10-K/A 1 v01350_10ka.txt SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K/A /X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For Fiscal Year ended June 30, 2003 / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _________________ to ________________________ . Commission File Number 0-14983 NUTRITION 21, INC. ------------------ (Exact Name of Registrant as Specified in its Charter) New York 11-2653613 --------------------------------- ------------------- (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 4 Manhattanville Road, Purchase, New York 10577-2197 (914) 701-4500 Securities registered pursuant to Section 12(b) of the Act: None ---- Securities registered pursuant to Section 12(g) of the Act: Common Stock (par value $.005 per share) ---------------------------------------- Title of Class Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve (12) months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past ninety (90) days. Yes /X/ No / / Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the registrant's best knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. /X/ Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes____ No __X___ The aggregate market value of voting stock held by non-affiliates of the Registrant was approximately $29,640,281 as of October 14, 2003. The number of shares outstanding of Registrant's Common Stock as of October 14, 2003: 37,986,988. 1 FORM 10-K REPORT INDEX
10-K Part and Item No. Page No. ---------------------------------------------------------------------------------------------------- PART I Item 1 Business 3 Item 2 Properties 12 Item 3 Legal Proceedings 12 Item 4 Submission of Matters to a Vote of Security Holders 13 PART II Item 5 Market Price of Registrant's Common Equity and Related Stockholder Matters 14 Item 6 Selected Financial Data 16 Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations 17 Item 7A Quantitative and Qualitative Disclosures About Market Risk 23 Item 8 Financial Statements and Supplementary Data 24 Item 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 24 Item 9A Controls and Procedures 24 PART III Item 10 Directors and Executive Officers of the Registrant 25 Item 11 Executive Compensation 28 Item 12 Security Ownership of Certain Beneficial Owners and Management 34 Item 13 Certain Relationships and Related Transactions 36 Item 14 Principal Accounting Fees and Services 37 PART IV Item 15 Exhibits, Financial Statement Schedules, and Reports on Form 8-K 39
2 Disclosures in this Form 10-K/A contain certain forward-looking statements, including without limitation, statements concerning the Company's operations, economic performance and financial condition. These forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The words "believe," "expect," "anticipate" and other similar expressions generally identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their dates. These forward-looking statements are based largely on the Company's current expectations and are subject to a number of risks and uncertainties, including without limitation, changes in external market factors, changes in the Company's business or growth strategy or an inability to execute its strategy due to changes in its industry or the economy generally, the emergence of new or growing competitors, various other competitive factors and other risks and uncertainties indicated from time to time in the Company's filings with the Securities and Exchange Commission. Actual results could differ materially from the results referred to in the forward-looking statements. In light of these risks and uncertainties, there can be no assurance that the results referred to in the forward-looking statements contained in this Form 10-K/A will in fact occur. The Company makes no commitment to revise or update any forward looking statements in order to reflect events or circumstances after the date any such statement is made. PART I ITEM 1. BUSINESS The Company is a New York corporation that was incorporated on June 29, 1983 as Applied Microbiology, Inc. GENERAL DEVELOPMENT OF THE COMPANY'S BUSINESS Prior to 1995 the Company focused on the development and commercialization of antibacterial technologies for new drugs. The Company subsequently licensed these technologies to third parties. Beginning in 1995, the Company shifted its focus to developing and marketing nutrition products and ingredients. In 1997 the Company acquired a comprehensive chromium-based patent portfolio based on a picolinate form of chromium that was invented and researched by the United States Department of Agriculture. The Company currently develops and markets nutrition ingredients that are associated with these patents, but is transitioning to a new business model to further commercialize its patent estate. Under this business model, the Company plans to market and distribute distinct branded therapeutic products for people with diabetes and other conditions associated with insulin resistance. Based on American Diabetes Association estimates, at least one in eight Americans is thought to be insulin resistant. In 1999, the Company acquired the Lite Bites consumer product line from Optimum Lifestyles, Inc. In August of 2003, the Company discontinued its investment in the Lite Bites product line and recorded a $4.4 million charge relating to the discontinuance. 3 THE COMPANY'S PRODUCTS AND PROPOSED PRODUCTS The Company's Existing Ingredients Business Since 1997, the Company's primary business has been to develop and market proprietary ingredients to the vitamin and supplement market for both human and animal applications. Today, Chromax(R) chromium picolinate is the Company's primary ingredients product. In late fiscal 2003, the Company launched a new chromium ingredient combination, Chromax chromium picolinate combined with conjugated linoleic acid called Zenergen(R), which potentiates glucose uptake in muscle cells in the absence of insulin stimulation. Pre-clinical research indicates that this combination promotes healthy weight loss in people who are insulin resistant. The Company's ingredient customers distribute Chromax as a stand alone chromium supplement either under the Chromax name under license from the Company, or under their own private labels. A license from the Company is required for all chromium picolinate products that are sold in the US for glucose control and its derivative benefits, including cholesterol control and improved body composition. The Company derives additional revenues from the sale and licensing of Chromax to customers who incorporate it and other of the Company's ingredients into over 900 finished multi-ingredient products. These include vitamin/mineral formulas, weight loss and sports nutrition supplements, baked goods, beverages and other products. These products are sold by the Company's customers under a variety of brands throughout the world through natural/health food stores, supermarkets, drug stores, and mass merchandisers, and also through direct sales and catalogue sales. The current annual US retail market for chromium mineral supplements is estimated to be $85 million based on retail sales data provided by SPINS and Information Resources, Inc. ("IRI"). Based on SPINS and IRI data, more than 80% of US chromium supplements are formulated with the Company's Chromax chromium picolinate, while the rest are manufactured using chloride, polynicotinate or other forms. Chromax chromium picolinate is also used for managing the health of breeding sows and their offspring, where it has been shown to improve glucose control in gestating swine. Research outcomes include improved fertility, productivity and recovery for the sows, and stronger and more resilient offspring. The Company's principal customers have entered into master license agreements with the Company that cover purchases that they decide to make from the Company from time to time. The Company has no long term purchase or sale commitments with its customers. The master license grants to these customers a license under the Company's patents to sell chromium picolinate for the particular uses covered by the patents. The fee for this license is bundled on an unallocated basis with the price that the Company charges to its customers for products that the Company sells to them. See "Supply and Manufacturing" for information on a long term manufacturing agreement between the Company and the manufacturer of its principal products. 4 During each of the fiscal years ended June 30, 2003, 2002 and 2001, respectively, ingredient sales of chromium picolinate accounted for more than 74%, 63%, and 57% of the Company's total revenues. Sales of the Company's Lite-Bite products during these three fiscal years accounted for more than 8%, 27%, and 27% of the Company's total revenues. One customer, Prince Agri Products, Inc., accounted for 18.95%, 12.58% and 6.60% of the Company's total revenues, respectively, in the Company's 2003, 2002 and 2001 fiscal years. In marketing its Chromax chromium picolinate, the Company must continue to demonstrate the safety of this product. The following studies in the Company's opinion demonstrate that chromium picolinate is safe. The United States Government, acting through the National Institutes of Health-National Toxicology Program ("NTP"), has independently evaluated the safety of chromium picolinate with government approved tests. In 2002, the NTP reported that it did not find any safety concerns with chromium picolinate, even at high doses. In 2002 a group of experts consisting of Richard Anderson, Ph.D. (USDA), Walter Glinsman, MD (retired from the USDA), and Joseph Borzelleca, Ph.D. (Virginia Commonwealth University) reviewed all existing studies of chromium picolinate and found no safety concerns. In 1997 United States Department of Agriculture ("USDA") researchers determined that chromium picolinate is safe. However, several researchers have questioned the safety of chromium picolinate. In 1995 and 2002 a research group headed by Dianne Stearns, Ph.D. (University of Dartmouth College and Northern Arizona University) administered chromium picolinate in a laboratory to Chinese hamster ovary cell lines, and in 2203 another research group headed by John Vincent, Ph.D. (University of Alabama) administered chromium picolinate to fruit flies. Both reported safety concerns. The Company's Proposed Therapeutic Branded Products The Company expects to position its first branded product, Diachrome(TM), as an aid in the dietary management of diabetes, and it expects to market this product with the support of healthcare professionals. Diachrome(TM) is a patented combination of Chromax chromium picolinate and biotin; these are nutritional ingredients that work synergistically to enhance blood sugar control and improve blood cholesterol profiles. Building on pre-clinical and early clinical research, the Company has formed a strategic alliance with Diabetex, a leading diabetes disease management company, to validate Diachrome's ability to significantly improve blood sugar control in people with type 2 diabetes. Together, the companies are conducting a 600 patient double-blind placebo controlled trial aimed at demonstrating the pharmacoeconomic and health benefits associated with the use of Diachrome as a nutritional adjunct to current diabetes management protocols. 5 The Diachrome study is expected to be completed by the end of fiscal year 2004 and, assuming positive results, Diachrome will be aggressively marketed to the diabetes healthcare market under the Nutrition 21 label. Through its alliance with Diabetex, the Company will also seek to include the Diachrome product on the Medicare formulary, and demonstrate the product's ability to improve patient outcomes and lower the cost of care. The Company plans a targeted direct-to-consumer marketing program to managed diabetic populations. The Company plans to build consumer awareness for its products through a media campaign that leverages research outcomes, in combination with consumer and physician testimonials. Communication of scientific findings will be used to build consensus within the healthcare community regarding the inherent value of the Company's products. Pharmaceutical Products Licensed to Third Parties The Company has infectious disease drug technology for diseases in humans, centered around the compound nisin, a member of the lanthocin class of peptides, as a potential treatment for infections of the colon and other bacterial infections, and lysostaphin, an enzyme, as a potential treatment for endocarditis and other Staphylococcal infections, and lysostaphin and antibiotic compositions to treat infections while suppressing the formation of staphylococcal and antibiotic resistance. The Company determined that it did not have the resources necessary to take these pharmaceutical products for the treatment of infectious diseases from the development stage through regulatory filings and ultimately to the marketplace, should a product be proven to be safe and effective. In March 1996, the Company entered into an exclusive Agreement with AZWELL, Inc. (formerly Nippon Shoji Kaisha, Ltd. of Osaka, Japan), under which AZWELL received exclusive rights to develop and market certain nisin-based drug products as a treatment of infections of the colon and nosocomial infections in Japan, certain Asian countries, Australia and New Zealand. In August 2000, the Company exclusively licensed to Biosynexus the Company's remaining rights to nisin and lysostaphin antibacterial technologies for development and marketing of new drugs for human uses. The Company received a payment of $1.4 million, and the license provides for milestone payments of up to $14 million, and royalties. The Company also received warrants to acquire common stock of Biosynexus, currently a privately held company. The Company also has infectious disease technology centered on nisin and lysostaphin for the treatment of diseases in animals, including a moistened towel using a nisin-based formulation for mastitis prevention that is used for preparing dairy cows for milking. The Company launched the product under its trademark Wipe Out(R) Dairy Wipes in April 1996. On December 30, 1999, the Company sold its Wipe Out Dairy Wipes business to ImmuCell Corporation ("ImmuCell"). On April 12, 2000, the Company exclusively licensed to ImmuCell worldwide rights to develop and market new antibacterial drugs for animals using the Company's technologies. 6 RESEARCH AND DEVELOPMENT During the fiscal years ended June 30, 2003, 2002 and 2001, the Company spent approximately $2.2 million, $1.0 million, and $1.9 million, respectively, on research and development. The Company's research and development program is based on chromium and seeks to discover and substantiate the efficacy and safety of ingredients and products that have a significant nutritional therapeutic value to consumers. The primary research focus over the past few years has been in the area of diabetes and cardiovascular health. Discovering the mechanism of action of chromium picolinate and further confirming the beneficial effects of chromium picolinate in people with diabetes have been critical objectives. The Company is also researching therapeutic areas involving obesity, depression, bone and joint health, and women's health. This research effort has enabled the Company to identify patentable new combinations of chromium and new uses for chromium, and new food systems that can be enhanced by the inclusion of its ingredient systems. Clinical Studies, Presentations and Publications The Company from time to time provides funding for clinical studies of its products to evaluate efficacy and mechanisms of action, and in other instances supplies chromium picolinate for use in studies for which it provides no funding. The Company believes that positive results in these studies, whether or not funded by it, provide benefits to the Company by furthering acceptance of its products. The Company also makes presentations at various meetings to gain acceptance of its products. The following information summarizes certain of these studies and details those studies that were funded by the Company. The information also summarizes several recent presentations and publications that relate to the Company's products. In no case is the Company required to provide any further funding. Studies in progress Chromax The Company has supplied its Chromax chromium picolinate to the University of Vermont for a clinical study that is funded by the American Diabetes Association. The study is entitled " Evaluation of the Effect of Chromium Picolinate in People with Type 2 Diabetes," and is designed to evaluate the effect of Chromax(R) on insulin sensitivity in people with type 2 diabetes mellitus ("DM"). The study is also designed to provide information on how chromium picolinate supplementation mediates glucose uptake and glucose transport, and how it enhances insulin action in cellular signaling through insulin receptor regulation. The Company has supplied its Chromax chromium picolinate to Pennington Biomedical Research for a clinical study funded by National Institutes of Health that is evaluating "Chromium and Insulin Action." This study focuses on the effects of chromium picolinate on glucose homeostasis, and is designed to generate dietary chromium recommendations for reducing the risk of diabetes and associated diseases. 7 The Company supplied its Chromax chromium picolinate to the University of Pennsylvania for a clinical study funded by the National Institutes of Health that is entitled " A Double Blind Randomized Controlled Clinical Trial of Chromium Picolinate on Clinical and Biochemical Features of the Metabolic Syndrome." This study is evaluating the effect of daily supplementation with chromium picolinate on insulin sensitivity in individuals with metabolic syndrome, and on glucose tolerance tests, HDL-C, triglycerides, body composition, BMI and blood pressure. This study will also provide the first human data on the effects of chromium picolinate supplementation on oxidative stress and inflammation, which are major risk factors in the progression of diabetes and cardiovascular disease. The Company gave a $900,000 research grant to Comprehensive Neuroscience Inc. to conduct a clinical study on "The Effects of Chromium Picolinate in Atypical Depression." The study is a double blind placebo controlled trial of Chromax chromium picolinate in people with depression and symptoms that include carbohydrate cravings, weight gain and tiredness. The Company expects that this study will provide information on the anti-depressant effects of chromium picolinate supplementation for these people. Diachrome The Company furnished its Diachrome product (Chromax chromium picolinate and biotin) to Diabetex Corporation and paid Diabetex $300,000 to conduct a clinical study that is entitled " A Randomized, Double Blinded, Placebo Controlled, Parallel Arm, Multicenter Study To Evaluate The Improvement In Glycemic Control, Lipid Levels, Quality Of Life And Healthcare Costs After Daily Administration Of Chromium Picolinate And Biotin In Patients With Type 2 Diabetes." The study is designed to provide data on the effects of Diachrome on diabetes risk factors, and is expected to reflect improvements effected by Diachrome in beta cell function and the risk of insulin resistance in type 2 diabetes patients. Any data that are positive should support chromium picolinate as an alternative nutritional therapy for diabetes patients. Studies Completed in 2003 Arginine Silicate Inositol Complex The Company provided its Arginine-Silicate-Inositol complex and a $90,000 research grant to the University of Alberta for a preclinical study on the "Effects Of Arginine Silicate Inositol Complex On Vascular Functions And Bone Health Markers." The study results suggested that the product helps reduce coronary risk factors and improve heart and bone health. Presentations and Publications in 2003 An article on "Chromium and Cardiovascular Disease" was published in Advances in Heart Failure (Intern. Acad. Cardiology). This article reviews the significant effects of chromium picolinate on coronary heart disease risk factors, such as lipids and lipoproteins, in both animal and human studies. 8 A paper on Glucose Uptake Of Chromium Picolinate, Chromium Polynicotinate And Niacin was accepted and presented at a meeting of the Federation of American Societies for Experimental Biology. This paper focuses on the enhancement of glucose uptake in skeletal muscle cells with chromium picolinate. A paper on "Chromium Picolinate Increases Skeletal Muscle PI3 Kinase Activity in Obese, Hyperinsulinemic JCR:LA Corpulent Rats" was accepted and presented at the 63rd annual meeting and scientific sessions of the American Diabetes Association. The paper reports a mechanism of action by which chromium picolinate enhances insulin activity. Studies Completed in 2002 Diachrome The Company gave a $200,000 research grant and supplied Diachrome to the Chicago Center for Clinical Research to conduct a "Study On Chromium With Biotin Decreases Coronary Risk Lipids And Lipoproteins In People With Type 2 Diabetes Ingesting Moderate Carbohydrate Nutritional Beverages." Results from this trial suggested that chromium picolinate and biotin can significantly reduce elevations in blood glucose levels and symptoms of fatigue in people with type 2 diabetes that are consuming a carbohydrate-containing beverage. These findings were presented at the Federation of American Societies for Experimental Biology ("FASEB"), and American College of Nutrition. Zeramax The Company gave a $110,000 research grant and supplied Zeramax to Duke University to study the "Effectiveness of Chromium Picolinate in Atypical Depression: A Placebo-Controlled Clinical Trial." Results from this study suggest that chromium picolinate helps reduce depression markers. In this study, seventy (70%) of chromium picolinate group and zero (0%) of placebo group responded to treatment. This paper was published in Biological Psychiatry. Presentations and Publications in 2002 An article on "Oral Chromium Picolinate Improves Carbohydrate And Lipid Metabolism And Enhances Skeletal Muscle Glut-4 Translocation In Obese, Hyperinsulinemic (JCR-LA Corpulent) Rats" was published in J Nutr. 2002. This article reports the results of a study to evaluate whether chromium picolinate helps in treatment of the insulin resistance syndrome. Chromium picolinate supplementation was shown to enhance insulin sensitivity, glucose metabolism and blood lipids. A paper entitled " Antimutagenic Activity Of Chromium Picolinate In The Salmonella Assay" was presented at XIV World Congress of Pharmacology. The paper reported that chromium picolinate is non-mutagenic. 9 GOVERNMENTAL REGULATION The U.S. Food and Drug Administration ("FDA") regulates the labeling and marketing of the Company's dietary supplements under the Dietary Supplement and Health Education Act ("DSHEA"). Under DSHEA, dietary supplements that were first marketed as dietary supplements after October 1994 require safety approval by the FDA. The Company's products do not require FDA safety approval because they were marketed as dietary supplements prior to October 1994. See "The Company's Existing Ingredient Products" for further information on the safety of the Company's products. Under DSHEA, the Company is required to submit for FDA approval claims regarding the effect of its dietary supplements on the structure or function of the body. DSHEA also requires an FDA approval process for claims (so-called "health claims") that relate dietary supplements to disease prevention. The Company will seek to secure FDA approval for health claims that its products can prevent diabetes and possibly other diseases. The Federal Trade Commission ("FTC") regulates product-advertising claims and requires that claims be supported by competent and reliable scientific evidence. Prior to the Company's acquisition of a California limited partnership called Nutrition 21 ("Nutrition 21 LP"), the FTC opened an inquiry into certain of the claims that Nutrition 21 LP was making for chromium picolinate. The inquiry was terminated by Nutrition 21 LP and the FTC entering into a consent decree that requires that claims be supported by competent and reliable scientific evidence. After the Company acquired Nutrition 21 LP, the Company undertook new clinical studies to support the claims it intended to make for its products. The FTC has subsequently audited the Company's chromium picolinate advertising and has not found either a lack of competent and reliable scientific evidence or a failure by the Company to comply with the consent decree. The FTC continues to monitor the Company's advertising and could limit its advertising in ways that could make marketing its products more difficult or result in lost sales. PROPRIETARY RIGHTS Trademarks Chromax, Diachrome, Selenomax, SelenoPure, Zinmax, Zenergen and Magnemax are among the more well known trademarks owned by Nutrition 21: Chromax for chromium picolinate; Diachrome for chromium picolinate and biotin; Selenomax for high selenium yeast, SelenoPure for yeast-free selenium; Zinmax for zinc picolinate; Magnemax for manganese picolinate, and Zenergen for chromium picolinate and conjugated linoleic acid. Brite Bites, Cardia, Lite Bites, Lite Bites Fat-Fighting System Chewies, and Metabolic Makeover are trademarks for its consumer products in the US, while Brite Bites is a UK trademark. Nutrition Patents The Company presently has 36 issued US patents and 13 pending US patent applications with foreign equivalents covering novel compositions and therapies directed towards significant health conditions such as cardiovascular disease, depression, polycystic ovary syndrome, both type 1 and type 2 diabetes, and sports nutrition. Of these patents, 24 U.S. patents and various foreign patents relate to chromium, including composition of matter patents for novel chromium picolinate complexes and their uses. Three of these patents relate to the accepted essential nutritional uses of chromium picolinate for glucose control, for managing cholesterol, and for increasing lean body mass and reducing body fat, and are in force through 2009. Patents for improved chromium picolinate complexes containing combinations of chromium and various nutrients for enhancing the benefits of chromium picolinate, are in force into the year 2017. More recently, the Company has secured patent rights to the uses of all forms of chromium in the treatment of depression and other mood disorders, rights that are in force through 2018. 10 The pending applications build upon the Company's expertise in technology areas such as nutritional mineral supplements, and are directed towards the synergistic effects of combining chromium with compounds such as biotin, alpha lipoic acid, conjugated linoleic acid (CLA), and CLA isomers. These include issued and pending patent applications covering the positive effects of chromium and biotin on type 2 diabetes. Outside of the chromium area, the Company continues to file patent applications in the area of arginine silicate, a patented compound that has shown promise in therapies for bone and joint health, cardiovascular disease, and glucose metabolism. The Company maintains non-disclosure safeguards, including confidentiality agreements, with employees and certain consultants. There can be no assurance, however, that others may not independently develop similar technology or that secrecy will not be breached despite any agreements that exist. Although the Company holds exclusive rights to United States patents for the nutritional uses for which chromium picolinate is sold, the Company is often faced with competition from companies, including importers, that disregard its patent rights. These companies take calculated risks that the Company will not sue to enforce its patent rights against them. The Company determines whether to file suit against an infringer by taking into consideration an estimate of infringing sales and the cost of patent enforcement. While there is no guarantee that the Company will be able to successfully enforce its patent rights against these competitors, the Company continues to monitor industry practices. The Company has initiated several patent infringement cases that it subsequently settled. In 2003, the Company settled a patent dispute with Lonza Inc., in which Lonza agreed to license the Company's glucose control patents for marketing Lonza's proprietary combination of carnitine and chromium picolinate for swine feed applications. No other rights were granted to Lonza to sell chromium picolinate, alone or in other combinations, for human or other animal applications. Pharmaceutical Patents The Company owns more than 200 patents relating to, among other things, the expression and production of proteins by recombinant Bacillus strains; plasmid vectors and methods of construction; expression and production of recombinant lysostaphin; novel bacteriocin compositions and their use as broad spectrum bactericides; the use of bacteriocin compositions to treat bovine mastitis; the use of bacteriocin compositions in oral healthcare; the use of bacteriocin compositions on skin for healthcare and hygiene; and the use of bacteriocin compositions in gastrointestinal healthcare. These patents are licensed to AZWELL Inc, Biosynexus Incorporated, and ImmuCell Corporation as set forth under "Pharmaceutical Products Licensed to Third Parties." 11 The Company maintains trade secret protection for bacterial strains, technical know-how, and other information it considers proprietary and beneficial for the manufacture, use, regulatory approval, and marketing of the Company's products. COMPETITION In considering its competitive position, the Company distinguishes between its existing ingredients business, on the one hand, and its prospective therapeutic branded products, on the other hand. The Company has a relatively strong position for its current chromium sales where it believes that it has an approximately 80% share of the market for stand alone sales, and it has a 15% market share for sales of chromium into multi-ingredient products, based on SPINS and IRI data reporting retail sales of chromium products. The Company's major competitor is InterHealth Nutraceuticals Inc. which is a privately held company. The Company's proposed therapeutic branded business will confront many large established companies in a huge industry that serves the diabetes management market. The Company's success in this arena will in large part depend on its ability to obtain a scientific consensus that its supplement offer benefits that are competitive with the numerous companies that participate in this business. The nutritional product industry and the related drug industries are, of course, intensely competitive. The great majority of these competitors have financial and technical resources as well as production and marketing capabilities substantially greater than the Company. In addition, many competitors have significantly greater experience in the development and testing of new or improved products. SUPPLY AND MANUFACTURING The Company has entered into a long-term manufacturing agreement with a third party for the manufacture of the Company's principal products. There are numerous sources of supply for the raw materials that the Company's manufacturers use to manufacture the Company's products. The Company has never experienced a shortage of ingredient products. The Company keeps on hand an average of four months' inventory. The Company believes that it has adequate inventory to accommodate a suspension in the manufacture of any of its products by its current manufacturers, and that it could in any event resort to other manufacturers with minimal disruption. The Company plans to continue to outsource the manufacturing and packaging needs as it expands its business to include its marketing and distribution of branded therapeutic supplements. 12 EMPLOYEES As of June 30, 2003, the Company had 27 full-time employees, of whom 3 were executive employees, 8 were administrative, 11 were engaged in marketing and sales, and 5 were involved in research, process and product development, and manufacturing. The Company does not have a collective bargaining agreement with any of its personnel and considers its relationship with its employees to be satisfactory. ITEM 2. PROPERTIES Since September 1998, the Company maintains its headquarters pursuant to a seven and one-half year lease at 4 Manhattanville Road, Purchase, New York 10577-2197 (Tel: 914-701-4500). In fiscal 2002, the Company's surrendered a portion of its leased premises, and received a reduction in its annual rental for its headquarters location from $589,420 to $370,443 which sum is due in monthly installments. The rent is subject to annual increases over the term of the lease based on increases in certain building operating expenses. ITEM 3. LEGAL PROCEEDINGS On March 21, 2003 Andrew Wertheim (a former Executive Officer) instituted arbitration with the American Arbitration Association against the Company. In the arbitration, which is taking place in New York City, Mr. Wertheim seeks $225,000 in severance benefits under the terms of his employment agreement and the vesting of options for approximately 840,000 shares at an exercise price of $0.36 per share. The Company believes that Mr. Wertheim is not entitled to any severance benefits, and that his stock options have terminated. The Company in the ordinary course of its business has brought patent infringement actions against companies that are selling chromium picolinate in violation of the Company's patent rights. As of this date, no actions are ongoing, and the Company, which intends to vigorously protect its proprietary rights, is evaluating bringing other patent infringement actions. Various actions have been terminated on terms that the Company believes will protect its rights. In addition, the Company has brought an action against a competitor for false and misleading advertising. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to the Company's shareholders during the fiscal quarter ended June 30, 2003. 13 PART II ITEM 5. MARKET PRICE OF REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Matters Relating to Common Stock The Company's Common Stock trades on the Nasdaq SmallCap Market System under the symbol "NXXI". The Company has not paid a cash dividend to its public shareholders on its Common Stock. The Company intends to retain all earnings, if any, for the foreseeable future for use in the operation and expansion of its business and, accordingly, the Company does not contemplate paying any cash dividends on its Common Stock in the foreseeable future. The following table sets forth the high and low sales prices as reported by the Nasdaq Market for the Common Stock.
Common Stock Fiscal Quarter Ended High Low -------------------------------------------------------------------------------------- September 30, 2001 $ 1.70 $ 0.74 December 31, 2001 $ 0.96 $ 0.60 March 31, 2002 $ 0.98 $ 0.63 June 30, 2002 $ 0.74 $ 0.54 September 30, 2002 $ 0.40 $ 0.37 December 31, 2002 $ 0.64 $ 0.48 March 31, 2003 $ 0.38 $ 0.35 June 30, 2003 $ 0.48 $ 0.44
As of September 23, 2003, there were approximately 470 holders of record of the Common Stock. The Company believes that the number of beneficial owners is substantially greater than the number of record holders, because a large portion of its Common Stock is held of record in broker "street names." 14 ADOPTION OF SHAREHOLDERS RIGHTS PLAN The Company adopted a Shareholder Rights Plan on September 12, 2002. Under this plan, the Company distributed, as a dividend, one preferred share purchase right for each share of Common Stock of the Company held by stockholders of record as of the close of business on September 25, 2002. The Rights Plan is designed to deter coercive takeover tactics, including the accumulation of shares in the open market or through private transactions, and to prevent an acquiror from gaining control of the Company without offering a fair price to all of the Company's stockholders. The Rights will expire on September 11, 2012. Each Right entitles stockholders to buy one one-thousandth of a share of newly created Series H Participating Preferred Stock of the Company for $3.00 per share. Each one one-thousandth of a share of the Preferred Stock is designed to be the functional equivalent of one share of Common Stock. The Rights will be exercisable only if a person or group acquires beneficial ownership of 15% or more of the Company's Common Stock (30% in the case of a person or group that is currently a 15% holder) or commences a tender or exchange offer upon consummation of which such person or group would beneficially own 15% or more of the Company's Common Stock. If any person or group (an "Acquiring Person") becomes the beneficial owner of 15% or more of the Company's Common Stock (30% in the case of a person that is currently a 15% holder), then (1) the Rights become exercisable for Common Stock instead of Preferred Stock, (2) the Rights held by the Acquiring Person and certain affiliated parties become void, and (3) the Rights held by others are converted into the right to acquire, at the purchase price specified in the Right, shares of Common Stock of the Company having a value equal to twice such purchase price. The Company will generally be entitled to redeem the Rights, at $.001 per Right, until 10 days (subject to extension) following a public announcement that an Acquiring Person has acquired a 15% position. 15 ITEM 6. SELECTED FINANCIAL DATA The following tables summarize selected consolidated financial data that should be read in conjunction the more detailed financial statements and related footnotes and management's discussion and analysis of financial condition and results of operations included herein. Figures are stated in thousands of dollars, except per share amounts.
SELECTED STATEMENT OF YEAR ENDED JUNE 30, ------------------------------------------------------------------------------------------------------------------------------- OPERATIONS DATA: 2003(3) 2002(2) 2001 2000 1999(1) ------------------------------------------------------------------------------------------------------------------------------- Total Revenues $ 10,615 $ 14,668 $ 23,252 $ 32,814 $ 28,301 Gross Profit 6,486 10,324 17,036 27,034 23,519 Operating (Loss) Income (11,081) (7,789) (955) 7,041 6,469 (Loss) Income Before Taxes (11,050) (6,011) 1,400 7,004 6,347 Income Taxes (544) -- 335 523 482 Net (Loss) Income (10,506) (6,011) 1,065 6,490 5,865 Diluted (Loss) Earnings per Share (0.32) (0.19) 0.03 0.20 0.19
AT JUNE 30, ------------------------------------------------------------------------------------------------------------------------------- SELECTED BALANCE SHEET DATA: 2003 2002 2001 2000 1999 ------------------------------------------------------------------------------------------------------------------------------- Working Capital $ 4,146 $ 8,002 $ 6,392 $ 6,486 $ 1,879 Total Assets 18,920 28,100 38,887 41,085 34,541 Total Liabilities 3,484 2,151 6,495 10,430 12,950 Long-Term Obligations -- -- 122 1,278 3,807 Redeemable Preferred Stock -- -- 418 676 921 Stockholders' Equity 15,436 25,949 31,974 29,979 20,670
---------------- (1) Consolidated Statements of Operations include the operations of the Lite Bites business from January 1, 1999, the effective date of acquisition. (2) Consolidated Statements of Operations include a $7.1 million non-cash charge for the impairment of goodwill. (3) Consolidated Statements of Operations include a $4.4 million non-cash charge for the impairment of intangibles. 16 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the Consolidated Financial Statements and related notes thereto of the Company included elsewhere herein. OVERVIEW The following table sets forth items in the Consolidated Statements of Operations as a percent of revenues:
Fiscal Year Percent of Revenues 2003 2002 2001 ---- ---- ---- Total Revenues 100.0% 100.0% 100.0% Gross profit* 59.8 69.7 70.1 Selling, general and administrative expense 77.3 50.1 44.4 Research and development expense 21.0 6.9 8.4 Operating (loss) (104.4) (53.1) (4.1) Net (loss) income (99.0) (41.0) 4.6
*Based upon percent of net sales Results of Operations 1. Year ended June 30, 2003 vs. Year ended June 30, 2002 Revenues Net sales of $10.3 million for fiscal year 2003 declined $4.0 million when compared to net sales of $14.3 million for fiscal year 2002. The decline in revenues primarily reflects unsatisfactory results in the marketing of the Company's Lite Bites product line. Lower sales to the QVC channel can be partially attributable to increased competition in the nutrition bar category and a general decline in the weight-loss supplement market related to negative press associated with the ephedra controversy. Softer sales resulted in more limited airtime driving the Lite Bites business on QVC into further decline. In parallel during fiscal year 2003, the Company continued to explore alternative cost-effective channels of distribution for the Lite Bites brand that, prior to this year, was by agreement sold exclusively through QVC, Inc. The Company tested the proposition of taking Lite Bites into retail distribution though an alliance with Leiner Health Products, one of the largest and most reputable supplement distributors in the U.S. The resulting feedback indicated that the brand would require a much larger investment in marketing than the Company believed was justified. Therefore, the Company has made the decision to no longer invest in the Lite Bites product line. As a result, the Company determined that a $4.4 million non-cash charge associated with the long-lived assets related to the Lite Bites product line was warranted. The Company will consider a sale of the Lite Bites assets. Any returns realized will be reinvested in the expansion of the Company's chromium-derived business opportunities. 17 Lower weight-loss and sports nutrition supplement sales have led to commensurate reductions in revenues from ingredient sales. Other revenue from license fees for fiscal year 2003 and fiscal year 2002 was $0.4 million. Cost of Goods Sold Cost of goods sold in fiscal year 2003 of $4.1 million declined $0.2 million when compared to $4.3 million in fiscal year 2002. A reduction in cost of goods sold, which is directly related to lower sales in fiscal year 2003, was partially offset by a charge of $0.2 million for slow-moving inventory of the Lite Bites product line. Gross margin on product sales was 59.8% in fiscal year 2003, compared to 69.7% in fiscal year 2002. The decline was due primarily to product mix and charges to cost of goods sold for slow-moving inventory. Selling, General and Administrative Selling, general and administrative expense for fiscal year 2003 of $8.2 million increased $0.9 million when compared to $7.3 million for fiscal year 2002. Marketing and related expenditures increased $0.5 million while personnel and personnel-related costs associated with organizational expansion to support the Company's planned launch of new chromium based therapeutic products increased $0.4 million.. Research and Development Research costs of $2.2 million for fiscal year 2003 increased $1.2 million when compared to $1.0 million in fiscal year 2002. The increase is due primarily to studies related to the Company's anti-depressant technology ($1.0 million) as well as increased expenditures for its Diachrome studies ($0.2 million). The Company's therapeutic strategy for the past year includes a larger commitment to spending on research and development and is targeted at further validating earlier findings focused on disease specific conditions in the areas of diabetes and depression. The Company entered into an agreement with Diabetex, Inc., a diabetes disease management company, and is funding a large-scale trial in managed patient populations to evaluate Diachrome's effect as a nutritional adjunct to standard care for people with diabetes. The clinical trial is planned to complete by the close of fiscal year 2004. The Company also entered into an agreement with Comprehensive NeuroSciences, Inc., a contract research organization in the neurosciences field, to perform studies related to the Company's anti-depressant technology. The Company expects that the first phase of its study will be completed during fiscal year 2004. 18 The Company expects to launch these products under the Dietary Supplement Health and Education Act (DSHEA) regulatory pathway that is less costly and less time consuming than that required for drug development. These large-scale studies are being conducted to secure medical acceptance and adoption for the Company's products as standard treatment protocols. The Company's spending in these areas of new technology is discretionary and is subject to the availability of funds. There can be no assurances that the Company's disease specific product development efforts will be successfully completed or that the products will be successfully manufactured or marketed. Impairment of Intangibles In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." This statement supercedes FASB Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." The statement requires the Company to review its long-lived assets whenever events or changes in circumstances indicate that impairment might exist. During fiscal year 2003, the Company decided to discontinue investing in its Lite Bites product line. As a result of a review of current and forecasted operating cash flows and the profitability of this line, the Company determined that a $4.4 million non-cash impairment charge was warranted. The Company used a discounted cash flow analysis for purposes of estimating the fair value of its reporting unit. Income Taxes The effective tax rate for fiscal year 2003 was a benefit of 5% compared to 0% for fiscal year 2002. For fiscal year 2003, the benefit was recorded up to the extent of the Company's net operating loss carryback. The difference between the federal statutory rate of 34% and the actual rate is primarily due to changes in the deferred tax asset valuation allowance. Results of Operations 2. Year ended June 30, 2002 vs. Year ended June 30, 2001 Revenues Net sales of $14.3 million for fiscal year 2002 declined $6.5 million when compared to net sales of $20.8 million for fiscal year 2001. The decline is primarily due to softness in retail sales of vitamin and mineral supplements, industry consolidation, and a shortfall in sales of consumer products as a result of a short-term quality control issue at the Company's supplier of Lite Bites products. Other revenues for fiscal year 2002 of $0.4 million declined $2.0 million when compared to $2.4 million of other revenues for fiscal year 2001. Fiscal year 2001 included $1.9 million of license fees earned from Biosynexus Incorporated in accordance with a License Agreement entered into on August 2, 2000 and ImmuCell Corporation in accordance with a License Agreement entered into on April 12, 2000. 19 Cost of Goods Sold Cost of goods sold in fiscal year 2002 of $4.3 million declined $1.9 million when compared to $6.2 million in fiscal year 2001. The reduction in cost of goods is directly related to lower sales in fiscal year 2002. Gross margin on product sales of 69.7% in fiscal year 2002 declined 0.4% when compared to 70.1% in fiscal year 2001. The decline is due primarily to product mix, with lower margin consumer products accounting for a greater proportion of the Company's revenues. Selling, General and Administrative Selling, general and administrative expense for fiscal year 2002 of $7.3 million decreased $3.0 million when compared to $10.3 million for fiscal year 2001. The restructuring charge in the second quarter of fiscal year 2001 of $2.4 million did not recur in fiscal year 2002. In addition in fiscal year 2002, there were cost savings of approximately $0.6 million for reductions in advertising and consulting expenditures. Research and Development Research costs of $1.0 million for fiscal year 2002 decreased $0.9 million when compared to $1.9 million for fiscal year 2001. The decrease principally reflects cost savings attributable to the restructuring undertaken by the Company in the second quarter of fiscal 2001 and the Company's decision to terminate its Internet business at that time. Goodwill Impairment The Company adopted SFAS No. 142 effective July 1, 2001. Under SFAS No. 142, goodwill is no longer amortized but reviewed for impairment annually, or more frequently if certain indicators arise. The Company is required to complete the initial step of a transitional impairment test within six months of adoption of SFAS No. 142 and to complete the final step of the transitional impairment test by the end of the fiscal year. The initial step was completed in the first quarter of fiscal 2002. In addition, the Company assesses the impairment of identifiable intangible assets and goodwill whenever events or changes in circumstances indicate that the carrying value of the relevant assets may not be recoverable. Management's judgment regarding the existence of impairment is based on factors such as significant changes in the manner or the use of acquired assets or the Company's overall business strategy; significant negative industry or economic trends; significant declines in the Company's stock price for a sustained period and the Company's market capitalization relative to book value. Upon adoption, goodwill in the amount of $4.1 million included in patents and trademarks since acquisition (although accounted for separately by the Company and included therein because of its estimated economic life) has been reclassified in the accompanying balance sheets in accordance with the requirements of SFAS No. 142. Due to declining market conditions, as well as a change in business strategy, it was determined that a $7.1 million impairment charge was warranted. The Company used a discounted cash flow analysis for purposes of estimating the fair value of its reporting unit. Other Income Other income of $1.8 million in fiscal year 2002 and $2.3 million in fiscal year 2001, was due primarily to amounts earned on the settlement of patent infringement lawsuits. 20 Income taxes The effective tax rate for fiscal year 2002 was 0.0% compared to 24.0% in fiscal year 2001. The difference between the effective rate and the federal statutory rate of 34% is due primarily to changes in the deferred tax valuation allowance, non-deductible amortization and impairment charges. Nutritional Products 1. Year ended June 30, 2003 vs. Year ended June 30, 2002 Nutritional products revenues of $10.2 million for fiscal year 2003 declined $4.0 million when compared to $14.2 million in fiscal year 2002. The decline is primarily due to a softness in sales of Lite Bites nutrition bars and related dietary supplements sold through QVC, as noted above. Nutritional products operating loss for fiscal year 2003 was $11.3 million, including a $4.4 million non-cash charge for impairment of long-lived assets, compared to an operating loss of $8.0 million in fiscal year 2002, which included a $7.1 million non-cash charge for impairment of goodwill. 2. Year ended June 30, 2002 vs. Year ended June 30, 2001 Nutritional products revenues of $14.2 million for fiscal 2002 decreased $6.9 million, when compared to nutritional products revenues of $21.1 million for fiscal year 2001. The decrease in revenues is primarily due a royalty reduction associated with the expiration of the Company's chromium picolinate composition of matter patent in August of 2000, softness in retail sales of vitamin and mineral supplements, and continuing industry consolidation. Nutritional products operating loss for fiscal year 2002 was $8.0 million, which included a $7.1 million non-cash charge for impairment of goodwill, compared to $2.9 million in fiscal year 2001. Pharmaceutical Products 1. Year ended June 30, 2003 vs. Year ended June 30, 2002 Pharmaceutical products revenues for fiscal years 2003 and 2002 were $0.4 million. License fee income accounted for the revenue in both years. Pharmaceutical products operating income for fiscal years 2003 and 2002 was $0.3 million, respectively. 21 2. Year ended June 30, 2002 vs. Year ended June 30, 2001 Pharmaceutical products revenues for fiscal year 2002 of $0.4 million decreased $1.7 million when compared to $2.1 million for fiscal year 2001. License fees earned from users of the Company's patented technologies in fiscal year 2001 did not recur in fiscal 2002. Pharmaceutical products operating income of $0.2 million for fiscal year 2002 decreased $1.7 million when compared to $1.9 million in fiscal year 2001. The primary reason for the decline was no significant license fees were earned in fiscal year 2002. Liquidity and Capital Resources Cash and cash equivalents at June 30, 2003 of $4.1 million declined $0.9 million when compared to $5.0 million at June 30, 2002. As of June 30, 2003, the Company had a working capital surplus of $4.1 million, compared to a working capital surplus of $8.0 million as of June 30, 2002. Changes in working capital included a decline in trade receivables and other current assets of $1.1 million and $0.6 million, respectively, and an increase of $1.3 million in accounts payable and accrued expenses. Net cash used in operating activities for fiscal 2003 was $0.3 million compared to cash provided by operating activities of $4.5 million in fiscal year 2002. An increase in the net loss in fiscal year 2003 of $4.5 million when compared to fiscal 2002 was the primary reason for the change. Net cash provided by investing activities for fiscal year 2003 was $0.5 million compared to cash used in investing activities of $4.2 million in fiscal year 2002. Lower contingent payments of $2.6 million for acquisitions was the primary reason for the change. In addition, $1.0 million invested in short-term instruments in fiscal year 2002 matured in fiscal year 2003. Net cash used in financing activities was $58 thousand compared to $1.7 million in fiscal year 2002. Fiscal year 2002 debt repayments of $1.1 million did not recur in fiscal year 2003. In addition, $0.4 million of cash used for redemption of preferred stock in fiscal year 2002 did not recur in fiscal year 2003. The Company's primary source of financing is cash generated from continuing operations. The Company believes that cash on hand and cash generated from operations will provide sufficient liquidity to fund continuing operations for the next twelve months. Future increases in marketing and research and development expenses over the present levels and any acquisition activities will require additional funds. The Company intends to seek any necessary additional funding through arrangements with corporate collaborators, through public or private sales of its securities, including equity securities, or through bank financing arrangements. The Company does not currently have any specific arrangements for additional financing and there can be no assurance that additional funding will be available at all or on terms acceptable to the Company. Critical Accounting Policies and Estimates The preparation of the consolidated financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities and expenses. On an on-going basis, the Company evaluates its estimates, including those related to uncollectible accounts receivable, inventories, goodwill, intangibles and other long-lived assets. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. 22 The Company believes the following critical accounting policies affect its more significant judgments and estimates used in the preparation of its consolidated financial statements: o The Company maintains allowances for uncollectible accounts receivable for estimated losses resulting from the inability of its customers to make required payments. If the financial condition of the Company's customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. o The Company carries inventories at the lower of cost or estimated net realizable value. If actual market conditions are less favorable than those projected by management write-downs may be required. o Property, plant and equipment, patents, trademarks and other intangible assets owned by the Company are amortized, over their estimated useful lives. Useful lives are based on management's estimates over the period that such assets will generate revenue. Intangible assets with definite lives are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. Future adverse changes in market conditions or poor operating results of underlying capital investments or intangible assets could result in losses or an inability to recover the carrying value of such assets, thereby possibly requiring an impairment charge in the future. Significant Accounting Pronouncements In June 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 141 "Business Combinations", and No. 142 "Goodwill and other Intangible Assets", effective for fiscal years beginning after December 15, 2001. Under the new rules, goodwill is no longer amortized but is subject to annual impairment tests in accordance with the Statement No. 142. Other intangible assets will continue to be amortized over their useful lives. See Note 18 for further discussion on the impact of SFAS No. 142 on Nutrition 21's 2002 financial position and results of operations for the year ended June 30, 2002. In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." The FASB's new rules on asset impairment supersede SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of," and is effective for the Company's fiscal year beginning July 1, 2002. (See Note 9 for impairment discussion). 23 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market risk represents the risk of changes in value of a financial instrument, derivative or non-derivative, caused by fluctuations in interest rates, foreign exchange rates and equity prices. The Company has no financial instruments that give it exposure to foreign exchange rates or equity prices. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements are included herein commencing on page F-1. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE At a meeting held on July 29, 2003, the Audit Committee of the Board of Directors of the Company approved the engagement of J. H. Cohn LLP as its independent public accountants for the fiscal year ending June 30, 2003 to replace the firm of Ernst & Young LLP, who were dismissed as auditors of the Company effective July 31, 2003. The audit reports of Ernst & Young LLP on the consolidated financial statements of Nutrition 21, Inc. as of and for the years ended June 30, 2002 and 2001, did not contain an adverse opinion or a disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope, or accounting principles. There were no disagreements between the Company and Ernst & Young LLP on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure, which, if not resolved to Ernst & Young LLP's satisfaction, would have caused Ernst & Young LLP to make reference to the subject matter of such disagreements in connection with its report. ITEM 9A. CONTROLS AND PROCEDURES The Company maintains disclosure controls and procedures designed to ensure that information required to be disclosed in reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the specified time periods. As of the end of the period covered by this Annual Report on Form 10-K, the Company's Chief Executive Officer and Chief Financial Officer evaluated, with the participation of the Company's management, the effectiveness of the Company's disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)). Based on the evaluation, which disclosed no significant deficiencies or material weaknesses, the Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective. There were no significant changes in the Company's internal controls over financial reporting that occurred during the Company's most recent fiscal quarter that have materially affected or are reasonably likely to materially affect the Company's internal control over financial reporting. 24 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT OFFICERS AND DIRECTORS The officers and directors of the Company are as follows:
Year Joined Name and Age Company Position -------------------------------------------------------------------------------------------------------------- Gail Montgomery (50) 1999 President, Chief Executive Officer, and Director John H. Gutfreund (73) 2000 Chairman of the Board P. George Benson, PhD (57) 1998 Director Warren D. Cooper, MD (50) 2002 Director Audrey T. Cross, PhD (58) 1995 Director Paul Intlekofer (35) 2002 Chief Financial Officer and Senior Vice President, Corporate Development Marvin Moser, MD (79) 1997 Director Robert E. Pollack, PhD (63) 1995 Director Benjamin T. Sporn (65) 1986 Senior Vice President, General Counsel, and Secretary
Gail Montgomery has been President, Chief Executive Officer and a Director of the Company since September 29, 2000, when she succeeded Fredrick D. Price. From July 1999 to September 2000, she served the Company's Nutrition 21 subsidiary in various capacities, most recently as Vice President and General Manager. From November 1998 to July 1999, Ms. Montgomery was President of Health Advantage Consulting, a consulting firm, which provided strategic planning, new product introduction, and market development services to the nutrition industry. From 1992 to 1998 she worked for Diet Workshop, a diet franchise network, most recently as President and CEO. From 1979 to 1992, Ms. Montgomery has served in various capacities in the health and fitness sector. She received a BA from Douglas College of Rutgers University in communications. 25 P. George Benson, PhD, was elected a Director of the Company in July 1998. Dr. Benson is Dean of the Terry College of Business and holds the Simon S. Selig, Jr. Chair for Economic Growth at the University of Georgia. Dr. Benson was previously the Dean of the Faculty of Management at Rutgers University and a professor of decision sciences at the Carlson School of Management of the University of Minnesota. In 1997, he was appointed by the U.S. Secretary of Commerce to a three-year term as one of the nine judges for the Malcolm Baldrige National Quality Award. In 1996, Business News New Jersey named Dr. Benson one of New Jersey's "Top 100 Business People". He received a BS from Bucknell University and a PhD in business from the University of Florida. Warren D. Cooper, MD was elected a Director of the Company in April 2002. Dr. Cooper is president and founder of Coalesence, Inc., a consultancy focused on business and product development for the pharmaceutical and healthcare industries. From 1995 to 1999, Dr. Cooper was the business unit leader of Cardiovascular Business Operations at AstraZeneca Pharmaceuticals LP. For three years before that he was executive director of the Medical Affairs & Drug Development Operations in the Astra/Merck Group of Merck & Co. Over a five-year period from 1987 to 1992, Dr. Cooper served as executive director for Worldwide Clinical Research Operations and as senior director for Clinical Research Operations (Europe) at Merck Research Laboratories. He was with Merck, Sharp & Dohme, U.K., from 1980 to 1987, first as a clinical research physician and later as director of medical affairs. Dr. Cooper is a member of the Medical Advisory Board of Zargis Medical Corp. (a Siemens joint venture). He also holds memberships in the American Association of Pharmaceutical Physicians, the American Society of Hypertension and the International Society of Hypertension. He received a B. Sc. in physiology and an M.B. B.S. (U.K. equivalent to U.S. MD) form The London Hospital Medical College, University of London. Audrey T. Cross, PhD, was elected a Director of the Company in January 1995. Dr. Cross has been Associate Clinical Professor at the Institute of Human Nutrition at the School of Public Health of Columbia University since 1988. She also works as a consultant in the areas of nutrition and health policy. She has served as a special assistant to the United States Secretary of Agriculture as Coordinator for Human Nutrition Policy and has worked with both the United States Senate and the California State Senate on nutrition policy matters. Dr. Cross received a BS in dietetics, a Master of Public Health in nutrition and a PhD from the University of California at Berkeley, and a JD from the Hastings College of Law at the University of California at San Francisco. John H. Gutfreund was elected a Director of the Company in February 2000 and Chairman of the Board in September 2001. Mr. Gutfreund is Senior Managing Director and Executive Committee Member of C. E. Unterberg, Towbin, investment bankers, and President of Gutfreund & Company, Inc., a New York-based financial consulting firm that specializes in advising select corporations and financial institutions in the United States, Europe and Asia. He is the former chairman and chief executive officer of Salomon Inc., and past vice chairman of the New York Stock Exchange and a past board member of the Securities Industry Association. Mr. Gutfreund is active in the management of various civic, charitable, and philanthropic organizations, including the New York Public Library, Montefiore Medical Center, The Brookings Institution, Council on Foreign Relations, Honorary Trustee, Oberlin (Ohio) College, and Chairman of the Aperture Foundation. Mr. Gutfreund is also a director of AccuWeather, Inc., Ascent Assurance, Inc., Evercel Inc., LCA-Vision, Inc., Maxicare Health Plans, Inc., The LongChamp Core Plus Fund Ltd., and The Universal Bond Fund. He received a BA from Oberlin College. 26 Paul Intlekofer was elected Chief Financial Officer and Senior Vice President, Corporate Development, on January 17, 2003. From June 2002 to January 2003, he served the Company in varying capacities. From September 2001 to June 2002, Mr. Intlekofer was Senior Vice President of Planit, Inc., which provided strategic planning, capital formation, M&A, marketing and new product development services to the healthcare and financial industries. From 1998 to 2001 he was Senior Vice President of Corporate Development for Rdental LLC, the exclusive technology alliance of the American Dental Association and oral health content provider of WebMD. From 1995 to 1997 he was Director of Strategic Operations/Business Development for Doctors Health, a practice management and health insurance company. Early in his career, he practiced corporate and securities law for Venable, Baetjer & Howard. Mr. Intlekofer received his MBA and Juris Doctor from the University of Maryland and BA from the Johns Hopkins University. Marvin Moser, MD was elected to the Board of Directors in October 1997. He is clinical professor of medicine at Yale and senior medical consultant at the National High Blood Pressure Education Program of the National Heart, Lung and Blood Institute. Dr. Moser's work has focused on various approaches to the prevention and treatment of hypertension and heart disease. He has published extensively on this subject with over 400 publications. He has authored or contributed to more than 30 books and numerous physician and patient education programs. He is editor-in chief of the Journal of Clinical Hypertension. Dr. Moser is also a member of the Board of The Third Avenue Value Funds and the Trudeau Institute. Dr. Moser holds a BA from Cornell University and an MD from Downstate University College of Medicine. Robert E. Pollack, PhD, was elected a Director of the Company in January 1995. Dr. Pollack has been a Professor of Biological Sciences at Columbia University since 1978. In addition, from 1982 to 1989 he was Dean of Columbia College. Prior thereto he was Professor of Microbiology at the State University of New York School of Medicine at Stony Brook, Senior Scientist at Cold Spring Harbor Laboratory, Special NIH fellow at the Weizmann Institute in Israel, and NIH Fellow in the Department of Pathology at New York University School of Medicine. He is the author of more than one hundred research papers on the molecular biology of viral oncogenesis, a dozen articles in the popular press, and three books. He received a BA in physics from Columbia University and a PhD in biology from Brandeis University. Benjamin T. Sporn has been legal counsel to the Company since 1990 and has served as Secretary of the Company since 1986, and was appointed Senior Vice President and General Counsel in February 1998. He was an attorney with AT&T from 1964 until December 1989 when he retired from AT&T as a General Attorney for Intellectual Property Matters. Mr. Sporn was a director of the Company from 1986 until 1994. He received a BSE degree from Rensselaer Polytechnic Institute and a JD degree from American University. 27 The Directors serve for a term of one year and until their successors are duly elected and qualified. Officers serve at the discretion of the Board of Directors, subject to the provisions of the employment agreements described below. Except for Mr. Paul Intlekofer, who is first cousin to Ms. Gail Montgomery, there are no family relationships among directors or executive officers. Arrangements Regarding the Election of Directors So long as Burns Philp & Company Limited (an owner of 22.89% of the Company's outstanding common shares) owns at least 20% of the Company's outstanding common stock, BP is entitled to nominate one member for election to the Company's Board. Currently, BP has not nominated a member for election to the Company's Board. See Item 13. Certain Relationships and Related Transactions. Committees of the Board of Directors The Company has an audit committee consisting of Dr. Benson, Dr. Cooper, and Mr. Gutfreund. In addition, the Company has a compensation committee consisting of Dr. Cross, Mr. Gutfreund, and Dr. Pollack. During the year ended June 30, 2003, the audit committee met four times, and the compensation committee met one time. ITEM 11. EXECUTIVE COMPENSATION The following table sets forth the compensation paid or accrued by the Company during the periods indicated for (i) the chief executive officer during fiscal year 2003 and (ii) certain other persons that served as executive officers in fiscal year 2003 whose total annual salary and bonus was in excess of $100,000. 28
SUMMARY COMPENSATION TABLE (1)(2) =================================================== =============================================== ============================= LONG-TERM ALL OTHER NAME AND PRINCIPAL POSITION ANNUAL COMPENSATION COMPENSATION COMPENSATION ----------------------------------------------- ----------------------------- PERIOD SALARY BONUS SECURITIES ($) ($) ($) UNDERLYING OPTIONS/SARS (#) --------------------------------------------------- ----------------------------------------------- ----------------------------- Gail Montgomery, President, Chief Executive Officer and Director 7/1/00 - 6/30/01 257,307 275,000 200,000 ------------------------------------------------------------------------------- 7/1/01 - 6/30/02 275,000 500,000 ------------------------------------------------------------------------------- 7/1/02 - 6/30/03 275,000 1,175,000 --------------------------------------------------- ------------------------------------------------------------------------------- Paul Intlekofer, Chief Financial Officer and Senior Vice President, Corporate Development 7/1/02 - 6/30/03 190,731 1,050,000 37,500 (3) --------------------------------------------------- ------------------------------------------------------------------------------- Alan J. Kirschbaum, Vice President, Finance and Treasury 7/1/00 - 6/30/01 150,000 30,000 75,000 ------------------------------------------------------------------------------- 7/1/01 - 6/30/02 150,000 ------------------------------------------------------------------------------- 7/1/02 - 6/30/03 150,000 30,000 --------------------------------------------------- ------------------------------------------------------------------------------- Benjamin T. Sporn, Senior Vice President, General Counsel and Secretary 7/1/00 - 6/30/01 207,500 66,688 165,000 ------------------------------------------------------------------------------- 7/1/01 - 6/30/02 207,500 ------------------------------------------------------------------------------- 7/1/02 - 6/30/03 207,500 225,000 --------------------------------------------------- ------------------------------------------------------------------------------- Andrew Wertheim, Chief Operating Officer (4) 7/1/02 - 6/30/03 162,211 675,000 =================================================== ===============================================================================
(1) The above compensation does not include the use of an automobile and other personal benefits, the total value of which do not exceed as to any named officer or director, the lesser of $50,000 or 10% of such person's annual salary and bonus. (2) Pursuant to the regulations promulgated by the Securities and Exchange Commission (the "Commission"), the table omits a number of columns reserved for types of compensation not applicable to the Company. (3) Fees earned in a consulting capacity during fiscal year 2003. (4) Employment terminated February 14, 2003. None of the individuals listed above received any long-term incentive plan awards during the fiscal year. EMPLOYMENT AND CONSULTING AGREEMENTS The Company has entered into a three-year employment agreement with Gail Montgomery as President and Chief Executive Officer, effective as of September 1, 2002. The agreement provides for an annual salary of $275,000, $300,000, and $325,000 in the successive years under the agreement, and for performance bonuses based on achieving defined revenue targets. Ms. Montgomery is also entitled to additional payments equal to one year's salary plus an additional month of salary for defined years of service, if her employment is terminated without cause before the agreement expires, or if the Company fails to offer to enter into a new one-year agreement upon expiration. If Ms. Montgomery's employment is terminated or she resigns within six months after a change of control (as defined) the Company will pay to her 2.99 times her annual salary and previous year's bonus plus certain gross-ups, but these payments will be reduced to the extent necessary to prevent the application of Section 280G of the Internal Revenue Code. 29 Effective as of September 16, 2002 the Company entered into a three-year employment agreement with Paul Intlekofer, who has served as Chief Financial Officer and Senior Vice President, Corporate Development since January 17, 2003. The agreement provides for an annual salary of $200,000, $225,000, and $250,000 in the successive years under the agreement, and for performance bonuses based on achieving defined revenue targets. Mr. Intlekofer is also entitled to additional payments equal to one year's salary, if his employment is terminated without cause before the agreement expires. If Mr. Intlekofer's employment is terminated or he resigns within six months after a change of control (as defined) the Company will pay to him 2.99 times his annual salary and previous year's bonus plus certain gross-ups, but these payments will be reduced to the extent necessary to prevent the application of Section 280G of the Internal Revenue Code. The Company entered into a four-year agreement with Benjamin Sporn effective, September 1, 2002, which provides for his services as Senior Vice President, General Counsel, and Secretary as an employee during the first two years of the term, and as General Counsel as a consultant during the balance of the term. Mr. Sporn's salary and fees will be $207,500, $225,000, $150,000 and $100,000 in successive years under the agreement, plus performance bonuses based on achieving defined revenue targets. Mr. Sporn is also entitled to additional payments equal to two years' salary if his employment is terminated without cause before the agreement expires. If Mr. Sporn's employment is terminated or he resigns within six months after a change of control (as defined) the Company will pay to him 2.99 times his annual salary and previous year's bonus plus certain gross-ups, but these payments will be reduced to the extent necessary to prevent the application of Section 280G of the Internal Revenue Code. The following tables set forth information with regard to options granted during the fiscal year (i) to the Company's Chief Executive Officer, and (ii) to other officers of the Company named in the Summary Compensation Table. 30
OPTION/SAR GRANTS IN LAST FISCAL YEAR (1) ------------------------------------------------------------------------------------------------ ---------------------------------- Potential Realizable Value At Individual Grants Assumed Annual Rates Of Stock Price Appreciation For Option Term ------------------------------------------------------------------------------------------------ ---------------------------------- Number Of Securities Percent Of Total Underlying Options/SARs Exercise Of Options/SARs Granted To Employees Base Price Name Granted (#) In Fiscal Year ($/Sh) Expiration Date 5% ($) 10% ($) ------------------------------------------------------------------------------- ----------------- ---------------------------------- A. Paul Intlekofer 550,000 30.3% $0.40 9/16/12 $138,537 $350,623 500,000 $0.31 10/18/12 $ 97,749 $247,030 ------------------------------------------------------------------------------- ----------------- ---------------------------------- B. Alan J. Kirschbaum 30,000 0.89% $0.38 5/22/13 $7,169 $ 18,169 ------------------------------------------------------------------------------- ----------------- ---------------------------------- C. Gail Montgomery 850,000 24.5% $0.39 7/31/12 $208,478 $528,326 325,000 SAR's 100% $ 79,712 $202,007 ------------------------------------------------------------------------------- ----------------- ---------------------------------- D. Benjamin T. Sporn 225,000 6.5% $0.39 7/31/12 $ 55,186 $139,850 ------------------------------------------------------------------------------- ----------------- ---------------------------------- E. Andrew Wertheim 675,000 19.5% $0.36 (2) $152,281 $387,279 ------------------------------------------------------------------------------- ----------------- ----------------------------------
(1) Consists of stock options except for 325,000 SARs shown for Gail Montgomery. (2) Expired by reason of termination of employment on February 14, 2003. 31 AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES
------------------------------------------------------------------------------------------------------------------------------------ INDIVIDUAL GRANTS ------------------------------------------------------------------------------------------------------------------------------------ NAME SHARES ACQUIRED VALUE NUMBER OF UNEXERCISED VALUE OF UNEXERCISED IN-THE-MONEY IN EXERCISE (#) REALIZED ($) OPTIONS/SARS AT FY-END (#) OPTIONS/SARS AT FY-END --------------------------------------------------------------------- Exercisable Unexercisable Exercisable Unexercisable ------------------------ ----------------- ------------------- --------------------------------------------------------------------- Paul 0 0 60,000 1,000,000 $2,500 $95,000 Intlekofer ------------------------ ----------------- ------------------- --------------------------------------------------------------------- Alan J. 0 0 79,000 101,000 $0 $4,200 Kirschbaum ------------------------ ----------------- ------------------- --------------------------------------------------------------------- Gail 0 0 435,000 1,465,000 $0 $87,900 Montgomery ------------------------ ----------------- ------------------- --------------------------------------------------------------------- Benjamin T. Sporn 0 0 188,500 284,000 $0 $13,500 ------------------------ ----------------- ------------------- --------------------------------------------------------------------- Andrew Wertheim (1) 0 0 0 0 0 0 ------------------------ ----------------- ------------------- ---------------------------------------------------------------------
(1) Stock Options expired by reason of termination of employment. PENSION PLANS Nutrition 21, Inc. Eligible employees of the Company are entitled to participate in the Burns Philp Inc. Retirement Plan for Non-Bargaining Unit Employees, a non-contributory pension plan (the "Pension Plan") maintained by Burns Philp as long as Burns Philp maintains the Pension Plan and owns at least 20% of the Company's outstanding Common Stock. At June 30, 2003, Burns Philp held approximately 24% of the Company's outstanding Common Stock. Assuming retirement at age 65, the Pension Plan provides benefits equal to the greater of (a) 1.1% of the employee's final average earnings multiplied by the number of years of credited service plus 0.65% of the employee's final average earnings in excess of the average of the contribution and the benefit bases in effect under Section 230 of the Social Security Act for each year in the 35-year period ending with the year in which the employee attains the Social Security retirement age as calculated under Section 401(l)(5)(E) of the Code and Table I of IRS Notice 89-70, multiplied by the employee's years of credited service up to 35, minus any predecessor plan benefit in the case of an employee who participated in a predecessor plan or (b) $24 multiplied by the number of years of credited service up to 25 years plus $12 multiplied by the years of employment from 26-40 years, minus any predecessor plan benefit in the case of an employee who participated in a predecessor plan. The "final average earnings" are the average earnings during the five highest-paid consecutive calendar years within the last ten calendar years of credited service with the Company. Earnings include the salary and bonus listed in the summary compensation table. Earnings, which may be considered under the Pension Plan, are limited to $200,000 per year subject to annual cost of living adjustments as determined by the IRS. 32 The following table sets forth estimated annual benefits payable upon retirement, assuming retirement at age 65 in 2003 and a single life annuity benefit, according to years of credited service and final average earnings. The benefits listed are not subject to any deduction for Social Security or other offset amounts.
YEARS OF CREDITED SERVICE Final average Earnings 15 20 25 30 35 ----------------------------------------------------------------------------------------------- $ 25,000 $ 4,320 $ 5,760 $ 7,200 $ 8,160 $ 9,600 $ 50,000 $ 8,760 $ 11,760 $ 14,640 $ 17,640 $ 20,520 $ 75,000 $ 15,360 $ 20,520 $ 25,960 $ 30,720 $ 35,080 $100,000 $ 21,960 $ 29,280 $ 36,600 $ 43,920 $ 51,240 $150,000 $ 35,040 $ 46,680 $ 58,440 $ 70,080 $ 81,840 $200,000 $ 48,120 $ 64,200 $ 80,280 $ 96,360 $112,440 and up
Paul Intlekofer, Alan J. Kirschbaum, Gail Montgomery, and Benjamin T. Sporn each have 0.8, 4.5, 3.9, and 11 years, respectively, of credited service under the Pension Plan as of June 30, 2003, and, at age 65, would have approximately 30, 11, 19, and 11 years of credited service, respectively. CERTAIN OTHER INFORMATION In 2002, the Board of Directors adopted a 2002 Inducement Stock Option Plan under which the Company can issue options to purchase up to 2,500,000 common shares to induce individuals to become employed by the Company. 33 DIRECTOR COMPENSATION Non-management Directors each receive a quarterly director's fee of $1,800 and the Chairman of the Board receives a quarterly director's fee of $3,600. Each also receives $500 for each meeting of the Board attended in person, $250 for each meeting of the Board attended telephonically, and each receives options to acquire 15,000 shares of Common Stock. Such options granted to Directors during the fiscal year ended June 30, 2003, were granted at an exercise price of $0.60. COMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT OF 1934 Section 16(a) of the Securities Exchange Act of 1934 requires the Company's officers and directors, and persons who own more than ten percent of a registered class of the Company's equity securities, to file reports of ownership and changes in ownership with the Securities and Exchange Commission. Officers, directors and greater than ten-percent shareholders are required by SEC regulation to furnish the Company with copies of all Section 16(a) forms they file. Based solely on review of the copies of such forms furnished to the Company, or written representations that no Forms 5 were required, the Company believes that during the period from July 1, 2002 through June 30, 2003, all Section 16(a) filing requirements applicable to its officers, directors and greater than ten-percent beneficial owners were complied with. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION The Board of Directors determines executive compensation taking into consideration recommendations of the Compensation Committee. No member of the Company's Board of directors is an executive officer of a company whose compensation committee or board of directors includes an executive officer of the Company. 34 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth, as of September 19, 2003, information regarding the beneficial ownership of the Company's Common Stock based upon the most recent information available to the Company for (i) each person known by the Company to own beneficially more than five (5%) percent of the Company's outstanding Common Stock, (ii) each of the Company's executive officers and directors and (iii) all executive officers and directors of the Company as a group. Unless otherwise indicated, each stockholder's address is c/o the Company, 4 Manhattanville Road, Purchase, New York 10577-2197.
SHARES OWNED BENEFICIALLY AND OF RECORD (1) NAME AND ADDRESS NO. OF SHARES % OF TOTAL P. George Benson (2) 85,000 * Warren D. Cooper (3) 25,000 * Audrey T. Cross (4) 109,000 * John H. Gutfreund (5) 105,000 * Paul Intlekofer (6) 295,383 * Alan J. Kirschbaum (3) 100,500 * Gail Montgomery (7) 834,933 2.41 Marvin Moser (8) 170,000 * Robert E. Pollack (3) 115,000 * Benjamin T. Sporn (9) 350,125 1.00 Andrew Wertheim 0 * Wyeth (10) 3,478,261 10.24 5 Giralda Farms Madison, NJ 07940 Burns Philp & Company Limited (11) 7,763,837 22.87 7 Bridge Street Sydney, NSW 2000, Australia All Executive Officers and Directors 1,293,959 6.10 as a Group (9 persons) (12)
35 * Less than 1% (1) Unless otherwise indicated, each person has sole investment and voting power with respect to the shares indicated. For purposes of this table, a person or group or group of persons is deemed to have "beneficial ownership" of any shares as of a given date, which such person has the right to acquire within 60 days after such date. For purposes of computing the percentage of outstanding shares held by each person or group of persons named above on a given date, any security which such person or group of persons has the right to acquire within 60 days after such date is deemed to be outstanding for the purposes of computing the percentage ownership of such person or persons, but is not deemed to be outstanding for the purpose of computing the percentage ownership of any other person. (2) Includes 75,000 shares issuable upon exercise of currently exercisable options under the Company's Stock Option Plans. (3) Consists of shares issuable upon exercise of currently exercisable options under the Company's Stock Option Plans. (4) Includes 105,000 shares issuable upon exercise of currently exercisable options under the Company's Stock Option Plans. (5) Includes 55,000 shares issuable upon exercise of currently exercisable options under the Company's Stock Option Plans. (6) Includes 283,333 shares issuable upon exercise of currently exercisable options under the Company's Stock Option Plans. (7) Includes 745,833 shares issuable upon exercise of currently exercisable options under the Company's Stock Option Plans. (8) Includes 160,000 shares issuable upon exercise of currently exercisable options under the Company's Stock Option Plans. (9) Includes 316,000 shares issuable upon exercise of currently exercisable options under the Company's Stock Option Plans. (10) Formerly American Home Products Corporation. (11) Consists of shares owned by subsidiaries. (12) Includes 1,740,166 shares issuable upon exercise of currently exercisable options under the Company's Stock Option Plans. 36 EQUITY COMPENSATION PLAN INFORMATION The following table sets forth securities authorized for issuance under equity compensation plans as of June 30, 2003.
EQUITY COMPENSATION PLAN INFORMATION ------------------------------- ----------------------------------------------------------- -------------------------------------- PLAN CATEGORY NUMBER OF SECURITIES WEIGHTED-AVERAGE NUMBER OF SECURITIES REMAINING TO BE ISSUED UPON EXERCISE PRICE OF AVAILABLE FOR FUTURE ISSUANCE EXERCISE OF OUTSTANDING OUTSTANDING OPTIONS, UNDER EQUITY COMPENSATION PLANS OPTIONS, WARRANTS AND RIGHTS WARRANTS AND RIGHTS (EXCLUDING SECURITIES REFLECTED IN COLUMN (A)) (A) (B) (C) ------------------------------- -------------------------------------------------------------------------------------------------- Equity compensation plans approved by security holders 4,931,002 $1.34 258,500 ------------------------------- -------------------------------------------------------------------------------------------------- Equity compensation plans not approved by security holders (1) 1,583,000 $0.38 3,417,000 (2) 0 (3) 845,000 $2.33 ------------------------------- -------------------------------------------------------------------------------------------------- Total 7,359,002 3,675,500 ------------------------------- --------------------------------------------------------------------------------------------------
(1) 2001 Stock Option Plan to provide non-executives, who render services to the Company additional incentives to advance the interests of the Company. Neither directors nor executive officers of the Company may be granted Stock Options under the Plan (Exhibit 10.70). (2) 2002 Inducement Stock Option Plan to inducement an individual to be come an employee of the Company, and provide additional incentives to advance the interests of the Company. Neither directors nor executive officers of the Company may be granted Stock Options under the Plan (Exhibit 10.71). (3) Warrants granted from time to time as an inducement to various persons or entities to enter into transactions with the Company. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS On December 12, 1996, the Company completed the sale of its UK-based food ingredients subsidiary, Aplin & Barrett Limited ("A&B"), to Burns Philp & Company Limited ("BP") for $13.5 million in cash and the return to the Company of 2.42 million shares of the Company's Common Stock held by BP. The sale included the Company's nisin-based food preservative business. In connection with the transaction, the Company and A&B entered into two License Agreements. Pursuant to the first License Agreement, the Company is exclusively licensed by A&B for the use of nisin generally in pharmaceutical products and animal healthcare products. Pursuant to the second License Agreement, A&B is exclusively licensed by the Company generally for the use of nisin as a food preservative and for food preservation. As long as BP owns at least 20% of the Company's outstanding common stock, BP is entitled to nominate one member for election to the Company's Board. BP has not nominated a member for election to the Company's Board. The amount of consideration for the sale was arrived at through arms-length negotiation and a fairness opinion was obtained. As of June 30, 2002, BP owned 7,763,837 shares of Common Stock, and continues such Common Stock ownership as of the date hereof. 37 In October 1998, the Company issued 3,478,261 shares of Common Stock to Wyeth for $4.0 million. At June 30, 2003, Wyeth held approximately 10.75% of the Company's outstanding Common Stock. Under a separate agreement in October 1998, Wyeth paid the Company $1.0 million for exclusive rights to sell the Company's Cardia Salt in retail markets in the United States. During fiscal 2001, Wyeth made payments to the Company of $500,000. On July 1, 2000, the Company licensed its remaining rights to sell lysostaphin for research purposes, to Benjamin T. Sporn, its senior vice president, for $300,000, payable in cash over a three-year period. Payment of the $300,000 has been made. The price and other terms of the transaction were established through arms-length negotiations. ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES 1. Information Concerning Fees Paid to Independent Auditors for the fiscal year ended June 30, 2003. Set forth below is certain information concerning audit services rendered to the Company by J.H. Cohn LLP and Ernst & Young LLP for the fiscal year ended June 30, 2003. As indicated below, in addition to reviewing financial statements, J.H. Cohn LLP and Ernst & Young LLP provided other services in the fiscal year ended June 30, 2003. The Audit Committee has determined that the provision of these other services is compatible with maintaining the independence of both firms. Audit Fees. Ernst & Young LLP billed the Company for aggregate fees of approximately $85,370 for (1) audit services for the fiscal year ended June 30, 2003, up to their dismissal on July 31, 2003, and (2) the reviews of the financial statements included in the Company's quarterly reports on Form 10-Q for periods within the fiscal year ended June 30, 2003. In addition, the Company incurred fees by J.H. Cohn LLP of approximately $60,000 for audit services rendered for the fiscal year ended June 30, 2003. Audit related fees. None Tax Fees. Ernst & Young LLP billed the Company for aggregate fees of approximately $25,975 for other services rendered in the fiscal year ended June 30, 2003, consisting primarily of tax compliance fees. In addition, the Company incurred fees by J.H. Cohn LLP of approximately $10,000 for other services rendered for the fiscal year ended June 30, 2003, consisting primarily of tax compliance fees. All other fees. None 2. Information Concerning Fees Paid to the Company's Auditors for the fiscal year ended June 30, 2002. 38 Set forth below is certain information concerning fees billed to the Company by Ernst & Young LLP in respect of services provided in the fiscal year ended June 30, 2002. As indicated below, in addition to auditing and reviewing financial statements, Ernst & Young LLP provided other services in the fiscal year ended June 30, 2002. The Audit Committee has determined that the provision of these other services is compatible with maintaining the independence of Ernst & Young LLP. Audit Fees. Ernst & Young LLP billed the Company for aggregate fees of approximately $214,000 for (1) professional services rendered for the audit of the Company's annual financial statements for the fiscal year ended June 30, 2002 and (2) the reviews of the financial statements included in the Company's quarterly reports on Form 10-Q for periods within the fiscal year ended June 30, 2002. Audit related fees. None Tax Fees. Ernst & Young LLP billed the Company for aggregate fees of approximately $39,191 for other services rendered in the fiscal year ended June 30, 2002 consisting primarily of tax compliance fees. All other fees. None 39 PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) 1. Financial Statements The financial statements are listed in the Index to Consolidated Financial Statements on page F-1 and are filed as part of this annual report. 2. Financial Statement Schedules The following financial statement schedule is included herein: Schedule II - Valuation and Qualifying Accounts All other schedules are not submitted because they are not applicable, not required, or because the information is included in the Consolidated Financial Statements. 3. Exhibits The Index to Exhibits following the Signature Page indicates the Exhibits, which are being filed herewith, and the Exhibits, which are incorporated herein by reference. (b) Reports on Form 8-K The Company filed one Report on Form 8-K during the fiscal quarter ended June 30, 2003. 1. Report dated May 16, 2003 furnishing a copy of a press release of financial results for the fiscal quarter ended March 31, 2003. 40 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. NUTRITION 21, INC. By: /s/ Gail Montgomery Gail Montgomery, President, CEO and Director Dated: January 27, 2004 Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below as of January 27, 2004 by the following persons on behalf of Registrant and in the capacities indicated. /s/ Gail Montgomery Gail Montgomery, President, CEO and Director /s/ John H. Gutfreund John H. Gutfreund, Chairman of the Board /s/ P. George Benson P. George Benson, Director /s/ Warren D. Cooper Warren D. Cooper Director /s/ Audrey T Cross Audrey T. Cross, Director /s/ Marvin Moser Marvin Moser, Director /s/ Robert E. Pollack Robert E. Pollack, Director /s/ Paul Intlekofer Paul Intlekofer, Chief Financial Officer 41 EXHIBITS
3.01 Certificate of Incorporation (1) 3.01a Certificate of Amendment to the Certificate of Incorporation (2) 3.01b Certificate of Amendment to the Certificate of Incorporation (3) 3.01c Certificate of Amendment to the Certificate of Incorporation (11) 3.01d Certificate of Amendment to the Certificate of Incorporation (11) 3.01e Certificate of Amendment to the Certificate of Incorporation (12) 3.02 Amended and Restated By-laws (2) 10.01 Form of Incentive Stock Option Plan (8) 10.02 Form of Non-qualified Stock Option Plan (8) 10.02a Form of 1989 Stock Option Plan (1) 10.02b Form of 1991 Stock Option Plan (1) 10.02c Form of 1998 Stock Option Plan (15) 10.24 Exclusive Option and Collaborative Research Agreement dated July 1, 1988 between the Company and the University of Maryland (4) 10.25 License and License Option Agreement dated December 15, 1988 between the Company and Babson Brothers Company (4) 10.36 Agreement, dated October 6, 1992 between the Company and PHRI (5) 10.47 Employment Agreement dated August 30, 1994 between the Company and Fredric D. Price, as amended and restated (6) 10.48 Lease dated as of February 7, 1995, between the Company and Keren Limited Partnership (7) 10.49 Share Purchase Agreement dated as of December 12, 1996, by and among Applied Microbiology, Inc., Aplin & Barrett Limited and Burns Philp (UK) plc. (9) 10.50 License Agreement dated as of December 12, 1996 between Licensee Applied Microbiology, Inc. and Licensor Aplin & Barrett Limited. (9) 10.51 License Agreement dated as of December 12, 1996 between Licensee Aplin & Barrett Limited and Licensor Applied Microbiology, Inc. (9) 10.52 Supply Agreement dated as of December 12, 1996 between Aplin & Barrett Limited and Applied Microbiology, Inc. (9)
42
10.53 Investors' Rights Agreement dated as of December 12, 1996 between Applied Microbiology, Inc. and Burns Philp Microbiology. Pty Limited. (9) 10.54 Revolving Loan and Security Agreement dated as of December 12, 1996 between Burns Philp Inc. as Lender and Applied Microbiology, Inc. as Borrower. (9) 10.55 Stock and Partnership Interest Purchase Agreement dated as of August 11, 1997, for the purchase of Nutrition 21. (10) 10.57 Sublease dated as of September 18, 1998, between the Company and Abitibi Consolidated Sales Corporation (12) 10.58 Stock Purchase Agreement dated as of September 17, 1998 between American Home Products Corporation and AMBI Inc. (13)* 10.59 License, Option, and Marketing Agreement dated as of September 17, 1998 between American Home Products, acting through its Whitehall-Robins Healthcare division, and AMBI Inc. (13)* 10.60 Amended and Restated Revolving Credit and Term Loan Agreement dated as of January 21, 1999 between State Street Bank & Trust Company as Lender and the Company and Nutrition 21 as Borrower. (14) 10.61 Agreement of Purchase and Sale of Assets made as of January 19, 1999 by and among Dean Radetsky and Cheryl Radetsky, Optimum Lifestyle, Inc. and AMBI Inc. (14) 10.62 Strategic Alliance Agreement dated as of August 13, 1999 between AMBI Inc. and QVC, Inc. (15)* 10.63 Asset Purchase Agreement made as of December 30, 1999, by and between ImmuCell Corporation and AMBI Inc. (16) 10.64 License Agreement entered into as of August 2, 2000 between AMBI Inc. and Biosynexus Incorporated. (17)* 10.65 License and Sublicense Agreement entered into as of August 2, 2000 between AMBI Inc. and Biosynexus Incorporated. (17)* 10.66 Amendment effective as of June 30, 2000, to the Amended and Restated Revolving Credit and Term Loan Agreement dated as of January 21, 1999 between Citizens Bank of Massachusetts (successor in interest to loans originally made by State Street Bank & Trust Company) as Lender and the Company and Nutrition 21 as Borrower. (17) 10.67 Employment Agreement dated as of October 16, 2000 between AMBI Inc. and Gail Montgomery. (18) 10.68 Consulting Agreement entered into as of September 29, 2000 between AMBI Inc. and Fredrick D. Price. (19)
43
10.69 Amended and Restated By-laws, and Rights Agreement adopted September 12, 2002 (20) 10.70 Nutrition 21, Inc. 2001 Stock Option Plan. (21) 10.71 Nutrition 21, Inc. 2002 Inducement Stock Option Plan. (21) 10.72 Nutrition 21, Inc. Change of Control Policy adopted September 12, 2002. (21) 10.73 Employment Agreement entered into as of September 1, 2002 between Nutrition 21, Inc. and Gail Montgomery. (21) 10.74 Employment Agreement entered into as of August 5, 2002 between Nutrition 21, Inc. and Andrew Wertheim. (21) 10.75 Employment Agreement entered into as of September 1, 2002 between Nutrition 21, Inc. and Benjamin Sporn (21) 10.76 Employment Agreement entered into as of September 16, 2002 between Nutrition 21, Inc. and Paul Intlekofer (22) 23.1 Consent of J.H. Cohn LLP (22) 23.2 Consent of Ernst & Young LLP (22) 31.1 Certification of President and Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (22) 31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (22) 32.1 Certification of President and Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (22)
-------------------- (1) Incorporated by reference to the Company's Report on Form 10-K for 1991. (2) Incorporated by reference to the Company's Report on Form 8-K dated September 4, 1992. (3) Incorporated by reference to the Company's Registration Statement on Form S-8 dated August 8, 1996, file No. 333-09801. (4) Incorporated by reference to the Company's Report on Form 10-K for 1988. (5) Incorporated by reference to the Company's Report on Form 10-K for the fiscal period January 31, 1992 through August 31, 1992. (6) Incorporated by reference to the Company's Report on Form 10-K for 1994.
44
(7) Incorporated by reference to the Company's Report on Form 10-K for 1995. (8) Incorporated by reference to the Company's Registration Statement on Form S-1 originally filed April 15, 1986, file No. 33-4822. (9) Incorporated by reference to the Company's Report on Form 8-K dated December 27, 1996. (10) Incorporated by reference to the Company's Report on Form 8-K dated August 25, 1997. (11) Incorporated by reference to the Company's Report on Form 10-K/A2 for 1997. (12) Incorporated by reference to the Company's Report on Form 10-K/A for 1998. (13) Incorporated by reference to the Company's Report on Form 10-Q for the quarter ended September 30, 1998. (14) Incorporated by reference to the Company's Report on Form 8-K dated February 3, 1999. (15) Incorporated by reference to the Company's Report on Form 10-K for 1999. (16) Incorporated by reference to ImmuCell Corporation's Report on Form 8-K dated January 13, 2000. (17) Incorporated by reference to the Company's Report on Form 10-K for 2000. (18) Incorporated by reference to the Company's Report on Form 10-Q for the quarter ended December 31, 2000. (19) Incorporated by reference to the Company's Report on From 10-K for 2001. (20) Incorporated by reference to the Company's Report on Form 8-K dated September 18, 2002. (21) Incorporated by reference to the Company's Report on From 10-K for 2002. (22) Filed herewith.
* Subject to an order by the Securities and Exchange Commission granting confidential treatment. Specific portions of the document for which confidential treatment has been granted have been blacked out. Such portions have been filed separately with the Commission pursuant to the application for confidential treatment. 45 NUTRITION 21, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS FILED WITH THE ANNUAL REPORT OF THE COMPANY ON FORM 10-K JUNE 30, 2003
PAGE ---- REPORTS OF INDEPENDENT PUBLIC ACCOUNTANTS F-2 & F-3 CONSOLIDATED BALANCE SHEETS AT JUNE 30, 2003 AND 2002 F-4 CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED JUNE 30, 2003, 2002 AND 2001 F-6 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED JUNE 30, 2003, 2002 AND 2001 F-7 CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED JUNE 30, 2003, 2002 AND 2001 F-8 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F-9
F-1 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS Stockholders and Board of Directors Nutrition 21, Inc. We have audited the accompanying consolidated balance sheet of Nutrition 21, Inc. and subsidiary as of June 30, 2003, and the related consolidated statements of operations, stockholders' equity and cash flows for the year then ended. Our audit also included the 2003 consolidated financial statement schedule listed in the Index at Item 15(a). These consolidated financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Nutrition 21, Inc. and subsidiary as of June 30, 2003, and their consolidated results of operations and cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the consolidated financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein. /s/ J.H. COHN LLP Roseland, New Jersey September 26, 2003 F-2 REPORT OF INDEPENDENT AUDITORS Stockholders and Board of Directors Nutrition 21, Inc. We have audited the accompanying consolidated balance sheet of Nutrition 21, Inc. (the "Company") as of June 30, 2002, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the two years in the period ended June 30, 2002. Our audits also included the related financial statement schedule (for the 2002 and 2001 information), listed in the index at Item 15(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Nutrition 21, Inc. at June 30, 2002, and the consolidated results of its operations and its cash flows for each of the two years in the period ended June 30, 2002, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule (for the 2002 and 2001 information), when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. /s/ ERNST & YOUNG LLP Stamford, Connecticut August 16, 2002, except for the first paragraph of Note 11, Note 12 and the first, second and third paragraphs of Note 20, as to which the date is September 12, 2002 F-3 NUTRITION 21, INC. CONSOLIDATED BALANCE SHEETS (in thousands)
June 30, June 30, 2003 2002 ------- ------- ASSETS Current assets: Cash and cash equivalents $ 4,059 $ 3,974 Short-term investments -- 1,000 Accounts receivable (less allowance for doubtful accounts and returns of $430 in 2003 and $19 in 2002) 1,140 2,219 Other receivables 1,100 1,097 Inventories 1,135 1,075 Prepaid expenses and other current assets 196 788 ------- ------- Total current assets 7,630 10,153 Property and equipment, net 479 654 Patents, trademarks and other intangibles (net of accumulated amortization of $13,334 in 2003 and $12,721 in 2002) 10,612 17,073 Other assets 199 220 ------- ------- TOTAL ASSETS $18,920 $28,100 ======= =======
See accompanying notes. F-4 NUTRITION 21, INC. CONSOLIDATED BALANCE SHEETS (in thousands, except share data)
JUNE 30, JUNE 30, 2003 2002 -------- -------- LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable and accrued expenses $ 3,456 $ 2,102 Contingent payments payable 26 43 Preferred dividends payable 2 6 -------- -------- TOTAL LIABILITIES 3,484 2,151 -------- -------- Commitments and contingent liabilities STOCKHOLDERS' EQUITY Preferred stock, $0.01 par value, authorized 5,000,000 shares Series G convertible preferred, 1,769 shares issued, 188 and 471 shares outstanding at June 30, 2003 and 2002, respectively (aggregate liquidation value $193) 188 471 Common stock, $0.005 par value, authorized 65,000,000 shares; 33,602,990 and 33,048,655 shares issued and outstanding at June 30, 2003 and 2002, respectively 168 165 Additional paid-in capital 64,103 63,936 Accumulated deficit (49,023) (38,501) Less: treasury stock, at cost, 136,000 shares of common stock at June 30, 2002 -- (122) -------- -------- TOTAL STOCKHOLDERS' EQUITY 15,436 25,949 -------- -------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 18,920 $ 28,100 ======== ========
See accompanying notes. F-5 NUTRITION 21, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except share and per share data)
YEAR ENDED JUNE 30, ------------------- 2003 2002 2001 ------------ ------------ ------------ Net sales $ 10,265 $ 14,314 $ 20,809 Other revenues 350 354 2,443 ------------ ------------ ------------ TOTAL REVENUES 10,615 14,668 23,252 Cost of goods sold 4,129 4,344 6,216 ------------ ------------ ------------ GROSS PROFIT 6,486 10,324 17,036 Selling, general & administrative expense 8,201 7,349 10,321 Research & development expense 2,232 1,017 1,946 Depreciation & amortization expense 2,691 2,619 3,359 Restructuring & other charges -- -- 2,365 Charges for impairment of intangibles 4,443 7,128 -- ------------ ------------ ------------ OPERATING (LOSS) (11,081) (7,789) (955) Interest income 64 94 304 Interest (expense) (33) (110) (291) Other income -- 1,794 2,342 ------------ ------------ ------------ (LOSS) INCOME BEFORE INCOME TAXES (11,050) (6,011) 1,400 Income taxes (benefit) (544) -- 335 ------------ ------------ ------------ NET (LOSS) INCOME $ (10,506) $ (6,011) $ 1,065 ============ ============ ============ Basic (loss) earnings per share $ (0.32) $ (0.19) $ 0.03 ============ ============ ============ Diluted (loss) earnings per share $ (0.32) $ (0.19) $ 0.03 ============ ============ ============ Weighted average number of common shares - basic 33,309,371 32,621,918 31,781,403 ============ ============ ============ Weighted average number of common shares and equivalents - diluted 33,309,371 32,621,918 31,879,614 ============ ============ ============
See accompanying notes. F-6 NUTRITION 21, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (in thousands, except share data)
Preferred Stock Series G Common Stock Shares $ Shares $ ------------ ------------ ----------- ------------ Balance at June 30, 2000 663 663 31,581,427 158 Conversion of Series E preferred stock to common stock -- 231,136 1 Cancellation of stock exercise -- -- (315,408) (2) Premium on redemption of Series F preferred stock -- -- -- -- Issuance of warrants -- -- -- -- Preferred stock dividends declared -- -- -- -- Preferred stock issued for Optimum Lifestyle, Inc. contingent payment 941 941 -- -- Conversion of Series G preferred stock to common stock (663) (663) 845,663 4 Net income for the year -- -- -- -- ------------ ------------ ----------- ------------ Balance at June 30, 2001 941 941 32,342,818 161 ------------ ------------ ----------- ------------ Conversion of Series E preferred stock to common stock -- -- 155,605 1 Issuance of warrants -- -- -- -- Preferred stock dividends declared -- -- -- -- Premium on redemption of Series F preferred stock -- -- -- -- Conversion of Series G preferred stock to common stock (470) (470) 686,232 3 Repurchase of common stock for treasury -- -- (136,000) -- Net loss for the year -- -- -- -- ------------ ------------ ----------- ------------ Balance at June 30, 2002 471 471 33,048,655 165 ------------ ------------ ----------- ------------ Preferred stock dividends declared -- -- -- -- Issuance of warrants -- -- -- -- Conversion of Series G preferred stock to common stock (283) (283) 654,335 4 Repurchase of common stock for treasury -- -- (100,000) -- Retirement of treasury stock -- -- -- (1) Net loss for the year -- -- -- -- ------------ ------------ ----------- ------------ Balance at June 30, 2003 188 $ 188 33,602,990 $ 168 ============ ============ =========== ============
Additional Accumulated Treasury Paid-In Capital Deficit Stock Total $ $ $ $ ------------ ------------ ------------ ------------ Balance at June 30, 2000 62,291 (33,133) -- 29,979 Conversion of Series E preferred stock to common stock 236 -- -- 237 Cancellation of stock exercise 2 -- -- -- Premium on redemption of Series F preferred stock -- (110) -- (110) Issuance of warrants 8 -- -- 8 Preferred stock dividends declared -- (146) -- (146) Preferred stock issued for Optimum Lifestyle, Inc. contingent payment -- -- -- 941 Conversion of Series G preferred stock to common stock 659 -- -- -- Net income for the year -- 1,065 -- 1,065 ------------ ------------ ------------ ------------ Balance at June 30, 2001 63,196 (32,324) -- 31,974 ------------ ------------ ------------ ------------ Conversion of Series E preferred stock to common stock 193 -- -- 194 Issuance of warrants 80 -- 80 Preferred stock dividends declared -- (51) -- (51) Premium on redemption of Series F preferred stock -- (115) -- (115) Conversion of Series G preferred stock to common stock 467 -- -- -- Repurchase of common stock for treasury -- -- (122) (122) Net loss for the year -- (6,011) -- (6,011) ------------ ------------ ------------ ------------ Balance at June 30, 2002 63,936 (38,501) (122) 25,949 ------------ ------------ ------------ ------------ Preferred stock dividends declared -- (16) -- (16) Issuance of warrants 47 -- -- 47 Conversion of Series G preferred stock to common stock 279 -- -- -- Repurchase of common stock for treasury -- -- (38) (38) Retirement of treasury stock (159) -- 160 -- Net loss for the year -- (10,506) -- (10,506) ------------ ------------ ------------ ------------ Balance at June 30, 2003 $ 64,103 $ (49,023) $ -- $ 15,436 ============ ============ ============ ============
See accompanying notes. F-7 NUTRITION 21, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
YEAR ENDED JUNE 30, 2003 2002 2001 -------- -------- -------- Cash flows from operating activities: Net (loss) income $(10,506) $ (6,011) $ 1,065 Adjustments to reconcile net (loss) income to net cash (used in)/provided by operating activities: Depreciation and amortization 2,691 2,619 3,359 Impairment write-off 4,443 7,128 -- Deferred taxes -- (725) (298) (Gain) loss on disposal of equipment 7 (55) (23) Issuance of warrants 47 80 8 Changes in operating assets and liabilities: Accounts receivable 1,079 1,744 624 Other receivables (3) 710 (1,186) Inventories (60) 231 60 Prepaid expenses and other current assets 591 26 540 Other assets 21 96 46 Accounts payable and accrued expenses 1,354 (1,391) (563) -------- -------- -------- Net cash (used in)/provided by operating activities (336) 4,452 3,632 -------- -------- -------- Cash flows from investing activities: Contingent payments for acquisitions (135) (2,770) (4,637) Purchases of property and equipment (86) (274) (167) Payments for patents and trademarks (350) (336) (209) Proceeds from sale of equipment 50 200 32 Proceeds (purchase) of investments 1,000 (1,000) -- -------- -------- -------- Net cash provided by/ (used in) investing activities 479 (4,180) (4,981) -------- -------- -------- Cash flows from financing activities: Debt repayments -- (1,125) (1,500) Purchase of common stock for treasury (38) (122) -- Redemption of redeemable preferred stock -- (345) (177) Preferred stock dividends paid (20) (61) (107) -------- -------- -------- Net cash used in financing activities (58) (1,653) (1,784) -------- -------- -------- Net increase (decrease) in cash and cash equivalents 85 (1,381) (3,133) Cash and cash equivalents at beginning of year 3,974 5,355 8,488 -------- -------- -------- Cash and cash equivalents at end of year $ 4,059 $ 3,974 $ 5,355 ======== ======== ========
See accompanying notes. F-8 NUTRITION 21, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES a) Consolidation Effective March 8, 2001, Nutrition 21, Inc. (the "Company") changed its name from AMBI Inc. The consolidated financial statements include the results of operations of the Company, and its wholly owned subsidiary, Nutrition 21, LLC. All intercompany balances and transactions have been eliminated in consolidation. b) Use of Estimates The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. Estimates also affect the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. c) Cash Equivalents The Company considers all liquid interest-earning investments with a maturity of three months or less when acquired to be cash equivalents. Investments with maturities beyond one year may be classified as short-term based on their highly liquid nature and because such marketable securities represent the investment in cash that is available for current operations. All short-term investments are classified as available for sale and are recorded at market value using the specific identification method: unrealized gains and losses would be reflected in Accumulated Comprehensive Income. Cash equivalents included in the accompanying financial statements include money market accounts, bank overnight investments and commercial paper. d) Inventories Inventories are carried at the lower of cost (on a first-in, first-out method) or estimated net realizable value. e) Property and Equipment Property and equipment are stated at cost less accumulated depreciation. Depreciation is provided using the straight-line method over the related assets' estimated useful lives. The estimated useful lives are as follows: Leasehold improvements -- Term of lease Furniture and fixtures -- 7 years Machinery and equipment -- 5 to 7 years Office equipment -- 3 to 5 years Computer equipment -- 3 to 5 years f) Patents and Trademarks The Company capitalizes certain patents and trademarks. Patents and trademarks are amortized over their estimated useful lives, ranging from 3 to 15 years. g) Revenue Recognition Sales revenue from proprietary ingredient products is recognized when title transfers, upon shipment of the product. Sales revenue from finished nutritional products are also recognized when title transfers, which is upon delivery at the customer site. There are no customer acceptance provisions to lapse before the recognition of any product revenue. Only revenue where collectability of accounts receivables is probable is recognized. Other revenues are comprised primarily of license and royalty fees recognized as earned in accordance with agreements entered into by the Company when there is no further involvement required by the Company. The Company accrues for related product returns based on historical activity. F-9 NUTRITION 21, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, (continued) h) Research and Development Research and development costs are expensed as incurred. i) Income taxes Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for future tax consequences attributable to the temporary differences between the financial statement carrying amounts of assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes the enactment date. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. j) Stock-based Compensation The Company continues to account for employee stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees". Compensation cost for stock options, if any, is measured as the excess of the quoted market price of the Company's stock at the date of grant over the amount an employee must pay to acquire the stock. Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation," established accounting and disclosure requirements using a fair-value method of accounting for stock-based employee compensation plans. The Company has elected to remain on its current method of accounting as described above, and has adopted the disclosure requirements of SFAS No. 123. The Company applies the intrinsic value method pursuant to APB Opinion No. 25 in accounting for its employee stock option plans and, accordingly, no compensation cost has been recognized in the consolidated financial statements for its employee stock options, which have an exercise price equal to the fair value of the stock on the date of the grant. Had the Company determined compensation cost based on the fair value at the grant date for its stock options under SFAS No. 123, the Company's net income (loss) would have been reduced (increased) to the pro forma amounts indicated below (in thousands, except per share data) (see Note 12):
Year-ended June 30, 2003 2002 2001 ---------- ---------- ---------- Net (loss) income as reported $ (10,506) $ (6,011) $ 1,065 Deduct: total stock-based employee compensation expense determined under fair value based method for all awards (256) (383) (432) ---------- ---------- ---------- Pro forma net (loss) income $ (10,762) $ (6,394) $ 633 ========== ========== ========== (Loss) earnings per share Basic - as reported $ (0.32) $ (0.19) $ 0.03 Basic - pro forma $ (0.32) $ (0.20) $ 0.02 Diluted - as reported $ (0.32) $ (0.19) $ 0.03 Diluted - pro forma $ (0.32) $ (0.20) $ 0.02
F-10 The effects of applying SFAS No. 123 in this pro forma disclosure are not necessarily indicative of future amounts because the calculation does not take into consideration pro forma compensation expense related to grants made prior to 1995. k) Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed The Company reviews long-lived assets and certain identifiable intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. l) Recently Issued Accounting Standards In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure- an Amendment of FASB Statement No 123." SFAS No. 148, provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 requires prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company adopted the disclosure provisions of SFAS No. 148 effective December 31, 2002. In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." The FASB's new rules on asset impairment supersede SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," and became effective for the Company's fiscal year beginning July 1, 2002. F-11 NUTRITION 21, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, (continued) m) Advertising costs Advertising costs are expensed as incurred. The amount charged to expense during fiscal years 2003, 2002 and 2001was $0.6 million, $0.4 million and $0.8 million, respectively. n) Reclassifications Certain reclassifications have been made to prior years' financial statement amounts to conform to the 2003 presentation. Note 2: ACQUISITION In 1999, the Company acquired the Lite Bites product line from Optimum Lifestyles, Inc. Contingent payments in conjunction with this acquisition are made to the former owners of Optimum Lifestyles, Inc. ("OLI") depending primarily on sales levels of the Lite Bites Business achieved during the five year period following closing and/or the availability of Lite Bites products through certain distribution channels in the future as follows: a maximum of $3.0 million in cash and/or Nutrition 21 common stock, at the option of the former owners of OLI, payable $1.0 million on each of the first three anniversaries of the acquisition; $3.0 million in newly issued Nutrition 21 preferred stock, payable $1.5 million, subject to adjustment for the achievement of net sales levels, on each of the first two anniversaries of the acquisition, in newly issued Nutrition 21 preferred stock; and a single payment of $1.0 million in cash, subject to achieving certain sales levels in new markets, prior to the fifth anniversary of the acquisition. During fiscal 2002, the Company, in satisfaction of the contingent payment requirement paid $1.0 million in cash resulting in an increase in goodwill. During fiscal 2001, the Company, in satisfaction of the contingent payment requirement, paid $1.0 million in cash and issued 941 shares of its Series G Preferred Stock, which resulted in an increase in goodwill of $1.9 million. During fiscal years ended June 30, 2003, 2002 and 2001, respectively, the Company recorded approximately $0.4 million in amortization expense related to other intangible assets. In connection with the Company's purchase agreement for Nutrition 21 on August 11, 1997, the Company made cash payments in fiscal year 2002 and fiscal year 2001 of $1.8 million an $3.6 million, respectively, representing the full amount of contingent payments due for each respective year. Note 3: SHORT-TERM INVESTMENT June 30, 2003 2002 Available for sale: 3.10% corporate bond, maturing 12/05/03 (in thousands) $ -- $1,000 Note 4: INVENTORIES The components of inventories at June 30, 2003 and 2002 are as follows (in thousands): 2003 2002 Raw materials $ -- $ 444 Finished goods 1,135 631 ------ ------ Total inventories $1,135 $1,075 ====== ====== F-12 NUTRITION 21, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 5: FAIR VALUE OF FINANCIAL INSTRUMENTS The fair value of cash and cash equivalents, short-term investments and accounts receivable approximate carrying amounts due to the short maturities of these instruments. Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash and cash equivalents and accounts receivable. Concentrations of credit risk with respect to accounts receivable are limited as the Company performs on-going credit evaluations of its customers and maintains credit insurance on customers' balances. On a periodic basis, the Company evaluates its accounts receivable and establishes an allowance for doubtful accounts, based on a history of past write-offs and collections and current credit considerations. Management does not believe that significant credit risk exists at June 30, 2003. The Company places its cash primarily in market interest rate accounts, overnight investments and short-term investments. The Company had $0.7 million in overnight investments and $3.4 million invested in mutual money market funds at June 30, 2003. The Company had $0.9 million in overnight investments; $3.0 million in invested money market funds and $1.0 million in short term investments at June 30, 2002. F-13 NUTRITION 21, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 5: FAIR VALUE OF FINANCIAL INSTRUMENTS (continued) The Company sells its products to customers in the Americas and Europe. The Company performs ongoing credit evaluations of its customer's financial condition and limits the amount of credit extended as deemed appropriate, but generally requires no collateral. The Company maintains reserves for credit losses and, to date, such losses have been within management's expectations. In fiscal year 2003, two customers accounted for approximately 27% of net sales. For fiscal years 2002 and 2001, one customer accounted for 28% and 29% of net sales, respectively. In addition, two customers accounted for 40% of accounts receivable, net at June 30, 2003, and one customer accounted for 23% of accounts receivable, net at June 30, 2002. Note 6: RELATED PARTY TRANSACTIONS On September 17, l998, the Company commenced a strategic alliance with Wyeth (formerly American Home Products Corporation) ("Wyeth") for retail distribution of the Company's proprietary nutrition products. As part of the alliance, Wyeth's Whitehall-Robins Healthcare Division was granted an exclusive license to sell the Company's Cardia(R) Salt in retail markets in the United States and received a first negotiation option for exclusive rights and licenses for additional nutrition products for retail distribution in the United States. The Company retained the exclusive rights to market its products in both direct response and ingredient channels. On October 8, l998, the Company received a non-refundable payment of $1.0 million for the rights granted to Wyeth. Also on October 8, l998, Wyeth paid $1.15 per share or a total of $4.0 million for 3,478,261 shares of the Company's Common Stock. For the fiscal year ended 2001, the Company received approximately $0.5 million in license fees from Wyeth. A former officer's employment with the Company terminated on September 29, 2000. Effective as of such date, the Company entered into a consulting agreement with the former officer. The agreement is for the period from October 1, 2000 through June 30, 2004, and provides for payment of $206,250 for the period from October 1, 2000 through June 30, 2001, and a fee at an annual rate of $100,000 thereafter. All of the former officer's stock options (900,000 shares) became fully vested and became exercisable until June 30, 2004. Upon the occurrence of a change of control (as defined in the agreement), the agreement terminates and the Company is required to pay to the former officer a lump-sum payment equal to the fees that would have been paid to him over the remaining term of the agreement had the change of control not occurred. On July 1, 2001 the Company licensed its remaining rights to sell lysostaphin for research purposes, to one of its senior vice presidents, for $300,000, payable in cash over a three-year period. As of June 30, 2003, all payments have been made. Note 7: PROPERTY AND EQUIPMENT, NET The components of property and equipment, net, at June 30, 2003 and 2002 are as follows (in thousands):
2003 2002 ------- ------- Furniture and fixtures $ 422 $ 422 Machinery and equipment 135 135 Office equipment & leasehold improvements 542 561 Computer equipment 766 732 ------- ------- 1,865 1,850 ------- ------- Less: accumulated depreciation and amortization (1,386) (1,196) ------- ------- Property and equipment, net $ 479 $ 654 ======= =======
F-14 NUTRITION 21, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 8: PATENTS AND TRADEMARKS, NET During fiscal year 2003, changes in intangible assets relate to the investment of $0.5 million in existing patents, which will be amortized over the remaining life of the patents, as well as a $4.4 million impairment charge relating to the discontinuance of the Lite Bites product line. No significant residual value is estimated for these intangible assets. Intangible asset amortization expense was $2.5 million for fiscal year 2003, $2.4 million for fiscal year 2002 and $2.7 million for fiscal year 2001. The components of intangible assets were as follows (in thousands):
June 30, 2003 2002 --------------------------- --------------------------- Gross Gross Carrying Accumulated Carrying Accumulated Amount Amortization Amount Amortization Patents and licenses $ 9,069 $ (6,346) $ 9,228 $ (5,582) Trademarks, trade names and other 14,877 (6,988) 20,566 (7,139) -------- -------- -------- -------- Intangible assets $ 23,946 $(13,334) $ 29,794 $(12,721) ======== ======== ======== ========
Amortization expense for the net carrying amount of intangible assets at June 30, 2003 is estimated to be $2.1 million in fiscal years 2004 through 2007, respectively. Note 9: ACCOUNTS PAYABLE AND ACCRUED EXPENSES The following items are included in accounts payable and accrued expenses at June 30, 2003 and 2002 (in thousands): 2003 2002 ---- ---- Accounts payable $1,903 $1,115 Consulting and professional fees payable 109 46 Accrued compensation and benefits 160 109 Taxes payable -- 725 Other accrued expenses 1,284 107 ------ ------ $3,456 $2,102 ====== ====== Note 10: REDEEMABLE PREFERRED STOCK During fiscal year 2002, all remaining shares of the Company's E Preferred Stock plus accrued dividends on these shares were converted into Common Stock. During fiscal year 2001, 285 shares of the Company's E Preferred Stock plus accrued dividends on these shares were converted into 231,136 shares of Common Stock. During fiscal year 2002, 227 shares of the Company's F Preferred Stock plus accrued dividends on these shares were redeemed for $0.3 million. During fiscal year 2001, 116 shares of the Company's F Preferred Stock plus accrued dividends on these shares were redeemed for $0.2 million. Note 11: STOCKHOLDERS' EQUITY Inducement Plan The Company adopted a 2002 Inducement Stock Option Plan (the "Inducement Plan"). The Inducement Plan provides for the grant of options to purchase shares of the Company's common stock to induce individuals to become employed by the Company. The aggregate number of shares of common stock, which may become subject to options shall not exceed 2,500,000. Approximately 2,500,000 options remain available for grant under the Inducement Plan at June 30, 2003. F-15 NUTRITION 21, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 11. STOCKHOLDERS' EQUITY (continued) Series G Convertible Preferred Stock In January 1999, the Company created a non-voting Series G Convertible Preferred Stock ("G Preferred") with a par value of $0.01 per share. The G Preferred bears dividends of $50 per share per annum. The G Preferred is convertible into Common Stock at the average closing price of the Common Stock during the 10 days immediately preceding conversion. The G Preferred is subject to mandatory conversion after three years from the date of issuance. During the fiscal year ended June 30, 2003 and 2002, 283 and 470 shares, respectively, of the Company's G Preferred were converted into 654,335 and 686,232 shares, respectively, of the Company's common stock. On February 12, 2001, the Company issued 941 shares of G Preferred, and converted 663 shares of G Preferred into 845,663 shares of the Company's Common Stock. Warrants The Company, from time to time, issues warrants to purchase Common Stock to non-employees for services rendered. Warrants are granted to purchase the Company's Common Stock with exercise prices set at fair market value on the date of grant. The terms of the warrants vary depending on the circumstances, but generally expire in three to five years. The Company had outstanding warrants for the purchase of its Common Stock as follows:
Number of Exercise price warrants per share Outstanding at June 30, 2000 1,348,926 $ 1.25-$6.75 Issued 50,000 $ 0.89 Exercised (8,265) $ 2.72 Cancelled (258,524) $ 1.25-$6.75 --------- Outstanding at June 30, 2001 1,132,137 $ 0.89-$6.30 Issued 160,000 $ 0.63-$0.74 Exercised -- -- Cancelled (482,137) $1.25 -$6.30 --------- Outstanding at June 30, 2002 810,000 $ 0.63-$3.65 Issued 105,000 $ 0.40-$0.57 Exercised -- -- Cancelled (70,000) $ 2.59-$3.62 --------- Outstanding at June 30, 2003 845,000 $ 0.40-$3.65 =========
The warrants expire between 2003 and 2012. Certain of the warrants include anti-dilution clauses. Warrants outstanding and exercisable at June 30, 2003, are as follows:
Warrants Outstanding Warrants Exercisable ----------------------------------------------- ---------------------------- Weighted Average Weighted Weighted Remaining Average Average Range of Number Contractual Exercise Number Exercise Exercise Prices Outstanding Life Price Exercisable Price --------------- ----------- ---- ----- ----------- ----- $0.40 - $0.89 315,000 3.43 $0.70 290,000 $0.73 $1.38 - $1.50 80,000 4.29 $1.42 70,000 $1.43 $3.26 - $3.65 450,000 1.30 $3.63 450,000 $3.63 -------- -------- 845,000 810,000 ======== ========
The Company recorded compensation expense associated with the issuance of warrants to third parties of $47 thousand, $80 thousand and $8 thousand during fiscal years 2003, 2002 and 2001, respectively. F-16 NUTRITION 21, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 11: STOCKHOLDERS' EQUITY (continued) Options In addition, the Company had adopted five other Stock Option Plans ("Plans") whereby options to purchase an aggregate of 8,750,000 shares of the Company's common stock may be granted to employees, consultants and others who render services to the Company. The exercise price per share for the options granted under these Plans may not be less than the fair value of the Company's Common Stock on the date of grant. The options issuable pursuant to the Plans expire between 2004 and 2013. Approximately 1,175,500 options remain available for grant under these Plans. A summary of stock option activity related to the Company's stock option plans is as follows:
Number of Exercise price options per share --------- -------------- Outstanding at June 30, 2000 2,649,391 $0.75 - $7.56 Issued 1,280,889 $0.81 - $2.63 Exercised -- -- Cancelled (978,181) $0.75 - $5.00 ---------- Outstanding at June 30, 2001 2,952,099 $0.81 - $7.56 Issued 1,230,000 $0.55 - $1.23 Exercised -- -- Cancelled (542,110) $0.69 - $7.56 ---------- Outstanding at June 30, 2002 3,639,989 $0.55 - $5.63 Issued 3,466,000 $0.31 - $0.71 Exercised -- -- Cancelled (591,987) $0.37 - $3.50 ---------- Outstanding at June 30, 2003 6,514,002 $0.31 - $5.63 ==========
Each of these options is entitled to one share of common stock. Stock options generally vest ratably over five years from the date of grant and expire within five years from the date of vesting. Options outstanding and exercisable at June 30, 2003 are as follows:
Options Outstanding Options Exercisable ---------------------------------------------- ------------------------------- Weighted Average Weighted Weighted Remaining Average Average Range of Number Contractual Exercise Number Exercise Exercise Prices Outstanding Life Price Exercisable Price --------------- ----------- ---- ----- ----------- ----- $0.31 - $0.94 3,860,000 9.05 $0.44 551,700 $0.73 $1.09 - $1.44 1,032,402 7.58 $1.21 660,998 $1.22 $1.50 - $2.94 996,600 2.80 $2.11 916,400 $2.13 $3.00 - $5.63 625,000 1.79 $3.49 612,200 $3.50 --------- --------- 6,514,002 2,741,298 ========= =========
The per share weighted-average fair value of stock options granted during fiscal years 2003, 2002 and 2001 was $0.06, $0.15 and $0.20, respectively, on the date of grant using the Black Scholes option-pricing model with the following weighted-average assumptions: 2003 2002 2001 ---- ---- ---- Risk-free interest rate 2.2% 3.8% 5.2% Expected life-years 2.5 2.0 2.5 Expected volatility 45.4% 45.6% 45.8% Expected dividend yield -- -- -- F-17 NUTRITION 21, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 12: SHAREHOLDER RIGHTS PLAN The Company adopted a Shareholder Rights Plan on September 12, 2002. Under this plan, the Company will distribute, as a dividend, one preferred share purchase right for each share of Common Stock of the Company held by stockholders of record as of the close of business on September 25, 2002. The Rights Plan is designed to deter coercive takeover tactics, including the accumulation of shares in the open market or through private transactions, and to prevent an acquirer from gaining control of the Company without offering a fair price to all of the Company's stockholders. The Rights will expire on September 11, 2012. Each Right initially will entitle stockholders to buy one one-thousandth of a share of newly created Series H Participating Preferred Stock of the Company for $3.00 per share. Each one one-thousandth of a share of the Preferred Stock is designed to be the functional equivalent of one share of Common Stock. The Rights will be exercisable only if a person or group acquires beneficial ownership of 15% or more of the Company's Common Stock (30% in the case of a person or group that is currently a 15% holder) or commences a tender or exchange offer upon consummation of which such person or group would beneficially own 15% or more the Company's Common Stock. If any person or group (an "Acquiring Person") becomes the beneficial owner of 15% or more of the Company's Common Stock (30% in the case of a person that is currently a 15% holder), then (1) the Rights become exercisable for Common Stock instead of Preferred Stock, (2) the Rights held by the Acquiring Person and certain affiliated parties become void, and (3) the Rights held by others are converted into the right to acquire, at the purchase price specified in the Right, shares of Common Stock of the Company having a value equal to twice such purchase price. The Company will generally be entitled to redeem the Rights, at $.001 per right, until 10 days (subject to extension) following a public announcement that an Acquiring Person has acquired a 15 % position. Note 13: (LOSS) EARNINGS PER SHARE Basic and diluted (loss) earnings per share for the fiscal years ended June 30, 2003, 2002 and 2001 are as follows (in thousands, except share and per share amounts): The following table sets forth the computation of basic and diluted ( loss) earnings per share for the periods indicated.
Year ended June 30, ------------------- 2003 2002 2001 ------------ ------------ ------------ Basic (loss) earnings per share: Net (loss) income $ (10,506) $ (6,011) $ 1,065 Less: Dividends on preferred shares (16) (51) (146) Premium on redemption of preferred stock -- (115) (110) ------------ ------------ ------------ (Loss) income applicable to common stockholders $ (10,522) $ (6,177) $ 809 ============ ============ ============ Weighted average shares 33,309,371 32,621,918 31,781,403 ============ ============ ============ Basic (loss) earnings per share $ (0.32) $ (0.19) $ 0.03 ============ ============ ============ Diluted (loss) earnings per share: (Loss) income applicable to common stockholders $ (10,522) $ (6,177) $ 809 ============ ============ ============ Weighted average shares 33,309,371 32,621,918 31,781,403 Plus incremental shares from assumed conversions of stock options -- -- 98,211 ------------ ------------ ------------ Adjusted weighted average shares 33,309,371 32,621,918 31,879,614 ============ ============ ============ Diluted (loss) earnings per share $ (0.32) $ (0.19) $ 0.03 ============ ============ ============
F-18 NUTRITION 21, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 13: (LOSS) EARNINGS PER SHARE (continued) Diluted (loss) earnings per share for the fiscal years ended June 30, 2003, 2002 and 2001, do not reflect the incremental shares from the assumed conversion of preferred stock (127,150, 377,181 and 833,313 shares, respectively) as the effect of such inclusion would be anti-dilutive. Note 14: RESTRUCTURING AND OTHER CHARGES The Company recorded $2.4 million for restructuring and other non-recurring charges, relating to its Nutritional Products segment, in the second quarter of fiscal 2001. A $1.6 million restructuring charge was recorded as part of the Company's initiative to reduce costs and to create a more flexible and efficient organization. Included in the restructuring charge were $0.7 million of cash termination benefits associated with the separation of twenty employees. All of the affected employees left their positions with the Company as of June 30, 2001. All of the termination benefits were paid. This cash outlay was funded through cash from operations. Approximately $0.9 million of the restructuring charge relates to the Company's decision to discontinue its efforts to launch NO YO, a consumer weight loss product intended for the retail channel and to consolidate certain of the Company's facilities. At June 30, 2001, all restructuring charges accrued during the fiscal year 2001 had been paid. Other charges of $0.7 million include a non-cash write off of the carrying value of the website development costs related to NutritionU.com, the Company's online nutrition education internet company. The Company believes that since sufficient uncertainty surrounds the ability of the Company to find strategic partners for NutritionU.com, there will be no substantive future benefit to be derived from the website development costs. In addition, other charges include $0.1 million for the write- off of the remaining carrying value of a license fee for one of its products. Note 15: OTHER INCOME During the fiscal year 2001, the Company recorded as other income $1.8 million from the settlement of patent infringement claims related to chromium picolinate as well as a sale of assets. Note 16: SEGMENT REPORTING Effective in fiscal year 1999, the Company adopted FASB Statement No. 131 "Disclosures about Segments of an Enterprise and Related Information" which established revised standards for reporting information about operating segments. Pursuant to Statement No. 131, the Company's reporting segments are nutritional products and pharmaceutical products. The Company's Nutritional Products segment develops and markets proprietary essential trace elements to the vitamin supplement market for both human and animal applications. The Company's Pharmaceutical Products segment includes all licensing activities related to certain antibacterial technologies. A summary of business data for the Company's reportable segments for the fiscal years 2003, 2002, and 2001 follows. Information by business segment (in thousands): F-19 NUTRITION 21, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 16:SEGMENT REPORTING (continued)
2003 2002 2001 -------- -------- -------- Revenues Nutritional Products $ 10,220 $ 14,237 $ 21,127 Pharmaceutical Products 395 431 2,125 -------- -------- -------- $ 10,615 $ 14,668 $ 23,252 ======== ======== ======== Operating (loss) Income Nutritional Products $(11,331) $ (8,046) $ (2,876) Pharmaceutical Products 250 257 1,921 -------- -------- -------- $(11,081) $ (7,789) $ (955) ======== ======== ======== Depreciation and Amortization Nutritional Products $ 2,577 $ 2,497 $ 3,216 Pharmaceutical Products 114 122 143 -------- -------- -------- $ 2,691 $ 2,619 $ 3,359 ======== ======== ======== Segment Assets Nutritional Products $ 18,149 $ 27,186 $ 37,698 Pharmaceutical Products 771 914 1,189 -------- -------- -------- $ 18,920 $ 28,100 $ 38,887 ======== ======== ======== Capital Expenditures Nutritional Products $ 571 $ 3,380 $ 5,013 Pharmaceutical Products -- -- -- -------- -------- -------- $ 571 $ 3,380 $ 5,013 ======== ======== ========
Geographic information about the Company's revenues, which is based on the location of the buying organization, for the fiscal years 2003, 2002 and 2001 is presented below (in thousands):
2003 2002 2001 -------- -------- -------- Revenues United States $ 10,560 $ 13,950 $ 21,526 United Kingdom 55 718 1,726 -------- -------- -------- $ 10,615 $ 14,668 $ 23,252 ======== ======== ======== Property and equipment, net United States $ 479 $ 654 $ 633 United Kingdom -- -- -- -------- -------- -------- $ 479 $ 654 $ 633 One nutritional product segment customer accounted for approximately 19%, 28% and 29% of the segment revenue in fiscal years 2003, 2002 and 2001, respectively. Presented below is a reconciliation of total business segment operating (loss) income to consolidated (loss) income before income taxes for the fiscal years 2003, 2002 and 2001(in thousands): 2003 2002 2001 -------- -------- -------- Total segment operating (loss) $(11,081) $ (7,789) $ (955) Other, net 31 1,778 2,355 -------- -------- -------- (Loss) income before income taxes $(11,050) $ (6,011) $ 1,400 ======== ======== ========
F-20 NUTRITION 21, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 17: GOODWILL The Company adopted SFAS No. 142 effective July 1, 2001. Under SFAS No. 142, goodwill is no longer amortized but reviewed for impairment annually, or more frequently if certain indicators arise. The Company was required to complete the initial step of a transitional impairment test within six months of adoption of SFAS No. 142 and to complete the final step of the transitional impairment test by the end of the fiscal year. The initial step was completed in the first quarter of fiscal 2002. In addition, the Company assesses the impairment of identifiable intangible assets and goodwill whenever events or changes in circumstances indicate that the carrying value of the relevant assets may not be recoverable. Management's judgment regarding the existence of impairment is based on factors such as significant changes in the manner or the use of acquired assets or the Company's overall business strategy; significant negative industry or economic trends; significant declines in the Company's stock price for a sustained period and the Company's market capitalization relative to book value. Upon adoption, goodwill in the amount of $4.1 million included in patents and trademarks since acquisition (although accounted for separately by the Company and included therein because of its estimated economic life) was reclassified in the accompanying balance sheets in accordance with the requirements of SFAS No. 142. Due to declining market conditions, as well as a change in business strategy, it was determined that a $7.1 million impairment charge was warranted in fiscal year 2002. The Company used a discounted cash flow analysis for purposes of estimating the fair value of its reporting unit. Had the Company been accounting for its goodwill under SFAS No. 142 for all periods presented, the Company's net (loss) income and (loss) earnings per share would have been as follows( in thousands, except share data):
Year-ended June 30, 2003 2002 2001 ---------- ---------- ---------- Reported net (loss) income: $ (10,506) $ (6,011) $ 1,065 Add back goodwill amortization, net of tax -- -- 475 ---------- ---------- ---------- Adjusted net (loss) income $ (10,506) $ (6,011) $ 1,540 ========== ========== ========== Basic (loss) earnings per share: Reported net (loss) income $ (0.32) $ (0.19) $ 0.03 Goodwill amortization, net of tax -- -- 0.02 ---------- ---------- ---------- Adjusted net (loss) income $ (0.32) $ (0.19) $ 0.05 ========== ========== ========== Diluted earnings per share: Reported net (loss) income $ (0.32) $ (0.19) $ 0.03 Goodwill amortization, net of tax -- -- 0.02 ---------- ---------- ---------- Adjusted net (loss) income $ (0.32) $ (0.19) $ 0.05 ========== ========== ==========
Note 18: PENSION PLAN Eligible employees of the Company are entitled to participate in the Burns Philp Inc. Retirement Plan for Non-Bargaining Union Employees (the "Pension Plan"), a defined benefit pension plan, as long as Burn Philp maintains the Pension Plan and owns at least 20% of the Company's outstanding Common Stock. At June 30, 2003, Burns Philp held approximately 24% of the Company's outstanding Common Stock. During fiscal years 2003, 2002, and 2001, the Company made contributions to the Pension Plan of $131 thousand, $106 thousand and $100 thousand, respectively. F-21 NUTRITION 21, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 19: INCOME TAXES The provisions for income taxes for the fiscal years ended June 30, 2003, 2002 and 2001 consist of the following (in thousands): 2003 2002 2001 ------- ------- ------- Current $(1,182) $ 725 $ 633 Deferred 638 (725) (298) ------- ------- ------- $ (544) $ -- $ 335 ======= ======= ======= Income taxes attributed to pre-tax ( loss) income differed from the amounts computed by applying the US federal statutory tax rate to pre-tax income as a result of the following (in thousands):
2003 2002 2001 ------- ------- ------- Income taxes at U.S. statutory rate $(3,757) $(2,044) $ 476 Increase/(reduction) in income taxes resulting from: Change in valuation allowance 4,184 1,607 (263) Goodwill book basis in excess of tax -- 263 -- State taxes, net of federal (663) (268) 26 Other items (308) 442 96 ------- ------- ------- $ (544) $ -- $ 335 ======= ======= =======
The tax effects of temporary differences that give rise to deferred taxes and deferred tax assets and deferred tax liabilities at June 30, 2003 and 2002 are presented below (in thousands): 2003 2002 ------- ------- Deferred tax assets: Net operating loss carryforwards $ 2,920 $ 515 Accrued expenses 580 234 Allowance for doubtful accounts 8 8 Inventory reserve 95 -- Intangible assets 2,188 1,370 Other -- 118 ------- ------- Total gross deferred tax assets 5,791 2,245 Less valuation allowance (5,791) (1,607) ------- ------- Net deferred tax assets $ -- $ 638 ======= ======= Income tax refunds receivable are included in other receivables. At June 30, 2003, the Company has available, for federal and state income tax purposes, net operating loss carry forwards of approximately $7.0 million and $9.0 million, respectively, expiring through 2023. Ultimate utilization of such net operating loss carryforwards may be significantly curtailed if a significant change in ownership of the Company were to occur. A valuation allowance is provided when it is more likely than not that some portion or all of the deferred tax assets will not be realized. F-22 NUTRITION 21, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 20: COMMITMENTS AND CONTINGENT LIABILITIES The Company entered into a three-year employment agreement with Gail Montgomery as President and Chief Executive Officer, effective as of September 1, 2002. The agreement provides for an annual salary of $275,000, $300,000, and $325,000 in the successive years under the agreement, and for performance bonuses based on achieving defined revenue targets. Ms. Montgomery is also entitled to additional payments equal to one year's salary plus an additional month of salary for defined years of service, if her employment is terminated without cause before the agreement expires, or if the Company fails to offer to enter into a new one-year agreement upon expiration. If Ms. Montgomery's employment is terminated or she resigns within six months after a change of control (as defined) the Company will pay to her 2.99 times her annual salary and previous year's bonus plus certain gross-ups, but these payments will be reduced to the extent necessary to prevent the application of Section 280G of the Internal Revenue Code. The Company in July 2002 granted to Ms. Montgomery options to purchase an aggregate of 850,000 shares of common stock at $0.39 per share, and 325,000 stock appreciation rights ("SAR") on the same general terms as the option grant, except that upon exercise of the SAR the Company will pay to her the SAR's in-the-money value in cash or common stock. The Company entered into a three-year employment agreement with Andrew Wertheim as Chief Operating Officer, effective as of August 5, 2002. The agreement provides for an annual salary of $225,000, $250,000, and $275,000 in the successive years under the agreement, and for performance bonuses based on achieving defined revenue targets. Mr. Wertheim is also entitled to additional payments equal to one year's salary, if his employment is terminated without cause before the agreement expires. If Mr. Wertheim's employment is terminated or he resigns within six months after a change of control (as defined) the Company will pay to him 2.99 times his annual salary and previous year's bonus plus certain gross-ups, but these payments will be reduced to the extent necessary to prevent the application of Section 280G of the Internal Revenue Code. The Company in August 2002 granted to Mr. Wertheim options to purchase an aggregate 675,000 shares of the Company's Common Stock at $0.36 per share. On February 14, 2003, Mr. Wertheim's employment with the Company was terminated. As a result, his stock options terminated. Mr. Wertheim has demanded arbitration of whether he has any entitlements under his employment agreement. As of June 30, 2003, the Company did not provide for any termination benefits. The Company entered into a four-year agreement with Benjamin Sporn effective as of September 1, 2002, which provides for his services as Senior Vice President, General Counsel, and Secretary as an employee during the first two years of the term and as General Counsel as a consultant during the balance of the term. Mr. Sporn's salary and fees will be $207,500, $225,000, $150,000 and $100,000 in successive years under the agreement, plus performance bonuses based on achieving defined revenue targets. Mr. Sporn is also entitled to additional payments equal to two years' salary if his employment is terminated without cause before the agreement expires. If Mr. Sporn's employment is terminated or he resigns within six months after a change of control (as defined) the Company will pay to him 2.99 times his annual salary and previous year's bonus plus certain gross-ups, but these payments will be reduced to the extent necessary to prevent the application of Section 280G of the Internal Revenue Code. The Company in July 2002 granted to Mr. Sporn options to purchase an aggregate of 225,000 shares of the Company's Common Stock at $0.39 per share. Effective as of September 16, 2002, the Company entered into a three-year employment agreement with Paul Intlekofer, who has served as Chief Financial Officer and Senior Vice President, Corporate Development since January 17, 2003. The agreement provides for an annual salary of $200,000, $225,000, and $250,000 in the successive years under the agreement, and for performance bonuses based on achieving defined revenue targets. Mr. Intlekofer is also entitled to additional payments equal to one year's salary if his employment is terminated without cause before the agreement expires. If Mr. Intlekofer's employment is terminated or he resigns within six months after a change of control (as defined) the Company will pay to him 2.99 times his annual salary and previous year's bonus plus certain gross-ups, but these payments will be reduced to the extent necessary to prevent the application of Section 280G of the Internal Revenue Code. The Company, in accordance with the agreement, granted to Mr. Paul Intlekofer options to purchase an aggregate 550,000 shares of the Company's common stock at $0.40 per share. F-23 NUTRITION 21, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 20: COMMITMENTS AND CONTINGENT LIABILITIES (continued) In October 1995, the Company entered into an exclusive license agreement whereby the Company received a license to sell a patented salt alternative in the United States. During the term of the license, the Company agreed to pay a royalty of 4.5% of net sales of the salt alternative. The Company is required to make royalty payments quarterly through 2007. In connection with this agreement, the Company recorded royalty expense of $2 thousand for the fiscal year ended June 30, 2003; $0.2 million for the fiscal year ended June 30, 2002 and $0.5 million for the fiscal year ended June 30, 2001. The Company has entered into various research and license agreements with certain universities to supplement the Company's research activities and to obtain for the Company rights to certain technology. The agreements generally require the Company to fund the research and to pay royalties based upon a percentage of product sales. The Company leases certain office space in the United States. The lease expires in the year 2006. Payments under this lease were approximately $0.4 million in fiscal year 2003, $0.5 million in fiscal year 2002, and $0.7 million in fiscal year 2001. Future non-cancelable minimum payments under this lease are as follows (in thousands): Year Amount ---- ------ 2004 $ 370 2005 370 2006 261 -------- Total $ 1,001 ======== Note 21: SUPPLEMENTAL CASH FLOW INFORMATION
Year ended June 30, 2003 2002 2001 ---- ---- ---- Supplemental disclosure of cash flow information (in thousands) Cash paid for interest $33 $ 62 $243 Cash paid for income taxes 41 504 146 Supplemental schedule of non-cash financing activities: Obligation for purchase of property & equipment -- -- 152 Obligation for N21 contingent payment 26 369 1,938 Obligation for Lite Bites contingent payment -- 589 970 Issuance of common stock for Series E conversion -- -- 237 Issuance of common stock for Series G conversion 283 -- 663 Issuance of Series G preferred stock for Optimum Lifestyle, Inc. contingent payment -- -- 941
Note 22: RISKS AND UNCERTAINTIES The Company buys certain of its inventories from single suppliers. Management believes that other suppliers could provide similar products at comparable terms. As a result, management believes a change in suppliers would not disrupt on-going operations and would not affect operating results adversely. F-24 NUTRITION 21, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 23: QUARTERLY FINANCIAL INFORMATION (unaudited)
First Second Third Fourth In thousands, except per share data Quarter Quarter Quarter Quarter (a) ----------------------------------- ------- ------- ------- ----------- Fiscal Year 2003 ---------------- Revenues $ 3,315 $ 2,334 $ 3,132 $ 1,834 Gross Profit 2,506 1,352 2,115 513 (Loss) before Income Taxes (112) (2,270) (1,449) (7,219) Net (Loss) (112) (2,270) (1,143) (6,981) Net (Loss) per common share: Basic $ (0.00) $ (0.07) $ (0.03) $ (0.22) Diluted $ (0.00) $ (0.07) $ (0.03) $ (0.22) Fiscal Year 2002 ---------------- Revenues $ 3,949 $ 2,912 $ 3,987 $ 3,820 Gross Profit 2,709 2,041 2,713 2,861 Income (loss) before Income Taxes 1,996 (627) (297) (7,083) Net Income (loss) 1,277 (375) (197) (6,716) Net Income (loss) per common share: Basic $ 0.04 $ (0.02) $ (0.01) $ (0.20) Diluted $ 0.04 $ (0.02) $ (0.01) $ (0.20)
(a) The fourth quarters of fiscal years 2003 and 2002 include $4.4 million and $7.1 million, respectively, of non-cash charges for impairment of intangibles. Note 24: SUBSEQUENT EVENT On August 28, 2003, the remaining 188 shares of Series G preferred stock were converted into 316,498 shares of the Company's Common Stock. F-25 SCHEDULE II NUTRITION 21, INC. VALUATION AND QUALIFYING ACCOUNTS
Additions Balance Charged to Charged to Beginning Cost and Other End Accounts of Year Expense Accounts Deductions of Year -------- ------- ------- -------- ---------- ------- ($ in thousands) Year ended June 30, 2003 Allowance for Doubtful Accounts 19 -- -- -- 19 Deferred Tax Valuation Allowance 1,607 4,184 -- -- 5,791 Allowance for returns and allowances 140 920 1,060* Allowance for inventory obsolescence 1 236 -- -- 237 Year ended June 30, 2002 Allowance for Doubtful Accounts 45 -- -- (26) 19 Deferred Tax Valuation Allowance 1,360 1,607 (1,360)** -- 1,607 Allowance for returns and allowances 117 23 0 140* Allowance for inventory obsolescence 31 (30) -- -- 1 Year ended June 30, 2001 Allowance for Doubtful Accounts 134 1 -- (90) 45 Deferred Tax Valuation Allowance 1,623 (263) -- 1,360 Allowance for returns and allowances 112 -- 5 -- 117* Allowance for inventory obsolescence 136 (105) -- -- 31
*Included in accounts receivable, net and accrued expenses in the consolidated balance sheets. ** Reclassified to reflect a deferred tax liability on acquired amortizable intangibles basis differences. F-26