00
9/30/96 $113.64 $78.95 $113.16
12/31/96 $110.25 $57.90 $118.73
3/31/97 $104.70 $58.55 $112.29
6/30/97 $113.03 $61.84 $132.88
9/30/97 $126.80 $50.66 $155.35
12/31/97 $113.92 $53.95 $145.69
3/31/98 $125.14 $48.68 $170.39
6/30/98 $115.81 $74.35 $175.04
9/30/98 $109.25 $52.63 $158.12
12/31/98 $144.82 $50.00 $205.17
Quarter End Values
</TABLE>
<TABLE>
<CAPTION>
QUARTER END VALUES
7/17/96 9/30/96 12/31/96 3/31/97 6/30/97 9/30/97 12/31/97 3/31/98 6/30/98
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
INH...................... $ 100.00 $ 78.95 $ 57.90 $ 58.55 $ 61.84 $ 50.66 $ 53.95 $ 48.68 $ 74.35
Nasdaq US Index.......... 100.00 113.16 118.73 112.29 132.88 155.35 145.69 170.39 175.04
Nasdaq Pharmaceutical
Index.................. 100.00 113.64 110.25 104.70 113.03 126.80 113.92 125.14 115.81
<CAPTION>
9/30/98 12/31/98
<S> <C> <C>
INH...................... $ 52.63 $ 50.00
Nasdaq US Index.......... 158.12 205.17
Nasdaq Pharmaceutical
Index.................. 109.25 144.82
</TABLE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table includes information as of December 31, 1998 concerning
the beneficial ownership of the holdings of the Company's Common Stock by (i)
all persons who are known by the Company to hold five percent or more of the
outstanding shares of INH Common Stock, (ii) each of the directors of the
Company, (iii) each Named Individual, and (iv) all directors and executive
officers of the Company as a group. Except as otherwise indicated, all shares
are owned directly, and the persons named in the table have sole voting and
investing power with respect to shares shown as beneficially owned by them.
<TABLE>
<CAPTION>
SHARES
BENEFICIALLY
NAME AND ADDRESS OF BENEFICIAL OWNER OWNED PERCENT
- ------------------------------------------------------------------------------------- ----------------- -----------
<S> <C> <C>
PRINCIPAL SHAREHOLDERS
R. Lindsey Duncan
10549 W. Jefferson Blvd.
Culver City, CA 90232.............................................................. 5,932,153 21.36%
Klee and Margareth Irwin
10549 W. Jefferson Blvd
Culver City, CA 90232.............................................................. 15,565,000 56.06%
DIRECTORS AND EXECUTIVE OFFICERS
R. Lindsey Duncan (2)(3)............................................................. See Above
Klee Irwin (2)(3).................................................................... See Above
Jonathan Diamond (2)................................................................. 0
James Jeffs (2)...................................................................... 0
All Officers and directors as a group (5 people)..................................... 21,497,153 77.42%
</TABLE>
- ------------------------
(1) Includes 405,439 shares of Common Stock owned by Cheryl Duncan, Mr. Duncan's
wife. Mr. Duncan disclaims ownership of such shares.
24
<PAGE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
(CONTINUED)
(2) Serves as a director of INH.
(3) Serves as an executive officer of INH and appears in the Summary
Compensation table.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In 1996, a $50,000 note receivable from a shareholder was cancelled in
exchange for 90,890 shares of the Company's common stock received from the
shareholder.
During 1996, the Company advanced the former Irwin Naturals shareholders
$478,000. Of such amount, $382,000 was recorded as compensation for services in
the accompanying statement of operations for 1996. The remaining $96,000 was
repaid to the Company in 1997.
From January 1, 1997 through June 30, 1998, the Company made distributions
totaling $1,682,000 ($579,000 in 1997 and $1,103,000 in 1998) to Mr. and Mrs.
Irwin, the S corporation shareholders of Irwin Naturals. These distributions
were for tax liabilities to be paid by the S corporation shareholders
attributable to their respective S corporation income.
The Company has receivables from both its Chief Executive Officer and its
President (see Note 4 of Notes to Financial Statements).
In June and October 1998, the Company entered into employment agreements
with the Chairman of the Board, Chief Executive Officer and President (see Note
10 of Notes to Financial Statements).
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
<TABLE>
<S> <C> <C>
(a) (1) Financial Statements. See Index to Financial Statements (and Financial Statement
Schedules) at page 27 of this Form 10-K.
(2) Financial Data Schedule. All other schedules required by Form 10-K Annual Report
have been omitted because they were not applicable, were included in the notes to
the financial statements, or were not required under the instructions contained
in Regulation S-X.
(3) Exhibits. See Exhibit Index at page 24 of this Form 10-K.
(b) Form 8-K dated October 14, 1997 consisting of the Registrant's press release
regarding its signing of a letter of intent to merge.
</TABLE>
25
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
SEC
EXHIBIT REFERENCE
NUMBER NUMBER TITLE OF DOCUMENT LOCATION
- ---------- ----------- ---------------------------------------------------------------------- --------------------
<C> <C> <S> <C>
Item 2. Plan of Acquisition, Reorganization, Liquidation, or Succession
2.01 2 Agreement and Plan of Merger dated April 10, 1996, by and between Incorporated by
4health, Inc., and Surgical Technologies, Inc. as amended June 4, 1996 Reference (4)
2.04 2 Amended and Restated Agreement and Plan of Merger dated December 24, Incorporated by
1997, signed January 7, 1998, by and between 4Health, Inc. and Irwin Reference (7)
Naturals as amended April 2, 1998.
2.05 2 Agreement to Purchase Asset of Inholtra Naturals Limited *
2.06 2 Agreement & Plan of Merger with Health Vitamin Express Inc. ("HVE") *
Item 3. Articles of Incorporation and Bylaws
3.01 3 Articles of Incorporation of Surgical Subsidiary, Inc., a Utah Incorporated by
Corporation now known as Surgical Technologies, Inc. Irwin Reference (5)
Naturals/4Health, Inc.
3.02 3 Articles of Merger and related Plan of Merger Incorporated by
Reference (5)
3.03 3 Bylaws Incorporated by
Reference (5)
3.04 3 Articles of Merger and related Plan of Merger Incorporated by
Reference (4)
3.05 3 Form of Articles of Merger and related Plan of Merger Incorporated by
Reference (7)
Item 4. Instruments Defining the Rights of Security Holders
4.01 4 Form of Warrant Agreement between 4Health, Inc. and Zions First Incorporated by
National Bank with related form of Warrant Reference (4)
4.02 4 Form of Sale Restriction Agreement respecting shareholders of both Incorporated by
Surgical Technologies, Inc., and 4Health, Inc. Reference (4)
4.03 4 Form of Consent, Approval, and Irrevocable Proxy respecting certain Incorporated by
Surgical stockholders with related schedule Reference (4)
4.04 4 Form of Consent, Approval, and Irrevocable Proxy respecting certain Incorporated by
4Health stockholders with related schedule Reference (4)
4.05 4 Specimen Common Stock Certificate Incorporated by
Reference (4)
4.06 4 Specimen Warrant Certificate Incorporated by
Reference (4)
4.07 4 Warrant certificates between 4Health and Allen & Company Incorporated Incorporated by
dated April 15, 1997 Reference (6)
Item 5. Other Items
</TABLE>
26
<PAGE>
<TABLE>
<CAPTION>
SEC
EXHIBIT REFERENCE
NUMBER NUMBER TITLE OF DOCUMENT LOCATION
- ---------- ----------- ---------------------------------------------------------------------- --------------------
<C> <C> <S> <C>
5.01 5 Summary of Revolving Line of Credit Agreement between 4Health and Incorporated by
Norwest Business Credit, Inc. Reference (1)
5.02 5 Summary of Revolving Line of Credit Agreement between 4Health and *
Wells Fargo Bank.
Item 10. Material Contracts
10.01 10 1996 Long-Term Stock Incentive Plan Incorporated by
Reference (4)
10.02 10 Form of Option granted to Rockwell D. Schutjer Incorporated by
Reference (4)
10.03 10 Form of Proprietary Information, Inventions, and Non-Competition Incorporated by
Agreement between 4Health and R. Lindsey Duncan Reference (4)
10.04 10 Form of Employment Agreement between the Surviving Corporation and Incorporated by
Rockwell Schutjer Reference (4)
10.05 10 Deed of Trust Note and related Deed of Trust, Assignment of Rents, Incorporated by
Security Agreement, and Fixture Filing, dated February 20, 1997, in Reference (3)
the principal amount of $1,350,000 due Standard Insurance Company
10.06 10 Form of Non-Negotiable Promissory Note Incorporated by
Reference (7)
10.07 10 Promissory Note to issued into Inholtra Naturals Limited *
10.08 10 Consulting Agreement with Michael Driver *
10.09 10 Employment Agreement with Louis Mancini, Lindsey Duncan & Klee Irwin *
Item 20. Other Documents or Statements to Security Holders
20.01 20 Notice of change of transfer and warrant agent. Incorporated by
Reference (2)
Item 23.
23 23 Consent of Independent Public Accountant This filing
Item 27. Financial Data Schedule
27.01 27 Financial Data Schedule This Filing
* To be filed by Amendment
(1) Incorporated by reference from 4Health's report on Form 10-Q for the quarter ended September 30, 1997.
(2) Incorporated by reference from 4Health's report on Form 10-Q for the quarter ended March 31, 1997.
(3) Incorporated by reference from 4Health's report on Form 10-K for the year ended December 31, 1996.
(4) Incorporate by reference from Surgical's registration statement on Form S-4 filed with the Commission,
SEC file number 33-03243.
</TABLE>
27
<PAGE>
<TABLE>
<CAPTION>
SEC
EXHIBIT REFERENCE
NUMBER NUMBER TITLE OF DOCUMENT LOCATION
- ---------- ----------- ---------------------------------------------------------------------- --------------------
<C> <C> <S> <C>
(5) Incorporated by reference from Surgical's report on Form 10-K for the year ended March 31, 1994.
(6) Incorporated by reference from Schedule 13D filed with the Commission by Allen & Company Incorporated
on April 18, 1997.
(7) Proxy Statement of 4Health, Inc. dated June, 1998.
</TABLE>
28
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Report of Independent Public Accountants.................................. F-2
Balance Sheets as of December 31, 1997 and 1998........................... F-3
Statements of Operations for each of the three years in the period ended
December 31, 1998....................................................... F-5
Statements of Shareholders' Equity for each of the three years in the
period ended December 31, 1998.......................................... F-6
Statements of Cash Flows for each of the three years in the period ended
December 31, 1998....................................................... F-7
Notes to Financial Statements............................................. F-9
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Irwin Naturals/4Health, Inc.:
We have audited the accompanying balance sheets of Irwin Naturals/4Health,
Inc. (a Utah corporation) as of December 31, 1997 and 1998, and the related
statements of operations, shareholders' equity and cash flows for each of the
three years in the period ended December 31, 1998. 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 financial position of Irwin Naturals/4Health, Inc.
as of December 31, 1997 and 1998, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 1998 in
conformity with generally accepted accounting principles.
/s/ ARTHUR ANDERSEN LLP
Los Angeles, California
April 14, 1999
F-2
<PAGE>
IRWIN NATURALS/4HEALTH, INC.
BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1997 1998
------------ ------------
<S> <C> <C>
CURRENT ASSETS:
Cash............................................ $ 637,000 $ 426,000
Accounts receivable, net of allowance for
doubtful accounts of $441,000 at December 31,
1997 and $1,131,000 at December 31, 1998...... 4,900,000 6,023,000
Inventories..................................... 2,162,000 2,855,000
Prepaid expenses and other...................... 322,000 290,000
Current portion of receivables from officer and
shareholder................................... -- 497,000
Current portion of note receivable.............. 35,000 99,000
Deferred tax asset.............................. 184,000 --
------------ ------------
Total current assets.......................... 8,240,000 10,190,000
------------ ------------
BUILDING HELD FOR SALE............................ -- 1,521,000
------------ ------------
PROPERTY AND EQUIPMENT, at cost:
Land............................................ 270,000 --
Building and building improvements.............. 1,606,000 --
Machinery and equipment......................... 292,000 355,000
Furniture and fixtures.......................... 776,000 758,000
Leasehold improvements.......................... 57,000 303,000
------------ ------------
3,001,000 1,416,000
Less--Accumulated depreciation and
amortization.................................. (552,000) (789,000)
------------ ------------
2,449,000 627,000
------------ ------------
OTHER ASSETS:
Intangibles, net of accumulated amortization of
$247,000 at December 31, 1997 and $307,000 at
December 31, 1998............................. 480,000 420,000
Trademarks, net of accumulated amortization of
$8,000 at December 31, 1997 and $13,000 at
December 31, 1998............................. 68,000 99,000
Receivable from officers and shareholder, net of
current portion............................... -- 175,000
Note receivable, net of current portion......... 78,000 --
Other........................................... 22,000 55,000
------------ ------------
648,000 749,000
------------ ------------
$ 11,337,000 $ 13,087,000
------------ ------------
------------ ------------
</TABLE>
The accompanying notes are an integral part of these balance sheets.
F-3
<PAGE>
IRWIN NATURALS/4HEALTH, INC.
BALANCE SHEETS
LIABILITIES AND SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1997 1998
------------ ------------
<S> <C> <C>
CURRENT LIABILITIES:
Line of credit.................................. $ 741,000 $ 1,000,000
Current portion of long-term debt............... 29,000 328,000
Accounts payable................................ 2,054,000 2,637,000
Accrued expenses................................ 1,317,000 942,000
Income taxes payable............................ 61,000 438,000
Customer deposits............................... 450,000 450,000
------------ ------------
Total current liabilities..................... 4,652,000 5,795,000
------------ ------------
LONG-TERM DEBT, net of current portion............ 1,298,000 1,423,000
------------ ------------
COMMITMENTS AND CONTINGENCIES (see Note 10)
SHAREHOLDERS' EQUITY
Preferred stock, $1.00 par value:
Authorized--5,000,000 shares
Issued and outstanding--none.................. -- --
Common stock, $.01 par value:
Authorized--50,000,000 shares
Issued--27,818,798 shares at December 31, 1997
and 27,857,139 shares at December 31, 1998
Outstanding--27,727,908 shares at December 31,
1997 and 27,766,249 shares at December 31,
1998........................................ 278,000 279,000
Additional paid-in capital...................... 11,656,000 14,333,000
Treasury stock--90,890 shares................... (50,000) (50,000)
Retained deficit................................ (6,497,000) (8,693,000)
------------ ------------
5,387,000 5,869,000
------------ ------------
$ 11,337,000 $ 13,087,000
------------ ------------
------------ ------------
</TABLE>
The accompanying notes are an integral part of these balance sheets.
F-4
<PAGE>
IRWIN NATURALS/4HEALTH, INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED
------------------------------------------
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1996 1997 1998
------------ ------------ ------------
<S> <C> <C> <C>
NET SALES................................................... $ 28,592,000 $ 29,353,000 $ 30,547,000
COST OF SALES............................................... 12,326,000 13,563,000 12,945,000
------------ ------------ ------------
Gross Profit............................................ 16,266,000 15,790,000 17,602,000
------------ ------------ ------------
OPERATING EXPENSES:
Selling, general and administrative....................... 17,564,000 17,226,000 15,775,000
Loss on write-off of goodwill............................. -- 3,202,000 --
------------ ------------ ------------
17,564,000 20,428,000 15,775,000
------------ ------------ ------------
Income (loss) from operations........................... (1,298,000) (4,638,000) 1,827,000
------------ ------------ ------------
OTHER INCOME (EXPENSE):
Interest expense.......................................... (117,000) (167,000) (163,000)
Interest income........................................... 146,000 52,000 10,000
Other..................................................... 72,000 36,000 (56,000)
------------ ------------ ------------
101,000 (79,000) (209,000)
------------ ------------ ------------
Income (loss) before provision for income taxes......... (1,197,000) (4,717,000) 1,618,000
PROVISION FOR INCOME TAXES.................................. 594,000 -- 600,000
------------ ------------ ------------
NET INCOME (LOSS)........................................... $ (1,791,000) $ (4,717,000) $ 1,018,000
------------ ------------ ------------
------------ ------------ ------------
INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES............. $ (4,717,000) $ 1,618,000
PRO FORMA PROVISION FOR INCOME TAXES (UNAUDITED)............ N/A 765,000 1,345,000
------------ ------------
PRO FORMA NET INCOME (LOSS)(UNAUDITED)...................... N/A $ (5,482,000) $ 273,000
------------ ------------
------------ ------------
EARNINGS (LOSS) PER COMMON SHARE:
Basic--Historical....................................... $ (0.07) $ (0.17) $ 0.04
------------ ------------ ------------
------------ ------------ ------------
Diluted--Historical..................................... $ (0.07) $ (0.17) $ 0.04
------------ ------------ ------------
------------ ------------ ------------
Basic--Pro Forma........................................ N/A $ (0.20) $ 0.01
------------ ------------
------------ ------------
Diluted--Pro Forma...................................... N/A $ (0.20) $ 0.01
------------ ------------
------------ ------------
WEIGHTED AVERAGE NUMBER OF SHARES OF COMMON STOCK
OUTSTANDING:
Basic--Historical....................................... 25,647,000 27,365,000 27,747,000
------------ ------------ ------------
------------ ------------ ------------
Diluted--Historical..................................... 25,647,000 27,365,000 28,221,000
------------ ------------ ------------
------------ ------------ ------------
Basic--Pro Forma........................................ N/A 27,365,000 27,747,000
------------ ------------
------------ ------------
Diluted--Pro Forma...................................... N/A 27,365,000 28,221,000
------------ ------------
------------ ------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE>
IRWIN NATURALS/4HEALTH, INC.
STATEMENTS OF SHAREHOLDERS' EQUITY
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1998
<TABLE>
<CAPTION>
CONVERTIBLE
PREFERRED STOCK COMMON STOCK
------------------ --------------------
SHARES AMOUNT SHARE AMOUNT
-------- -------- ---------- --------
<S> <C> <C> <C> <C>
BALANCE, December 31, 1995........................ 376,167 $ 15,000 24,464,727 $245,000
Conversion of a $50,000 note receivable for
Treasury Stock................................ -- -- -- --
Conversion of Series A Convertible Preferred
Stock......................................... (376,167) (15,000) 376,167 4,000
Common stock issued in merger with Surgical
Technologies, Inc............................. -- -- 2,271,108 22,000
Issuance of common stock in connection with
exercise of stock options..................... -- -- 98,372 1,000
Net loss........................................ -- -- -- --
-------- -------- ---------- --------
BALANCE, December 31, 1996........................ -- -- 27,210,374 272,000
-------- -------- ---------- --------
Issuance of common stock in connection with
exercise of stock options..................... -- -- 108,424 1,000
Issuance of warrants as compensation for
investment banking services................... -- -- -- --
Issuance of common stock to old 4Health
Shareholders pursuant to a realignment of
equity interests (see note 11)................ -- -- 500,000 5,000
Distributions................................... -- -- -- --
Net loss........................................ -- -- -- --
-------- -------- ---------- --------
BALANCE, December 31, 1997........................ -- -- 27,818,798 278,000
-------- -------- ---------- --------
Issuance of common stock in connection with
exercise of stock options..................... -- -- 38,341 1,000
Compensation expense incurred in connection with
issuance of stock options..................... -- -- -- --
Compensation expense in connection with warrants
issued for investment banking services........ -- -- -- --
Distributions................................... -- -- -- --
Effect of Irwin Naturals terminating its S
Corporation election.......................... -- -- -- --
Net income...................................... -- -- -- --
-------- -------- ---------- --------
BALANCE, December 31, 1998........................ -- $ -- 27,857,139 $279,000
-------- -------- ---------- --------
-------- -------- ---------- --------
<CAPTION>
ADDITIONAL TREAURY STOCK RETAINED
PAID IN ---------------- EARNINGS
CAPITAL SHARES AMOUNT (DEFICIT) TOTAL
---------- ------ -------- ----------- -----------
<S> <C> <C> <C> <C> <C>
BALANCE, December 31, 1995........................ $2,355,000 -- $ -- $ 590,000 $ 3,205,000
Conversion of a $50,000 note receivable for
Treasury Stock................................ -- 90,890 (50,000) -- (50,000)
Conversion of Series A Convertible Preferred
Stock......................................... 11,000 -- -- -- --
Common stock issued in merger with Surgical
Technologies, Inc............................. 8,775,000 -- -- -- 8,797,000
Issuance of common stock in connection with
exercise of stock options..................... 94,000 -- -- -- 95,000
Net loss........................................ -- -- -- (1,791,000) (1,791,000)
---------- ------ -------- ----------- -----------
BALANCE, December 31, 1996........................ 11,235,000 90,890 (50,000) (1,201,000) 10,256,000
---------- ------ -------- ----------- -----------
Issuance of common stock in connection with
exercise of stock options..................... 151,000 -- -- -- 152,000
Issuance of warrants as compensation for
investment banking services................... 275,000 -- -- -- 275,000
Issuance of common stock to old 4Health
Shareholders pursuant to a realignment of
equity interests (see note 11)................ (5,000) -- -- -- --
Distributions................................... -- -- -- (579,000) (579,000)
Net loss........................................ -- -- -- (4,717,000) (4,717,000)
---------- ------ -------- ----------- -----------
BALANCE, December 31, 1997........................ 11,656,000 90,890 (50,000) (6,497,000) 5,387,000
---------- ------ -------- ----------- -----------
Issuance of common stock in connection with
exercise of stock options..................... 172,000 -- -- -- 173,000
Compensation expense incurred in connection with
issuance of stock options..................... 6,000 -- -- -- 6,000
Compensation expense in connection with warrants
issued for investment banking services........ 388,000 -- -- -- 388,000
Distributions................................... -- -- -- (1,103,000) (1,103,000)
Effect of Irwin Naturals terminating its S
Corporation election.......................... 2,111,000 -- -- (2,111,000) --
Net income...................................... -- -- -- 1,018,000 1,018,000
---------- ------ -------- ----------- -----------
BALANCE, December 31, 1998........................ 1$4,333,000 90,890 $(50,000) $(8,693,000) $ 5,869,000
---------- ------ -------- ----------- -----------
---------- ------ -------- ----------- -----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE>
IRWIN NATURALS/4HEALTH, INC.
STATEMENTS OF CASH FLOWS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1998
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1996 1997 1998
------------ ------------ ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)......................................... $ (1,791,000) $ (4,717,000) $ 1,018,000
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization......................... 337,000 557,000 550,000
Provision for returns, allowances and doubtful
accounts............................................ 181,000 2,549,000 2,116,000
Loss on disposition of property
and equipment......................................... 7,000 99,000 10,000
Warrants issued as compensation....................... -- 275,000 388,000
Compensation expense in connection with issuance of
stock options....................................... -- -- 6,000
Loss on write-off of goodwill......................... -- 3,202,000 --
Changes in operating assets and liabilities:
Accounts receivable................................. (2,402,000) (3,559,000) (3,239,000)
Inventories......................................... (1,576,000) 850,000 (693,000)
Prepaid expenses and other.......................... (154,000) (122,000) 119,000
Deferred taxes...................................... (316,000) 125,000 184,000
Accounts payable.................................... 878,000 132,000 583,000
Accrued expenses.................................... 936,000 68,000 (375,000)
Income taxes payable................................ 731,000 (682,000) 377,000
------------ ------------ ------------
Net cash provided by (used in) operating activities... (3,169,000) (1,223,000) 1,044,000
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment....................... (587,000) (216,000) (350,000)
Proceeds from disposition of property and equipment....... -- 1,000 --
Collections on note receivable............................ 262,000 269,000 14,000
Proceeds from the sale of securities...................... 524,000 -- --
Acquisition of Surgical Technologies...................... 3,639,000 -- --
Receivables from officers and shareholders................ (96,000) 96,000 (672,000)
------------ ------------ ------------
Net cash provided by (used in) investing activities... 3,742,000 150,000 (1,008,000)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings on line of credit.......................... -- 741,000 259,000
Proceeds from exercise of stock options................... 95,000 152,000 173,000
Payments of note payable to shareholder................... (213,000) -- --
Distributions to shareholders............................. -- (579,000) (1,103,000)
Surgical Technologies acquisition costs................... (457,000) -- --
Borrowing under long-term debt............................ -- 1,350,000 592,000
Payments of long-term debt................................ (77,000) (1,322,000) (168,000)
Proceeds from customer deposits........................... 450,000 -- --
------------ ------------ ------------
Net cash provided by (used in) financing activities... (202,000) 342,000 (247,000)
------------ ------------ ------------
NET INCREASE (DECREASE) IN CASH............................. 371,000 (731,000) (211,000)
CASH, beginning of year..................................... 997,000 1,368,000 637,000
------------ ------------ ------------
CASH, end of year........................................... $ 1,368,000 $ 637,000 $ 426,000
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
F-7
<PAGE>
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1996 1997 1998
------------ ------------ ------------
<S> <C> <C> <C>
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the year for:
Interest................................................ $ 107,000 $ 133,000 $ 148,000
------------ ------------ ------------
------------ ------------ ------------
Income taxes............................................ $ 409,000 $ 291,000 $ 24,000
------------ ------------ ------------
------------ ------------ ------------
Non-cash transactions:
</TABLE>
During 1996, the Company acquired the following assets and liabilities in
connection with a merger:
<TABLE>
<S> <C>
Cash.................................... $3,639,000
Marketable securities................... 524,000
Accounts receivable..................... 76,000
Inventories............................. 391,000
Deferred tax asset...................... 51,000
Property and equipment.................. 118,000
Other assets............................ 1,037,000
Notes receivable........................ 644,000
Accounts payable........................ (194,000)
Taxes payable........................... (9,000)
Deferred tax liability.................. (58,000)
----------
Net assets acquired................... 6,219,000
Less acquisition costs................ (457,000)
----------
Net equity issued..................... $5,762,000
----------
----------
</TABLE>
In addition, during 1996, a $50,000 note receivable from a shareholder was
cancelled in exchange for 90,890 shares of the Company's common stock received
from the shareholder.
During 1998, the Company reduced property and equipment by $1,677,000 and
recorded prepaid expenses of $156,000 and building held for sale of $1,521,000.
The accompanying notes are an integral part of these financial statements.
F-8
<PAGE>
IRWIN NATURALS/4HEALTH, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998
1. NATURE OF BUSINESS
Irwin Naturals/4Health, Inc. (the Company) is a formulator and supplier of
branded natural health, herbal and nutritional supplement products. The
Company's products are sold through mass retail, specialty natural health,
nutrition and food retail stores.
2. BUSINESS COMBINATION
Effective June 30, 1998, 4Health, Inc. consummated a merger with Irwin
Naturals in a transaction that was accounted for as a pooling of interests. The
merged entity changed its name to Irwin Naturals/4Health, Inc. The Company
issued 15,750,000 shares of common stock in exchange for all the outstanding
shares of Irwin Naturals. The accompanying financial statements have been
restated to include the financial position and results of operations for both
companies as if the merger was consummated at the beginning of all periods
presented.
Net sales and historical net income (loss) of the combining companies for
the past three years are as follows (individual line items, other than the
totals, for the year ended December 31, 1998 are unaudited):
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1996 1997 1998
------------- ------------- -------------
<S> <C> <C> <C>
Net Sales:
4Health (pre-merger).......................... $ 17,352,000 $ 12,432,000 $ 6,373,000
Irwin Naturals (pre-merger)................... 11,240,000 16,921,000 9,291,000
Irwin Naturals/4Health (post-merger).......... -- -- 14,883,000
------------- ------------- -------------
Total......................................... $ 28,592,000 $ 29,353,000 $ 30,547,000
------------- ------------- -------------
------------- ------------- -------------
Net Income (Loss):
4Health (pre-merger).......................... $ (2,550,000) $ (6,629,000) $ (900,000)
Irwin Naturals (pre-merger)................... 759,000 1,912,000 1,070,000
Irwin Naturals/4Health (post-merger).......... -- -- 848,000
------------- ------------- -------------
Total......................................... $ (1,791,000) $ (4,717,000) $ 1,018,000
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
USE 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.
BUSINESS SEGMENTS
The Company operates as one reportable business segment. The former Irwin
Naturals and 4Health, Inc., now the Company, sell branded natural health, herbal
and nutritional supplement products. The products are sold through mass retail,
specialty natural health, nutrition and food retail stores. The product sales
from each former company share similar profitability margins.
F-9
<PAGE>
IRWIN NATURALS/4HEALTH, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CONCENTRATION OF RISK
Accounts receivable are unsecured and the Company is at risk to the extent
such amounts become uncollectable. At December 31, 1997, one customer
represented 28.1 percent of accounts receivable. At December 31, 1998, two
customers represented 25.5 and 10.9 percent of accounts receivable,
respectively.
The Company had sales to a single customer that represented 23.5, 15.6 and
13.3 percent of net sales in 1996, 1997 and 1998, respectively.
The Company's foreign sales represented 9.6, 14.1 and 10.0 percent of total
net sales in 1996, 1997 and 1998, respectively.
During 1998, approximately 77 percent of the Company's total purchases were
from a single supplier. Management believes that if the Company was unable to
make further purchases from this supplier, it would be able to find alternative
suppliers with terms and quality levels similar to those currently in place.
INVENTORIES
Inventories are valued at the lower of cost (first-in, first-out) or market
and are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1997 1998
------------ ------------
<S> <C> <C>
Raw Materials.................................................... $ 70,000 $ 803,000
Finished Goods................................................... 2,092,000 2,052,000
------------ ------------
$2,162,000 $2,855,000
------------ ------------
------------ ------------
</TABLE>
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation and amortization are
computed using the straight-line method over the following estimated useful
lives:
<TABLE>
<S> <C>
3 to 10
Machinery and equipment....................................... years
Furniture and fixtures........................................ 3 to 7 years
Life of
Leasehold improvements........................................ lease
</TABLE>
When an asset is sold or otherwise disposed of, the cost and related
accumulated depreciation are removed from the accounts and any resulting gain or
loss are included in results of operations. Repairs and maintenance are charged
to expense as incurred and major replacements or betterments are capitalized.
INTANGIBLES
The Company acquired ID Technology in connection with a 1996 merger with
Surgical Technologies. ID Technology is used in angioplasty procedures. The
technology is being amortized using the straight-line method over an 8-year
period. Management believes the carrying value of the ID Technology is fully
recoverable.
F-10
<PAGE>
IRWIN NATURALS/4HEALTH, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
TRADEMARKS
Costs associated with the establishment and defense of trademarks have been
capitalized and are being amortized over seventeen years using the straight-line
method.
REVENUE RECOGNITION
The Company recognizes revenue at the time of shipment. Provisions for
returns and allowances are recorded as products are shipped. During the years
ended 1996, 1997 and 1998, the Company provided $181,000, $2,549,000 and
$2,116,000, respectively, for returns and allowances, including allowances for
doubtful accounts, and incurred related write-offs of $154,000, $2,288,000 and
$1,426,000, respectively.
STOCK BASED COMPENSATION
The Company adopted Statement of Financial Accounting Standards (SFAS) No.
123, "Accounting for Stock Based Compensation" (SFAS 123) in fiscal 1996. As
allowed by SFAS 123, the Company has elected to continue to measure compensation
cost under Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees" (APB 25) and comply with the pro forma disclosure
requirements of the new standard (see Note 11).
EARNINGS PER SHARE
Earnings per share calculations are in accordance with SFAS No. 128,
"Earnings per Share." "Basic" earnings per share is computed by dividing net
income (loss) by the weighted average number of common shares outstanding for
the year. "Diluted" earnings (loss) per share is computed by dividing net income
(loss) by the total of weighted average number of common shares outstanding plus
the dilutive effect of outstanding stock options and warrants (applying the
treasury stock method). For the years ended December 31, 1996 and 1997, the
effect of stock options and warrants were not included as the results would be
antidilutive.
A reconciliation of the "basic" weighted average number of common shares
outstanding to the "diluted" weighted average number of common shares
outstanding for each of the three years in the period ended December 31, 1998
follows:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1996 1997 1998
------------ ------------ ------------
<S> <C> <C> <C>
Weighted average number of common
shares outstanding--Basic......................... 25,647,000 27,365,000 27,747,000
Dilutive effect of outstanding stock options........ -- -- 474,000
------------ ------------ ------------
Weighted average number of common
shares outstanding--Dilutive...................... 25,647,000 27,365,000 28,221,000
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
PRO FORMA STATEMENTS OF OPERATIONS
From January 1, 1997 through June 30, 1998, Irwin Naturals had elected
treatment as an S corporation under provisions of the Internal Revenue Code.
Effective June 30, 1998, Irwin Naturals terminated its S corporation election
and became a C corporation.
F-11
<PAGE>
IRWIN NATURALS/4HEALTH, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
See Note 9 for explanation of pro forma provision for income taxes and the
related pro forma net income (loss).
STATEMENTS OF CASH FLOWS
The Company prepares it statements of cash flows using the indirect method
as prescribed by Statement of Financial Accounting Standards (SFAS) No. 95. The
Company considers all highly liquid investments with an original maturity of
three months or less to be cash equivalents.
NEW AUTHORITATIVE PRONOUNCEMENTS
The Financial Accounting Standards Board has issued SFAS No. 132,
"Employer's Disclosure about Pensions and Other Postretirement Benefits" and
SFAS No. 133, "Accounting for Derivative and Hedging Activities." These new
accounting standards do not have any impact on the Company's financial
statements or financial reporting.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's financial instruments consist of cash, short-term trade
receivables and payables and short-term and long-term debt. The carrying values
for all such instruments, considering the terms, approximate fair value at
December 31, 1997 and 1998.
RECLASSIFICATIONS
Certain amounts in prior years have been reclassified to conform to the
current year's presentation.
4. RECEIVABLES FROM OFFICERS AND SHAREHOLDER
The receivables from officers and shareholder consist of the following at
December 31, 1998:
<TABLE>
<S> <C>
Receivable from the Chief Executive Officer, bearing interest at an annual rate
of 8 percent, payable in full no later than December 31, 1999.................. $ 322,000
Receivable from the President, bearing interest at an annual rate of 8 percent,
principal and accrued interest to be forgiven based on continued employment at
the rate of 50 percent at December 31, 1999 and the remaining 50 percent at
December 31, 2000, otherwise payable in full upon terminating employment prior
to such target dates........................................................... 350,000
---------
672,000
Less--current portion............................................................ (497,000)
---------
$ 175,000
---------
---------
</TABLE>
5. NOTE RECEIVABLE
The note receivable is from a third party for the purchase of certain
assets. The third party is also a vendor to the Company. The note is secured by
the purchased assets and bears interest at an annual rate of 10 percent. The
original maturity of the note was February 1999. The maturity has been extended
but no specific date has been set. Management believes it will fully realize
this receivable during 1999 through both cash receipts and offsets of purchases
from this vendor.
F-12
<PAGE>
IRWIN NATURALS/4HEALTH, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
6. BUILDING HELD FOR SALE
On March 25, 1999, the Company completed the sale of the former 4Health,
Inc. corporate facility. Key terms under the agreement are as follows:
- Sales price of $2,350,000
- Buyer assumes mortgage loan ($1,300,000 as of December 31, 1998)
- Company holds a note receivable from Buyer for $458,000
Gains from the sale of this facility will be recorded in the results of
operations in the first quarter of 1999.
7. LINE OF CREDIT
As of December 31, 1998, the Company had outstanding borrowing of $1,000,000
under a revolving line of credit with a bank. In February 1999, the outstanding
balance was paid in full and the line was closed.
On February 1, 1999, the Company obtained a new line of credit with a
different bank. The line of credit agreement was subsequently amended in March
1999. Maximum borrowings under the amended line of credit are limited to
$6,400,000 based on eligible accounts receivable and inventories. Borrowings
under the line are secured by Company assets, and are also personally guaranteed
by the Company's Chief Executive Officer up to $2.5 million. Borrowings under
the line bear interest at an annual rate of either prime plus .25 percent or
LIBOR plus 2.0 percent. The amended line of credit expires on June 30, 1999.
Selected information regarding borrowing under prior line of credit
agreements for 1998 follows:
<TABLE>
<S> <C>
Average amount outstanding...................................... $ 620,000
Maximum amount outstanding...................................... $1,500,000
Weighted average interest rate during the period................ 8.4%
</TABLE>
F-13
<PAGE>
IRWIN NATURALS/4HEALTH, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998
8. LONG-TERM DEBT
Long-term debt consists of the following at December 31, 1997 and 1998:
<TABLE>
<CAPTION>
1997 1998
---------- ----------
<S> <C> <C>
Note payable to a bank, secured by land and a
building, bearing interest at an annual rate of
8.25 percent, payable in monthly installments of
principal and interest of approximately $11,000,
due March 2002.................................. $1,327,000 $1,300,000
Notes payable to three individuals, unsecured,
bearing interest at an annual rate of 6.0
percent, payable in monthly installments of
principal and interest of approximately $26,000,
due June 2000................................... -- 451,000
---------- ----------
1,327,000 1,751,000
Less--current portion........................... (29,000) (328,000)
---------- ----------
$1,298,000 $1,423,000
---------- ----------
---------- ----------
</TABLE>
In March 1999, the Company sold the building that was the underlying
security for the note payable to the bank above. In connection with the sale,
the Buyer assumed the related note payable (see Note 6). After subtracting the
payments required under the note payable to the bank, the future principle
payments under the remaining debt agreements as of December 31, 1998 are as
follows:
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31,
- ------------------------------------------------------------------
<S> <C>
1999.............................................................. $ 296,000
2000.............................................................. 155,000
---------
$ 451,000
---------
---------
</TABLE>
9. INCOME TAXES
From January 1, 1997 through June 30, 1998, Irwin Naturals had elected
treatment as an S corporation under provisions of the Internal Revenue Code.
Effective June 30, 1998, Irwin Naturals terminated its S corporation election
and became a C corporation. As such, the actual taxes due by Irwin Naturals for
the period from January 1, 1997 to June 30, 1998 are based on S corporation tax
rates, which are substantially less than C corporation tax rates. As a result of
the "pooling of interests" between Irwin Naturals and 4Health, Inc., the
accompanying statements of operations for 1997 and 1998 reflect historical tax
provisions which are a combination of both C corporation and S corporation tax
rates. Because of the Irwin Natural's change in tax status, historical results
of operations, including income taxes and earnings (loss) per share information
may not, in all cases, be comparable to or indicative of current and future
results. Therefore, the statements of operations for 1997 and 1998 also include
unaudited pro forma provisions for income taxes and resulting unaudited pro
forma net income (loss) and unaudited pro forma earnings (loss) per share
information as if Irwin Naturals had been a C corporation during the period from
January 1, 1997 to June 30, 1998.
The Company accounts for income taxes under the provisions of Statement of
Financial Accounting Standards (SFAS) No. 109. Under SFAS No. 109, deferred
income tax assets or liabilities are computed based on the temporary difference
between the financial statement and income tax bases of assets and
F-14
<PAGE>
IRWIN NATURALS/4HEALTH, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
9. INCOME TAXES (CONTINUED)
liabilities using the current marginal income tax rate. Deferred income tax
expenses or credits are based on the changes in the deferred income tax assets
or liabilities from period to period.
Deferred tax assets may be recognized for temporary differences that will
result in deductible amounts in future periods and for loss carryforwards. A
valuation allowance is recognized if, based on the weight of available evidence,
it is more likely than not that some portion or all of the deferred tax asset
will not be realized. As of December 31, 1997 and 1998, the Company had recorded
valuation allowances.
The components of the deferred income tax assets (liabilities) are as
follows:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1997 1998
------------ ------------
<S> <C> <C>
Allowance for doubtful accounts......... $ 25,000 $ 369,000
Inventory tax adjustment................ (24,000) 83,000
Inventory reserve....................... 71,000 186,000
Barter credits.......................... -- 303,000
Warrants................................ 107,000 52,000
Accrued liabilities..................... 164,000 33,000
NOL carryforwards....................... 5,642,000 2,817,000
Other................................... (161,000) (15,000)
------------ ------------
5,824,000 3,828,000
Valuation allowance..................... (5,642,000) (3,828,000)
------------ ------------
$ 182,000 $ --
------------ ------------
------------ ------------
</TABLE>
At December 31, 1998, the Company has federal and state net operating loss
carryforwards of approximately $7,876,000 and $4,660,000, respectively, expiring
at various dates through 2012. Future use of these net operating loss
carryforwards may be limited subject to certain provisions of the Internal
Revenue Code.
The components of the provision for income taxes for the period ended
December 31 are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1996 1997 1998
------------ ------------ ------------
<S> <C> <C> <C>
Federal................................. $626,000 $(17,000) $287,000
State................................... 94,000 (1,000) 131,000
------------ ------------ ------------
720,000 (18,000) 418,000
------------ ------------ ------------
Deferred................................ (126,000) 18,000 182,000
------------ ------------ ------------
Provision for income taxes.............. $594,000 $ -- $600,000
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
F-15
<PAGE>
IRWIN NATURALS/4HEALTH, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
9. INCOME TAXES (CONTINUED)
Differences between the provision for income taxes and income taxes at the
statutory federal income tax rate are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1996 DECEMBER 31, 1997 DECEMBER 31, 1998
---------------------- ----------------------- ----------------------
<S> <C> <C> <C> <C> <C> <C>
Income tax at statutory
federal rate............................ $(407,000) (34.0)% $(1,604,000) (34.0)% $ 550,000 34.0 %
State income taxes...................... (43,000) (3.6) (236,000) (5.0) 131,000 8.1
S corporation income not taxed at C
corporation rates..................... -- -- (765,000) (16.2) (374,000) (23.1)
Permanent differences................... -- -- -- -- 156,000 9.6
Use of net operating loss
carryforwards......................... -- -- -- -- (332,000) (20.5)
Change in valuation allowance........... 860,000 71.9 3,271,000 69.3 469,000 29.0
Short year tax provision................ 149,000 12.4 -- -- -- --
Other items, net........................ 35,000 2.9 (666,000) (14.1) -- --
--------- ----- ---------- ----- --------- -----
$ 594,000 49.6 % $ -- -- % $ 600,000 37.1 %
--------- ----- ---------- ----- --------- -----
--------- ----- ---------- ----- --------- -----
</TABLE>
The components of the unaudited pro forma provision for income taxes for
1997 and 1998 are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1997 1998
------------ ------------
<S> <C> <C>
Federal................................. $ 633,000 $ 890,000
State................................... 114,000 271,000
------------ ------------
747,000 1,161,000
------------ ------------
Deferred................................ 18,000 184,000
------------ ------------
Pro forma provision
for income taxes........................ $ 765,000 $1,345,000
------------ ------------
------------ ------------
</TABLE>
Differences between the unaudited pro forma provision for income taxes and
income taxes at the statutory federal income tax rate are as follows:
<TABLE>
<S> <C> <C> <C> <C>
DECEMBER 31, 1997 DECEMBER 31, 1998
----------------------- ----------------------
Income tax at statutory federal
rate............................ $(1,604,000) (34.0)% $ 550,000 34.0 %
State income taxes................ (236,000) (5.0) 271,000 16.8
Permanent differences............. -- -- 372,000 22.9
Use of net operating loss
carryforwards................... -- -- (332,000) (20.5)
Change in valuation allowance..... 3,271,000 69.3 484,000 29.9
Other, net........................ (666,000) (14.1) -- --
---------- ----- --------- -----
$ 765,000 16.2 % $1,345,000 83.1 %
---------- ----- --------- -----
---------- ----- --------- -----
</TABLE>
F-16
<PAGE>
IRWIN NATURALS/4HEALTH, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
10. COMMITMENTS AND CONTINGENCIES
OPERATING LEASES
The Company leases its facilities and certain property and equipment under
long-term operating leases expiring at various dates through 2004. Future
minimum lease payments as of December 31, 1998 are as follows:
<TABLE>
<CAPTION>
OPERATING
YEAR ENDING DECEMBER 31, LEASES
- -------------------------------------------------------------------------------- ------------
<S> <C>
1999............................................................................ $ 712,000
2000............................................................................ 831,000
2001............................................................................ 529,000
2002............................................................................ 526,000
2003............................................................................ 546,000
Thereafter...................................................................... 281,000
------------
$ 3,425,000
------------
------------
</TABLE>
Total rental expense for the years ended December 31, 1996, 1997 and 1998
was approximately $246,000, $390,000 and $557,000, respectively.
EMPLOYMENT CONTRACTS
In August 1997, the Company entered into an employment agreement with its VP
of Sales. Under the terms of the agreement, the annual base salary is a minimum
of $70,000 through December 31, 2000.
On June 30, 1998, the Company entered into a three-year employment contract
with its Chief Executive Officer. Under the terms of the contract, the annual
base salary is a minimum of $350,000, subject to review and possible increases
at the discretion of the Board of Directors. In addition, a bonus is to be paid,
in the form of cash, stock or both, based on an amount equal to two percent of
earnings before taxes in excess of $6,000,000.
On June 30, 1998, the Company entered into a three-year employment contract
with its Chairman of the Board of Directors. Under the terms of the contract,
the annual base salary is a minimum of $225,000, subject to review and possible
increases at the discretion of the Board of Directors. In addition, a bonus is
to be paid, in the form of cash, stock or both, based on an amount equal to two
percent of earnings before taxes in excess of $6,000,000.
In October 1998, the Company entered into a three-year employment agreement
with its President. Under the terms of the agreement, the annual base salary is
$250,000, increasing to $300,000 in the second and third years. In addition, a
bonus is to be paid based on growth targets to be determined.
ROYALTY AGREEMENTS
The Company entered into a royalty agreement (the Agreement) that provides
for royalties to be paid based on a percentage of net sales of certain products.
The current term expires on April 30, 1999 and requires minimum royalties from
January 1, 1999 to April 30, 1999 of $50,000.
F-17
<PAGE>
IRWIN NATURALS/4HEALTH, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
10. COMMITMENTS AND CONTINGENCIES (CONTINUED)
The Company has the option to renew the Agreement for two additional
one-year terms. Under the renewal terms, the Company would guarantee minimum
royalties as follows:
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31,
- ----------------------------------------------------------------------------------
<S> <C>
1999.............................................................................. $ 133,000
2000.............................................................................. 233,000
2001.............................................................................. 84,000
----------
$ 450,000
----------
----------
</TABLE>
LEGAL
The Company has been named as defendant in various claims arising out of the
normal course of business. In the opinion of management, the outcome of these
claims will not have a material effect on the Company's financial position or
results of operations.
11. SHAREHOLDERS' EQUITY
PREFERRED STOCK
The Company has authorized 5,000,000 shares of Preferred Stock. Under the
terms of the Article of Incorporation, the Board of Directors may issue
Preferred Stock for any proper corporate purpose. In approving any issuance, the
Board has broad authority to determine the rights, privileges, and preferences
of the Preferred Stock, which may be issued as one or more classes or series.
The rights, privileges and preferences may include voting, dividend, conversion,
redemption, participation and liquidation rights. As of December 31, 1997 and
1998, no Preferred Stock is issued or outstanding.
COMMON STOCK
In September 1997, pursuant to a clause in a July 1996 merger agreement,
500,000 additional shares of common stock were issued to "pre-1996 merger"
shareholders to realign the equity interests.
WARRANTS
In 1997, the Company entered into a three year consulting agreement with an
investment banking firm. In consideration for the consulting services, the
Company issued the investment banking firm warrants to purchase 1,000,000 shares
of the Company's common stock at an exercise price of $6.00 per share and
additional warrants to purchase 250,000 shares of common stock at an exercise
price of $4.00 per share. Both sets of warrants are exercisable for five years
from the date of issuance. The Company recorded professional services expense of
$275,000 and $388,000 in 1997 and 1998, respectively, in connection with the
fair value of these warrants. As of December 31, 1998, all warrants were still
outstanding.
STOCK OPTIONS
In 1996, the Company adopted the Long-Term Stock Incentive Plan (LTSIP).
Under the terms of the LTSIP, the Company is authorized to issue incentive and
non-qualified stock options to its directors,
F-18
<PAGE>
IRWIN NATURALS/4HEALTH, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
11. SHAREHOLDERS' EQUITY (CONTINUED)
officers, key employees and consultants totaling up to 3,250,000 shares of
common stock. At December 31, 1998, 406,470 shares are available for future
grant under this plan. Options are generally granted at exercise prices not less
than the fair market value on the date of grant and expire from two to seven
years after the date of grant. Options granted under this plan vest over varying
terms ranging from immediate vesting to seven years.
In November 1998, the Company's Board of Directors approved a Stock Option
Pool authorizing management of the Company to make discretionary grants up to
500,000 shares.
In 1996, the Company adopted SFAS 123. Therefore, the following information
is presented in accordance with the provisions of SFAS 123.
A summary of the Company's outstanding options and activity follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1996 DECEMBER 31, 1997 DECEMBER 31, 1998
----------------------- ----------------------- -----------------------
<S> <C> <C> <C> <C> <C> <C>
WEIGHTED WEIGHTED WEIGHTED
SHARES AVERAGE SHARES AVERAGE SHARES AVERAGE
UNDER EXERCISE UNDER EXERCISE UNDER EXERCISE
OPTION PRICE OPTION PRICE OPTION PRICE
---------- ----------- ---------- ----------- ---------- -----------
OPTIONS OUTSTANDING,
beginning of year............................. 275,355 $ 4.57 866,103 $ 4.35 742,643 $ 4.57
Granted....................................... 1,211,814 4.37 192,500 5.92 1,853,860 5.22
Exercised..................................... (172,622) 3.91 (186,396) 4.01 (38,341) 4.51
Cancelled..................................... (448,444) 4.93 (129,564) 6.00 (111,991) 5.46
---------- ---------- ----- ---------- -----
OPTIONS OUTSTANDING,
end of year................................... 866,103 $ 4.35 742,643 $ 4.57 2,446,171 $ 5.01
---------- ---------- ----------
---------- ---------- ----------
Options exerciseable at end of year............. 498,478 $ 4.01 585,516 $ 4.24 675,253 $ 4.49
---------- ---------- ----------
---------- ---------- ----------
Weighted average fair value of options granted
during the year............................... $ 0.56 $ 1.62 $ 1.99
----- ----- -----
----- ----- -----
</TABLE>
The following table summarizes information about the options outstanding at
December 31, 1998:
<TABLE>
<CAPTION>
NUMBER WEIGHTED WEIGHTED EXERCISABLE WEIGHTED
OUTSTANDING AT AVERAGE AVERAGE AT AVERAGE
RANGE OF DECEMBER 31, EXERCISE REMAINING DECEMBER 31, EXERCISE
EXERCISE PRICES 1998 PRICE LIFE 1998 PRICE
- ----------------- -------------- ----------- ---------- ------------ -----------
<S> <C> <C> <C> <C> <C>
3$.32 - $5.00.... 1,335,644 $ 3.93 4.9 years 560,642 $ 4.18
5$.50 - $8.00.... 1,060,027 $ 6.21 5.6 years 109,611 $ 5.87
8$.44 - $8.75.... 50,500 $ 8.47 4.1 years 5,000 $ 8.75
-------------- ------------
2,446,171 $ 5.01 5.2 years 675,253 $ 4.49
-------------- ------------
-------------- ------------
</TABLE>
The Company has elected to continue to measure compensation costs associated
with its stock option plan under APB No. 25, "Accounting for Stock Issued to
Employees" and comply with the pro forma disclosure requirements of SFAS No.
123.
F-19
<PAGE>
IRWIN NATURALS/4HEALTH, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
11. SHAREHOLDERS' EQUITY (CONTINUED)
Had the Company applied the fair value based method of accounting, which is
not required, to all grants of stock options, under SFAS No. 123, the Company
would have recorded additional compensation expense and computed pro forma net
income (loss) and pro forma earnings (loss) per share amounts as follows for
1996, 1997 and 1998 as follows:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1996 1997 1998
------------- ------------- ------------
<S> <C> <C> <C>
Additional compensation expense.................. $ 1,038,000 $ 281,000 $ 672,000
Pro forma net income (loss)...................... (2,829,000) (4,998,000) 346,000
Pro forma earnings (loss) per share:
Basic.......................................... $ (0.11) $ (0.18) $ 0.01
Diluted........................................ $ (0.11) $ (0.18) $ 0.01
</TABLE>
These pro forma amounts were determined by computing the fair vale of each
option on its grant date using the Black-Scholes option pricing model with the
following assumptions:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1996 1997 1998
------------ ------------ -----------------
<S> <C> <C> <C>
Risk free interest rate....................... 5.60% 5.97% 4.34% - 5.55%
Expected life................................. 1.5 years 2.2 years 2 - 7 years
Volatility.................................... 58.44% 60.68% 60.00%
Expected dividend yield....................... None None None
</TABLE>
12. RELATED PARTY TRANSACTIONS
In 1996, a $50,000 note receivable from a shareholder was cancelled in
exchange for 90,890 shares of the Company's common stock received from the
shareholder.
During 1996, the Company advanced the former Irwin Naturals shareholders
$478,000. Of such amount, $382,000 was recorded as compensation for services in
the accompanying statement of operations for 1996. The remaining $96,000 was
repaid to the Company in 1997.
From January 1, 1997 through June 30, 1998, the Company made distributions
totaling $1,682,000 ($579,000 in 1997 and $1,103,000 in 1998) to the S
corporation shareholders of Irwin Naturals. These distributions were for tax
liabilities to be paid by the S corporation shareholders attributable to their
respective S corporation income.
The Company has receivables from both its Chief Executive Officer and its
President (see Note 4).
In June and October 1998, the Company entered into employment agreements
with the Chairman of the Board, Chief Executive Officer and President (see Note
10).
13. SUBSEQUENT EVENTS
LINE OF CREDIT
On February 1, 1999, the Company obtained a new $5,000,000 line of credit
agreement (see Note 7).
F-20
<PAGE>
IRWIN NATURALS/4HEALTH, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
13. SUBSEQUENT EVENTS (CONTINUED)
SALE OF BUILDING
On March 25, 1999, the Company completed the sale of the former 4Health,
Inc. corporate facility. In connection with this sale, the Buyer assumed the
note payable secured by the facility (see Notes 6 and 8).
HEALTH & VITAMIN EXPRESS ACQUISITION
Effective February 15, 1999, the Company, through its newly formed
wholly-owned subsidiary HealthZone.com, purchased the issued and outstanding
shares of Health &Vitamin Express, Inc. (HVE). The purchase price is to be paid
in shares of Company stock and is comprised of several components as follows:
- Initial Shares--363,636 shares issued to Sellers of HVE ($6.25 per share
at the closing)
- Revenue Shares--Up to 272,727 shares issued to Sellers of HVE based upon
certain revenue thresholds during first 42 months subsequent to February
15, 1999
- Profit Shares--Up to 90,909 shares issued to Sellers of HVE based upon
certain profit thresholds during the first seven years subsequent to
February 15, 1999
In addition, the Company is obligated to invest or contribute to the
Internet operations a minimum of (A) $4,000,000 during the 18 months subsequent
to February 15, 1999 and (B) $10,000,000 (inclusive of the $4,000,000 provided
in clause (A) above) during the 36 months subsequent to February 15, 1999. If
the Company fails to make the investments or contributions defined above, the
Sellers of HVE will automatically receive the maximum allowable shares subject
to issuance under the provisions of the Revenue and Profit Shares.
INHOLTRA ACQUISITION
Effective March 10, 1999, the Company purchased certain assets and
liabilities of Inholtra Investment Holdings and Trading, N.V., Inholtra, Inc.,
and Inholtra Natural, Ltd. (collectively the Sellers). The purchase price
totaled $13,250,000, of which $3,250,000 was paid in cash. The remaining
$10,000,000 is payable through a promissory note secured by the acquired assets.
The note bears interest at an annual rate of 8 percent and is due in full on
June 10, 1999. The Seller's net assets at the acquisition date were
approximately $2,000,000 (unaudited).
In connection with this acquisition, the Company entered into a consulting
agreement with a former employee of the Sellers. The two year agreement requires
annual consulting fees of $60,000.
The Company is currently seeking to raise additional financing to enable it
to repay the $10,000,000 promissory note above. There can be no assurance that
the Company will be able to secure additional financing at terms acceptable to
the Company, if at all. If the Company is unable to repay the $10,000,000
promissory note, the Company may lose the acquired assets and a portion or all
of the $3,250,000 initial investment.
F-21
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
<TABLE>
<S> <C> <C>
Dated: April 18, 1998 IRWIN NATURALS/4HEALTH, INC.
By: /s/ R. LINDSEY DUNCAN
-----------------------------------------
R. Lindsey Duncan
CHAIRMAN OF THE BOARD
</TABLE>
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------ -------------------------- -------------------
<S> <C> <C>
/s/ R. LINDSEY DUNCAN
- ------------------------------ Chairman of the Board April 18, 1999
R. Lindsey Duncan
/s/ KLEE IRWIN
- ------------------------------ Chief Executive Officer April 18, 1999
Klee Irwin and Director
/s/ JONATHAN DIAMOND
- ------------------------------ Director April 18, 1999
Jonathan Diamond
/s/ JAMES JEFFS
- ------------------------------ Director April 18, 1999
James Jeffs
/s/ LOU MANCINI
- ------------------------------ President & Chief April 18, 1999
Lou Mancini Operating Officer
/s/ DAN MARTIN
- ------------------------------ Chief Financial Officer April 18, 1999
Dan Martin
</TABLE>
<PAGE>
EXHIBIT 23
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
We hereby consent to the incorporation of our report dated April 14, 1999
included in this Form 10-K, into the Company's previously filed Registration
Statement File No. 33-8445.
/s/ ARTHUR ANDERSEN LLP
Los Angeles, California
April 14, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 425,990
<SECURITIES> 0
<RECEIVABLES> 7,130,988
<ALLOWANCES> (1,131,379)
<INVENTORY> 2,855,307
<CURRENT-ASSETS> 10,189,857
<PP&E> 1,416,005
<DEPRECIATION> (789,314)
<TOTAL-ASSETS> 13,087,093
<CURRENT-LIABILITIES> 5,795,579
<BONDS> 1,422,795
0
0
<COMMON> 12,501,182
<OTHER-SE> 6,582,464
<TOTAL-LIABILITY-AND-EQUITY> 13,087,093
<SALES> 30,546,361
<TOTAL-REVENUES> 30,546,361
<CGS> 12,944,756
<TOTAL-COSTS> 15,774,267
<OTHER-EXPENSES> 46,395
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 162,863
<INCOME-PRETAX> 1,618,079
<INCOME-TAX> 600,419
<INCOME-CONTINUING> 1,827,337
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,017,660
<EPS-PRIMARY> .04
<EPS-DILUTED> .04
</TABLE>
