SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K/A
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
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
OMNI NUTRACEUTICALS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
UTAH 87-0468225
(STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NO.)
5310 BEETHOVEN STREET
LOS ANGELES, CALIFORNIA 90066
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (310) 306-3636
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)
1
<PAGE>
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. Yes: /X/ No: / /
As of March 31, 2000, 28,894,617 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 $57,749,391 (computed based upon the closing price for the Common
Stock on the Nasdaq National Market on that date.)
DOCUMENTS INCORPORATED BY REFERENCE
None
2
<PAGE>
OMNI NUTRACEUTICALS, INC.
INDEX TO FORM 10-K
PAGE
PART 1
Item 1 Business 4
Item 2 Properties 11
Item 3 Legal Proceedings 11
Item 4 Submission of Matters to a Vote of Security Holders 12
PART II
Item 5 Market for the Registrant's Common Stock and
Related Stockholder Matters 12
Item 6 Selected Financial Data 14
Item 7 Management's Discussion and Analysis of Financial
Condition and Results of Operation 15
Item 7a Quantitative and Qualitative Disclosure about Market Risk 21
Item 8 Financial Statements and Supplementary Data 21
Item 9 Changes in and Disagreements With Accountants on
Accounting and Financial Disclosure 21
PART III
Item 10 Directors and Executive Officers of the Registrant 21
Item 11 Executive Compensation 24
Item 12 Security Ownership of Certain Beneficial Owners
and Management 27
Item 13 Certain Relationships and Related Transactions 28
PART IV
Item 14 Exhibits, Financial Statement Schedules, and Reports on
Form 8-K 31
Exhibit Index 32
Index to Financial Statements F-1
Financial Statements F-2
Signature Page
3
<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
FACT 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 THE COMPANY," "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS" AND ELSEWHERE IN THE ANNUAL REPORT.
ITEM 1. BUSINESS
GENERAL
Omni Nutraceuticals, Inc., a Utah corporation (the "Company" or "Omni"),
formerly known as Irwin Naturals/4Health, Inc., is the surviving corporation of
a merger (the "Merger") of 4Health, Inc., a Utah corporation ("4Health") with
Irwin Naturals, 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. On
August 20, 1999, the Company changed its name to Omni Nutraceuticals, Inc.
The Company is a supplier and formulator of branded natural health, herbal and
nutritional supplements designed and formulated to address the dietary needs of
the general public. The Company's products are produced solely from natural
ingredients and are formulated for the purposes of achieving specific dietary or
nutritional goals. During 1999, the Company began an Internet initiative by the
creation of HealthZone.com via the acquisition of Health & Vitamins Express,
Inc. HealthZone.com is an online retail store and information source for
vitamins, supplements, minerals and other natural and healthy living products.
Through the Company's innovative combination of content and commerce, management
intends to establish HealthZone.com as the preferred destination for consumers
interested in natural and healthy living products. HealthZone.com currently
offers approximately 16,000 products on its site and can special order
additional products through the Company's supplier relationships. The Company
continues to increase our product assortment. In addition, the Company provides
educational and authoritative news and information about its products and
healthy living in general, which we integrate with its product offerings in an
easily accessible way. Through the Company's marketing efforts, the Company is
seeking to establish HealthZone.com as a trusted advisor to the Company's online
community.
4
<PAGE>
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 was organized in August 1995 and formulated and distributed
nutritional supplements through the food, drug and mass market, internationally
and through health food stores. The Merger was accounted for under the
"pooling-of-interests" method of accounting, in accordance with generally
accepted accounting principles. 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.
On February 15, 1999, the Company acquired by way of a merger with and into its
California subsidiary, HealthZone.com, Health & Vitamin Express, Inc. ("HVE"), a
California on-line retailer of health products, in consideration for the
issuance of 363,636 shares of common stock of the Company issued in a private
placement to the three shareholders of HVE, with a further contingent issue of
363,636 shares of common stock depending upon HVE meeting certain performance
criteria (assuming a $10 million investment in its subsidiary by the Company
within 36 months) and the assumption of approximately $571,000 of debt.
On March 10, 1999, the Company acquired certain assets and liabilities of
Inholtra Investment Holdings and Trading, N.V., Inholtra Inc. and Inholtra
Natural, Ltd., including the Inholtra-registered trademark- brand of anti-joint
pain product and associated trademarks, patent and inventory, for $13.3 million,
which was initially seller financed with a short term promissory note,
subsequently refinanced in June 1999 with a $20 million secured asset based term
and revolving credit facility with a bank. See Item 7 "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
On March 17, 2000 the Board of Directors of the Company authorized the Company
to change its name to HealthZone.com subject to shareholder approval, and to
effect a merger of its subsidiary HealthZone.com, with and into the Company.
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 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- (23.1%
of 1999 revenue), Inholtra - Registered Trademark (19.3% of sales in 1999) Diet
Systems 6-Registered Trademark- (15.9% of 1999 revenue), and Irwin
Naturals-Registered Trademark (15.0% of 1999 revenue).
With over 69 registered and pending trademarks worldwide, the Company 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 the Company's products were developed
by the Company's founders R. Lindsey Duncan, a nutritionist certified by the
National Institute of Nutritional Education and Klee Irwin, the Company's
current Chief Executive Officer and its principal shareholder. The Company
trademarks all brand line names and most product names. The Company further
protects its trademarks by taking prompt action against potential infringements.
5
<PAGE>
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 the Company 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, the Company 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 Los Angeles, 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 has 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
(51.5% of 1999 revenue), specialty health food stores (40.7% of 1999 revenue),
and internationally (7.8% of 1999 revenue). 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.
The Company is positioned to pursue a distribution strategy of multiple brands
within multiple retail channels and via the Internet. Since the Merger, the
Company has expanded its consumer base, and now offers products in distinct
product categories.
CUSTOMER CONCENTRATION
The Company's top ten customers represented approximately 42% of its 1999 total
revenues including GNC, which represented approximately 18.6% of its 1999 total
revenues. Management believes that, except for its sales to GNC, its remaining
business is sufficiently diversified among its customers. However, the Company
is undertaking additional efforts to diversify its revenues along both
distribution channels and among specific customers. In this regard, the Company
intends to develop its e-commerce business as a new potential distribution
channel for its products.
6
<PAGE>
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 ten largest competitors are large well-capitalized companies that have the
ability to change and shape the industry.
In the health and natural food sector these include: Nature's Way (Murdock
Madaus Schwabe), Rainbow Light Nutritional Systems (Nutraceuticals, Inc.) Solgar
(American Home Products), Nature's Herbs and Twinlabs (Twin Laboratories, Inc.)
In the Mass Market sector the competitors include: Whitehall Robins Healthcare
(American Home Products), Bayer AG (Bayer Corp.), Mead Johnson Nutritionals
(Bristol Myers Squibb Co.), Johnson & Johnson, Inc. and Leiner Health Products
Group, Inc.
The Company continues to be a leader in internal cleansing products and intends
to leverage this success to launch other products. The Company'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.
The electronic commerce industry is new, rapidly evolving and intensely
competitive, and we expect competition to intensify in the future. Barriers to
entry are minimal and current and new competitors can launch sites at a
relatively low cost. Many of our competitors are significantly larger and have
greater financial resources. In addition, the vitamins, supplements, minerals
and natural and healthy living products market is very competitive and highly
fragmented, with no clear dominant leader and increasing public and commercial
attention.
EMPLOYEES
As of the end of 1999, the Company had 93 employees, 9 senior managers, 7 middle
managers, 33 individuals in general administration, 25 individuals in sales and
marketing, 16 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. The Company has not experienced any work stoppages
or slow downs.
RISKS RELATED TO THE BUSINESS OF THE COMPANY
In order to fund its operations, the Company has relied on raising additional
equity capital and the use of bank debt to fund any operating losses and
acquisitions. In view of the Company's losses for the period ending December 31,
1999 and the anticipated loss for the period ending March 31, 2000, no assurance
can be given that these sources of capital will remain available to the Company.
7
<PAGE>
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. The Company also intends to expand its marketing strategy to
strengthen the HealthZone.com brand name, increase traffic to the HealthZone.com
store, build strong customer loyalty, maximize repeat purchases and develop
incremental revenue opportunities.
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 the Company 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 that 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.
8
<PAGE>
CONCENTRATION OF CUSTOMERS
The Company received approximately 18.6% and 13.3% of its revenues from a single
customer (GNC) during 1999 and 1998, respectively. 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 the Company.
RELIANCE ON LIMITED NUMBER OF PRODUCTS
The Company currently offers approximately 313 products and derived more than
30.5% of its revenues during 1999 from the sale of two products, Ultimate
Cleanse - Registered Trademark - and Inholtra - Registered Trademark. As a
result of the limited number of products from which the Company derives its
revenue, the risks associated with the Company'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 THE COMPANY'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 the Company, 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.
Our Internet competitors can be divided into several groups including:
traditional vitamins, supplements, minerals and natural and healthy living
products retailers, including General Nutrition Centers and Vitamin Shoppe; the
online retail initiatives of several traditional vitamins, supplements, minerals
and natural and healthy living products retailers, including MotherNature.com,
VitaminShoppe.com and Vitamins.com; online retailers of pharmaceutical and other
health-related products that also carry vitamins, supplements, minerals and
natural and healthy living products, including Drugstore.com, PlanetRx.com,
More.com, SelfCare and CVS.com; independent on-line retailers specializing in
vitamins, supplements, minerals and natural and healthy living products,
including HealthShop.com, eNutrition, allherb.com, vitamins.net, HealthQuick and
Vitanet; mail-order and catalog retailers of vitamins, supplements, minerals and
natural and healthy living products, including NBTY, Amrion, Rexall Sundown and
Vitamin Shoppe, some of which have already developed online retail outlets; and
direct sales organizations, retail drugstore chains, health and natural food
store merchants, mass market retail chains and various manufacturers of natural
products.
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 the
Company's identity and recognition in the nutritional supplement industry. The
loss of the services of certain members of management such as Mr. Klee Irwin,
the Chief Executive Officer, could have a material effect on the business,
operations and financial condition of the Company. The Company currently has no
long-term agreement with any executive officer or key employee.
9
<PAGE>
Effective March 12, 2000, both the Company's Chairman of the Board, R. Lindsey
Duncan and its President and Chief Executive Officer, Louis Mancini ceased to be
employed by the Company. Mr. Mancini was replaced by Mr. Klee Irwin as
President and Chief Executive Officer. See Part III Item 10 for a discussion of
the recent changes in management and the terms of the severance agreements
between such individuals and the Company. At this time, the Company believes
that such changes in management will not materially adversely affect the
Company.
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 the Company 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, the Company 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. The Company has had this policy since its inception and
experienced product returns of approximately 6.7% of gross sales in 1999. There
can be no assurance that such a policy will not result in additional product
returns in the future.
POTENTIAL TRADEMARK INFRINGEMENT
The conduct of the Company'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 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.
IMPACT OF YEAR 2000
In prior years, the Company discussed the nature and progress of its plans to
become Year 2000 ready. In late 1999, the Company completed its remediation and
testing of systems. As a result of those planning and implementation efforts,
the Company experienced no significant disruptions in mission critical
information technology and non-information technology systems and believes those
systems successfully responded to the Year 2000 date change. The Company
expensed approximately $25,000 during 1999 in connection with remediating its
systems. The Company is not aware of any material problems resulting from Year
2000 issues, either with its products, its internal systems, or the products and
services of third parties. The Company will continue to monitor its mission
critical computer applications and those of its suppliers and vendors throughout
the year 2000 to ensure that any latent Year 2000 matters that may arise are
addressed promptly.
10
<PAGE>
ITEM 2. PROPERTIES
The Company's principal offices are located at 5310 Beethoven Street, Los
Angeles, California, 90066 in a building and warehouse leased by the Company at
a monthly rental charge of $39,000. This is a five-year lease subject to
escalation. On November 1, 1999 the Company entered into a five-year lease for
the office located in Broomfield, Colorado. The monthly rent is $3,724.08 and
is subject to escalation (please see schedule below). In addition, in 1999 the
Company owned a building in Boulder, Colorado and leased warehouse space in
Broomfield, Colorado. On March 25, 1999, the Company completed the sale of its
former 4Health, Inc. corporate facility located in Boulder Colorado (the
"Property"). The sale price for the Property was $2,350,000, which consisted of
(i) cash consideration of $600,000 that was paid at closing, (ii) assumption of
a $1,300,000 existing first mortgage loan on the Property made by the buyer,
and (iii) the receipt of a $450,000 promissory note secured by a second trust
deed in the Property. The note receivable is to be paid in monthly installments
of $3,688, including principal and interest at a rate of 7 1/2% per annum,
until March 1, 2002 when the note is payable in full.
In November 1999 the Company entered into a 5 year lease of it's office
facilities in Broomfield, Colorado. The lease agreement calls for escalating
lease payment over the term of the lease.
Schedule of Escalation for
Broomfield, Colorado Office
- -----------------------------
Year 1 $29,456
Year 2 $29,456
Year 3 $31,560
Year 4 $31,560
Year 5 $32,612
LOCATION SIZE FUNCTION
- -------- ---- --------
Los Angeles, California 52,000 sq. ft. Corporate Headquarters &
Distribution Center
Broomfield, Colorado 3,500 sq. ft. Midwest Office
ITEM 3. LEGAL PROCEEDINGS
On December 23, 1999, a lawsuit was filed against the Company, the Company's
current President and Chief Executive Officer, Klee Irwin, and the Company's
former President, Louis Mancini, entitled David Mandel, Jeffrey D. Segal and
----------------------------------
Gordon D. Barker v. Omni Nutraceuticals, Inc., Klee Irwin, Louis Mancini and
-----------------------------------------------------------------------------
Does 1 through 50 (Superior Court of the State of California, County of Los
-----------------
Angeles - Central District, Case No. BC222263). The lawsuit includes various
-
causes of action, including fraud, negligent misrepresentation, misappropriation
of trade secrets, unjust enrichment, unfair business practices and violations of
the Racketeer Influenced and Corrupt Organizations Act (RICO) (under which
treble damages have been claimed). The lawsuit is based on various alleged
claims, including that the plaintiffs, the sole shareholders of Health & Vitamin
Express ("HVE"), were fraudulently induced to enter into a merger agreement
pursuant to which HVE became a wholly-owned subsidiary of the Company based on
false representations of the defendants. The lawsuit does not specify the
amount of damages claimed. Although the Company believes that the claims made
in the lawsuit are without merit, the Company is currently in settlement
negotiations with the plaintiffs in the lawsuit. The proposed terms of the
settlement provide that the Company will issue an additional 363,636 shares of
common stock to the former shareholders of HVE. Management and the Company's
legal counsel believe that the claims will be settled in accordance with the
proposed settlement agreement. As such, the Company has estimated and recorded
a charge of $1,200,000 in the accompanying statement of operations as of
December 31, 1999, in connection with this claim.
11
<PAGE>
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 the
Company's business or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On December 22, 1999, a Special Meeting in Lieu of an Annual Meeting was held at
Omni headquarters for the following purpose: (i) to ratify an amendment to
Article III of the Company's Bylaws eliminating Section 3.14 providing for an
Executive Committee of the Board of Directors; (ii) to elect Mr. Santo P.
Panzarella to the Board of Directors of Omni Nutraceuticals as a Class III
director; (iii) to ratify amendments to the Long Term Stock Incentive Plan of
Omni Nutraceuticals increasing the number of shares of Common Stock that may be
awarded under the Plan to 4,500,000, including 1,000,000 shares that may be
granted to non-employee directors; and (iv) to ratify the selection of Arthur
Andersen LLP, independent public accountants, as Omni Nutraceuticals'
independent auditors for the fiscal year 1999. The matters were voted upon at
the meeting, and the number of votes cast for, against or withheld, as to each
matter, where applicable, are set forth below.
<TABLE>
<CAPTION>
<S> <C> <C> <C>
PROPOSAL . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . VOTES FOR VOTES AGAINST VOTES WITHHELD
- -------------------------------------------------------------------------- ---------- ------------- --------------
To ratify an amendment to Article III of the Company's Bylaws. . . . . . . 22,350,092 31,890 130,950
To elect Mr. Santo P. Panzarella to the Board of Directors . . . . . . . . 22,062,992 - 449,940
To ratify amendments to the Long Term Stock Incentive Plan . . . . . . . . 21,625,572 755,610 131,750
To ratify selection of Arthur Andersen LLP, independent public accountants 24,469,070 41,962 1,900
</TABLE>
PART II
-------
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK 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. On
August 20, 1999, the Company changed its stock symbol to OMNT. On April 1,
2000, the Company changed its symbol to ZONE.
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.
12
<PAGE>
The high and low closing bid prices reported for the period between January 1,
1998 and March 31, 2000 appear in the following table:
<TABLE>
<CAPTION>
<S> <C> <C> <C>
FISCAL YEAR QUARTER HIGH LOW
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
1999 2nd $2.500 $1.500
1999 3rd $2.500 $1.500
1999 4th $2.313 $1.125
2000 1st $8.625 $1.375
2000 2nd (through 4/10/00) $7.375 $3.75
</TABLE>
As of March 29, 2000, there were approximately 187 stockholders of record of the
Company's Common Stock, exclusive of stockholders who hold title to their shares
in street name.
SALES OF RESTRICTED SECURITIES
During the year ended December 31, 1999, and subsequently, the Company completed
the following transactions:
On February 15, 1999, the Company acquired by way of a merger with and into its
California subsidiary, HealthZone.com, Health & Vitamin Express, Inc. ("HVE"), a
California on-line retailer of health products, in consideration for the
issuance of 363,636 shares of common stock of the Company issued in a private
placement to the three shareholders of HVE. The shares were issued to three
shareholders of HVE in a transaction intended to qualify for the exemption from
registration afforded by Section 4(2) of the Securities Act of 1993 and Rule 506
promulgated thereunder. Refer to March 31, 1999 quarterly report filed on Form
10Q.
During the year ended December 31, 1999, the Company issued 53,000 shares of
common stock valued at prices ranging from $1.43 to $2.37 per share to
consultants and to settle certain obligations. The shares were issued in a
transaction intended to qualify for the exemption from registration under the
Securities Act of 1933, as amended, afforded by Section 4(2) thereof.
On January 5, 2000, as compensation for serving on the Board of Directors, the
Company issued to each of Mr. Jonathan Diamond, Mr. Andrew Volloro Jr., and Mr.
Mr. Santo P. Panzarella 25,000 restricted shares of the Company's $.01 par value
common stock. The shares were issued in a transaction intended to qualify for
the exemption from registration under the Securities Act of 1933, as amended,
afforded by Section 4(2) thereof.
13
<PAGE>
On January 24, 2000, the Company completed an equity transaction whereby the
Company agreed to issue, at its election, up to 4,500,000 shares of its newly
created 5% Convertible Preferred Stock, Series A ("Preferred Shares ") and seven
year warrants to purchase up to an aggregate of 775,000 shares of common stock
at an exercise price of $2.25 per share, subject to adjustment. The aggregate
purchase price for the Preferred Shares and warrants was $4,000,000 payable in
two installments, the first in the amount of $2,000,000 that was funded on
January 21, 2000, and subject to the satisfaction of certain performance
targets, the second in the amount of $2,000,000. Concurrently with the first
installment payment, the Company's Internet subsidiary, HealthZone.com, issued
222,222 shares of its common stock and a seven year warrant to purchase up to
37,000 shares of its common for a purchase price of $1,000,000. On March 24,
2000, the Company converted the Preferred Shares into an aggregate of 2,016,438
shares of common stock pursuant to the mandatory conversion provision of the
Preferred Shares. The investor was also provided certain registration rights in
connection with this transaction.
On March 12, 2000, the Company entered into a two year Consulting Agreement
with Liviakis Financial Communications, Inc. ("LFC") and, in connection
therewith, authorized the issuance of 1,200,000 restricted shares of
Common Stock to LFC in consideration of, and as a retainer and prepayment
for, the consulting services to be rendered to the Company by LFC.
Pursuant to the provisions of the Consulting Agreement, LFC will be
entitled to receive a 2.5% finder's fee in connection with any debt or
equity financing for the Company from a source introduced to the Company by
LFC and a 2% finder's fee in connection with any acquisition by the Company,
or its nominee, of a candidate introduced to the Company or its nominee by
LFC. The Company also agreed to reimburse LFC for extraordinary expenses
incurred by LFC on behalf of the Company with its permission.
On March 27, 2000, the Company sold 700,000 shares of common stock in a private
placement for aggregate proceeds of $2,100,000. The shares were issued in a
transaction intended to qualify for the exemption from registration under the
Securities Act of 1933, as amended, afforded by Section 4(2) thereof. The
investor was also provided certain registration rights in connection with this
transaction.
DIVIDEND POLICY
The Company has never paid dividends with respect to the Company's 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. The Company is also
currently prescribed from issuing cash dividends on its Common Stock under the
terms of its Credit Facility with its bank.
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, 1999, 1998 and 1997 and the selected balance sheet data as of
December 31, 1999 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.
14
<PAGE>
YEARS ENDING DECEMBER 31
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA 1999 1998 1997 1996 1995
Net sales $35,308 $30,547 $29,353 $28,592 $12,824
Gross profit 17,461 18,007 16,050 16,266 7,620
Operating (loss) income (8,306) 1,827 (4,638) (1,298) 1,342
Other income (expense), net (829) (209) (79) 101 (76)
Income (loss) before provision for income taxes (9,135) 1,618 (4,717) (1,197) 1,266
Provision for income taxes (274) 600 -- 594 360
Net income (loss) (8,861) 1,018 (4,717) (1,791) 906
Pro forma provision for income taxes (unaudited) N/A 1,345 765 N/A 439
Pro forma net income (loss) (unaudited) N/A 273 (5,482) N/A 827
PER SHARE DATA:
Historical
Earnings (loss) per common share
- -- Basic and diluted $ (0.31) $ 0.04 $ (0.17) $ (0.07) $ 0.04
Pro forma
Earnings (loss) per common share
- -- Basic and diluted (unaudited) $ (0.31) $ 0.01 $ (.20) N/A $ 0.03
Historical
Weighted average number of shares of common
stock outstanding--Basic 28,177 27,747 27,365 25,647 24,457
Weighted average number of shares of common
stock Outstanding Diluted 28,177 28,221 27,365 25,647 24,583
Pro forma
Weighted average number of shares of common
stock outstanding -- Basic (unaudited) N/A 27,747 27,365 N/A 24,457
Weighted average number of shares of common
stock outstanding -- Diluted (unaudited) N/A 28,221 27,365 N/A 24,583
</TABLE>
YEARS ENDING DECEMBER 31
(in thousands)
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA. . . . . . . . . . . 1999 1998 1997 1996 1995
-------- ------- ------- ------- ------
Working Capital (Deficit) . . . . . . . $(6,364) $ 4,395 $ 3,588 $ 4,843 $2,385
Total Assets. . . . . . . . . . . . . . 31,727 13,087 11,337 15,832 5,786
Long Term Debt, Net of Current Portion. 10,187 1,423 1,298 1,276 1,296
Shareholders' Equity. . . . . . . . . . 1,878 5,869 5,387 10,256 3,205
</TABLE>
15
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
REFERENCE IS HEREBY MADE TO THE DISCLOSURE REGARDING "FORWARD-LOOKING"
STATEMENTS ON PAGE 3.
On August 19, 1999 Irwin Naturals/ 4 Heath Inc. filed an amendment to its
Articles of Incorporation changing its name to Omni Nutraceuticals, Inc. (the
"Company"). 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.
On February 15, 1999, the Company acquired Health & Vitamin Express, Inc.
("HVE"), an on-line retailer of health products. On March 10, 1999, the Company
acquired certain assets and liabilities of Inholtra Investment Holdings and
Trading, N.V., Inholtra Inc. and Inholtra Natural, Ltd.
The following table sets forth, for years 1999, 1998 and 1997, certain items
from the Company's Statements of Operations included elsewhere herein, expressed
as a percentage of net sales.
YEARS ENDING DECEMBER 31
<TABLE>
<CAPTION>
<S> <C> <C> <C>
1999 1998 1997
------- ------ -------
Net Sales. . . . . . . . . . . . . . . . . . . . . . 100% 100.0% 100.0%
Cost of Sales. . . . . . . . . . . . . . . . . . . . 50.5% 41.0% 45.3%
Gross Profit . . . . . . . . . . . . . . . . . . . . 49.5% 59.0% 54.7%
Operating Expenses . . . . . . . . . . . . . . . . . 67.7% 53.0% 59.6%
Loss on write-off of Goodwill/Surgical Technologies --- --- 10.9%
Loss on Intangibles 1.9% --- ---
Legal Settlement 3.4 --- ---
Income (loss) from operations. . . . . . . . . . . . (23.5)% 6.0% (15.8)%
Other income (expense), net. . . . . . . . . . . . . (2.3)% (0.7)% (0.3)%
Income (loss) before provision for income taxes. . . (25.8)% 5.3% (16.1)%
Provision Benefit for income taxes (.7)% 2.0% ---
Net income (loss). . . . . . . . . . . . . . . . . . (25.1)% 3.3% (16.1)%
======= ====== =======
</TABLE>
RESULTS OF OPERATIONS
1999 COMPARED TO 1998
Operating Results
- ------------------
Consolidated net sales for the year ended December 31, 1999 were $35,308,000
with an operating loss of $8,306,000 and a net loss of ($8,861,000), or $.31 per
basic and diluted share. Consolidated net sales for the same period in the prior
year were $30,547,000 with operating income of $1,827,000 and net income of
$1,018,000 , or $.04 per basic and $.01 per diluted share. The net loss for the
year was impacted by: a $ 634,000 loss in operations from the Company's
Internet subsidiary HealthZone.com ("HealthZone"), goodwill amortization of
$640,000, a $640,000 loss incurred with the write off of intangibles, non-cash
warrant and option compensation costs of $903,000 and $288,000 related to the
relocation of the Company's corporate and warehouse facilities.
16
<PAGE>
Net sales for the year ended December 31, 1999 increased by $4,761,000, or
15.6%, to $35,308,000 from $30,547,000 for the comparable period in 1998. The
increase in sales relates primarily to the introduction of the Company's new
Inholtra pain relieving product, as well as an overall increase in certain of
the Company's base product lines.
Gross profit for the year ended December 31, 1999 decreased $546,000, or 3.1%,
to $17,461,000 from $18,007,000 for the comparable period in 1998. Gross
profits as a percentage of sales for the year ended December 31, 1999 decreased
to 49.5% from 59.0% in the comparable period in 1998. The decrease in the
margin relates to: (i) pricing concessions offered during 1999 in conjunction
with the launch and early stage sales of several new products, (ii) sales
adjustments given to certain customers, and (iii) an overall shift in product
mix to certain items which have a slightly lower margin.
Sales and marketing expenses for the year ended December 31, 1999, increased by
$2,838,000 or 41.8%, to $9,631,000 from $6,793,000 for the comparable period in
1998. The increase primarily relates to wages, advertising and other costs
incurred on marketing and media campaigns to (i) launch the introduction of
Inholtra, (ii) launch the Company's new products, Cholestaid and Veromax, for
the fourth quarter 1999 and fiscal 2000, (iii) media and advertising campaigns
to support certain of the Company's other products, and (iv) continual
repackaging and redesign of the Company's core product lines.
General and administrative expenses for the year ended December 31, 1999,
increased by $333,000, or 3.5% to $9,720,000 from $9,387,000 for the comparable
period in 1998. Included in 1999 general and administrative expenses were: (i)
legal and professional fees of $806,000, (ii) $717,000 in costs incurred on the
Company's HealthZone operations, (iii) $415,000 for consulting costs incurred
to implement the Company's acquisition of Inholtra and other products, (iv)
approximately $1,136,000 in bad debts (v) $903,000 of non-cash warrant and
compensation costs, and (vi) a $300,000 charge related to the relocation of the
Company's corporate and warehouse facilities.
Depreciation and amortization for the year ended December 31, 1999, increased by
$987,000 to $1,890,000 from $903,000 for the comparable period in 1998. The
increase specifically relates to amortization costs relating to the Inholtra and
HVE acquisitions.
Interest expense for the year ending December 31, 1999 increased $1,176,000 to
$1,339,000 from $163,000 for the comparable period in 1998. This increase is
consistent with the increase in the utilization of the Company's line of credit,
the incurrence of the Inholtra acquisition debt and the term loan incurred to
refinance the Inholtra acquisition debt in 1999. Other income included a
$481,000 gain on the sale of the former 4Health corporate headquarters building
located in Boulder, Colorado.
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 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.
17
<PAGE>
Gross Profit Margins rose to $18,007,000 in 1998 from $16,050,000 in 1997, an
increase of 12.2%. The post-merger product re-positioning resulted in a one-time
$172,000 (1.1%) decrease in Gross Margins. Gross Margin as a percentage of net
sales increased to 58.9% of net sales in 1998 from 54.7% 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.
Sales and marketing expenses for the year ended December 31, 1998 decreased by
$3,050,000, or 31.0% to $6,793,000 from $9,843,000 for the comparable period in
1997. Much of the decrease in Sales and Marketing expense was attributable to
the synergies achieved as a result of the merger.
General and administrative expenses for the year ended December 31, 1998,
increased by $1,744,000 , or 22.8% to $9,387,000 from $7,643,000 for the
comparable period in 1997. The 1998 General and Administrative expenses, when
adjusted for merger related expenses of $1,614,000, were $7,773,000, a net
increase of $130,000 compared to the 1997 General and 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. Much of the
remainder of the decrease was attributable to the synergies achieved as a result
of the merger.
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.
LIQUIDITY AND CAPITAL RESOURCES
During the year ended December 31, 1999, the Company experienced negative cash
flow from operations of $2,485,000 and utilized another $14,270,000 for
investing activities, of which $13,493,000 was used for acquisitions. To
finance the above, the Company utilized its existing credit facilities, issued a
$10,000,000 promissory note payable, and issued 363,636 shares of the Company's
common stock.
On June 10, 1999, the Company secured a loan from a lending institution that
will provide up to $20 million dollars of financing. The credit facility
consists of a $13 million term loan ("Term Loan") and up to a $7 million
revolving loan ("Revolving Loan"), subject to borrowing base availability and
compliance with certain financial and other covenants and agreements. At
closing, $4,527,000 of loan proceeds were disbursed to repay and close the
Company's previous existing credit facility, and $10,000,000 was disbursed to
repay the promissory note incurred in connection with the acquisition of the
Inholtra assets. The remainder of the available financing will be used to fund
the Company's on-going working capital requirements.
The loans under the facility are secured by substantially all the assets of the
Company. Borrowings under the Term Loan bear interest at an annual rate of
either prime plus 2.25 percent or LIBOR plus 3.75 percent and is paid quarterly.
Borrowings under the Revolving Note currently bear interest at an annual rate of
either prime plus 1.75 percent or LIBOR plus 3.0 percent and is paid quarterly.
The rates are subject to decrease based upon the Company obtaining certain
operating performance levels. The Revolving Loan commitment expires on June 15,
2004, when the loan is payable in full. As of December 31, 1999, the maximum
additional available credit under the borrowing limitations was $564,000. The
$13,000,000 Term Loan is payable in quarterly installments of $583,333 beginning
October 15, 1999, which will increase to $750,000 on October 15, 2002, until the
Loan is paid in full on April 15, 2004. In addition, the Company shall make a
payment of principal on the Term Loan in addition to the quarterly payments in
an amount equal to 50% of "Excess Cash Flow" (as defined) for each fiscal year.
Furthermore, the Company would be required to apply receipt of any equity
infusion, loan proceeds or proceeds from other non-operating activities to
reduce the outstanding debt.
18
<PAGE>
The credit facility agreement contains certain financial and other covenants or
restrictions, including the maintenance of certain financial ratios, limitations
on capital expenditures, restrictions on acquisitions, limitations on the
incurrence of indebtedness and restrictions on dividends paid by the Company.
The Company was out of compliance with certain of the financial ratios at
December 31, 1999 and secured waivers from its lender for such non-compliance.
As a condition of the waiver, the Term Loan and Revolving Loan agreements will
be amended to change the expiration dates of both facilities to April 30, 2001.
There is no assurance that the Company will continue to have the available funds
necessary to meet its next required payment, unless the Company achieves
profitable operations, refinances its indebtedness, receives an equity infusion,
modifies the covenants, or obtains waivers from the bank. There can be no
assurances that such level of profitable operations can be achieved, that such
refinancing or equity will be available on terms satisfactory to the Company,
that the bank agrees to modify the covenants, or such waivers will be obtained.
Future losses or the inability to refinance or to complete an equity placement
may result in further renegotiations of such covenants or the need to seek
replacement financing.
If the Company fails to invest or contribute to its HVE operations $10,000,000
during the 36 months subsequent to February 15, 1999, the Company may be
obligated to issue up to 363,636 additional shares of the Company's common stock
to the sellers. A legal proceeding has been commenced by the former
shareholders of HVE against the Company and certain of its current and former
officers regarding an alleged failure by the Company to fund HVE. The Company
is currently in settlement negotiations with the plaintiffs in this action.
(See Other Information, Item 1, Legal Proceedings)
The Company has primarily funded its operations to date through internally
generated capital, bank financing or sales of its securities. The Company's
future capital requirements will depend on many factors, including the nature
and timing of orders from customers, collection of trade accounts receivable,
the expansion of sales and marketing efforts, costs associated with entering
into new channels of distribution, and the status of competitive products.
The Company was notified by the Nasdaq Stock Market in September 1999 that the
Company failed to meet the minimum tangible net asset requirement necessary for
continued listing on the Nasdaq National Market. The Company presented a
specific plan to Nasdaq for achieving compliance with all Nasdaq National Market
listing requirements, including the sale of the convertible preferred stock
described below and a capital contribution of $305,000 made to the Company by
Mr. Klee Irwin, first on or about October 8, 1999 and then at a hearing held on
February 10, 2000. On March 15, 2000, the Company was notified by Nasdaq that it
had met one of the alternative maintenance standards by virtue of having
exceeded a $5 minimum bid price for its common stock for the ten consecutive
trading days ending March 10, 2000, and, accordingly, Nasdaq had closed the file
with respect to the possible delisting of the Company's common stock. There can
be no assurance that the Company will continue to meet such listing requirements
in the future.
19
<PAGE>
SUBSEQUENT EVENTS
Subsequent to December 31, 1999, the Company completed two transactions
involving the sale of equity securities, which resulted in aggregate proceeds of
$4,100,000 to the Company and $1,000,000 to its subsidiary HealthZone.com. On
January 24, 2000, the Company completed an equity transaction whereby the
Company issued up to 4,500,000 shares of its newly created 5% Convertible
Preferred Stock, Series A ("Preferred Shares") and seven year warrants to
purchase up to an aggregate of 775,000 shares of common stock at an exercise
price of $2.25 per share, subject to adjustment. The aggregate purchase price
for the Preferred Shares and warrants sold by the Company in the initial
installment was $2,000,000. Concurrently with the first installment payment,
HealthZone issued 222,222 shares of its common stock and a seven year warrant to
purchase up to 37,000 shares of its common for a purchase price of $1,000,000.
On March 24, 2000, all of the issued and outstanding Preferred Shares were
mandatorily converted into 2,016,438 shares of common stock. On March 29, 2000,
the Company completed a private sale of its securities whereby 700,000 shares of
common stock of the Company were sold for an aggregate purchase price of
$2,100,000. The Company used the proceeds from the sale of its securities to
reduce indebtedness and for working capital purposes.
Management believes that additional investment capital will be required to
permit the Company to meets its business objectives in the near term. Such
funds may be raised either through debt or equity offerings or some combination
of the two, however, there is no assurance that the Company will be able to
secure such funds on commercially reasonable terms, if at all. If not
successful in securing additional funds, the Company may be forced to dispose of
its assets outside of its normal course of business and/or resort to bankruptcy
protection.
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 1998 and 1999. 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.
QUARTERS ENDED 1999
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 TOTAL
----------- ------------ -------------- ------------- ------------
Net sales. . . . . . . . . . . . . . . . . . . . $6,991,000 $ 7,991,000 $ 9,539,000 $ 10,787,000 $35,308,000
Gross profit . . . . . . . . . . . . . . . . . . 3,584,000 4,006,000 4,542,000 5,329,000 17,461,000
Loss from operations . . . . . . . . . . . . . . (1,065,000) (2,930,000) (999,000) (3,312,000) (8,306,000)
Other income (expense), net. . . . . . . . . . . 411,000 (355,000) (414,000) (471,000) (829,000)
----------- ------------ -------------- ------------- ------------
Loss before provision (benefit) for income taxes (654,000) (3,285,000) (1,413,000) (3,783,000) (9,135,000)
Benefit for income taxes . . . . . . . . . . . . -- (123,000) (113,000) (38,000) (274,000)
----------- ------------ -------------- ------------- ------------
Net loss . . . . . . . . . . . . . . . . . . . . $ (654,000) $(3,162,000) $ (1,300,000) $ (3,745,000) $(8,861,000)
=========== ============ ============== ============= ============
Net loss per common
share-Basic and Diluted. . . . . . . . . . . . $ (0.02) $ (0.11) $ (0.05) $ (0.13) $ (0.31)
=========== ============ ============== ============= ============
</TABLE>
QUARTERS ENDED 1998
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 TOTAL
----------- ------------ -------------- ------------- ------------
Net sales. . . . . . . . . . . . . . . . . . . . $8,746,000 $ 7,013,000 $ 7,225,000 $ 7,563,000 $30,547,000
Gross profit . . . . . . . . . . . . . . . . . . 5,223,000 3,835,000 4,280,000 4,669,000 18,007,000
Loss from operations . . . . . . . . . . . . . . 1,610,000 (1,178,000) 988,000 407,000 1,827,000
Other (expense) income, net. . . . . . . . . . . (7,000) (41,000) (64,000) (97,000) (209,000)
----------- ------------ -------------- ------------- ------------
(Loss) before provision (benefit) for
income taxes . . . . . . . . . . . . . . . . . 1,603,000 (1,219,000) 924,000 310,000 1,618,000
Provision (benefit) for income taxes . . . . . . (34,000) (45,000) -- 679,000 600,000
----------- ------------ -------------- ------------- ------------
Net (loss) . . . . . . . . . . . . . . . . . . . $1,637,000 $(1,174,000) $ 924,000 $ (369,000) $ 1,018,000
=========== ============ ============== ============= ============
Net (loss) per common share-- Basic and Diluted. $ 0.06 $ (0.04) $ 0.03 $ (0.01) $ 0.04
=========== ============ ============== ============= ===========
</TABLE>
20
<PAGE>
NEW AUTHORITATIVE PRONOUNCEMENTS
In December 1999, the SEC staff released Staff Accounting Bulletin (SAB) No.
101, Revenue Recognition, to provide guidance on the recognition, presentation
and disclosure of revenue in financial statements. Changes in accounting to
apply the guidance in SAB No. 101 may be accounted for as a change in accounting
principle effective January 1, 2000. Management has not yet determined the
complete impact of SAB No. 101 on the Company; however, management does expect
that application of SAB No. 101 will have a material effect on the Company's
revenue recognition and results of operations.
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, 1999, all of the Company's debt obligations were subject to variable
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-1 through F-23. 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 notified Arthur Andersen LLP that they will be replaced by
another firm upon completion of the 1999 audit. The Company does not have any
disagreement with its accountants regarding accounting or financial disclosure.
When auditing our consolidated financial statements for the year ending December
31, 1999, our independent auditors reported conditions they believed to be
material weaknesses in the Company's system of internal accounting and financial
controls. In response, management has begun to identify measures to improve the
Company's system of internal controls, including implementing more rigorous
internal accounting policies, procedures and controls. Management believes
these improved procedures should correct the noted weaknesses.
21
<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 the Company in 1999.
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
NAME. . . . . . . . . . . AGE OFFICER SINCE DIRECTOR SINCE POSITION
- ------------------------- --- ------------- -------------- -----------------------------------------------
Mr. Andrew Vollero, Jr. . 63 1999 2000 Chairman of the Board
Mr. Klee Irwin. . . . . . 34 1998 1998 President and Chief Executive Officer, Director
Mr. Albert Kashani. . . . 40 - 2000 Director
Mr. Christof Ballin . . . 35 - 2000 Director
Mr. Marty Sumichrast. . . 58 - 2000 Director
Mr. R. Lindsey Duncan (1) 37 1993 1993 Chairman of the Board, Director
Mr. Louis Mancini (2) . . 54 1999 1999 President and Chief Executive Officer, Director
Mr. Jonathan Diamond (3). 41 - 1998 Director
Mr. James Jeffs (4) . . . 49 - 1998 Director
Mr. Santo Panzarella (5). 60 - 1999 Director
</TABLE>
(1) Served as Chairman of the Board and a Director until March 12, 2000
(2) Served as a Director until October 1999. Served as President and
Chief Executive Officer April 20, 1999 until March 12, 2000.
(3) Served as a Director until March 3, 2000
(4) Served as a Director until July 1999
(5) Served as a Director from December 22, 1999 until February 20, 2000
Mr. Andrew Vollero, Jr. became Chairman of the Board of Omni Nutraceuticals on
March 12, 2000, and has served as a Director since 1999. Mr. Vollero is an
independent general management consultant and private investor specializing in
the small business area since 1970. During that period, Mr. Vollero has worked
with over 100 companies, mostly privately held and in non-high tech industries.
Since 1994, Mr. Vollero has served as a Board member of AC International, A.C.
Vroman, Inc., Vroman Real Estate Ventures, Magnum Air and Rahn Industies. Mr.
Vollero is a graduate of Yale and Harvard Business School.
Mr. Klee Irwin. Mr. Irwin served as the President and Chief Executive Officer
of Omni Nutraceuticals from June 30, 1998 until April 20, 1999. Prior to June
30, 1998, Mr. Irwin served as the President and Chief Executive Officer of Irwin
Naturals, which he founded in 1995. Prior to his involvement in Irwin Naturals,
beginning in 1989, Mr. Irwin served as a vice president of sales and marketing
and general manager of Helsneva Labs, a division of Pantron I Corp., a privately
held consumer products company. Mr. Irwin served as the Chief Executive Officer
and a Director of HealthZone.com, the Company's e-commerce subsidiary in 1999
and rejoined Omni as the Chief Executive Officer and President in March 2000.
Mr. Albert Kashani. Mr. Kashani became a director on March 12, 2000. He has
been specializing in transactional and business litigation matters at his own
practice, the Law Offices of Albert R. Kashani. From 1991 to the present, Mr.
Kashani has been a principal executive officer of Menorah Fusing & Services,
Inc., a clothing interlining business, and its predecessors. From 1995 to 1998,
Mr. Kashani was a tax consultant at Ernst & Young, LLP in Los Angeles. In 1988,
Mr. Kashani founded Torina, Inc., a clothing manufacturing company. Mr. Kashani
received his Bachelor of Arts degree in Economics from California State
University, Northridge, in 1992, and graduated from University of Southern
California Law Center in 1995. Mr. Kashani is currently a member of the Board
of Directors of two other publicly traded companies, named Electronic Components
& Systems, Inc. and Integrated Communication Networks, Inc.
22
<PAGE>
Mr. Christof Ballin. Mr. Christof Ballin became a director on March 12, 2000.
He graduated from California State University Fullerton with a Bachelor of Arts
degree in International Business. He has over 10 years of management experience
within the healthcare field and is a former Managing Director, South East Asia,
of Allergan, Inc., which is a U.S. Fortune 500 Specialty Healthcare Company.
Mr. Ballin is currently the Chairman and CEO of the American Academy of
Nutrition, College of Nutrition which is a Nationally Accredited Distance
Education College focused on the field of Nutrition.
Mr. Martin A. Sumichrast. Mr. Sumichrast became a director on March 12, 2000.
He is the co-founder, Chairman of the Board, Chief Executive Officer and
President of Global Capital Partners, Inc. Mr. Sumichrast has held various
positions at Global Capital Partners, Inc. since its inception in 1993. Mr.
Sumichrast is a Director of EB I Securities Corporation and Chairman of
MoneyZone.com.
Mr. James Jeffs. Mr. 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 private capital
management division at Trust Services of America (TSA) served as its Chief
Investment Officer and President of TSA Capital Management.
Mr. Jon Diamond. Mr. Diamond has served as the Chairman and Managing Partner of
J. Diamond Group, L.P., a media entertainment investment partnership from
January 1993 through June 1995, and as Vice Chairman of N2K Inc., a media and
entertainment company from June 1995 to March 1999. Mr. Diamond is currently
the Chairman of CDNow, a media entertainment company and a successor by way of
merger of N2K Inc., a position he has held since March 1999.
The Board of Directors met 19 times during 1999 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 1999,
the Audit Committee and the LTSIP Administration Committee were composed of
Messrs. Diamond and Jeffs . The Audit and LTSIP Administration Committees did
not meet during 1999, the functions of such committees being performed by the
Board of Directors as a whole. The LTSIP Administration Committee is responsible
for overseeing the Company'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 1999, the Compensation
Committee was composed of Messrs. Duncan and Irwin. The Compensation Committee
met once in 1999. The primary responsibility of the Compensation Committee is to
establish and review the compensation policies of the Company, including those
for executives. During 1999, the Company did not have a nominating committee,
the functions of such a committee being performed by the Board of Directors as a
whole.
23
<PAGE>
In 1999, the LTSIP provided that upon assuming office, each non-employee
director would 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 December 1999, the LTSIP was amended to grant 75,000 options at market price
at the time of grant over three years to new directors.
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 the Company are required to file
reports on Form 3, 4 and 5 of their beneficial holdings and transactions in the
Company Common Stock. With the exception of Form 3's required to be filed by
Messrs. Vollero and Panzarella on becoming directors in October 1999 and a Form
4 filing required to have been made by Mr. Irwin in connection with a sale of
common stock in September 1999 pursuant to Rule 144 and a capital contribution
to the Company in October, 1999, during 1999, all such reports were filed in a
timely manner.
ITEM 11. EXECUTIVE COMPENSATION
The following table shows, for the years ended December 31, 1999, 1998 and 1997
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 1999:
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Long Term Compensation
----------------------
Annual Compensation Awards Payouts
Restricted Securities All Other
Name and Position . . Year Salary Bonus Other Stock Award Underlying Options LTSIP Payouts Compensation
R. Lindsey Duncan (2) 1999 $ 225,000 $ 50,000 $ 0 0 0 $ 0 0
1998 192,219 0 0 0 50,000 0 0
1997 150,000 0 0 0 401,252 0 0
Klee Irwin (1). . . . 1999 259,808 0 0 0 0 0 0
1998 455,000 0 0 0 50,000 0 0
1997 0 0 0 0 0 0 0
Louis Mancini (3) . . 1999 284,615 0 0 0 0 0 0
Rockwell Schutjer . . 1999 51,923 0 0 0 0 0 0
1998 122,163 0 0 0 0 0 0
1997 80,000 0 0 0 0 0 0
1996 80,000 0 0 0 132,500 0 0
</TABLE>
24
<PAGE>
(1) Mr. Irwin's employment ceased on April 20, 1999, and his options have
expired unexercised. Mr. Schutjer's employment with Omni Nutraceuticals ceased
on July 15, 1999. Mr. Schutjer's options have expired unexercised.
(2) Mr. Duncan's options remain exercisable subject to the terms of the
Withdrawal Agreement.
(3) Mr. Mancini's options were cancelled pursuant to the Termination Agreement.
OPTION GRANTS
The following table presents information with respect to the Named Individuals
concerning the exercise of options during 1999 and unexercised options held as
of December 31, 1999.
Individual Grants
- ------------------
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Potential Realizable Value
at Assumed Annual Rates of
Stock Price Appreciation for
% Total Option Term
Number of Securities Options/SARS
Underlying Options Granted to
/SARS Granted Employees in Exercise Stock Price on
Fiscal Year Price Grant Date Expiration Date 0% 5% 10%
R. Lindsey
Duncan 550,000 -- $2.00 $2.00 6/30/03 -- -- --
</TABLE>
OPTION EXERCISES AND HOLDINGS
The following table presents information with respect to the Named Individuals
concerning the exercise of options during 1998 and unexercised options held as
of February 15, 2000:
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
Number of Unexercised
In-The-Money Options at Value of Unexercised Options at
December 31, 1999 (1) December 31, 1999
------------------------ -----------------
Name. . . . . . . Shares Exercised (#) Value Realized ($) Exercisable Unexercisable Exercisable Unexercisable
R. Lindsey Duncan 0 $ 0 1,003,029 33,334 $0 $0
</TABLE>
(1) Based on the closing market price of $1.125 per share for the Company's
Common Stock as of December 31, 1999.
25
<PAGE>
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
R. Lindsey Duncan, and Klee Irwin, the Company's current Chief Executive
Officer, served on the Compensation Committee of the Board of Directors during
1999.
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
Omni Nutraceuticals. In 1999, Mr. Duncan was 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 was employed as the Chief
Executive Officer and as a member of the Executive Committee with all duties and
responsibilities normally associated with this position until April 20, 1999. On
that date, Mr. Irwin resigned, as Chief Executive Officer of Omni Nutraceuticals
and his employment agreement was terminated effective April 20, 1999. In
connection with his resignation the Board of Directors appointed him as Chief
Executive Officer of HealthZone.com, the Company's wholly owned e-commence
subsidiary ("HealthZone"). In October of 1998 (as revised in June 1999), Omni
Nutraceuticals entered into an agreement to hire Mr. Louis Mancini as President
and Chief Operating Officer and, subsequently, Chief Executive Officer.
These employment agreements provide for: (i) annual salaries of $225,000, and
$300,000 for Messrs. Duncan and Mancini, respectively; (ii) the right for Mr.
Duncan to receive an annual bonus equal to 2% of the consolidated earnings
before income taxes in excess of $6,000,000 and the right for Mr. Mancini to
receive an annual bonus of 2% of earnings before depreciation, interest,
individual taxes and amortization above six (6), eight (8), twelve (12) and
fourteen (14) million dollars for the years 1999-2002, respectively; 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.
Under his terminated employment agreement Mr. Irwin received an annual salary of
$350,000 and the right to the same annual bonus and to participate in the same
retirement and welfare, benefit, fringe, perquisite and other plans and programs
as Mr. Duncan. All of the Employment Agreements have been terminated. See
"Item 13. Certain Relationships and Related Transactions--Irwin Settlement
Agreement" and "Recent Changes in Management" below.
RECENT CHANGES IN MANAGEMENT
Mr. Duncan's Withdrawal
Effective on March 12, 2000 (the "Effective Date"), Mr. R. Lindsay Duncan, the
former Chairman of the Board of Omni, and his spouse, Cheryl Wheeler, entered
into an Agreement dated March 11, 2000 (the "Withdrawal Agreement") with the
Company, pursuant to which (i) Mr. Duncan agreed to resign from the Board of
Directors of the Company (the "Board"), terminate his employment agreement with
the Company (the "Employment Agreement") and cease all further involvement with
the Company, and (ii) Mr. Duncan and Cheryl Wheeler both agreed to (A) vote
their respective shares of the common stock of the Company (or give their
written consent) on all matters on the same proportionate basis as the remaining
shareholders of the Company vote their shares (or give their written consent) on
such matters for a period of five years from the Effective Date, and (B) appoint
Andrew Vollero, Jr., currently a director of the Company, as attorney-in-fact
for each of them to vote their shares of Common Stock (or give their written
consent) as aforesaid.
26
<PAGE>
Mr. Duncan's agreement to resign from the Board and terminate the Employment
Agreement was conditioned upon the occurrence of certain enumerated events,
circumstances or conditions, each of which occurred or was satisfied or waived
on or before March 12, 2000, including the following:
(i) The execution and delivery by the Company of an indemnity agreement
indemnifying Mr. Duncan and related persons for losses in connection with his
services to the Company (the "Indemnity Agreement").
(ii) In settlement of the remaining obligations owed Mr. Duncan under the
Employment Agreement, the extension of the exercise and expiration dates of all
of his existing stock options to purchase 1,003,029 shares of the Common Stock
to the seventh anniversary of the Effective Date.
(iii) The receipt by Mr. Duncan of $1,500,000 in net proceeds from the sale
of shares of Common Stock owned by Mr. Duncan at a price of $3.00 per share in
one or more transactions which were not required to be aggregated with sales
made by Mr. Duncan pursuant to Rule 144 promulgated under the Securities Act of
1993, as amended.
(iv) The execution and delivery by American Equities LLC and Corporate
Financial Enterprises, Inc. (collectively, the "Investors") of a term sheet
providing for the purchase by the Investors from the Company of 2,000,000 shares
of 5% Convertible Preferred Stock, Series A and warrants to purchase up to
500,000 shares of Common Stock for an aggregate purchase price of $2,000,000.
(v) The execution and delivery by each of the Investors to Mr. Duncan of a
General Release.
(vi) The execution and delivery by the Company and Mr. Duncan of a
Registration Rights Agreement (the "Registration Rights Agreement").
(vii) The termination of the Voting Agreement dated October 8, 1999 by and
between Mr. Duncan and Klee and Margareth Irwin.
(viii) The execution and delivery by each of Klee Irwin and Mr. Duncan of
mutual General Releases.
All of the above conditions were satisfied or waived and Mr. Duncan resigned
from the Board and terminated the Employment Agreement effective March 12, 2000.
Change in Management
- ----------------------
At a meeting of the Board held on March 12, 2000 (the "Board Meeting"), at which
the Withdrawal Agreement and the ancillary agreements executed and delivered by
the Company in connection therewith were approved, ratified and adopted, the
Board filled the vacancies created by the resignations of Mr. Santo P.
Panzarella as a Class III director and Mr. Jonathan Diamond as a Class II
director, with the election of Messrs. Christof Ballin and Albert Kashani,
respectively. Upon Mr. Duncan's resignation as a Class I director, the vacancy
created thereby was filled with the appointment of Mr. Martin Sumichrast. Each
of these individuals was appointed to serve in such respective capacities for
the remaining balance of his respective term of office until his successor has
been duly elected and has qualified.
At the Board Meeting, the Board terminated Mr. Louis Mancini's employment as
President and Chief Executive Officer of the Company and Mr. Klee Irwin was
appointed to fill the vacancy created thereby. The Company negotiated a
settlement with Mr. Mancini regarding the terms under which his employment has
been terminated. Pursuant to the terms of the settlement, Mr. Mancini is
entitled to (i) payment of unpaid salary, vacation and sick pay in an amount of
$22,644.23; (ii) cancellation of all Mr. Mancini's stock options outstanding
other than 50,000 previously vested options at $2.50 per share provided they are
exercised prior to December 31, 2000; (iii) forgiveness by the Company of an
outstanding indebtedness in the original principal amount of $350,000 made to
Mr. Mancini by the Company; (iv) waiver by Mr. Mancini of any and all other
compensation and/or benefits by the Company or any of its subsidiaries; and (v)
mutual releases between Mr. Mancini and the Company, R. Lindsey Duncan and his
spouse, Klee Irwin and his spouse and Andrew Vollero, Jr.
27
<PAGE>
At the Board Meeting, the Board also authorized the termination of that certain
Settlement Agreement dated October 8, 1999, by and among the Company and Mr. and
Mrs. Klee Irwin, and the ancillary agreements executed and delivered by the
Company in connection therewith. See Item 13 "Certain Relationships and Related
Transactions"
By letter dated April 10, 2000, Mr. Martin Sumachrast resigned, for personal
reasons, as a director of the Company. Mr. Sumachrast did not resign because of
any disagreement with the Company on any matter relating to the Company's
operations, policies or practices or otherwise any other matter required to be
disclosed.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table includes information as of March 31, 2000 concerning the
beneficial ownership of the holdings of Common Stock by (i) all persons who are
known by Omni Nutraceuticals to hold five percent or more of the outstanding
shares of Common Stock, (ii) each of the directors of Omni Nutraceuticals, (iii)
each executive officer of Omni Nutraceuticals, and (iv) all directors and
executive officers of Omni Nutraceuticals 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>
<BTB>
<S> <C> <C> <C>
Name and Address of Beneficial Owner Shares Beneficially Owned Percent
------------------------------------ ------------------------- -------
PRINCIPAL SHAREHOLDER
R. Lindsey Duncan
1750 Chastain Pkwy,
Pacific Palisades, CA
90066 (1) (2) (3) (4) 6,806,369 23.6%
Klee and Margareth Irwin
7825 Veragua Drive,
Playa del Rey, CA 90293 14,688,335 43.5%
DIRECTORS AND EXECUTIVE OFFICERS
Klee Irwin (5) See Above
Louis Mancini (2) 0 0.0%
Christof Ballin (6) 15,000 *
Martin Sumichrast (7) 0 0.0%
Jonathan Diamond 25,000 *
Santos Panzarella 0 *
Andrew Vollero (3) 25,000 *
Albert Kashani 0 *
ALL DIRECTORS AND OFFICERS AS A GROUP 21,559,704 74.6%
</TABLE>
28
<PAGE>
*Less than 1%
(1) Includes 405,439 shares of Common Stock owned by Cheryl Duncan, Mr.
Duncan's wife. Mr. Duncan disclaims ownership of such shares.
(2) Options have been cancelled pursuant to Termination Agreement.
(3) Became a director of Omni Nutraceuticals effective October 8, 1999.
Includes 4,803,340 shares of common stock registered in the names of R. Lindsey
Duncan and Cheryl Wheeler over which Mr. Vollero exercises an irrevocable proxy.
(4) Served as an executive officer of Omni Nutraceuticals during 1999
and appears in the Summary Compensation Table. Resigned effective March 12, 2000
(5) Resigned as an officer of Omni Nutraceuticals effective April 20,
1999. Became Chief Executive Officer of the Company on March 12, 2000.
(6) Became a director on March 12, 2000.
(7) Became a director on March 12, 2000 and resigned from the Board
April 10, 2000.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In June and October 1998, the Company entered into employment agreements with
the former Chairman of the Board, current Chief Executive Officer and former
Chief Executive Officer and President (see Note 10 of Notes to Financial
Statements). All such employment agreements have been terminated.
On October 8, 1999, the Company and Mr. Klee Irwin entered into a settlement
agreement (the "Settlement Agreement') in order to resolve certain mutual claims
that had arisen between the Company and Mr. Irwin. Among the principal terms of
the settlement were the following:
(a) The Company agreed to provide Mr. Irwin with the following severance
benefits: (a) a monthly payment in the same amount that he received under his
former employment agreement, for the period commencing October 1, 1999 until the
earlier of (i) April 16, 2000 or (ii) the sale, merger, bankruptcy or other
transaction involving HealthZone which results in HealthZone being capitalized
at more than $1,700,000; (b) continued coverage for Mr. Irwin and members of his
immediate family under the Company's health insurance plans, and (c) the
continued provision of an automobile until November 22, 1999.
(b) Mr. Irwin agreed to assume the defense of a claim asserted by the former
shareholders of Health and Vitamin Express, Inc. ("HVE"), a company acquired by
HealthZone in February 1999, and in connection therewith agreed to indemnify the
Company from any liability associated therewith except that the Company agreed
to issue up to 363,636 shares of common stock to the former HVE shareholders in
settlement of their claim.
(c) Mr. Irwin agreed to reimburse the Company for any excess tax payments
made on his and his wife's behalf since October 17, 1997 attributable to all
periods prior to the merger of Irwin Naturals with and into 4Health, Inc.
29
<PAGE>
(d) Mr. Irwin agreed to fund substantially all the net operating losses of
HealthZone pending its spin-off or sale by means of purchases of shares of
HealthZone common stock at a price per share based upon a base valuation (as
adjusted) for HealthZone of $3,500,000, until at least $280,00 in aggregate
common stock purchases have been made, after which such price per share shall be
based upon the greater of such base valuation (as adjusted) or HealthZone's then
market value.
(e) Mr. Irwin agreed that he would guarantee a market value for the
Company's ownership interest in HealthZone of $2.3 million as of one year after
a spin-off of HealthZone or October 8, 2001, and further agreed that he would
place in escrow 1,022,222 shares of his common stock as security for such
guarantee at such time as the Company first filed a registration statement with
the Securities and Exchange Commission relating to the proposed spin-off of
HealthZone.
(f) The Company, HealthZone and Mr. Irwin entered into a Tax Allocation and
Indemnification Agreement pursuant to which the Company and HealthZone allocated
certain tax liabilities and attributes between themselves and HealthZone
indemnified the Company for any liability associated with the spin-off not
qualifying as a tax free transaction under Section 355 of the Internal Revenue
Code of 1986, as amended, with Mr. Irwin guaranteeing HealthZone's
indemnification obligation in the event of its bankruptcy.
(g) The Company and Mr. Irwin issued mutual releases and indemnified each
other against certain claims. As security for his indemnification obligations
Mr. Irwin placed in escrow with Wells Fargo Bank 1,000,000 shares of his common
stock, 500,000 shares of which would be released on December 31, 1999 (in the
absence of any claims for indemnification asserted by the Company) and the
balance would be released on March 31, 2000 (in the absence of any claims for
indemnification asserted by the Company).
(h) The Company granted Mr. Irwin a "call" option on the Company's shares of
HealthZone for the greater of $2.3 million or HealthZone's market value
commencing March 31, 2000 if the spin-off is not consummated before then.
(i) Mr. Irwin granted the Company a "put" option on its shares of HealthZone
for $2.3 million commencing June 1, 2000 if the spin-off is not consummated
before then or the Company's shares of HealthZone are not sold for at least
$2,300,000.
(j) The Company agreed to bear the first $100,000 in expenses incurred by
the Company attributable to the spin-off and HealthZone agreed to bear all
documented and reasonable costs and expenses incurred by the Company in excess
of such $100,000 payment of such excess costs to be personally guaranteed by Mr.
Irwin.
On or about the date of the Settlement, Mr. Irwin made a capital contribution of
$410,000, and returned 941,436 shares of Omni Nutraceutical common stock to the
Company. The Company has set aside 363,363 of these shares to be issued, if
necessary, to the former owners of HVE, and the remainder will be reflected as
treasury stock.
In connection with the settlement, Mr. Irwin and Omni's chairman R. Lindsey
Duncan, who together own approximately 74% of the outstanding shares of voting
capital stock of Omni, each entered into a five-year voting agreement pursuant
to which Mr. Irwin has agreed to certain stand-still provisions and he and Mr.
Duncan have agreed to vote their respective shares of Omni common stock for
their respective nominees for Class I and II directors and the candidate for
Class III director nominated by the two Class II directors.
Effective March 12, 2000, the Settlement Agreement and all ancillary agreements
thereto, including the Voting Agreement between Mr. Duncan and Mr. Irwin, were
terminated.
30
<PAGE>
SUBSEQUENT EVENTS
On January 24, 2000, the Company completed an equity transaction with American
Equities, LLC and Corporate Financial Enterprises, Inc. (collectively, the
"Investors") that was intended to provide up to $5,100,000 of capital to the
Company and its wholly owned Internet subsidiary HealthZone.com ("HealthZone").
Under the terms of the transaction, the Company issued 3,000,000 shares of its
newly created 5% Convertible Preferred Stock, Series A ("Preferred Shares ") and
seven year warrants to purchase up to an aggregate of 775,000 shares of common
stock at an exercise price of $2.25 per share, subject to adjustment, with an
additional 1,500,000 shares to be issued in July 2000, subject to the Company
meeting certain performance criteria. The aggregate purchase price for the
Preferred Shares and warrants was $4,000,000 payable in two installments, the
first in the amount of $2,000,000 and, subject to the satisfaction of certain
performance targets, the second in the amount of $2,000,000. Concurrently with
the first installment payment, HealthZone issued 222,222 shares of its common
stock (representing approximately 10% of HealthZone's issued and outstanding
shares of common stock) and a seven year warrant to purchase up to 37,000 shares
of its common stock at an exercise price, subject to adjustment, equal to the
lesser of $1.00 or 70% of the lowest price received by HealthZone on future
sales of its capital stock, for a purchase price of $1,000,000. The Company
also agreed to lend HealthZone $1,000,000 out of second installment proceeds.
The Company used the proceeds from the sale of its securities to reduce
indebtedness and for working capital purposes. The Preferred Shares are
convertible into an aggregate of 3,000,000 shares of Company common stock
(assuming issuance of the full amount of Preferred Shares), subject to
adjustment. The Preferred Shares are not redeemable but may be subject to
mandatory conversion under certain circumstances. The Preferred Shares will vote
together with the common stockholders on an as converted basis and will have
separate class voting rights to elect one director and in connection with
certain corporate changes. The Preferred Shares will carry a liquidation
preference of $.60 per share and an annual dividend rate of $.05 per share,
payable semi-annually. The Company may elect to pay the dividend in additional
Preferred Shares at a rate of .05 share of Preferred Stock.
In connection with the above transaction, the Company has (i) amended its
Articles of Incorporation to provide for the Preferred Shares, (ii) amended the
Settlement Agreement between the Company and Klee Irwin as it related to certain
funding provisions of HealthZone, and (iii) the entered into two separate
consulting agreements, pursuant to one of which the Company to issued 560,000
restricted shares of its Common Stock.
On March 24, 2000 all of the outstanding shares of Preferred Shares were
mandatorily converted into 2,016,438 shares of common stock.
31
<PAGE>
PART IV
-------
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(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) (1) Form 8-K dated March 12, 2000 regarding the issuance of
equity securities to American Equities LLP and Corporate
Financial Enterprises, Inc.
(2) Form 8-K dated April 14, 2000 regarding changes in
management and other issues
EXHIBIT INDEX
<TABLE>
<CAPTION>
<BTB>
<S> <C> <C> <C> <C>
SEC
EXHIBIT REFERENCE
NUMBER NUMBER TITLE OF DOCUMENT LOCATION
- - ---------- ----------- ---------------------------------------------------------------------- --------------------
</TABLE>
<TABLE>
<CAPTION>
<BTB>
<S><C> <C> <C> <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 Incorporated by
Reference (9)
2.06 2 Agreement & Plan of Merger with Health Vitamin Express Inc. ("HVE") Incorporated by
Reference (9)
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)
3.06 3 Bylaws - Change to By-Laws Eliminating Executive Committtee Incorporated by
Approved by Shareholders in December 1999 Reference (15)
3.07 3 Form of Articles of Merger and related Plan of Merger Incorporated by
Amendment to Articles Changing Name and Authorizing the Series Reference (14)
A Preferred Stock
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)
4.08 4 Stock Purchase Agreement by and among Omni Nutraceuticals, Inc. and Incorporated by
HealthZone.com, Inc. and American Equities, LLC and Corporate Reference (14)
Financial Enterprises, Inc. dated as of January 24, 2000
4.09 4 Registration Rights Agreement among Omni Nutraceuticals, Inc. and Incorporated by
American Equities, LLC and Corporate Financial Enterprises, Inc. Reference (14)
dated as of January 24, 2000
4.10 4 Warrant Agreement among Omni Nutraceuticals, Inc. and American Equities Incorporated by
LLC and Corporate Financial Enterprises, Inc. dated as of January Reference (14)
24, 2000.
4.11 4 Warrant Agreement between HealthZone.com, Inc. and American Equities Incorporated by
LLC and Corporate Financial Enterprises, Inc. dated as of January Reference (14)
24, 2000
Item 5. Other Items
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 Incorporated by
Wells Fargo Bank. Reference (9)
</TABLE>
32
<PAGE>
<TABLE>
<CAPTION>
SEC
EXHIBIT REFERENCE
NUMBER NUMBER TITLE OF DOCUMENT LOCATION
- - ---------- ----------- ---------------------------------------------------------------------- --------------------
Item 10. Material Contracts
<C> <C> <S> <C>
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 Incorporated by
Reference (9)
10.08 10 Consulting Agreement with Michael Driver Incorporated by
Reference (9)
10.09 10 Employment Agreement with Louis Mancini, Lindsey Duncan & Klee Irwin Incorporated by
Reference (9)
10.10 10 Letter of Intent with Klee Irwin dated April 16, 1999 Incorporated by
Reference (10)
10.11 10 Indemnity Agreement with Klee Irwin dated April 19, 1999 Incorporated by
Reference (10)
10.12 10 Secured Credit Agreement by and among Irwin Naturals/4 Health, Inc Incorporated by
as Borrower, and First Source Financial LLP, as Agent and Lender Reference (11)
dated as of June 10, 1999.
10.13 10 Settlement Agreement dated October 8, 1999 between Omni Incorporated by
Omni Nutraceuticals, Inc. and Klee Irwin Reference (12)
10.14 10 Tax Indemnification and Allocation Agreement dated October 8, 1999 Incorporated by
between Omni Nutraceuticals, Inc. and Klee Irwin Reference (12)
10.15 10 Voting Agreement dated October 8, 1999 by and among Klee Irwin Incorporated by
and Margareth Irwin and R. Lindsey Duncan. Reference (12)
10.16 10 Escrow Agreement dated October 8, 1999 by and among Klee Irwin Incorporated by
Wells Fargo Bank as the Escrow Agent and Omni Nutraceuticals Reference (12)
10.17 10 Amendment No. 1 to Settlement Agreement dated October 8, 1999 Incorporated by
between Omni Nutraceuticals, Inc. and Klee Irwin Reference (14)
10.18 10 Consulting Agreement by and between Omni Nutraceuticals, Inc Incorporated by
and Corporate Financial Enteprises, Inc. dated as of January 24, 2000 Reference (14)
10.19 10 Consulting Agreement by and between Omni Nutraceuticals, Inc. and Incorporated by
Monfort Investments dated as of January 24, 2000 Reference (14)
10.20 10 Lock up Agreement by Klee Irwin and B. Lindsey Duncan Incorporated by
Reference (14)
10.21 10 Indemnity Agreement between Omni Nutraceuticals, Inc. and Reid Incorporated by
Breitman Reference (14)
10.22 Agreement dated March 11, 2000 among the Company, Incorporated by
R. Lindsay Duncan and Cheryl Wheeler Reference (15)
10.23 Indemnity Agreement dated March 11, 2000, between the Incorporated by
Company and R. Lindsay Duncan Reference (15)
10.24 Term Sheet dated March 11, 2000 between the Company Incorporated by
and American Equities LLC Reference (15)
10.25 Registration Rights Agreement dated March 11, 2000 Incorporated by
among the Company, R. Lindsay Duncan and Cheryl Reference (15)
Wheeler
10.26 Consulting Agreement between the Company and Liviakis Incorporated by
Financial Communications, Inc. Reference (15)
10.27 Termination Agreement between the Company and Louis Incorporated by
Mancini Reference (15)
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 Incorporated by
Reference (16)
Item 27. Financial Data Schedule
27.01 27 Financial Data Schedule Incorporated by
Reference (16)
</TABLE>
33
<PAGE>
- - ------------------------
(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.
(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.
(8) Incorporated by reference from Irwin Naturals/4/Health Annual Report on Form
10-K for the year ended December 31, 1998.
(9) Incorporated by reference from the Company's report on Form 10-K for the
year ended December 31, 1998.
(10) Incorporated by reference from the Company's report on Form 8-K filed on
June 7, 1999.
(11) Incorporated by reference from the Company's report on Form 8-K filed on
July 22, 1999.
(12) Incorporated by reference from the Company's report on Form 8-K filed on
October 28, 1999.
(13) Incorporated by reference from the Company's proxy statement filed on
December 10, 1999
(14) Incorporated by reference from the Company's report on Form 8-K filed on
January 31, 2000.
(15) Incorporated by reference from the Company's report on Form 8-K filed on
April 14, 2000.
(16) Incorporated by reference from the Company's report on Form 10-K filed
for December 31, 1999.
34
<PAGE>
ITEM 1. FINANCIAL STATEMENTS
INDEX TO FINANCIAL STATEMENTS
PAGE
Report of Independent Public Accountants F-2
Balance Sheets as of December 31, 1999 and 1998 F-3
Statements of Operations for each of the three
years in the period ended December 31, 1999 F-4
Statements of Shareholders' Equity for each of the
three years in the period ended December 31, 1999 F-5
Statements of Cash Flows for each of the three years
in the period ended December 31, 1999 F-6
Notes to Financial Statements F-7
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Omni Nutraceuticals, Inc.:
We have audited the accompanying consolidated balance sheets of Omni
Nutraceuticals, Inc. (a Utah corporation) and Subsidiary (the Company) as of
December 31, 1999 and 1998, and the related consolidated statements of
operations, shareholders' equity and cash flows for each of the three years in
the period ended December 31, 1999. 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 auditing standards generally accepted
in the United States. 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 Omni Nutraceuticals, Inc. and
Subsidiary as of December 31, 1999 and 1998, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1999 in conformity with accounting principles generally accepted in the
United States.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
financial statements, for the year ended December 31, 1999, the Company incurred
a loss from operations of $8,306,000, and at December 31, 1999, the Company had
a working capital deficit of $6,364,000 and a retained deficit of $17,554,000
which raise substantial doubt about its ability to continue as a going concern.
Management's plans in regard to these matters are also described in Note 1. The
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
/s/ ARTHUR ANDERSEN LLP
Los Angeles, California
April 12, 2000
F-2
<PAGE>
OMNI NUTRACEUTICALS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
<S> <C> <C>
DECEMBER 31 DECEMBER 31
1999 1998
------------ ------------
ASSETS
CURRENT ASSETS:
Cash $ - $ 426,000
Accounts receivable, net of reserves and allowances
of $3,163,000 in 1999 and $1,131,000 in 1998 6,776,000 6,023,000
Inventories 5,972,000 2,855,000
Prepaid expenses and other 539,000 290,000
Current portion of receivables from officers and shareholder - 497,000
Current portion of notes receivable 11,000 99,000
------------ ------------
TOTAL CURRENT ASSETS 13,298,000 10,190,000
Building held for sale - 1,521,000
Property and equipment, net 1,516,000 627,000
Trademarks, net of accumulated amortization of
$726,000 in 1999 and $13,000 in 1998 12,798,000 99,000
Goodwill, net of accumulated amortization of $484,000 in 1999 2,422,000 -
Intangibles, net of accumulated amortization of $307,000 in 1998 - 420,000
Finance fees, net of accumulated amortization of $110,000 in 1999 934,000 -
Other assets 320,000 55,000
Receivables from officers and shareholder, net of current portion - 175,000
Notes receivable, net of current portion 439,000 -
------------ ------------
$ 31,727,000 $ 13,087,000
============ ============
</TABLE>
LIABILITIES AND SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
<S> <C> <C>
CURRENT LIABILITIES:
Cash overdraft $ 165,000 $ -
Accounts payable 7,176,000 2,637,000
Accrued liabilities 2,875,000 942,000
Line of credit 6,436,000 1,000,000
Current portion of term loan 2,332,000 -
Current portion of notes payable 176,000 328,000
Income taxes payable 52,000 438,000
Customer deposits 450,000 450,000
------------- ------------
TOTAL CURRENT LIABILITIES 19,662,000 5,795,000
------------- ------------
Term loan, net of current portion 10,085,000 -
Notes payable, net of current portion 102,000 1,423,000
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY:
Shares issuable under legal settlement 1,200,000 -
Preferred stock; $1 par value; 5,000,000 shares authorized;
Issued and outstanding, none - -
Common stock, $.01 par value; 50,000,000 shares authorized;
Issued - 27,352,009 in 1999 and 27,857,139 in 1998;
Outstanding - 27,261,119 in 1999 and 27,766,249 in 1998 274,000 279,000
Additional paid-in capital 18,008,000 14,333,000
Treasury stock, 90,890 shares at cost (50,000) (50,000)
Retained deficit (17,554,000) (8,693,000)
------------- ------------
1,878,000 5,869,000
------------- ------------
$ 31,727,000 $13,087,000
============= ============
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
F-3
<PAGE>
OMNI NUTRACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
<S> <C> <C> <C>
YEAR ENDED DECEMBER 31,
--------------------------
1999 1998 1997
-------------------------- ------------ ------------
Net Sales $ 35,308,000 $30,547,000 $29,353,000
Cost of Sales 17,847,000 12,540,000 13,303,000
-------------------------- ------------ ------------
Gross profit 17,461,000 18,007,000 16,050,000
-------------------------- ------------ ------------
Costs and Expenses:
Selling, general and administrative 23,927,000 16,180,000 17,486,000
Loss on write-off of intangibles 640,000 - -
Loss on write-off of goodwill - - 3,202,000
Legal settlement 1,200,000 - -
-------------------------- ------------ ------------
25,767,000 16,180,000 20,688,000
-------------------------- ------------ ------------
Income (loss) from operations (8,306,000) 1,827,000 (4,638,000)
-------------------------- ------------ ------------
Other Income (Expense):
Interest income 32,000 10,000 52,000
Interest expense (1,339,000) (163,000) (167,000)
Other 478,000 (56,000) 36,000
-------------------------- ------------ ------------
(829,000) (209,000) (79,000)
-------------------------- ------------ ------------
Income (loss) before provision (benefit)
for income taxes (9,135,000) 1,618,000 (4,717,000)
Provision (benefit) for income taxes (274,000) 600,000 -
-------------------------- ------------ ------------
Net income (loss) $ (8,861,000) $ 1,018,000 $(4,717,000)
========================== ============ ============
Income (loss) before provision for income taxes 1,618,000 (4,717,000)
Pro forma provision for income taxes (unaudited) N/A 1,345,000 765,000
------------ ------------
Pro form net income (loss) (unaudited) N/A $ 273,000 $(5,482,000)
============ ============
Earnings (loss) per common share:
Basic - historical $ (0.31) $ 0.04 $ (0.17)
Diluted - historical $ (0.31) $ 0.04 $ (0.17)
Basic - pro forma N/A $ 0.01 $ (0.20)
Diluted - pro forma N/A $ 0.01 $ (0.20)
Weighted Average Shares Outstanding
Basic - historical 28,177,000 27,747,000 27,365,000
Diluted - historical 28,177,000 28,221,000 27,365,000
Basic - pro forma N/A 27,747,000 27,365,000
Diluted - pro forma N/A 28,221,000 27,365,000
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE>
OMNI NUTRACEUTICALS, INC.
STATEMENTS OF SHAREHOLDERS' EQUITY
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1999
<TABLE>
<CAPTION>
SHARES ADDITIONAL
ISSUABLE UNDER COMMON STOCK PAID IN TREASURY STOCK REATINED
------------ --------------
LEGAL SETTLEMENT SHARES AMOUNT CAPITAL SHARES AMOUNT DEFICIT TOTAL
---------------- ------ ------ ------- ------ ------ ------- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE, December 31, 1996 $ - 27,210,374 $272,000 $11,235,000 90,890 $ (50,000) $(1,201,000) $10,256,000
Issuance of common stock
in connection with exercise
stock options - 108,424 1,000 151,000 - - - 152,000
Compensation expense
incurred in connection
with warrants issued for
investment banking services - - - 275,000 - - - 275,000
Distributions - - - - - - (579,000) (579,000)
Issuance of common stock to
old 4Health Shareholders
pursuant to a realignment
of equity interests - 500,000 5,000 (5,000) - - - -
Net loss - - - - - - (4,717,000) (4,717,000)
------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1997 - 27,818,798 278,000 11,656,000 90,890 (50,000) (6,497,000) 5,387,000
Issuance of common stock in
connection with exercise
of stock options - 38,341 1,000 172,000 - - - 173,000
Compensation expense incurred
in connection with issuance
of stock options - - - 6,000 - - - 6,000
Compensation expense incurred in
connection with warrants issued
for investment banking services - - - 388,000 - - - 388,000
Distributions - - - - - - (1,103,000) (1,103,000)
Effect of Irwin Naturals
termination of its "S"
Corporation election - - - 2,111,000 - - (2,111,000) -
Net income - - - - - - 1,018,000 1,018,000
----------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1998 - 27,857,139 279,000 14,333,000 90,890 (50,000) (8,693,000) 5,869,000
Issuance of common stock in
connection with HVE acquisition - 363,636 4,000 2,269,000 - - - 2,273,000
Issuance of common stock in
connection with exercise
of stock options - 19,670 - 85,000 - - - 85,000
Issuance of common stock for
services - 53,000 1,000 174,000 - - - 175,000
Compensation expense incurred in
connection with issuance of
warrants and options for
services - - - 832,000 - - - 832,000
363,636 shares issuable under
under legal settlement (see
Note 12) 1,200,000 - - - - - - 1,200,000
Capital contribution
and return of shares
(see Note 13) - (941,436) (10,000) 315,000 - - - 305,000
Net loss - - - - - - (8,861,000) (8,861,000)
-----------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1999 $1,200,000 27,352,009 $274,000 $18,008,000 90,890 $ (50,000)$(17,554,000) $1,878,000
============= ========== ======== =========== ====== =========== ============ ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE>
OMNI NUTRACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
<S> <C> <C> <C>
YEAR ENDED DECEMBER 31,
-------------------------
1999 1998 1997
------------------------- ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (8,861,000) $ 1,018,000 $(4,717,000)
Adjustments to reconcile net income
(loss) to net cash provided by
(used in) operating activities;
Depreciation and amortization 1,892,000 550,000 557,000
Provision for returns, allowances and doubtful accounts 3,153,000 2,116,000 2,549,000
(Gain) loss on disposition of building, property and equipment (478,000) 10,000 99,000
Loss on write-off of intangibles 640,000 - -
Loss on write-off of goodwill - - 3,202,000
Legal settlement 1,200,000 - -
Issuance of warrants and options as compensation for services 832,000 394,000 275,000
Issuance for common stock for services 175,000 - -
Write-off of notes receivable 389,000 - -
(Increase) Decrease in;
Accounts receivable (3,906,000) (3,239,000) (3,559,000)
Inventory (3,367,000) (693,000) 850,000
Prepaid and other (405,000) 119,000 (122,000)
Increase (Decrease) in:
Bank overdraft 165,000 - -
Accounts payable 4,539,000 583,000 132,000
Accrued liabilities 1,933,000 (375,000) 68,000
Income taxes payable (386,000) 377,000 (682,000)
Deferred income taxes - 184,000 125,000
------------------------- ------------ ------------
Net cash provided by (used in) operating activities (2,485,000) 1,044,000 (1,223,000)
------------------------- ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (1,396,000) (350,000) (216,000)
Net proceeds from disposition of building, property and equipment 494,000 - 1,000
Net cash paid for purchase of Inholtra and HVE (13,493,000) - -
Collection of note receivable 68,000 14,000 269,000
Other assets (265,000) - -
Receivables from Officers and Shareholders 322,000 (672,000) 96,000
------------------------- ------------ ------------
Net cash used in investing activities (14,270,000) (1,008,000) 150,000
------------------------- ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of options 85,000 173,000 152,000
Net borrowings under line of credit 5,436,000 259,000 741,000
Borrowings under Term Loan 13,000,000 - -
Payments under Term Loan (583,000) - -
Borrowings under notes payable 10,000,000 592,000 1,350,000
Repayments of notes payable (10,870,000) (168,000) (1,322,000)
Costs incurred with financing (1,044,000) - -
Capital contribution from shareholder 305,000 - -
Distributions to shareholders - (1,103,000) (579,000)
------------------------- ------------ ------------
Net cash provided by (used in) financing activities 16,329,000 (247,000) 342,000
------------------------- ------------ ------------
Net decrease in cash (426,000) (211,000) (731,000)
Cash at beginning of year 426,000 637,000 1,368,000
------------------------- ------------ ------------
Cash at end of year $ - $ 426,000 $ 637,000
========================= ============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the year for:
Interest $ 1,326,000 $ 148,000 $ 133,000
Income Taxes $ 40,000 $ 24,000 $ 291,000
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
</TABLE>
During 1999, in connection with the sale of the Company's facility in Boulder,
Colorado, (i) a note receivable of $450,000
was received from the buyer, and (ii) $1,300,000 of debt was assumed by the
buyer.
During 1999, in connection with the acquisition of Health and Vitamin Express
Inc., the Company (i) issued 363,636 shares
of the Company's common stock valued at $2,273,000, and (ii) assumed $571,000
of debt.
During 1999, the Company acquired property and equipment totaling $126,000 under
capital lease obligations.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
F-6
<PAGE>
OMNI NUTRACEUTICALS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
1. BUSINESSES AND LIQUIDITY/GOING CONCERN
BUSINESS AND ORGANIZATION
Omni Nutraceuticals, Inc. (the "Company" "Omni") 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, and via the Internet.
Omni is a Utah corporation, and was formerly known as Irwin Naturals/
4Health Inc, which was formerly known as 4Health, Inc. Omni 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 that was accounted for as a
pooling of interests, 4Health issued 15,750,000 shares of common stock in
exchange for all the outstanding shares of Irwin Naturals. The accompanying
financial statements for 1998 and 1997 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. In August 1999, the
Company changed its name to Omni Nutraceuticals, Inc. On March 21, 2000, the
Company announced it intended to change its name to HealthZone.com.
Net sales and net income (loss) of the combining companies for 1998 and
1997 are as follows (individual line items, other than the totals, for the year
ended December 31, 1998 are unaudited):
<TABLE>
<CAPTION>
<S> <C> <C>
December 31, December 31,
1998 1997
-------------- --------------
Net Sales
4Health (pre-merger) . . . . . . . . $ 6,373,000 $ 12,432,000
Irwin Naturals (pre-merger). . . . . 9,291,000 16,921,000
Irwin Naturals/4Health (post-merger) 14,883,000 -
-------------- --------------
Total. . . . . . . . . . . . . . . . $ 30,547,000 $ 29,353,000
============== ==============
Net Income (Loss):
4Health (pre-merger) . . . . . . . . $ (900,000) $ (6,629,000)
Irwin Naturals (pre-merger). . . . . 1,070,000 1,912,000
Irwin Naturals/4Health (post-merger) 848,000 -
-------------- --------------
Total. . . . . . . . . . . . . . . . $ 1,018,000 $ (4,717,000)
============== ==============
</TABLE>
LIQUIDITY/GOING CONCERN
The Company has incurred losses from operations in two of the last three
years. For the year ended December 31, 1999, the Company incurred a loss from
operations of $8,306,000, and at December 31, 1999, the Company had a working
capital deficit of $6,364,000 and a retained deficit of $17,554,000 that raise
substantial doubt about its ability to continue as a going concern. In
addition, the Company used cash in operations of $2,485,000 and used cash for
investing activities, primarily acquisitions, of $14,270,000. The Company had
net cash outflows in each of the last three years. Due to the Company's
operating losses, a large portion of the trade accounts payable is past due at
December 31, 1999. The Company had a cash overdraft of $165,000 at December 31,
1999. Further, availability under the Company's line of credit is limited. At
December 31, 1999, the Company had $6,436,000 outstanding out of a maximum of
$7,000,000 under the facility.
Management's plans in regard to these items include the following:
- - The Company raised $3,000,000 via a private placement in January 2000 (see
Note 16)
- - The Company raised $2,100,000 via a private placement in March 2000 (see
Note 16)
- - The Company has a commitment from the January 2000 investor to provide an
additional $2,000,000 in private placement funding contingent on the Company
achieving certain sales benchmarks for the first two quarters of 2000 (see Note
16)
- - The Company is currently negotiating to raise an additional $15 million
via a private placement with a plan to pay off the Term Loan with the proceeds
- - The Company has received a waiver from its credit facility lender for
violations of certain covenants included in the loan agreement (see Note 8)
- - The Company has reduced portions of its fixed overhead expenses, including
executive salary reductions of $1,300,000
- - Management has revised its marketing strategy and plans to reduce
advertising expenditures
- - Management intends to focus additional efforts toward developing its
e-commerce operations to generate additional revenues
There are no assurances that the capital already raised by the Company in
conjunction with the expense reductions will be sufficient to fund the Company's
operations through 2000. In addition, there are no assurances that the Company
will be able to successfully achieve the sales benchmarks necessary to raise the
additional $2,000,000 or successfully raise other additional private placement
funds. Further, there is no assurance that management will be able to
successfully enter the e-commerce marketplace. The failure of the Company to
successfully achieve one or all of the above items will have a material impact
on the Company's financial position and results of operations. The accompanying
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
Omni Nutraceuticals, Inc. and its wholly owned subsidiary, HealthZone.com
("HealthZone"). All significant intercompany accounts and transactions have been
eliminated. Subsequent to December 31, 1999, the Company entered into a
transaction where 222,222 shares, which represents approximately 10% of the
outstanding shares of its HealthZone subsidiary, were issued to a third party as
part of a financing transaction (see Note 16).
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 1997, 1998 and 1999, the Company provided $2,549,000, $2,116,000, and
$3,153,000, respectively, for returns and allowances, including allowances for
doubtful accounts, and incurred related write-offs of $2,288,000, $1,426,000 and
$1,121,000, respectively.
STRAIGHT-LINE RENT
Certain of the Company's operating leases include scheduled increasing
monthly payments. In accordance with accounting principles generally accepted
in the United States, the Company has accounted for the leases to provide
straight-line charges to operations over the lives of the leases.
INVENTORIES
Inventories are valued at the lower of cost, determined on a first-in,
first-out basis, or market. Inventories at December 31, 1999 and 1998 are
summarized as follows:
<TABLE>
<CAPTION>
<S> <C> <C>
1999 1998
---------- ----------
Raw Materials. $2,135,000 $ 803,000
Finished Goods 3,837,000 2,052,000
---------- ----------
$5,972,000 $2,855,000
========== ==========
</TABLE>
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation and amortization
are provided using the straight-line method over the estimated useful lives of
the assets, which range from three to ten years. Depreciation and amortization
expenses are included in selling, general and administrative expenses in the
accompanying statements of operations.
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.
LONG-LIVED ASSETS
The Company follows Financial Accounting Standards Board Statement No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed of," which required impairment losses to be recorded on long-lived
assets used in operation when indicators of impairment are present.
GOODWILL
Goodwill is recorded at cost and is being amortized on straight-line basis
over five years. The recoverability of goodwill is assessed periodically based
on management estimates of undiscounted future operating income or from sales of
equity from the acquired business to which the goodwill relates.
FINANCING FEES
Financing fees incurred with the acquisition of the Company's existing
credit facility have been deferred and are being amortized over the life of the
debt.
F-7
<PAGE>
PATENTS AND TRADEMARKS
Costs associated with the establishment and defense of trademarks have been
capitalized and are being amortized over periods of fifteen to seventeen years
using the straight-line method.
ADVERTISING
The Company expenses advertising costs as incurred. These costs include
promotional literature, direct mailing brochures, telemarketing and trade shows.
Costs incurred relating to the production of television commercials are deferred
until the commercial has aired. The Company incurred $3,191,000, $1,920,000,
and $3,114,000 for advertising expenses in 1999, 1998 and 1997, 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 No. 13).
INCOME TAXES
The Company records its provision for income taxes using the liability
method. Under this method, deferred tax assets and liabilities are recognized
based on the anticipated future tax effects arising from financial reporting
basis and tax basis of the Company's assets and liabilities at currently enacted
tax rates.
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, 1999 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, 1999
follows:
<TABLE>
<CAPTION>
<S> <C> <C> <C>
1999 1998 1997
---------- ---------- ----------
Weighted average number of
common shares outstanding -
Basic . . . . . . . . . . . . . . 28,177,000 27,747,000 27,365,000
Dilutive effect of outstanding stock
options . . . . . . . . . . . . . - 474,000 -
---------- ---------- ----------
Weighted average number of
common shares outstanding -
Dilutive. . . . . . . . . . . . . 28,177,000 28,221,000 27,365,000
========== ========== ==========
</TABLE>
For the year ended December 31, 1998, 497,000 options have been excluded
from the calculation of dilutive shares applying for treasury stock method as
the option exercise prices were greater than average market price for the period
and therefore anti-dilutive.
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 become a C corporation. See Note 11 for explanation of pro forma provision
for income taxes and the related pro forma net income (loss).
USE OF ESTIMATES
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amounts of
assets, liabilities, disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
FAIR VALUE OF FINANCIAL INSTRUMENTS AND CONCENTRATION OF CREDIT RISK
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, 1999 and 1998.
Financial instruments that potentially subject the Company to
concentrations of credit risk consist primarily of cash and accounts receivable.
Accounts receivable are subject to credit limits, ongoing credit evaluations and
account monitoring procedures to minimize the risk of loss. In certain
instances, customer deposits are obtained which would also reduce the risk of
loss. Collateral is generally not required.
The Company sells the majority of its products and services to various
customers, which include a variety of large companies and distributors
throughout the United States, and to a limited extent, foreign customers. In
1999, 1998, and 1997, sales to the Company's largest customer accounted for
18.6 % 13.3%, and 15.6%, respectively, of total net sales. At December 31, 1999
and 1998, two customers represented 35.1% and 36.4% of accounts receivable,
respectively. In 1999, 1998, and 1997 sales to foreign customers accounted for
7.5 %, 10%, and 14.1%, respectively, of total net sales.
During 1999, approximately 64% of the Company's total purchases were from
four suppliers. Management believes that if the Company were unable to make
further purchases from these suppliers, it would be able to find alternative
suppliers with terms and quality levels similar to those currently in place.
STATEMENTS OF CASH FLOWS
The Company prepares its 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.
F-8
<PAGE>
NEW AUTHORITATIVE PRONOUNCEMENTS
In December 1999, the SEC staff released Staff Accounting Bulletin (SAB)
No. 101, Revenue Recognition, to provide guidance on the recognition,
presentation and disclosure of revenue in financial statements. Changes in
accounting to apply the guidance in SAB No. 101 may be accounted for as a change
in accounting principle effective January 1, 2000. Management has not yet
determined the complete impact of SAB No. 101 on the Company; however,
management does expect that application of SAB No. 101 will have a material
effect on the Company's revenue recognition and results of operations.
RECLASSIFICATIONS
Certain amounts in prior years have been reclassified to conform to the current
year's presentation.
3. SIGNIFICANT FOURTH QUARTER ADJUSTMENTS
The Company recorded the following significant adjustments in the fourth
quarter of fiscal 1999:
- - Legal settlement (see Note 12) $1,200,000
- - Provision for doubtful accounts for large
customer balances deemed uncollectable
in the fourth quarter 916,000
- - Provision for discounts and rebates tied
to fourth quarter sales 824,000
--------------
$2,940,000
========
4. BUSINESS COMBINATIONS
HEALTH & VITAMIN EXPRESS INC.
On February 15, 1999, the Company, through its newly formed wholly owned
subsidiary, HealthZone.com, purchased for $2,880,000 the issued and outstanding
shares of Health & Vitamin Express, Inc. (HVE), an e-commerce distribution
company. The purchase consideration consisted of the issuance of 363,636 shares
of the Company's common stock valued at $2,273,000 ($6.25 per share) and the
assumption of $571,000 of debt. The Company has accounted for the acquisition as
a purchase, and the excess purchase price, including acquisition costs, of
$2,906,000 over the fair value of net assets acquired has been allocated to
goodwill and is being amortized over 5 years.
In addition to the 363,636 shares issued upon acquisition, the Company may
contingently issue to the sellers of HVE (i) up to 272,727 shares of the
Company's common stock based upon certain revenue thresholds during first 42
months subsequent to February 15, 1999 (the "Revenue" shares), and (ii) up to
90,909 shares of the Company's common stock based upon certain profit thresholds
during the first seven years subsequent to February 15, 1999 (the "Profit"
shares). The Company has the right to repurchase up to 65% of the shares
issued for a period of one (1) year following the date of issuance at a purchase
price of $13.75 per share (the "Repurchase Price"). The repurchase price may be
adjusted if upon repurchase the closing bid price of the Company's common stock
as quoted on the Nasdaq National Market System exceeds $20 per share (the
"Market Price"), the Company will pay to the sellers 50% of the difference
between the Market Price and $20 per share. Furthermore, in the event Revenue
and Profit shares are issued because of a funding failure discussed below, the
repurchase price shall be reduced to $9.63 per share. The Company has granted
to the Sellers certain "demand registration rights" and "piggyback registration
rights" on these shares, if issued, in the event the Company undertakes a sale
of its securities to the public.
In addition, the Company is obligated to invest or contribute to HVE
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. The former
shareholders of HVE have filed a lawsuit against the Company asserting certain
claims under this agreement. The Company is currently in settlement discussions
with the plaintiffs and have proposed a settlement (see Note 12).
INHOLTRA
On March 10, 1999, the Company purchased for $13,250,000 certain assets and
liabilities of Inholtra Investment Holdings and Trading, N.V., Inholtra, Inc.,
and Inholtra Natural, Ltd. (collectively the Sellers). The purchase price
consisted of the payment of $3,250,000 in cash at closing, and the issuance of a
$10,000,000 promissory note. The promissory note was refinanced on June 10, 1999
in connection with the Company's new banking facility (see Note 8). The Company
has accounted for the acquisition as a purchase. The purchase price has been
allocated to the patents and trademarks associated with the Inholtra product,
and is being amortized over a fifteen-year period. 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 table below reflects the unaudited pro forma combined results of the
Company after giving effect to i) the March 10, 1999 acquisition of Inholtra,
and ii) the February 15, 1999 acquisition of Health & Vitamin Express, Inc, had
the acquisitions taken place at the beginning of fiscal 1998. The pro forma
financial information does not necessarily reflect the operating results that
would have occurred had the acquisition taken place from the beginning of each
period presented, nor is such information indicative of future operating
results.
<TABLE>
<CAPTION>
(Unaudited)
<S> <C> <C>
------------ --------
1999 1998
------------ --------
(in 000's)(in 000's)
Net sales. . . . . . . . . . . . . . $ 36,160 $36,048
Cost of sales. . . . . . . . . . . . 18,246 15,296
Selling, general and administrative. 24,423 19,490
Write-off of intangibles . . . . . . 640 -
Legal settlement . . . . . . . . . . 1,200 -
------------ --------
Income (loss) from operations. . . . (8,349) 1,262
Other expense. . . . . . . . . . . . (1,055) (1,291)
Benefit for income taxes . . . . . . (274) -
------------ --------
Net loss . . . . . . . . . . . . . . $ (9,130) $ (29)
------------ --------
Loss per share . . . . . . . . . . . $ (0.32) $ (0.00)
------------ --------
</TABLE>
The above amount includes adjustments for $283,000 and $1,466,000 for
additional goodwill amortization in 1999 and 1998, respectively, and $220,000
and $1,060,000 for additional interest expense in 1999 and 1998, respectively.
5. PROPERTY AND EQUIPMENT
Property and equipment consists of the following at December 31;
<TABLE>
<CAPTION>
<S> <C> <C>
1999 1998
------------ -----------
Machinery and equipment . . . . . . $ 303,000 $ 355,000
Furniture and equipment . . . . . . 1,438,000 758,000
Leasehold improvements. . . . . . . 910,000 303,000
------------ -----------
2,651,000 1,416,000
Less - Accumulated depreciation and
amortization. . . . . . . . . . . (1,135,000) (789,000)
------------ -----------
$ 1,516,000 $ 627,000
============ ===========
</TABLE>
6. BUILDING HELD FOR SALE/NOTE RECEIVABLE
On March 25, 1999, the Company completed the sale of its former 4Health,
Inc. corporate facility located in Boulder, Colorado (the "Property"). The
sales price for the Property was $2,350,000, which consisted of (i) cash
consideration of $600,000 that was paid at closing, (ii) assumption of a
$1,300,000 exiting first mortgage loan on the Property by the buyer, and (iii)
the receipt of a $450,000 promissory note secured by a second trust deed in the
Property. The note receivable is to be paid in monthly installments of $3,688,
including principal and interest at a rate of 7 1/2% per annum, until March 1,
2002 when the note is payable in full. The Company's results of operations for
the first quarter of 1999 include a gain of $481,000 that resulted from the sale
of this Property.
7. RECEIVABLES FROM OFFICERS AND SHAREHOLDER
Receivables from officers and shareholder consist of the following at
December 31; 1998:
<TABLE>
<CAPTION>
<S> <C> <C>
1998
----------
Receivable from the Chief Executive Officer, bearing interest
at an annual rate of 8 percent, collected in full in October 1999 $ 322,000
Receivable from the President, bearing interest at an annual rate
of 8 percent, $175,000 forgiven during 1999 in connection with
the President's continued employment and $175,000 forgiven in
connection with the termination of the President's employment
(See Note 12) $ 350,000
---------
$ 672,000
Less Current Portion $ 497,000
---------
$ 175,000
</TABLE>
F-9
<PAGE>
8. CREDIT FACILITY
As of December 31, 1998, the Company had outstanding borrowings 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, and then again on
May 9, 1999. Maximum borrowings under the amended line of credit were limited
to $5,000,000 based on eligible accounts receivable and inventories. Borrowings
under the line accrued interest at an annual rate of either prime plus .25
percent or LIBOR plus 2.0 percent. The amended line of credit was to expire on
June 30, 1999.
On June 10, 1999, the Company secured a new loan from a lending institution
that provides up to $20 million dollars of financing. The loan was subsequently
amended on January 21, 2000. The credit facility consists of a $13 million term
loan ("Term Loan") and up to a $7 million revolving loan ("Revolving Loan"),
subject to borrowing base availability and compliance with certain financial and
other covenants and agreements. At closing, $4,527,000 of loan proceeds were
disbursed to repay and close the Company's previous existing credit facility,
and $10,000,000 was disbursed to repay the promissory note issued in connection
with the acquisition of the assets of Inholtra Naturals, Ltd. (see Note 4).
The loans under the facility are secured by substantially all the assets of
the Company. Borrowings under the Term Loan bear interest at an annual rate of
either prime plus 2.25 percent or LIBOR plus 3.75 percent and are paid
quarterly. Borrowings under the Revolving Loan currently bear interest at an
annual rate of either prime plus 1.75 percent or LIBOR plus 3.0 percent, and are
paid quarterly. The rates are subject to decrease based upon the Company
satisfying certain operating performance levels. The credit facility agreement
contains certain financial and other covenants or restrictions, including the
maintenance of certain financial ratios, limitations on capital expenditures,
restrictions on acquisitions, limitations on the incurrence of indebtedness and
restrictions on dividends paid by the Company. As of December 31, 1999, the
Company was in violation of several covenants, including maintenance of certain
financial ratios. The Company obtained a waiver from the lender for these
covenants.
The Revolving Loan commitment, as revised in connection with the waiver
from the lender, expires on April 30 2001, when the loan is payable in full. As
of December 31, 1999, the maximum additional credit available under the
borrowing limitations was $564,000.
Selected information regarding borrowings under line of credit agreements
for 1999 and 1998 follows:
<TABLE>
<CAPTION>
<S> <C> <C>
1999 1998
----------- -----------
Average amount outstanding. . . . . . . . $3,967,000 $ 620,000
Maximum amount outstanding. . . . . . . . $6,436,000 $1,500,000
Weighted average interest rate during the
period . . . . . . . . . . . . . . . . 9.1% 8.4%
</TABLE>
The $13,000,000 Term Loan is payable in quarterly installments of $583,333
that began October 15, 1999, and which will increase to $750,000 on October 15,
2002, until the Loan is paid in full on April 15, 2004. In addition, the Company
shall make a payment of principal on the Term Loan in addition to the quarterly
payments in an amount equal to 50% of "Excess Cash Flow" (as defined) for each
fiscal year. Each Excess Cash Flow Payment shall be applied to reduce the
remaining regularly scheduled principal installments of the Term Loan in inverse
order of their maturity. Additionally, upon receipt by Borrower of any
unapplied insurance or condemnation proceeds, the proceeds of key-man life
insurance which has been assigned to an Agent, asset sale proceeds or debt sale
proceeds, the Company shall make a mandatory prepayment of the Term Loan in the
amount thereof. Furthermore, upon receipt by Borrower of any equity sale
proceeds, Borrower shall make a mandatory prepayment of (i) the Revolving Loan
to the limited extent necessary to fully prepay the Revolving Loan or, if less,
in such amount so that borrowing availability after giving effect thereto equals
$3,000,000 and (ii) to the extent of any balance of any equity sale proceeds
after the application to the Revolving Loan to the extent provided in the
preceding clause, the Term Loan; provided, however, if at the time of receipt of
such equity sale proceeds, no event of default has occurred and is continuing
and the debt to EBITDA ratio meets certain defined levels, then the amount of
such mandatory prepayment on the Term Loan shall be 50% of the amount of such
equity sale proceeds remaining after application to the Revolving Loan pursuant
to the preceding clause, and, further, provided, however, if such ratio is less
than a defined amount, then no such prepayment on the Term Loan from equity sale
proceeds need be made.
As a condition of the waiver, the Term Loan and Revolving Loan agreements
will be amended to change the expiration dates of both facilities to April 30,
2001. Further, under the proposed amendment the lender will require the Company
to meet certain revised financial ratios.
Future annual payments under the Term Loan, as revised, are as follows as
of December 31:
<TABLE>
<CAPTION>
<S> <C>
YEAR ENDED DECEMBER 31,
- ------------------------
2000 . . . . . . . . . . $ 2,332,000
2001 . . . . . . . . . . 10,085,000
------------
12,417,000
Less - current portion (2,332,000)
------------
$10,085,000
=============
</TABLE>
9. NOTES PAYABLE
Notes payable consists of the following at December 31:
<TABLE>
<CAPTION>
<BTB>
<S> <C> <C>
1999 1998
---------- -----------
Note payable to a bank assumed by the buyer of the Boulder Building. . $ - $1,300,000
(see Note 6)
Notes payable to three individuals, unsecured, bearing interest at an. 155,000 451,000
annual rate of 6.0 percent, payablein monthly installments of
principal and interest of approximately $26,000, due June 2000
Capital lease obligation (see Note 12) . . . . . . . . . . . . . . . . 123,000 -
---------- -----------
278,000 1,751,000
Less current portion . . . . . . . . . . . . . . . . . . . . . . . . . (176,000) (328,000)
---------- -----------
$ 102,000 $1,423,000
========== ===========
</TABLE>
Future annual payments under the notes payable and capital lease
obligations are as follows as of December 31, 1999:
<TABLE>
<CAPTION>
<S> <C>
Year ended
- -------------
December 31,
- -------------
2000. . . . . $176,000
2001. . . . . 23,000
2002. . . . . 26,000
2003. . . . . 30,000
2004. . . . . 23,000
- ------------- --------
278,000
=============
</TABLE>
10. WRITE-OFF OF INTANGIBLES
The Company acquired ID Technology in connection with a 1996 merger. ID
Technology is used in angioplasty procedures. In the third quarter of 1999, the
Company determined that the value of such technology was impaired and,
therefore, wrote-off the remaining unamortized balance of $390,000. In
addition, the Company wrote-off $250,000 of inventories related to this
technology. Total charges in connection with this impairment were $640,000.
11. 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 1998 and 1997 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 1998 and 1997 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 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, 1999 and 1998, the Company had recorded
valuation allowances.
The components of the deferred income tax assets (liabilities) as of
December 31, 1999 and 1998 are as follows:
<TABLE>
<CAPTION>
<S> <C> <C>
1999 1998
----------- --------------------
Allowance for doubtful accounts $1,265,000 $ 369,000
Inventory tax adjustment. . . . 484,000 83,000
Inventory reserve . . . . . . . 216,000 186,000
Warrants. . . . . . . . . . . . 373,000 52,000
Accrued liabilities . . . . . . 588,000 33,000
NOL carryforwards . . . . . . . 3,872,000 2,817,000
Other . . . . . . . . . . . . . - 288,000
----------- --------------------
6,798,000 3,828,000
Valuation allowance . . . . . . (6,798,000) (3,828,000)
----------- --------------------
$ - $ -
=========== ====================
</TABLE>
At December 31, 1999, the Company has federal net operating loss
carryforwards of approximately $9,405,000 expiring at various dates through
2019. 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 (benefit) for income taxes for the periods
ended December 31, 1999, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
<S> <C> <C> <C>
1999 1998 1997
---------- -------- ----------------
Current:
Federal. . . . . . . $(274,800) $287,000 $ (17,000)
State. . . . . . . . 800 131,000 (1,000)
---------- -------- ----------------
(274,000) 418,000 (18,000)
Deferred. . . . . . . . - 182,000 18,000
---------- -------- ----------------
Provision (benefit) for
income taxes . . . . $(274,000) $600,000 $ -
========== ======== ================
</TABLE>
Differences between the provision for income taxes and income taxes at the
statutory federal income tax rate are as follows:
<TABLE>
<CAPTION>
<S> <C> <C> <C>
December 31, 1999 December 31, 1998 December 31, 1997
------------------------- -------------------- ---------------------
Income tax at statutory federal rate (3,106,000) (34.0)% $550,000 34.0 % (1,604,000) (34.0)%
State income taxes . . . . . . . . . (502,000) (5.5) 131,000 8.1 (236,000) (5.0)
S corporation income not taxed at
C corporation rates . . . . . . . - - (374,000) (23.1) (765,000) (16.2)
Permanent differences. . . . . . . . 407,000 4.5 156,000 9.6 - -
Use of net operating loss. . . . . . - - (332,000) (20.5) - -
Carryforwards
Change in valuation allowance. . . . 2,970,000 32.5 469,000 29.0 3,271,000 69.3
Current losses not benefited . . . . 690,000 7.5
Reversal of 1998 excess provision. . (274,000) (3.0) - - - -
Other items, net . . . . . . . . . . (459,000) (5.0) - - (666,000) (14.1)
------------------------- -------------------- -----------------
(274,000) (3.0)% $600,000 37.1 % $ - -%
========================= ==================== ================
</TABLE>
The components of the unaudited pro forma provision for income taxes for
1998 and 1997 are as follows:
<TABLE>
<CAPTION>
<S> <C> <C>
December 31, 1998 December 31, 1997
------------- ------------------
Federal. . . . . . . . . . . . . . . $ 890,000 $ 633,000
------------- ------------------
State. . . . . . . . . . . . . . . . 271,000 114,000
------------- ------------------
1,161,000 747,000
Deferred . . . . . . . . . . . . . . 184,000 18,000
------------- ------------------
Pro forma provision for income taxes $ 1,345,000 $ 765,000
============= ==================
</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>
<CAPTION>
<S> <C> <C>
December 31, 1998 December 31, 1997
----------------------- ------------------------
Income tax at statutory federal
rate. . . . . . . . . . . . . 550,000 34.0 % (1,604,000) (34.0) %
State income taxes. . . . . . . 271,000 16.8 (236,000) (5.0)
Permanent differences . . . . . 372,000 22.9 - -
Use of net operating loss . . . (332,000) (20.5) - -
Carryforwards
Change in valuation allowance . 484.000 29.9 3,271,000 69.3
Other, net. . . . . . . . . . . - - (666,000) (14.1)
----------------------- ------------------------
1,345,000 83.1 % 765,000 16.2 %
======================= ========================
</TABLE>
F-10
<PAGE>
12. COMMITMENTS AND CONTINGENCIES
CAPITAL AND OPERATING LEASE OBLIGATIONS PAYABLE
The Company leases its facility and certain property and equipment under
long-term operating leases expiring at various dates through 2004. The Company
also leases property and equipment under a capital lease. Included in property
and equipment is $132,000, at cost, related to capital leases.
The future minimum lease payments at December 31, 1999 under capital and
operating leases are as follows:
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Capital Operating
Leases Leases Total
--------- ---------- ----------
2000 . . . . . . . . . . . . $ 35,000 $ 672,000 $ 707,000
2001 . . . . . . . . . . . . 35,000 667,000 702,000
2002 . . . . . . . . . . . . 35,000 656,000 691,000
2003 . . . . . . . . . . . . 35,000 647,000 682,000
2004 . . . . . . . . . . . . 23,000 292,000 315,000
--------- ---------- ----------
Total future minimum lease
payments. . . . . . . . . 163,000 $2,934,000 $3,097,000
========== ==========
Less - amount representing
interest at 12% . . . . . (40,000)
---------
Present value of minimum
capital lease payments. . 123,000
Less - current portion . . (21,000)
---------
102,000
=========
</TABLE>
Total rental expense for the years ended December 31, 1999, 1998 and 1997
was approximately $588,000, $557,000 and $390,000, respectively.
EMPLOYMENT CONTRACTS
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 was 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 was employed as the Chief Executive
Officer and as a member of the Executive Committee with all duties and
responsibilities normally associated with this position until April 20, 1999. On
that date, Mr. Irwin resigned, as Chief Executive Officer of Omni Nutraceuticals
and his employment agreement was terminated effective April 20, 1999. In
connection with his resignation the Board of Directors appointed him as Chief
Executive Officer of HealthZone.com, the Company's wholly owned subsidiary
("HealthZone"). In October of 1998 (as revised in June 1999), the Company
entered into an agreement to hire Mr. Louis Mancini as President and Chief
Operating Officer and, subsequently, Chief Executive Officer.
These employment agreements provided for: (i) annual salaries of $225,000,
and $300,000 for Messrs. Duncan and Mancini, respectively; (ii) the right for
Mr. Duncan and Mr. Mancini to receive an annual bonus based on certain
performance incentives.
On March 12, 2000, Mr. Duncan agreed to resign from the Board of Directors
of the Company and agreed to terminate his employment agreement. Also on March
12, 2000, the Board of Directors terminated Mr. Mancini's employment. Klee Irwin
replaced Mr. Mancini as President and Chief Executive Officer.
As a result of the March 12, 2000 employment realignments, the Company has
the following obligations to the above individuals:
- - Lindsay Duncan: extension of exercise and expiration dates for
1,003,029 stock options to March 2007
- - Louis Mancini: payout accrued vacation, forgiveness of $175,000
note receivable (see Note 6)
- - Klee Irwin: none
LEGAL
On December 23, 1999, a lawsuit was filed against the Company, the
Company's former President and Chief Executive Officer, Klee Irwin, and the
Company's then current President, Louis Mancini, entitled David Mandel, Jeffrey
---------------------
D. Segal and Gordon D. Barker v. Omni Nutraceuticals, Inc., Klee Irwin, Louis
- ------------------------------------------------------------------------------
Mancini and Does 1 through 50 (Superior Court of the State of California, County
- -----------------------------
of Los Angeles - Central District, Case No. BC222263). The lawsuit includes
various causes of action, including fraud, negligent misrepresentation,
misappropriation of trade secrets, unjust enrichment, unfair business practices
and violations of the Racketeer Influenced and Corrupt Organizations Act (RICO)
(under which triple damages have been claimed). The lawsuit is based on various
alleged claims, including that the plaintiffs, the sole shareholders of Health &
Vitamin Express ("HVE"), were fraudulently induced to enter into a merger
agreement pursuant to which HVE became a wholly-owned subsidiary of the Company
based on false representations of the defendants. The lawsuit does not specify
the amount of damages claimed. Although the Company believes that the claims
made in the lawsuit are without merit, the Company is currently in settlement
negotiations with the plaintiffs in the lawsuit. The proposed terms of the
settlement provide that the Company will issue an additional 363,636 shares of
common stock to the former shareholders of HVE. Management believes that the
claims will be settled in accordance with the proposed settlement agreement. As
such, the Company has estimated and recorded a charge of $1,200,000 in the
accompanying statement of operations as of December 31, 1999 in connection with
this claim.
The Company has been named as defendant in various other 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.
13. 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, 1999 and
1998, no Preferred Stock is issued or outstanding. Subsequent to December 31,
1999, the Company amended its Articles of Incorporation to allow for the
issuance of a new series of Convertible Preferred Stock (see Note 16).
COMMON STOCK
In February 1999, the Company issued 363,636 shares of common stock in
connection with the acquisition of HVE (see Note 4).
In August 1999, the Company entered into a three-year agreement with an
individual to be the spokesperson for its Inholtra product line. The Company
issued 15,000 shares of common stock and recorded compensation of $36,000 in
connection with the issuance of these shares. In addition, the Company granted
this individual an option to purchase 75,000 shares of common stock. The
Company recorded compensation expense of $29,000 in 1999 in connection with the
grant of these options to this non-employee.
In October 1999, the Company issued 13,000 shares of common stock to its
previous facility landlord in lieu of cash for one month's rent due. The
Company recorded expense of $19,000 in connection with the issuance of these
shares.
In October 1999, the former Chief Executive Officer and shareholder
returned 941,436 shares to the Company as a contribution to capital. The
Company retired these returned shares.
During 1999, the Company issued 25,000 shares of common stock to a
consultant in exchange for services performed during the same period. The
Company recorded compensation of $120,000 in connection with the issuance of
these shares.
In September 1997, pursuant to a clause in a July 1996 merger agreement,
500,000 additional shares 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. The warrants are exercisable for five years from the
date of issuance. The Company recorded professional services expense of
$388,000, $388,000 and $275,000 in 1999, 1998 and 1997, respectively, in
connection with the fair value of these warrants based upon the Black Scholes
pricing model. As of December 31, 1999, all warrants were still outstanding.
During the year ended December 31, 1999, the Company entered into a
consulting agreement with an advisor. In consideration of the consulting
services, the Company issued to the advisor warrants to purchase 62,500 shares
of the Company's common stock at an exercise price of $4.75 per share. The
Company recorded professional services expense of $415,000 in 1999 in connection
with the fair value of these warrants based upon the Black Scholes pricing
model. These warrants were exercised subsequent to year-end.
Subsequent to year-end, the Company issued 775,000 warrants to acquire
shares of common stock at $2.25 per share in connection with the issuance of a
new series of Convertible Preferred Stock (see Note 16).
F-11
<PAGE>
STOCK OPTIONS
In 1996, the Company adopted the Long-Term Stock Incentive Plan (LTSIP).
This plan was amended on December 22, 1999. Under the terms of the LTSIP, the
Company is authorized to issue incentive and non-qualified stock options to its
directors, officers, key employees and consultants totaling up to 4,500,000
shares of common stock. At December 31, 1999, 653,402 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>
<S> <C> <C> <C> <C>
Exercisable
WEIGHTED WEIGHTED
AVERAGE AVERAGE
NUMBER OF EXERCISE NUMBER OF EXERCISE
OPTIONS PRICE OPTIONS PRICE
----------- --------- --------- ---------
Balance, January 1, 1997 . 866,103 $ 4.35
Granted. . . . . . . . . . 192,500 5.92
Exercised. . . . . . . . . (186,396) 4.01
Cancelled. . . . . . . . . (129,564) 6.00
----------- ---------
Balance, December 31, 1997 742,643 4.57 585,516 $ 4.24
========= =========
Granted. . . . . . . . . . 1,853,860 5.22
Exercised. . . . . . . . . ( 38,341) 4.51
Cancelled. . . . . . . . . (111,991) 5.46
----------- ---------
Balance, December 31, 1998 2,446,171 5.01 675,253 $ 4.49
========= =========
Granted. . . . . . . . . . 3,167,500 2.15
Exercised. . . . . . . . . (19,670) 4.33
Cancelled. . . . . . . . . (1,747,403) 5.03
----------- ---------
Balance, December 31, 1999 3,846,598 $ 2.58 1,991,904 $ 3.34
=========== ========= ========= =========
</TABLE>
Weighted average fair value of all options granted during years ended
December 31 1999, 1998 and 1997 were $1.13, $1.99 and $1.62, respectively,
F-12
<PAGE>
The following table summarizes information about the options outstanding at
December 31, 1999:
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
Number Weighted Weighted Weighted
outstanding at Average Average Exercisable at Average
Range of. . . . December 31, Exercise Remaining December 31, Exercise
Exercise Prices 1999 Price Life 1999 Price
$ 2.00 - $2.99 1,137,500 $ 2.23 9.7 years 975,000 $2.21
$ 3.00 - $3.99 1,818,955 3.20 8.8 years 593,871 3.61
$ 4.00 - $6.00 870,729 5.77 8.9 years 413,229 5.51
$ 6.01 - $8.75 19,414 7.40 7.5 years 9,804 7.93
3,846,598 $ 3.51 1,991,904 $3.34
========= ======= ========= =====
</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. 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 1999, 1998 and 1997 as follows:
<TABLE>
<CAPTION>
<S> <C> <C> <C>
1999 1998 1997
------------- -------- ------------
Additional compensation expense . . . $ 3,004,000 $672,000 $ 281,000
Pro forma net income (loss) . . . . . (11,865,000) 346,000 (4,998,000)
Pro forma earnings (loss) per share:
Basic. . . . . . . . . . . . . . . $ (0.43) $ 0.01 $ (0.18)
Diluted. . . . . . . . . . . . . . $ (0.43) $ 0.01 $ (0.18)
</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>
<S> <C> <C> <C>
1999 1998 1997
-------- ------------- ----------
Risk free interest rate 6.03% 4.34%-5.55% 5.97%
Expected life . . . . . 4 years 2 to 7 years 2.2 years
Volatility. . . . . . . 90.00% 60.00% 60.68%
Expected dividend yield None None None
</TABLE>
14. RELATED PARTY TRANSACTIONS
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.
During the year ended December 31, 1999, a bonus of $50,000 was paid to Mr.
Lindsey Duncan, Chairman of the Board.
On October 8, 1999, the Company and Mr. Klee Irwin entered into a
settlement agreement (the 'Settlement Agreement') in order to resolve certain
mutual claims that had arisen between the Company and Mr. Irwin. Subsequent to
year-end, the Settlement Agreement and all ancillary agreements thereto,
including the voting agreement between Mr. Duncan and Mr. Irwin were terminated.
On or about October 8, 1999, Mr. Irwin made a capital contribution of
$305,000, and returned 941,436 shares of Omni Nutraceutical common stock to the
Company.
15. SEGMENT INFORMATION
In 1997 and 1998, the Company operated as one reportable business segment.
Since February 15, 1999, concurrent with the acquisition of the Company's
e-commerce operations by its subsidiary HealthZone (see Note 4), the Company's
businesses have been organized, managed and internally reported as two segments:
wholesale and retail product distribution, and e-commerce. These segments are
based on differences in products, customer type and sales and distribution
methods. The distribution segment consists primarily of the sales of the
Company's products directly to retailers, wholesalers, mass merchants and
distributors who stock and manage inventory within health stores. The Company's
e-commerce business, HealthZone.com, enables customers to choose from the
Company's brand-name products and also gives customers the opportunity to buy
products from other vendors.
DISTRIBUTION E-COMMERCE TOTAL
------------ ---------- -----
1999
- ----
Net sales $35,013,000 $295,000 $35,308,000
Cost of sales 17,635,000 212,000 17,847,000
Gross profit 17,378,000 83,000 17,461,000
Costs and expenses 25,050,000 717,000 25,767,000
Loss from Operations (7,672,000) (634,000) (8,306,000)
Interest income 32,000 - 32,000
Interest expense (1,326,000) (13,000) (1,339,000)
Other income (expense) 479,000 (1,000) 478,000
Benefit for income taxes (274,000) - (274,000)
Net loss (8,213,000) (648,000) (8,861,000)
Depreciation and amortization 1,875,000 17,000 1,892,000
Assets 31,669,000 58,000 31,727,000
Expenditures for long-lived
assets 15,154,000 - 15,154,000
16. SUBSEQUENT EVENTS
Financings - On January 24, 1999, the Company completed an equity
----------
transaction with American Equities, LLC and Corporate Financial Enterprises,
Inc. that will provide up to $5,000,000 of capital to the Company and its wholly
owned subsidiary HealthZone.com (HealthZone).
Under the terms of the transaction, the Company will issue up to 4,500,000
shares of its newly created 5% Convertible Preferred Stock, Series A ("Preferred
Shares ") and seven year warrants to purchase up to an aggregate of 775,000
shares of common stock at an exercise price of $2.25 per share, subject to
adjustment. The aggregate purchase price for the Preferred Shares and warrants
is $4,000,000 payable in two installments, the first in the amount of $2,000,000
that was funded on January 21, 2000, and subject to the satisfaction of certain
performance targets, the second in the amount of $2,000,000. Concurrently with
the first installment payment, HealthZone issued 222,222 shares of its common
stock (representing approximately 10% of HealthZone's issued and outstanding
shares of common stock) and a seven year warrant to purchase up to 37,000 shares
of its common stock at an exercise price, subject to adjustment, equal to the
lesser of $1.00 or 70% of the lowest price received by HealthZone on future
sales of its capital stock, for a purchase price of $1,000,000. The Company has
also agreed to lend HealthZone $1,000,000 out of second installment proceeds.
The Company will use the proceeds from the sale of its securities to reduce
indebtedness and for working capital purposes. The Preferred Shares are
convertible into an aggregate of 3,000,000 shares of Company common stock
(assuming issuance of the full amount of Preferred Shares), subject to
adjustment. The Preferred Shares are not redeemable but may be subject to
mandatory conversion under certain circumstances. The Preferred Shares will vote
together with the common stockholders on an as converted basis and will have
separate class voting rights to elect one director and in connection with
certain corporate changes. The Preferred Shares will carry a liquidation
preference of $0.60 per share and an annual dividend rate of $0.05 per share,
payable semi-annually. The Company may elect to pay the dividend in additional
Preferred Shares at a rate of .05 shares per share. The investor was also
provided certain registration rights in connection with this transaction. In
connection with the above transaction, the Company has (i) amended its Articles
of Incorporation to provide for the Preferred Shares, (ii) amended the
Settlement Agreement between the Company and Klee Irwin as it related to certain
funding provisions of HealthZone, and (iii) entered into two separate consulting
agreements, one of which requires the Company to issue 560,000 shares of its
Common Stock. Further, in connection with the above transaction, the Chairman
and the former Chief Executive Officer, both significant shareholders, each sold
220,000 (totaling 440,000) shares of their personally held Company common stock
to the investing parties for $250,000 (totaling $500,000).
On March 29, 1999, the Company completed a private sale of its securities
whereby 700,000 shares of common stock of the Company were sold for an aggregate
purchase price of $2,100,000. The investor was also provided certain
registration rights in connection with this transaction.
The pro forma effect of these transactions as if they had occurred at
December 31, 1999 is as follows, before giving effect to any application of the
proceeds:
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Balance Pro forma Pro forma
December 31, 1999 Adjustments December 31, 1999
------------------ ------------ ------------------
ASSETS
Current assets . . . . . . . . . . . . . . $ 13,298,000 $ 5,100,000 $ 18,398,000
Other assets . . . . . . . . . . . . . . . 18,429,000 - 18,429,000
------------------ ------------ ------------------
Total assets . . . . . . . . . . . . . . . $ 31,727,000 $ 5,100,000 $ 36,827,000
================== ============ ==================
LIABILITIES AND SHAREHOLDERS' EQUITY
Line of credit . . . . . . . . . . . . . . $ 6,436,000 $ - $ 6,436,000
Other current liabilities. . . . . . . . . 13,226,000 - 13,226,000
Debt, net of current portion . . . . . . . 10,187,000 - 10,187,000
Shareholders' equity . . . . . . . . . . . 1,878,000 5,100,000 6,978,000
------------------ ------------ ------------------
Total liabilities and shareholders' equity $ 31,727,000 $ 5,100,000 $ 36,827,000
================== ============ ==================
</TABLE>
Other - In January 2000, the Company issued 75,000 shares of common stock
-----
to its three then current outside board of directors as compensation for
services.
Effective January 24, 2000, the Company entered into a two year consulting
agreement with an advisor that required the issuance of 1,200,000 shares of the
Company's common stock. 400,000 of these shares may be returned to the Company
if at any time during the second year of the consulting agreement the Company
gives the consultant a properly noticed Early Termination Notice.
In March 2000, the Company formed a joint venture for the purpose of
distributing its products throughout the European Union. The Company
contributed $5,000 for a 50 percent ownership in the venture.
In March and April 2000, the Company signed term sheets constituting their
intent to acquire two separate companies. Under the currently proposed terms,
if the acquisitions are consummated, the Company will issue 240,000 shares of
common stock as purchase consideration (120,000 shares for each acquisition).
F-13
<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.
Dated: July 14, 2000 OMNI NUTRACEUTICALS, INC.
By: /s/ KLEE IRWIN
Klee Irwin
CHIEF EXECUTIVE OFFICER
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.
SIGNATURE TITLE DATE
--------- ----- ----
/s/KLEE IRWIN Chief Executive Officer July 14, 2000
--------------
Klee Irwin
/s/ ANDREW VOLLERO, JR. Director July 14, 2000
-------------------------
Andrew Vollero, Jr.
/s/ ALBERT KASHANI Director July 14, 2000
--------------------
Albert Kashani
/s/ CHRISTOF BALLIN Director July 14, 2000
---------------------
Christof Ballin
/s/ Herman Rosenman Chief Financial Officer July 14, 2000
-----------------
Herman Rosenman
