**SECURITIES AND EXCHANGE COMMISSION****WASHINGTON, D.C. 20549**

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**FORM 10–Q**

**(Mark one)**

 

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

 

**FOR THEQUARTERLY PERIOD ENDED JUNE 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)

 

INDICATEBY A CHECK 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

 

Indicatethe number of shares outstanding of the issuer’s common stock, as of the latestpracticable date:

 
| Class                         | August 1, 2002 |
|-------------------------------|----------------|
|                          |
| Common stock, $0.01 par value | 12,853,714     |

 

 

 

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PART1. FINANCIAL INFORMATION

ITEM1. CONSOLIDATED FINANCIAL STATEMENTS

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

 
|                                                                                                                           |   | **June 30,**    |   | **December  31,** |   |
|--------------------------------------------------------------------------------------------------------------------------------|--------|-----------------|--------|-------------------|--------|
|                                                                                                                           |   | **2002**        |   | **2001**          |   |
|                                                                                                                           |   | **(Unaudited)** |   |              |   |
| **Assets**                                                                                                                     |   |            |   |              |   |
| Current assets:                                                                                                                |   |            |   |              |   |
| Cash  and cash equivalents                                                                                                     |   | $               | 11,151 |              | $      | 5,485 |   |
| Accounts  receivable, net of allowances of $506 and $363 at June 30, 2002 and December  31, 2001, respectively                 |   | 8,434           |   | 6,787             |   |
| Inventories                                                                                                                    |   | 7,966           |   | 9,743             |   |
| Deferred  taxes                                                                                                                |   | 1,324           |   | 1,324             |   |
| Income  taxes receivable                                                                                                       |   | —          |   | 1,408             |   |
| Prepaid  expenses and other current assets                                                                                     |   | 1,140           |   | 1,826             |   |
| Total current assets                                                                                                           |   | 30,015          |   | 26,573            |   |
|                                                                                                                           |   |            |   |              |   |
| Property  and equipment:                                                                                                       |   |            |   |              |   |
| Building  and improvements                                                                                                     |   | 15,607          |   | 15,625            |   |
| Machinery  and equipment                                                                                                       |   | 5,761           |   | 5,708             |   |
| Furniture  and office equipment                                                                                                |   | 2,524           |   | 2,019             |   |
|                                                                                                                           |   | 23,892          |   | 23,352            |   |
| Accumulated  depreciation and amortization                                                                                     |   | (6,282          | )      | (5,606            | )      |
|                                                                                                                           |   | 17,610          |   | 17,746            |   |
|                                                                                                                           |   |            |   |              |   |
| Goodwill,  net of accumulated amortization of $24,123 at June 30, 2002 and December 31,  2001                                  |   | 8,215           |   | 8,215             |   |
| Intangible  assets, net of accumulated amortization of $2,600 and $2,300 at June 30, 2002  and December 31, 2001, respectively |   | 6,469           |   | 6,769             |   |
| Other  assets                                                                                                                  |   | 50              |   | 54                |   |
| Total  assets                                                                                                                  |   | $               | 62,359 |              | $      | 59,357 |   |

 

See accompanying notes

 

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|                                                                                                                       |   | **June 30,**    |   | **December  31,** |   |
|----------------------------------------------------------------------------------------------------------------------------|--------|-----------------|--------|-------------------|--------|
|                                                                                                                       |   | **2002**        |   | **2001**          |   |
|                                                                                                                       |   | **(Unaudited)** |   |              |   |
| **Liabilities and stockholders’ equity**                                                                              |   |            |   |              |   |
| Current  liabilities:                                                                                                      |   |            |   |              |   |
| Accounts  payable                                                                                                          |   | 4,992           |   | 3,372             |   |
| Accrued  expenses                                                                                                          |   | 5,188           |   | 4,240             |   |
| Accrued  payroll and related liabilities                                                                                   |   | 574             |   | 494               |   |
| Income  taxes payable                                                                                                      |   | 310             |   | —            |   |
| Current  portion of long-term debt                                                                                         |   | 277             |   | 277               |   |
| Total  current liabilities                                                                                                 |   | 11,341          |   | 8,383             |   |
|                                                                                                                       |   |            |   |              |   |
| Deferred  income taxes, noncurrent                                                                                         |   | 251             |   | 251               |   |
| Long-term  debt, less current portion                                                                                      |   | 7,944           |   | 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 — 13,775,614 and 13,712,354 at June 30, 2002 and  December 31, 2001, respectively |   | 138             |   | 137               |   |
| Additional  paid-in capital                                                                                                |   | 61,988          |   | 61,869            |   |
| Accumulated  deficit                                                                                                       |   | (16,422         | )      | (16,485           | )      |
|                                                                                                                       |   | 45,704          |   | 45,521            |   |
| Shares held in treasury, at cost— 921,900shares  at June 30, 2002 and December 31, 2001                               |   | (2,881          | )      | (2,881            | )      |
| Total  stockholders’ equity                                                                                           |   | 42,823          |   | 42,640            |   |
| Total  liabilities and stockholders’ equity                                                                           |   | $               | 62,359 |              | $      | 59,357 |   |
|                                                                                                                            |        |                 |        |                   |        |  |  |

 

See accompanying notes

 

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NATROL, INC.****CONSOLIDATED STATEMENTS OF INCOME(IN THOUSANDS EXCEPT FOR SHARE AND PER SHARE AMOUNTS)
|                                               |   | **Three  months ended** |   | **Six months  ended** |   |
|----------------------------------------------------|--------|-------------------------|--------|-----------------------|--------|
|                                               |   | **June 30,**            |   | **June 30,**          |   |
|                                               |   | **2002**                |   | **2001**              |   | **2002** |   | **2001** |   |
|                                               |   | **(Unaudited)**         |   | **(Unaudited)**       |   |
| Net sales                                          |   | $                       | 17,843 |                  | $      | 19,260 |   | $ | 35,382 |   | $ | 38,316 |   |
| Cost of goods sold                                 |   | 10,744                  |   | 11,295                |   | 21,704 |   | 22,568 |   |
| Gross profit                                       |   | 7,099                   |   | 7,965                 |   | 13,678 |   | 15,748 |   |
|                                               |   |                    |   |                  |   |   |   |   |   |
| Selling and marketing expenses                     |   | 4,325                   |   | 3,519                 |   | 8,058 |   | 7,353 |   |
| General and administrative expenses                |   | 2,573                   |   | 2,726                 |   | 5,220 |   | 5,400 |   |
| Total operating expenses                           |   | 6,898                   |   | 6,245                 |   | 13,278 |   | 12,753 |   |
| Operating income                                   |   | 201                     |   | 1,720                 |   | 400 |   | 2,995 |   |
|                                               |   |                    |   |                  |   |   |   |   |   |
| Interest income                                    |   | 26                      |   | 27                    |   | 45 |   | 93 |   |
| Interest expense                                   |   | (171                    | )      | (209                  | )      | (341 | ) | (481 | ) |
| Income before income tax provision                 |   | 56                      |   | 1,538                 |   | 104 |   | 2,607 |   |
| Income tax provision                               |   | 20                      |   | 618                   |   | 41 |   | 1,030 |   |
| Net income                                         |   | $                       | 36     |                  | $      | 920 |   | $ | 63 |   | $ | 1,577 |   |
|                                               |   |                    |   |                  |   |   |   |   |   |
| Basic earnings per share                           |   | $                       | 0.00   |                  | $      | 0.07 |   | $ | 0.00 |   | $ | 0.12 |   |
|                                               |   |                    |   |                  |   |   |   |   |   |
| Diluted earnings per share                         |   | $                       | 0.00   |                  | $      | 0.07 |   | $ | 0.00 |   | $ | 0.12 |   |
|                                               |   |                    |   |                  |   |   |   |   |   |
| Weighted average shares outstanding — basic   |   | 12,842,714              |   | 12,742,282            |   | 12,838,365 |   | 12,791,880 |   |
|                                               |   |                    |   |                  |   |   |   |   |   |
| Weighted average shares outstanding — diluted |   | 12,957,890              |   | 12,894,621            |   | 13,087,662 |   | 12,890,350 |   |

 

See accompanying notes

 

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NATROL, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS(IN THOUSANDS EXCEPT FOR SHARE AND PER SHARE AMOUNTS)(Unaudited)
|                                                                               |   | **Six Months  Ended June 30,** |   |
|------------------------------------------------------------------------------------|--------|--------------------------------|--------|
|                                                                               |   | **2002**                       |   | **2001** |   |
|                                                                               |   |                           |   |   |   |
| **Operating activities**                                                           |   |                           |   |   |   |
| Net income                                                                         |   | $                              | 63     |   | $ | 1,577 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |   |                           |   |   |   |
| Depreciation and amortization                                                      |   | 676                            |   | 720 |   |
| Amortization of goodwill and intangibles                                           |   | 300                            |   | 1,140 |   |
| Provision for bad debts                                                            |   | 235                            |   | 307 |   |
| Shares issued for services                                                         |   | 14                             |   | 6 |   |
| Changes in operating assets and liabilities:                                       |   |                           |   |   |   |
| Accounts receivable                                                                |   | (1,882                         | )      | 695 |   |
| Inventories                                                                        |   | 1,777                          |   | 374 |   |
| Income taxes receivable/payable                                                    |   | 1,718                          |   | 3,547 |   |
| Prepaid expenses and other current assets                                          |   | 686                            |   | 3 |   |
| Accounts payable                                                                   |   | 1,620                          |   | 758 |   |
| Accrued expenses                                                                   |   | 947                            |   | (1,156 | ) |
| Accrued payroll and related liabilities                                            |   | 80                             |   | 136 |   |
| Net cash provided by operating activities                                          |   | 6,234                          |   | 8,107 |   |
|                                                                               |   |                           |   |   |   |
| **Investing activities**                                                           |   |                           |   |   |   |
| Purchases of property and equipment                                                |   | (540                           | )      | (135 | ) |
| Other assets                                                                       |   | 5                              |   | 2 |   |
| Net cash used in investing activities                                              |   | (535                           | )      | (133 | ) |
|                                                                               |   |                           |   |   |   |
| **Financing activities**                                                           |   |                           |   |   |   |
| Repayments on line of credit, net                                                  |   | —                         |   | (8,300 | ) |
| Repayments on long-term debt                                                       |   | (138                           | )      | (109 | ) |
| Proceeds from stock purchase plan                                                  |   | 7                              |   | 2 |   |
| Proceeds from exercise of stock options                                            |   | 98                             |   | — |   |
| Net cash used in financing activities                                              |   | (33                            | )      | (8,407 | ) |
| Net increase (decrease) in cash and cash  equivalents                              |   | 5,666                          |   | (433 | ) |
| Cash and cash equivalents, beginning of period                                     |   | 5,485                          |   | 4,004 |   |
| Cash and cash equivalents, end of period                                           |   | $                              | 11,151 |   | $ | 3,571 |   |
|                                                                               |   |                           |   |   |   |
| **Supplemental disclosures of cash flow information:**                             |   |                           |   |   |   |
| Cash paid for interest                                                             |   | $                              | 341    |   | $ | 481 |   |

 

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 OF PRESENTATION

 

Inthe opinion of management, the accompanying unaudited consolidated financialstatements include all necessary adjustments (consisting of normal recurringaccruals) and present fairly in all material respects the consolidatedfinancial position of Natrol, Inc. and its subsidiaries (collectively, the “Company”or “Natrol”) as of June 30, 2002 and the results of its operations for thethree and six months ended June 30, 2002 and 2001 and cash flows for the sixmonths ended June 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 sixmonths ended June 30, 2002 are not necessarily indicative of the results to beexpected 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

 

Inventoriesconsist of the following:

 
|                                |   | **June 30,** |   | **December 31,** |   |
|-------------------------------------|--------|--------------|--------|------------------|--------|
|                                |   | **2002**     |   | **2001**         |   |
|                                |   |         |   |             |   |
| Raw material and packaging supplies |   | $            | 3,499  |             | $      | 4,280 |   |
| Finished goods                      |   | 4,467        |   | 5,463            |   |
|                                |   | $            | 7,966  |             | $      | 9,743 |   |

 

3.COMPREHENSIVE INCOME

 

TheCompany’s comprehensive income items were not material at June 30, 2002 orDecember 31, 2001 and therefore no disclosures have been made.

 

4.SHIPPING AND HANDLING COSTS

 

Outboundshipping and fulfillment costs are classified as selling and marketing expensesand totaled $719 and $839 for the three months ended June 30, 2002 and 2001,respectively, and $1,452 and $1,575 for the six month periods ending June 30,2002 and June 30, 2001, respectively.

 

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5.EARNINGS PER SHARE

 

TheCompany calculates earnings per share in accordance with SFAS No. 128 “Earningsper share”.  Basic earnings per sharehas been computed by dividing net income by the weighted average number ofcommon shares outstanding. Diluted earnings per share has been computed bydividing net income by the weighted average of securities or other contracts toissue Common Stock as if these securities were exercised or converted to CommonStock.  Common Stock equivalent sharesfrom stock options representing 2,303,000 shares and 1,865,000 have beenexcluded from the computation of diluted earnings per share for the threemonths ending June 30, 2002 and for the six months ending June 30, 2002,respectively, because the effect would be antidilutive.

 

6.STOCKHOLDERS’ EQUITY

 

STOCKOPTIONS

 

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 threemonths ended June 30, 2002, 530,000 stock options were granted with exerciseprices equal to the fair value of the underlying Common Stock on the date ofgrant.

 

7.CREDIT AGREEMENT

 

At June 30, 2002 and December 31, 2001 theCompany was in violation of certain covenants in its line of credit agreementwith Wells Fargo Bank, N.A.  Duringthese periods the Company had no borrowings under its line of credit.  The line of credit agreement expired on July15, 2002.

 

8.REVENUE RECOGNITION

 

The Company sells its products to retail outlets througha direct sales force and a national broker network. The Company recognizesrevenue from sales only after product is shipped.  Net sales represent products shipped less returns, estimates forfuture returns, spoilage allowances, allowances for product deemed to beunsaleable by customers, and free goods shipped to customers for promotional orother purposes. Estimates and allowances are based upon known claims and anestimate of additional returns.

 

Effective January 1, 2002 the Company adopted theFinancial Accounting Standards Board’s (FASB) Emerging Issues Task Force (EITF)Issue No. 01-9 “Accounting for Consideration Given by a Vendor to a Customer orReseller of the Vendor’s Products,” which codified and reconciled the consensusreached on EITF Issue No. 00-14, “Accounting for Certain Sales Incentives,”EITF Issue No. 00-22 “Accounting for ‘Points’ and Certain Other Time-Based orVolume Based Sales Incentive Offers, and Offers of Free Products or Services tobe Delivered in the Future,” and EITF Issue No. 00-25 “Vendor Income StatementCharacterization of Consideration Paid to a Reseller of the Vendor’sProducts.”  The guidance in these Issuesis to be applied for financial statements for any period beginning afterDecember 15, 2001. Under this pronouncement, slotting fees, rebates, pricereduction 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 June 30, 2001 have beenreduced from $20.2 million to $19.2 million and net sales for the six monthsended June 30, 2001 have been reduced from $40.0 million to $38.3 million withselling and marketing expenses being reduced by the same amount due to thereclassification of certain expenses from selling and marketing expenses to netsales.

 

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9.ACCOUNTING FOR GOODWILL AND INTANGIBLES

 

The Company reviews the impairment of long-lived assetsand certain identifiable intangibles whenever events or changes incircumstances indicate that the carrying amount of any asset may not berecoverable. 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 of FinancialAccounting Standards (SFAS) No. 142, “Goodwill and Other Intangible Assets.”SFAS 142 prohibits the amortization of goodwill and intangibles with indefiniteuseful lives and requires these assets to be reviewed for impairment at leastannually. Intangible assets with finite lives will continue to be amortizedover their estimated useful lives. The Company began applying SFAS 142 in thefirst quarter of fiscal 2002 and application of the nonamortization provisionsof this standard is expected to result in an increase in net income of $821,000in 2002 on an annual basis. SFAS 142 requires testing of goodwill impairmentunder a two-step process. The first step is screen for potential impairment,while the second step measures the amount of impairment, if any.

 

During 2001, the Company reviewed the goodwillassociated 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, historical cashflows and earnings, depth of management and other measures.

 

After the review, the Company determined that theunamortized 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 six months ending June 30, 2001, the Companyrecorded amortization of $85,000  and$170,000 relative to goodwill associated with its acquisition of Laci Le Beau.

 

TheCompany next determined that the unamortized goodwill associated with its acquisitionof EPI was also not impaired.  However,the Company also determined that due to the nature of its supply agreement withConAgra, which expires in approximately six years and the fact that ConAgra isEPI’s major source of supply for the majority of its business, the goodwillrecorded related to the intangible value of the favorable terms of the contractacquired should be amortized. As such, this intangible is continuing to beamortized at the rate of $600,000 per year, consistent with the amount of goodwillamortized 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 the 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.  The Companydoes not believe that a further write down of goodwill is necessary.  However, in accordance with SFAS 142, theCompany will review the valuation of all of its goodwill during the thirdquarter of 2002 and it cannot guarantee that a further reduction of Prolab’sgoodwill or a reduction of Laci Le Beau’s or EPI’s goodwill in addition to whathas been described will not be necessary. In the three and six months endingJune 30, 2001, the Company recorded amortization of $335,000 and $670,000relative to goodwill associated with its acquisition of Prolab.

 

 

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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 of long-livedassets and supercedes SFAS No. 121, “Accounting for the Impairment ofLong-Lived Assets and Long-Lived Assets to Be Disposed Of,” and the accountingand reporting provisions of APB Opinion No. 30, “Reporting the Results ofOperations — Reporting the Effects of a Disposal of a Segment of a Business,and Extraordinary, Unusual and Infrequently Occurring Events and Transactions,”for the disposal of a segment of a business. The Company adopted SFAS 144 inthe first quarter of 2002 and the adoption of the statement had no effect onthe Company’s financial position or results of operations.

 

11.RECLASSIFICATIONS

 

Certain reclassifications have been made tothe 2001 consolidated financial statements to conform to the presentation in2002.

 

ITEM2: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 forwardlooking statements. Examples of forwardlooking statements 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.

 

The Company’s ability to predict results or the effect of certainevents on the Company’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 the Company’sactual results differing materially from those discussed herein or for theCompany’s stock price to be affected adversely include, but are not limited to:(i) industry trends, including a general downturn or slowing of the growthof the dietary supplement industry which has occurred during recent years andmay continue, (ii) increased competition from current competitors and newmarket entrants including but not limited to increased competition from privatelabel house brands supported by retailers seeking to increase the market shareof their proprietary house brands, (iii) adverse publicity regarding thedietary supplement industry or the Company’s products including recentpublicity regarding ephedrine-based products, (iv) the Company’s dependenceupon its ability to develop new products, (v) a continued high rate (orincrease in the rate) of returns of the Company’s products, (vi) theCompany’s ability to gain or expand or maintain distribution within new orexisting customers and new or existing channels of trade, (vii) anincrease in the cost of obtaining and maintaining shelf space with majornational retailers who demand various 

 

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forms of incentives from their suppliers such as slottingfees, coop advertising, or rebates, (viii) adverse changes in governmentregulation, (ix) exposure to product liability claims including productliability claims from products which include ephedrine or other products forwhich the Company has either not been able to secure product liability coverageor been able to secure such coverage at reasonable prices., (as of June 30,2002, the availability of product liability insurance for ephedrine-basedproducts was non-existent and the Company expects substantial increases in thecost for product liability insurance as its policies renew during the secondhalf of 2002), (x) dependence on significant customers, (xi) theCompany’s ability to keep and attract key management employees, (xii) the Company’sinability to manage growth and execute its business plan, or the Company’sability to modify its business plan in response to market conditions,including, but not limited to, its ability to enter new businesses andcapitalize upon new business opportunities (xiii) the Company’s ability toconsummate future acquisitions and its ability to integrate acquiredbusinesses, including without limitation Prolab Nutrition, Inc.(“Prolab”), acquired in October, 1999 for which the Company took a $20 millionimpairment charge in the year ending December 31, 2001 due to the write down ofgoodwill associated with the acquisition, (xiv) the absence of conclusiveclinical studies for many of the Company’s products, (xv) the Company’sinability to obtain raw materials that are in short supply including itsability to obtain garlic powders under its supply agreement with ConAgra forits Essentially Pure Ingredient (EPI) raw material sales division,(xvi) sales and earnings volatility, (xvii) volatility of the stockmarket (xviii) the Company’s ability to manufacture its productsefficiently, (xix) the Company’s ability to manage inventory or sell itsinventory before such inventory becomes outdated, (xx) the Company’sreliance on independent brokers to sell its products, (xxi) the inabilityof the Company to protect its intellectual property, (xxii) control of theCompany by principal shareholders, (xxiii) the possible sale of largeamounts of stock by controlling shareholders, (xxiv) a continued generaldownturn in the national economy as a whole, and (xxv) continued marketacceptance of Natrol supplements, Laci Le Beau teas, Prolab’s sports nutritionproducts, and Essentially Pure Ingredients’ raw material products.

 

RESULTSOF OPERATIONS

 

THEFOLLOWING DISCUSSION 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.

 

THREEMONTHS ENDED JUNE 30, 2002 AND JUNE 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 7.4%, or $1.4 million, to $17.8 million for thethree months ended June 30, 2002 from $19.3 million for the three months endedJune 30, 2002.  The decline in net saleswas primarily due to a lower volume of shipments as well as the Companyproviding for an increased level of returns stemming from inventory realignmentsat certain large mass market accounts. Themarket for nutritional supplements is very competitive and for the last twoyears industry trends have been negative. In this environment, majorretail outlets have not been as willing as in past years to promote vitamins,minerals and supplements (VMS).  Manyretailers reduced the amount of shelf space devoted to the VMS sector andretailers in general demanded higher levels of promotional support from vendorsof VMS product. All of the factors mentioned above contributed to the declinein net sales for the quarter.

 

GROSSPROFIT.  Gross profit decreased 10.9%,or $866,000, to $7.1 million for the three months ended June 30, 2002 from $8.0million for the three months ended June 30, 2001. Gross margin decreased to39.8% for the three months ended June 30, 2002 from 41.4% for the three monthsended June 30, 2001.  The decline wasdue to a higher percentage cost of materials and allocated overhead expensesrelative to the dollar value of product shipped during the quarter.

 

SELLINGAND MARKETING EXPENSES.  Selling andmarketing expenses consist primarily of advertising and promotional expenses,cost of distribution, and related payroll expenses and commissions. Selling andmarketing expenses increased 22.3%, or $805,000, to $4.3 million for the threemonths ended June 30, 2002 from $3.5 million for the three months ended June30, 2001. The level of selling and 

 

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marketingexpenditures in the quarter ending June 30, 2002 were higher due to anincreased level of coop advertising and consumer print advertising than in thesame quarter of 2001.

 

GENERALAND ADMINISTRATIVE EXPENSES.  Generaland administrative expenses consist primarily of personnel costs related togeneral management functions, finance, accounting and information systems,research and development expenses, as well as professional fees related tolegal, audit and tax matters and depreciation and amortization of goodwill.General and administrative expenses decreased 5.6%, or $153,000, and wereapproximately $2.6 million for the three months ended June 30, 2002. Thedecrease related primarily to a decrease in amortization of goodwill for thequarter ending June 30, 2002 to $150,000 as opposed to the $570,000 recorded inthe quarter ended June 30, 2001 as a result of the application of SFAS 142.This decrease is partially offset by an increase in officers salaries. In thequarter ended June 30, 2001, Mr. Balbert, Natrol’s President, did not draw asalary whereas for the quarter ending June 30, 2002, Mr. Balbert’s salaryamounted to $150,000.

 

INTERESTEXPENSE.  The Company recorded interestexpense of $171,000 for the three months ended June 30, 2002 as compared tointerest expense of $209,000 for the three months ended June 30, 2001. TheCompany pays interest on approximately $8.2 million of long-term mortgage debtas well as interest on its line of credit. During the quarter ended June 30, 2002, the Company had no borrowingsunder its line of credit whereas in the quarter ended June 30, 2001, theCompany had average borrowings of $1.7 million under its line of credit.

 

INCOMETAX PROVISION. The Company’s effective tax rate was approximately 36% in thesecond quarter of 2002 as opposed to 40% in the second quarter of 2001.  The change in the income tax provision atJune 30, 2002 from June 30, 2001 is not considered significant by the Companyand is due to temporary differences in the makeup of taxable and non-taxableexpenses.

 

SIXMONTHS ENDED JUNE 30, 2002 AND JUNE 30, 2001

 

NET SALES. Net sales decreased 7.7%, or $2.9million, to $35.4 million for the six months ended June 30, 2002 from $38.3million for the six months ended June 30, 2001. The decline in net sales wasprimarily due to a lower volume of shipments as well as  the Company providing for an increased levelof returns stemming from inventory realignments at certain large mass marketaccounts. The market for nutritionalsupplements is very competitive and for the last two years industry trends havebeen negative. In this environment, major retail outlets have not beenas willing as in past years to promote vitamins, minerals and supplements(VMS).  Many retailers reduced theamount of shelf space devoted to the VMS sector and retailers in general demandedhigher levels of promotional support from vendors of VMS product. All of thefactors mentioned above contributed to the decline in net sales for the period.

 

GROSS PROFIT.  Gross profit declined 13.1%, or $2.0 million, to $13.7 millionfor the six months ended June 30, 2002 from $15.7 million for the six monthsended June 30, 2001. Gross margin decreased to 38.7% for the six months endedJune 30, 2002 from 41.1% for the six months ended June 30, 2001. The declinewas due to a higher percentage cost of materials and allocated overheadexpenses relative to the dollar value of product shipped during the period.

 

SELLINGAND MARKETING EXPENSES.  Selling andmarketing expenses consist primarily of advertising and promotional expenses,cost of distribution, and related payroll expenses and commissions. Selling andmarketing expenses increased 9.6%, or $705,000, to $8.1 million for the sixmonths ended June 30, 2002 from $7.4 million for the six months ended June 30,2001. The level of selling and marketing expenditures in the six months endingJune 30, 2002 were higher due to an increased level of coop advertising andconsumer print advertising than in the same period of 2001.

 

GENERALAND ADMINISTRATIVE EXPENSES.  Generaland administrative expenses consist primarily of personnel costs related togeneral management functions, finance, accounting and information systems,research and development expenses, as well as professional fees related tolegal, audit and tax matters and depreciation and amortization. General andadministrative expenses decreased 3.3%, or $181,000, to $5.2 million for thesix months ended June 30, 2002 from $5.4 million for the six months 

 

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endedJune 30, 2001. The decrease related primarily to a decrease in amortization ofgoodwill for the six months ending June 30, 2002 to $300,000 as opposed to the$1.1 million recorded in the six months ended June 30, 2001 as a result of theapplication of SFAS 142. This decrease is partially offset by an increase inofficers salaries. In the six months ended June 30, 2001, Mr. Balbert, Natrol’sPresident, did not draw a salary whereas for the six months ending June 30,2002, Mr. Balbert’s salary amounted to $300,000.  The only other significant change in general and administrativeexpenses were legal expenses which rose $477,000 when compared to the sameperiod of 2001. The Company is currently defending itself in a number of tradeand patent , product liability and regulatory lawsuits at this time.    Although the Company does not believe anyone of these matters is material, the Company expects to incur higher legalexpenses as it defends these lawsuits in future periods.  Litigation is inherently uncertain and as aresult, there can be no assurance that, if these or other lawsuits are decidedadversely to the Company, it would not have a materially adverse effect on theCompany’s financial condition and results of operations.

 

 

INTERESTEXPENSE.  Interest expense decreased to$341,000 for the six months ended June 30, 2002 from $481,000 for the sixmonths ended June 30, 2001. The Company pays interest on approximately $8.2million of long-term mortgage debt as well as interest on its line ofcredit.  During the six months endedJune 30, 2002, the Company had no borrowings under its line of credit whereasin the six months ended June 30, 2001, the Company had average borrowings of$4.1 million under its line of credit.

 

INCOMETAX PROVISION. The Company’s effective tax rate increased to 39.7% in the sixmonths ended June 30, 2002 from 39.5% in the six months ended June 30, 2001.

 

**LIQUIDITY ANDCAPITAL RESOURCES**

 

At June 30, 2002, the Company had working capital of$18.7 million, as compared to $18.2 million in working capital atDecember 31, 2001. The Company’s cash balance at June 30, 2002 wasapproximately $11.2 million.

 

Net cash provided by operating activities was$6.2 million for the six months ended June 30, 2002 versus net cash provided of$8.1 million for the six months ended June 30, 2001. Cash provided by operatingactivities during the six month period ended June 30, 2002 was primarily due toa decrease in inventory levels of $1.8 million, a reduction in income taxesreceivable of $1.7 million, an increase in trade payables and accrued expensesof  $2.6 million, depreciation andamortization of $976,000 and a reduction in prepaid expenses of $686,000 offsetby increases in accounts receivable of $1.9 million.

 

Netcash used in investing activities was $535,000 for the six months ended June30, 2002 and $133,000 during the six months ended June 30, 2001. Nearly all ofthe cash used in  investing activitiesin both periods was in property and equipment.

 

Net cash used by financing activities was$33,000 for the six months ended June 20, 2002 as opposed to $8.4 million usedby financing activities during the six months ended June 30, 2001. During thesix months ended June 30, 2002, the Company made principal payments of $138,000on its long-term mortgage debt and received $105,000 from the proceeds of theexercise of stock options and the sale of stock to employees through itsemployee stock purchase program.  Duringthe six months ended June 30, 2001, the Company reduced its line of credit by$8.3 and repaid $109,000 in long-term debt.

 

As of June 30, 2002, the Company had $8.2 million ofoutstanding debt all of which is the result of a mortgage on the Company’smanufacturing/headquarters facility and a mortgage on the Company’s shippingfacility.

 

At June 30, 2002, the Company was out of compliance withcertain financial ratios contained in its line of credit. This line of creditexpired on July 15, 2002.  As of thefiling of this report, the Company was not in negotiations to re-establish itsline of credit.  As of June 30, 2002 theCompany’s cash balance was approximately $11.2 million.

 

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If the Company is unable to re-establish a line ofcredit or obtain additional financing, its sources of liquidity will bereduced.  If the Company were to seek orobtain additional debt financing, potential lenders may seekto institute covenants restricting the Company from certain activities. If theCompany deems it necessary to borrow funds with these restrictions inplace,  its ability to compete effectivelyin its market sector and to otherwise operate its business may be hindered

 

Regardlessof its ability to borrow additional funds, the Company believes that itscurrent cash balance together with cash generated from operations will besufficient to fund its anticipated working capital needs and capitalexpenditures for the next 12 months.

 

Item3.    QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK

 

The following discussion about the Company’s market riskdisclosures involves forward–looking statements. Actual results coulddiffer materially from those projected in the forward–looking statements.The Company does not believe it is exposed to market risk related to changes ininterest rates. The risks related to foreign currency exchange rates areimmaterial and the Company does not use derivative financial instruments.

 

TheCompany currently has no short-term borrowings and as of July 15, 2002 it hadno line of credit established with any lender. The Company does not believe that the risk is significant for itslong-term debt due to the low fixed rates and insignificance of the long-termdebt to the Company’s consolidated balance sheet.

 

PART II

OTHER INFORMATION

 

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 
| a)     |   | The  2001 Annual Meeting of Stockholders of Natrol, Inc. (the “Annual Meeting”)  was held on June 14, 2002. |       |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------|------------|
| b)     |   | At  the Annual Meeting, the following were re-elected to the Company’s Board of  Directors:                      |       |
|   |   |                                                                                                                  |       |   |   |
|   |   |                                                                                                                  | Votes For  |   | Votes  Withheld |   |
|   |   |                                                                                                                  |       |   |   |   |
|   |   | Dennis Jolicoeur                                                                                                      | 12,300,566 |   | 85 |   |
|        |        |                                                                                                                       |            |  |  |  |  |

 

Thefollowing individuals are members of the Company’s Board of Directors whoseterms of office as directors continued after the Annual Meeting.  

 

Elliott BalbertDennis De ConciniVernon BrunnerDennis GriffinDennis Jolicoeur

 

Mr. Griffin resigned his position on August1, 2002 and on that date joined the Company as President of the Company’sEssentially Pure Ingredients division.

 

ITEM6.  EXHIBITS AND REPORTS ON FORM 8-K

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

 

Noreports on Form 8-K were filed during the quarter for which this report isfiled

 

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SIGNATURES

 

Pursuantto the 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:  8/14/02 | By:           | /s/  Elliott Balbert |
|           |          | Chairman,  President and Chief Executive Officer |
|           |          |   |
| Date:  8/14/02 | By:           | /s/  Dennis R. Jolicoeur |
|           |          | Chief  Financial Officer and Executive  Vice President |
|           |          |   |

 

 

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