**SECURITIES AND EXCHANGE COMMISSIONWASHINGTON, 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 THE QUARTERLY PERIOD ENDED MARCH 31, 2003**

** **

**OR**

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

 

**FOR THE TRANSITION PERIOD FROM                 TO                 **

**COMMISSION FILE NO: 0-24567**

 

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

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

 

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

 

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

 

INDICATE BY A CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALLREPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGEACT OF 1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THEREGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCHFILING REQUIREMENTS FOR THE PAST 90 DAYS.YES  ý   NO  o

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Exchange Act Rule 12b-2). YES  o   NO  ý

 

 

Indicate the number of shares outstanding of the issuer’s common stock,as of the latest practicable date:

 

| **Class**                      |   | **April 30,  2003** |
|--------------------------------|--------|---------------------|
|                           |   |                |
| Common  stock, $0.01 par value |   | **12,876,200**      |

 

 

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PART 1. FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

 

**Natrol, Inc. and Subsidiaries**

**Consolidated Balance Sheets**

 (Inthousands, except share and per share data)

(unaudited)

 
|                                                                                                                                |   | **March 31  2003** |   | **December 31  2002** |   |
|-------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|--------|-----------------------|--------|
|                                                                                                                                |   |               |   |                  |   |
| **Assets**                                                                                                                          |   |               |   |                  |   |
| Current  assets:                                                                                                                    |   |               |   |                  |   |
| Cash and  cash equivalents                                                                                                          |   | $                  | 8,865  |                  | $      | 10,077 |   |
| Accounts  receivable, net of allowances of $464 and $409 at March 31, 2003 and December  31, 2002, respectively                     |   | 8,419              |   | 6,790                 |   |
| Inventory                                                                                                                           |   | 8,545              |   | 8,669                 |   |
| Income taxes  receivable                                                                                                            |   | 79                 |   |                  |   |
| Deferred  income taxes                                                                                                              |   | 665                |   | 665                   |   |
| Prepaid  expenses and other current assets                                                                                          |   | 1,433              |   | 1,452                 |   |
|                                                                                                                                |   |               |   |                  |   |
| Total  current assets                                                                                                               |   | 28,006             |   | 27,653                |   |
|                                                                                                                                |   |               |   |                  |   |
| Property and  equipment:                                                                                                            |   |               |   |                  |   |
| Building and  improvements                                                                                                          |   | 15,607             |   | 15,607                |   |
| Machinery  and equipment                                                                                                            |   | 5,067              |   | 5,067                 |   |
| Furniture  and office equipment                                                                                                     |   | 3,072              |   | 3,003                 |   |
|                                                                                                                                |   | 23,746             |   | 23,677                |   |
| Accumulated  depreciation and amortization                                                                                          |   | (6,240             | )      | (5,867                | )      |
|                                                                                                                                |   | 17,506             |   | 17,810                |   |
| Deferred  income taxes                                                                                                              |   | 3,853              |   | 3,853                 |   |
| Goodwill,  net of accumulated amortization and impairment charge of $37,381 at March 31,  2003 and December 31, 2002 , respectively |   | 4,026              |   | 4,026                 |   |
| Other assets                                                                                                                        |   | 43                 |   | 39                    |   |
| Total assets                                                                                                                        |   | $                  | 53,434 |                  | $      | 53,381 |   |
|                                                                                                                                |   |               |   |                  |   |
| **Liabilities and stockholders’ equity**                                                                                       |   |               |   |                  |   |
| Current  liabilities:                                                                                                               |   |               |   |                  |   |
| Accounts  payable                                                                                                                   |   | $                  | 5,743  |                  | $      | 4,395 |   |
| Accrued  expenses                                                                                                                   |   | 2,518              |   | 3,358                 |   |
| Accrued  payroll and related liabilities                                                                                            |   | 628                |   | 693                   |   |
| Income taxes  payable                                                                                                               |   | —             |   | 205                   |   |
| Current  portion of long-term debt                                                                                                  |   | 267                |   | 301                   |   |
| Total  current liabilities                                                                                                          |   | 9,156              |   | 8,952                 |   |
| Long-term  debt, less current portion                                                                                               |   | 7,736              |   | 7,778                 |   |
| 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                                                                                                  |   |               |   |                  |   |
| Outstanding  shares—13,798,720 and 13,788,720 at March 31,2003 and December 31, 2002,  respectively                            |   | 138                |   | 138                   |   |
| Additional  paid-in capital                                                                                                         |   | 62,020             |   | 62,005                |   |
| Accumulated  deficit                                                                                                                |   | (22,735            | )      | (22,611               | )      |
|                                                                                                                                |   | 39,423             |   | 39,532                |   |
| Shares held  in treasury, at cost—921,900 shares at March 31, 2003 and December 31, 2002                                       |   | (2,881             | )      | (2,881                | )      |
| Total  stockholders’ equity                                                                                                    |   | 36,542             |   | 36,651                |   |
| Total  liabilities and stockholders’ equity                                                                                    |   | $                  | 53,434 |                  | $      | 53,381 |   |

 

See accompanying notes

 

2

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**Natrol, Inc. and Subsidiaries**

**Consolidated Statements of Operations**

**(In thousands, except share and per sharedata)**

 
|                                                                                             |   | **Quarter  Ended March 31,** |   |
|--------------------------------------------------------------------------------------------------|--------|------------------------------|--------|
|                                                                                             |   | **2003**                     |   | **2002** |   |
|                                                                                             |   | **(unaudited)**              |   |
|                                                                                             |   |                         |   | **(as  restated)** |   |
| Net sales                                                                                        |   | $                            | 19,167 |   | $ | 17,539 |   |
| Cost of  goods sold                                                                              |   | 10,904                       |   | 10,960 |   |
| Gross profit                                                                                     |   | 8,263                        |   | 6,579 |   |
| Selling and  marketing expenses                                                                  |   | 5,319                        |   | 3,886 |   |
| General and  administrative expenses                                                             |   | 2,997                        |   | 2,344 |   |
| Total  operating expenses                                                                        |   | 8,316                        |   | 6,230 |   |
| Operating  income (loss)                                                                         |   | (53                          | )      | 349 |   |
| Interest  income                                                                                 |   | 10                           |   | 19 |   |
| Interest  expense                                                                                |   | (162                         | )      | (170 | ) |
| Income  (loss) before income tax provision (benefit) and cumulative effect of  accounting change |   | (205                         | )      | 198 |   |
| Income tax  provision (benefit)                                                                  |   | (81                          | )      | 77 |   |
| Income  (loss) before cumulative effect of change in accounting principle                        |   | (124                         | )      | 121 |   |
| Cumulative  effect of change in accounting principle, net of income tax benefit of $4,139        |   |                         |   | (6,819 | ) |
| Net loss                                                                                         |   | $                            | (124   | ) | $ | (6,698 | ) |
| Income  (loss) per share:                                                                        |   |                         |   |   |   |   |   |
| Income  (loss) per share before cumulative effect of change in accounting principle              |   | $                            | (0.01  | ) | $ | 0.01 |   |
| Income  (loss) per share attributable to cumulative effect of change in accounting  principle    |   | —                       |   | (0.53 | ) |
| Loss per  share                                                                                  |   | $                            | (0.01  | ) | $ | (0.52 | ) |
|                                                                                             |   |                         |   |   |   |
| Weighted-average  shares outstanding—basic and diluted                                      |   | 12,870,598                   |   | 12,833,913 |   |

 

See accompanying notes

 

3

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# **Natrol, Inc. andSubsidiaries**

**Consolidated Statements of Cash Flows**

(In thousands)

 

* *
|                                                                                                                                                        |   | **Three  Months Ended  March 31,** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------|--------|
|                                                                                                                                                        |   | **2003**                           |   | **2002** |   |
|                                                                                                                                                        |   | **(unaudited)**                    |   |
|                                                                                                                                                        |   |                               |   | **(as  restated)** |   |
| **Operating activities**                                                                                                                                    |   |                               |   |   |   |
| Net Loss                                                                                                                                                    |   | $                                  | (124   | ) | $ | (6,698 | ) |
| Cumulative  effect of change in accounting principle, net of income taxes benefit of  $4,139 in 2002                                                   |   | —                             |   | 6,819 |   |
|                                                                                                                                                        |   |                               |   |   |   |
| Income  (loss) before cumulative effect of change in accounting principle                                                                                   |   | (124                               | )      | 121 |   |
|                                                                                                                                                        |   |                               |   |   |   |
| Adjustments  to reconcile income (loss) before cumulative effect of change in accounting  principle to net cash provided by (used in) operating activities: |   |                               |   |   |   |
| Depreciation  and amortization                                                                                                                              |   | 373                                |   | 348 |   |
| Provision  for bad debts                                                                                                                                    |   | 55                                 |   | 115 |   |
| Shares issued  for services                                                                                                                                 |   | 15                                 |   | 1 |   |
| Changes in  operating assets and liabilities:                                                                                                               |   |                               |   |   |   |
| Accounts  receivable                                                                                                                                        |   | (1,684                             | )      | (2,042 | ) |
| Inventory                                                                                                                                                   |   | 124                                |   | 1,300 |   |
| Income taxes  receivable/payable                                                                                                                            |   | (284                               | )      | 75 |   |
| Prepaid  expenses and other current assets                                                                                                                  |   | 19                                 |   | 424 |   |
| Accounts  payable                                                                                                                                           |   | 1,348                              |   | 1,768 |   |
| Accrued  expenses                                                                                                                                           |   | (840                               | )      | 366 |   |
| Accrued  payroll and related liabilities                                                                                                                    |   | (65                                | )      | (96 | ) |
| Net cash  provided by (used in) operating activities                                                                                                        |   | (1,063                             | )      | 2,380 |   |
|                                                                                                                                                        |   |                               |   |   |   |
| **Investing activities**                                                                                                                                    |   |                               |   |   |   |
| Purchases of  property and equipment                                                                                                                        |   | (69                                | )      | (62 | ) |
| Other assets                                                                                                                                                |   | (4                                 | )      | 2 |   |
| Net cash  used in investing activities                                                                                                                      |   | (73                                | )      | (60 | ) |
|                                                                                                                                                        |   |                               |   |   |   |
| **Financing activities**                                                                                                                                    |   |                               |   |   |   |
| Repayments  on long-term debt                                                                                                                               |   | (76                                | )      | (70 | ) |
| Proceeds  from issuance of common stock                                                                                                                     |   | —                             |   | 103 |   |
| Net cash  (used in) provided by financing activities                                                                                                        |   | (76                                | )      | 33 |   |
| Net increase  in cash and cash equivalents                                                                                                                  |   | (1,212                             | )      | 2,353 |   |
| Cash and  cash equivalents, beginning of year                                                                                                               |   | 10,077                             |   | 5,485 |   |
| Cash and  cash equivalents, end of year                                                                                                                     |   | $                                  | 8,865  |   | $ | 7,838 |   |

 

See accompanying notes

 

4

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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

 

In the opinion of management, the accompanying unaudited consolidatedfinancial statements include all necessary adjustments (consisting of normalrecurring accruals) and present fairly in all material respects theconsolidated financial position of Natrol, Inc. and its subsidiaries(collectively, the “Company” or “Natrol”) as of March 31, 2003 and the resultsof its operations and its cash flows for three months ended March 31, 2003 and2002, in conformity with accounting principles generally accepted in the UnitedStates of America for interim financial information. The results of operationsfor the three months ended March 31,2003 are not necessarily indicative of theresults to be expected for the full year.

 

Certain information and footnote disclosures which are normallyincluded in the annual financial statements prepared in accordance withaccounting principles generally accepted in the United States have beenomitted.  These consolidated financialstatements should be read in conjunction with the audited consolidatedfinancial statements and notes thereto included in included in the Company’sForm 10-K for the year ended December 31, 2002 as filed with the Securities andExchange Commission.

 

2.  STOCK BASED COMPENSATION

 

The Company accounts for its employee stock option plan under theintrinsic value method prescribed by Accounting Principles Board Opinion No.25, *Accounting for Stock Issued toEmployees,*and related interpretations.  The Company has a stock-based compensation plan.  The Company’s operating results do notinclude a compensation charge related to this plan, as all options granted hadan exercise price equal to the market value of the underlying common stock onthe date of grant.  The following tableillustrates the effect on the operating results and per share amounts if thefair value recognition provisions of Statement of Financial AccountingStandards No. 123, *Accounting forStock-Based compensation, had been applied to stock-based employeecompensation:*

 

* *
|                                                                                                                                            |   | **3 Months Ended   March 31,** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------|--------|
|                                                                                                                                            |   | **2003**                       |   | **2002** |   |
| Income (loss) before  cumulative effect of accounting change                                                                                    |   | $                              | (124   | ) | $ | 121 |   |
|                                                                                                                                            |   |                           |   |   |   |
| Total stock-based expense determined under fair  value based method for all awards, net of related tax benefits “Stock  compensation” |   | 145                            |   | 105 |   |
| Income (loss) before cumulative effect of  accounting change- pro-forma                                                                         |   | $                              | (269   | ) | $ | 16 |   |
|                                                                                                                                            |   |                           |   |   |   |
| Net loss                                                                                                                                        |   | $                              | (124   | ) | $ | (6,698 | ) |
| Stock Compensation                                                                                                                              |   | 145                            |   | 105 |   |
| Pro forma net loss                                                                                                                              |   | $                              | (269   | ) | $ | (6,803 | ) |
|                                                                                                                                            |   |                           |   |   |   |
| Income (loss) per share before cumulative effect  of accounting change:                                                                         |   |                           |   |   |   |
|                                                                                                                                            |   |                           |   |   |   |
| Basic and diluted - as reported                                                                                                                 |   | $                              | (0.01  | ) | $ | 0.01 |   |
| Basic and diluted - pro forma                                                                                                                   |   | $                              | (0.02  | ) | $ | (0.00 | ) |
|                                                                                                                                            |   |                           |   |   |   |
| Net loss per share:                                                                                                                             |   |                           |   |   |   |
|                                                                                                                                            |   |                           |   |   |   |
| Basic and diluted - as reported                                                                                                                 |   | $                              | (0.01  | ) | $ | (0.52 | ) |
| Basic and diluted - pro forma                                                                                                                   |   | $                              | (0.02  | ) | $ | (0.53 | ) |

 

During the three months ended March 31, 2003, 100,000 stock optionswere granted with exercise prices equal to the fair value of the underlyingCommon Stock on the date of grant.

 

5

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3.  INVENTORY

 

Inventories consist of the following:

 
|                                 |   | **March 31,  2003** |   | **December  31,  2002** |   |
|--------------------------------------|--------|---------------------|--------|-------------------------|--------|
|                                 |   |                |   |                    |   |
| Raw material  and packaging supplies |   | $                   | 3,333  |                    | $      | 2,950 |   |
| Work in  Process                     |   | 1,426               |   | 1,354                   |   |
| Finished  goods                      |   | 3,786               |   | 4,365                   |   |
|                                 |   | $                   | 8,545  |                    | $      | 8,669 |   |

 

 

4. SHIPPING AND HANDLING COSTS

 

Outbound shipping and fulfillment costs are classified as selling andmarketing expenses and totaled $802 and $619 for three months ended March 31,2003 and 2002 respectively.

 

6

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5.  EARNINGS PER SHARE

 

Basic earnings per share has been computed by dividing net income(loss) by the weighted average number of common shares outstanding during theperiod. Diluted earnings per share has been computed by dividing net income(loss) by the weighted average number of common shares and dilutive commonstock equivalents (stock options), when dilutive.

 

6.  RECENTLY ISSUED ACCOUNTINGPRONOUNCEMENTS

 

In June 2002, the Financial Accounting Standards Board (“FASB”)issued Statement of Financial Accounting Standards (“SFAS”) No. 146, *Accounting for Costs Associated with Exit or DisposalActivities*. SFAS No. 146 requires that the liability for costsassociated with an exit or disposal activities be initially measured at fairvalue and recognized when the liability is incurred. As required, the Companywill apply the provisions of SFAS No. 146 prospectively to exit ordisposal activities, if any, initiated after December 31, 2002.

 

In November 2002, the FASB issued Interpretation No. 45, “Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Others” (“FIN 45”).  This interpretation elaborates on disclosures to be made by aguarantor in its interim and annual financial statements with regard to itsobligations under certain guarantees that it has issued.  It also clarifies that a guarantor isrequired to recognize, at the inception of a guarantee, a liability for thefair value of the obligation undertaken in issuing the guarantee.  The disclosure requirements of FIN 45 areeffective prospectively for guarantees issued or modified after December 31,2002.  The adoption of the recognitionand initial measurement requirements of FIN 45 did not have a material impacton the Company’s financial position or results of operations.

 

In January 2003, the FASB issued Interpretation No. 46, “Consolidationof Variable Interest Entities” (“FIN 46”). This interpretation of Accounting Research Bulletin No. 51,“Consolidated Financial Statements,” addresses consolidation by businessenterprises of variable interest entities. Under current practice, two enterprises generally have been included inconsolidated financial statements because one enterprise controls the otherthrough voting interests.  FIN 46defines the concept of “variable interests” and requires existingunconsolidated variable interest entities to be consolidated by their primarybeneficiaries if the entities do not effectively disperse risks among theparties involved.  This interpretationapplies immediately to variable interest entities in which an enterprise holdsa variable interest that it acquired after January 31, 2003. Thisinterpretation may be applies immediately to variable interest entities inwhich an enterprise holds a variable interest that it acquired before February 1,2003.  The interpretation may be appliedprospectively with a cumulative-effect adjustment as of the date on which it isfirst applied or by restating previously issued financial statements for one ormore years with a cumulative-effect adjustment as of the beginning of the firstyear restated.  The Company believes thethat the adoption of FIN 46 will not have a material impact on its financialposition or results of operations.

 

7. OPERATING SEGMENTS

 

The Company has three operating segments: the Natrol operating segmentwhich manufactures and markets Natrol and Laci LeBeau branded products, andwhich, under the EPI name contract manufactures products and sells raw materialingredients; Prolab Nutrition, Inc. which develops, manufactures and marketssports nutrition products; and, Annasa, which was established during 2002 todevelop a direct-to-consumer, multi-level marketing business.

 

Segment information for the quarters endedMarch 31, 2003 and March 31,2002 is as follows (in thousands):

 

 
|                                 |   | **Natrol** |   | **Prolab** |   | **Annasa** |   | **Total** |   |
|--------------------------------------|--------|------------|--------|------------|--------|------------|--------|-----------|--------|
|                                 |   |       |   |       |   |       |   |      |   |
| **2003**                             |   |       |   |       |   |       |   |      |   |
| Net sales                            |   | $          | 13,930 |       | $      | 5,087      |   | $         | 150    |   | $ | 19,167 |   |
| Gross profit                         |   | 6,873      |   | 1,278      |   | 112        |   | 8,263     |   |
| Income  (loss) from operations       |   | 888        |   | (432       | )      | (509       | )      | (53       | )      |
| Other  (expense) income              |   | (157       | )      | 5          |   |       |   | (152      | )      |
| Income  (loss) before taxes          |   | 731        |   | (427       | )      | (509       | )      | (205      | )      |
| Depreciation  and amortization       |   | 352        |   | 20         |   | 1          |   | 373       |   |
| Segment  assets                      |   | 39,878     |   | 13,159     |   | 397        |   | 53,434    |   |
| Additions to  property and equipment |   | 67         |   | 1          |   | 1          |   | 69        |   |
|                                      |        |            |        |            |        |            |        |           |        |  |  |  |  |

 

7

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|                                 |   | **Natrol** |   | **Prolab** |   | **Annasa** |   | **Total** |   |
|--------------------------------------|--------|------------|--------|------------|--------|------------|--------|-----------|--------|
|                                 |   |       |   |       |   |       |   |      |   |
| **2002**                             |   |       |   |       |   |       |   |      |   |
| Net sales                            |   | $          | 12,685 |       | $      | 4,854      |   | —    |   | $ | 17,539 |   |
| Gross profit                         |   | 5,355      |   | 1,224      |   | —     |   | 6,579     |   |
| Income  (loss) from operations       |   | 128        |   | 221        |   | —     |   | 349       |   |
| Other  (expense) income              |   | (162       | )      | 11         |   | —     |   | (151      | )      |
| Income  (loss) before taxes          |   | (34        | )      | 232        |   | —     |   | 198       |   |
| Depreciation  and amortization       |   | 325        |   | 23         |   | —     |   | 348       |   |
| Segment  assets                      |   | 39,002     |   | 15,636     |   | —     |   | 54,638    |   |
| Additions to  property and equipment |   | 57         |   | 5          |   | —     |   | 62        |   |
|                                      |        |            |        |            |        |            |        |           |        |  |  |  |

 

8. RESTATEMENT OF MARCH 31, 2002 FINANCIAL STATEMENTS

 

The Company adopted SFAS No.142, “Goodwill and Other Intangible Assets,” on January 1, 2002.  As initially applied, the Companyreclassified approximately $3.6 million out of goodwill and into a separatelyidentified intangible asset related to a supply contract.  The supply contract had originally beenacquired as part of the Company’s acquisition of EPI.  The supply contract had a remaining life of six years, and duringthe quarter ended March 31, 2002 the Company had recorded amortization expenseof $150,000 and an increase in income tax expenses of $56,000.  During the fourth quarter of 2002, theCompany determined that the supply contract should not have been reclassifiedout of goodwill as it had not been assigned a cost equal to its estimated fairvalue at the date the EPI acquisition was initially recorded, and because theamount had not been separately identified in the accounting records orpreviously amortized over its useful life. As a result, the $3.6 million was reallocated to goodwill retroactive toJanuary 1, 2002.  Pursuant to therequirements of SFAS No. 142, goodwill is not amortized, but subject to anannual impairment test.  The companyrecorded an impairment charge of $10,958,000 as a cumulative effect of a changein accounting principle in the first quarter of 2002.  The $3.6 million described above was included in that amount.

 

The interim financialstatements for the three months ended March 31, 2002 have been restated toreflect a reduction in amortization expense of $150,000.

 
|                                                               |   | **March 31,  2002** |   |
|--------------------------------------------------------------------|--------|---------------------|--------|
|                                                               |   | **As  Previously**  |   |   |   |
|                                                               |   | **Reported**        |   | **As  Restated** |   |
|                                                               |   | **(in  thousands)** |   |
|                                                               |   |                |   |   |   |
| Net Sales                                                          |   | $                   | 17,539 |   | $ | 17,539 |   |
| Gross profit                                                       |   | 6,579               |   | 6,579 |   |
| Operating expenses                                                 |   | $                   | 6,380  |   | 6,230 |   |
| Income before cumulative effect of change  in accounting principle |   | 27                  |   | 121 |   |
|                                                                    |        |                     |        |  |  |  |  |

 

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

 

This report contains “forward lookingstatements.” Natrol, Inc., a Delaware corporation organized in 1980, (the“Company”), is including this statement for the express purpose of availingitself of protections of the safe harbor provided by the Private SecuritiesLitigation Reform Act of 1995 with respect to all such forward lookingstatements. Examples of forward looking statements include, but are not limitedto, the use of forward-looking terminology such as “believes,” “expects,”“may,” “will,” “should,” “intend,” “estimate,” “assume,” “plan,” or“anticipates” or the negative thereof, other variations thereon, or comparableterminology, or by discussions of strategy that predict or indicate futureevents or trends or that are not historical facts. The Company cannot assurethe future results or outcome of the matters described in these statements;rather, these statements merely reflect its current expectations of theapproximate outcome of the matter discussed. The Company does not undertake anyobligation and does not currently intend to update any such statements at anytime in the future.

 

The Company’sability to predict results or the effect of certain events on the Company’soperating results is inherently uncertain. Forward-looking statements shouldnot be unduly relied on since they involve known and unknown risks,uncertainties and other factors, some of which are beyond the Company’scontrol. These risks, uncertainties and other factors may cause actual results,performance or achievements to differ materially from the anticipated futureresults, performance or achievements expressed or implied by such forward-lookingstatements. Therefore, the Company wishes to caution each reader of this reportto carefully consider the following factors and certain other factors discussedherein and factors discussed in other past reports. The factors discussedherein may not be exhaustive. Therefore, the factors contained herein should beread together with other reports and documents that are filed by the Companywith the SEC from time to time, which may supplement, modify, supersede orupdate the factors listed in this document.

 

Factors thatcould cause or contribute to the Company’s actual results differing materiallyfrom those discussed herein or for the Company’s stock price to be affectedadversely include, but are not limited to: (i) industry trends, includinga general downturn or slowing of the growth of the dietary supplement industry;(ii) increased competition from current competitors and new marketentrants including but not limited to increased competition from private labelhouse brands supported by retailers seeking to increase the market share oftheir proprietary house brands; (iii) adverse publicity regarding thedietary supplement industry or the Company’s products including recentpublicity regarding ephedrine-based products; (iv) exposure to productliability claims including product liability claims from products which includeephedrine or other products for which the Company has either not been able tosecure product liability coverage or has not been able to secure such coverageat reasonable prices; (v) exposure to and the expense of resolving anddefending potential product liability claims that are left uncovered byinsurance; (vi) the Company’s dependence upon its ability to develop newproducts; (vii) a continued high rate (or increase in the rate) of returnsof the Company’s products; (viii) the Company’s ability to manageinventory or sell its inventory before such inventory becomes outdated,(xix) the Company’s ability to gain or expand or maintain distributionwithin new or existing customers and new or existing channels of trade;(x) an increase in the cost of obtaining and maintaining shelf space withmajor national retailers who demand various forms of incentives from theirsuppliers such as slotting fees, coop advertising, or rebates; (xi) adversechanges in government regulation or changes in local or national laws;(xii) dependence on significant customers; (xiii) the Company’sability to keep and attract key management employees; (xiv) 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 into new businesses andcapitalize upon new business 

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opportunities; (xv) the Company’sability to consummate future acquisitions and its ability to integrate acquiredbusinesses; (xvi) the absence of conclusive clinical studies for many ofthe Company’s products; (xvii) the Company’s inability to obtain rawmaterials that are in short supply including its ability to obtain garlicpowders under its supply agreement with ConAgra for its Essentially PureIngredient (EPI) raw material sales division; (xviii) sales and earningsvolatility, (xix) volatility of the stock market; (xx) the Company’sability to manufacture its products efficiently; (xxi) the Company’sreliance on independent brokers to sell its products; (xxii) the inabilityof the Company to protect its intellectual property; (xxiii) control ofthe Company by principal shareholders, (xxiv) the possible sale of largeamounts of stock by controlling stockholders; (xxv) a continued generaldownturn in the national economy as a whole; (xxvi) continued marketacceptance of Natrol supplements, Laci Le Beau teas, Prolab’s sports nutritionproducts and EPI’s raw material products; (xxvii) increases in the cost ofborrowings; (xxviii) unavailability of additional debt or equity capital;(xix) legal actions brought forth by governmental and private agencies;and, (xx) that its investment in a new multi-level marketing company,Annasa Inc., will prove to be profitable in the near or long-term.

 

RESULTS OF OPERATIONS

 

THREE MONTHS ENDED MARCH 31,2003 AND MARCH 31, 2002

 

NET SALES.  Sales are recognizedat the time product is shipped. Net sales are net of discounts, allowances, andestimated returns and credits, slotting fees, rebates and other expenses thatreduce the cost of product to the Company’s customers.  Net sales increased 9.3%, or $1.6 million,to $19.1 million for the three months ended March 31,2003 from $17.5million forthe three months ended March 31, 2002. The increase in net sales was primarily due a $2.4 million reduction inthe cost of returns, damages and outdates in the first quarter of 2003 when comparedto the first quarter of 2002.  Returnsand damage claims are netted against gross sales when calculating netsales.  During the 2003 quarter, returnsas a percentage of gross sales were 3.7% as compared to 14.5% in the 2002quarter.

 

GROSS PROFIT.  Gross profitincreased 25.6%, or $1.7 million, to $8.3 million for the three months endedMarch 31,2003 from $6.6 million for the three months ended March 31, 2002.Gross margin increased to 43.1% for the three months ended March 31,2003 from37.5% for the three months ended March 31, 2002.  The increase in gross margin was due to the lower volume ofreturns and other deductions from gross sales in the first quarter of 2003 ascompared to the first quarter of 2002.  The cost of sales is primarily related to the amount of gross shipmentsand when net sales are substantially less than the amount of gross sales, asthey were in the first quarter of 2002, gross margin declines and thepercentage cost of goods sold increases as a percentage of net sales.

 

SELLING AND MARKETING EXPENSES. Selling and marketing expenses consist primarily of advertising andpromotional expenses, cost of distribution, and related payroll expenses andcommissions. Selling and marketing expenses increased 36.9%, or $1.4 million,to $5.3 million for the three months ended March 31,2003 from $3.9 million forthe three months ended March 31, 2002. The Company incurred $330,000 of sellingand marketing expenses as part of its launch of its Annasa multi-levelmarketing subsidiary.  The Companyincurred no Annasa related expenses in the first quarter of 2002. Sales andmarketing expenses of the Company’s Prolab subsidiary rose approximately$500,000 when compared to the first quarter of 2002 with a majority of theincrease being due to a higher level of advertising activity as well asincreased payroll and commission expenses. The remainder of the increase inselling and marketing expenses was primarily due to increased payroll andadvertising expenses within the Natrol business segment.

 

GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses consist primarily of personnel costsrelated to general management functions, finance, accounting and informationsystems, as well as professional fees related to legal, audit and tax mattersand depreciation. General and administrative expenses increased  27.9%, or $653,000, to $3.0 million for thethree months ended March 31,2003 from $2.3 million for the three months endedMarch 31, 2002.  Approximately $291,000of the increase was due to expenses incurred by Annasa which did not exist inthe first quarter of 2002.  Theremainder of the increase was due primarily to the increased costs of personnelas well as higher insurance cost for product liability and other generalliability insurance.

 

INTEREST EXPENSE.  The Companyrecorded interest expense of $162,000 for the three months ended March 31,2003as compared to interest expense of $170,000 for the three months ended March31, 2002. The Company pays interest on approximately $8.0 million of long-termmortgage debt.

 

INCOME TAX PROVISION.  For thethree months ended March 31,2003 the Company’s effective tax rate wasapproximately 39.5%.  For the threemonths ended March 31, 2002 the Company’s apparent effective tax rate was38.9%.

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

At March 31, 2003, the Company had working capital of $18.9 million ascompared to $18.7million in working capital at December 31, 2002. TheCompany’s cash balance at March 31, 2003 was approximately $8.9 million.

 

Net cash used in operating activities was $1.1 million for the threemonths ended March 31,2003 versus net cash provided of $2.4 million for thethree months ended March 31, 2002. Cash used in operating activities during thethree month period ended March 31, 2003 was primarily due to the Company’s netloss of $124,000, an increase in accounts receivable and other receivables of$2.0 million, offset by an increase in net accounts payables and other accrualsof $444,000, depreciation and amortization of $373,000 and a decrease ininventory of $124,000.

 

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Net cash used in investing activities was $73,000 for the three monthsended March 31,2003 versus net cash provided of $60 during the three monthsended March 31, 2002. Nearly all of the cash used in investing activities inboth periods was for property and equipment.

 

Net cash used in financing activities was $76,000 for the three monthsended March 31,2003 as opposed to $33,000 provided by financing activitiesduring the three months ended March 31, 2002. During the three months endedMarch 31,2003, the Company made principal payments of $76,000 on its long-termmortgage debt.  In the first quarter of2002, the Company made principal payments of $70,000 and received $103,000 fromthe proceeds of the exercise of stock options and the sale of stock toemployees through its employee stock purchase program.

 

As of March 31, 2003, the Company had $8.0 million of outstanding debtall of which is the result of long-term mortgage debt on the Company’smanufacturing/headquarters facility and on the Company’s shipping facility. TheCompany has no line of credit in place.

 

The Company expects its cash balances to decline during the nextseveral quarters as it invests in the launch of its Annasa multi-levelmarketing subsidiary.

 

Despite the anticipated decline in cashbalances, the Company believes that its current cash balance together with cashgenerated from operations other than Annasa 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.

 

## **CRITICAL ACCOUNTINGPOLICIES**

## ** **

Management’s beliefs regarding significant accounting policies have notchanged significantly from those discussed in Item 7 of the Company’s AnnualReport on Form 10-K for the year ended December 31, 2002.

 

ITEM 3.                     QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

There has been no material change during the quarter ended March 31,2003 form the disclosures about market risk provided in the Company’s AnnualReport on Form 10-K for the year ended December 31, 2002.

 

Item 4.    CONTROLS AND PROCEDURES

 

(a)          Evaluation of disclosurecontrols and procedures.

 

As required by new Rule 13a-15 under the Securities Exchange Actof 1934, within the 90 days prior to this report, we carried out anevaluation under the supervision and with the participation of our management,including our Chief Executive Officer and Chief Financial Officer, of theeffectiveness of the design and operation of our disclosure controls andprocedures. In designing and evaluating our disclosure controls and procedures,we and our management recognize that any controls and procedures, no matter howwell designed and operated, can provide only reasonable assurance of achievingthe desired control objectives, and our management necessarily was required toapply its judgment in evaluating and implementing possible controls andprocedures. Based on evaluations as of a date within 90 days of the filing dateof this report, our principal executive officer and principal financialofficer, with the participation of our management team, have concluded that ourdisclosure controls and procedures (as defined in Rules ...under the Securitiesand Exchange Act are effective to ensure that information required to bedisclosed by us in reports that we file or submit under the Securities ExchangeAct is recorded, processed, summarized and reported within the time periodsspecified in the rules and forms of the SEC.

 

(b)         Changes in internalcontrols

 

None.

 

PART II

 

ITEM 6.  EXHIBITS AND REPORTS ONFORM 8-K

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

 

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Reports on Form 8-K; 8-K/A filed on January 7, 2003

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 

 
|          | NATROL, INC. |
|---------------|--------------|
|          |         |   |
| Date: 5/15/03 | By:          | /s/ Elliott Balbert |   |
|          |         | Chairman, President and Chief Executive  Officer |
|          |         |   |   |
| Date: 5/15/03 | By:          | /s/ Dennis R. Jolicoeur |   |
|          |         | Chief Financial Officer and Executive Vice  President |
|          |         |   |

 

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Certification

 

I, Dennis R. Jolicoeur, Chief Financial Officer and Executive VicePresident of Natrol, Inc., certify that:

 

1.               I have reviewedthis quarterly report on Form 10-Q of Natrol Inc.;

 

2.               Based on myknowledge, this quarterly report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which statements were made, notmisleading with respect to the period covered by this quarterly report;

 

3.               Based on myknowledge, the financial statements, and other financial information includedin this quarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this quarterly report;

 

4.               The registrant’sother certifying officer and I are responsible for establishing and maintainingdisclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and15d-14) for the registrant and we have:

 

a.               designed such disclosurecontrols and procedures to ensure that material information relating to theregistrant, including its consolidated subsidiaries, is made known to us byothers within those entities, particularly during the period in which thisquarterly report is being prepared;

 

b.              evaluated theeffectiveness of the registrant’s disclosure controls and procedures as of adate within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c.               presented in thisquarterly report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.               The registrant’sother certifying officers and I have disclosed, based on our most recentevaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

a.               all significantdeficiencies in the design or operation of internal controls which couldadversely affect the registrant’s ability to record, process, summarize andreport financial date and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b.              any fraud, whetheror not material, that involves management or other employees who have asignificant role in the registrant’s internal controls; and

 

6.               The registrant’sother certifying officer and I have indicated in this quarterly report whetheror not there were significant changes in internal controls or in other factorsthat could significantly affect internal controls subsequent to the date of ourmost recent evaluation, including any corrective actions with regard tosignificant deficiencies and material weaknesses.

 

 
| Date:  | 5/15/2003 |   | Name:  |   | /s/Dennis R. Jolicoeur                |
|--------|-----------|--------|--------|--------|---------------------------------------|
|   |      |   |   |   |                                  |
|   |      |   | Title: |   | Chief Financial Officer and Executive |
|   |      |   |   |   | Vice President                        |

 

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Certification

 

I, Elliott Balbert, President, Chief Executive Officer and Chairman ofNatrol Inc., certify that:

 

1.               I have reviewedthis quarterly report on Form 10-Q of Natrol Inc.;

 

2.               Based on myknowledge, this quarterly report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which statements were made, notmisleading with respect to the period covered by this quarterly report;

 

3.               Based on myknowledge, the financial statements, and other financial information includedin this quarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this quarterly report;

 

4.               The registrant’sother certifying officer and I are responsible for establishing and maintainingdisclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and15d-14) for the registrant and we have:

 

a.               designed suchdisclosure controls and procedures to ensure that material information relatingto the registrant, including its consolidated subsidiaries, is made known to usby others within those entities, particularly during the period in which thisquarterly report is being prepared;

 

b.              evaluated theeffectiveness of the registrant’s disclosure controls and procedures as of adate within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c.               presented in thisquarterly report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.               The registrant’sother certifying officers and I have disclosed, based on our most recentevaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

a.               all significantdeficiencies in the design or operation of internal controls which couldadversely affect the registrant’s ability to record, process, summarize andreport financial date and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b.              any fraud, whetheror not material, that involves management or other employees who have asignificant role in the registrant’s internal controls; and

 

6.               The registrant’sother certifying officer and I have indicated in this quarterly report whetheror not there were significant changes in internal controls or in other factorsthat could significantly affect internal controls subsequent to the date of ourmost recent evaluation, including any corrective actions with regard tosignificant deficiencies and material weaknesses.

 

 
| Date:  | 5/15/2003 |   | Name:  | /s/Elliott Balbert     |
|--------|-----------|--------|--------|------------------------|
|   |      |   |   |                   |
|   |      |   | Title: | President/CEO/Chairman |

 

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