**SECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549**

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**FORM 10–Q**

**(Markone)**

 

| ý |   | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|--------|--------|-----------------------------------------------------------------------------------------------|

 

**FOR THEQUARTERLY PERIOD ENDED SEPTEMBER 30, 2002**

 

**OR**

 

| o |   | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|---|--------|------------------------------------------------------------------------------------------------|

 

**FOR THETRANSITION PERIOD FROM                     TO                      COMMISSION FILE NO: 0-24567**

** **

**NATROL, INC.**(Exact name of registrant as specified in its charter)

 

| **DELAWARE**             |   | **95-3560780**                       |
|--------------------------|--------|--------------------------------------|
| (State of Incorporation) |   | (I.R.S. Employer Identification No.) |

** **

**21411 PRAIRIE STREETCHATSWORTH, CALIFORNIA 91311**(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)

 

**(818) 739–6000**(REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE)

 

INDICATE BY ACHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED TO BEFILED BY SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING THEPRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WASREQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILINGREQUIREMENTS FOR THE PAST 90 DAYS.YES  ý   NO  o

 

Indicate thenumber of shares outstanding of the issuer’s common stock, as of the latestpracticable date:

 
| **Class**                     |   | **November 1, 2002** |
|-------------------------------|--------|----------------------|
|                          |   |
| Common stock, $0.01 par value |   | 12,866,050           |

 

 

 

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PART 1.FINANCIAL INFORMATION

ITEM 1.CONSOLIDATED FINANCIAL STATEMENTS

NATROL, INC.CONSOLIDATED BALANCE SHEETS(IN THOUSANDS EXCEPT SHARE AND PER SHARE AMOUNTS)

 
|                                                                                                                                |   | **September  30,** |   | **December  31,** |   |
|-------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|--------|-------------------|--------|
|                                                                                                                                |   | **2002**           |   | **2001**          |   |
|                                                                                                                                |   | **(Unaudited)**    |   |              |   |
| **Assets**                                                                                                                          |   |               |   |              |   |
| Current assets:                                                                                                                     |   |               |   |              |   |
| Cash and cash  equivalents                                                                                                          |   | $                  | 10,515 |              | $      | 5,485 |   |
| Accounts  receivable, net of allowances of $620 and $363 at September 30, 2002 and  December 31, 2001, respectively                 |   | 7,223              |   | 6,787             |   |
| Inventories                                                                                                                         |   | 7,555              |   | 9,743             |   |
| Deferred taxes                                                                                                                      |   | 1,324              |   | 1,324             |   |
| Income taxes  receivable                                                                                                            |   | —             |   | 1,408             |   |
| Prepaid  expenses and other current assets                                                                                          |   | 1,223              |   | 1,826             |   |
| Total current assets                                                                                                                |   | 27,840             |   | 26,573            |   |
|                                                                                                                                |   |               |   |              |   |
| Property and  equipment:                                                                                                            |   |               |   |              |   |
| Building and  improvements                                                                                                          |   | 15,607             |   | 15,625            |   |
| Machinery and  equipment                                                                                                            |   | 5,344              |   | 5,708             |   |
| Furniture and  office equipment                                                                                                     |   | 2,654              |   | 2,019             |   |
|                                                                                                                                |   | 23,605             |   | 23,352            |   |
| Accumulated  depreciation and amortization                                                                                          |   | (5,765             | )      | (5,606            | )      |
|                                                                                                                                |   | 17,840             |   | 17,746            |   |
|                                                                                                                                |   |               |   |              |   |
| Goodwill, net  of accumulated amortization of $24,123 at September 30, 2002 and December 31,  2001                                  |   | 8,215              |   | 8,215             |   |
| Intangible  assets, net of accumulated amortization of $2,750 and $2,300 at September 30,  2002 and December 31, 2001, respectively |   | 6,319              |   | 6,769             |   |
| Other assets                                                                                                                        |   | 50                 |   | 54                |   |
| Total assets                                                                                                                        |   | $                  | 60,264 |              | $      | 59,357 |   |
|                                                                                                                                     |        |                    |        |                   |        |  |  |  |

 

See accompanying notes

 

 

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|                                                                                                                            |   | **September  30,** |   | **December  31,** |   |
|---------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|--------|-------------------|--------|
|                                                                                                                            |   | **2002**           |   | **2001**          |   |
|                                                                                                                            |   | **(Unaudited)**    |   |              |   |
| **Liabilities and stockholders’ equity**                                                                                   |   |               |   |              |   |
| Current  liabilities:                                                                                                           |   |               |   |              |   |
| Accounts  payable                                                                                                               |   | 5,092              |   | 3,372             |   |
| Accrued  expenses                                                                                                               |   | 3,706              |   | 4,240             |   |
| Accrued  payroll and related liabilities                                                                                        |   | 429                |   | 494               |   |
| Income taxes  payable                                                                                                           |   | 79                 |   | —            |   |
| Current  portion of long-term debt                                                                                              |   | 277                |   | 277               |   |
| Total current  liabilities                                                                                                      |   | 9,583              |   | 8,383             |   |
|                                                                                                                            |   |               |   |              |   |
| Deferred  income taxes, noncurrent                                                                                              |   | 251                |   | 251               |   |
| Long-term  debt, less current portion                                                                                           |   | 7,874              |   | 8,083             |   |
|                                                                                                                            |   |               |   |              |   |
| Commitments  and contingencies                                                                                                  |   |               |   |              |   |
|                                                                                                                            |   |               |   |              |   |
| Stockholders’  equity:                                                                                                     |   |               |   |              |   |
| Preferred  stock, par value of $0.01 per share:                                                                                 |   |               |   |              |   |
| Authorized  shares — 2,000,000                                                                                             |   |               |   |              |   |
| Issued and  outstanding shares — none                                                                                      |   | —             |   | —            |   |
| Common stock,  par value of $0.01 per share:                                                                                    |   |               |   |              |   |
| Authorized  shares — 50,000,000                                                                                            |   |               |   |              |   |
| Issued and  outstanding shares — 13,787,750 and 13,712,354 at September 30, 2002 and  December 31, 2001, respectively |   | 138                |   | 137               |   |
| Additional  paid-in capital                                                                                                     |   | 62,004             |   | 61,869            |   |
| Accumulated  deficit                                                                                                            |   | (16,705            | )      | (16,485           | )      |
|                                                                                                                            |   | 45,437             |   | 45,521            |   |
| Shares held in treasury, at cost— 921,900shares at September 30, 2002 and  December 31, 2001                               |   | (2,881             | )      | (2,881            | )      |
| Total  stockholders’ equity                                                                                                |   | 42,556             |   | 42,640            |   |
| Total  liabilities and stockholders’ equity                                                                                |   | $                  | 60,264 |              | $      | 59,357 |   |
|                                                                                                                                 |        |                    |        |                   |        |  |  |

 

See accompanying notes

 

 

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NATROL, INC.****CONSOLIDATED STATEMENTS OFOPERATIONS(IN THOUSANDS EXCEPT FOR SHARE AND PER SHARE AMOUNTS)
|                                               |   | **Three  months ended** |   | **Nine  months ended** |   |
|----------------------------------------------------|--------|-------------------------|--------|------------------------|--------|
|                                               |   | **September  30,**      |   | **September  30,**     |   |
|                                               |   | **2002**                |   | **2001**               |   | **2002** |   | **2001** |   |
|                                               |   | **(Unaudited)**         |   | **(Unaudited)**        |   |
| Net sales                                          |   | $                       | 18,021 |                   | $      | 20,374 |   | $ | 53,403 |   | $ | 58,691 |   |
| Cost of goods sold                                 |   | 11,035                  |   | 11,113                 |   | 32,740 |   | 33,682 |   |
| Gross profit                                       |   | 6,986                   |   | 9,261                  |   | 20,663 |   | 25,009 |   |
|                                               |   |                    |   |                   |   |   |   |   |   |
| Selling and marketing expenses                     |   | 4,675                   |   | 4,615                  |   | 12,758 |   | 11,968 |   |
| General and administrative expenses                |   | 2,628                   |   | 2,800                  |   | 7,823 |   | 8,201 |   |
| Total operating expenses                           |   | 7,303                   |   | 7,415                  |   | 20,581 |   | 20,169 |   |
| Operating income (loss)                            |   | (317                    | )      | 1,846                  |   | 82 |   | 4,840 |   |
|                                               |   |                    |   |                   |   |   |   |   |   |
| Interest income                                    |   | 24                      |   | 32                     |   | 69 |   | 126 |   |
| Interest expense                                   |   | (169                    | )      | (153                   | )      | (510 | ) | (634 | ) |
| Income (loss) before income tax provision          |   | (462                    | )      | 1,725                  |   | (359 | ) | 4,332 |   |
| Income tax provision (benefit)                     |   | (180                    | )      | 677                    |   | (139) |   | 1,707 |   |
| Net income (loss)                                  |   | $                       | (282   | )                      | $      | 1,048 |   | $ | (220) |   | $ | 2,625 |   |
|                                               |   |                    |   |                   |   |   |   |   |   |
| Basic earnings (loss) per share                    |   | $                       | (0.02  | )                      | $      | 0.08 |   | $ | (0.02 | ) | $ | 0.21 |   |
|                                               |   |                    |   |                   |   |   |   |   |   |
| Diluted earnings (loss) per share                  |   | $                       | (0.02  | )                      | $      | 0.08 |   | $ | (0.02 | ) | $ | 0.20 |   |
|                                               |   |                    |   |                   |   |   |   |   |   |
| Weighted average shares outstanding — basic   |   | 12,847,397              |   | 12,764,768             |   | 12,860,577 |   | 12,790,393 |   |
|                                               |   |                    |   |                   |   |   |   |   |   |
| Weighted average shares outstanding — diluted |   | 12,847,397              |   | 13,455,018             |   | 12,860,577 |   | 13,202,837 |   |

 

See accompanying notes

 

 

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NATROL, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS(IN THOUSANDS EXCEPT FOR SHARE AND PER SHARE AMOUNTS)(Unaudited)
|                                                                                      | **Nine  Months Ended September 30,** |   |
|-------------------------------------------------------------------------------------------|--------------------------------------|--------|
|                                                                                      | **2002**                             |   |   | **2001** |   |
| **Operating Activities**                                                                  |                                 |   |   |   |   |
| Net income (loss)                                                                         | $                                    | (220   | ) |   | $ | 2,625 |   |
| Adjustments to reconcile net  income (loss) to net cash provided by operating activities: |                                 |   |   |   |   |
| Depreciation  and amortization                                                            | 901                                  |   |   | 1,046 |   |
| Amortization  of goodwill and intangibles                                                 | 450                                  |   |   | 1,710 |   |
| Provision for  bad debts                                                                  | 257                                  |   |   | 436 |   |
| Shares issued  for services                                                               | 17                                   |   |   | 8 |   |
| Changes in  operating assets and liabilities:                                             |                                 |   |   |   |   |
| Accounts  receivable                                                                      | (693                                 | )      |   | (2,407 | ) |
| Inventories                                                                               | 2,188                                |   |   | (768 | ) |
| Income taxes  receivable/payable                                                          | 1,487                                |   |   | 3,565 |   |
| Prepaid expenses  and other current assets                                                | 603                                  |   |   | (798 | ) |
| Accounts  payable                                                                         | 1,720                                |   |   | 1,639 |   |
| Accrued  expenses                                                                         | (535                                 | )      |   | 920 |   |
| Accrued  payroll and related liabilities                                                  | (65                                  | )      |   | 217 |   |
| Net cash  provided by operating activities                                                | 6,110                                |   |   | 8,193 |   |
|                                                                                      |                                 |   |   |   |   |
| **Investing Activities**                                                                  |                                 |   |   |   |   |
| Purchases of  property and equipment                                                      | (995                                 | )      |   | (246 | ) |
| Other assets                                                                              | 4                                    |   |   | 12 |   |
| Net cash used  in investing activities                                                    | (991                                 | )      |   | (234 | ) |
|                                                                                      |                                 |   |   |   |   |
| **Financing Activities**                                                                  |                                 |   |   |   |   |
| Repayments on  line of credit, net                                                        | —                               |   |   | (8,300 | ) |
| Repayments on  long-term debt                                                             | (208                                 | )      |   | (197 | ) |
| Proceeds from  stock purchase plan                                                        | 21                                   |   |   | 22 |   |
| Proceeds from  exercise of stock options                                                  | 98                                   |   |   | 47 |   |
| Net cash used  in financing activities                                                    | (89                                  | )      |   | (8,428 | ) |
|                                                                                      |                                 |   |   |   |   |
| Net increase (decrease) in cash and cash  equivalents                                     | 5,030                                |   |   | (469 | ) |
| Cash and cash equivalents, beginning of  period                                           | 5,485                                |   |   | 4,004 |   |
| Cash and cash equivalents, end of period                                                  | $                                    | 10,515 |   |   | $ | 3,535 |   |
|                                                                                      |                                 |   |   |   |   |

 

See accompanying notes

 

 

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NATROL, INC.NOTES TO CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS(ALL AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)

 

1. BASIS OFPRESENTATION

 

In the opinionof management, the accompanying unaudited consolidated financial statementsinclude all necessary adjustments (consisting of normal recurring accruals) andpresent fairly in all material respects the consolidated financial position ofNatrol, Inc. and its subsidiaries (collectively, the “Company” or “Natrol”) asof September 30, 2002 and the results of its operations for the three and ninemonths ended September 30, 2002 and 2001 and cash flows for the nine monthsended September 30, 2002 and 2001, in conformity with accounting principlesgenerally accepted in the United States for interim financial informationapplied on a consistent basis. The results of operations for the three and ninemonths ended September 30, 2002 are not necessarily indicative of the resultsto be expected for the full year.

 

Certaininformation and footnote disclosures which are normally included in financialstatements prepared in accordance with accounting principles generally acceptedin the United States have been omitted. These consolidated financial statements should be read in conjunctionwith the audited consolidated financial statements and notes thereto includedin Natrol’s December 31, 2001 audited consolidated financial statementsincluded in the Company’s Form 10-K for the year ended December 31, 2001 asfiled with the Securities and Exchange Commission (file number 000–24567).

 

2. INVENTORIES

 

Inventories consistof the following:

 
|                                |   | **September 30,** |   | **December 31,** |   |
|-------------------------------------|--------|-------------------|--------|------------------|--------|
|                                |   | **2002**          |   | **2001**         |   |
|                                |   |              |   |             |   |
| Raw material and packaging supplies |   | $                 | 3,319  |             | $      | 4,280 |   |
| Finished goods                      |   | 4,236             |   | 5,463            |   |
|                                |   | $                 | 7,555  |             | $      | 9,743 |   |

 

3.COMPREHENSIVE INCOME

 

The Company’scomprehensive income items were not material at September 30, 2002 or December31, 2001 and therefore no disclosures have been made.

 

4. SHIPPINGAND HANDLING COSTS

 

Outboundshipping and fulfillment costs are classified as selling and marketing expensesand totaled $725 and $878 for the three months ended September 30, 2002 and2001, respectively, and $2,177 and $2,453 for the nine month periods endingSeptember 30, 2002 and September 30, 2001, respectively.

 

 

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5. EARNINGSPER SHARE

 

The Companycalculates earnings per share in accordance with SFAS No. 128 “Earnings pershare”.  Basic earnings per share hasbeen computed by dividing net income by the weighted average number of commonshares outstanding. Diluted earnings per share has been computed by dividingnet income by the weighted average of securities or other contracts to issueCommon Stock as if these securities were exercised or converted to CommonStock.  Common Stock equivalent sharesfrom stock options representing 3,148,000 shares have been excluded from thecomputation of diluted earnings per share for the three months ending September30, 2002 and for the nine months ending September 30, 2002, because the effectwould be antidilutive.

 

6.STOCKHOLDERS’ EQUITY

 

STOCK OPTIONS

 

Statementof Financial Accounting Standards No. 123, “Accounting for Stock-BasedCompensation” encourages, but does not require, companies to recordcompensation cost for stock-based employee compensation plans at fair value.The Company has chosen to continue to account for stock-based compensationusing the intrinsic value method prescribed in Accounting Principles BoardOpinion No. 25, “Accounting for Stock Issued to Employees.”  During the three months ended September 30,2002, 220,000 stock options were granted with exercise prices equal to the fairvalue of the underlying Common Stock on the date of grant.

 

 

7. REVENUERECOGNITION

 

The Company sells its products to retailoutlets through a direct sales force and a national broker network. The Companyrecognizes revenue from sales only after product is shipped.  Net sales represent products shipped lessreturns, estimates for future returns, spoilage allowances, allowances forproduct deemed to be unsaleable by customers, and free goods shipped tocustomers for promotional or other purposes. Estimates and allowances are basedupon known claims and an estimate of additional returns.

 

Effective January 1, 2002 the Company adoptedthe Financial Accounting Standards Board’s (FASB) Emerging Issues Task Force(EITF) Issue No. 01-9 “Accounting for Consideration Given by a Vendor to aCustomer or Reseller of the Vendor’s Products,” which codified and reconciledthe consensus reached on EITF Issue No. 00-14, “Accounting for Certain SalesIncentives,” EITF Issue No. 00-22 “Accounting for ‘Points’ and Certain OtherTime-Based or Volume Based Sales Incentive Offers, and Offers of Free Productsor Services to be Delivered in the Future,” and EITF Issue No. 00-25 “VendorIncome Statement Characterization of Consideration Paid to a Reseller of theVendor’s Products.”  The guidance inthese Issues is to be applied for financial statements for any period beginningafter December 15, 2001. Under this pronouncement, slotting fees, rebates,price reduction scanbacks and miscellaneous other expense items which in effectreduce the cost of product to the Company’s customers must be deducted fromgross sales revenue when calculating net sales revenue. As a result of theadoption of this EITF, net sales for the quarter ending September 30, 2001 havebeen reduced from $21.2 million to $20.4 million and net sales for the ninemonths ended September 30, 2001 have been reduced from $61.2 million to $58.7million with selling and marketing expenses being reduced by the same amountdue to the reclassification of certain expenses from selling and marketingexpenses to net sales.

** **

 

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8.ACCOUNTING FOR GOODWILL AND INTANGIBLES

 

The Company reviews the impairment oflong-lived assets and certain identifiable intangibles whenever events orchanges in circumstances indicate that the carrying amount of any asset may notbe recoverable. An impairment loss would be recognized when the estimatedundiscounted future cash flows expected to result from the use of the asset andits eventual disposition is less than the carrying amount. If an impairment isindicated, the amount of the loss to be recorded is based on an estimate of thedifference between the carrying amount and the fair value of the asset. Fairvalue is based upon discounted estimated cash flows expected to result from theuse of the asset and its eventual disposition and other valuation methods.

 

In June 2001, the FASB issued Statement ofFinancial Accounting Standards (SFAS) No. 142, “Goodwill and Other IntangibleAssets.” SFAS 142 prohibits the amortization of goodwill and intangibles withindefinite useful lives and requires these assets to be reviewed for impairmentat least annually. Intangible assets with finite lives will continue to beamortized over their estimated useful lives. The Company began applying SFAS142 in the first quarter of fiscal 2002 and application of the nonamortizationprovisions of this standard is expected to result in an increase in net incomeof $821,000 in 2002 on an annual basis. SFAS 142 requires testing of goodwillimpairment under a two-step process. The first step is to screen for potentialimpairment, while the second step measures the amount of impairment, if any.

 

During 2001, the Company reviewed thegoodwill associated with its Laci Le Beau, EPI, and Prolab acquisitions.  The Company measured the valuation of theunamortized goodwill associated with these acquisitions relative to the marketcapitalization of the Company as a whole, relative to the undiscounted cashflows produced by these entities as well as potential future discounted cashflows with these cash flows being discounted by a required rate of return thattook into account the risk-free rate of return as measured by the 20-year longbond rate of return as well as other measures of risk such as the Company’ssmall capitalization, risk associated with market size, volatility, historicalcash flows and earnings, depth of management and other measures.

 

After the review, the Company determined thatthe unamortized goodwill associated with its Laci Le Beau acquisition was notimpaired.  It further determined that inaccordance with SFAS 142 no write down of this goodwill would benecessary in 2002 unless conditions surrounding this division’s performancechange substantially.  In 2001, theCompany amortized $340,000 relative to goodwill associated with its acquisitionof Laci Le Beau. In the three and nine months ending September 30, 2001, theCompany recorded amortization of $85,000 and $255,000 relative to goodwill associated with its acquisition ofLaci Le Beau.

 

TheCompany next determined that the unamortized goodwill associated with itsacquisition of EPI was also not impaired. However, the Company also determined that due to the nature of itssupply agreement with ConAgra, which expires in approximately six years and thefact that ConAgra is EPI’s major source of supply for the majority of itsbusiness, the goodwill recorded related to the intangible value of thefavorable terms of the contract acquired should be amortized. As such, thisintangible is continuing to be amortized at the rate of $600,000 per year,consistent with the amount of goodwill amortized for EPI in 2001.

 

Withrespect to Prolab, the Company determined that it was appropriate to write downassociated goodwill by $20 million during 2001. The Company considered all ofthe factors mentioned above but focused on Prolab’s declining sales volume,issues surrounding Prolab’s ephedrine-based products, the Sports Nutritionmarket as a whole, and undiscounted cash flows.  Based on all of these considerations, the Company deemed that inaccordance with accounting rules in effect in 2001 that a $20 million writedown of goodwill was appropriate.  Inaddition, the Company reviewed the Prolab business and future expectations inaccordance with SFAS 142.  In accordancewith SFAS 142, the Company reviews, on an ongoing basis,  the valuation of all of its goodwill .  It cannot guarantee that a further reductionof Prolab’s goodwill or a reduction of Laci Le Beau’s or EPI’s goodwill inaddition to what has been described will not be necessary. In the three andnine months ending September 30, 2001, the Company recorded amortization of$335,000 and $1.0 million relative to goodwill associated with its acquisitionof Prolab.

 

9.INVESTMENT IN WHOLLY OWNED SUBISIDIARY.

 

Duringthe three and nine months ending September 30, 2002, the Company spent $405,000and $582,00 to launch a new multi-level marketing company.  This company, Annasa, Inc. (“Annasa”), is awholly owned subsidiary of Natrol. Annasa is still in the launch phase and hasnot recorded any revenues through September 30, 2002. All of the expendituresmade through September 30, 2002 have been expensed with approximately $149,000 includedin selling and marketing expenses and $433,000 included in general andadministrative expenses on the consolidated statements of operations for thenine month period ended September 30, 2002.

 

 

10.LONG-LIVED ASSETS

 

In August 2001, the FASB issued SFAS No. 144,“Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS 144),which addresses financial accounting and reporting for the impairment oflong-lived assets and supercedes SFAS No. 121, “Accounting for the Impairmentof Long-Lived Assets and Long-Lived Assets to Be Disposed Of,” and theaccounting and reporting provisions of APB Opinion No. 30, “Reporting theResults of Operations — Reporting the Effects of a Disposal of a Segment of a 

 

 

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Business, and Extraordinary, Unusual and InfrequentlyOccurring Events and Transactions,” for the disposal of a segment of abusiness. The Company adopted SFAS 144 in the first quarter of 2002 and theadoption of the statement had no effect on the Company’s financial position orresults of operations.

 

11.RECLASSIFICATIONS

 

Certain reclassifications have been made to the 2001consolidated financial statements to conform to the presentation in 2002.

 

ITEM 2:MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Informationcontained or incorporated by reference in this quarterly report on Form 10–Qand in other SEC filings by the Company contains “forward looking statements”within the meaning of  the  Private Securities Litigation Reform Act of1995. The Company is including this statement for the express purpose ofavailing itself of protections of the safe harbor provided by the PrivateSecurities Litigation Reform Act of 1995 with respect to all such forward lookingstatements. Examples of forward lookingstatements include, but are not limited to, the use of forward–lookingterminology such as “believes,” “expects,” “may,” “will,” “should”, “intend”,“estimate”, “assume”, “plan” or “anticipates” or the negative thereof, othervariations thereon, or comparable terminology, or by discussions of strategythat predict or indicate future events or trends or that are not historicalfacts. The Company cannot assure the future results or outcome of the mattersdescribed in these statements; rather, these statements merely reflect itscurrent expectations of the approximate outcome of the matter discussed. TheCompany does not intend and undertakes no obligation to update any suchstatements at any time in the future.

 

TheCompany’s ability to predict results or the effect of certain events on theCompany’s operating results is inherently uncertain. Forward–lookingstatements should not be unduly relied upon since they involve known andunknown risks, uncertainties and other factors, some of which are beyond theCompany’s control. These risks, uncertainties and other factors may causeactual results, performance or achievements to differ materially from theanticipated future results, performance or achievements expressed or implied bysuch forward–looking statements. Therefore, the Company wishes to cautioneach reader of this report to carefully consider the following factors andcertain other factors discussed herein and in other past reports, including butnot limited to the prior year annual reports on Form 10-K filed with theSecurities and Exchange Commission. The factors discussed herein and containedin that Form 10-K may not be exhaustive. Therefore, the factors containedherein should be read together with other reports and documents that are filedby the Company with the SEC from time to time, including Form 10-Q which maysupplement, modify, supersede or update the factors listed in this document.

 

Factors that could cause or contribute to theCompany’s actual results differing materially from those discussed herein orfor the Company’s stock price to be affected adversely include, but are notlimited to: (i) industry trends, including a general downturn or slowingof the growth of the dietary supplement industry which has occurred duringrecent years and may continue, (ii) increased competition from currentcompetitors and new market entrants including but not limited to increasedcompetition from private label house brands supported by retailers seeking to increasethe market share of their proprietary house brands, (iii) adversepublicity regarding the dietary supplement industry or the Company’s productsincluding recent publicity regarding ephedrine-based products, (iv) theCompany’s dependence upon its ability to develop new products, (v) acontinued high rate (or increase in the rate) of returns of the Company’sproducts, (vi) the Company’s ability to gain or expand or maintaindistribution within new or existing customers and new or existing channels oftrade, (vii) an increase in the cost of obtaining and maintaining shelfspace with major national retailers who demand various 

 

 

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forms of incentives from their suppliers suchas slotting fees, coop advertising, or rebates, (viii) adverse changes ingovernment regulation, (ix) exposure to product liability claims includingproduct liability claims from products which include ephedrine or otherproducts for which the Company has either not been able to secure productliability coverage or been able to secure such coverage at reasonable prices.,(as of September 30, 2002, the availability of product liability insurance forephedrine-based products was non-existent and the Company expects substantialincreases in the cost for product liability insurance as its policies renewduring the last quarter of 2002), (x) dependence on significant customers,(xi) the Company’s ability to keep and attract key management employees,(xii) the Company’s inability to manage growth and execute its businessplan, or the Company’s ability to modify its business plan in response tomarket conditions, including, but not limited to, its ability to enter newbusinesses and capitalize upon new business opportunities (xiii) theCompany’s ability to consummate future acquisitions and its ability tointegrate acquired businesses, including without limitation ProlabNutrition, Inc. (“Prolab”), acquired in October, 1999 for which theCompany took a $20 million impairment charge in the year ending December 31,2001 due to the write down of goodwill associated with the acquisition,(xiv) the absence of conclusive clinical studies for many of the Company’sproducts, (xv) the Company’s inability to obtain raw materials that are inshort supply including its ability to obtain garlic powders under its supplyagreement with ConAgra for its Essentially Pure Ingredient (EPI) raw materialsales division, (xvi) sales and earnings volatility,(xvii) volatility of the stock market (xviii) the Company’s ability tomanufacture its products efficiently, (xix) the Company’s ability tomanage inventory or sell its inventory before such inventory becomes outdated,(xx) the Company’s reliance on independent brokers to sell its products,(xxi) the inability of the Company to protect its intellectual property,(xxii) control of the Company by principal shareholders, (xxiii) thepossible sale of large amounts of stock by controlling shareholders,(xxiv) a continued general downturn in the national economy as a whole,(xxv) continued market acceptance of Natrol supplements, Laci Le Beauteas, Prolab’s sports nutrition products, and Essentially Pure Ingredients’ rawmaterial products, or, (xxvi) that its planned investment in a new multi-levelmarketing company, Annasa Inc.  willprove to be profitable in the near or long-term.

 

RESULTS OFOPERATIONS

 

THE FOLLOWINGDISCUSSION OF THE RESULTS OF OPERATIONS AND FINANCIALCONDITION OF THE COMPANY SHOULD BE READ IN CONJUNCTION WITH THE RESPONSE TOPART I, ITEM 1 OF THIS REPORT.

 

THREE MONTHSENDED SEPTEMBER 30, 2002 AND SEPTEMBER 30, 2001

 

NET SALES. Sales are recognized at the timeproduct is shipped. Net sales are net of discounts, allowances, and estimatedreturns and credits, slotting fees, rebates and other expenses that reduce thecost of product to the Company’s customers. Net sales decreased 11.5%, or $2.4 million, to $18.0 million for thethree months ended September 30, 2002 from $20.4 million for the three monthsended September 30, 2002.  The declinein net sales was primarily due to a lower volume of shipments as well as theCompany providing for an increased level of returns as it focused on removingslower moving items from store shelves to replace them with better sellingproducts. The Company has also aggressivelypromoted certain products with special promotions and price rollbacks whichalso reduced net sales.  All ofthe factors mentioned above contributed to the decline in net sales for thequarter.

 

GROSSPROFIT.  Gross profit decreased 24.6%,or $2.3 million, to $7.0 million for the three months ended September 30, 2002from $9.3 million for the three months ended September 30, 2001. Gross margindecreased to 38.8% for the three months ended September 30, 2002 from 45.5% forthe three months ended September 30, 2001. The decline in gross margin was due to the lower volume of net salesrelative to fixed and semi-fixed manufacturing expenses.

 

SELLING ANDMARKETING EXPENSES.  Selling andmarketing expenses consist primarily of advertising and promotional expenses, costof distribution, and related payroll expenses and commissions. Selling andmarketing expenses increased 1.3%, or $60,000, to $4.7 million for the threemonths ended September 30, 2002 from $4.6 million for the three months endedSeptember 30, 2001. The Company incurred $95,000 of selling and marketingexpenses as part of its preparation for launching its Annasa multi-levelmarketing subsidiary, which is currently recruiting distributors.  While some sales revenue is expected during2002,  the full national launch of thebusiness will not occur until the first quarter of 2003.  The Company’s business plan calls for anincreased level of sales and marketing expenditures on the part of Annasaduring the fourth quarter of 2002 as it prepares for the full launch of thebusiness. Without the expenditures incurred by Annasa, Natrol’s other sales andmarketing expenditures would have been marginally less than those during thesame quarter of 2001.

 

GENERAL ANDADMINISTRATIVE EXPENSES.  General andadministrative expenses consist primarily of personnel costs related to generalmanagement functions, finance, accounting and information systems, research anddevelopment expenses, as well as professional fees related to legal, audit andtax matters and depreciation and amortization of goodwill. General andadministrative expenses decreased 6.2%, or $172,000, and were approximately$2.6 million for the three months ended September 30, 2002. The decreaserelated primarily to a decrease in amortization of goodwill and intangibles forthe quarter ending September 30, 2002 to $150,000 as opposed to the $570,000recorded in the quarter ended September 30, 2001 as a result of the applicationof SFAS 142. This decrease is primarily offset by the Company’s investment ofapproximately $310,000 in Annasa’s general and administrative expenses.  

 

 

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INTERESTEXPENSE.  The Company recorded interestexpense of $169,000 for the three months ended September 30, 2002 as comparedto interest expense of $153,000 for the three months ended September 30, 2001.The Company pays interest on approximately $8.2 million of long-term mortgagedebt.  

 

INCOME TAXPROVISION. The Company’s effective tax rate was approximately 39% in the thirdquarter of 2002 as well as in the third quarter of 2001.

 

NINE MONTHSENDED SEPTEMBER 30, 2002 AND SEPTEMBER 30, 2001

 

NET SALES. Net sales decreased 9.0%, or $5.3million, to $53.4 million for the nine months ended September 30, 2002 from$58.7 million for the nine months ended September 30, 2001. The decline in netsales was primarily due to a lower volume of shipments as well as the Companyproviding for an increased level of returns as it focused on removing slowermoving items from store shelves to replace them with better selling products. The Company has also aggressively promotedcertain products with special promotions and price rollbacks which also reducednet sales.  All of the factorsmentioned above contributed to the decline in net sales for the nine monthperiod ended September 30, 2002.

 

GROSSPROFIT.  Gross profit declined 17.4%, or$4.3 million, to $20.7 million for the nine months ended September 30, 2002from $25.0 million for the nine months ended September 30, 2001. Gross margindecreased to 38.7% for the nine months ended September 30, 2002 from 42.6% forthe nine months ended September 30, 2001. The decline in gross margin was dueto the lower volume of net sales relative to fixed and semi-fixed manufacturingexpenses.

 

SELLING ANDMARKETING EXPENSES.  Selling andmarketing expenses consist primarily of advertising and promotional expenses,cost of distribution, and related payroll expenses and commissions. Selling andmarketing expenses increased 6.6%, or $790,000, to $12.8 million for the nine monthsended September 30, 2002 from $12.0 million for the nine months ended September30, 2001. The level of selling and marketing expenditures in the nine monthsending September 30, 2002 were higher due to an increased level of coopadvertising and consumer print advertising than in the same period of2001.  In addition, the Company spent$149,000 in selling and marketing expenses to prepare for the launch of itsAnnasa multi-level marketing subsidiary.

 

GENERAL ANDADMINISTRATIVE EXPENSES.  General and administrativeexpenses consist primarily of personnel costs related to general managementfunctions, finance, accounting and information systems, research anddevelopment expenses, as well as professional fees related to legal, audit andtax matters and depreciation and amortization. General and administrativeexpenses decreased 4.6%, or $378,000, to $7.8 million for the nine months endedSeptember 30, 2002 from $8.2 million for the nine months 

** **

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ended September30, 2001. The decrease related primarily to a decrease in amortization ofgoodwill and intangibles for the nine months ending September 30, 2002 to$450,000 as opposed to the $1.7 million recorded in the nine months endedSeptember 30, 2001 as a result of the application of SFAS 142. This decrease ispartially offset by an increase in officer salaries. In the six months endedJune 30, 2001, Mr. Balbert, Natrol’s President, voluntarily opted not to notdraw his  salary whereas for the sixmonths ending September 30, 2002, Mr. Balbert’s salary amounted to$300,000.  Outside legal expenses alsorose $569,000 when compared to the same period of 2001. The Company iscurrently defending itself in a number of trade and patent , product liabilityand regulatory lawsuits at this time.   Although the Company does not believe any one of these matters ismaterial, the Company expects to incur higher legal expenses as it defendsthese lawsuits in future periods. Litigation is inherently uncertain and as a result, there can be noassurance that, if these or other lawsuits are decided adversely to theCompany, it would not have a materially adverse effect on the Company’sfinancial condition and results of operations. The launch of the Annasa multi-level marketing subsidiary added $433,00to consolidated general and administrative expenses during the nine monthsended September 30, 2002 when compared to the same nine months of 2001.  The remaining reduction in General and administrativeexpenses was primarily due to a reduction in payrll expenses during theyear.  In June, the Company began theinstallation of a new, integrated, SAP accounting and manufacturingsystem.  This system, which is estimatedto cost the Company between $1.5 and $2.0 million dollars once fullyimplemented, will add to the Company’s depreciation expense beginning in thefourth quarter of 2002.  In addition,training expenses related to the installation will be expensed in the fourthquarter. 

 

 

INTERESTEXPENSE.  Interest expense decreased to$510,000 for the nine months ended September 30, 2002 from $634,000 for thenine months ended September 30, 2001. The Company pays interest onapproximately $8.2 million of long-term mortgage debt. During the first twoquarters of 2001, it also paid interest on borrowings under a line of creditagreement.

 

INCOME TAXPROVISION. The Company’s effective tax rate was approximately 39% during thenine months ended September 30, 2002 as well as in the nine months endedSeptember 30, 2001.

 

**LIQUIDITY ANDCAPITAL RESOURCES**

 

At September 30, 2002, the Company hadworking capital of $18.3 million, as compared to $18.2 million in workingcapital at December 31, 2001. The Company’s cash balance at September 30,2002 was approximately $10.5 million.

 

Net cash provided by operating activities was$6.1 million for the nine months ended September 30, 2002 versus net cashprovided of $8.2 million for the nine months ended September 30, 2001. Cashprovided by operating activities during the nine month period ended September30, 2002 was primarily due to a decrease in inventory levels of $2.2 million,activity in the income tax accounts providing $1.5 million, an increase intrade payables and accrued expenses of $1.2 million, depreciation and amortization of $1.4 million and areduction in prepaid expenses of $603,000 offset by increases in accountsreceivable of $693,000.

 

Netcash used in investing activities was $991,000 for the nine months endedSeptember 30, 2002 and $234,000 during the nine months ended September 30, 2001.Nearly all of the cash used in investing activities in both periods was in property and equipment.During the nine months ended September 30, 2002, the majority of the Company’sexpenditures in fixed assets was in new computer software and hardware relatedto its installation of an SAP computer system.

 

Net cash used by financing activities was$89,000 for the nine months ended September 30, 2002 as opposed to $8.4 millionused by financing activities during the nine months ended September 30, 2001. Duringthe nine months ended September 30, 2002, the Company made principal paymentsof $208,000 on its long-term mortgage debt and received $119,000 from theproceeds of the exercise of stock options and the sale of stock to employeesthrough its employee stock purchase program. During the nine months ended September 30, 2001, the Company reduced itsline of credit by $8.3 million and repaid $197,000 in long-term debt.

 

As of September 30, 2002, the Company had $8.2 million of outstandingdebt all of which is the result of a mortgage on the Company’smanufacturing/headquarters facility and a mortgage on the Company’s shippingfacility. The Company currently has no line of credit in place.

 

The Companyexpects its cash balances to decline during the next several quarters as itinvests in the launch of its Annasa multi-level marketing subsidiary.

 

Despitethe anticipated decline in cash balances, the Company believes that its currentcash balance together with cash generated from operations other thanAnnasa  will be sufficient to fund itsanticipated working capital needs and capital expenditures for the next 12months.  If the Company’s expectationsare not met and the Company has to borrow funds, the cost of borrowing may beunfavorable and the terms of such borrowings may limit the Company’s ability togrow.

 

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Item3.    QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK

 

The following discussion about the Company’smarket risk disclosures involves forward–looking statements. Actualresults could differ materially from those projected in the forward–lookingstatements. The Company does not believe it is exposed to market risk relatedto changes in interest rates. The risks related to foreign currency exchangerates are immaterial and the Company does not use derivative financialinstruments.

 

The Company currently has no short-term borrowings.  The Company does not believe that the riskis significant for its long-term debt due to the low fixed rates andinsignificance of the long-term debt to the Company’s consolidated balancesheet.

 

Item 4.    CONTROLS AND PROCEDURES

 

(a)           Evaluation ofdisclosure controls and procedures.

 

As required by newRule 13a-15 under the Securities Exchange Act of 1934, within the 90 days priorto the date of this report, we carried out an evaluation under the supervisionand with the participation of our management, including our Chief ExecutiveOfficer and Chief Financial Officer, of the effectiveness of the design andoperation of our disclosure controls and procedures.  In designing and evaluating our disclosure controls andprocedures, we and our management recognize that any controls and procedures,no matter how well designed and operated, can provide only reasonable assuranceof achieving the desired control objectives, and our management necessarily wasrequired to apply its judgment in evaluating and implementing possible controlsand procedures.  Based upon thatevaluation, our Chief Executive Officer and Chief Financial Officer haveconcluded that, as of the date of the completion of that evaluation, Natrol'sdisclosure controls and procedures were reasonably effective to ensure thatinformation required to be disclosed by us in the reports we file or submitunder the Exchange Act is recorded, processed, summarized and reported, withinthe time periods specified in the Securities and Exchange Commission's rulesand forms.  In connection with the newrules, we will continue to review and document our disclosure controls andprocedures, including our internal controls and procedures for financialreporting, on an ongoing basis, and may from time to time make changes aimed atenhancing their effectiveness and to ensure that our systems evolve with ourbusiness.

 

(b)           Changes in internal controls.

 

None.

 

 

PART II

 

 

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

 
| Exhibit 99.1 |   | Certification  of Chief Financial Officer |
|--------------|--------|-------------------------------------------|
| Exhibit 99.2 |   | Certification  of President/CEO/Chairman  |

 

No reports onForm 8-K were filed during the quarter for which this report is filed

 

 

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SIGNATURES

 

Pursuant tothe requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
|            | NATROL, INC. |
|-----------------|--------------|
|            |         |   |
| Date:  11/14/02 | By:          | /s/ Elliott  Balbert |
|            |         | Chairman,  President and Chief Executive Officer |
|            |         |   |
| Date:  11/14/02 | By:          | /s/ Dennis  R. Jolicoeur |
|            |         | Chief  Financial Officer and Executive  Vice President |
|            |         |   |

 

 

 

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Certification

** **

I, Dennis R. Jolicoeur, Chief FinancialOfficer and Executive Vice President of Natrol, Inc., certify that:

 

1.     I have reviewed this quarterly report onForm 10-Q of Natrol Inc.;

2.     Based on my knowledge, this quarterlyreport does not contain any untrue statement of a material fact or omit tostate a material fact necessary to make the statements made, in light of thecircumstances under which statements were made, not misleading with respect tothe period covered by this quarterly report;

3.     Based on my knowledge, the financialstatements, and other financial information included in this quarterly report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periodspresented in this quarterly report;

4.     The registrant’s other certifying officersand I are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for theregistrant and we have:

a.     designed such disclosure controls andprocedures to ensure that material information relating to the registrant,including its consolidated subsidiaries, is made known to us by others withinthose entities, particularly during the period in which this quarterly reportis being prepared;

b.     evaluated the effectiveness of theregistrant’s disclosure controls and procedures as of a date within 90 daysprior to the filing date of this quarterly report (the “Evaluation Date”); and

c.     presented in this quarterly report ourconclusions about the effectiveness of the disclosure controls and proceduresbased on our evaluation as of the Evaluation Date;

5.     The registrant’s other certifying officersand I have disclosed, based on our most recent evaluation, to the registrant’sauditors and the audit committee of registrant’s board of directors (or personsperforming the equivalent function):

a.     all significant deficiencies in the designor operation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial date and haveidentified for the registrant’s auditors any material weaknesses in internalcontrols; and

b.     any fraud, whether or not material, that involvesmanagement or other employees who have a significant role in the registrant’sinternal controls; and

6.     The registrant’s other certifying officersand I have indicated in this quarterly report whether or not there weresignificant changes in internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 

 
| Date:  | 11/14/2002 |   | Name:  | /s/Dennis R. Jolicoeur                |
|--------|------------|--------|--------|---------------------------------------|
|   |       |   |   |                                  |
|   |       |   | Title: | Chief Financial Officer and Executive |
|   |       |   |   | Vice President                        |
|   |       |   |   |                                  |

 

 

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Certification

** **

I, Elliott Balbert, President, ChiefExecutive Officer and Chairman of Natrol Inc., certify that:

 

1.     I have reviewed this quarterly report onForm 10-Q of Natrol Inc.

2.     Based on my knowledge, this quarterlyreport does not contain any untrue statement of a material fact or omit tostate a material fact necessary to make the statements made, in light of thecircumstances under which statements were made, not misleading with respect tothe period covered by this quarterly report

3.     Based on my knowledge, the financialstatements, and other financial information included in this quarterly report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periodspresented in this quarterly report;

4.     The registrant’s other certifying officersand I are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for theregistrant and we have:

a.     designed such disclosure controls andprocedures to ensure that material information relating to the registrant,including its consolidated subsidiaries, is made known to us by others withinthose entities, particularly during the period in which this quarterly reportis being prepared;

b.     evaluated the effectiveness of theregistrant’s disclosure controls and procedures as of a date within 90 daysprior to the filing date of this quarterly report (the “Evaluation Date”); and

c.     presented in this quarterly report ourconclusions about the effectiveness of the disclosure controls and procedures basedon our evaluation as of the Evaluation Date;

5.     The registrant’s other certifying officersand I have disclosed, based on our most recent evaluation, to the registrant’sauditors and the audit committee of registrant’s board of directors (or personsperforming the equivalent function):

a.     all significant deficiencies in the designor operation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial date and haveidentified for the registrant’s auditors any material weaknesses in internalcontrols; and

b.     any fraud, whether or not material, thatinvolves management or other employees who have a significant role in theregistrant’s internal controls; and

6.     The registrant’s other certifying officersand I have indicated in this quarterly report whether or not there weresignificant changes in internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 

 
| Date:  | 11/14/2002 |   | Name:  | /s/Elliott Balbert     |
|--------|------------|--------|--------|------------------------|
|   |       |   |   |                   |
|   |       |   | Title: | President/CEO/Chairman |

 

 

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