-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, QKv35587TW/0ZklgxtxUwNaDXfant3G0zWcHwcWk9fg41IqMP1xgS+W/5gfgchAU NyQg76RFvxt9p8WCMPz0og== 0000950149-99-000674.txt : 19990413 0000950149-99-000674.hdr.sgml : 19990413 ACCESSION NUMBER: 0000950149-99-000674 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990227 FILED AS OF DATE: 19990412 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ODWALLA INC CENTRAL INDEX KEY: 0000892058 STANDARD INDUSTRIAL CLASSIFICATION: CANNED, FRUITS, VEG & PRESERVES, JAMS & JELLIES [2033] IRS NUMBER: 770096788 STATE OF INCORPORATION: CA FISCAL YEAR END: 0831 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-23036 FILM NUMBER: 99592026 BUSINESS ADDRESS: STREET 1: 120 STONE PINE ROAD STREET 2: DRAWER O CITY: HALF MOON BAY STATE: CA ZIP: 94019 BUSINESS PHONE: 4157261888 10-Q 1 FORM 10-Q FOR PERIOD DATED 2-27-99 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-Q [ODWALLA LOGO] (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended February 27, 1999 OR [ ] 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 0-23036 ODWALLA, INC. (Exact name of registrant as specified in its charter) California 77-0096788 - ---------------------------------- ----------------------------------- (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 120 Stone Pine Road, Half Moon Bay, CA 94019 (Address and zip code of principal executive offices) (650) 726-1888 (Registrant's telephone number) (Former name, former address and former fiscal year, if changed since last report) Indicate by check X 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 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 90 days. Yes X No --- --- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: Common Stock, no par value 5,093,651 shares (Class) (Outstanding at April 2, 1999) 2 [ODWALLA LOGO] ODWALLA, INC. FORM 10-Q FOR THE QUARTERLY PERIOD ENDED FEBRUARY 27, 1999 INDEX
PAGE ---- PART I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets as of August 29, 1998 and February 27, 1999............................................ 3 Consolidated Statements of Operations for the thirteen week and twenty-six week periods ended February 28, 1998 and February 27, 1999............................................ 4 Consolidated Statements of Cash Flows for the twenty-six weeks ended February 28, 1998 and February 27, 1999.................... 5 Notes to Consolidated Financial Statements....................... 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations........................................ 9 Part II. Other Information Item 1. Legal Proceedings................................................ 21 Item 6. Exhibits and Reports on Form 8-K................................. 22
2 3 [ODWALLA LOGO] PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS ODWALLA, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA)
AUGUST 29, FEBRUARY 27, 1998 1999 ---------- ------------ Current assets Cash and cash equivalents .................................................. $ 3,191 $ 4,060 Short-term investments ..................................................... -- 4,956 Trade accounts receivable, less allowance for doubtful accounts of $588 and $624 ............................................... 5,491 6,084 Inventories ................................................................ 3,044 2,866 Prepaid expenses and other current assets .................................. 796 1,414 Deferred tax assets ........................................................ 1,164 1,320 -------- -------- Total current assets ................................................. 13,686 20,700 -------- -------- Plant, property and equipment, net ............................................. 13,135 13,092 -------- -------- Other assets Excess of cost over net assets acquired, net ............................... 1,225 1,171 Covenants not to compete, net .............................................. 606 552 Deferred tax assets ........................................................ 366 438 Other ...................................................................... 332 296 -------- -------- Total other assets ................................................... 2,529 2,457 -------- -------- Total assets ................................................................... $ 29,350 $ 36,249 ======== ======== Current liabilities Accounts payable ........................................................... $ 5,339 $ 6,865 Accrued payroll and related items .......................................... 1,091 950 Line of credit ............................................................. 2,044 2,533 Other accruals ............................................................. 2,963 2,275 Current maturities of capital lease obligations ............................ 159 61 Current maturities of long-term debt ....................................... 421 311 -------- -------- Total current liabilities ............................................ 12,017 12,995 Long-term debt, less current maturities ........................................ 888 798 -------- -------- Total liabilities .............................................................. 12,905 13,793 -------- -------- Shareholders' equity Preferred stock, no par value, shares authorized, 5,000,000; shares issued and outstanding, 0 and 1,000,000 ................................. -- 7,300 Common stock, no par value, shares authorized, 15,000,000; shares issued and outstanding, 5,061,000 and 5,065,000 ......................... 29,499 29,506 Retained earnings (deficit) ................................................ (13,054) (14,350) -------- -------- Total shareholders' equity ..................................................... 16,445 22,456 -------- -------- Total liabilities and shareholders' equity ..................................... $ 29,350 $ 36,249 ======== ========
See accompanying notes to consolidated financial statements 3 4 [ODWALLA LOGO] ODWALLA, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
THIRTEEN WEEKS ENDED TWENTY-SIX WEEKS ENDED ---------------------------- ---------------------------- FEBRUARY 28, FEBRUARY 27, FEBRUARY 28, FEBRUARY 27, 1998 1999 1998 1999 -------- -------- -------- -------- Net sales .................................... $ 14,192 $ 16,342 $ 28,342 $ 31,674 Cost of sales ................................ 7,243 9,009 14,353 16,645 -------- -------- -------- -------- Gross profit ............................. 6,949 7,333 13,989 15,029 -------- -------- -------- -------- Operating expenses Sales and distribution ................... 4,943 5,617 9,792 11,180 Marketing ................................ 694 773 1,269 1,569 General and administrative ............... 1,661 1,826 3,401 3,653 -------- -------- -------- -------- Total operating expenses ........... 7,298 8,216 14,462 16,402 -------- -------- -------- -------- Loss from operations ......................... (349) (883) (473) (1,373) Other income (expense) Interest expense, net .................... (50) (74) (65) (144) Other .................................... 84 (3) 22 (6) -------- -------- -------- -------- Loss before income taxes ..................... (315) (960) (516) (1,523) Income tax benefit ........................... 41 143 67 227 -------- -------- -------- -------- Net loss ..................................... $ (274) $ (817) $ (449) $ (1,296) ======== ======== ======== ======== Net loss per common share .................... $ (0.05) $ (0.16) $ (0.09) $ (0.25) ======== ======== ======== ======== Weighted average common shares outstanding ............................... 5,047 5,063 5,040 5,063 ======== ======== ======== ========
See accompanying notes to consolidated financial statements 4 5 [ODWALLA LOGO] ODWALLA, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
TWENTY-SIX WEEKS ENDED --------------------------- FEBRUARY 28, FEBRUARY 27, 1998 1999 ------------ ------------ Cash flows from operating activities Net loss .............................................. $ (449) $(1,296) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization .................... 1,164 1,151 Deferred taxes ................................... (35) (229) Gain (loss) from disposal of assets .............. (80) 82 Changes in assets and liabilities Trade accounts receivable ...................... (312) (593) Inventories .................................... 378 178 Refundable income taxes ........................ 660 -- Prepaid expenses and other current assets ...... (87) (618) Other noncurrent assets ........................ (4) 33 Accounts payable ............................... (736) 1,525 Accrued payroll and related items .............. (70) (141) Other accruals ................................. (871) (689) ------- ------- Net cash used in operating activities .................... (442) (597) ------- ------- Cash flows from investing activities Capital expenditures .................................. (453) (1,078) Proceeds from sale of assets .......................... 106 2 Proceeds from (purchase of) short-term investments, net 1,008 (4,956) ------- ------- Net cash provided by (used in) investing activities ...... 661 (6,032) ------- ------- Cash flows from financing activities Principal payments under long-term debt ............... (92) (201) Net borrowings under line of credit ................... 11 489 Payments of obligations under capital leases .......... (103) (98) Sale of preferred stock ............................... -- 7,300 Sale of common stock .................................. 136 8 ------- ------- Net cash provided by (used in) financing activities ...... (48) 7,498 ------- ------- Net increase in cash and cash equivalents ................ 171 869 Cash and cash equivalents, beginning of period ........... 2,217 3,191 ------- ------- Cash and cash equivalents, end of period ................. $ 2,388 $ 4,060 ======= =======
See accompanying notes to consolidated financial statements 5 6 ODWALLA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF ACCOUNTING POLICIES AND BASIS OF PRESENTATION Basis of Presentation. The accompanying consolidated balance sheet of Odwalla, Inc. and its subsidiary ("Odwalla" or "Company") at February 27, 1999 and the related consolidated statements of operations and of cash flows for each of the thirteen and twenty-six week periods ended February 28, 1998 and February 27, 1999 have not been audited by independent accountants. However, in management's opinion, they include all adjustments (which include only normal recurring adjustments) necessary for a fair presentation of the financial position and the results of operations for the periods presented. The statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, certain information and footnote disclosure normally included in financial statements prepared in conformity with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. The operating results for the interim periods are not necessarily indicative of results to be expected for an entire year. The aforementioned statements should be read in conjunction with the consolidated financial statements for the year ended August 29, 1998 appearing in Odwalla's 1998 Annual Report on Form 10-K. 2. CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS We consider all investments with an initial maturity of three months or less at the date of purchase to be cash equivalents. Both cash equivalents and short term investments are considered available-for-sale securities and are reported at amortized cost, which approximates fair value. The following schedule summarizes the estimated fair value of our cash, cash equivalents and short-term investments (in thousands):
August 29, February 27, 1998 1999 ---------- ------------ Cash and cash equivalents: Cash ........................................... $ 1,092 $ (42) Money market funds ............................. 2,099 4,102 ------- ------- $ 3,191 $ 4,060 ======= ======= Short-term investments U.S. Government and Agency securities .......... $ 2,475 Corporate obligations .......................... 2,481 ------- $ -- $ 4,956 ======= =======
3. INVENTORIES Inventories consist of the following (in thousands):
August 29, February 27, 1998 1999 ---------- ------------ Raw materials .............................. $1,755 $2,009 Packaging supplies and other ............... 708 339 Finished product ........................... 581 518 ------ ------ Total ...................................... $3,044 $2,866 ====== ======
6 7 ODWALLA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 4. PLANT, PROPERTY AND EQUIPMENT Plant, property and equipment consist of the following (in thousands):
August 29, February 27, 1998 1999 ---------- ------------ Land ............................................... $ 1,046 $ 1,046 Buildings and building improvements ................ 7,205 7,205 Leasehold improvements ............................. 2,490 1,336 Machinery and equipment ............................ 7,054 7,401 Vehicles ........................................... 538 541 Other .............................................. 3,179 3,528 -------- -------- 21,512 21,057 Less accumulated depreciation and amortization ..... (8,377) (7,965) -------- -------- Plant, property and equipment, net ................. $ 13,135 $ 13,092 ======== ========
5. EARNINGS PER COMMON SHARE Basic earnings per share is computed using the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed using the weighted average number of common and dilutive common equivalent shares outstanding during the period. Common equivalent shares consist of the shares issuable upon the exercise of stock options, preferred shares and warrants under the treasury stock method. We had no dilutive common equivalent shares during any of the periods presented due to the reported net loss. 6. RECLASSIFICATION To conform with fiscal 1999 financial statement presentation, we reclassified certain fiscal 1998 expenses to be comparable to the new classification. The main reclassification was an increase ($139,000 for the quarter ended February 28, 1998 and $232,000 for the twenty-six weeks ended February 28, 1998) in fiscal 1998 sales and distribution costs and a corresponding decrease in general and administrative expenses. 7 8 ODWALLA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 7. PREFERRED STOCK ISSUANCE On January 7, 1999, we signed an agreement with Catterton-Simon Partners III, L.P. ("Catterton-Simon"), a Delaware limited partnership, to sell 1,000,000 shares of Odwalla Series A Preferred Stock ("Series A Stock") at $8.00 per share. The Series A Stock will receive an 8% annual dividend which is payable in either cash or additional Series A Stock, at our discretion. The dividend is payable semi-annually. All Series A Stock is convertible on a one-for-one basis into Odwalla common stock (a) upon a request by Catterton-Simon at any time after July 6, 1999, and (b) automatically upon the earlier of (i) an acquisition of Odwalla by another company, either for cash or publicly traded stock, at a price in excess of $12.00 per share, (ii) the average trading price of Odwalla common stock exceeding $12.00 per share for 20 consecutive trading days, or (iii) January 7, 2002. Holders of Series A Stock are entitled to preferential payment, in the event of any liquidation of Odwalla, in an amount equal to the greater of $8.00 per share, plus any accrued but unpaid dividend, or the amount due each holder of common stock. Catterton-Simon also received a warrant to purchase 75,000 shares of Odwalla common stock at $10.00 per share. The warrant expires in seven years. This transaction was funded and closed in February 1999. We also paid fees and issued a warrant to our financial advisor in connection with this transaction. The warrant is for 24,806 shares of common stock at an exercise price approximating $6.45 per share and expires in five years. Total costs of the transaction approximate $700,000, including the financial advisor fees, reimbursement of certain costs of Catterton-Simon and other transaction costs. 8 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CAUTION ABOUT FORWARD-LOOKING STATEMENTS This Form 10-Q includes "forward-looking" statements about future financial results, future business changes and other events that haven't yet occurred. For example, statements like we "expect," we "anticipate" or we "believe" are forward-looking statements. Investors should be aware that actual results may differ materially from our expressed expectations because of risks and uncertainties about the future. We will not necessarily update the information in this Form 10-Q if any forward-looking statement later turns out to be inaccurate. Details about risks affecting various aspects of our business are discussed throughout this Form 10-Q. Investors should read all of these risks carefully. Investors should also refer to Odwalla's Form 10-K for the year ended August 29, 1998, including our financial statements and related notes included in that Form 10-K, and other documents that we file from time to time with the Securities and Exchange Commission in conjunction with the following discussion and analysis. OVERVIEW Odwalla's business is to provide easy access to great tasting nourishment. We are the leading branded fresh juice and beverage company in the country, serving selected markets in the western, mid-west and mid-Atlantic regions of the United States. Odwalla's complete product line consists of more than 25 fresh-squeezed and nutritionally fortified juices and smoothies, all-natural meal replacement beverages, geothermal natural spring water and all-natural food bars. Our beverage product line appeals to many consumers because of its superior taste of fresh and minimally processed beverages and greater nutritional value compared to juice from concentrate or with artificial flavors. We want to be the leading nourishment company in our existing and future markets. We seek to achieve this objective by leading the industry in beverage and other food knowledge, optimizing quality through sourcing and production, controlling product access and distribution from production through retail, artful presentation, growing through geographic and product line expansion, leveraging our information systems, interacting with consumers and living our vision. Our current product line consists of single-flavor and blended fruit and vegetable based juice products, meal replacement beverages, wholesome food bars and natural spring water. Except for our 100% fresh squeezed citrus line, all juices are minimally processed (some produced on a seasonal basis). These products are currently sold in California, Washington, Oregon, Colorado, New Mexico, Nevada, Texas, Illinois, Wisconsin, Arizona, Michigan, Minnesota, Pennsylvania, Maryland and the Washington, D.C. area. Odwalla's sourcing procedures and production methods enable us to create products with high nutritional and flavor quality. The distribution of our products through both our own and other direct-store-delivery ("DSD") systems allows us to control product quality and presentation, as well as to develop relationships with trade partners. Odwalla sells and distributes our products to almost 3,000 retail locations, including supermarkets, specialty retailers, natural food stores, warehouse outlets, convenience stores and food service operators through our DSD system. Odwalla is committed to certain values -- nourishing consumers, shareholders and other stakeholder groups; environmental awareness; and support for the communities we serve. We believe that our products reflect these values. 9 10 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, continued. PRODUCT RECALL On October 30, 1996, Odwalla was notified by the State of Washington Environmental Health Services of an epidemiological link between several cases of E. coli O157:H7 and Odwalla's apple juice products. We immediately implemented a recall (the "Recall") of all Odwalla products containing apple juice. We experienced a significant decline in sales immediately following the Recall and we weren't able to immediately and significantly modify certain on-going production, distribution and other costs. Twenty-two personal injury claims and legal proceedings have been filed against Odwalla seeking monetary damages and other relief relating to the Recall. There was also one legal proceeding alleging fraudulent business acts and practices relating to the recall products. Eighteen of these claims and proceedings have been settled. Settlement of the personal injury legal proceedings and other Recall damage claims was covered under our insurance policy. At this time, we are unable to determine the potential liability from the remaining legal proceedings and claims. We believe our insurance coverage is adequate to cover such claims and legal proceedings, but the ultimate outcome of any litigation is uncertain and we cannot be certain that insurance coverage will be adequate. Litigation can also have an adverse impact on a company, regardless of the outcome, due to defense costs, diversion of management resources and other factors. Odwalla maintains insurance coverage for product recall, product adulteration, lost income and other first party business risks. We submitted a claim to our insurance carriers for product recall costs and for business losses incurred due to the Recall. The amount and timing of proceeds, if any, from the claims and any future insurance claims cannot be presently determined. RESULTS OF OPERATIONS The following table presents, as a percentage of net sales, certain statements of operations data for the thirteen and twenty-six week periods ended February 28, 1998 and February 27, 1999. These operating results are not necessarily indicative of the results for any future period.
THIRTEEN WEEKS ENDED TWENTY-SIX WEEKS ENDED -------------------- ---------------------- FEBRUARY 28, FEBRUARY 27, FEBRUARY 28, FEBRUARY 27, 1998 1999 1998 1999 ----- ----- ----- ----- Net sales .......................................... 100.0% 100.0% 100.0% 100.0% Cost of sales ...................................... 51.0 55.1 50.6 52.6 ----- ----- ----- ----- Gross margin ....................................... 49.0 44.9 49.4 47.4 ----- ----- ----- ----- Operating expenses Sales and distribution ........................... 34.8 34.4 34.5 35.3 Marketing ........................................ 4.9 4.7 4.5 4.9 General and administrative ....................... 11.7 11.2 12.0 11.5 ----- ----- ----- ----- Loss from operations ............................... (2.4) (5.4) (1.6) (4.3) Interest and other income (expense), net ........... 0.2 (0.5) (0.2) (0.5) Income tax benefit ................................. 0.3 0.9 0.2 0.7 ----- ----- ----- ----- Net loss ........................................... (1.9)% (5.0)% (1.6)% (4.1)% ===== ===== ===== =====
10 11 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, continued. THIRTEEN WEEKS ENDED FEBRUARY 27, 1999 AND FEBRUARY 28, 1998 NET SALES. Net sales for the second quarter of fiscal 1999 increased 15% to $16.3 million compared to $14.2 million in the second quarter of fiscal 1998. We experienced most of that growth in our DSD business in all market categories, and particularly in our newest markets. We also experienced growth in our distributor business, both in existing markets and in our expansion markets where our volume was minimal in the second quarter of fiscal 1998. Because we sell product to distributors at a wholesale price lower than the price to retail trade partners, our increased use of distributors will not produce the same net sales growth that would occur if the same number of products were sold to retail trade partners. Our food bar business, which was introduced at the very end of fiscal 1998, was also an important factor this quarter although food bar sales represented less than 5% of our net sales. We did not enter any new geographic markets in the second quarter of fiscal 1999. COST OF SALES. Cost of sales increased to $9.0 million in the second quarter of fiscal 1999 compared to $7.2 million for the same period during fiscal 1998. Gross margin as a percentage of net sales was 44.9% in the second quarter of fiscal 1999, a decrease from 49.0% when compared to the second quarter of fiscal 1998. As we have previously mentioned, we didn't expect fruit pricing to be as favorable in the second quarter of fiscal 1999 as previous winter quarters due to weather conditions affecting Florida oranges. In late December, the San Joaquin Valley in central California experienced a citrus freeze that seriously damaged the navel orange crop. Other parts of California were also affected, but to a significantly lesser extent. The impact on the California Valencia crop, much of which is produced in the San Joaquin Valley, isn't yet known. The immediate affect of the freeze was to raise the price of the fresh citrus we purchase. We also experienced poorer citrus yields and some delay in fruit maturity. We are also more reliant on citrus sources further from our production facility than in prior years, which causes an increase in freight cost. Gross margin decreased primarily due to (a) unfavorable pricing and yield for ingredients, primarily citrus, (b) introductory margins on new product, and (c) increases in labor, due to poorer yields, and co-packing costs. The continued use of third party distributors also negatively affected gross margins. As a result of the citrus freeze, we are now more dependent upon alternative and more expensive sources of fresh supply than in prior years. We will continue to use our extensive network of grower contacts to seek to obtain a continual supply of fresh ingredients. The affect on orange and other ingredient costs to Odwalla is not yet fully determined, but we may experience higher orange costs for the remainder of the fiscal year and possibly into the early fall. In an attempt to partially offset the increased costs, we implemented a price increase on many of our beverage products in February 1999. At this time, we aren't able to determine either the extent to which consumers will accept the price increase or the degree by which the price increase will offset the expected costs of increased raw materials. The overall freeze impact may cause an operating loss beyond the second quarter and for fiscal 1999. SALES AND DISTRIBUTION. Sales and distribution expenses were $5.6 million in the second quarter of fiscal 1999 compared to $4.9 million in the second quarter of fiscal 1998, and decreased as a percentage of net sales to 34.4% from 34.8% last year. The decrease, as a percentage of net sales, results from increased sales volume supported by a more fixed cost operations structure, offset to some extent by increased labor costs and an increase in our expansion efforts compared to last year. Future decisions regarding growth and expansion consistent with long-term strategic objectives may increase sales and distribution costs as a percentage of net sales as compared to their pre-Recall levels. In both the sales and cost of sales discussions above, we mentioned the impact that the expanded use of third party distributors would have on each line item. We continue to look for efficiencies in this part of our business. However, expansion into markets serviced by our DSD system, such as the Washington, D.C. area, will require an investment for some initial period. 11 12 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, continued. Expenses will also be affected as we experiment to find the proper mix between third party distributors and our DSD system in a given market. The perishable nature of most of our products and the stringent service standards established can make it difficult to find responsible distributors in some markets. In late December 1998, Mr. Doug Hrdlicka joined Odwalla as Senior Vice President, Sales and Operations. Mr. Hrdlicka has many years of sales and operations experience, including DSD and other distributor operations. Mr. Hrdlicka proposed some changes to the existing sales and distribution organizational structure which will, on a short-term basis, increase payroll in this area. We do not expect to realize the benefits of these additional costs until late in Fiscal 1999, if at all during this fiscal year. MARKETING. Marketing expenses increased to $773,000 in the second quarter of fiscal 1999 compared to $694,000 in the second quarter of fiscal 1998. Most of the change from last year results from increased product tastings, both in retail locations and at community events, and in consumer and other communications. We expect marketing expenses to increase in both dollars and as a percentage of net sales. GENERAL AND ADMINISTRATIVE. General and administrative expenses increased to $1.8 million in the second quarter of fiscal 1999 from $1.7 million in the second quarter of fiscal 1998, and decreased as a percentage of net sales to 11.2% from 11.7% last year. The change was primarily due to an increase in payroll as several open positions were not filled until later in fiscal 1998. We don't expect general and administrative costs for the remainder of fiscal 1999 to increase significantly in absolute dollars when compared to the prior year. However, there can be no assurance that general and administrative costs will not increase significantly in absolute dollars. We will continue to invest in infrastructure, particularly in information systems and research and development, to provide for sustainable growth. INTEREST AND OTHER EXPENSE. Odwalla had net interest and other expense of $77,000 in the second quarter of fiscal 1999 compared to net other interest and other income of $34,000 in the second quarter last year. The net interest expense results primarily from borrowings under the line of credit and other existing debt for this quarter. In the same quarter last year, interest expense was offset by a gain from equipment sale. INCOME TAX BENEFIT. The $143,000 and $41,000 income tax benefit for the second quarters of 1999 and 1998 results from the tax benefit associated with the loss following the Recall. The 15% effective tax rate in 1999 and the 13% effective tax benefit rate in 1998 varies from the federal statutory tax rate primarily due to the effect of establishing a deferred tax asset valuation allowance. We recorded a valuation allowance for a portion of the net deferred tax asset due to uncertainty as to the ultimate realization of such assets. We will continue to assess the valuation allowance as additional information regarding the impact of the Recall on our future profitability is available. TWENTY-SIX WEEKS ENDED FEBRUARY 27, 1999 AND FEBRUARY 28, 1998 NET SALES. Net sales for the first half of fiscal 1999 increased 12% to $31.7 million compared to $28.3 million in the first half of fiscal 1998. We experienced most of that growth in our DSD business in all market categories, and particularly in our newest markets. We also experienced growth in our distributor business, both in existing markets and in our expansion markets where our volume was minimal in the first half of fiscal 1998. As noted above, we implemented a price increase on many of our beverage products in February 1999, although this had minimal impact on fiscal 1999 sales to date. Our food bar business, which was introduced at the very end of fiscal 1998, was also an important factor this quarter although food bar sales represented less than 5% of our net sales. We did not enter any new geographic markets in the first half of fiscal 1999. COST OF SALES. Cost of sales increased to $16.6 million in the first half of fiscal 1999 compared to $14.3 million for the same period during fiscal 1998. Gross margin as a percentage of net sales was 47.4% in the first half of fiscal 1999, a decrease from 49.4% when compared to the first half of fiscal 1998. 12 13 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, continued. In the first quarter of fiscal 1999, we had a higher gross margin compared to the prior quarter that was significantly influenced by favorable pricing and yield for fruit and other beverage ingredients. As noted above, this trend was significantly reversed in the second quarter while increases in labor and co-packing costs and the impact of introductory margins on new product continued. These factors resulted in an overall decrease on year-to-date gross margin. The continued use of third party distributors also negatively affected gross margins. As a result of the citrus freeze discussed above, we are now more dependent upon alternative and more expensive sources of fresh supply than in prior years. We will continue to use our extensive network of grower contacts to seek to obtain a continual supply of fresh ingredients. The affect on orange and other ingredient costs to Odwalla is not yet fully determined, but we may experience higher orange costs for the remainder of the fiscal year and possibly into the early fall. At this time, we aren't able to determine either the extent to which consumers will accept the price increase mentioned above or the degree by which the price increase will offset the expected costs of increased raw materials. The overall freeze impact may cause an operating loss beyond the first half and for fiscal 1999. SALES AND DISTRIBUTION. Sales and distribution expenses were $11.2 million in the first half of fiscal 1999 compared to $9.8 million in the first half of fiscal 1998, and increased as a percentage of net sales to 35.3% from 34.5% last year. In the first quarter of fiscal 1999, sales and distribution expenses were 36.3% of net sales compared to 34.3% in the first quarter of fiscal 1998 and we explained that this increase resulted from expansion efforts and an increase in both sales and operations support that had been in place for a higher sales volume than we achieved in the first quarter. As noted above, in the second quarter we enjoyed an increased sales volume supported by a more fixed cost operations structure, offset to some extent by increased labor costs and an increase in our expansion efforts compared to last year. The higher than expected costs in the first quarter, as a percentage of net sales, were not offset by benefits from second quarter results. Future decisions regarding growth and expansion consistent with long-term strategic objectives may increase sales and distribution costs as a percentage of net sales as compared to their pre-Recall levels. In both the sales and cost of sales discussions above, we mentioned the impact that the expanded use of third party distributors would have on each line item. We continue to look for efficiencies in this part of our business. However, expansion into markets serviced by our DSD system will require an investment for some initial period. Expenses will also be affected as we experiment to find the proper mix between third party distributors and our DSD system in a given market. The perishable nature of most of our products and the stringent service standards established can make it difficult to find responsible distributors in some markets. MARKETING. Marketing expenses increased to $1.6 million in the first half of fiscal 1999 compared to $1.3 million in the first half of fiscal 1998. Most of the change from last year results from increased product tastings, both in retail locations and at community events, and in consumer and other communications. We expect marketing expenses to increase in both dollars and as a percentage of net sales. GENERAL AND ADMINISTRATIVE. General and administrative expenses increased to $3.6 million in the first half of fiscal 1999 from $3.4 million in the first half of fiscal 1998, and decreased as a percentage of net sales to 11.5% from 12.0% last year. The change was primarily due to an increase in payroll as several open positions were not filled until later in fiscal 1998. We don't expect general and administrative costs for the remainder of fiscal 1999 to increase significantly in absolute dollars when compared to the prior year. However, there can be no assurance that general and administrative costs will not increase significantly in absolute dollars. We will continue to invest in infrastructure, particularly in information systems and research and development, to provide for sustainable growth. 13 14 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, continued: INTEREST AND OTHER EXPENSE. Odwalla had net interest and other expense of $150,000 in the first half of fiscal 1999 compared to net other interest and other expense of $43,000 in the first half last year. The net interest expense results primarily from borrowings under the line of credit and other existing debt for this quarter. In the same half of last year, net interest and other expense was offset by an $80,000 gain from an equipment sale. INCOME TAX BENEFIT. The $227,000 and $67,000 income tax benefit for the first half of 1999 and 1998 results from the tax benefit associated with the loss following the Recall. The 15% effective tax rate in 1999 and the 13% effective tax benefit rate in 1998 varies from the federal statutory tax rate primarily due to the effect of establishing a deferred tax asset valuation allowance. We recorded a valuation allowance for a portion of the net deferred tax asset due to uncertainty as to the ultimate realization of such assets. We will continue to assess the valuation allowance as additional information regarding the impact of the Recall on our future profitability is available. LIQUIDITY AND CAPITAL RESOURCES At February 27, 1999, we had working capital of $7.7 million compared to working capital of $1.7 million at August 29, 1998. The increase resulted primarily from cash provided by the sale of Series A Preferred Stock, described below, offset by capital asset purchases and normal debt payments. At February 27, 1999, we had cash and cash equivalents and short-term investments of $9.0 million, compared to $3.2 million August 29, 1998. Net cash used in operating activities in the first half of fiscal 1999 was $597,000. This consisted of the net loss plus depreciation and amortization and the increase in accounts payable, offset by an increase in accounts receivable and decreases in payroll and other accrued expenses. Net cash used in investing activities in the first half of fiscal 1999 was $6.0 million, consisting primarily of short-term investments following the preferred stock sale and capital expenditures for production equipment at the Dinuba plant and, to a lesser extent, computer equipment. Net cash provided by financing activities in the first half of fiscal 1999 was $7.5 million, consisting of net proceeds from the preferred stock sale offset by scheduled debt and capital lease payments. We've used, and expect to continue to use, both operating and capital lease financing to obtain coolers used in selling our products, computer and communication equipment, and production assets, primarily equipment. We are currently discussing additional lease lines with several companies, although we haven't completed a transaction with a leasing company and there can be no assurance that we will finalize the proposed transaction. If we don't obtain adequate lease or other financing, our ability to obtain needed equipment may negatively affect our operations. On January 7, 1999, we signed an agreement with Catterton-Simon Partners III, L.P. ("Catterton-Simon"), a Delaware limited partnership, to sell 1,000,000 shares of Odwalla Series A Preferred Stock ("Series A Stock") at $8.00 per share. The Series A Stock will receive an 8% annual dividend which is payable in either cash or additional Series A Stock, at our discretion. The dividend is payable semi-annually. All Series A Stock is convertible on a one-for-one basis into Odwalla common stock (a) upon a request by Catterton-Simon at any time after July 6, 1999, and (b) automatically upon the earlier of (i) an acquisition of Odwalla by another company, either for cash or publicly traded stock, at a price in excess of $12.00 per share, (ii) the average trading price of Odwalla common stock exceeding $12.00 per share for 20 consecutive trading days, or (iii) January 7, 2002. Holders of Series A Stock are entitled to preferential payment, in the event of any liquidation of Odwalla, in an amount equal to the greater of $8.00 per share, plus any accrued but unpaid dividend, or the amount due each holder of common stock. Catterton-Simon also received a warrant to purchase 75,000 shares of Odwalla common stock at $10.00 per share. The warrant expires in seven years. This transaction was funded and closed in February 1999. We also paid fees and issued a warrant to our financial advisor in connection with this transaction. The warrant is for 24,806 shares of common stock at an 14 15 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, continued. exercise price approximating $6.45 per share and expires in five years. Total costs of the transaction approximate $700,000, including the financial advisor fees, reimbursement of certain costs of Catterton-Simon and other transaction costs. Based upon information currently available, we believe that our existing cash and cash equivalents and our current and anticipated borrowing capability will be adequate to meet our obligations as they become due in the next twelve months. YEAR 2000 Many existing computer systems use only the last two digits to identify a year. Consequently, as the year 2000 approaches, many systems do not yet recognize the difference in a year that begins with "20" instead of "19." This, as well as other date related processing issues, may cause systems to fail or malfunction unless corrected. We are currently taking steps to identify and address our internal Year 2000 issues. Our team, which has executive sponsorship, consists of both internal and external personnel. We have reviewed certain systems, including information systems, handheld computer systems, production systems and non-information systems such as phones. We have modified certain systems and have scheduled modifications on other systems. We are now beginning to address the readiness of key third parties with which we have relationships. While we may obtain assurances from third parties regarding their Year 2000 readiness, we do not have any plans to otherwise assess their readiness and do not expect to perform such an assessment. While Year 2000 costs incurred to date have not been material, we will incur additional costs as we complete our readiness. We don't believe that the additional costs will be material, but we have not completed our assessment and can't offer assurance regarding the additional costs. We believe we are dedicating adequate resources toward attaining Year 2000 readiness, but there is no assurance that we will be successful in our efforts to address all Year 2000 issues. As with all companies, we also rely on other more widely used entities such as government agencies, public utilities and other external forces common to business and industry. Consequently, if such entities were to experience Year 2000 failures, this could disrupt our ability to conduct ongoing operations. We have not developed a contingency plan in the event we experience potential failures. We intend to assess the need for contingency plans, but can't offer any assurance that we will successfully develop such plans for areas that might result in significant exposure. The above discussion regarding costs, risks and estimated completion dates for the Year 2000 is based on our best estimates given information that is currently available, and is subject to change. As we continue to study this issue, we may discover that actual results will differ materially from the estimates noted above. 15 16 OTHER FACTORS AFFECTING ODWALLA'S BUSINESS PRODUCTS, DISTRIBUTION AND TRADE PARTNERS. Our current product line consists of single-flavor and blended fruit- and vegetable-based juice products, meal replacement beverages, wholesome food bars and natural spring water. Except for our 100% fresh squeezed citrus line, all juices are minimally processed (some produced on a seasonal basis). We strive for consistent "day-of-production" quality in all our products. We establish shelf life standards for each product to maintain the flavor and nutritional integrity that consumers associate with freshly produced fruit and vegetable beverages. Our policy is to have all products removed from trade partners' shelves on or before their Odwalla-established expiration date. In addition, because of our "day of production" quality standards, products reflect the seasonal changes in fruit varieties in color and taste. Our production methods are designed to minimize the effect of processing on the fruit juice extracted. Our entire product line varies due to a significant component of seasonal ingredients, seasonal product usage, and the addition and deletion of products. At most DSD accounts, we are responsible to stock, order and merchandise our products at the point of sale, and we issue credits to the trade partner for unsold product. This full service relationship allows us to avoid paying slotting fees for shelf space as well as other handling fees and to maintain control over our product merchandising at the point of sale. We provide a lesser degree of service to certain trade partners who are responsible for stocking, ordering and merchandising Odwalla products. These trade partners don't receive credit for unsold products. We also distribute our products through third party distributors. Although we have used distributors to some extent for several years (primarily in geographic regions outside of our then base geographic markets and to comply with certain trade partner requests), we began actively exploring this channel at the very end of fiscal 1997. This distribution channel, with merchandising support provided by our employees, provides an opportunity to expand product distribution, increase DSD efficiency, and still maintain relationships with trade partners. During fiscal 1998, we began using third party distributors primarily in the Chicago, Detroit, Philadelphia, Minneapolis and Phoenix markets. We sell directly to the third party distributors and they generally don't receive credit for unsold product. RAW MATERIALS. Producing and selling our minimally processed products entails special requirements in ingredient sourcing, production, distribution and sales in order to preserve and maximize the products freshness and flavor quality. We source and select fruits and vegetables to meet a variety of established criteria, including overall quality, flavor profile, variety, ripeness and other factors. Processing of the fruit and vegetables is performed in a manner to capture and preserve various qualities of fresh flavors and consistency. Odwalla has focused on each of these elements in an effort to achieve our goal of providing the safest, best tasting and most nutritious beverage and other products for consumers. Odwalla buys ingredients according to stringent specifications. Fruits and vegetables, in particular, are purchased year-round or seasonally depending on the type of produce. Because various types of fruit and vegetable crops are harvested at different times of the year, we obtain and produce different juices on a seasonal basis. Most of our fruits and vegetables are purchased in the open market on a negotiated basis. Historically, oranges, apples and carrots are the largest volume commodities we purchase. We have developed an extensive network of ingredient sourcing relationships over the years and rely on this network and new sources for the ingredients we need. We farm a small orange ranch in a part of California to have access to local fresh fruit in the early winter months. Recently, we began purchasing organic oats as a significant ingredient in our food bars. All of these key ingredients are subject to volatility in supply, price and quality that could materially and adversely affect our business and results of operations. We are subject to the same issues with our other ingredients as well. We also source a number of fruits, such as tropical fruits, from foreign suppliers in the form of frozen fruit puree. 16 17 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, continued. As with most agricultural products, the supply and price of raw materials we use can be affected by a number of factors beyond our control, such as frost, drought, flood, hurricane and other natural disasters. Weather conditions, economic factors affecting growing decisions, various plant diseases and pests will affect the condition and size of the crop. The heavy rains and flooding that occurred in California in the first and second quarters of fiscal 1995 resulted in higher costs of fruit and lower yields from the California orange crop in the last quarter of fiscal 1995 and the first quarter of fiscal 1996. We understand that the El Nino conditions and other weather patterns in the winter of 1997-1998 caused temporary shortages of certain tropical products. Weather conditions reduced the Florida projected orange harvest for the 1998-1999 season. The La Nina weather pattern in the western part of North and Central America in the 1998-1999 winter season is having an adverse effect on the prices and availability of fruits and vegetables in addition to the impact of the citrus freeze during December 1998 previously discussed. RISKS ASSOCIATED WITH PERISHABLE PRODUCTS. Except for geothermal spring water, meal replacement beverages and food bars, Odwalla's products are fresh, flash pasteurized or heat treated and don't contain any preservatives. They have a limited shelf life because of this. In order to maintain our "day-of-production" quality standards, we further restrict the shelf life of products through early expiration dates. The restricted shelf life means that we don't have any significant finished goods inventory and our operating results are highly dependent on our ability to accurately forecast near term sales in order to adjust fresh fruit and vegetable sourcing and production. We've historically experienced difficulties in accurately forecasting product demands and expect that challenge to continue. When we don't accurately forecast product demand, we are either unable to meet higher than anticipated demand or we produce excess inventory that cannot be profitably sold. In addition, most of our trade partners have the right to return any products that are not sold by their expiration date. Our inability to meet higher than anticipated demand or excess production or significant amounts of product returns on any of our products could have a material negative effect on our business and results of operations. COST SENSITIVITY. Our profitability is highly sensitive to increases in raw materials, labor and other operating costs. Unfavorable trends or developments concerning factors such as inflation, raw material supply, labor and employee benefit costs (including increases in hourly wage and minimum unemployment tax rates), rent increases resulting from the rent escalation provisions in our leases, and the availability of hourly employees may also adversely affect our results. We've benefited in prior years from relatively favorable inflation rates and part-time labor supplies in our principal market areas in recent years. However, there is no assurance that these conditions will continue or that we will have the ability to control costs in the future. DEPENDENCE ON ONE OR A FEW MAJOR TRADE PARTNERS. Safeway, Inc. ("Safeway") is our largest single account and accounted for 13% of our fiscal 1998 sales. We spend considerable time to maintain a good relationship with Safeway and other significant accounts, but we can't offer any assurance that sales to significant accounts will not decrease or that these trade partners will not choose to replace our products with those of competitors. The loss of Safeway or other significant accounts or any significant decrease in the volume of products purchased by their customers in the future would materially and adversely affect our business and results of operations. Continuity of trade partner relationships is important, and events that impact our trade partners, such as labor disputes, may have an adverse impact on our results of operations. COMPETITION. In a broad sense, our beverages compete with all beverages available to consumers and our food bars compete with all food bars currently available. The natural foods market is highly competitive. It includes national, regional and local producers and distributors; many of them have greater resources than we do, and many of them have shelf stable products that can be distributed with significantly less cost. We believe our niche is easily accessed nourishing beverages in the super premium juice, emerging meal replacement beverage, all-natural food bar and bottled water categories. We believe our direct competition in this market niche is currently from nationally, regionally and locally focused juice producers, certain of which are owned by major beverage producers, nationally branded meal replacement beverage 17 18 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, continued. producers, food and energy bar companies and premium bottled waters. Our direct competitors in the juice business are national brands such as Just Squeezed, Tropicana, Minute Maid and Nantucket Nectars. Our juice products compete with regional brands such as Naked Juice (owned by Chiquita Brands International, Inc. ("Chiquita")) in Southern California and Colorado, Fresh Samantha's in the Northeast and Mid-Atlantic sections of the United States and Fantasia in the Chicago and other Midwest market areas. Juice and smoothie bars such as Jamba Juice are also competitors. In addition, a number of major supermarkets and other retail outlets squeeze and market their own brand of fresh juices that compete with the Company's products. A decision by Chiquita or any other large company to focus on Odwalla's existing markets or target markets could have a material adverse effect on our business and results of operations. In late 1998, we began the introduction of food bars. Our food bar products will compete with several more established companies, such as PowerBar, Balance Bar or Clif Bar. While we believe that we compete favorably with our competitors on factors such as quality, nutritional integrity, food safety, merchandising, service, sales and distribution, multiple flavor categories, brand name recognition and loyalty, our products are typically sold at prices higher than most other competing beverage and bar products. Significant competitive pressure from these or other companies could negatively impact our sales and results of operations. PRODUCT LIABILITY. Because our 100% fresh-squeezed citrus products and certain other citrus-based products are not pasteurized or chemically treated, they are highly perishable and contain certain naturally occurring microorganisms. In addition to the Recall (see "Item 1. Legal Proceedings" on page 21) associated with the E. coli O157:H7 bacteria in 1996, from time to time we receive complaints from consumers regarding ill effects allegedly caused by our products. These past claims haven't resulted in any material liability to date, but there can be no assurance that we won't have future claims or that any claims associated with the Recall in 1996 will not result in adverse publicity or monetary damages, either of which could materially and adversely affect our business and results of operations. We currently maintain $52,000,000 in product liability insurance, which may not be sufficient to cover the cost of defense or related damages in the event of a significant product liability claim. ORCHARD PRODUCTION. Historically, we've depended upon the fruit produced from the trees of large orchards. These trees may become damaged, diseased or destroyed as a result of windstorms, pests or fungal disease. Additionally, there are types of controllable fungal diseases that can affect fruit production although not fatal to the trees themselves. These types of fungal diseases are generally controllable with fungicides. However, we can't be sure that such control measures will continue to be efficacious. Any decrease in the supply of fresh fruit as a result of windstorms, pests or fungal disease could have a material adverse effect on our business and results of operations. GEOGRAPHIC CONCENTRATION. Our wholesale accounts and retail trade partners have their largest concentration in Northern California, with most located in the metropolitan areas surrounding the San Francisco Bay. Due to this concentration, natural occurrences, economic downturns and other conditions affecting Northern California may adversely affect our business and results of operations. CONCENTRATION OF PRODUCTION CAPACITY. Virtually all of our juice production capacity is located at our Dinuba, California facility. Because we maintain minimal finished goods inventory as part of our "day-of-production" production system, we could be unable to continue to produce fresh beverages in the event that production at or transportation from Dinuba were interrupted by fire, earthquakes, floods or other natural disasters, work stoppages, regulatory actions or other causes. Such an interruption would materially and adversely affect our business and results of operations. Separate companies produce our meal replacement beverages, water and food bars. 18 19 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, continued. LACK OF DIVERSIFICATION. Odwalla's business is vertically integrated and centered around essentially one product, fresh beverages, sold primarily through our DSD system. Although we've added meal replacement beverages, water and food bars and are using more third party distributors, the risks associated with focus on essentially one product are exemplified by the material adverse effect on our business and results of operations that resulted from the Recall in October 1996. Any significant decrease in the consumption of beverages generally or specifically with respect to our products would have an adverse effect on our business and results of operations. RISKS RELATED TO EXPANSION. Continued growth depends in part upon our ability to expand into new geographic areas, either through internal growth or by acquisition. Following the 1996 Recall, management attention was primarily focused on restoring production and sales in our then-existing markets and dealing with legal and other company issues. This diverted our plans for expansion, for the most part, until fiscal 1998. There can be no assurance that we will expand into new geographic areas or continue to invest in newer markets or if such expansion or investment is undertaken that it will be successful or that such expansion can be accomplished on a profitable basis. Demands on management and working capital costs associated with the Recall as well as the perishability of our products and current reliance on the personnel-intensive direct-store-delivery system may limit the ability, or increase the cost of, expansion into new regions. Furthermore, perceptions of the Recall and consumer tastes vary by region and there can be no assurance that consumers located in other regions will be receptive to our products. We've expanded into certain new markets, such as the Pacific Northwest and Colorado, through acquisitions of local juice manufacturers. Acquisitions involve a number of special risks, including the diversion of management's resources, issues related to the assimilation of the operations and personnel of the acquired businesses, potential adverse effects on operating results and amortization of acquired intangible assets. In addition, gross margins may be negatively affected to the extent that gross margins on acquired product lines are lower than Odwalla's average gross margins. If we seek and find attractive acquisition candidates, we may not be able to complete the transaction on acceptable terms, to successfully integrate the acquisition into our operations, or to assure that the acquisition won't have an adverse impact on our operations. Any plans to invest in new markets or to consider acquisitions may cause us to seek additional financing that may be dilutive to current investors or result in a higher debt-to-equity ratio than would otherwise be the case. Any financing we obtain may not be on terms favorable to us, even if it is available. GOVERNMENT REGULATION. The production and sales of beverages are subject to the rules and regulations of various federal, state and local food and health agencies, including the U.S. Food and Drug Administration ("FDA"). On September 8, 1998, the FDA regulations for fresh apple juice went into effect. The regulations for fresh-squeezed citrus juices are scheduled to go into effect in May 1999. The FDA's guidelines for fresh juice require producers to achieve at least a 5-log reduction in potential pathogens (99.999% barrier). Pasteurization is one way for juice producers to meet the requirement. We currently Flash Pasteurize our apple juice and are in compliance with the FDA regulations. For juice producers who choose not to use pasteurization, the FDA has mandated either a HACCP plan that achieves the required 5-log reduction or a warning label on the bottle to alert consumers of the presence of unprocessed produce. Because all products produced in our Dinuba, California production facility are manufactured under a HACCP plan with validated critical control points, we are already in compliance with the new FDA regulations and will not need to use warning labels on unpasteurized juice products. For our 100% fresh-squeezed citrus juices (orange, grapefruit, tangerine, lemon and lime), we've designed a process that has been scientifically validated to achieve the FDA-required 5-log reduction without pasteurizing. Because our process meets the FDA's new requirements, and our own quality assurance standards, Odwalla continues to offer our 100% fresh-squeezed, unpasteurized citrus juice without a warning label. We don't anticipate significant additional costs to comply with current FDA regulations. 19 20 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, continued. VOLATILITY OF STOCK PRICE. Odwalla's common stock price has, at certain times, experienced significant price volatility. Announcements of developments related to our business, fluctuations in operating results, failure to meet securities analysts' expectations, general conditions in the fruit and vegetable industries and the worldwide economy, announcements of innovations, new products or product enhancements by us or our competitors, fluctuations in the level of cooperative development funding, acquisitions, changes in governmental regulations, developments in patents or other intellectual property rights and changes in our relationships with trade partners and suppliers could cause the price of our common stock to fluctuate substantially. In addition, in recent years the stock market in general, and the market for small capitalization stocks in particular, has experienced extreme price fluctuations which have often been unrelated to the operating performance of affected companies. Such fluctuations could adversely affect the market price of our common stock. 20 21 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. The following personal injury claims and legal proceedings seeking monetary damages and other relief relating to the Recall are pending against Odwalla, as discussed in Item 2 "Management's Discussion and Analysis of Financial Condition and Results of Operations": 1. The McGregor Case: A personal injury lawsuit filed in Santa Clara County Superior Court, San Jose, California on June 2, 1997 and served on June 16, 1997. There is no trial date set. 2. The Jackson Case: A personal injury lawsuit filed in King County Superior Court, Seattle, Washington, and served on or about June 8, 1998. The case is set for trial on October 25, 1999. 3. The Nixon Case: A personal injury lawsuit filed in Sacramento County Municipal Court, Sacramento, California on August 15, 1997. There is no trial date set. The Company has one additional proceeding allegedly arising out of product consumption prior to the Recall: 1. The Fujita Case: A personal injury lawsuit filed in Alameda Superior Court. The case has no trial date and discovery has commenced. The following personal injury claims and legal proceedings have been settled: 1. The Sawchuk Case: A personal injury lawsuit filed in the United States District Court for the Northern District of California and served on or about October 10, 1997. The case was settled on April 7, 1999 subject to final court approval. We maintained commercial general liability insurance totaling $27,000,000 during the period including the Recall. We have notified our insurance carrier of these events. At this time, we are unable to determine the potential liability from the remaining legal proceedings and claims. The Recall related legal proceedings settled to date were covered under our commercial general liability insurance policy and did not result in any additional costs to us. In early 1997, Odwalla was informed that it was the subject of a federal grand jury investigation (Eastern District of California) concerning the E. coli O157:H7 incident and related issues. In July 1998, we entered into a misdemeanor plea agreement with the United States, concerning 16 shipments in October 1996 of unpasteurized apple juice from a single contaminated batch. As part of the plea agreement, Odwalla agreed to pay, over a period of five years, $1.25 million to the U.S. Government and $250,000 to three non-profit organizations involved with advancing the cause of food safety. We also agreed, as part of the conditions attached to a five year term of unsupervised Court probation, to develop and implement a HACCP plan and to undertake other measures related to food safety. We are subject to other legal proceedings and claims that arise in the course of our business. We currently believe that the ultimate amount of liability, if any, for any pending actions (either alone or combined) will not materially affect our financial position, results of operations or liquidity. However, the ultimate outcome of any litigation is uncertain, and unfavorable outcomes could have a material negative impact. 21 22 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K a. EXHIBITS
EXHIBIT NUMBER DESCRIPTION -------- ------------ 27.1 Financial Data Schedule
b. REPORTS ON FORM 8-K The Company did not file any reports on Form 8-K during the quarter ended February 27, 1999. 22 23 SIGNATURE Pursuant to the requirements of the Securities Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. ODWALLA, INC. (Registrant) Date: April 9, 1999 By: /s/ D. STEPHEN C. WILLIAMSON ------------------------------- D. Stephen C. Williamson Chief Executive Officer (Principal Executive Officer) Date: April 9, 1999 By: /s/ JAMES R. STEICHEN ------------------------ James R. Steichen Chief Financial Officer (Principal Financial and Accounting Officer) 23 EX-27.1 2 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM ODWALLA, INC. FINANCIAL STATEMENTS FOR THE TWENTY-SIX WEEKS ENDED FEBRUARY 27, 1999 AS FILED ON FORM 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FILING ON FORM 10-Q. 1,000 6-MOS AUG-28-1999 AUG-30-1998 FEB-27-1999 4,060 4,956 6,708 624 2,866 20,700 21,057 7,965 36,249 12,995 798 0 7,300 29,506 (14,350) 36,249 31,674 31,674 16,645 16,645 16,402 120 212 (1,523) (227) (1,296) 0 0 0 (1,296) (.25) (.25)
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