**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,DC 20549**

**FORM 10-Q**

**QUARTERLY REPORT PURSUANT TO SECTION 13OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

**Forthe quarterly period ended June 30, 2005**

Commission file number 000-23731

**NUTRACEUTICAL INTERNATIONAL CORPORATION**

(Exact name of registrantas specified in its charter)

| **Delaware**                                           | **87-0515089**                     |
|--------------------------------------------------------|------------------------------------|
| (State of  incorporation)                              | (IRS Employer  Identification No.) |
| **1400 Kearns Boulevard, 2nd Floor,  Park City, Utah** | **84060**                          |
| (Address of  principal executive office)               | (Zip code)                         |

 

**(435) 655-6106**

(Registrant’s telephonenumber, including area code)

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.

YES* *x   NO o

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2of the Exchange Act).

YES x   NO o

At July 29,2005, the registrant had 11,465,603 shares of common stock outstanding.

 

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**NUTRACEUTICAL INTERNATIONAL CORPORATION**

**INDEX**
| Description   | ** ** | ** **             | ** ** | ** **                                                                                                                                     | ** ** | **Page No.** |
|---------------|------------|------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|
| Part I.  |       | Financial  Information |       | 3                                                                                                                                              |
|          |       | Item 1.           |       | Financial  Statements                                                                                                                          |       | 3                 |
|          |       |                   |       | Condensed Consolidated Balance Sheets—  September 30, 2004 and June 30, 2005                                                    |       | 3                 |
|          |       |                   |       | Condensed Consolidated Statements of Operations and  Comprehensive Income—Three Months and Nine Months Ended June 30, 2004  and 2005 |       | 4                 |
|          |       |                   |       | Condensed Consolidated Statements of Cash Flows—  Nine Months Ended June 30, 2004 and 2005                                           |       | 5                 |
|          |       |                   |       | Notes to Condensed Consolidated Financial Statements                                                                                           |       | 6                 |
|          |       | Item 2.           |       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                                                    |       | 10                |
|          |       | Item 3.           |       | Quantitative and Qualitative Disclosures about Market  Risk                                                                                    |       | 18                |
|          |       | Item 4.           |       | Controls and Procedures                                                                                                                        |       | 18                |
| Part II. |       | Other  Information     |       | 19                                                                                                                                             |
|          |       | Item 1.           |       | Legal  Proceedings                                                                                                                             |       | 19                |
|          |       | Item 6.           |       | Exhibits and Reports on Form 8-K                                                                                                          |       | 19                |

 

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**PART I—FINANCIALINFORMATION**

**Item 1.**                        FinancialStatements

**NUTRACEUTICAL INTERNATIONAL CORPORATIONCONDENSED CONSOLIDATEDBALANCE SHEETS(unaudited)(dollars in thousands)**
| ** **                                     | ** ** | **September 30,** | ** ** | **June 30,** | ** ** | ** ** |
|------------------------------------------------|------------|------------------------|------------|-------------------|------------|------------|
| ** **                                     | ** ** | **2004(1)**            | ** ** | **2005**          | ** ** | ** ** |
| **ASSETS**                                     |       |                   |       |              |       |       |   |   |
| Current assets                                 |       |                   |       |              |       |       |   |   |
| Cash                                           |       |                   | $          | 2,134             |       |       | $ | 2,027 |   |   |
| Accounts receivable, net                       |       |                   | 10,567     |              |       | 10,369     |   |   |
| Inventories, net                               |       |                   | 24,058     |              |       | 25,281     |   |   |
| Prepaid expenses and other current assets      |       |                   | 3,372      |              |       | 2,109      |   |   |
| Deferred income taxes                          |       |                   | 1,118      |              |       | 1,188      |   |   |
| Total current assets                           |       |                   | 41,249     |              |       | 40,974     |   |   |
| Property, plant  and equipment, net            |       |                   | 22,657     |              |       | 24,289     |   |   |
| Goodwill                                       |       |                   | 14,108     |              |       | 18,387     |   |   |
| Intangible  assets, net                        |       |                   | 7,055      |              |       | 7,100      |   |   |
| Other non-current  assets, net                 |       |                   | 796        |              |       | 652        |   |   |
| Deferred income  taxes, net                    |       |                   | 7,522      |              |       | 6,303      |   |   |
|                                           |       |                   | $          | 93,387            |       |       | $ | 97,705 |   |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY** |       |                   |       |              |       |       |   |   |
| Current liabilities                            |       |                   |       |              |       |       |   |   |
| Accounts payable                               |       |                   | $          | 9,844             |       |       | $ | 8,530 |   |   |
| Accrued expenses                               |       |                   | 4,950      |              |       | 4,772      |   |   |
| Total current liabilities                      |       |                   | 14,794     |              |       | 13,302     |   |   |
| Long-term debt                                 |       |                   | 6,500      |              |       | 5,000      |   |   |
| Other non-current  liabilities                 |       |                   | 494        |              |       | 245        |   |   |
| Total liabilities                              |       |                   | 21,788     |              |       | 18,547     |   |   |
| Stockholders’ equity                      |       |                   |       |              |       |       |   |   |
| Common stock                                   |       |                   | 119        |              |       | 114        |   |   |
| Additional paid-in capital                     |       |                   | 45,530     |              |       | 39,046     |   |   |
| Retained earnings                              |       |                   | 30,380     |              |       | 39,875     |   |   |
| Accumulated other comprehensive income         |       |                   | 173        |              |       | 123        |   |   |
| Treasury stock                                 |       |                   | (4,603     | )                 |       | —     |   |   |
| Total stockholders’ equity                |       |                   | 71,599     |              |       | 79,158     |   |   |
|                                           |       |                   | $          | 93,387            |       |       | $ | 97,705 |   |   |

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(1)          The condensed consolidatedbalance sheet as of September 30, 2004 has been prepared using informationfrom the audited financial statements at that date.

The accompanying notes are an integral part of these condensed consolidated financial statements.

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**NUTRACEUTICAL INTERNATIONAL CORPORATIONCONDENSED CONSOLIDATEDSTATEMENTS OF OPERATIONSAND COMPREHENSIVE INCOME(unaudited)(dollars in thousands, except per share data)**
| ** **                                          | ** ** | **Three months ended June 30,** | ** ** | **Nine months ended June 30,** | ** ** |
|-----------------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                          | ** ** | **2004**                                            | ** ** | **2005**                                           | ** ** | **2004** | ** ** | **2005** | ** ** |
| Net sales                                           |       | $                                                   | 33,787     |                                               | $          | 37,233 |   | $ | 104,614 |   | $ | 111,381 |   |
| Cost of sales                                       |       | 15,984                                              |       | 18,092                                             |       | 49,785 |   | 53,929 |   |
| Gross profit                                        |       | 17,803                                              |       | 19,141                                             |       | 54,829 |   | 57,452 |   |
| Operating expenses                                  |       |                                                |       |                                               |       |   |   |   |   |
| Selling, general and administrative                 |       | 12,808                                              |       | 13,676                                             |       | 37,251 |   | 41,188 |   |
| Amortization of intangible assets                   |       | 93                                                  |       | 94                                                 |       | 281 |   | 282 |   |
| Income from  operations                             |       | 4,902                                               |       | 5,371                                              |       | 17,297 |   | 15,982 |   |
| Interest and  other expense, net                    |       | 172                                                 |       | 162                                                |       | 650 |   | 542 |   |
| Income before  provision for income taxes           |       | 4,730                                               |       | 5,209                                              |       | 16,647 |   | 15,440 |   |
| Provision for  income taxes                         |       | 1,821                                               |       | 2,006                                              |       | 6,409 |   | 5,945 |   |
| Net income                                          |       | $                                                   | 2,909      |                                               | $          | 3,203 |   | $ | 10,238 |   | $ | 9,495 |   |
| Other comprehensive  income/(loss)                  |       |                                                |       |                                               |       |   |   |   |   |
| Foreign currency translation adjustment, net of tax |       | (3                                                  | )          | (73                                                | )          | 23 |   | (50 | ) |
| Comprehensive  income                               |       | $                                                   | 2,906      |                                               | $          | 3,130 |   | $ | 10,261 |   | $ | 9,445 |   |
| Net income per common  share                        |       |                                                |       |                                               |       |   |   |   |   |
| Basic                                               |       | $                                                   | 0.25       |                                               | $          | 0.28 |   | $ | 0.91 |   | $ | 0.82 |   |
| Diluted                                             |       | 0.24                                                |       | 0.27                                               |       | 0.87 |   | 0.80 |   |
| Weighted average common  shares outstanding         |       |                                                |       |                                               |       |   |   |   |   |
| Basic                                               |       | 11,496,923                                          |       | 11,560,503                                         |       | 11,290,942 |   | 11,539,643 |   |
| Dilutive effect of stock options and warrants       |       | 526,193                                             |       | 199,073                                            |       | 499,120 |   | 264,315 |   |
| Diluted                                             |       | 12,023,116                                          |       | 11,759,576                                         |       | 11,790,062 |   | 11,803,958 |   |

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

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**NUTRACEUTICAL INTERNATIONAL CORPORATIONCONDENSED CONSOLIDATEDSTATEMENTS OF CASH FLOWS(unaudited)(dollars in thousands)**
| ** **                                                                          | ** ** | **Nine months ended  June 30,** | ** ** |
|-------------------------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                          | ** ** | **2004**                                       | ** ** | **2005** | ** ** |
| **Cash flows from operating  activities**                                           |       |                                           |       |   |   |
| Net income                                                                          |       | $                                              | 10,238     |   | $ | 9,495 |   |
| Adjustments to reconcile  net income to net cash provided by   operating activities |       |                                           |       |   |   |
| Depreciation and amortization                                                       |       | 3,207                                          |       | 3,279 |   |
| Amortization of deferred financing fees                                             |       | 137                                            |       | 137 |   |
| Losses on disposals of property and equipment                                       |       | 88                                             |       | 40 |   |
| Deferred income taxes                                                               |       | 964                                            |       | 1,003 |   |
| Tax benefit from stock option exercises                                             |       | 3,193                                          |       | 333 |   |
| Changes in assets and liabilities, net of effects of  acquisitions                  |       |                                           |       |   |   |
| Accounts receivable, net                                                            |       | 1,372                                          |       | 416 |   |
| Inventories, net                                                                    |       | (2,725                                         | )          | (387 | ) |
| Prepaid expenses and other current assets                                           |       | (2,540                                         | )          | 1,311 |   |
| Other non-current assets, net                                                       |       | 20                                             |       | (18 | ) |
| Accounts payable                                                                    |       | 893                                            |       | (1,314 | ) |
| Accrued expenses                                                                    |       | 494                                            |       | (257 | ) |
| Other non-current liabilities                                                       |       | —                                         |       | (24 | ) |
| Net cash provided by operating activities                                           |       | 15,341                                         |       | 14,014 |   |
| **Cash flows from investing  activities**                                           |       |                                           |       |   |   |
| Acquisitions of  businesses, net of cash acquired                                   |       | (9,388                                         | )          | (5,821 | ) |
| Purchases of  property and equipment                                                |       | (4,132                                         | )          | (4,350 | ) |
| Net cash used in investing activities                                               |       | (13,520                                        | )          | (10,171 | ) |
| **Cash flows from financing  activities**                                           |       |                                           |       |   |   |
| Payments on other  non-current liabilities                                          |       | (225                                           | )          | (225 | ) |
| Proceeds from  long-term debt                                                       |       | 9,000                                          |       | 5,500 |   |
| Payments on  long-term debt                                                         |       | (12,000                                        | )          | (7,000 | ) |
| Proceeds from  issuances of common stock                                            |       | 2,705                                          |       | 831 |   |
| Purchases of common  stock for treasury                                             |       | (425                                           | )          | (3,050 | ) |
| Net cash used in financing activities                                               |       | (945                                           | )          | (3,944 | ) |
| Effect of  exchange rate changes on cash                                            |       | 5                                              |       | (6 | ) |
| Net increase  (decrease) in cash                                                    |       | 881                                            |       | (107 | ) |
| Cash at beginning  of period                                                        |       | 2,196                                          |       | 2,134 |   |
| Cash at end of period                                                               |       | $                                              | 3,077      |   | $ | 2,027 |   |

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

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**NUTRACEUTICAL INTERNATIONAL CORPORATIONNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (dollars in thousands, except per share data)**

**1. INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

In the opinion of management, the accompanyingunaudited condensed consolidated financial statements include all necessaryadjustments (consisting of normal recurring accruals) to present fairly the consolidatedfinancial position of Nutraceutical International Corporation and itssubsidiaries (the “Company”) as of June 30, 2005, the results of theiroperations for the three months and nine months ended June 30, 2004 and2005 and their cash flows for the nine months ended June 30, 2004 and2005, in conformity with accounting principles generally accepted in the UnitedStates of America for interim financial information applied on a consistentbasis. The results for the three months and nine months ended June 30,2005 are not necessarily indicative of the results to be expected for the fullfiscal year.

Certain information andfootnote disclosures normally included in financial statements prepared inaccordance with accounting principles generally accepted in the United Statesof America have been omitted. Accordingly, these financial statements should beread in conjunction with the Company’s Form 10-K for the fiscal year endedSeptember 30, 2004, which was filed with the Securities and ExchangeCommission on December 3, 2004.

**2. ACCOUNTSRECEIVABLE, NET**

Accountsreceivable, net of allowances for sales returns and doubtful accounts, were asfollows:
| ** **           | ** ** | **September 30,** | ** ** | **June 30,** | ** ** |
|----------------------|------------|------------------------|------------|-------------------|------------|
| ** **           | ** ** | **2004**               | ** ** | **2005**          | ** ** |
| Accounts  receivable |       |                   | $          | 12,300            |       |   | $ | 12,196 |   |
| Less allowances      |       |                   | (1,733     | )                 |       | (1,827 | ) |
| ** **           |       |                   | $          | 10,567            |       |   | $ | 10,369 |   |

 

**3. INVENTORIES, NET**

Inventories,net of reserves for slow moving, obsolete and/or damaged inventory, were asfollows:
| ** **      | ** ** | **September 30,** | ** ** | **June 30,** | ** ** |
|-----------------|------------|------------------------|------------|-------------------|------------|
| ** **      | ** ** | **2004**               | ** ** | **2005**          | ** ** |
| Raw materials   |       |                   | $          | 7,477             |       |   | $ | 9,627 |   |
| Work-in-process |       |                   | 6,162      |              |       | 6,784 |   |
| Finished goods  |       |                   | 12,290     |              |       | 10,993 |   |
|            |       |                   | 25,929     |              |       | 27,404 |   |
| Less reserves   |       |                   | (1,871     | )                 |       | (2,123 | ) |
|            |       |                   | $          | 24,058            |       |   | $ | 25,281 |   |

 

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**NUTRACEUTICAL INTERNATIONAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (unaudited) (dollars in thousands, except per share data)**

**4. GOODWILL AND INTANGIBLE ASSETS**

Thechange in the carrying amount of goodwill from September 30, 2004 to June 30,2005 was as follows:
| ** **                                                         | ** ** | **Goodwill** | ** ** | ** ** |
|--------------------------------------------------------------------|------------|--------------|------------|------------|
| Balance as of  September 30, 2004                             |       | $14,108      |       |       |
| Goodwill attributable to fiscal 2005 first quarter  acquisition    |       | 1,368        |       |       |
| Goodwill attributable to fiscal 2005 second quarter  acquisition   |       | 3,001        |       |       |
| Purchase accounting adjustment related to fiscal  2004 acquisition |       | (90          | )          |       |
| Balance as of  June 30, 2005                                  |       | $18,387      |       |       |

 

Thecarrying amounts of intangible assets at September 30, 2004 and June 30,2005 were as follows:
| ** **                                     | ** ** | **September 30, 2004** | ** ** | **June 30, 2005** | ** ** | **Weighted-** | ** ** |
|------------------------------------------------|------------|----------------------------------|------------|-----------------------------|------------|---------------|------------|
| ** **                                     | ** ** | **Gross**                        | ** ** | ** **                  | ** ** | **Net**       | ** ** | **Gross** | ** ** | ** ** | ** ** | **Net** | ** ** | **Average** | ** ** |
| ** **                                     | ** ** | **Carrying**                     | ** ** | **Accumulated**             | ** ** | **Carrying**  | ** ** | **Carrying** | ** ** | **Accumulated** | ** ** | **Carrying** | ** ** | **Amortization** | ** ** |
| ** **                                     | ** ** | **Amount**                       | ** ** | **Amortization**            | ** ** | **Amount**    | ** ** | **Amount** | ** ** | **Amortization** | ** ** | **Amount** | ** ** | **Period (Years)** | ** ** |
| Intangible assets subject to amortization:     |       |                             |       |                        |       |          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Non-compete agreements                         |       |                             | $          | 1,000                       |       |          |       | $ | (417 | ) |   |   | $ | 583 |   |   |   | $ | 1,000 |   |   |   | $ | (667 | ) |   |   | $ | 333 |   |   |   | 3 |   |   |
| Trademarks/trade  names/patents                |       |                             | 300        |                        |       |          | (206       | ) |   |   | 94 |   |   |   | 327 |   |   |   | (238 | ) |   |   | 89 |   |   |   | 5 |   |   |
|                                           |       |                             | 1,300      |                        |       |          | (623       | ) |   |   | 677 |   |   |   | 1,327 |   |   |   | (905 | ) |   |   | 422 |   |   |   |   |   |   |
| Intangible assets not subject to amortization: |       |                             |       |                        |       |          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Trademarks/trade  names/licenses               |       |                             | 6,378      |                        |       |          | —     |   |   |   | 6,378 |   |   |   | 6,678 |   |   |   | — |   |   |   | 6,678 |   |   |   |   |   |   |
|                                           |       |                             | $          | 7,678                       |       |          |       | $ | (623 | ) |   |   | $ | 7,055 |   |   |   | $ | 8,005 |   |   |   | $ | (905 | ) |   |   | $ | 7,100 |   |   |   |   |   |   |

 

Estimatedfuture amortization expense related to the net carrying amount of $422 forintangible assets subject to amortization at June 30, 2005 is as follows:
| ** **                                   | ** ** | **Estimated**    | ** ** |
|----------------------------------------------|------------|------------------|------------|
| ** **                                   | ** ** | **Amortization** | ** ** |
| **Year Ending September 30,** | ** ** | ** **       | ** ** | **Expense(1)** | ** ** |
| 2005                                         |       |             | $          | 94 |   |   |
| 2006                                         |       |             | 284        |   |   |
| 2007                                         |       |             | 21         |   |   |
| 2008                                         |       |             | 12         |   |   |
| 2009                                         |       |             | 9          |   |   |
| Thereafter                                   |       |             | 2          |   |   |
|                                         |       |             | $          | 422 |   |   |
|                                              |            |                  |            |  |  |  |  |  |

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(1)          Estimated amortizationexpense for the year ending September 30, 2005 includes only amortization to berecorded after June 30, 2005.

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**NUTRACEUTICAL INTERNATIONAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (unaudited) (dollars in thousands, except per share data)**

**5. CAPITALSTOCK**

All stock optionsoutstanding at June 30, 2004 were included in the computation of dilutedearnings per share. Stock options to purchase 140,340 shares of common stockthat were outstanding at June 30, 2005 were not included in the computationof diluted earnings per share because the exercise prices of these stockoptions were greater than the average share price of the Company’s common stockand, therefore, the effect would have been antidilutive. All warrantsoutstanding at June 30, 2004 were included in the computation of dilutedearnings per share. No warrants were outstanding at June 30, 2005.

**6. SHARE PURCHASES**

During fiscal 2000, theCompany’s Board of Directors approved a share purchase program authorizing theCompany to buy up to 1,500,000 shares of common stock of the Company. Underthis program, the Company purchased 199,300 shares during the three monthsended June 30, 2005 for an aggregate price of $2,613. These shares ofcommon stock held in treasury were retired on June 30, 2005. Totalpurchases under this stock purchase program from inception to June 30,2005 were 1,115,222 shares of common stock for an aggregate price of $9,000. Duringthis time period, the Company also repurchased and cancelled 690,446 warrantsrelated to the Company’s common stock for an aggregate purchase price of $1,726.In addition, 55,848 warrants related to the Company’s common stock weresurrendered and retired in connection with certain exercises.

**7. OPERATING SEGMENTS**

Segment identification and selection is consistentwith the management structure used by the Company to evaluate performance andmake decisions regarding resource allocation, as well as the materiality offinancial results consistent with that structure. Based on the Company’smanagement structure and method of internal reporting, the Company has oneoperating segment. The Company does not review operating results on adisaggregated basis; rather, management reviews operating results on anaggregate basis.

Net sales outside theUnited States were less than 10% of consolidated net sales for the three monthsand nine months ended June 30, 2004 and 2005.

**8. STOCK-BASED COMPENSATION**

The Company accounted for its stock-based employeecompensation plans using the intrinsic value method prescribed by AccountingPrinciples Board Opinion No. 25, *Accounting for StockIssued to Employees*. No stock-based employee compensation cost wasreflected in net income for the three months and nine months ended June 30,2004 and 2005, as all options granted under those stock-based employeecompensation plans had exercise prices equal to the market values of theunderlying common shares on the dates of grant. The following table illustratesthe effect on net income and earnings per share as if the Company had appliedthe fair value recognition provisions of Statement of Financial AccountingStandards No. 123, *Accounting for Stock-BasedCompensation*, to stock-based employee compensation.

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**NUTRACEUTICAL INTERNATIONAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (unaudited) (dollars in thousands, except per share data)**

**8. STOCK-BASEDCOMPENSATION (Continued)**
| ** **                                                                                                                                        | ** ** | **Three months  ended June 30,** | ** ** | **Nine months  ended June 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                                                                                        | ** ** | **2004**                                        | ** ** | **2005**                                       | ** ** | **2004** | ** ** | **2005** | ** ** |
| Net income, as  reported                                                                                                                          |       | $                                               | 2,909      |                                           | $          | 3,203 |   | $ | 10,238 |   | $ | 9,495 |   |
| Deduct: Total  stock-based employee compensation expense determined under the fair value  based method for all awards, net of related tax effects |       | (161                                            | )          | (124                                           | )          | (471 | ) | (371 | ) |
| Pro forma net  income                                                                                                                             |       | $                                               | 2,748      |                                           | $          | 3,079 |   | $ | 9,767 |   | $ | 9,124 |   |
| Earnings per share                                                                                                                                |       |                                            |       |                                           |       |   |   |   |   |
| Basic—as reported                                                                                                                            |       | $                                               | 0.25       |                                           | $          | 0.28 |   | $ | 0.91 |   | $ | 0.82 |   |
| Diluted—as reported                                                                                                                          |       | 0.24                                            |       | 0.27                                           |       | 0.87 |   | 0.80 |   |
| Basic—pro forma                                                                                                                              |       | $                                               | 0.24       |                                           | $          | 0.27 |   | $ | 0.87 |   | $ | 0.79 |   |
| Diluted—pro forma                                                                                                                            |       | 0.23                                            |       | 0.26                                           |       | 0.83 |   | 0.77 |   |

 

In December 2004, the Financial AccountingStandards Board issued Statement of Financial Accounting Standards No. 123R,*Share-Based Payment* (“SFAS 123R”). SFAS123R requires companies to expense the value of employee stock options and similarawards. SFAS 123R is effective for annual financial statements beginning after June 15,2005 and will apply to all outstanding and unvested share-based payments at thetime of adoption. The Company is currently evaluating the impact SFAS 123R willhave on its consolidated financial statements and will adopt such standard asrequired.

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**Item 2.**                        Management’sDiscussion and Analysis of Financial Condition and Results of Operations

**General**

The following discussion and analysis should be readin conjunction with this report on Form 10-Q, including Part I, Item1.

Nutraceutical International Corporation (the “Company”)is an integrated marketer, distributor, retailer and manufacturer of brandednutritional supplements and other natural products sold primarily to andthrough domestic health and natural food stores. Internationally, the Company sellsits branded products to and through health and natural product distributors andretailers. The Company’s core business strategy is to acquire, integrate andoperate, from beginning to end, the marketing, distribution, retailing andmanufacturing operations of businesses in the natural products industry. TheCompany believes that the consolidation and integration of acquired businessesprovides ongoing financial synergies through increased scale and marketpenetration, as well as strengthened customer relationships.

The Company sells its branded products under thetrademarks *Solaray®*, *KAL®*,*Nature’s Life®*, *NaturalBalance®*, *NaturalMax®*, *VegLife®*, *Premier One®*, *Sunny Green®*, *Natural Sport®*,*FunFresh FoodsTM*, *ActiPet®*,*Action Labs®*, *Thompson®*,*Montana Big SkyTM*, *Body Gold®*and *Pioneer®*. The Company also sellsbranded bulk products and custom blends under the trademark *Monarch Nutritional LaboratoriesTM*. Under the name *Woodland PublishingTM*, the Company publishes, prints andmarkets a line of books and booklets to, among others, book distributors,national retail bookstores and health and natural food stores. The Company’sneighborhood natural food markets operate under the trade names *The Real Food CompanyTM*, *Thom’s Natural FoodsTM*and *Cornucopia Community MarketTM* and itshealth food stores operate under the trade names *ArizonaHealth FoodsTM*, *Granola’sTM* and *Pilgrim’s NaturewayTM*. The Company also distributes thebranded products of certain third parties.

The Company was formed in1993 by senior management and Bain Capital, Inc. to effect a consolidationstrategy in the fragmented vitamin, mineral, herbal and other nutritionalsupplements industry (the “VMS Industry”). Since its formation, the Company hascompleted the following acquisitions: Solaray, Inc., Premier One Products, Inc.,Makers of KAL, Inc. and Makers of KAL, B.V., Monarch NutritionalLaboratories, Inc., Action Labs, Inc., NutraForce (Canada)International, Inc., Woodland Publishing, Inc. and Summit Graphics, Inc.,Thompson Nutritionals, Inc., The Real Food Company, Inc., Thom’sNatural Foods, M.K. Health Food Distributors, Inc. (dba Nature’s Life),Arizona Health Foods, Inc., Natural Balance, Inc., Montana Naturals, Inc.,Cornucopia Community Market, Inc., Pilgrim’s Natureway LLC and PioneerNutritional Formulas, Inc. As a result of these acquisitions, internalgrowth and cost management, management believes that the Company is wellpositioned to continue to capitalize on the consolidation the Company believesis occurring in the VMS Industry.

**Critical Accounting Policies**

The preparation of the Company’s financial statementsin conformity with accounting principles generally accepted in the UnitedStates of America required management to make estimates and assumptions thataffected the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the dates of the financial statements andthe reported amounts of net sales and expenses during the reported periods. Estimatesincluded values and lives assigned to acquired intangible assets, reserves forcustomer returns and allowances, uncollectible accounts receivable and slowmoving, obsolete and/or damaged inventory.

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The Company’sestimates and judgments related to its critical accounting policies, includingfactors and assumptions considered in making these estimates and judgments, didnot vary significantly for the periods presented and had no material impact onthe consolidated financial statements as reported. The Company’s criticalaccounting policies include, but are not limited to:

*Accounts Receivable*—Provision ismade for estimated bad debts based on periodic analysis of individual customerbalances, including an evaluation of days sales outstanding, payment history,recent payment trends and perceived credit worthiness. If general economicconditions and/or customer financial condition were to change, additionalprovisions for bad debts may be required, which could have a material impact onthe consolidated financial statements.

*Inventories*—Provision is made forslow moving, obsolete and/or damaged inventory based on periodic analysis ofindividual inventory items, including an evaluation of historical usage and/ormovement, age, expiration date and general condition. If market demand and/orconsumer preferences are less favorable than historical trends or futureexpectations, additional provisions for slow moving, obsolete and/or damagedinventory may be required, which could have a material impact on theconsolidated financial statements.

*Property, Plant and Equipment*—Depreciationand amortization expense is impacted by the Company’s judgments regarding theestimated useful lives of assets placed in service. If the estimated lives ofassets are significantly less than expected, depreciation and amortizationexpense would be accelerated, which could have a material impact on theconsolidated financial statements.

*Goodwill and Intangible Assets*—Statementof Financial Accounting Standards No. 141, *BusinessCombinations,*and Statement of Financial Accounting Standards No. 142,*Goodwill and Other Intangible Assets* (“SFAS142”), require estimates and judgments in determining the initial recognitionand measurement of goodwill and intangible assets, including factors andassumptions used in determining fair value and useful life.  Intangible assets with finite useful livesare amortized while intangible assets with indefinite useful lives are notamortized. In addition, SFAS 142 requires ongoing, periodic impairment testing,which relies on such factors and assumptions as identified reporting units, aswell as expected future net cash flows relative to recorded book values. If anasset impairment were identified, a loss would be recorded, which could have amaterial impact on the consolidated financial statements.

*Revenue Recognition*—Revenueis recognized in accordance with Staff Accounting Bulletin No. 104, *Revenue Recognition*, which states that revenue should berecognized when the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) theproduct has been shipped and the customer takes ownership and assumes the riskof loss; (3) the selling price is fixed or determinable; and (4) collectionof the resulting receivable is reasonably assured. The Company believes thatthese criteria are satisfied upon shipment from its facilities or, in the caseof the Company’s neighborhood natural food markets and health food stores, atthe point of sale within these stores. Revenue is reduced by provisions for estimatedreturns and allowances, which are based on historical averages that have notvaried significantly for the periods presented, as well as specific knownclaims, if any. No other significant deductions from revenue must be estimatedat the point in time that revenue is recognized.

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**Results ofOperations**

The following table setsforth certain consolidated statement of operations data as a percentage of netsales for the periods indicated:
| ** **                                | ** ** | **Three months ended June 30,**                                                      | ** ** | **Nine months ended June 30,**                                                       | ** ** |
|-------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|
| ** **                                | ** ** | **        2004        ** | ** ** | **        2005        ** | ** ** | **        2004        ** | ** ** | **        2005        ** | ** ** |
| Net sales                                 |       |                                                                                                     | 100.0      | %                                                                                                        |       |   | 100.0 | % |   |   | 100.0 | % |   |   | 100.0 | % |   |
| Cost of sales                             |       |                                                                                                     | 47.3       | %                                                                                                        |       |   | 48.6 | % |   |   | 47.6 | % |   |   | 48.4 | % |   |
| Gross profit                              |       |                                                                                                     | 52.7       | %                                                                                                        |       |   | 51.4 | % |   |   | 52.4 | % |   |   | 51.6 | % |   |
| Selling, general and  administrative      |       |                                                                                                     | 37.9       | %                                                                                                        |       |   | 36.7 | % |   |   | 35.6 | % |   |   | 37.0 | % |   |
| Amortization of  intangible assets        |       |                                                                                                     | 0.3        | %                                                                                                        |       |   | 0.3 | % |   |   | 0.3 | % |   |   | 0.3 | % |   |
| Income from operations                    |       |                                                                                                     | 14.5       | %                                                                                                        |       |   | 14.4 | % |   |   | 16.5 | % |   |   | 14.3 | % |   |
| Interest and other  expense, net          |       |                                                                                                     | 0.5        | %                                                                                                        |       |   | 0.4 | % |   |   | 0.6 | % |   |   | 0.4 | % |   |
| Income before provision  for income taxes |       |                                                                                                     | 14.0       | %                                                                                                        |       |   | 14.0 | % |   |   | 15.9 | % |   |   | 13.9 | % |   |
| Provision for income  taxes               |       |                                                                                                     | 5.4        | %                                                                                                        |       |   | 5.4 | % |   |   | 6.1 | % |   |   | 5.4 | % |   |
| Net income                                |       |                                                                                                     | 8.6        | %                                                                                                        |       |   | 8.6 | % |   |   | 9.8 | % |   |   | 8.5 | % |   |
| EBITDA(1)                                 |       |                                                                                                     | 17.7       | %                                                                                                        |       |   | 17.3 | % |   |   | 19.6 | % |   |   | 17.3 | % |   |

 

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(1)          See“—EBITDA.”

**Comparisonof the Three Months Ended June 30, 2005 to the Three Months Ended June 30,2004**

*Net Sales*.   Net salesincreased by $3.4 million, or 10.2%, to $37.2 million for the three monthsended June 30, 2005 (“third quarter of fiscal 2005”) from $33.8 millionfor the three months ended June 30, 2004 (“third quarter of fiscal 2004”).Net sales of branded products increased by $2.1 million, or 7.3%, to $30.4million for the third quarter of fiscal 2005 from $28.3 million for the thirdquarter of fiscal 2004. The increase in net sales of branded products wasrelated to the integration of the fiscal 2004 third quarter acquisitions of the*Natural Balance*® and *Montana Big Sky*TMbrands, as well as the March 2005 acquisition of the *Pioneer*®brand and, to a lesser extent, an increase in sales in certain brands andcustomers within health and natural food stores. Net sales of otherproducts increased by $1.3 million, or 25.3%, to $6.8 million for the thirdquarter of fiscal 2005 from $5.5 million for the third quarter of fiscal 2004. Thisincrease was related to the integration of the fiscal 2004 acquisition ofCornucopia Community Market, Inc. and the fiscal 2005 acquisition of Pilgrim’sNatureway LLC, partially offset by a softness in comparable store sales, whichthe Company believes is primarily related to decreased low-carb consumerinterest and demand.

*Gross Profit*.   Gross profitincreased by $1.3 million, or 7.5%, to $19.1 million for the third quarter offiscal 2005 from $17.8 million for the third quarter of fiscal 2004. Thisincrease in gross profit was primarily attributable to the increase in netsales. As a percentage of net sales, gross profit was 51.4% for the thirdquarter of fiscal 2005 and 52.7% for the third quarter of fiscal 2004. Thisdecrease in gross profit as a percentage of net sales was primarilyattributable to increased material cost as a percentage of net sales, as wellas a change in sales mix to lower margin non-branded products, including retailand bulk.

*Selling, General and Administrative*.   Selling,general and administrative expenses increased by $0.9 million, or 6.8%, to $13.7million for the third quarter of fiscal 2005 from $12.8 million for the thirdquarter of fiscal 2004. This increase in selling, general and administrativeexpenses was primarily attributable to the timing of acquisition andintegration-related expenses, including technology and employee transition, forthe fiscal 2004 acquisitions of the *NaturalBalance*® and *Montana BigSky*TM brands and Cornucopia Community Market, Inc., aswell as the fiscal 2005 acquisitions of Pilgrim’s Natureway LLC and the *Pioneer*® brand. Additionally, increased costsassociated with insurance impacted the Company in the third quarter of fiscal2005. As a percentage of net sales, selling, general and 

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administrative expensesdecreased to 36.7% for the third quarter of fiscal 2005 from 37.9% for thethird quarter of fiscal 2004. This decrease in selling, general andadministrative expenses, as a percentage of net sales, was primarilyattributable to year-over-year sales increases in relation to certain fixedexpenses.

*Amortization of Intangibles*.   Amortizationof intangibles was $0.1 million for the third quarter of fiscal 2005 and 2004. Foreach period, amortization expense was primarily related to intangible assetsrecorded in connection with acquisitions.

*Interest and Other Expense, Net*.   Netinterest and other expense was $0.2 million for the third quarter of fiscal2005 and 2004 and primarily consisted of interest expense on indebtedness underthe Company’s revolving credit facility.

*Provision for Income Taxes*.   TheCompany’s effective tax rate was 38.5% for both the third quarter of fiscal2005 and for the third quarter of fiscal 2004. In each period, the Company’seffective tax rate was higher than the federal statutory rate primarily due tostate taxes.

**Comparisonof the Nine Months Ended June 30, 2005 to the Nine Months Ended June 30,2004**

*Net Sales*.   Net salesincreased by $6.8 million, or 6.5%, to $111.4 million for the nine months endedJune 30, 2005 from $104.6 million for the nine months ended June 30,2004. Net sales of branded products increased by $3.9 million, or 4.4%, to$91.3 million for the nine months ended June 30, 2005 from $87.4 millionfor the nine months ended June 30, 2004. The increase in net sales ofbranded products was related to the integration of the fiscal 2004 thirdquarter acquisitions of the *NaturalBalance*® and *Montana Big Sky*TMbrands, as well as the March 2005 acquisition of the *Pioneer*®brand, partially offset by a softness in sales in certain brands and customerswithin health and natural food stores. Net sales of other productsincreased by $2.9 million, or 16.7%, to $20.1 million for the nine months endedJune 30, 2005 from $17.2 million for the nine months ended June 30,2004. This increase was related to the integration of the fiscal 2004acquisition of Cornucopia Community Market, Inc. and the fiscal 2005acquisition of Pilgrim’s Natureway LLC, partially offset by a softness incomparable store sales, which the Company believes is primarily related todecreased low-carb consumer interest and demand.

*Gross Profit*.   Gross profitincreased by $2.7 million, or 4.8%, to $57.5 million for the nine months ended June 30,2005 from $54.8 million for the nine months ended June 30, 2004. Thisincrease in gross profit was primarily attributable to the increase in netsales. As a percentage of net sales, gross profit was 51.6% for the nine monthsended June 30, 2005 and 52.4% for the nine months ended June 30, 2004.This decrease in gross profit as a percentage of net sales was primarilyattributable to increased material cost as a percentage of net sales, as wellas a change in sales mix to lower margin non-branded products, including retailand bulk.

*Selling, General and Administrative*.   Selling,general and administrative expenses increased by $3.9 million, or 10.6%, to $41.2million for the nine months ended June 30, 2005 from $37.3 million for thenine months ended June 30, 2004. As a percentage of net sales, selling,general and administrative expenses increased to 37.0% for the nine monthsended June 30, 2005 from 35.6% for the nine months ended June 30,2004. This increase in selling, general and administrative expenses wasprimarily attributable to the timing of acquisition and integration-relatedexpenses, including technology and employee transition, for the fiscal 2004acquisitions of the *NaturalBalance*® and *Montana BigSky*TM brands and Cornucopia Community Market, Inc., aswell as the fiscal 2005 acquisition of Pilgrim’s Natureway LLC and the *Pioneer*® brand. Additionally, increased costsassociated with litigation, insurance and corporate governance impacted theCompany during the nine months ended June 30, 2005.

*Amortization of Intangibles*.   Amortizationof intangibles was $0.3 million for the nine months ended June 30, 2005and 2004. For each period, amortization expense was primarily related tointangible assets recorded in connection with acquisitions.

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*Interest and Other Expense, Net*.   Netinterest and other expense was $0.5 million for the nine months ended June 30,2005 and $0.7 million for the nine months ended June 30, 2004 andprimarily consisted of interest expense on indebtedness under the Company’srevolving credit facility.

*Provision for Income Taxes*.   TheCompany’s effective tax rate was 38.5% for both the nine months ended June 30,2005 and for the nine months ended June 30, 2004. In each period, theCompany’s effective tax rate was higher than the federal statutory rateprimarily due to state taxes.

**EBITDA**

EBITDA (a non-GAAPmeasure) is defined as earnings before net interest and other expense, taxes,depreciation and amortization. EBITDA hassome inherent limitations in measuring operating performance due to theexclusion of certain financial elements such as depreciation and is notnecessarily comparable to other similarly titled captions of other companiesdue to potential inconsistencies in the method of calculation. Furthermore,EBITDA is not intended to be a substitute for cash flows from operatingactivities, as a measure of liquidity, or an alternative to net income indetermining the Company’s operating performance in accordance with generallyaccepted accounting principles. The Company’s use of EBITDA should beconsidered within the following context:

·       TheCompany acknowledges that plant and equipment (while less important in theCompany’s line of business due to outsourcing alternatives) are necessary to earnrevenue based on the Company’s current business model.

·       TheCompany’s use of EBITDA as a measure of operating performance is not based onany Company belief about the reasonableness of excluding depreciation whenmeasuring financial performance.

·       TheCompany’s use of EBITDA is supported by the importance of EBITDA to thefollowing key stakeholders:

·        **Analysts**—whoestimate the Company’s projected EBITDA and other EBITDA-based metrics in theirindependently developed financial models for investors;

·        **Creditors**—whoevaluate the Company’s operating performance based on compliance with certainEBITDA-based debt covenants;

·        **InvestmentBankers**—who use EBITDA and other EBITDA-based metrics in theirwritten evaluations and comparisons of companies within the Company’s industry;and

·        **Board ofDirectors and Executive Management**—who use EBITDA as an essentialmetric for evaluating management performance relative to the Company’soperating budget and bank covenant compliance, as well as the Company’s abilityto service debt and raise capital for growth opportunities, includingacquisitions, which are a critical component to the Company’s stated strategy. Historically,the Company has recorded a monthly accrual for incentive compensation, whichhas been paid out to executive management, as well as other employees. Thismonthly accrual is computed as a percentage of EBITDA.

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The following table setsforth a reconciliation of net income to EBITDA for each period included herein:
| ** **                          | ** ** | **Three months ended June 30,**                                                      | ** ** | **Nine months ended June 30,**                                                       | ** ** |
|-------------------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|
| ** **                          | ** ** | **        2004        ** | ** ** | **        2005        ** | ** ** | **        2004        ** | ** ** | **         2005         ** | ** ** |
| Net income                          |       |                                                                                                     | $          | 2,909                                                                                                    |       |   |   | $ | 3,203 |   |   |   | $ | 10,238 |   |   |   | $ | 9,495 |   |   |
| Provision for income  taxes         |       |                                                                                                     | 1,821      |                                                                                                     |       |   | 2,006 |   |   |   | 6,409 |   |   |   | 5,945 |   |   |
| Interest and other  expense, net(1) |       |                                                                                                     | 172        |                                                                                                     |       |   | 162 |   |   |   | 650 |   |   |   | 542 |   |   |
| Depreciation and  amortization      |       |                                                                                                     | 1,092      |                                                                                                     |       |   | 1,059 |   |   |   | 3,207 |   |   |   | 3,279 |   |   |
| EBITDA                              |       |                                                                                                     | $          | 5,994                                                                                                    |       |   |   | $ | 6,430 |   |   |   | $ | 20,504 |   |   |   | $ | 19,261 |   |   |

 

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(1)          Includesamortization of deferred financing fees and losses associated with fixed assetdisposals.

The Company’s EBITDA increased to $6.4 million for thethird quarter of fiscal 2005 from $6.0 million for the third quarter of fiscal2004. EBITDA as a percentage of net sales decreased to 17.3% for the thirdquarter of fiscal 2005 from 17.7% for the third quarter of fiscal 2004.

The Company’s EBITDAdecreased to $19.3 million for the nine months ended June 30, 2005 from$20.5 million for the nine months ended June 30, 2004. EBITDA as apercentage of net sales decreased to 17.3% for the nine months ended June 30,2005 from 19.6% for the nine months ended June 30, 2004.

**Seasonality**

The Company believes thatits business is characterized by minor seasonality. However, sales to anyparticular customer can vary substantially from one quarter to the next basedon such factors as industry trends, timing of promotional discounts,international economic conditions and acquisition-related activities. Excludingthe effects of acquisitions, the Company historically has recorded higherbranded products sales volume during the second fiscal quarter due to increasedinterest in health-related products among consumers following the holidayseason.

**Liquidity and Capital Resources**

The Company had working capital of $27.7 million as ofJune 30, 2005 compared to $26.5 million as of September 30, 2004. Thisincrease in working capital was primarily the result of an increase ininventories and decreases in accounts payable and accrued expenses, partiallyoffset by decreases in accounts receivable and prepaid expenses and othercurrent assets.

Net cash provided by operating activities for the ninemonths ended June 30, 2005 was $14.0 million compared to $15.3 million forthe comparable period in fiscal 2004. The decrease in net cash provided byoperating activities for the nine months ended June 30, 2005 was primarilyattributable to decreases in net income and the tax benefit from stock optionexercises as well as changes in cash used for accounts receivable, accountspayable and accrued expenses, partially offset by changes in cash provided byinventories and prepaid expenses and other current assets.

Net cash used in investing activities was $10.2million for the nine months ended June 30, 2005 and $13.5 million for thecomparable period in fiscal 2004. The Company’s investing activities duringthese periods consisted of acquisitions of businesses and capitalexpenditures. Capital expenditures during these periods related primarily to distributionand manufacturing equipment, building improvements related to facilityconsolidation efforts and information systems, including retail technology. TheCompany intends to finance anticipated capital expenditures through internallygenerated cash flow and, if necessary, through funds provided under itsrevolving credit facility.

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Net cash used in financing activities was $3.9 millionfor the nine months ended June 30, 2005 compared to $0.9 million for thecomparable period in fiscal 2004. During these periods, financing activitiesprimarily related to borrowings and repayments under the Company’s revolvingcredit facility, purchases of common stock for treasury and proceeds from theissuance of common stock.

The Company’s current revolving credit facility hadavailable credit borrowings of $52.5 million at June 30, 2005. Theavailable credit borrowings are reduced quarterly by $1.25 million with thenext reduction occurring in September 2005. Borrowings under the revolvingcredit facility are collateralized by substantially all assets of the Company. Atthe Company’s election, borrowings bear interest at the applicable EurodollarRate plus a variable margin or at a base rate, which is the higher of theFederal Funds Rate plus 0.5% or the Prime Lending Rate, plus a variable margin.At June 30, 2005, the applicable weighted-average interest rate forborrowings was 4.73%. The Company is also required to pay a variable quarterlyfee on the unused balance under the revolving credit facility. At June 30,2005, the applicable rate was 0.25%. Accrued interest on Eurodollar Rateborrowings is payable based on elected intervals of one, two or three months.Accrued interest on base rate borrowings is payable quarterly. The revolvingcredit facility matures on January 28, 2007, and the Company is requiredto repay all principal outstanding under the revolving credit facility on suchdate.

The revolving credit facility contains restrictivecovenants, including restrictions on incurring other indebtedness, limitationson capital expenditures and requirements that the Company maintain certainfinancial ratios. As of June 30, 2005, the Company was in compliance withthese restrictive covenants. Upon the occurrence of a default or an event ofdefault, the lender has various remedies or rights, which may includeproceeding against the collateral or requiring the Company to repay all amountsoutstanding under the revolving credit facility.

A key component of the Company’s business strategy isto seek to make additional acquisitions, which may require that the Companyobtain additional financing, which could include the incurrence of substantialadditional indebtedness. The Company believes that borrowings under its currentrevolving credit facility or a replacement credit facility, together with cashflows from operations, will be sufficient to make required payments under thecurrent credit facility or a replacement credit facility, and to makeanticipated capital expenditures and fund working capital needs for fiscal2005.

The Company’s significantnon-cancelable contractual obligations as of June 30, 2005 were asfollows:
| ** **                       | ** ** | **Payments Due By Period** | ** ** |
|----------------------------------|------------|-------------------------------------------|------------|
| ** **                       | ** ** | **(dollars in thousands)**      | ** ** |
| ** **                       | ** ** | ** **                                | ** ** | **Less Than** | ** ** | **1-3** | ** ** | **4-5** | ** ** | **After** | ** ** |
| **Contractual Obligations** | ** ** | ** **                                | ** ** | **Total** | ** ** | **1 Year** | ** ** | **Years** | ** ** | **Years** | ** ** | **5 Years** | ** ** |
| Long-term debt                   |       | $                                         | 5,000      |   |   | $ | — |   |   | $ | 5,000 |   | $ | — |   |   | $ | — |   |   |
| Interest on long-term  debt(a)   |       | 598                                       |       |   | 381 |   |   | 217 |   | — |   |   | — |   |   |
| Operating leases                 |       | 4,420                                     |       |   | 1,758 |   |   | 2,258 |   | 321 |   |   | 83 |   |   |
| Total                            |       | $                                         | 10,018     |   |   | $ | 2,139 |   |   | $ | 7,475 |   | $ | 321 |   |   | $ | 83 |   |   |
|                                  |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(a)           Representsestimated interest obligations associated with the Company’s outstandingrevolving credit facility balance of $5.0 million at June 30, 2005,assuming no principal payments are made before maturity, a weighted-averageinterest rate of 4.73% and an underutilization fee rate of 0.25%.

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**New Accounting Standards**

InDecember 2004, the Financial Accounting Standards Board issued Statement ofFinancial Accounting Standards No. 123R, *Share-Based Payment*(“SFAS 123R”).  SFAS 123R requirescompanies to expense the value of employee stock options and similarawards.  SFAS 123R is effective forannual financial statements beginning after June 15, 2005 and will apply to alloutstanding and unvested share-based payments at the time of adoption.  The Company is currently evaluating theimpact SFAS 123R will have on its consolidated financial statements and willadopt such standard as required.

Basedon the Company’s review of other new accounting standards released during thequarter ended June 30, 2005, the Company did not identify any standard requiringadoption that would have a significant impact on its consolidated financialstatements for the periods reported.

**Inflation**

Inflation affects the costof raw materials, goods and services used by the Company. In recent years,inflation has been modest. The competitive environment somewhat limits theability of the Company to recover higher costs resulting from inflation byraising prices. The Company seeks to mitigate the adverse effects of inflationprimarily through improved productivity and cost containment programs. TheCompany does not believe that inflation has had a material impact on itsresults of operations for the periods presented, except with respect topayroll-related costs, insurance premiums and other costs arising from orrelated to government imposed regulations.

**Forward-LookingStatements**

The Securities andExchange Commission (“SEC”) encourages companies to disclose forward-lookinginformation so that investors can better understand a company’s futureprospects and make informed investment decisions. Information contained in thisForm 10-Q contains certain forward-looking statements within themeaning of the Private Securities Litigation Reform Act of 1995 with respect toour financial condition, results of operations and business. Any statementscontained herein that are not statements of historical fact may be deemed to beforward-looking statements. Without limitation, the words “may,” “will,” “should,”“believes,” “anticipates,” “plans,” “expects,” “intends,” “estimates” andsimilar expressions or the negative thereof, or variations thereon, orsimilarly, discussions of strategy, although believed to be reasonable areintended to identify forward-looking statements, although not allforward-looking statements contain these words or discussions. There are anumber of important factors that could cause actual events or the Company’sactual results to differ materially from those indicated by suchforward-looking statements, including, without limitation, (i) changingdomestic and international market and political conditions; (ii) interruptionof business or negative impact on sales and earnings due to acts of war,terrorism, bio-terrorism, civil unrest or disruption of mail service; (iii) slowor negative growth in the nutritional supplement industry; (iv) changes inlaws and regulations, including adverse federal, state or foreign legislationor regulation or adverse determinations or actions by regulators; (v) import/exportcontrols with respect to products sold into or purchased from foreigncountries, as well as other restrictions on the purchase or sale of the Company’sproducts to or from such countries; (vi) unavailability of or interruptionin the supply of utilities, including electricity and telecommunications; (vii) increasedproduct competition; (viii) adverse publicity regarding nutritionalsupplements; (ix) increased costs, including raw material and labor costs,as well as increases in the costs of borrowing (or the unavailability ofadequate credit); (x) inability of the Company to gain and/or hold marketshare of its health and natural food store customers and bulk branded productscustomers; (xi) loss or retirement of key members of management; (xii)inability of the Company to successfully implement its business strategy orplan or otherwise manage growth, including the Company’s ability to locate andconsummate advantageous acquisitions, or otherwise integrate or profitablymanage acquired operations, including the ability to retain customers ofexisting and acquired operations; (xiii) product development efforts andconsumer acceptance of the Company’s products; (xiv) adequacy and availabilityof insurance coverage, 

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and anylosses or damages sustained by the Company not covered by insurance; (xv)availability and price of raw materials, including increased costs; (xvi) theCompany’s ability to manufacture its products efficiently; (xvii) the mix ofthe Company’s products and their related profit margins; (xviii) dependence ondistributors and customers; (xix) sales and earnings volatility; (xx) absenceof clinical trials for many of the Company’s products; (xxi) exposure to andexpense of prosecuting, defending and/or resolving and defending claims orlitigation, including but not limited to product liability claims, class actionsuits, stockholder derivative suits, employment or labor related suits orinvestigations, patent or trademark infringement suits and other litigationwhich may arise from time to time; (xxii) inability of the Company’s retailstores to attain or maintain profitability; (xxiii) other factors discussed inthe Company’s filings with the Securities and Exchange Commission or referencedin its press releases, and (xxiv) other factors beyond the Company’s control.

In addition, anyforward-looking statements represent the Company’s estimates only as of the daythis Form 10-Q was first filed with the SEC and should not be reliedupon as representing the Company’s estimates as of any subsequent date. Noassurance can be given that the future results covered by such forward-lookingstatements will be achieved and readers are cautioned not to place unduereliance on forward-looking statements. While the Company may elect to updateforward-looking statements at some point in the future, the Companyspecifically disclaims any obligation to do so.

The SEC maintains anInternet site (*http://www.sec.gov*) whichcontains reports, proxy and information statements, and other informationregarding the Company. Copies of this Form 10-Q are availablewithout charge upon request. Please contact the Company to request copies ofthis Form 10-Q (435-655-6106).

**Item3.**                        Quantitativeand Qualitative Disclosures about Market Risk

At the Company’s election,borrowings under the Company’s revolving credit facility bear interest at theapplicable Eurodollar Rate plus a variable margin or at a base rate, which isthe higher of the Federal Funds Rate plus 0.5% or the Prime Lending Rate, plusa variable margin. At June 30, 2005, the applicable weighted-averageinterest rate for borrowings was 4.73% and the Company had total borrowingsoutstanding of $5.0 million. To date, the Company has not obtained interestrate protection with respect to these borrowings.

With respect to itsinternational operations, the Company is subject to currency fluctuations;however, the Company does not believe that these fluctuations would have amaterial adverse impact on the Company’s financial position. To date, theCompany has not hedged any of its potential foreign currency exposures.

**Item4.**                        Controlsand Procedures

*Evaluation of Disclosure Controlsand Procedures*.   The Company’s chief executive officerand chief financial officer evaluated the effectiveness of the Company’sdisclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and15d-15(e)) as of the end of the period covered by this report. Based onthis evaluation, the chief executive officer and chief financial officerconcluded that the Company’s disclosure controls and procedures were effectiveto provide reasonable assurance that material information related to theCompany and its consolidated subsidiaries would be made known to them by otherswithin those entities, particularly during the period in which this report wasprepared.

In designing andevaluating the disclosure controls and procedures, management recognized thatany controls and procedures, no matter how well designed and operated, canprovide only reasonable, not absolute, assurances of achieving the desiredcontrol objectives, and management necessarily was required to apply itsjudgment in evaluating and implementing possible disclosure controls andprocedures.

*Changes in Internal Controls*.   Therewere no significant changes in the Company’s internal controls over financialreporting that occurred during the last fiscal quarter that have materiallyaffected, or are reasonably likely to materially affect, the Company’s internalcontrols over financial reporting.

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**PART II—OTHER INFORMATION**

**Item 1.**                        LegalProceedings

As discussed in other filings, the Company is subjectto regulation by a number of federal, state and foreign agencies and isinvolved in various legal matters arising in the normal course of business.

The Company carries insurance coverage in the typesand amounts that management considers reasonably adequate to cover the risks itfaces in the industry in which it competes. However, the Company’s currentliability policy excludes claims related to certain ingredients, includingproducts containing ephedra.

In the opinion ofmanagement, the outcomes of individual regulatory and legal matters in whichthe Company is presently involved are not probable and no estimate can be madeof the range of potential gains or losses. While incapable of estimation, inthe opinion of management, the individual regulatory and legal matters in whichit is involved are not expected to have a material adverse effect on theCompany’s financial position, results of operations or cash flows. However, theaggregate liability of the Company arising from regulatory and legalproceedings related to these matters could have a material effect on theCompany’s financial position, results of operations or cash flows.

**Item 6.**                        Exhibitsand Reports on Form 8-K

(a)   Exhibits

31.1   Certifications Pursuant toSection 302 of the Sarbanes-Oxley Act of 2002.

32.1   Certifications Pursuant to 18U.S.C. Section 1350, as Adopted Pursuant to Section 906 of theSarbanes-Oxley Act of 2002.

(b)         Reports on Form 8-K

The followingreports were filed on Form 8-K during the last quarter covered bythis report:

(i)             On April 14,2005, the Company announced an important court decision that was issued on April 13,2005. The United States District Court for the District of Utah, CentralDivision, granted the Company’s motion for summary judgment against FDA in theCompany’s lawsuit involving FDA’s Final Rule on Ephedra.

(ii)         On April 28, 2005,the Company reported results for the fiscal 2005 second quarter and six monthsended March 31, 2005.

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**SIGNATURE**

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.

NUTRACEUTICALINTERNATIONAL CORPORATION(Registrant)
| Date:  July 29, 2005 |   | By:    |   | /s/ LESLIE M.  BROWN, JR.                                                                                                                            |
|---------------------------|--------|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------|
|                      |   |   |   | Leslie M. Brown, Jr.

Senior Vice President, Finance, Chief

Financial Officer and Assistant Secretary

(Principal Financial and Accounting Officer) |

 

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